Bread Financial Holdings Inc (BFH) 2005 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen. My name is Martina, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Alliance fourth quarter yearend 2005 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. If you would like to ask a question during this time please press star, then the number one on your telephone keypad. If you would like to withdraw your question press the pound key.

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

Thank you, Operator.

By now you should have received a copy of the Company's fourth quarter and yearend 2005 earnings release. If you haven't please call Financial Dynamics at 212-850-5608.

On the call today we've Mike Parks, Chairman and Chief Executive Officer and Ed Heffernan, Chief Financial Officer of Alliance Data.

Before we begin, I would like to remind you that some of the comments made on today's call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and uncertainties described in the Company's earnings release and other filings with the SEC. Alliance Data has no obligation to update the information presented on the call.

Also on today's call our speakers will reference 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 web site at www.alliancedatasystems.com.

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

Thanks, Julie. Good afternoon, everyone. Thanks for joining us.

If you'll turn to the agenda page, as usual, we'll spend a few moments reviewing our highlights of the fourth quarter. I will focus on our three growth engines, and then we'll take a look at the full year results, and we'll give a brief recap of the year, and we'll also talk a little bit about our '06 outlook. And then I'll turn it over to Ed to review some of the financial details.

Now, let's turn to the next slide. Looking at the fourth quarter we're obviously very excited to announce another record quarter for Alliance Data, posting revenue this quarter of 421 million, a 21% increase over last year. EBITDA for the quarter increased by 36% to 92 million, and cash EPS was up 42% to $0.54 per share. This is our nineteenth consecutive quarter since going public and meeting or exceeding our plan.

Our performance is a result of our ability to deliver on our business model, add new clients, and renew key relationships that provide us with great visibility. The commitment and hard work of the Management Team and our 8,000 associates has resulted in the strongest quarter in our Company's history, and I want to thank everybody for their efforts

Let's take a look at the fourth quarter activity, starting with utility services now. Our Utility Services Group had a very strong quarter, posting double-digit growth in both top line and EBITDA. We also had a great sales quarter, completing two signings that will give us great traction into 2006.

We signed a 10-year agreement with First Choice Power to provide a full suite of billing and customer care services for their 215,000 plus residential and business customers throughout Texas. First Choice Power is the deregulated subsidiary of P&M Resources, an energy holding company based in Albuquerque, New Mexico.

We are also pleased to have completed a 10-year agreement with Green Mountain Energy to host and manage their CIS platform, as well as manage billing operations. Green Mountain is one of the nation's leading retail providers of clean air electricity products that are generated from the sources such as wind, water, solar, geothermal, and natural gas. They offer services to residents in Texas, New York, New Jersey, Florida, Oregon, and Pennsylvania.

To recap, we've had three nice wins this year. First Choice, Green Mountain, and Cobb Energy. Additionally, we secured consulting engagements with a number of utilities, which continues to broaden our reach in this large and emerging market.

Turn to the next slide, and talk a little bit about private label. Our private label group had another stellar performance this quarter, and with the record new signings of this year we're seeing strong momentum in our overall credit sales and portfolio growth. In the first quarter of 2005 credit sales growth was 2%, and by the fourth quarter almost 10%. Portfolio growth doubled from 4% in Q1 to 8% by Q4, and that's great momentum. These strong metrics have also contributed to double-digit growth in revenue and EBITDA, and this despite an $11 million bankruptcy spike resulting from the recently enacted legislation.

During the quarter we were pleased to announce that we renewed our relationship with our largest and most tenured client, Limited Brands. We will continue to provide a full suite of private label card services for Victoria's Secret Stores and catalog, the Limited, Express, Bath & Body Works, and Henri Bendel. Limited Brands continues to be a valued partner, and we both have a strong commitment to growing their card program, which over the last few years has been waning in some of their brand. We'll be deploying new tools and resources to expand their program, including enhanced analytical capabilities.

We also expanded our relationship with Spiegel and Newport News, launching integrated co-brand credit card programs for each brand, catalog, and online channel. As consistent with the private label program our co-brand offering will meet our traditional credit quality standards but we will target inactive accounts for our client. The programs will feature a rewards program where account holders earn points and then can be redeemed for merchandise. We anticipate picking up another 5% of wallet share through these programs. All in all, a very nice quarter.

Let's turn next to the marketing services area which include both our AIR MILES Program and our Epsilon business unit. Marketing services had a great quarter. Their strong financial performance continues, particularly including a 400 basis point expansion in margin. Our AIR MILES Program delivered above expectation as the fundamentals of the AIR MILES Program, that being sponsors, collectors, and rewards remain quite strong. We renewed two of our top sponsors in the program who, by the way, are also top 10 Alliance Data clients.

