Edward Sebor – FTI Consulting Ed Heffernan – President & Chief Executive Officer Charles Horn – Chief Financial Officer.

David Togut – Evercore ISI Darrin Peller – Barclays David Scharf – JMP Securities Tim Willi – Wells Fargo. George Mihalos – Cowen Eric Wasserstrom – Guggenheim Securities Moshe Katri – Wedbush Securities Ramsey El-Assal – Jefferies Jason Deleeuw – Piper Jaffray Andrew Jeffrey – SunTrust Ashish Sabadra – Deutsche Bank.

Good morning, and welcome to the Alliance Data System’s First Quarter 2017 Earnings Conference Call. At this time, all parties have been placed on a listen-only mode. And following today’s presentation the floor will be open for your questions. [Operator Instructions] 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 first 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, Ed. We’re going to follow a similar format that we did last the quarter that people seem to like which was focusing on a shorter commentary period and more questions. And so with that we’re just going to jump right in here. I’m going to have Charles go ahead and walk through the first quarter results.

And then I’ll talk about trends and our full year outlooks. So Charles, go ahead..

Sure. Thanks, Ed. Let’s start with Slide number 3, and if you look at our start to 2017, it was better than expected with revenue of 12% to a $1.88 billion and core EPS of 2% to $3.91. Both exceeded guidance for the first quarter, which is a very good start. Adjusted EBITDA net was flat at $440 million compared to the first quarter of 2016.

A $72 million reserve billed at Card Services and a $17 million decrease in adjusted EBITDA at AIR MILES due to the breakage reset at the end of 2016 dampen the growth rate for the quarter.

As delinquency trends moderate over the course of 2017 consistent with a wedge the quarterly reserve billed will moderate while the year-over-year hole in AIR MILES adjusted EBITDA should close this program changes or implemented over the course of 2017. Starting the year, we knew we need to deliver on three major assertions.

First, that Epsilon could return to positive revenue in adjusted EBITDA growth and that we could stabilize the technology platform offering. We would say we’re on track; especially I view it as very strong Q1. Second, the credit normalization will conclude by the end of 2017 with a check as we’re definitely tracking to the wedge on Slide 11.

Third, that we can retool the AIR MILES model to replace loss to EBITDA from the breakage reset. We’d say that still in the process, but we do expect EBITDA margins to increase appreciably especially in the back half of 2017.

Turning to capital allocation, we were active with our repurchase program during the first quarter, spending $415 million of the $500 million board authorization to acquire 1.7 million shares. Let’s go to the next slide and talk about LoyaltyOne.

We’ll start with AIR MILES, and AIR MILES revenue decreased 6% to $181 million for the first quarter of 2017. The decrease is largely due to a 4% decline in AIR MILES redeemed which was expected given the elevated redemption activity in 2016.

The burn rate which were miles redeemed divided by miles issued was still elevated during the first quarter of 2017 due to a backlog that carried over from 2016. But we expect it to normalize at about a 78% burn rates for full year 2017. AIR MILES adjusted EBITDA decreased 32% to $35 million or a 20% EBITDA margin.

The decrease was primarily due to the lower breakage rate entering 2017, as you recall it’s now 20% versus historically it was 26% and that knocks about one cent or one penny off profitability per mile redeemed. This is the whole we’ve talked about before.

We are focused primarily on lowering the cost per mile redeemed by negotiating better vendor pricing and we started to see results in March. From a collector standpoint, our active collector statistics overall are down from last year but on par with 2015 levels.

Our promotions in market such as a recently completed cruise promotion where every mile earned during the qualifying period was an entry into one of 1,300 cruise packages are stimulating issuance per transaction which is positive news.

BrandLoyalty revenue and adjusted EBITDA decreased 6% to $152 million and 14% to $24 million respectively compared to the first quarter of 2016. The declines are largely due to program timing between years as well as unfavorable FX rates been a 3-point drag on both.

There’s really nothing new to report on the North American expansion effort at this time, but there were several high potentials for 2017. Let’s flip to the next slide and discuss Epsilon.

It’s the first quarter in some time that I actually enjoy talking about the Epsilon results, as we started the year very strongly with revenue up 7%, adjusted EBITDA up 5% a very nice flow through the top line growth to adjusted EBITDA. And there was a better balance of revenue growth in the key product categories than we’ve seen in some time.

Epsilon agency, auto and CRM were all at double digits with the CRM/Direct at a robust 47%. Data and affiliate product offerings increased in low single-digit range, to acknowledge in your platform which is about 25% of Epsilon’s revenue decreased 7% which was a sequential improvement to the minus 13% in Q1 of 2016 – Q4 of 2016, sorry.

This offering turn quickly in 2016 as growth rates went from plus 5% growth in Q1 to flat in Q2 to minus 4% in Q3 and then minus 13% in Q4. The change in 2016 was due to the loss of a few key clients midyear, importantly the client base has since been very stable. Lastly Conversant Agency was down 28% compared to the first quarter of 2016.

