Bread Financial Holdings Inc (BFH) 2004 Q3 法說會逐字稿

Welcome to today's Alliance Data Systems third quarter 2004 earnings conference call. (OPERATOR INSTRUCTIONS). It is now my pleasure to turn the floor over to Julie Prozeller of Financial Dynamics.

Thank you, operator. By now you should have received a copy of the Company's third quarter 2004 earnings release. If you haven't please call Financial Dynamics at 212-850-5608.

On the call today we have Mike Parks, Chairman and CEO, and Ed Heffernan, CFO of Alliance Data Systems.

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 Systems 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 www.alliancedatasystems.com. With that I'd like to turn the call over to Mike Parks. Mike?

Thank you. Good afternoon everyone. Thanks for joining us. Our agenda as usual is to spend a few minutes reviewing our highlights and I'll talk about the quarter a bit, and then we'll focus on the three growth engines. I'll turn it over to Ed for some financials and then we'll take your questions. So let's get started.

Turning to the next slide, we are obviously very pleased to announce another record quarter for the Company, with all three segments -- transaction, credit and marketing services -- bringing double-digit topline growth. This resulted in revenues of almost 300 million, a 15 percent increase for the quarter over last year.

During the same period, EBITDA increased by 18 percent to approximately 65 million. Cash earnings was up 29 percent to 36 cents a share. All three engines -- utility services, private-label services and the loyalty AIR MILES business -- continued to drive the strong performance. Let's take a moment to look at each.

On the next slide we'll start with the utility services group (indiscernible) as you know, where the past 12 to 15 months we've had significant activity in terms of new business development, and demonstrated by topline growth for the quarter and year over year. This year we plan two to three, maybe four new client relationships. And as you recall last year, last quarter I mean, we announced the city of St. Louis transaction.

Also in June, Entergy, a Louisiana-based energy provider announced their plans to outsource CIS processing, billing and call center support to Alliance Data. By way of update, the Entergy contract signing is imminent, and we fully expect to begin that relationship very shortly. In addition to these two, I expect another one or two announcements before the end of the year.

We're pleased that even with the current wave of deregulation, our strategy of integrating transaction processing and marketing is being executed in the utility industry. Our frequency marketing group has signed an agreement to build and manage a database marketing system we call Valuscape (ph) for Georgia Natural Gas. Using selected data from their billing system, a customizable data mart (ph) and analytical tool kit will enable GNG to gain insights to their customer base. By creating this marketing database, our clients will be able to identify their best customers and find more like them, identify up-selling and cross-selling opportunities and begin to measure the return on the marketing investment. While a great cross-selling opportunity for the future, it's also another example of the implementation of our strategy to integrate processing and loyalty marketing services.

Turning now to private-label, our group had another tremendous quarter. By delivering on their promises, we continue to gain client confidence, enabling us to renew and expand these relationships. We are excited by the announcement earlier of a new five-year agreement with American TV and Appliance to provide a comprehensive card program for their commercial customers. This is our first commercial card product and will target AMTV's commercial customers with prime credit history, primarily building contractors. As a new growth vehicle for the private-label world, commercial card will increase wallet share by capturing valuable commercial business sales.

This quarter we also renewed one of our top private-label clients, Reeds Jewelers. The new agreement for private-label extends through 2011. There are a multichannel jewelry retailer, operating primarily across the South and Southeast. And as our key metrics continue to perform strongly, we saw double-digit growth in credit sales in the portfolio as well as positive trends in credit quality, including solid improvement in credit losses for the quarter. All in all, a very strong quarter.

Let's turn to the AIR MILES business. Our team there continues their strong pace. As we have discussed in the past, the AIR MILES results continue to be impressive. And as you know, they're built really on a three-legged stool of sponsors, collectors and rewards. Regarding sponsor activity, Rona, the leading retailer and distributor of hardware, home renovation and gardening in Canada, has expanded their participation to a national level. Since 1992 they have been a regional sponsor in Québec and we're very pleased to expand their relationship nationally. They have approximately 530 stores and the largest marketshare of any major do-it-yourself retailer in Canada. Our second (indiscernible) growth continues to be strong and steady. Québec continues their expected increase with mid-ten growth over last year. And as a country-wide, we are now well over 70 percent Canadian households as active collectors in the program.

The AIR MILES portfolio of rewards is our third leg, and we know that providing an exciting portfolio of rewards is key to the success of the program. Our scorecard on how we're doing is seen in the performance of our key metrics -- miles issued and redeemed -- both with strong increases. While somewhat seasonal, we're on track to deliver 10 percent and 20 percent, as you've heard us talk about in our model before. All in all another strong performance and a very strong outlook for the next couple of years.

Last week -- turning to the next slide -- you noticed a little bit of an announcement, a small acquisition called Epsilon Data Management, a leading provider of integrated direct marketing solutions. They've been a recognized leader for quite some time in customer management and loyalty solutions, and frankly, over 35 years of experience across global brands such as Hilton, Pfizer and Midas.

The acquisition, along with our AIR MILES team and our frequency marketing group expands our significant loyalty presence in North America. Epsilon's offerings and extremely high rate of client retention are consistent with our business model of transaction-rich processing and marketing services. Their top 25 clients representing the bulk of the revenues have an average tenure of almost 10 years.

We see new opportunities across our client base as well as an immediate presence in new verticals such as health-care, financial, insurance and travel. Whether it's a coalition model, one-to-one or multi-partner loyalty programs, we provide effective value-added services aimed at allowing our clients to capture and retain long-term and loyal customer relationships. While we're very pleased that this acquisition enhances our breadth and depth, we are even more excited about the talent and expertise that the Epsilon management team adds. I would like to welcome Mike Iaccarino, Brian Kennedy, and the entire Epsilon team to Alliance Data. We couldn't be more pleased and excited about our future together.