First, we signed a long-term renewal for American Express Canada where they view their AIR MILES Reward Program as an instrumental part of growing their card base and creating greater levels of loyalty in card usage. We also announced the renewal of a longtime sponsor, Canada Safeway, a sponsor since the program's inception in 1992.

Now, switching to our U.S. business, we completed a very smooth integration of Bigfoot Interactive with our Epsilon Group. This acquisition is a great fit for our Epsilon business as it expanded our service offering to include permission-based e-mail marketing services.

We're also very pleased to be recently cited as a leader in Forrester Wave database marketing and service providers in an evaluation of top database marketing companies. According to this report Epsilon ranked number one in current offering and strategy categories with a report noting and I quote, 'Epsilon sets the standard for database marketing services providers.'

This also follows Forrester's recent citing of Epsilon Interactive as a market leader for the third consecutive year in the e-mail marketing service providers' evaluation, giving Epsilon the distinction of having a leading offering in both the database and e-mail marketing industries.

And, finally, Forrester notes Epsilon as 'in the sweet spot of marketing demand,' and touts the Company for its comprehensive offering and exceptional service. Congratulations to the Epsilon Team.

All right, let's turn and talk about the full year results. We had a great year. We finished the year with $1.552 million in revenue, EBITDA of 350 million and cash EPS of $2.06, a 34% increase over last year. Our focus has and will continue to be on those markets that have solid organic growth potential.

We had a tremendous year in forging new relationships equivalent of 20+ new clients from all three growth engines. We worked hard to ensure we delivered on our promise to drive results for our clients, and those results drive their confidence in us. Our success is demonstrated by the number of renewals and expanded relationships we secured with our key client. All of our top client relationships are secure, providing us with great predictability and visibility in the future.

Our financial positioning has never been stronger, as is our confidence in our ability to increase stockholder value. We've increased our liquidity and financial flexibility by adding another $300 million in capacity to our credit facilities. And in October we announced a new stock repurchase program that along with our announcement in June provides the ability to buy-back up to 300 million of outstanding common stock, or roughly 10% of outstanding shares.

2005 was another strong year for Alliance Data, and I would like to thank and recognize our Management Team and associates for their hard work and commitment. The direct result of their passion and commitment that we receive recognition, such as Forrester, as well as some recent recognition by Forbes, and we were for the second straight year announced as part of the Platinum 400 Program and we were also recently cited by the American Society for Training and Development as the best place to learn in Dallas.

Having said that, 2005 is over. We're done patting ourselves on the back. It's time for a new year, and we're just as excited about our prospects for '06. So, let's turn to the next slide.

The outlook for 2006 continues to be bullish with our strong business fundamentals at work. We expect our long track record of performance to continue, fueled by our new business activity in 2005. We expect the momentum we saw in the fourth quarter to continue into and through 2006. We expect balanced growth across all units and our pipeline is solid across all businesses.

During 2006 we expect to secure four to five new private label clients, two to three utility clients, and four to six in our combined loyalty and marketing service businesses, all of which drive our highly organic growth model.

You should also expect us to continue to invest in select tuck-in acquisitions to enhance our product offerings and leverage our talent. All in all, 2006 is looking to be another good year for Alliance.

Now, I'll turn it over to Ed for a more detailed review of our financial performance and expectations. Ed.

Thanks, Mike.

If you could pull-up the slide, fourth quarter consolidated results, we'll start there. Q4, as Mike mentioned, marked our nineteenth quarter as a public company and further extended our track record of delivering or over-delivering on what we've promised. Simply put, this was the strongest quarter in the history of the Company.

Revenues which grew over 20% and topped 400 million for the first time, powered by exceptional results in marketing services and solid performances in both transaction and credit services. EBITDA of 92 million was also led by marketing, and for the first time this year transaction services turned from negative growth to 18% positive YOY growth. And, finally, credit had another solid double-digit quarter.

Operating EBITDA or operating cash flow surged ahead 29% and finished the year at 382 million or 32 million ahead of reported EBITDA, significantly higher than expected due to the strong performance out of Canada.

Finally, strong operating results plus solid free cash flow generation provided further lift to the bottom line as evidenced by cash EPS growth of over 40%.

Overall, Q4's results delivered on what we've been saying all year, and that is that marketing services will over-perform, that you'll gradually see the gradual return to growth in transaction services, and that you'll start to see the increasing momentum in private label credit sales and portfolio growth metrics as we exit '05. And, finally, that you'll see stable credit trends and funding costs as we move through '06. In a nutshell, strong momentum heading into '06, and we are as confident as ever in another solid year.