This offering has been a consistent drag now for about nine quarters, but it’s now reaching a level where at less than 5% of Epsilon’s revenue, it appears to be stabilizing. Let’s turn to Slide 6 and talk about Card Services.

Revenue increased 22%, just slightly over $1 billion for the first quarter of 2017 driven by strong gross yields which increased 80 bps compared to first quarter 2016.

Operating expenses increased only 3% to $360 million for the first quarter and expressed as a percentage of average card receivables decline to 120 basis points compared to the first quarter of 2016 that is a very strong start to the year in terms of expense leveraging.

Adjusted EBITDA net increased 8% to $331 million for the first quarter of 2017, despite a $72 million billed allowance for the loan losses and as we talked about before that number should drop in Q2 and Q3. Credit sales increased 6% to $6.6 billion for the first quarter aided by tender share gains to about 100 basis points.

Over one-third of credit sales for the quarter were through digital channels reflecting the change in retail landscape. Web mobile applications increased 13% while traditional channel applications such as in-store increased 6% during the quarter. Web mobile applications now count for over 30% of all applications.

Recognizing the shift to digital sales, we recently introduced a Frictionless mobile acquisition capability which reduces the application process to only a few keystrokes reducing the abandonment rate of over 95%. These capabilities will allow us to continue to add etailers such as Wayfair and its clients.

Lastly to clarify the topic of raise in interest rates, yes the benefits Card Services made interest margin. The APR we charged is variable rate tied to primary, an increase in prime rate will reset the APR to the card holder within 2 billion cycles. Conversely funding costs which are about 70% fixed rate will reset over a two-year period.

Now with that, I’ll turn it over to Ed..

Great. Thanks Charles. If you will turn to Slide 8 just a quick summary of the first quarter of 2017, as we mentioned that a consolidated basis top line was up 12% and we had a couple of points of growth on our core EPS against guidance, the guidance was less than that for – and was looking for high single-digit top line and flat core.

So little bit better than guidance which is always a good way to start the year. What I think was a nice change as we began 2017 was we’re beginning to see balance a return to the model, obviously Card Services continue to have a very strong performance. But now we had Epsilon produce one of its best quarters since 2015.

And it looks like a lot of the initiatives we took in play – we put in place last 15 months finally beginning to take route, so that was positive there.

And then finally on the LoyaltyOne which is the final piece to add balance to the company, we all knew that we had a hole to dig out in the first part of the year, we are on track to return back to a nice healthy margin in the back half.

And then BrandLoyalty, that jumps up and down by quarter depending upon when the big grocers want to launch their campaigns. This year it looks more like it’s going to be back half as opposed to front half but those things are beginning to screw up as we had hoped for.

And so as we exit the second quarter and into the back half, you should have the third engine also contributing very nicely and that that would restore the full balance that we’ve been lacking in the last year or two.

So, that’s where we stand right now if you move to sort of the full year outlook by business, Epsilon, as we talked about very strong start to the year. In the full year guidance, we’re going to keep unchanged at this point which is $2.24 billion, up 4% and $0.5 billion of EBITDA up 4%.

So given the start to the year, we think this is a reasonable target set for the year. Furthermore on the piece of the Epsilon that went south on us last year which was the big technology platform business about a quarter of Epsilon Conversant.

The move that we’ve been trying to make is changing the model such that the pricing is more competitive with some of the SaaS-based solutions out there, where someone could bring it in-house and then hire a bunch of analysts or come to us. We think with our initiatives at the office, we have the pricing in the control.

And we’re beginning to see some momentum on the pipeline in terms of selling a more standardized product into the market. So our goal is to move from sort of that negative comp to basically flat by the end of the year, which will obviously raise the overall growth rate at Epi.

Turning to LoyaltyOne, again similar to Epsilon full year guidance remains unchanged in Canada, we expect the $760 in revs and about $180 million in EBITDA that’s versus a couple $100 million in EBITDA prior year that’s the hole the Charles talked about that we need to fill-in in order to make up for the breakage change that was made.

We expect this model to be fully retooled by the third quarter and I expect to see 25% margins return starting no later than the third quarter compared to sort of the 20% this quarter. We’re making good progress on what we need to do there.

Overall issuance as we expected also would be a little bit like till we get through some of the lingering noise from the Q4 change in law up in Canada. We are beginning to see is the activity level is beginning to return on our collector side.

And what we really need now as for the sponsors to really put their shoulder into the big promotional activities that account for a large chunk of the miles issued up there. And then as we talked about BrandLoyalty, the big programs will be launching in the back half. All right, Card Services Slide 10.

We still expect to see very nice receivable growth of roughly 15% almost $2.5 billion of growth, the pipeline remains robust and we certainly expect to sign another $2 billion vintage meaning signing a number of clients such that as they move from startup into full run rate after about three years.

All these clients combined will add about $2 billion of portfolio growth. Growth yields certainly stable and we expect an ongoing benefit from operating leverage. Credit normalization, which is of course the big thing everyone was concerned about over the last year or so, it is very nicely on track.

