Bread Financial Holdings Inc (BFH) 2005 Q3 法說會逐字稿

Good afternoon. My name is Jason and I'll be your conference facilitator today. At this time, I would like to welcome everyone to Alliance Data Systems' third quarter 2005 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS).

It is now my pleasure to the floor over to your host, Julie Prozeller of Financial Dynamics. Julie, you may begin.

Thank you Operator. By now you should have received a copy of the Company's third quarter 2005 earnings release. If you haven't please call Financial Dynamics at 212-850-5608. On the call today, we have Mike Parks, Chairman and Chief Executive Officer and Ed Heffernan, Chief Financial Officer 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 another follows with 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. Reconciliation of those measures to GAAP will be posted on the Investor Relations website at www.Alliance Data Systems.com.

With that, I would like to turn the call over to Mike Parks. Mike.

Thanks Julie. Good afternoon, everybody, and thanks for joining us today. As usual as you'll see in our agenda I'll spend a few minutes reviewing the highlights of the quarter. Ed will then give us some more detail around the financials and then we will take your questions.

So let's turn on to the Highlights page. I will start. As you would expect, we are very excited to announce our record quarter posting our biggest revenue ever, with 385 million in revenue, up almost 30% over last year. We had a well-balanced quarter with all businesses, our AIR MILES business, Epsilon, Utility and Private Label turning in double-digit growth.

EBITDA for the quarter increased by 33% to 86 million and cash earnings per share was up 42%, $0.51 per share. We have seen an acceleration from the first of the year in our key financial metrics. And this acceleration positions us very nicely for 2006.

Our performance is a result of our ability to deliver on our business model, adding new clients and renewing key relationships that provide us with great visibility. Let's take a look at a few of the quarter's accomplishments, starting with Utility Services on the next slide.

Our Utility Group has been focused on both growth and margin expansion. We are very pleased to report double-digit growth for Utility Services team. The strong growth is fueled by ramp ups from our large wins in late 2004, Entergy and Direct Energy, as well as some smaller wins earlier this year, including Cobb Energy.

Additionally, we expect to see one or two more announcements before the year end in our traditional CIS billing and customer care activities, along with our expanded services in non-outsourcing, consulting and professional services.

In a market that has had limited signings, as well as merger and acquisition activity, we are satisfied with our new business development efforts. We also view the M&A activity in the industry as an opportunity for our business process outsourcing and consulting group has newly formed entities look for ways to remain and increase their competitiveness.

Conversion and integration activities continue to progress. For two significant wins that I mentioned Entergy and Direct Energy, we completed the conversions of the call center -- of the customer care call center and our collections operations for both clients. We will complete the conversion of the billing platform in 2006. For Energy, obviously with the impact of Hurricane Katrina, the platform conversion has been delayed. But note that this timing change will have no impact on revenues, which are fully flowing into us today as we operate in the current system.

All of the effort position us very nicely for 2006. Now let's turn to Private Label.

Our Private Label retail group continues to exceed plan. We added Gander Mountain, expanding our vertical reach in the outdoor recreation specialty retailing sector. Gander is one of the largest and fastest-growing retailers in the outdoor lifestyle industry with over 800 million in sales. We will provide a full suite of Private Label services, as well as leveraging our expertise and analytics in marketing, to deliver an integrated loyalty program.

We also announced an agreement with Carter Lumber to provide an integrated consumer and commercial Private Label program for this home improvement retailer, which operates 240 stores, and sales of about 675 million. In addition, our Network Services business will provide authorization and settlement services for other card-based payments.

Our unique advantage is our ability to utilize a common platform that allows Carter Lumber to extend seamless branded experience across their customer base. And this in turn will help them drive more sales and increase loyalty.

We also expanded our relationship with Gordmans, an Omaha apparel and home fashions retailer. We will provide Gift Card services, designed to augment their existing Private Label program with us, and expand the wallet share of merchant-controlled payment. The program allows Gordmans to offer flexible denomination, easy reloading and the ability to use the card for in-store credit and returns. We will provide unique opportunities to integrate this with our retail Private Label program by fulfilling Private Label Rewards via Gift Cards and Gift Card promotions included in New Cardholder Welcome Kit.

We expect a strong finish in '05 and, coupled with our strong sales year-to-date, expect double-digit growth in 2006. Around our yearly target of around 4 to 5 new clients, we've delivered an equivalent of 10 so far the share. Pricing remains firm, further underscoring the value we deliver our clients.

Before we move onto loyalty and marketing services, though, I want to touch on the Private Label market in general, if you'll turn to the next slide. We are often asked if we view the Private Label market as a growing opportunity. For several years, the view from the outside is that this is a shrinking market. This in spite of mid-teen growth we have experienced since even before going public the last five to seven years of our Company.

The chart that you see demonstrates how we are expanding our sandbox. The market represents retail segment that we consider our addressable market. The dark green indicates the segment where we hold a market leader position, apparel. The medium shade of green, we have a solid foothold with room to grow. The light green areas are emerging opportunities. And we have had some early success, expanding into either new segments or providing new products. The gray represents new opportunities and the white are areas where we do not target.

Our growth is a result of our ability to continuously expand our sandbox and create additional opportunities. As we first add new clients, our success has been to focus on growth strategy that targets our sweet spot, that of specialty retailing -- predominantly apparel -- but also includes home furnishings and catalog.

We are the leading provider of Private Label programs in this space and they look to us to help launch new programs like Maurices, Pottery Barn, Restoration Hardware, The Gallery, Shop NBC, and a variety of others you have seen us announce over the last few years.

Secondly, we expand by focusing on new retail segments. Segments that are either new to us or have not traditionally had private-label programs, like the outdoor recreation market and home improvement. And next by expanding our Card services to offer a full suite of products -- commercial, co-brand, gift card and others to come -- we gain more share of our retailers consumer payment stream, just as we did with Gordmans and their Gift Card program or Hanover and their integrated private-label and co-brand programs and, recently, Carter Lumber.