Let's turn now to the segments. First up, transaction services which houses private label services, utility services, and our traditional merchant bank card business. Once again, as promised, momentum continues to build. Revenues moved from negative growth in the first half of '05 to 6% positive growth in Q3, to 8% growth in Q4. Utilities services drove much of the gain as new client wins resulted in strong double-digit growth. Also, private labels started to see some growth return as new clients started to ramp-up.

Speaking of growth, overall, was understated in that it didn't include Entergy and direct energy customers since they have yet to be converted. However, all services, such as call center, customer care, and collections for these clients have been completed and, thus, drove the strong revenue growth, itself.

EBITDA grew a solid 18% in the quarter versus negative growth through the first three quarters of '05. Simply put, the top line momentum gained steam, more and more drops straight to EBITDA.

All right, what's the outlook for '06? Look for momentum to continue and statement growth to accelerate, with top line results somewhat tempered by our traditional merchant bank card business, which is about 20% of the segment, which will remain roughly flat. Overall, however, it should be a very good year for the segment.

Next up, credit services, which put in a heroic performance by growing top line double-digit in EBITDA over 20% despite incurring roughly $11 million in extra expense triggered by the recently enacted bankruptcy law. How did it manage to 'play through' this expense? Let's hit the four key drivers.

First, credit sales came in right around 10% versus only 2% in Q1. As we have suggested all year, the huge book of signings in '05 would start to 'move the needle' by Q4. This ramp-up will continue and gives us a strong jumping off point for '06.

Second, portfolio growth also started to reflect the benefit of the ramp-up as it grew 8% or doubled its growth rate from Q1. Again, this will drive into '06.

Third, funding costs improved during the quarter as our long-term fixed rate funding book had a favorable reset to some of its rates. We expect good news on this front, as well, in 2006.

So, pluses from solid credit sales and portfolio growth, along with slightly favorable funding costs overwhelmed the negative impact of the bankruptcy legislation's related credit losses. Specifically, credit losses came in around the mid 7% range versus a 'normalized' or expected rate in the low 6s. The delta was $11 million, and as noted resulted from the new legislation.

This should also help clear the decks for part of '06. Our full year loss rate for 2005 was in the mid 6s, around 6.5%, and we expect very stable results in 2006, as well. That is, no upward pressure.

Wrapping up credit, the ramp-up came through as anticipated and will continue into '06. Additionally, we expect no drag whatsoever from either funding costs or credit losses. Full steam ahead.

All right, finally, let's finish-up with marketing services, which earned the gold star for the quarter. Despite the anniversary of Epsilon revenues still grew 39% and EBITDA rocketed 89%. Also, of importance was EIBTDA margin, which shot-up dramatically and is about 400 basis points and came in 130 basis points ahead of last year on a full year basis. This demonstrates the leveragability of the business.

Loyalty led the charge, once again, as revenue growth surpassed 20% with miles issued and miles redeemed both growing double digit. Along with the renewals of American Express and Safeway Loyalty is poised for a solid '06, as well.

Epsilon also had an outstanding quarter and year as new or expanded deals with Hilton, Pfizer, B of A, TruGreen, and others drove over-performance throughout the year. And, finally, Bigfoot, now called Epsilon Interactive, joined the team in Q4 and added a few million to the top line.

Looking ahead at '06 we expect marketing services to have another tremendous year as the percentage of the cash flow begins to swing more towards marketing and a bit away from credit. Nonetheless, we expect all three segments to have a good year in '06.

All right, let's now move over to the balance sheet. Four items to talk about. First, as AIR MILES continues to over perform and the Canadian dollar remains strong our deferred revenue balance continues to grow at above trend rates and has surpassed U.S. 600 million. That's a 60 million plus from a year ago versus a normal trend rate of 40 million.

What does that all mean? Well, it's all going to flow into the P&L, so it's positive news for '06, '07, and '08 as it starts to flow-through the P&L.

Second, share buyback program. In all of 2005 we spent 150 million buying back just under 4 million shares at an average price of a bit under 38 per share. This program is accretive into the high 40's making it a good use of cash. Also, our goal is to provide very strong support during any pullbacks rather than use the cash to try to drive-up the price. For '06 we have another 150 million to spend which looks highly attractive at these prices.