It’s obviously nice to see that Q1 came in precisely where the wedge said, it would come in which was 50 basis points over last year, so that big hurdle is done. And right now, we’re looking at Q2 to Q4, the gap looks like it’s going to narrow as we expected.

So you know, we have at this point a very good visibility into pretty much the rest of the year in terms of the delinquency flows and it’s everything we’re seeing now it’s no longer a guessing game of two years ago. This is now in the gun sights, and we can see it happening as we speak.

So the gaps going to close and that essentially means that loss rates will follow and that gives us a very high level of confidence that the 2018 loss rate is going to be flat to 2017, so good news there. On the principal loss rate side, we won’t go into all the stuff about denominator effects and timing and all that other stuff.

Suffice to say the guidance that we gave on the prior call remains consistent, which is we’re going to have a six handle on the losses in the first half. And I expect that to drop 100 basis points as so as we are in the back half. And so we think we’re in good shape with the losses.

And then finally full year guidance double-digit revenue growth and importantly, I think the one tweak we’ve made is we expect 10% growth on adjusted EBITDA and again it’s kind of a funny term to use in the card business but adjusted EBITDA for us does include all the expenses associated with losses as well as all the expenses associated with funding.

We just happen to call that EBITDA to keep it consistent.

What that also indicates is we had an 8% to 10% range to start the year, we’re now firming it up at the high end and so even if loss rates or other variables jump around a little bit here or there, we feel very comfortable that the higher end of the range is achievable this year, which is good news.

Finally, you’ll see the fabulous delinquency wedge and tracking very nicely and I will look forward to retiring this charge sometime in October, when it is no longer relevant and then talk solely about no need to build up those big reserves for 2018 because we’re going to be flat to 2017 and that will though of course drive the slingshot. Okay.

Finishing up, 2017 outlook full year consolidated guidance remains the same $7.7 billion, on revs and core EPS roughly 10%, $18.50.

In terms of how it should flow out, guidance it was high-single and flat in Q1, we came a little better on plus 12% plus 2%, Q2 we still want to keep it at mid-single and flat until we see the LoyaltyOne businesses being AIR MILES and BrandLoyalty kick into full gear by Q3.

And then by Q3, you’re going to have the LoyaltyOne businesses along with Epsilon continuing to produce as well as lower loss rates start the acceleration process and start moving us in to mid-teens earnings growth. And then by Q4, your right in the teeth of it and we’ll be looking at low-teens top line mid-teens core EPS.

And then the fun begins as we move into 2018. And right now the visibility on the slingshot of very significant acceleration into the back half and into 2018 remains right on track. I would say the only change is that it’s we have much better visibility as each month goes by and it’s certainly increasing our confidence each month that takes by.

So that’s sort of where we are, it’s a good quarter for Cards, it was a very good quarter for Epsilon. And then the businesses in LoyaltyOne are tracking to add to the balance in the back half and that being said, we should be in good shape this year and very good shape going into 2018. And we’ll keep it short and sweet, that’s it.

We will open up for questions, please..

[Operator Instructions] And your first question comes from the line of David Togut with Evercore ISI..

Thank you, good morning. Nice to see the continued growth in tender share in card. My question really focuses on operating expense discipline. You closed out 2016 with 1,000 associates in India.

What are your plans to continue to build out the India office and low-cost locations generally? And what impact should that have on margins over the next year or so?.

It’s a great question David. Again, that’s primarily focused around the Epsilon division. We are not doing any off-shoring with Card Services. You’re right, we ended last year with about 1,000 associates in India. We’re now up to about 1,300, I believe. The target will be to continue to grow that within the Epsilon division.

I would not expect to see any EBITDA margin expansion. Right at the moment from it, what it does allow us to do, David, is be more price competitive on that core Tech Platform offering that we have, where, as Ed talked about, we’ve seen some pressure coming through from some SaaS products and cloud based.

So what I’m looking for is to allow us to really grow the top line, sustain EBITDA margins but not necessarily be incremental to EBITDA margins until at a future day..

Got it. Just as a quick follow-up, the rewards propositions on traditional Visa and MasterCards continue to increase. I recognize this is more at the mass affluent end of the market, which is not necessarily your core in Private Label.

But can you just talk about what you’re seeing in your demographics in Visa and MasterCard as a sort of a competitor for the Private Label business and how you think about tweaking the value proposition to your consumers?.

Sure. I’ll take that one, David. It’s no question on the general-purpose cards. We know that the reward portion are getting more robust than they have in the past. From our perspective, again we view the Private Label product as a specific loyalty product for an individual brand and not necessarily catering to the mass spend.

And so the ability for us, I think, to keep at the sort of current level of rewards, I think, is reasonable. Where we’re getting the juice, so to speak, is our ability to target the offers much more precisely than we have in the past.

So in the past, if we were out there offering a third of the base 10% off and a third 20% off, et cetera, et cetera, based upon their buying behavior, what we can do now is we can essentially go down to personalize targeting, which allows us to be much more efficient with the marketing dollars and get a higher lift.