By focusing on adjacency opportunities, we've created a dynamic and reliable growth engine, which we believe will provide double-digit growth for years to come.

Let's now turn on to loyalty and marketing services. Once again our AIR MILES Reward Program and Epsilon had another outstanding quarter, turning in strong double-digit growth. Continuing this year's trend AIR MILES grew over 20%. Over the previous year, highlights included the addition of a new sponsor -- Alamo Rental Car -- where collectors can both earn and redeem miles for car rental.

We also renewed two key sponsors. First, Soby's, a leading Canadian grocery retailer with 12 billion in sales, will continue to hold an important anchor position within our sponsor base for Quebec in the Atlantic region. Soby's branded outlets include IGA, IGA Extra and Lawton's Drugstores.

We also renewed LCBO, the Liquor Control Board of Ontario, which sells a variety of beverages including wine, spirits, and selected beers as well as an assortment of merchandise for entertaining. The multiyear renewals demonstrate the important role of AIR MILES playing (ph) regarding their commitment to providing an enhanced in-store experience for their customers. Both Soby's and LCBO are top ten sponsors in AIR MILES program.

Turning to the U.S.-based business, we announced a business-to-business customer loyalty program for CompUSA. The program members receive immediate benefits designed specifically for small businesses. We will be providing a full range and suite of loyalty marketing services, analytics, creative development and the ongoing program management.

And, lastly, at the very end of the quarter we completed the acquisition of Bigfoot Interactive, a leading email communications and marketing firm. They will become Epsilon Interactive, expanding Epsilon's existing communications capability from our traditional and direct mail and call center to now permission-based e-mail marketing. They serve over 165 different companies and brands, including JPMorgan Chase, Capital One, Target, Amazon.com and Expedia, to name a few. They have been recognized by Forrester and Jupiter Research as a market leader among e-mail marketing firms.

And the management team significantly expands our experience and our thought leadership in interactive marketing. We are very pleased to have them join the team. Welcome aboard, Bigfoot.

Turning to our outlook, we have had a tremendous year and based on our strong third quarter results, we continue to track well ahead of our 2005 expectations. We are seeing across all of our businesses the impact of some very strong business development efforts and the impact of some large ramp ups in our Private Label and Utility businesses. We also expect make several announcements before the year end as I mentioned earlier and as such we are very comfortable raising our guidance to $2.00 to $2.02 for cash EPS, representing a minimum 30% increase over last year.

Looking ahead to 2006, we are shaping up very nicely. Our business with strong organic growth and highly motivated associates, we will deliver what we promised. We are confident that we will deliver on our long-term model of 12% growth in revenue, 15% EBITDA, and 18% cash earnings per share.

I know there are concerns about the potential of slowing consumers (technical difficulty) in our business. I want you to rest assured we have factored that into our thinking and nonetheless feel quite confident that our model will continue to deliver in this environment, as well, just like it has in the past. My personal thanks to the hard work and commitment of all of our Alliance Data Associates. Thanks for your efforts.

Ed, will you take us through the financial reviews?

Sure. Thanks Mike. Why don't we turn to the slide that said "Third Quarter Consolidated Results". Q3 marked our 18th quarter as a public company and further extended our track record of delivering or overdelivering on what we have promised.

Very simply, the quarter could be boiled down to three key themes. Organic growth, balance, and accelerating earnings.

First, organic growth. It continued to accelerate and was comfortably tracking within our long-term model of double-digit organic growth. Second, balance. Q3, as Mike mentioned, marked the first time this year that all four businesses -- Loyalty, Epsilon, Utility and Private Label -- each delivered double-digit topline growth. And third, acceleration. Acceleration in growth was achieved across revenues, EBITDA and cash EPS.

On the revenue side, growth accelerated from 20% in Q1 to approximately 30% in Q3, driven by all four engines. Specifically, AIR MILES overperformed and continued its 20% plus growth, Epsilon overperformed, Private Label -- quite frankly to the surprise of many -- accelerated and notched a nice double-digit gain. And finally, Utility Services returned to double-digit growth as well.

Turning now to EBITDA, growth also accelerated from the mid-teens in Q1 to over 30% in Q3 as strong revenue growth and solid expense leverage drove results. Operating EBITDA or operating cash flow surged ahead 26% as our Canadian business continued its overperformance and is tracking nicely to be at least 25 million ahead of reported EBITDA for this year.

And of course, finally, strong operating results plus solid free cash flow generation provided further lift to the bottom line, as evidenced by cash EPS growth over 40%. Again, showing nice acceleration from earlier quarters.

So in summary, all the engines clicked along in a double-digit pace and we think these results bode well for a nice jump off to another strong year in '06.

All right. Let's flip over and start talking about the segments. First up, transaction services which houses Private Label services, Utility services and our traditional Merchant Bankcard services.

Well, we're getting there slowly but surely. Revenues turned the corner from negative growth in the first half of this year to decent positive growth in Q3. The turn was primarily driven by Utility services which returned to double-digit growth as we migrated the customer care call center and collection activities of Entergy and Direct Energy to ADS. Also contributing was some positive movement in Private Label, as statements generated return to growth.

Essentially all the new business signed had started the process of ramping up and offsetting some tough comps at one major client. This process is expected to truly "move the needle" in Q4 as anticipated.

EBITDA followed a similar pattern as it moved from 20 million in Q1 to 22 million in Q2 to over 23 million in Q3. Of interest was the nice pop we got in Utility. It was however largely offset by Private Label expenses associated with getting a large book of new business up and running. Obviously, these are the types of expenses we will choose to incur all day long. But the outlook, we do expect steady improvement as the segment continues to ramp up as we head into 2006.

Okay, Credit Services which showed accelerated growth in both topline -- which grew prove double-digit -- as well as EBITDA which surged ahead 50%. Let's go ahead and walk through the drivers.