Turning to the next slide as I wrap up this quarter's highlights, there are a few other notable activities I'd like to comment on. First, we completed, as you know, a 900 million asset backed offering. This marks the completion of a three-year program -- $2.6 billion program to lock in long-term and very attractive rates that gives us lower operating expenses, increased visibility, and certainly dampens the impact of the potential rising rate environment.

Secondly, we hit a milestone in the third quarter. We reached $500 million in deferred revenue, providing us with great visibility in the future with regard to our AIR MILES business. And lastly, just a few weeks ago we completed the second annual loyalty marketing summit, hosted by our frequency marketing team? While only in its second year, the loyalty summit is quickly becoming the event where loyalty marketing professionals share ideas and best practices. Companies that manage some of the most successful loyalty programs in North America and around the world participated. The event drew over 125 professionals from more than 20 countries, and, like our publication, COLLOQUY, is seen as a forum for thought leadership in loyalty marketing.

Turning to the next slide and our outlook. First year in, we're very excited about finishing out the year strong as all units continued to perform. As you know last week we announced our 2005 guidance. We will deliver on our long-term business model of 12 percent topline, 15 percent EBITDA and 18 percent cash EPS. And with the acquisition of Epsilon, we expect a 20 percent increase across all three metrics. The entire Alliance Data team continues to deliver outstanding results. Speaking on behalf of our clients and shareholders, I want to thank the team for another record performance.

Ed, will you share some more details on the financials please?

Thanks Mike. It looks like we had another good quarter. Q3 marked our 14th quarter as a public company and further extended the track record of delivering or over-delivering on what we have promised. Why don't we get right at it?

Revenues moved up nicely with the 15 percent growth to approximately 300 million. The key message here, I think, this quarter was balance, and that is all three growth engines. That would be the loyalty AIR MILES, utility services and private-label services. And hence, all three reporting segments contributed solid double-digit growth. The significant book of business put on over the last two years, plus solid performances from our more seasoned client base drove the results.

Moving down to EBITDA -- came in around 65 million, up 18 percent with positive growth across the board. Importantly, this growth was achieved despite having to absorb certain marketing and new product expenses that had been delayed a bit from the early part of the year. A nice surprise on operating EBITDA, which is a decent proxy for operating cash flow -- came in very strong at 74 million, or 9 million ahead of reported EBITDA. Through nine months it's running about $17 million higher then reported EBITDA, and is obviously comfortably on track to hit or exceed our goal of 20 million ahead for the year. Finally, cash EPS jumped up close to 30 percent to 36 cents a share.

To sum up, results were strong across all the metrics -- revenue, EBITDA, operating EBITDA and cash EPS. Double-digit topline growth across all three engines and segments, and the cash flow generation was robust. All in all another good quarter. Q4 looks solid and next year looks good. We'll touch on the latter two items a bit, but first let's stay on Q3 and hit the segments. So if you could pull up your segment slide.

First up, transaction services, which houses two of our three growth engines. Those would be private-label services and utility services, as well as being the home of our traditional merchant acquiring business. Understanding the segment is pretty straightforward -- two items drive results. First, look at the number of statements generated, since this captures the activities of both private-label and utility services. Combined, these engines achieved statement or account growth of 14 percent in the quarter. Of equal importance is the ability to maintain pricing power while growing statements.

Once again, pricing remained firm during the quarter. This firm pricing and strong mid-teens growth in statements generated cover over 80 percent of the segment's results and 100 percent of its growth, the remaining piece being our traditional merchant bank card business. And on that note, our merchant bank card business is driven off of the second driver published, which is transactions processed. Since this business isn't really growing revenue-wise and as such continues to shrink as a percent of ADS, we'll most likely no longer report the driver in '05 since it seems to confuse more people than it helps, quite honestly. We would expect this to be probably less than 7 percent of the Company in '05.

Anyhow, back to the growth engines. Utility and private-label, behind the growth was the huge book of business put on over the last couple of years, plus solid performances from our more seasoned base. In utilities last year, signings of AEP, Centrica, TXU, Orlando combined with the Orcom and CBSI tuck-in acquisitions to drive growth. With St. Louis added this year and with a couple of more announcements coming before year-end, utility services remains our fastest-growing engine.

In private-label, same deal. Last year's signings included Eddie Bauer, Spiegel, Newport News, Stage Door, American Home, Shop at Home, and Fortune Off (ph), and they continue to do well. You can then add in the four deals announced so far in '04 -- Siegel's, (ph) Design Within Reach, Little Switch (ph), which is a sub of Tiffany's, and AMTV, as Mike mentioned, our first commercial card, and things look pretty good. And as Mike also alluded to, there's probably a couple of more announcements before the end of the year. Looking at the full year picture, we expect another solid year of double-digit organic growth in this segment. To that end, through nine months both revenues and EBITDA are up in the mid-teens.

Turning to credit services, it continued to outperform the performance at a high level can be explained by three things. First, the big book of new business put on during the last couple of years. Second, the loyalty aspect of our programs which keeps consumers coming back to shop despite the macro "headwinds" that are out there. And three, continued good news on expenses.

To understand this segment, let's walk through the four key drivers of the P&L which are credit sales, portfolio growth, funding costs and credit losses. The first, credit sales, remained strong and came in around $1.5 billion, 10 percent growth rate. Credit sales drive earnings in two ways. First, we earn merchant discount fees on every purchase, and second, a portion of sales turn into new cardholder balances which drive finance charge income.

During the quarter sales were strong and cut across both existing clients as well as the newer ones. While overall growth remained at double-digit levels, it was tempered a bit by the anniversary of Stage Doors which was converted during Q3 of last year. Regarding portfolio growth, which grew at an even stronger 16 percent, similar factors were at work. On the operating expense front we saw a continuation of positive news. Credit losses, which tend to seasonally peak in Q2, improved as expected and came in a bit under 7 percent for Q3, well ahead of last year. Looking ahead we expect low 7 percent levels in Q4 and are comfortably tracking to come in the low sevens for the full year as well versus our general long-term target of mid sevens in terms of loss rates. So very good news on that front.