Third, the debt increase in Q4 was due to three items. First, the purchase of the Blair file which was 160 million. Seasonal up tick in the cards receivables required to be held on the balance sheet, which was 120 million. And a share repurchase which was about 80 million. The card related items, which are the first two, will go away either following post-holiday, that is the end of Feb. or when we securitize, so it's mainly timing.

Finally, capital structure and liquidity. We increased our core borrowing facilities by $300 million in January. These facilities, along with our expected free cash flow from 2006 brings capacity to over $1 billion of which less than half is being utilized today. This also excludes additional borrowings that we have available using CDs to fund on-balance sheet card programs. So, overall, lots and lots of flexibility to pursue any number of opportunities.

Let's turn now to 2006 guidance. As has been the case in the five years that we've been public during our Q3 call we gave the following year's guidance and that guidance was as follows. Revenue, we wanted to come in for '06 minimum of $1.68 billion. EBITDA at least $400 million, and cash EPS of $2.36.

Where do we stand right now? Just sort of a general comment about guidance in general. We don't want to get into the tweaking the guidance every single quarter throughout the year, so, therefore, we sort of set the minimum targets which we did during Q3's call. We will adjust guidance as necessary as the year plays out.

Right now, the trends seem very strong, and we are certainly expecting, once again, to outperform this guidance. And so as the year unfolds to the extent there is positive news that will flow through as the quarters unfold and we'll bring up guidance accordingly. For Q1 we expect a minimum cash EPS of $0.62, which is up around 20% versus last year.

Next page, estimated free cash flow, most of the folks have heard us go through this many times, but essentially we're one of the few companies where our cash flow tends to run ahead of our reported numbers because of the way the accounting works for loyalty up in Canada.

Essentially, if we were to report EBITDA of 400 million it'd be an extra 25 million of profit from our Canadian business that is sitting in there in cash, but hasn't been flowed through the P&L yet. So, we use a term called 'operating EBITDA,' of about 4.25. If you were to take out CapEx, interest, and taxes, a little over 200 million, you'd have pure free cash flow of about 220 million. So, we expect greater than or equal to 2.60 per share. I think actually we tweaked that a little bit from 2.56 last time, so it is, it's definitely heading up.

Okay, turning now to -- what we try to do is gather the top questions that we've, that either Mike or I have received throughout the quarter from folks and hit it straight on during this part of the call. The three questions have to do with consumer spending, credit quality, and the Canadian income trust.

Let's first talk about consumer spending. For half our business it doesn't matter. We've went through this many times before, like in the utility business folks are going to be sending in their bills, and our loyalty business in Canada has nothing to do with airplanes, it has to do with folks spending on their everyday purchases, like gas and grocery and going to the pharmacy.

But for the other half of our business, which is private label, a weak consumer in 2006 will not derail the business simply due to the massive amount of new business that's still ramping up from '05. We saw the ramp-up really kick-in in Q4 and that's why we're confident in another fine year.

Next, credit quality. As mentioned earlier, our 2005 loss rate was in the mid 6s, around 6.5%. We are very comfortable that 2006 is also tracking in that range. In fact, Q4's delinquency rate of about 4.5% was 30 basis points better than prior year's rate. since delinquency rates give us the trend of the ultimate credit losses it certainly looks promising.

I think I'll stop just briefly at this point, just to make a couple of comments. And one is, obviously, there was an awful lot of noise out there in the market about ADS, I think last year, the fact that one of our loyalty vehicles used a credit card and thus had a credit component. And I think the argument that raged through most of '05 was the fact that with the credit cycle peaking and the consumer weakening and this being our largest Division that, quite frankly, the wheels were going to fall-off the bus in '06. I think that's the simplest way I can put it.

What you're seeing in Q4 is what we had tried to communicate I think unsuccessfully during '05 which is that's not the case. The credit quality remained very, very stable. The growth rate in the credit sales in the portfolio is actually accelerating and we would expect private label to have a very strong 2006. You roll that in with the rest of the business and that's why we're so comfortable not only providing guidance last Q3 but also saying that we're expecting over performance during the year, as well.

Okay, finally, the AIR MILES income trust, the source of many, many questions. We'll take this as quickly as possible. First, yes, the large Canadian banks came to visit us in the Fall. Yes, we are fully up-to-speed on how it would work. Yes, the bankers put a median value of U.S. 1.6 billion on AIR MILES based on 2005's U.S. 100 million of operating EBITDA.

We spent a great deal of time gathering input from Board members, shareholders, and others in studying this option. Quite frankly, it's a house divided, between those who believe in a quick pop versus those that want us to 'just keep doing what you're doing, you're building a great franchise and track record.'