First, credit sales came in at a mid single digits growth rate which was a bit lighter than what we wanted. The existing base is grinding through some tough comps at one major client plus a bit of an air pocket from the hurricanes. But our newly signed business posted strong results as they began their ramp up.

For Q3, the ramp up was still in the early stages and wasn't quite at the point of truly making a dent in the overall growth rate. The good news is that this changes in Q4 as the ramp up hits critical mass and we expect a very nice jump off into '06, where the plan remains the same, calling for double-digit growth.

Second, portfolio growth has started to accelerate and came in a bit better than expected. We expect that trend to continue as well as a large book of new business continues its ramp up.

Third, funding costs improved during the quarter as a portion of our long-term funding reset downwards. What that means, became cheaper. This is a trend that will continue. Previously, we had expected our funding rate to be flat through 2007. However, we now believe that there will actually be a benefit in 2006 versus this year.

Finally, credit quality remains favorable with billing (indiscernible) levels at or below 5%, and credit losses coming in at 6.4% versus 6.6% last year. A 20 basis point pickup.

The outlook remains solid and we expect '06's experience to be roughly flat to '05, given that we have such good visibility into much of '06, based on current delinquency flows.

Furthermore, any blip here or there should be relatively minor and, if one occurs, should be nicely offset by the funding costs improvement we mentioned earlier. Also of interest is that the strong overperformance for the entire Company this quarter came without a significant contribution from improving credit quality, which only improved 20 basis points year-over-year or roughly 1 penny to earnings.

I think the takeaway here is that we don't need ongoing credit quality to improve, in order to grow double-digit.

All right, let's wrap up credit. Excellent quarter for Q4. We will see a few million in expenses rolled through from the bankruptcy bill that was just enacted. This is a timing thing, since it encouraged bankruptcy filings prior to the effectiveness of the new regulations. More importantly, we do not expected to have any meaningful impact on the quarter and we expect to absorb it and play through.

So expect a good Q4 and, despite general concerns about the consumer, we expect a strong '06 due to nothing else but the sheer volume of new business ramping up.

Let's finish up with marketing services, which primarily includes our Loyalty AIR MILES business in Canada as well as our U.S. platform called Epsilon. The AIR MILES business continued to overperform and once again grew north of 20% due to firm or firm plus pricing, 100 present retention of major customers, and the additions of large new customers. The outlook for Q4 is bright as well and 2006 is shaping up to be another fine year for this business.

Turning to the U.S., Epsilon also continued to overperform and is reaping the benefits of strong pricing, strong client retention, and enhanced revenues and earnings from this year's announced deals with Hilton, Pfizer, ViaVe (ph), Trugreen and others. Q4 (ph) looks good and '06 is shaping up nicely, based upon a very robust pipeline.

Let's wrap up the segments. All the key engines as we have talked about Loyalty, Epsilon, Utility, Private Label, post double-digit growth at the same time for the first time this year. Combine this with the large ramp ups and new clients in Private Label and we expect a strong finish to the year, as well as having additional comfort in providing strong '06 guidance, despite general macro concerns about the consumer.

Let's now turn and talk a little bit about balance sheet. Three items. First, our AIR MILES business continues as we talked about to overperform and, along with the strength of the Canadian dollar, has driven our deferred revenue balance close to $600 million. To remind folks, this is cash received and revenue earned but not yet recognized in the P&L due to the deferred nature of the accounting.

Normally the account grows 40-ish million in a year. Over the past year it's been closer to 100 million. This is a great sign for '06 and '07 because it will flow into the P&L.

Second, after netting out cash generated during the quarter, core debt increased 45 million due to the acquisition of Bigfoot at quarter end.

Let's talk a little bit about capital structure. Earlier this year, we announced our first-ever share buyback program. This $80 million program is well underway and has proved to be a worthy use of cash. Today, even with the Bigfoot deal and our buyback our core debt to operating remains below one times which is well below our self-imposed guideline of less than or equal to two times.

Given that amount of capacity plus a significant free cash flow generated by the business, we will continue to explore stockholder enhancing opportunities. Whether it is a buyback or taking a look at an income trust structure for AIR MILES or other opportunities, management is committed to not only providing strong and consistent earnings in cash flow growth but also finding additional means to return cash and value to our stockholders.

Stay tuned.

All right, moving on to the rest of this year 2005, real simple. We're going to bump it up again. We believe the strong run this far will continue and as such we once again feel comfortable raising guidance. Specifically, last quarter our guidance was cash EPS of 192, 195. We are comfortable raising that again and fully expect to come in this year at -- let's call it to $2.00 to $2.02 per share.

I think a key note here is that Q4 will be incurring a few million -- let's call it $5 million -- in extra costs associated with the Bankruptcy Bill's enactment and the October 17th rush to file deadline. Despite this, we will absorb it. We expect to play through. And we still feel comfortable raising guidance and finish the year north of $2.00 per share. Clearly Q4 is shaping up to be a good one.

That finishes up '05. Let's start talking a little bit about what we are seeing in '06 if everyone can turn to the slide, "The 2006 Outlook". Our guess is that the No. 1 question hanging out there right now is, what happens if the consumer slows? How will that impact ADS?

We spent a fair amount of time working through each of our businesses. And pretty much this is where we came out. Over half the Company's revenues, close to 60%, we don't expect any impact whatsoever. If you were to just go down the list, for example our Canadian business -- even though it's called AIR MILES we don't make a dime from the airlines. It is essentially consumer nondiscretionary spin.

We make money when folks go to the gas station, go to the grocery store, go to the pharmacy. These are things that they will do week in and week out, and obviously, actually, a nice little kiss we got recently is the fact that as gas prices go up we make more and more money because it is based on the dollar value spent.

Second, our Loyalty business in the U.S. called Epsilon, in many cases, if there is slowing consumer spend and slowing demand out there, many of our clients will actually step up the spending their Loyalty programs since they have so much excess capacity to fill. In the Utility space, pretty sure the utility bill is at the top of the consumers pile. And, finally, in our old legacy merchant acquiring business, we are all in the petroleum space. And as gas prices have gone up, we are processing more and more transactions.