So as long as we continue to have the ability to target a lot better than sort of a general-purpose card, we should be – I think our reward structure is about where it should be..

Understood. Thank you..

Yep..

Your next question comes from the line of Darrin Peller with Barclays..

Thanks guys. Just a quick follow-up on the private – on the Card Services business. The growth that you’re calling for, it does account for any weakness there might be on the – certain types of retailers that you guys have as clients, I mean, in terms of same-store sales growth.

Can you remind also which buckets it’s coming from? I know there’s not a lot coming from portfolio acquisitions. And then just a quick follow-up on the provisions side. It did come in higher than we thought. Can you give us a little guidance? In other words, there’s a nice cushion now, it looks like, versus charge-offs.

I think you ended up where the reserves are around 6.5% or 6.6% maybe. Where should we be versus charge-offs by the end of the year. Thanks guys..

Sure. I’ll take the first and Charles can take the second. In terms of retailer sales, for sure I – or the sort of traditional customer that we have out there, our traditional client, probably is looking at negative comps as they were during holiday season as opposed to a more traditional plus 3%.

And recall that if they do plus 3% because of our tender share gains, we get our first 8% to 10% of growth just from that. Now if they’re looking at minus 2%, we’ll still get our tender share gains. But rather than getting up to plus 8%, we’ll probably do like plus 3%.

That essentially means that if we want to see our 15% growth in the file, we’re going to have to have good performance out of the more recent signings, and we are seeing that, as well as continuing to sign a $2 billion-type vintage to keep those numbers up.

Essentially, we’re going to have to put more in the funnel in terms of number of clients to get the same level of growth that we had before. And that’s effectively what we’re looking at right now..

On the reserve side, Darrin, the reserve was 6.6% in reservable AR at 12 – sorry, at March 31. What I would expect is the provision build, that reserve build, which was $72 million in Q1, should drop probably below $50 million Q2 – below $50 million Q3.

Q4 is really going to come down to growth and whether we see any type of bulk acquisition coming through. So I think that your question’s right. Based on the trends we’re seeing, should it be lower than 6.6% at year-end? I’d say based on trends now, that would be an accurate assumption..

Yes, and just to finish up, Darrin, on the question about the organic growth, all the growth we’re talking about here, the plus 15%, is organic, which is a combo of the core clients plus the spool-up of the recent signings over the past 3 years. There’s no large portfolio acquisition or even modest portfolio acquisition put in there..

All right, that’s helpful. And just a quick follow-up, guys, on the AIR MILES side of the business. Just to be clear, I mean, are you actually seeing sponsors willing to come back and provide more in the way of promotions again? I mean, I know it was a little bit of sour spot for some of them last – at the end of last year.

You’re saying collectors are now looking like they’re coming in again. I guess to compensate for what’s probably going to be a slightly lower reward percentage in terms of the cost to redeem a reward helping your margins, it’s going to make your sponsors are all on board for that and the program should still be very much intact..

Yes. I mean it’s – look, no one had a lot of fun in Q4, I’ll tell you that. It – with the change in law up there threw everything into – everyone into a tizzy. And right now, the noise has fortunately abated.

What we’re looking at is the number of – the volume levels to the call centers into the online reward redemptions and everything else has stabilized. It’s come back, virtually all the way back to where it was pre-noise, if I could call it. And so I think from that perspective, that’s good. We are comfortable with the sponsors. There was a lot of noise.

But right now, most of the – or in fact, all the sponsors have basically said, hey, enough already, let’s get back to driving sales. So everyone is looking forward at this point. We don’t expect to see any fallout from the sponsor side.

The big questions right now and what we’re doing is to get the 11 million collectors fired up again, and that’s why we’re spending a lot of money on sort of a relaunch and lots of marketing in terms of the benefits of the program.

And we expect sponsors who have been on the sidelines for the last quarter or so to start putting their marketing dollars into the big promotional programs really starting in Q2. If I look at issuance level, I would say this would be the bottom in terms of the growth rate.

I would expect to see about halfway back to flat in Q2, and I would expect to see healthy positive growth in issuance Q3, Q4. That seems to be how the promotional spend is beginning to fall out this year..

And Darrin, the only thing I’d add on the cost-to-mile, the reason we’re attacking the cost-to-mile is it does not reduce the value proposition to the collector.

So if we can go through and negotiate better pricing for the same product, we basically fill the hole and the lost EBITDA without affecting the experience of the consumer, which is really the reason why we’re attacking it in that approach..

Okay. All right, that’s great to hear, guys. Thank you..

Your next question comes from the line of David Scharf with JMP Securities..

All right, good morning. Thanks for taking the questions. First is, and I know this is sort of a difficult topic to discuss in much detail on this call.

But can you remind us, as it relates to big AIR MILES sponsors, what sort of the forward 24-month calendar looks like for renewals? And curious whether or not the events of the last year are likely to impact some of the pricing discussions you have as it relates to the value of those miles to your sponsor..