Delinquency rates, which give us a look at the future loss rate, are also tracking favorably, which again bodes well for 2005. Finally, funding. (technical difficulty) quarter for us as we completed the last portion of our three-year 2.6 billion program to lock down and extend the maturities of our funding book. As it stands today, a rising rate environment will have no meaningful impact on our business over the next several years. Our costs are locked down and even contain features where funding rates will actually decline over the next few years. This should nicely offset higher costs needed to fund incremental new growth. To sum up, our biggest macro risk going into this year and as we thought about 2005, 2006 has been neutralized, and that would be -- would have been the impact of a rising rate environment.

Wrapping up credit, another strong one with positive trends continuing. The massive growth rates in the early part of the year will continue to moderate a bit with the anniversary of Stage Doors. Other than that consumer spending remains very strong. Nonetheless, our 10 million active consumers are spending; they're not running up their balances and they're paying off more in a timely manner. From what we see, things look pretty bright.

Finally let's finish up with marketing services, which essentially is our loyalty AIR MILES program in Canada, had a very strong quarter as miles issued and miles redeemed both rose solidly. While these numbers can be a bit choppy quarter to quarter, AIR MILES remains comfortably on track with our targets of 10 percent growth in miles issued and 20 percent growth in miles redeemed. Through this year's first nine months, miles issued are up 10 percent and miles redeemed are up 23 percent. This will loosely translate into mid-teens organic growth in topline. For the quarter, revenues increased 18 percent, and regarding EBITDA, recall that Q3 included the additional burden of some marketing and advertising expenses that had been deferred from Q1. Perhaps more relevant would be to look at the EBITDA growth to date which is up a healthy 18 percent over the first 9 months versus last year.

I want to pause just for a second and spend a bit more time on marketing since we usually zip right through it, as it always seems to post strong consistent results year to year. In fact, over the last four years, roughly corresponding to our life as a public company, the segment has grown revenue 18 percent per year and EBITDA 21 percent per year, all organic.

More impressive is the fact that as we head into 2005 we are even more bullish. I mention this in response to off-and-on questions about the sustainability of these high growth rates for business that has two-thirds of an entire country already active. We believe that after 12 years of growth we still have a long way to go. Specifically, while two-thirds of the country is active, we still have a tremendous amount of room left to grow by expanding sponsor penetration. Again, after 12 years, we believe we are only about 60 percent of the way there in terms of sponsor penetration.

This year we launched the WestJet Bank of Montreal card, a new category for us, and we announced a national deal with Rona in the home improvement space. For those of you in the States, we all know the Home Depots and the Loews, but Rona is the largest player in Canada. Combining new sponsor groups with an unmatched record of renewals bodes very well for the continued growth of loyalty AIR MILES for many years. We mention this now because Epsilon will soon be joining this family to represent our major push into the U.S. Combined, we expect (technical difficulty) to make quite a splash in the North American marketplace. Let's hit the balance sheet.

Next slide. Two items of interest, both of which are milestones for us. Mike mentioned the first one, but up in Canada our deferred revenue spiked up over 36 million and hit $500 million for the first time. This represents 500 million in revenues which have been earned via the issuance of AIR MILES but have yet to flow into the P&L. They will do so over the next several years. Strong continued growth combined with a strong Canadian dollar continued to enhance the value of our loyalty business.

Next up, capital structure strength. I have been here seven years and when I joined the Company our debt to cash flow ratio was around six times, if anyone remembers those days. Well today we can say for the first time that our net debt position is officially zero -- actually a bit positive on the cash side to be precise. It's a huge event here and demonstrates the free cash flow generation inherent in our model. Obviously, with Epsilon this will increase debt a bit, but we'll be quickly paying that down with the significant cash generated (technical difficulty) going forward.

Let's finish up 2004 with a look at our full-year outlook. Pretty straightforward. Previous guidance on cash EPS was $1.44 to $1.48. Q4 looks solid. So we would expect to be coming in a bit ahead of the high-end of approximately let's call it $1.50 a share, up 46 percent for the year. Top line should also be trending up from a sequential basis, and so far so good for '04. I think we want to end on a very good note. At this point we don't know exactly when Epsilon will be merged into the Company. Clearly, that would be additive to these numbers.

Turning to 2005 guidance which we put out a week or so ago, just reiterating what Mike said. We took our guidance that we had out there for 2004. We continued to reiterate our long-term model of 12 percent topline, 15 percent EBITDA, 18 percent cash EPS. We then laid on top of that what we expect Epsilon to bring to the table and that's how we came up with our starting point for '05 guidance. Again, we want to put a stake in the ground, and that stake is as follows. We expect revenues to be about 1.45 billion to 1.47 billion, EBITDA 330 plus, cash EPS in the low 180s. All metrics up over 20 percent versus '04 guidance. As we mentioned, we expect '05 to be another strong year.

Specifically, let's get into a little bit of what we should think about as we look into how the quarters will flow into '05. Obviously we will be providing much more detail on our Q4 call sometime in January, but here's our thought process. For those of you who recall back in Q1, Q1 was just an absolute boomer of a quarter, partially due to the fact that there was a fair amount of marketing and advertising and new product expenses which we did not spend. They were shifted into Q3 and Q4. So therefore, less the timing of roughly a nickel, probably the base place start would be roughly 38 cents as a starting point as you start to figure out Q1 of '05. We would then add 20 percent onto that 38, and we'd get to about 46 cents for the Q1. So the potential rollout to get into the low 180's would be sort of a 46. Q2 tends to be a little bit lighter than Q1. Q3 tends to be about flat to Q2 (technical difficulty) tends to be a little bit stronger. So I think '05 will look like a much more traditional year that folks are used to, as opposed to this year where I think it was a bit more front-end loaded. So hopefully that gives people a sense of what we're looking at as we develop 2005.