So let's turn to the other part of the Company, less than half of revenues, which would be our Private Label. I think what we are basically feeling here is that even if the consumer weakens and some of our existing core clients may find the going a bit tougher than normal, the huge book of business that we have signed over the past year -- the equivalent of 10 new deals -- as they ramp up, just the sheer volume itself should power this segment to a nice double-digit growth in '06.

And then finally on the expense side, some good news as we went back and reviewed all the funding cost that we have. We are actually going to have a funding pickup in 2006 and based on what we are seeing on the credit side now, it looks pretty decent for '06 as well. And the funding pickup would be a nice offset if there is a little blip along the way on the credit side. But right now we're not really seeing any.

So overall we think we are in decent shape for '06 and as a result if you could turn to the next slide, "Our 2006 Guidance". For those of you who have known us since we went public about five years ago, we have a model which really has two key features. The first is we like to do double-digit organic growth and at the same time overall growth where baseline growth should be a minimum of 12% topline, 15% EBITDA, and 18 in cash EPS.

We are comfortable with that guidance for 2006 and that would bring revenues in at approximately 1.68 billion, EBITDA of around 400 million, and cash EPS around 236. So that is our guidance for '06.

And if you can turn to the next slide, we also -- one of the unique features of our model is that our free cash flow tends to run ahead of our reported earnings because of how we treat the business in Canada where, for accounting purposes, it's deferred. But if you look at our free cash flow, which I usually refer to as what's in our pocket at the end of the day? There is about $25 million of extra profits in Canada of cash flow that is deferred for accounting purposes. So our operating cash flow is going to be about 425 back out CapEx and interest in taxes. And we will probably do about $2.56 of pure free cash flow for 2006 over $200 million.

Last couple of slides, if you are looking at operating leverage, we've had a pretty good track record back, can only fit on here back to '99 a very nice leverage over the years. We expect that to continue through 2006 as it has continued in 2005. No reason to slow that down.

Then 2000 to 2006 revenue, EBITDA, and cash EPS, the next slide. That basically shows the track record of the Corporation over the past, I guess, five years or so as well as projecting into '06. And that includes some very weak periods economically as well as some very strong periods. And through it all the ADS model seems to hold up pretty nicely.

Last slide. What Mike and I refer to as our top five for the quarter. What we try to do is consolidate the top five questions that we've received during the past three months. The questions that we hear over and over and over again, we try to address them upfront here in the call.

The first, of course, was the consumer spending and credit quality. Quite frankly I think we have beaten on this enough. But suffice to say we have been at this a long time and our model has held up extremely well through good times and in bad. Our guidance has already factored in macro assumptions at just tepid consumer spending, rising interest rates and a peaking credit cycle. Even with those assumptions we feel '06 is in good shape.

Next question, Master Trust data. Many of you know that we are required to file a monthly report outlining certain financial metrics associated with the performance of our card accounts which back our public asset-backed bonds. These are just suggestions, given that we usually get some calls each month. First, it is probably not useful to look at just one month. The report is a point in time cutoff. The timing can cause numbers to overstate or understate in any one month. Rather to start with it certainly would suggest using a trailing three-month average.

Second, especially this year and the bulk of next year, the data will not be highly indicative of overall Private Label performance for things such as credit sales or portfolio growth and, to a lesser degree, losses. Specifically the huge book of new accounts will not be added to the trust for another year or more. And as such the ramp up of growth will be upside of the trust and hence upside of the report.

Usually we do a big bond deal each year which adds the new business into the Master Trust. We doubled up last year and as such, didn't do one this year and won't be doing one until late '06.

Finally you should note that at the end of September or September's report, all of October and part of November due to timing will, of course, reflect the timing spike from the Bankruptcy Bill. So expect reported losses to pop up 60, 70 bips, and then settle back down again as we exit the year.

As noted earlier, this won't get in the way of finishing strong and hitting our newly raised guidance which, again, is a good testament to the strength of the overall business model.

Again, (technical difficulty) and we fully expect to absorb that bankruptcy hit in Q4 and still hit the higher end, still hit our guidance.

AIR MILES income trust. Lot of questions about that. Here's where we stand. We have provided key financial data of our AIR MILES business to the top experts in Canada. These are primarily big banks up there. For the past couple of months, we have met with five separate institutions. The median value of their estimates as to the value of our AIR MILES business is U.S. $1.6 billion, based on what we're going to do this year, which is U.S. 100 million of operating EBITDA. We have talked to a number of stockholders. We have presented our findings to the board and the net results quite simply is no decision at this time, partly due to the current uncertainties surrounding the future tax status of the entire income trust business. There are -- the expectations are we will get some more clarity over the next few months and will certainly keep you posted. And that, quite frankly, is all we know at this point.

Next up, breakage, also relating to AIR MILES. Breakage is an estimate of how many miles will eventually be used or go unused. For 13 years, we have assumed two-thirds of all miles will be used, one-third won't, and hence, one-third breakage. After 13 years, our actual experience suggests that we have been quite conservative, which is good since we want to continue to encourage people to use their MILES.

We have and so have our auditors always been very comfortable with this estimate. Nonetheless, as part of our income trust exercise, we went out and engaged another one of the Big 4 accounting firms to triple check our assumptions. And they have been spending the last few months poring through the data and just finished their work.

Their study confirmed that our methodology was and is both appropriate and correct. It never hurts to triple check.

And finally '06, I think we have covered that and with that, I'll turn it back over to Mike.

Thanks Ed. I just have one quick comment before we move to questions. I think the key point in the income trust exercise, which we have spent the last few months, is really highlighting the value of the AIR MILES program. I know many of you -- most of you listening probably -- don't get to Canada that often to see the impact that this program has across Canada.