So, where are we today? Most importantly, our number one focus is to ensure that 2006 is another strong and successful year for the Company, period. In addition, we've cranked up a 300 million share repurchase program, representing 10% of our outstanding shares to further provide confidence to our stockholders.

However, we will continue to monitor the trust market. This is an option that we can utilize at any time. Right now, it is simply one of several opportunities that could potentially enhance stockholder value. We will focus on the Company, the buyback, and the market's opinion of the Company on an ongoing basis to help guide us as to whether or not we should further explore this option.

Now, turning to the last two slides, just showing our operating leverage, back in '99 when it was under 14, and we expect to be right around 24% EBITDA margin during '06.

And then the final slide, again, shows the consistency, the predictability, and the visibility of the business model over all these years. We tend to stick to a 12, 15, 18 type model of 12 top line, 15 EBITDA, 18 per share. Clearly, over the last six or seven years we've out-performed that, and so far this year we're off to a great start.

With that, I'll turn it back over to Mike.

Thanks, Ed. Nice job.

That's it, Operator. We're ready to take questions. Please line them up.

[CALLER INSTRUCTIONS.]

Your first question comes from Jim Kissane, Bear Stearns.

Thanks, and great job, guys. Given the changing mix in the marketing business, you know, with Bigfoot and Epsilon and the AIR MILES business, you know, what's the right margin on an EBITDA basis to think about going forward?

Good question. I think on a go-forward basis the margin expansion that we expect across the three segments would probably go something like this, Jim. We probably won't see a loss if any margin expansion in the credit segment. I think we've sort of leveled out in terms of funding costs and credit quality. I don't think it'll go down but I don't think there's a lot of room there.

So, you're really left with transaction and marketing, and we want to grow overall consolidated margin at least 50 basis points a year for the entire Company. So, I would probably say they would be, to get there we'd split it evenly between marketing and transaction services, so look for marketing – I don't think they'll do 130 basis points again in '06 but maybe half that is probably fairly reasonable as a starting point.

And not to focus too much on minutia, but I think you had been talking about 150 basis points, Ed?

Right.

What, do you spend more in the fourth quarter in marketing?

Yes, it was sort of a stick in the sand that we placed there and we came in at 130 as opposed to 150.

Got you. And it just seems like you're being overly conservative on the credit margins for '06 because you've indicated that funding costs should step-down a bit, and your charge-offs, while you're saying mid 6s I mean all the trends would indicate it's going to be lower than that.

Well, that's the way we like to start off the year, I think. I think clearly on the funding cost side, obviously, we have full year visibility on that, and that where things stand now with our step-downs and everything else there is probably or there is definitely a little kiss there on the funding cost.

On the credit losses, the credit quality, you're exactly right. We had initially sort of talked about what happens if there was a 50 basis point worsening in the credit quality, you know, would that drive us from our guidance? What we're saying now is, you know, we don't expect any worsening whatsoever. To the extent it improves even more we would consider that up side, but right now with delinquencies, as you mentioned, where they are it's looking like a real solid start to '06.

Great. Now, if I can get one last one, Mike, what's your sense of the pipeline, particularly the private label business, because you had such a big year in '05?

You know, as I mentioned in my earlier comments, we have good pipelines across, Jim, but we had certainly a great year in '05, and probably pulled a few deals forward but we're still comfortable with our guidance.

Excellent. Thank you.

Thank you. Your next question comes from Tien-Tsin Huang with JP Morgan.

Thanks. Nice job, guys.

Thanks Tien-Tsin.

A few questions. How many shares did you guys buy back in the quarter? I think I missed that, and I was hoping to get the yearend share count?

We bought back a total of 4 million shares during the entire buyback for '05. We used the [450] million. Our average share count was around 82, 83, 82.3, 82.4 is where our average was for the quarter. As for the quarter end share count, yes, maybe about 400,000 below that.

Okay, great. And then…

Maybe about 82 flat.

82 even?

Yes.

Got you. And then the interest expense line was a little higher than what we expected. I just wanted to make sure I understand, that expense is attributable also to funding the higher on balance sheet credit receivables, correct?

You bet, that's a great pickup. Actually, I'm glad you mentioned that. Because we didn't have a deal maturing, a bond deal maturing in '05 we're building up the balance sheet with new programs awaiting the maturity of a bond deal in the Fall of '06. When that happens, we will be adding a good number of those new receivables on to the new deal and do one big deal in the Fall of '06.

So, in the interim we're funding them on balance sheet which means that the, we need to fund them with something. We issue CDs and we incur interest expense, and that's exactly what you're seeing below the line. Any pick-up in interest expense will be related to funding of on balance sheet receivables. When it's securitized that interest is netted as part of revenue.