Getting near the end here, finishing up on 2005 estimated free cash flow. We expect EBITDA as we talked about to be 330 plus, and then in Canada what we call operating EBITDA of about 20 million of cash that is ours as profit. We haven't recognized it yet. Our operating cash flow should be north of 350 million. Some people then back out CapEx, interest, taxes. At the end of the day we should have about 170 million-plus of pure free cash, which should exceed $2 a share. So the free cash flow of the model should be very, very strong during '05 as well.

The final slide basically shows a picture of where we we're going over the last five years, been fairly consistent, and we expect '05 to shape up to be another good one. And we expect Q4 of this year also to be solid as well.

With that, I'll kick it over to Mike.

Thanks Ed. Operator, we'll take questions now.

(OPERATOR INSTRUCTIONS). James Kissane, Bear Stearns.

Thanks, great job Mike and Ed. I have a question on Epsilon following the acquisition last week. Just sounds like it's more than a tuck-in acquisition; it sounds like more a strategic platform for expanding the marketing business into the United States. Can you can elaborate on some of your plans to combine the, I guess the private-label and the AIR MILES business with Epsilon to grow a loyalty business in the U.S.?

Yes, Jim. I was a little tongue in cheek with regard to that little acquisition that we did. No question it's the biggest we have done. But the nice thing is it's pretty obviously I think based on what we have seen in terms of the response to the marketplace, it's a perfect fit with our transaction processing and marketing world. You know what we tried to communicate in the past is that this is a good strong business in and of itself, got a good strong management team, and what I have called a pretty low risk deal, in that there's no conversions required, no synergies built in or any (technical difficulty) to make the transaction accretive for us. That being said, to your point, there are some opportunities that we are going to pursue. There's no question. From their strength one-to-one loyalty programs and customer loyalty programs, we think there's opportunities within our client base. Not only our Canadian clients, but those here in the U.S. in our retail sector. Although oftentimes the retail sector is a little slower to adopt some of the more progressive marketing topics, we think there's the beginnings of some what I would call kind of a crack in the armor there, and we think there's opportunities for growth there. Broader than that though, if you look at the -- one of their skill sets that really was developed with regard to the development and running of the Hilton honors program and some of their early stage work with United, they have got a multi-partner platform and expertise and talent, and we think there's opportunities to expand there and potentially perhaps on a regional basis begin to look at opportunities for a full coalition model, similar to what we run, obviously, in Canada. If we get maybe 1/10 the size -- 1/10 of the U.S., which is basically the size of Canada, we've got a pretty nice platform. So we're very excited about (technical difficulty) there is frankly one specific area we have already started a pilot with a major grocer here in Texas and on a one-on-one kind of loyalty program. You know the kind of (indiscernible) anchor programs that you need, loyalty program include grocer, petroleum, banking, pharmacy, etcetera. So we're excited (technical difficulty) long-term three to five-year outlook for the database and loyalty (technical difficulty) the leader -- the emerging leader in that space.

That's great. Just a question on utility, because in the release you talked about ongoing infrastructure investments into the utility business. Ed, maybe can you be a little bit more specific in terms of the dollar amounts and the duration (technical difficulty) investment spending?

I don't know if I can be more specific on the dollar amounts, but I can tell you in general where we're heading, and that is we expect to continue to grow that business rapidly. So we would expect (technical difficulty) to continue to grow very fast as it has this year and as we head into next year. Along with that (technical difficulty) comes with it the fact that we have -- oh gosh (technical difficulty) platforms -- and we need to start getting our brains around the concept of starting to consolidate in choosing best-of-breed and getting that cut down to probably one for reg, one for dereg, (technical difficulty) probably half as many as we have today. And that is going to continue to drag on margins, which we hope one day will pop up to that nice high-teens, 20 percent level. We're probably around that 10 percent level today, Jim. And so it's a question of we're going to probably be spending some money in '05 and '06 as part of the consolidation effort.

Just one last question on the credit business. Credit quality and credit losses continue to improve. Ed, do you have new targets given the big improvement?

I don't, but I would say that we just finished the year -- you know, I think we have always (technical difficulty) type environment like '01. We would like to think that we peak out at an 8 percent loss rate during sort of a decent sluggish recovery to run around 7.5 percent, which is sort of what we targeted this year. (technical difficulty) full-blown recovery we target probably closer to the 7 percent level. It looks like this year we're going to actually be coming in around the 7 percent level, which cycles back to us what we're seeing out there from a consumer spend pattern, losses, delinquency, payment rate, balances, (technical difficulty) the sector we serve looks like spending remains very strong. So I would say as we enter '05, we would expect -- we would probably say we would shoot for the mid-7s, but hopefully we would probably bring our target in a bit to maybe 7.25, something like that.

Dris Upitis, CSFB.

Just a question first on the growth (technical difficulty) it slowed the last couple of quarters. Is that mostly the anniversary of Stage that you mentioned? Is there anything else affecting that?

That's all stage.

Okay. So 14, 15 percent going forward is a pretty good number it sounds like?

Stage didn't start the anniversary until around September.

Okay.

In Q3. So that may tick down a little bit in Q4. And then as we start heading into next year, and as Mike said, when the announcements come out on utility, then it starts cycling back up again.

Is that also on the private-label sales, the 10 percent growth is Stage (technical difficulty)

That's the entire factor, for sure.

And then just a question on Epsilon on the accretion that you expect from that in '05. Is that in the range of 8 to 10 cents EPS?