Sure. No, it’s not uncomfortable. It’s a reasonable question. I’d say obviously, we’re not going to talk about specific names, but we have a handful of renewables that we’re looking to get done this year. We’ve got 2 of the 4 done so far, which is good news.

We have certainly had our heads filled with a number of comments about what are we going to do about getting this brand going again. And I think where we’re coming out, it’s going to be less about any type of pricing pressure. I think we’re going to be okay on that perspective.

What it is going – where it’s going to show up, David, is we’ve agreed to fund some fairly robust spend in the first half of this year to reengage the collectors.

So a lot of the marketing dollars that normally wouldn’t need to be spent to get people fired up again, we’re going to take – we’re going to shareholder that, and that’s what’s reflected in guidance..

Got it. Got it. And as a follow-up, just switching to the card business, you partially addressed this in the discussion of retailer sales.

Can you give us a sense for the 6% credit sales growth, how that tracked relative to your expectations, and whether there’s any type of rule of thumb we ought to be thinking about for the relationship between credit sales growth, tender share and, ultimately, the mid-teens portfolio growth assumption?.

Yes, I mean, you’re going to have – I don’t think there’s a good rule of thumb. I think over the long haul, things seem to – growth rate should be roughly in line with each other, but it’s going to vary year-by-year. You’re going to have years where credit sales growth is higher than portfolio growth and vice versa.

I think the 6% in terms of sales versus the 15% or whatever we did in the portfolio is – you’re not going to see that big of a discrepancy going forward.

My guess is you’re going to start seeing that credit sales, we think, is probably going to be back maybe 8%, 9% in second quarter and will be double digit Q3, Q4 based on what we’re looking at in terms of trends and in terms of comps. And then you’re going to see the portfolio, right, will start trending in that sort of mid-teens level.

So they’re going to – the gap should close this year. They’ll never be one-to-one. But look for the credit sales number to move from 6% to sort of 8% to 9% and then probably 11% or 12% in the back half..

Got it, helpful, thank you..

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

Thank you, good morning. Hey, there. Two questions and first one on Epsilon. Could you just talk a little bit around your, I guess, industry exposure? You highlighted auto being strong. But it seems like every day, there are more stories about – of auto sales peaks, funding being cut off for borrowing, et cetera.

Just, I guess, how you think about auto and your discussions about vertical. But just any other industry verticals you would highlight as potentially strengthening or didn’t have as great of a quarter but could bounce back.

Just anything along those lines?.

Sure. Yes, one of the interesting things, obviously, if auto sales fall off a cliff, we’ll certainly be impacted because there’ll tend to be sort of across-the-board cut.

However, if auto sales sort of level out at, what do we have, about $17 million or so a year, that’s actually just fine because what will happen is the OEMs and the dealers will certainly be very focused on reaching any and all incremental buyer out there.

A lot of the work that we do with the dealerships, which really drives the auto vertical, doesn’t necessarily have to deal with just the new car sales. It has to do with the communication of ongoing services. So as you know, dealers make a bunch of money on the services side.

And so a lot of our work is predicting when someone needs that oil change or someone needs the new tires and things like that. And those are the communications that will be ongoing regardless of where new sales are. And then if new sales soften a bit, that means that the sort of one-to-one personalized marketing becomes more and more important.

So the long-winded way of saying, Tim, that I think from the auto vertical itself, we are looking at another record year in terms of growth there, and it’s mainly due to the dealerships signing up for the data-driven, personalized marketing that we’re doing in communications.

So I think unless auto sales fall off a cliff, we should be in pretty good shape. Otherwise, the other verticals look to be fairly healthy..

Great, thanks and my follow-up on card, you referenced what you’re seeing in the digital channels both in terms of spend and applications. And you also, I think, mentioned Wayfair as a customer.

I’m just curious, as online has obviously evolved and maybe hit an inflection point around consumers’ shopping behaviors, has that at all expanded what you view as your addressable market of potential customers versus how you might have thought about your addressable market of retailers a couple of years ago?.

Yes. I mean, it’s a good question. I think you’re seeing some of the splintering of the retail space, much like we saw in TV when cable channels came along 1,000 years ago and splintered it and now it’s being splintered even more. So the name brands that use to need the floor space in a big department store don’t need that anymore.

They can have their own e-commerce site. And so our game plan going forward is you may not get the huge sales growth from signing a big brand or big department store, but we can scoop up those individualized brands as they develop their own e-commerce sites.

So our focus is going to be very, very heavily on helping our existing customers grow their online presence and their ability to more precisely target the customer as well as look at some of these newer e-commerce players..

Great, thanks very much. That’s all I had..

Your next question comes from the line of George Mihalos with Cowen..

Great. Good morning, thanks for taking my question guys. Wanted to start off with the first quarter being as strong as it’s been and, obviously, several catalysts in the back half, faster Card Services growth, better growth in Loyalty.

What keeps you at this juncture from increasing the guidance? What could sort of worry you in terms of eating into this buffer that you built in?.

Too many years of doing this, I guess, is probably a good starting point. I think what we traditionally do, George, is we’ll take a look at everything on the July call.