But anybody that would like to visit our location travel to Toronto, we would love to host shareholders and potential shareholders just to show you how powerful it is. Because it certainly does represent a unique business that has a significant amount of value. And as the income trust model showed, perhaps that segment of our business is well undervalued.

But that being said, it is our job to continue to make sure shareholders and potential shareholders understand that business and we get fair value for them.

That's wrapping up. Operator we will turn it over for questions.

(OPERATOR INSTRUCTIONS) Jim Kissane of Bear Stearns.

Great job, guys. Mike, can you discuss the pipeline in the Private Label business? You had a great year this year signing up the equivalent of 10 new retailers. Next year do you need to do more than your typical four to five to keep the growth going?

No, our traditional model is we've always said is a four to five kind of new accounts to establish that continued growth model. I will tell you, however, just as this year was a very strong year, the pipeline for Private Label is just as strong going into next year. And so we are pretty bullish about our share of the win.

And Ed, can you give us a sense of what you're modeling for charge-offs in '06? Is it pretty much kind of flat at around 6 3, 6 4 and can you talk about the sensitivity? If that was the bump up, 50 basis points are so?

Yes, sure. We think next year will be roughly flat. Your number was fine, let's call it mid sixes is probably a good place to start and then I think to the extent, based on delinquency flows that we see right now we have a very good idea what the first half looks like already. So I don't think we are going to have any surprises next year. I think when we modeled out and gave our guidance and suggested that we factored in slowing macro environment and maybe a little bit of upward pressure there, that to the extent that that trips up 50 basis points or so, we should have back nicely offset on our funding side.

In the marketing business did you step up spending during the quarters, given the strength that you have on the credit side and more discretionary investment spending?

On the marketing side?

Yes.

No.

Tien-tsin Huang. J.P. Morgan.

Just wondering. Can you actually quantify the direct impact of Katrina in the quarter? Is there a way to do that, Ed?

Katrina? I don't think there was any impact from Katrina in the quarter itself in terms of the bottomline. I think it was a little bit more on just the credit sales were maybe a point or so off. It wasn't a big nut. Certainly there wasn't enough to really impact the bottomline.

Okay so -- .

Yeah, Tien-tsin, I was going to say we've talked in the past a little bit about 1% or so of our cardholders were in that area. And I know we gave basically a free pass in terms of fees and charges for them because of what they are going through. But it is not going to affect the numbers and that's again well baked into our guidance.

And in the 5 million, I think I heard estimated impact from bankruptcy legislation. Is that based on actual results seen month-to-date? I guess we are beyond the October 17th -- the legislation date.

Yes I think the cutoff was, what, Friday? It's going to take I think could take ten days or more before everything finally cycles through. So it won't hit the P&L. Some of it may dribble into November but we have, as you could well imagine, a pretty good idea of what the number is at this point.

There was a little bit of pressure at the very end of September and there was a big rush the first part of October. And that is why I think 5 at the most 6 million is going to be the sum total of that spike. We feel very good about that number and like you said, based on how the business is running, we are okay with absorbing that and still coming in where we said.

That's helpful and then, lastly, just hoping to get the foreign currency contribution in the marketing side.

Yes, there's probably around 7 or 8 on top line and probably a little over a million on EBITDA so about a penny.

Charles Trafton of America's Growth Capital.

I don't want to talk to -- force your hand on this AIR MILES income trust possibility too much but given they gave out some numbers, I just wanted to press and see how far I can get. Have you gotten any guidance that you can pass on about a potential tax impact, if you were to do such a deal? Your cost basis in that business, about 180 million?

I don't think we have a lot more to offer other than there is nothing from a structural perspective that would preclude that type of transaction.

We haven't done a big five on the backside but from our at least cursory understanding there, that would not be that much of a change.

No but you would be hit with a pretty sizable tax bill.

(MULTIPLE SPEAKERS)

Talking about the original, the actual --

No, I'm not challenging (ph) your tax rate going forward but you have a pretty sizable capital gain.

We would have a pretty decent capital gain for sure on something like that and then obviously what Mike is referring to is the overall trust market itself is a little bit foggy right now.

Right. Understood. I guess there is a contingent of investors out there that seriously doubt your claim of a 700 FICO score average for the portfolio. Let me just ask a couple of questions on that. Is there a meaningfully higher proportion of accounts that are in workout arrangement today than a year ago, two years ago?

No.

And of the accounts that have 0 credit limit balance, it's about 8% today. How high can that go? And do you want that down, do you want that up? Are you comfortable at 8%? Do you care?

Quite frankly, I don't think -- that is one of the key drivers we look at when we are doing it. Everything has been in the same range for years and years and years. This goes back the original limited days back in the '80s. And we really haven't changed anything other than the quality of the portfolio itself has been, I think, tweaked up over the last few years as we brought on a different set of clients and at the same time our backend collection, activities, the personnel we have there. Quite frankly I think we got the A Team.

And as a result I think that is one of the reasons you are seeing such nice improvements, steady improvements and losses in delinquencies. And that's why I think even with a consumer slowdown, we are not all that concerned that there is going to be more than a blip going forward.

When you get to our size you still still certainly get the leverage technology much better than we did in the early '80s and '90s when we were a much smaller company too. So between the people, the technology and bringing on more and more new customers that are of higher quality, it's been driving our model for the last five years.

Yes I really don't know -- just to chat a little bit more -- I don't know what else to say about the FICA. we sell, we have billions of publicly traded asset-backed bonds out there. And we do roadshows with the bond investors and it is what it is. Very high-quality portfolio.

Particularly given the margins. Ed, you said that the increasing credit quality this quarter had accounted for about a penny of earnings growth? Is that a penny of the eight year-over-year increase?

Yes. If you were to look at the losses for the quarter and, again, this is where I think some folks need to be a little careful about just looking at Master Trust data. It also includes private conduit and anything that is on our balance sheet, which isn't in those reports. We are overall credit loss rate improved 20 basis points and if you did 20 basis points on a $3 billion for one quarter and do it after-tax, it is about a penny.