That's probably a little high. I was thinking more like a nickel or so. I think what we basically (technical difficulty) is if we do call it up a buck and a half this year, you know, you add 18 percent on that, that gets us into the high 170s. You add a nickel (technical difficulty) the low 180s. Basically you need to take the EBITDA which is pretty healthy there, you had some depreciation, not more than 5 percent of topline, and then you've got financing costs until we pay it off, which would be pretty rapid. So you should have sort of a nice step up as we enter '06 from both the nice organic growth of Epsilon plus the deleveraging of the balance sheet itself.

Ken Sang Wang (ph), J.P. Morgan.

Hi, it's (indiscernible). A question on Epsilon. How do you plan on segmenting the Epsilon business in the topline? Is it all marketing?

We're going to keep it real simple. Because it is going to roll up sort of what we call the North American marketing effort, and be run (technical difficulty) who now currently runs the AIR MILES program, it's logical for us to put it all in marketing. And again, there are pieces of it that could be in transaction services and pieces of it that could be in marketing, but we're just trying to keep it as simple as possible.

Okay. What should we assume in terms of longer-term growth and margins for Epsilon, and will you provide us with any metrics to track the business going forward?

Sure will. We would assume that Epsilon from a purely organic perspective should effectively match the model of our company, which is 12 percent topline and 15 percent EBITDA, which would also suggest generally expanding EBITDA margins as well. You'll get the secondary impact as we enter '06 and '07, the deleveraging effect from the purchase -- from the debt we take on to purchase the deal. In terms of the metrics, yes -- we are still noodling on (technical difficulty). So we'll have something on our next quarterly call.

And nice to hear that consumer spending was in your base and still strong, and I guess outperforming the market. So how much of this strength can be explained by private-label clients cranking up their card marketing efforts? Is there any way to quantify it that way?

I don't know that I would call it cranking it up. Again, you've heard us talk about this for years. Our clients' customers are the cream of the crop, the percentage of the portfolios that drives the majority of the sales. They are the loyal returning customers. They don't swing way high when all of a sudden there are great economic recoveries and they don't swing low when it slows down. So it's been a pretty consistent growth pattern, which is consistent with the loyalty market.

Charles Trafton, American Growth.

Actually it's a clarification. There's two items on the tape here. One says on the Dow Jones Newswire Alliance Data CFO says consumer spending has slowed, and the next one says Alliance Data CFO says consumer spending still solid. Have you said anything to the press today about slowing (multiple speakers)

No. I said it remains solid.

Okay. It must be a misprint then. Did you say you're not going to report the currency impact next year, in '05?

No. The segment to the transaction segment, one of the drivers is transactions processed which relate to our old merchant acquiring business. The merchant acquiring business is like, going to be 7 percent of the company, so I don't think it's relevant to anyone to use that driver. It doesn't drive any of the growth, it doesn't drive any of the topline or the profit growth.

When does Stage anniversary?

It anniversaried in September.

It did already?

I think going back to that Dow Jones article, the only thing I could think they took it is that the growth rate year-over-year in our credit segments has moderated sort of back to the mid-teens level.

It was positioned as a quote from you, so it's probably just a misread off the press release or something. What do you think that -- you said you have zero net debt now. What is the debt going to look like in December now that you have got the Epsilon thing under your belt?

In terms of the financing it's going to be around 300 million. So probably use about 100 million or so of cash, and we'll take the rest on just really easily with our existing credit facilities. We'll just borrow against that.

And that's like at 3 percent?

Around there, yes.

The loyalty business up in Canada, you guys own the rights to do that in the U.S. also and in the UK? Is that right? Somebody is already doing it in Scotland.

We don't own the rights in the UK, Charles. When we acquired the company back in '98 from the group that started a program in the UK has the rights in the UK and internationally.

What I'm getting at is a couple of years ago you had kind of a start and stop idea to do what you're doing in Canada down here in the States. What do you think about that front in '05 or '06?

Let me talk to that, because I know some people that have been with us for awhile remember right at the time we were thinking about going public thought about the opportunity to roll out in the U.S., and to roll out a national program to copy the coalition program in Canada based on a study we performed and some market research would have been a 200 million-plus kind of investment. If a -- as you recall from the early days of our business in Canada, it doesn't make money for close to five years, but once it finally turns it's pretty profitable. But as a public company, we didn't feel like our investors would really look through that kind of investment, given the size we were and given the turmoil around 9/11, and others chose not to proceed with the program. However, I think as I mentioned earlier, on a regional basis, a much smaller coalition kind of program will be more acceptable to the marketplace, easier to roll out, easier to communicate, and I think does have some potential. There is a lot of loyalty programs in the U.S. We started this program in Canada in '92-ish. It's been 14 years. A lot of companies have tried to emulate and copy and done a lot of one-on-one loyalties. There's some clutter in the marketplace, so -- but we still think there's an opportunity and we're going about it pretty methodically, and will (multiple speakers)

It's going to be off-balance sheet? How would you finance it?

We've not even gotten that far with the financing piece of it and how we would structure the transactions yet, Charles.

Last question is a rhetorical question. What is the name of the head of sales at Epsilon?

The head of sales. I don't think they have one head of sales (multiple speakers) for the company. With regard to their St. Louis office, are you referring to some of their marketing communications piece?

What's the guy's name?

G. Steinbrenner.

George Steinbrenner?

Something like that. Very common name in St. Louis.

That's not a deal-breaker?

It's a very common name. An avid hockey fan, doesn't watch baseball much. Thanks Charles. It's been a pleasure.

Gregory Smith, Merrill Lynch.

On the private-label side of the business looking forward, should we still expect kind of the three to four new clients there in '05? And what is the outlook for any portfolio acquisitions at this time?

I would say we're not quite done with '04 yet. I would say there's probably going to be one or two more announcements out of private-label before the year is out. As we look into next year, I would certainly assume the three to four but I would also assume -- we would like to also announce a commercial card client or two on top of that. So I would like -- we would like to think we could be up around the four to six in terms of announcements.

Okay. And then on the -- back to the AIR MILES program. How do you actually measure that penetration rate? Did you guys say it hit 70 percent?