And on the July call, if we see a continuation of what we expect to see, which is Card Services being strong and actually loss rates or the wedge closing and loss rates beginning to head downward again into the 5s, that will be check the box number one.

If we see Epsilon continuing to deliver solid mid-single or higher growth rate, that check the box number two. What we still need to check the box on is making sure we get all of our margin back at LoyaltyOne in the Canadian business. And we won’t know that probably – we’re on track – we’re tracking to it, but we’ll have a much better sense in July.

So July is where we sort of say, okay, here’s what we thought, here’s where we are and what’s it mean for the rest of the year and for 2018. So all we can say is it’s a good start, but we’ll talk again in July..

Okay, that’s very helpful. And then just as it relates to Epsilon, Charles, I know you’re talking about revenue growth and EBITDA growth sort of converging at the 4% range for the full year. In the first quarter, revenues sort of outpaced EBITDA by 2 points.

Just curious what drove that, if there’s any anomaly there and why that would reverse over the course of the year..

I’ll tell you what I look at most, George, is what did payroll do. What did the fully burdened cost of payroll do? And it was up less than 6% in Q1 versus 7%.

You always have some other operating expenses if you onboard a new program, such as the rollout of some new auto programs we have in place where you get some other expenses behind the scene ahead of it.

But what you’re really trying to do with the Epsilon model is always make sure the revenue growth rate is better than the payroll growth rate, and we definitely did that in the first quarter. And I think that’s really the trend we’ll look to continue at the back half of the year.

Like we said, we had a couple of new programs within the auto we’re rolling out. We incur quite a bit of costs up front before they come functional, and that’s part of the pressure why you didn’t see a one-for-one flow-through. But really, it’s the comparison of revenue to payroll that’s relevant to us..

Yes. And I think, just to follow up from Charles comment, look, we are not immune to the commentary that is out there regarding guidance we give on the Epsilon/Conversant businesses and being disappointed the last couple years.

So while we think we’re in good shape and it’s been a very nice start for Epsilon/Conversant and it looks like the visibility is there, we want to be very disciplined in our guide as the year close out.

We want to basically let the results get 2, 3 quarters in where we can finally say, okay, we’re beginning to really reestablish the credibility that we – that frankly, I think, we lost some in the last couple years..

Fair enough. Thank you..

Your next question comes from the line of Eric Wasserstrom with Guggenheim Securities..

Thanks very much. I know we’ve touched on this a couple of times, but I just want to circle back to the issue of the health of retailers, because several have not just indicated same-store sales comps, if I looking to restructure balance sheets and maybe just doing some of the things that signal the beginning of a broader decline.

So can you just remind us how you deal with a potentially stressed partner and how that process works if they end up having to go into a bankruptcy process?.

Sure. To quote our fabulous President of Card Services, retail is not dead. Retail itself continues to grow, albeit a bit more modestly than it has in the past. But the overall category itself isn’t dead. 85% of sales are still taking place in the store. What’s happening is you’re having a reallocation of where – of who is getting those sales.

And as we talked about, with the splintering of sort of department stores into their individual brands creating their own e-commerce sites to the Amazons of the world and the Wayfairs of the world and everything else, you’re seeing a redistribution take place, which is causing an upheaval. So on an aggregate basis, the pie is still growing.

On an individual basis, it remains to be seen who the winners and losers are going to be. That being said, to your point, you’re dead on. There are a number of clients of ours who are being stressed right now.

And traditionally, what happened in the past, as you mentioned, is that there’s some type of prepackaged bankruptcy or something like that, that takes place. Really, the last thing they want to do is shut down the sales pipeline. For us, you’ll remember, we don’t lose money if a retailer goes bankrupt.

What we do lose, however, is we don’t have that growth the following – we don’t own that portfolio the following year. That just collects out. So from our perspective, the fewer that show stress, the better off we are.

The more that shows stress, that just means we’re going to have to pedal the bike a little bit harder with a couple more names in the pipeline than we had before, which, I think, is our go-forward approach, frankly, is we’re going to need to sign another 2, 3 names a year above what we used to in the past to make up for that weakness.

Fortunately, a lot of the marketing dollars continue to flow over to the data-driven marketing that we do. So you’ve got a push-pull going on..

Yes, the only thing I would add, and I think this is a very important piece, historically, when we’ve had a retailer just basically go out of business, going through liquidation, the loss rates in that portfolio are no different than the overall portfolio experience. So to Ed’s point, you lose the opportunity. They can’t go on to the store and spend.

But the good cardholder does not and of itself they’re going to walk away from this account. I’m going to charge it off and run the risk of basically cross-defaulting a different credit card. So our experience in the loss rate is basically similar to what the overall portfolio experience is..

Thank, you anticipated my next question.

And is there anyone in your portfolio, not by name, but are there any retailers that you’re particularly concerned about at the moment and engaging in discussion on their outlook?.

I’d say there’s none in particular. We had two small retailers go into liquidation, but they’re very small portfolios, really aren’t affecting us. In terms of any material client, there’s none that have given us any pause at this point..