So the EBITDA margin and credit that went from 21 7 to 28 8, most of that was driven by lower funding costs?

And the yield picked up a little bit. And what is interesting is that it is almost a trade-off of when you have a little bit slower growth than you'd normally have in the portfolio. What you do have almost offsetting that is that you have a number of clients that are really getting more and more mature.

And as they become more and more mature and fully ramped up, you are beginning to optimize the yield on those clients. So you can actually get the yield picked up well after the client has fully ramped up which could take three years. And that is sort of what we are seeing this year and then as we move into next year, you are going to see that yield pick up. You probably won't see a yield pickup next year but you are going to see very nice growth return to the portfolio in sales.

Last question. Blair. Is that live and if not will you have it live before Black Friday?

Mid-November.

Mid-November.

Yes and I think end of the first week of November is where we are scheduled.

Yes. That's good to go.

Greg Smith of Merrill Lynch.

Can you give us an update on the Coalition Rewards pilot you have going on there in Texas?

Again, we don't break out too much detail there. It is a grosser pilot, it is not a coalition pilot yet. Obviously as we said we have two paths for our Loyalty business in the U.S. driving individual one off Loyalty businesses expanding our Epsilon channels into groceries. And that also happens to be obviously the key anchor tentative to any coalition program. And after we prove results there, we believe that not only from an expense management perspective for sponsors, as well as a list for consumer activity at their stores, a coalition model is the best model.

So we are in the first stage of a grosser only pilot which we will wrap up at the end of this year.

Great. And then, Ed, you've mentioned something about pricing being, I think pretty solid at Epsilon. Is that on basically new clients coming on? Can you just give us a little more detail on that?

Yes. I don't think there's a lot more detail I can give. It's both with the new folks coming on as well as we've had some pretty significant renewals/expansions of existing clients. And we've been quite pleased with the pricing there as well.

And then just lastly, Ed, on the tax rate for 2006? Pretty similar?

Yes.

So 537.5, maybe?

Yes.

Don McArthur of Stifel Nicolaus.

Congratulations on the quarter. Can you talk about the addition of Gift Card capabilities and how many of your Private Label customers have Gift Cards currently? From another source?

I can't give you the number on the existing relationships that are outside ours. This is a relatively new product we are ramping up, as we again want to help our clients manage all payment types, not only merchant control that drive their costs but also allow us to capture data and information on their consumers to target markets. So it is really a beginning stage ramp up for us.

And then other than I guess existing contracts and the length of them, is there any impediment that we should be aware of, of competitive takeaways of Gift Card programs which are existing if somebody had one already?

Is there an impediment?

Well, (MULTIPLE SPEAKERS) to you from somebody else other than the length of the contract?

No, there's no conversion issue. There's no other than whatever relationship they had with an existing one, if they had one.

Finally, did you earn a float off of the funds on those?

(MULTIPLE SPEAKERS)

No. The store carries the float.

Andrew Jeffrey of STRH.

Suntrust Robinson Humphrey. Ed, can you give a little color on what you think the segment EBITDA margin should look like in '06 or even on a -- in a normalized kind of environment? We have seen some movement around in the margins and I think I understand what is going on in transaction. But for example in marketing this quarter, was down a bit sequentially. And I would think maybe Bigfoot is poised to help that in 4Q, but I'm wondering if you can give us some guidance as to where you think, all us being equal, the normalized kind of EBITDA margins are on a segment basis?

Yes. I think if you were to look at starting with marketing services, yes, obviously, that jumps all over the place by quarter. But it is still tracking as we had been promising all year very nicely. Call it 150 basis points on a full year basis to be up versus last year. And if you were to look at last year's margin this quarter was up 60 basis points.

So I think overall we're very nicely on track to have the Marketing Services group be up 150 bips versus prior year on a full year basis and on a go forward basis you are exactly right. I mean, Bigfoot has better EBITDA margins than Alliance as a whole and we would also expect between Bigfoot and between Epsilon and between the way Canada is just cooking along, that you are going to have some decent margin expansion in the Marketing Services bucket.

I think you were also going to have decent margin expansion in the Transaction Services bucket. And that is the result of you are not going to have the Utility cleanup costs that we had and you are not going to have the huge startup costs that we incurred sort of in the back half of this year. Hopefully, we will have some new start-up costs as well. And then what I would do is I would hold margins flat in the Credit Services bucket and I think you can back into, given the guidance we've given you for 2006, we do expect decent EBITDA margin expansion. And if you hold Credit Services flat and split the remainder between Transaction and Marketing you are going to get pretty close to our budget.

Then, one additional question in terms of charge-offs. Is it possible to give us a sense on a dollar basis what you would expect charge-offs to look like in '06? You talked about the 1 penny lift or something less than that in the third quarter. But when we look at '06 in terms of absolute dollar charge-offs, how should that look compared to 2005?

Hopefully, it will be going up from a dollar perspective because, hopefully, the portfolio will be nicely up as well. So if you were to take the assumption that we would expect our charge-off rate -- I know you want to get to dollars -- but our charge-off rate in the 6.5-ish. And if you want to stress test it, it certainly wouldn't -- disaster would be if it went up 50 which is sort of how we stress tested our guidance. 6.5 to 7 which again that would be highly unlikely against a portfolio that -- let's call the portfolio up 10 or 11% and you just do the math and that will get you dollars.

Colin Gillis of Adams Harkness.

Is there any difference in charge-offs that the level of charge-offs between your new accounts versus those that are already part of the Master Trust?

For sure. Usually a typical cycle in the Private Label would be the first few months of a brand-new card you're not going to have a lot of charge-offs. Then what happens is, eventually, you are going to have a bubble up where you have a spike in the charge-offs. And then it starts to head back down to the normal rates. But given that our portfolio grows fairly consistently year after year after year and it is a very very mature portfolio, I think our average account age is 36 months or older, which is considered a very mature portfolio.