Yes. And I'm sorry; I forgot to answer your question about portfolio deals as well. The fact of the matter is in the private-label business, there were a couple of very large ones that came out this year. We decided not to get too aggressive with them. We're not in the business to build huge amounts of balances and portfolios. So we would like to continue hopefully four or five announcements. Hopefully the first three are actually retailers who don't have a program and we'd start them from scratch. So I would guess to answer your question there is no massive portfolio out there that we are looking at or going to bid aggressively on. If something like a Stage Doors comes along again, certainly we'd be excited about that. And in terms of the AIR MILES question in terms of penetration, are you talking about consumer?

Yes, on the consumer front.

We talk about our collectors, active collectors, collectors that use our -- one of our variety of AIR MILES cards as a percent of households in Canada.

So it's as a percent of households?

Households, yes.

Do you think there's any room to move that? It sounds like on the actual retailer side you think there's still a ways to go in the penetration. But what about just purely on the consumer front?

We'll continue to see growth. It's going to be mid to low single digits probably on a national basis. But the real metric that we also spend time on is collector activity across the number of sponsors. So we drive as many new issued miles from getting collectors to spend at more and more of our sponsor locations as well. So it's not just how many new collectors that we bring on board, it's getting their activity to grow as well.

I think to Mike's point, if we're looking for sort of mid-teens organic growth, we sort of say let's assume the penetration of the consumer base is -- we're going to begin to start topping out here. It will probably grow at household formation rate, call it three to five percent, plus a little bit if you want. But the bulk of it, the other 10 points are coming from deeper penetration into the existing sponsors. And then the whole new sponsor categories, like this deal with the home improvement deal with Rona and the WestJet Bank of Montreal card. There's some neat stuff. So again, I think on the sponsor side, after 12 years the folks feel we're only about 60 percent of the way there. So this thing has got a lot of legs left.

Lastly, I know this question comes up every quarter, but just on the utility space -- any new potential competitors out there besides the usual list of names? Anything changing on the competitive landscape?

Not since last quarter. I think we talked about the one big splash was Cap Gemini (ph) doing something in an acquisition kind of mode. But no, there's been no new announcements.

And that's more on the lines of an Accenture that's looking to do quite a bit more, rather than -- (multiple speakers).

Peter Swanson, Piper Jaffray.

Mike and Ed, as you look at the utility business, you have the six platforms right now. As you look through your pipeline of opportunities, would you potentially take a contract with a utility and take on business on their existing platform? In other words go for maybe 6 to 7 to 8 platforms ands eventually consolidate it down longer-term, or is that not the type of opportunity you're looking for right now?

You really have to look at the individual kind of submarket between whether it's a regulated entity or a deregulated entity. If you look at the regulated, yes, we might bring on another regulated platform similar to what we did with Puget Sound, as that market begins to change to again build scale and expertise in that area. In the deregulated side, probably won't add anymore platforms. We have plenty to -- based on the states and areas that are deregulated so far, and even if -- and as the new ones open up, we believe we have got the capability to move into those states with one of the existing platforms.

The municipal platform that we are operating under we think is most likely going to be the one we will carry forward, so I doubt that we'll bring on any new one in that arena. And then in the submetering space, that's a space that is -- we have a small start with, if you recall from a small tuck-in acquisition last year. There are some expanding product opportunities that we may -- we're in a build or buy mode kind of decision right now, that may add a couple of more adjacent platforms that we would tie together that I hope to be speaking about in some of our R&D. We talked a little bit earlier about some of the R&D and spending we are doing. I hope to be able to talk more on that in the coming quarter or two.

And as you look into 2005 within the utility pipeline, can you size up two, three, four, good opportunities? It sounds like you're optimistic about a couple more by the end of this year. But looking beyond December.

yes. I think going into next year as we've always talked about we'll do two to three a year, and I think the pipeline is supportive of that kind of continued steady growth.

Lou Miscioscia, Lehman Brothers.

I wanted to ask a question about fourth-quarter guidance. I guess simple math suggests that you're suggesting 34 cents, and I wanted to clarify that.

I think if you do the math it comes out there. What we basically said is we're certainly running ahead of the high-end of our previous guidance. Quite honestly we said $1.50 sounds like a good place to sort of put the stake in the ground. Could it be a little north of that? Yes. Things look pretty good right now. We don't know when Epsilon is going to come in. That does not include any potential benefit from Epsilon which we hope to get closed here in the next couple of weeks. So we're basically trying to communicate that Q4 looks solid. Again, Q4, similar to Q3, is absorbing some of the marketing and advertising and new product expenses that we deferred from Q1, but in general Q4 looks strong and I would expect us to wind up on a pretty good note. So we're basically saying we're running ahead of the high-end of our guidance.

(indiscernible) sounds like a pretty conservative number for you guys. The second part of the question was I think you talked about this sponsor penetration. Can you give us an idea as to how high you think you can get to that with the AIR MILES program?

From a sponsor penetration perspective, what we tried to do, Lou, was we sat down and basically said where does the average family in Canada spend all their money? And then we basically tried to exclude certain categories where it just doesn't make sense to have some type of AIR MILES representation. And then what we wound up with are all these categories across all the different provinces of Canada, and we said let's go after it, category by category, province by province, granting exclusivity by category either by provinces or on a national basis, and keep plugging away. And we have been doing it. Obviously, the big ones that we mailed early and often would have been the gas and the grocery and the financial services and the pharmacy. We also nailed the national deal with the home improvement side as well. But other areas that we are beginning to -- that we haven't touched on would be areas in the automotive sector for example. We talked about how about the restaurant sector, the dominant restaurant chains in each industry? There are an awful lot of categories that we are still -- haven't even touched it. So we think we are at 60 percent out of 100 percent penetration of what we believe can be penetrated, which is obviously somewhat less than someone's overall disposable income. So we're saying we are two-thirds of the way out of what we believe is a total AIR MILES opportunity.