Thanks very much..

You’re next question comes from the line of Moshe Katri with Wedbush Securities..

Hey, thanks. Thanks for taking my call. Guys, good performance on Epsilon. One of the things that I remember that we kind of struggled with besides the cost structure was actually re- competes for – especially with a couple of clients last year. Where are we on that front? And are there more large re-competes for Epsilon this year? Thanks..

I’d say, Moshe, I think that the three clients we lost last year midyear definitely affected us. They did shift to a little bit different model than what we’re providing for them.

As part of what Ed talked about, how we had to shift to a little bit more of a packaged product to lower the costs, lower pricing, what you have seen us do is as we’ve had renewals since then, we had come down a little bit on the pricing. We had to offset it by lower operating costs primarily in parallel with our off-shoring to India.

So we’d say that base is stable. As Ed talked about before, we’re expecting it to basically return to flat growth year-over-year probably as early as Q3. So we think that we’ve addressed the salient issues with the technology platforms. We’ve not seen any further client attrition.

And we think the changes we’ve made have really put this back in place frankly to return it to a growth offering versus where it declined over the last three quarters..

Fair. And then given where we are on the cost structure of Epsilon, are you at this point feeling that you’re competitive in this market? Because that was also an issue last year, especially in terms of pricing. Thanks..

Yes, absolutely. We’re now at the point where pricing – we are out there selling, and the pricing levels that we’re at are deemed very competitive by the chief marketing officers versus an alternative like a SaaS-based and hiring 100 analysts. So we’re there. We’ve got the packaged solution in the pipe, and now it’s execution.

So we’ve got a labor force structure for Epsilon/Conversant which basically calls for, in total, a stable headcount in the United States and then somewhat growing at our India office. But most of the surgery is over at this point..

All right, guys thanks..

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

[Audio Dip] is on the Tech Platform side. Also, your Epsilon business.

How material is the difference in economics that you guys capture for the SaaS implementation versus the fully outsourced model? And do you have any visibility as to how that mix is evolving with your new kind of more nimble offerings?.

I’d say, Ramsey, it’s a little bit early. We’re just now introducing the packaged offering to the market. I would expect that – the EBITDA margins to be fairly consistent with the full service, maybe down a little bit. But it’s too early for us to really know what the answer is going to be there..

Okay.

Could you give us a little more granularity on the cadence of BrandLoyalty revenue this year? Do you have visibility as to whether there will be a quarter later in the year where that business just really pops like it has in the past? Or is it something more and it’s just going to fall at some point, you’re just not – quite have that kind of visibility to it yet..

Q3, Q4..

Yes..

Both would be strong..

And Q4 is always the strongest for BrandLoyalty..

Okay. All right, fair enough. Thanks a lot..

Your next question comes from the line of Jason Deleeuw with Piper Jaffray..

Thanks and good morning. Just hoping to get a little bit more color on the OpEx leverage in Card Services, just kind of the drivers there.

And can we expect this to be a sustainable level?.

Obviously, Q1, it was extremely good. I don’t expect it to be quite that good for the full year. As Ed talked about, probably 20, 30 basis points versus a very strong start to the year. I’d say it’s coming from pretty much all angles. So it’s the growth in the portfolio.

Obviously, it’s the influence of co-brand that we put in there over the last few years, which has a little bit lower OpEx. But it gets into the way we do collection activities, whether we source within our own operations or we allow people to work from home. I would say there’s really no one silver bullet.

It’s a combination of different factors that really allowing us to drive that operating leverage..

Great. Thanks for that. And then just following up on the other discussion around how retail the landscape is evolving more e-commerce, maybe different players, maybe a bigger addressable market for you guys.

Is that just simply a Card Services, Private Label offering? Or is that also open up opportunities for Epsilon? Like how do you think about those opportunities as the retail space continues to evolve?.

Yes, it’s a good question. It’s Ed. The biggest opportunity within the Epsilon/Conversant family is actually over on the Conversant side, the CRM product, which, as you know, is when we’re out there, we use all the data from the SKU level information and the various demographic, psychographic information about the customers.

And we can reach out and touch you across device multiple times every single day and do it in a very targeted, personalized basis because we do have the ability to identify your own unique device. And so from a retailer perspective, that is becoming sort of almost table stakes at this point that they have to participate in that.

And that’s something that is one of the reasons where CRM this quarter grew what, Charles, 40%?.

47%..

47%. Retail is going to be a huge growth driver for that as the retailers are shifting toward identifying their customers and offering them a different deal depending upon who they are.

It’s almost like pricing airline seats – everyone has a different price – and then also using sort of that anonymized profile to then go out and prospect and find new customers.

So the net result of all of it is that the way marketing was done in the past has changing – in the retail space, it’s changing even faster, which fortunately means that our type of product is pretty attractive..

Great, thank you..

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

Thanks for taking the question. Lots of talk about retailer health and same-store sales and changing consumer behavior.