What you're basically going to see is there's not going to be any major swing in your loss experience due to new accounts being added or new accounts not being added. It is just not enough to move the overall weighted average of the portfolio.

Great. Is there any timing, might you move up the timing in regard to hitting the markets for asset-back bond sales or are you pretty firm about doing that in the back half of '06?

Yes what we usually do -- that's a great question. What we usually do is we try to tie the -- all the new business that we have been growing either in private conduits on or on the balance sheet and add those two, whatever existing bond deal is maturing. And basically you make a bigger deal and you just do one big one as opposed to a couple of smaller ones.

So we have a deal that is maturing in the fall of 2006 and when that matures what we will do is, we will take a whole bunch of the new stuff, add it to that, and then just roll it over and refinance over the next five years.

Got it. So as we move through 2006 the Master Trust data we're going to get is going to be an increasingly incomplete picture?

You've got, it, that's exactly right.

Dynamite. A couple of housekeeping items. Could you just talk about the share buyback in the quarter. What was executed?

Sure. We completed -- substantially I think we are well through this program. I think we put a footnote in the release. I think we spent 60 -- year-to-date we spent 65 million average purchase of 39 45.

The length of time for miles to redeem, can you just refresh us what's that at and are we seeing any change going on there?

I think we take it over 42 months.

Dan Perlin of Legg Mason.

I guess I have several questions, the first of which is did Bigfoot impact in the quarter. What are you expecting in the fourth quarter and what are you building in for the full year?

No impact in the quarter. We closed it, I believe, on the very last day of the month. And for the full year I don't think it's a huge number, maybe a few million on top line and probably not enough to really move the needle on bottomline.

And '06?

And '06, I think when we put out the original Bigfoot announcement we were saying it was doing roughly 30-ish top line growing at a faster rate than Alliance overall in margins would be in the high 20s.

This funding cost issue is the last -- I guess last quarter, in the second quarter was when the first stepdown actually dropped 50 basis points. As I recall it was $500 million. Is that correct? First of all, and then the second part of the question is, how much and what is the schedule going to look like as we go into 2006? Is all 2.2 billion going to have a stepdown function or is there just another $500 million charge or is it a billion? Can you give us some insight there?

It's all stepping down by -- I can't answer your first part of your question. The 500 million 50 bip sounds right but I'd have to go check it, Dan. They're stepping down, there's a whole group of different tranches and different bond deals that we did but, overall, your number is exactly right. There's a couple billion dollars there that will be stepping down over the next few years.

Obviously, offsetting that to some degree would be all the new stuff that is coming on that we fund at the short end of the curve until we are ready to do a long-term bond deal. That is at a higher rate most likely these days. And that is why when we did our first real cut of 2006 we were pleasantly relieved to see that it looks like we are going to have a pickup next year, somewhere to the tune of minimum 25 bips. Perhaps even more than that, which is why we are pretty comfortable that any little blip on the credit loss side will be nicely offset.

And none of that had any reflection on your decision not to securitize certain portions of the new portfolio? Meaning, you have this kind of track record of building this kind of step function up over time for earnings growth. And it would seem to me that you have the funding cost for '06 almost in the bag. New growth that's coming on isn't enough to offset it or make it neutral. So you are pushing off the securitization until the second half of the year where therefore you are going to have lower rates again.

No, well -- (MULTIPLE SPEAKERS)

I mean that's going to happen. That's a (indiscernible).

Yes, we are actually pushing were not pushing it off because what we're doing there is a deal maturing in the fall of next year and that is when we are going to lump all the new stuff on to the maturing deal and just do one big deal.

The reason that you are changing the managed or giving this managed receivables is for that reason?

You got it.

And in your planning (technical difficulty) pertains to income trust decisions, do you or do you not forego growth opportunities if you do an income trust. Meaning, you have a short-term pop in the potential value of your Company but because you have to pad all your distributable cash, doesn't that preclude you from growing that business?

Yes, it is a very good question. I think it is more of a question of if it is nothing more than what everyone called a public mark-to-market where it is only 10 or 15%, recall the remaining 85% is still retained by ADS and their cash flow resides within ADS as well.

So that's one of the many things obviously that we are noodling on at this point.

What are your CAD (ph) assumptions for '06?

Our what?

Your Canadian dollar assumptions for '06 in your earnings guidance?

We kept it roughly flat to where it was this year.

Lou Miscioscia of Lehman Brothers.

I thought your Private Label sandbox chart was interesting. Could you maybe go into it in a little bit more detail? Maybe size could be (technical difficulty) entire market if you have actually put a number on it or I see obviously you've got it color-coded with the emerging -- I mean, how aggressively do you think you are attacking the merging area. And is the other areas you haven't attacked still equally attractive and take a couple of years for you to decide to really start to go after that?

Yes I'll start and then kick it over to Mike. But we've -- our cut over the past few years when we stayed a little closer to home has always been, let's look at potential prospects that are of decent size where brand is all important and where the typical customer walking through the door for the most part is prime quality credit, which again gets back to why the portfolio is a 700 FICO.

When we did all those different cuts we came up with about 220 or so prospects in our world of which only about half have a program today, about 110. And of those 110, 75 are with Alliance. So we've got about two-thirds of the sandbox defined that way.

As we continue to expand into the new spaces like the home improvement and the outdoor rec as well as the new product extensions that we have, my guess is, you are going to start seeing that number go up. Could it be as high as 300? Could be but my guess is, it is going to be a significant increase to that original target market that we've talked about before.

And we are dividing our salesforce and attacking obviously all of the green sectors as our priority, based on our experience and leveraging our infrastructure there and in the gray areas during some initial feeler kind of approach. But our target is really the greens.

Mark Marostica, Piper Jaffray.

Actually this is A. J. Congratulations on your quarter. Ed, could you just go over your quantifying startup costs transaction services? What would the EBITDA have been in that segment without those startup costs?