Colin Gillis, Adams, Harkness & Hill.

Just a couple of quick questions. Wondering about, Ed, if you could quantify a little bit about more call on the delinquency rates in the quarter and if that's trending down in a similar manner, that 30, 40 BIP downward trend as the defaults?

You nailed that one. Similar to the question earlier, I sort of only addressed the loss side, which is the piece that hits our P&L. But to your point, the delinquency side doesn't hit the P&L immediately. What it does is an accountant must roll for 180 days before it is written off. It gives us a very good window as to the trends and future write-offs. We normally would sit there and say hey, we're going to target roughly a 6 percent delinquency rate. And once again we were very pleasantly surprised this quarter. Our delinquency rate came in just over 5 percent. So that bodes like I said -- since that is a forward-looking indicator, suggests as we enter '05 again getting back to what we see in the consumer -- you know, it looks good. It really does look solid.

That's a great stat. I guess on the acquisition front, are you looking at any other targets sort of given the current zero net debt position?

We've been a little busy with the one we just got through, but we certainly as we have been saying since we went public -- we always are out there probably looking to do a couple of small tuck-ins. We certainly won't stop that process. So to the extent there are a couple of small tuck-in opportunities, we will scoop those up as well. At this point in time, however, I think we're full up in terms of the big stuff. So we're probably going to spend our time getting everything shipshape. Maybe a couple of small tuck-ins as we look ahead here. But I think our plate's pretty full right now.

David Scharf, JMP Securities.

Ed, as I look to modeling transaction service margins next year, they seem to be down nine months year-to-date versus the prior year. With the expectation that these new utilities are going to be operating under current suite of CIS software platforms, it doesn't sound like you're adding any new ones based on energy and the two contemplated. Should we be comfortable that this thing is going to scale a little more rapidly and we should be expanding our margins next year in that whole segment, or do you think there are going to be a little more integration costs upfront, conversion costs in utility that will keep it down?

You know, again, the year isn't over yet. I think our overall annual margin -- you know, for example Q1's I think in transaction services margin was ahead of last year's. Q2 was ahead. Q3 was a little bit behind. It obviously bounces a little bit by quarter. But I think on a full-year basis, our EBITDA margins for the segment will actually be up, and I think that's a fair thing we should use going forward. I would use as sort of a place marker, I'd say 50 basis points is probably a good place to start. So we are certainly going to get scale as we continue to grow. I think what Mike and I were alluding to is the fact that it's going to take some time to get all these platforms consolidated and get best of breed. So while we're pricing contracts at a very nice rich margin, we are carrying some baggage as we -- that we need to clean up over the next few years.

As you gain scale in adding some new utilities, particularly another three at the end of the year, does your per seat license -- a lot of this software license you're licensing from third party vendors in the utility space. Are you able to negotiate more attractive licensing fees going forward? Is that an opportunity for a little more margin pickup quicker?

I don't see significant. We went into some long-term partnerships with our license folks early on and anticipated some pretty attractive rates. So I don't see a lot of uptick in negotiating new license fees with our guys. I want to go back to your point in terms of (indiscernible). Our focus is going to be on growth first, and platform consolidation second. And so given the amount of resources we have, we will move into integration and conversion activities as the primary vehicle, and then do the consolidation and margin improvement as a second priority. We know we will get their, but we're not going to go out and hire extra resources just to accomplish that in a shorter timeframe than the normal course.

Lastly, Ed, just refresh my memory on deferred revenue. There was a huge sequential increase this quarter. It was about 34, 35 million. It seemed to be flattish the last few quarters. With the rate of miles issuance relatively stable over the last few quarters, why would it spike up so much?

It's a couple of things actually. If you were to look at year over year, I think it's up about 60 million. And this quarter alone was something like 36 million, to your point. You have to remember what is in deferred revenue. What's in deferred revenue are not only the revenue that we earn when we issue a mile, but then you subtract out every time a mile is redeemed, deferred revenue comes out of that balance. So when you have a huge redemption quarter like Q1 and Q2, you are actually pulling out more deferred revenue. In Q3, our rate of growth in redemptions actually slowed quite a bit and trending back towards our 20 percent level, and we had a strong issuance. That would bring it up. But on top of that, the Canadian dollar I think moved up 3.5 cents, something like that. So I would say of the 36 million, I would say more than half of that was nothing more than foreign exchange gain. And then a little bit less than that would have been the net of issuance and redemptions. And that's why our operating EBITDA was 9 million and not 36 million. Does that help?

Yes. You just answered my last question.

Don McArthur, Stifel Nicolaus.

Great quarter guys. Looking at your interest expense or financing cost, it looks a little bit lower than I was looking for, even with debt paydown. Was there something unique in there, and is that swap payment over now?

Yes. The swap is done. That thankfully is gone forever, never to poke its head up again. So we are basically right now back to just general interest, whatever is left in terms of debt that's on the balance sheet. So the mark-to-market and the swap is gone.

Within your credit services segment, how much of that revenue was for the finance charge portion?

Boy, that's a good question. Finance charge -- out of the 120 or so million, finance charge usually runs about 65. Two-thirds of that.

And it was like that this quarter?

Yes. Call it 80 million.

Within the private-label, have you seen any change within the competitive landscaping? It looks like one of your larger competitors is forming a group to target smaller (indiscernible) market portfolios. Is there any change in pricing or competition, or is it just the same issues with people don't want to go with the larger providers in that business?

I'm sure you read the same industry press as we did, and we're obviously respectful of all competitors. I guess I would suggest you go talk to some of the industry consultants that have been in the industry for some 20, 25 years, and you'll find out that this isn't anything new. This has been an in and out kind of thing for the past 20 years and here it comes again. But we're never going to take anybody lightly and we're going to continue to be very aggressive in the marketplace.