Ed, can you just address how big that you think the TAM is for Card Services, how penetrated you are, and whether the market has changed in a meaningful way, either having expanded or contracted over the years?.

Sure. I think – and clearly, I don’t think you’ll find anyone out there who thinks we need more stores. I think we’ve all realized that we’ve been – it’s been overbuilt and needs to come down to reality. But again, the overall market for retail is a growing market, again not quite as fast as it used to be, but it is growing.

You have different players shifting. In terms of the TAM from our perspective, we believe that we are roughly half-way through what we believe is our comfortable sandbox. So if you think of $15 billion, $16 billion portfolio as roughly half penetrated, that would be about right.

I think we’re probably – the last cut I saw, if you included e-commerce – sorry, pure e-commerce players, would be – we think overall, our sandbox is about a $35 billion portfolio. And so the delta between where we are today and where we’re going surprisingly is not filled by a bunch of folks who have an existing program.

A lot of these folks are just now beginning to shift their dollars away from the traditional marketing spend channels and into – really getting into the personalized one-to-one data driven targeted marketing. And, we all think that everyone has already done all that, and the answer is they haven’t.

It’s a trend that’s well under way, but there’s a long, long way to go. And based on our pipeline, we feel comfortable that our sandbox is certainly not shrinking and perhaps growing just a little bit more.

If you think about some of the folks that weren’t in our sandbox had these massive $5 billion, $6 billion, $8 billion files, which frankly were too big for us, but if those are some of these massive department stores where you have the name brands within those stores now cutting out on their own to become e-commerce players, they’re much smaller and more bite-sized, and we excel at bite-sized..

Okay. That’s helpful. Thanks. And then when you look at – I think you said about 47% CRM revenue growth in the first quarter..

Yes..

That’s pretty encouraging.

Can you talk a little bit about the pipeline and how much of continued growth in that business is coming from existing customers taking share within their marketing budgets versus new customers signing?.

Sure.

You’re going down the right area, which is the way that CRM signings work is almost like a vintage, where in the first year you’ll sign a group that maybe they do $50 million of revenue first year, $75 million second year, $100 million third year, and we are definitely benefiting at the same time that we are definitely benefiting from new clients.

Last year, we added about 33 new clients with CRM. This year, it could be an estimate as high as 50. So it’s the combination of both the ability to leverage a new client for three to four years, get revenue growth, plus we’re continuing to onboard new clients as people see – companies see the value of the proposition we bring..

Yes, it’s a pretty cool business in the sense of much like the card business, it’s – you have clients that spool up over two to three year periods. So you can – you build these vintages, and so you can have pretty good visibility into the next year or two based upon the number of client signings.

But for sure, existing clients are spending more and the market for new clients is getting deeper..

Terrific. Thank you..

All right, one more..

Our final question comes from the line of Ashish Sabadra with Deutsche Bank..

Thanks for taking my question. Congrats, I really saw the results. Quick question on gross yield expansion. I understand you benefit from higher interest rate, but we saw some pretty solid growth there. I was just wondering what drove that.

And how should we think about it through the rest of the year?.

The way we look at it, Ashish, we knew that we had a little pressure early in 2016 that will play through starting this year at 25.5% gross yield is consistent with the average we had last year. So we would tell you there could be a little positivity to it based upon, obviously, any changes with the Fed raising rates and so forth.

It could pass a little bit through to gross yield. The thing that always creates noise within your gross yields is if you do find a bulk file and you acquire it, it puts temporary pressure. So there’s a lot of moving parts. But we would say steady state. 25.5% feels good for the year.

It could up maybe 10, 20 basis points given further interest rate increases coming through. But really, it goes back to mid-2015. If you remember, we’ve put some changes in place that were cardholder friendly. We had to burn through those issues in the temporary pressure we put. And we would tell you at this point, we’re past that..

That’s great. Maybe one quick follow-up would be just the free cash flow expectations for this year.

And how do you think about the capital allocation through the rest of the year?.

Yes, Charles can hit the free cash flow. I think from an allocation, I’m going down the spending side of it. Certainly, we instituted a dividend, which is couple $100 million. Then you’ve got buyback. We’ve had authorization for $500 million. Obviously, we had the opportunity to go back to the well if we so choose.

So at a minimum, that gets you to $700 million. There’s probably $400 million or so we’re setting aside for growth, the capital required to grow to $2.5 billion. If I’m doing my math right about $1.1 billion or so. And then that leaves a little room for either maybe a tuck-in deal if there’s something attractive by the end of the year.

We’re not going to do anything until we’re sure that all three businesses are – have executed and are all contributing and the balance has been restored. So that would be one thing. It wouldn’t be until late in the year. Or we could certainly go back to the well for additional buyback if we so choose. So I think that would chew up.

The goal is to basically get through the free cash flow. But trying to keep the leverage multiple under three, which is what we traditionally do.

So Charles?.

No, nothing to add to that..

That’s great. Thank you..

All right. Well, thank you, everyone. And we kept it exactly to an hour, and we’ll talk to you again in a few months. Bye..

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