Got you. So, to securitize that it would basically go towards the credit segment? As a contra revenue?

You bet you.

Great, that's helpful. And then, lastly, I guess, Mike, you know, a question about merchant processing. The bank card portfolio. I guess Nova bought First Horizon and it looked like a pretty healthy valuation. Does that change your thinking on the portfolio that you guys have?

Not yet, no. Again, it continues to provide nice cash and we continue to use it, particularly in the petroleum segment as we look for broader opportunities in the U.S.

Okay. If I could actually sneak in one more. Ed, what's the target for stock based compensation in '06?

Stock based comp is probably going to be pretty similar to what we had this year, so from a non-cash perspective there's probably 15 related to the restricted stock, and probably 15, 14, 15 related to the options, so about flat to this year.

Got it. Thank you.

Yes.

Thank you. Our next question comes from Greg Smith with Merrill Lynch. Mr. Smith, your line is live.

Hey, guys. I apologize if this is already asked, I missed some of the q-and-a, but what did the losses look like on the receivables on the balance sheet?

They're all over the place. I mean it's, you've got a number of programs that are startups, that are growing on the balance sheet that we signed, you know, over the last 12 months. And essentially, Greg, they have very little in terms of the losses. Then you have the Blair file which is very similar to the Stage file that we bought a couple of years ago which came in probably with losses in the mid-teens, quite frankly, and we're going to work those down very quickly, just like Stage, into the single digits over the next 12 months. So, we would expect as we add these files and these ramp-ups to the new bond deal in the Fall that you're not going to see a blip at all in the master trust loss data.

Okay. That's helpful. And then in the utility segment are you done with all of the platform consolidation at this point, and what kind of, what did margins look like in '05 versus expectations for '06?

I'll talk to the – all of our conversion activity now are for boarding new customers. We're not spending any money with regard to platform consolidations and the like, but we have a nice, as you now, from these signings, a nice backlog of clients that we're starting to work on and we're excited about that.

Ed, margin wise for the year, expect margin similar to this year given the…

Maybe a little higher.

Higher.

Yes, reporting – yes, there's a couple of other thing in the works right now. Obviously, you saw the Cobb announcement, you saw the First Choice announcement, and you saw the Green Mountain announcement. There are a couple of more pretty significant deals in the pipe that are going to require a little bit of up front expense to get up and running, so it's one of those, it's good news but it costs some money.

Okay. And then, lastly, on the income trust, I mean it sounds like you kind of have a loaded weapon so to speak, and you have your finger there ready to pull the trigger if need be. But what are the tax implications, and how should we think about if you actually did it how you might structure an income trust transaction?

Sure. I mean, you know, there are a number of ways, right? And you could do the 100% spin, you could do just enough to get a public mark-to-market, like 10 or 15% sort of IPO. I think if it's something like a 10 or 15% equity stake as an IPO we'll keep, obviously, you need to pay tax on the sale. We'd probably keep about 75 to 80% of the proceeds after taxes. And what you could do with that I guess would be buy back shares or something like that. And then you'd have a public mark-to-market for the rest of the business. It would also allow us to retain 80 plus percent of the free cash flow that's pouring off that thing as part of our own business. So, that's one of the structures that folks have talked about.

You know, we've heard the tax free spin-off, we've heard the numbers keep going up and up, but what we're basically doing right now, and I'll kick it back over to Mike, is we're just, we're making sure we have all of our ducks in a row and know what's going on and know what the market is doing and we'll see how this year plays out.

If, quite frankly, if I think some of the noise, if we think some of the noise in the market in 2005 was nothing more than folks really having a hearty debate on whether the private label business is a loyalty business that can withstand a credit cycle peak and a consumer slowdown, which we believe it can and we're showing that, or it's nothing more than a credit card business, if that was the debate in '05 hopefully that is being, that's dead and buried at this point or it will be shortly. So, if that's what's holding thing back then that's what we want to focus on first.

We're not going to be rushed to make that decision. We're going to focus on the year. We know that the loyalty group and the business has opportunities outside of Canada that we want to take advantage of. We know that there's some integration opportunities in the grocery sector from one-to-one loyalty marketing through our Epsilon business with the knowledge of our segment expertise in the loyalty group in Canada. And so there's just a lot of value to the Company that we want to make sure we don't lose for the long term health and growth of the Company.

Great. Thank you.

You bet.

Operator, next question, please.

Your next question comes from Andrew Jeffrey with Robinson Humphrey.

Hi, guys. Good afternoon.