Sounds good, just like business as usual.

I think we've got a few more minutes so let's keep going. I know everyone has got plans for hopefully a game 7 TV night tonight. So fire away. Anymore on the line operator?

Dan Perlin, Legg Mason.

I just wanted to make sure that these two to four potential new contracts you guys are talking about in private-label utility are not contemplated in your $1.82 estimate?

That's all part of --

Is that part of the guidance?

Yes. That's part of just our ongoing growth.

So if you announce these the next two weeks, today's numbers would not go up as a result of that?

That's correct.

It would be considered for us to be growing the utility whatever 20 percent a year, we would need the quarter (indiscernible) plus two or three new deals signings each year. So that would get us up to our 12, 15, 18 model for next year. And the normal 10 to 12 kind of new deals that we talk about each year. Our standard model.

Right now as we look into '05, obviously there's still what we call unfilled faith, unfilled revenue, we call it blue sky, that we need to chip away at. And that's how we do it.

Ed, can you just explain to me one more time why there hasn't been more sequential improvement in transaction processing in four quarters? I look at December '03 and I see 167 million, and I look at September '04 and I see 169 million. To me (multiple speakers) -- you would think there would be more growth sequentially in that business.

Again, I think the fact that over the first nine months of this year, you know, we're running about 14 percent ahead.

Right. But it was kind of like a step function up and then it just kind of has petered away really.

But Q1 was a little bit different this year. Q1 don't forget was just an enormous year in terms of what we saw on the private-label side. There was just massive spending carrythrough from the holiday season. So the number of statements we generated were up a huge amount. I think it sort of settled back into what we normally would see which is sort of the -- quite honestly the low to mid-teens, and that's where we are running right now through nine months. Don't forget also in there, Dan, is the fact that we have -- if statement growth is running in the mid teens, and I have very firm revenue per statement, you would expect my revenue to be running ahead about mid-teens. It's running a little bit less than that because of what is left over in that segment as our old merchant acquiring business -- that isn't growing at all.

So that represents kind of a headwind for you?

Yes. It tempers it two, three points from -- if you just took --

But going into '05 that should be certainly less so.

It should be.

So we should be seeing more sequential improvements as we think about '05?

It should be going up.

We hope, right? The same question really for credit services, Ed. December '03, 122 million; September '04, 122 million. What's the delta there? I can understand the traditional (indiscernible) services, but what about credit services?

Credit services Q4 is traditionally pretty strong. That's our holiday season. And last year we also -- that was our first full quarter of Stage Doors, which was very big. And then what tends to happen is Q1 tends to be strong. We were obviously very surprised this year that Q1 was so far ahead. Basically what we saw was just massive consumer spending in Q1. But then seasonality kicks in. Q2 and Q3 tend to be pretty close to each other, which is what we saw. And then Q4, you should see this drift up.

The marketing and advertising expenses that you guys originally had in the first quarter of '03 but pushed off -- is that -- was that a onetime or is that an annual budgeting thing that you typically do in the first part of the year? Yes, it is going to happen again in first quarter.

Absolutely. It's not a question of is it a onetimer. What we talked about, I think -- I'm trying to remember the numbers -- is somewhere around --

It was pretty big; I just forgot if it was recurring typically in your budget for the first quarter we should normally see, and then it's kind of just pushed off.

It was about 15 million in Canada we spent annually, and Mike talks about somewhere between 10 and 12 million here in the States for some new products and some launches. So there's a bucket of $25 million or so that we talked about, and what we do budget time is usually spread it evenly throughout the year. And in Q1 we just didn't use it. But that is -- you should consider that -- that's an ongoing expenses; we're going to have it every year; we're going to grow it every year. And the idea is, especially here in the States, let's figure out three, four, five projects we want to go after, and hopefully a couple of them stick.

David Trossman, Wachovia.

Ed, why don't the statements grow sequentially June quarter to September quarter? Is that a seasonality thing I'm missing, or are we still just kind of normalizing up this big huge March quarter peak? And where do those trend on the card side versus the utility side?

I think from a statements generated perspective, obviously we hope to see a tickup in Q4. Again, statements generated, as you know, David, is a proxy for how the business is doing itself. We had very strong, probably over-performance on the consumer spend side in Q1. That extended into part of Q2. That then by definition generates a statement. Right? A statement is anything where there's a sale activity or there's a balance. So I think that probably means that the Q2 was a little bit higher because of that activity. Q3 I think is pretty much a normalized number. I think Q4 will pick up a little bit. So I think we should -- I think as we look into '05 as we talked about, you're going to see things return to a much more normal pattern that we are used to seeing in prior years. And I think this year, Q1 well into Q2 was running a little bit ahead than what we had thought. In terms of the breakdown between private-label and between utility services versus prior year, I think utility services was up over 20 percent. And in the private-label space that was more in the low double digits. And that's where the 14 percent came from.

Charlie Chen, Needham & Co.

Would that last explanation also explain the quarter-on-quarter, the 2Q to 3Q decline in the credit sales number, that Q2 may have been unusually strong? I don't know if '03 is an accurate comparison, if there's some stage getting into September. But in '02 it looked like it was sort of flattish 2Q to 3Q.

I think so. I think what we are seeing is, again, in terms of the sequential change in the credit sales, first quarter was just an absolute blowout of course. And then second quarter was exceptionally strong. I mean it was up I think in the mid-teens or higher. And then I think Q3, you're beginning to see a more normalized pattern, which we expect to extend into Q4.

We have no further questions at this time. I would now like to turn the floor back over to management for closing remarks.

Thank you. I'll make this quick. I know everybody's got some planned activities tonight. Again, as we said in the opening we look forward to a strong end to the year and exciting 2005. We appreciate everybody's support and we'll talk to you next quarter. Have a good one. Thanks.

Thank you. This concludes today's conference.