Yes I mean probably about one get into a lot of detail assume it is a couple of mil. It is more of a question of these are not onetime costs. These are things that hopefully we incur all the time. So I would be a little cautious of saying they are onetime costs of a couple of mil. We include it in our operating plan.

Fair enough and then, also, I know on the AIR MILES program, you signed or renewed LCBO Ontario. How does that deal -- I mean you've had a relationship with them already -- but how does that deal position you to sign deals with additional provinces in Canada?

Very well. That is on our -- as you've seen us do in the past the kind of target segment we've done, penetrated yet as limited to other provinces. Having that relationship and showing how it drives customer behavior for the benefit of Ontario is working in other provinces, as well. It is a little bit slower sale cycle than other sponsored categories because of the government influence. But it is something I expect to see this year and actually more next year in terms of added account.

And I think, to Mike's point, if there are ten provinces up there we have exclusivity by province. I think to date we have Ontario, I think it is Manitoba and Alberta as the three that we have today. So that leaves seven and that is why I think it is going to be a good category for growth going into '06.

Lastly, just on marketing, just in terms of redemption of AIR MILES in the quarter. It was about 9%. Can you give us maybe at a trend? That seems a little bit low, lower than what I was expecting. Is there a trend there or is there just -- is it seasonal? Just a little more detail behind that?

We would love to tell you there's a trend. All we know is it jumps around quite a bit quarter to quarter, depending upon what the rewards are. Maybe there is some rewards in the quarter. Maybe folks are waiting to redeem with more miles in the latter part of the year. It is tough to say. What's interesting is when the hockey season was off the last year or so, that was a big category for us. We saw some big shifting of behavior there but, overall, I think what we are seeing in Loyalty is, the miles issued metric which we usually run about 10% is way ahead on the issuance side. I think the redemption side, which doesn't trigger any profit -- all it does is trigger recognition of revenue and an offsetting cost of goods sold -- we usually run around mid-teens. And we may be on the low to mid-teens this year on a full year basis.

Jason Buesser (ph), Raymond James.

I was wondering about the sequential rollout for the transaction services EBITDA margin next year?

We haven't even come close to rolling anything out on a sequential basis. We will have a pretty good idea in January if you can hold off until then.

Okay. Also was there an uptick this quarter in revenue per statement?

Revenue per statement, pretty flattish. It runs around $3.00 per account, $3.00 per statement per month and it will be anywhere from $2.90 to probably $3.05.

Paul Bartolai of Credit Suisse First Boston.

First on the transaction side, the margins were a little bit lower than expected and you talked about the extra cost of Private Label. Was that expected? Because I thought we were looking for margins to be up there after we'd finished off the Utility spending there?

Yes, I think we -- from the expense side I don't think we were expecting to have signed so many new clients this year that absolutely demanded that they get up and running for the fall and preholiday. So I think from that perspective, it was a no-brainer.

And then, are all those costs, are any of that in the credit side or is that all housed in the transaction side as far as the start-up costs?

That's transaction.

Okay. And then shifting to credit, the credit margin's pretty impressive up 700 basis points. I mean, it sounds like loss rates was not as big of a factor. What is driving that? Is there anything else in those numbers that we might not be aware of?

Yes it's out think it's anything you are not aware of. I think I would lump them into, Paul, three buckets. I would say, first, yeah, there was a little bit of a kiss on the credit loss side. Not much, as you correctly pointed out. On the funding side, you picked up some benefit there because that's netted in revenue and then the overall yield ticked up as well. And I think we chatted about it a little bit earlier -- when you have a portfolio that isn't sort of growing at our 10 to 12% that we normally run, what you have is, you tend to have programs that are a little bit more mature. And the more mature the program is, the better we are at knowing consumer behavior and actually optimizing those individual programs. And as a result, you tend to have yield go up.

And then what will happen next year in '06 is you'll start as soon as the growth starts returning to very nice double-digit growth, you are no longer going to have that yield pickup.

And then on the credit sales I mean that slowed a little bit sequentially. Anything that was weaker there than you expected? I mean, with all the contracts you guys have signed I would have thought that we would have continued to see that ramp up over the course of the year.

Yes I think you'll see -- I mean, it's a fair question. I think what we are seeing is absolutely in Q4. It is going to be enough to move the needle. I just don't think it was enough, Paul, at this point in the year. All the new ramp ups. They just didn't have enough juice yet in Q3 to really move the needle and they will in Q4.

All right then. Just last, moving to marketing. I think this was asked earlier but on the margins they're down 200 basis point sequentially. And I know it can move around a bit but anything that caused that?

No, we, in the marketing side, much like can you talk about the jump around in miles issue or miles redeemed, what you're really going to see is, we are all about the full year. And we are very comfortable. The full year you are going to see 150 basis points expansion in the EBITDA. It's that simple.

And then when you have lower miles redeemed in the quarter shouldn't that benefit margins, though? Just given that those are kind of 0 profit?

Yes it could. It depends what expenses are in there as well. I mean, I think someone asked if we spent more -- did we have some super duper marketing program in the quarter. We are always spending on marketing and we managed to the full year number and the full year number is a nice expansion of 150 bips.

Then last, I think Canada Safeway is up at the end of the year. Has that been renewed or are we still waiting for that announcement?

We are well on target if we haven't already come close but I don't really have the -- just a minute here let me look at the (indiscernible) chart. (MULTIPLE SPEAKERS)

It's in good shape.

It's in good shape. There's nothing to worry about but I don't have the exact timing of that on a monthly basis.

Thank you. Good job.

We have run out of time for questions. I will now turn the floor back over to management for any closing remarks.

Again, thanks, everybody for joining us. We are excited about how we're going to wrap up the year and 2006 is looking very strong. We will be talking to you on the roadshows coming over the next quarter. Have a good week.

Thanks now.

Thank you. This concludes today's conference.