Hi.

A couple of questions for you. First, just to drill down a little bit more on transaction services. Ed, does this look like a sequential revenue increase as '06 progresses? Do you still think this is a double-digit revenue growth segment for you in '06?

Good question. I think let's start with EBITDA, I think for sure from an EBITDA perspective we are expecting double-digit growth in this segment. From a revenue perspective we would expect double-digit growth out of both the retail, I'm sorry, the private label and the utility businesses which make-up, as you know, about 80% of the segment.

The question is with what's left over which is, you know, primarily the merchant bank card business, not really growing, sort of drifting there. You know, will that drag that double-digit private label and utility growth so that the overall segment is just under double digit? That could happen, but I think we're very comfortable with double digits on EBITDA and then, you know, high single digits for sure on transaction including double-digit growth from private label and utility, and, hopefully, we can trip over double digit overall.

Okay. And as it pertains to the marketing business and some of the anticipated synergies between both Epsilon and private label potentially but also maybe lower hanging fruit between Epsilon and Bigfoot, could you elaborate on that a little bit? Is Epsilon still using a third-party provider for targeted e-mail?

No, we're obviously bringing any new business on to our own platform, both across our financial services sectors and pharmaceuticals, and even beginning in the retail.

The other interesting, you know, just even from an operational perspective, one of the notes I got from Ivan the other day is integrating our Epsilon interactive process just to our own internal outbound e-mails for our retail paper suppression credit card holders, to alert them when their statement is ready to be reviewed. And then we also use it to satisfy our legal requirement to identify customers that receive mail bounce backs, so they've obviously changed their e-mail address.

So, we're not only looking at it from a revenue opportunity within Epsilon and their clients, but actually some great expense opportunity savings as we look to drive more and more credit cardholders off of paper statements to electronic and that saves us money as well, and they're being a great help there. That's, in fact, already been implemented in our private label group already.

Okay, great. Thank you very much.

You bet.

Thank you. Your next question comes from David Scharf with JMP Securities.

Hey, good afternoon.

Hey, David.

Ed, can you remind me, what type of portfolio growth was inherent in the '06 guidance you originally provided a few months ago? Was it close to 10%?

I'm trying to think what we provided, but I think we certainly said double digits, for sure.

Okay. Now, in the past you characterized portfolio growth as sort of an even mix of wallet share gains, organic sales growth with your clients, as well as new clients. What is the mix looking like this year? I mean I'm trying to get a sense for how much of the expected growth is from that, you know, big surge in new clients in '05 and whether you're assumptions about actual sales growth and wallet share gains in your existing base, if you would characterize those as being conservative, typical, or aggressive?

Yes, that's a fair comment, and it's something we talk about a lot here. I think for us to get to double-digit portfolio growth the base assumption was that the core client base doesn't have to do a whole heck of a lot, quite frankly. We've taken the approach if it's going to be, you know, if it's not, it could be as low as zero or a couple of points from the core and yet we'd still be able to get to double digit because of, as you put it, the huge ramp-up of '05.

Now, hopefully, that's extremely conservative, and to the extent there is life left in the consumer and shopping continues and jobs keep growing and wages keep growing, that we'll have good news there, and rather than 10% maybe we'll see 12, 13% growth in the portfolio. But that's sort of the general assumption. We took kind of a worst case and said we still think we can do double digit in the worst case.

Okay. So, it sounds like you're pretty much assuming sort of worst case, no growth, and spending you're keeping credit losses flat despite declining delinquencies, and ultimately it's just the Blair acquisition and new clients boarding that's driving the growth and all the rest is potential up side.

You bet.

Okay. You know, lastly, I just want to make sure I understood your comments about share repurchasing. You've got 150 million left on the authorization at yearend, you said it was accretive into the high 40s, but I wasn't sure of your comment afterwards, if you were implying you intended to fulfill that at current levels, keep buying?

We are going to be extremely supportive to the extent there is weakness and very opportunistic if there is a pullback, which is kind of a non-answer to your question other than saying we're not just going to go out there and spend it just to drive the stock up but we will be very much in the defensive mode and pick our spots and we fully expect to utilize that cash. And at the end of the day it is highly accretive. It gets less so, obviously, the higher you go, but I think up to like $48 it's almost a push.

Mike?

There's no question we will use up the other 150 that we have left on the authorization.

Great. Thank you.

We'll be opportunistic.

Okay. Congratulations.

Thank you.

Your next question comes from Dan Perlin with Stifel Nicolaus.

Thanks. My question is on really credit services margins and you talk about the incremental 11 million that you incurred in the quarter which would have been in that segmentation data, I'm assuming? If you, am I right in assuming that if you just added that back your credit service margins kind of sans the bankruptcy bubble would have been closer to 36.5%? Or am I missing something?

Well, revenue goes up, as well.

Right.

So, you'd boost the revenue 11, and you'd boost the EBITDA 11. Correct.

So, as that kind of tapers off, as you head into '06, is it not at least a potential that that margin YOY could expand versus being flat?

Yes.

In theory, given your comments that funding costs should be improving and loss rates shouldn't get any worse?

Yes.

Okay, easy. Margin differential in your marketing businesses, again, if you could remind us kind of at least the order of magnitude with AIR MILES, Epsilon, and Bigfoot? You said Bigfoot added a couple of million in revenue in the quarter, was it like 2 or 5 million, or?

I think it was a little bit above 5, quite frankly.

Yes, okay.

And I think from a margin, there was a question earlier, we were sort of targeting all year 150 basis points expansion overall, and it came in at whatever, it was 130 basis points. I mean it's a whole million dollars difference.

Is that more or less a function of adding Bigfoot?

No, I think the Canadian business, itself, which had very strong, as you know, issuance growth, and obviously when you're issuing 3.2 billion miles in a given year you ought to get some leverage. So, you're getting it out of Canada, you're definitely getting it out of Epsilon and Bigfoot, as well.

No, I'm sorry, I was actually asking the difference between the 130 and the 150 expected? When you gave the original 150 I don't know if you had contemplated the purchase of Bigfoot at that point? And I'm wondering if that was felt?

No. No, we just put our stake in the ground and if you're within a million bucks it's, in our shop that's close enough.

And from the point at which you acquired Epsilon can you at least directionally talk about how margins are for the rest of the year? Is that something where you're reinvesting in it, so therefore they were flat? Or are they actually up YOY?

I would say that, again, we'll have to go back and get some data here.

Okay.

But my guess is that for the most part it will be slightly up just because of the leverage they get also from increasing revenue, but there was no significant amount. When we bought the Company we did not plan on a lot of synergies with the rest of the Company, so to speak, from infrastructure or costs, so to speak.

So, the other addition, certainly, of Epsilon Interactive added some costs to the year that, in that integration activity. We have now I think probably in most of '05 we took any of the severance and other kind of costs, when we integrated we let a few people go. We moved some people around, so.

Yes, I just checked the numbers. Yes, Epsilon absolutely helped during the year. I don't want to get into the specific numbers but let's peg it in the low 20s.

Okay, that's very helpful. Thank you very much.

You bet. Next question, please?

Your next question comes from Colin Gillis with Canaccord [Adam].

Yes, good afternoon, everybody.

Hello.

And so can you talk a little bit, on the AIR MILES, we've got strong redemption numbers, can we look at that as a forward indicator for improved collection?

Improved collection?

Well, you know, once people redeem and they get juiced up by the program?

You know, we've had a pretty, a 10-year model, Colin, that depending on the different types of, you know, we've got over 300 different types of redemption opportunities from merchandise, to gift cards, to gift certificates, air, and I don't know that you could directly tie all of this in the surprise, big blip in redemptions, [that is you're going to] drive a big blip in issuance.

Yes, sometimes there's special programs that go on. And I think in Q4, correct me if I'm wrong, Mike, we actually saw an interesting shift where there was quite a bit more activity with folks redeeming for airline tickets and a little bit less for the merchandise. So, we'll see some behavioral shifts. I don't know whether it was just extra cold up there or not, but we see shifts like that. But, in general, I think what we're seeing is a program that can very easily support a mid-teens type organic growth financially for years to come.

Okay, great. And then certainly once you see improved redemptions, I mean that's not going to be turning off your customer base, right? You know, they're getting an actual value out of the program.

Absolutely. As we've talked many times before we want to push redemptions, that's what drives consumer behavior and that loyal.

Okay, great. And, you know, in terms of efforts to jumpstart sort of a stagnant or lower balance loyalty cards, what are the programs there that are going on?

Are you talking about the co-branded activity, where we have a number of inactive accounts?

Basically, yes.

That's the new program that we rolled out with Spiegel and Newport News and a couple of other customers, and that's all to drive more sales to our client locations. We've got some accounts that we've got a good handle on their credit worthiness but for one reason or another haven't got on the bandwagon, so we're going to use a points based loyalty model to drive more sales to our customers. And we expect it to be another 4 to 5% wallet share, and we think it's going to be a nice add to the toolkit.

Yes, I think, Colin, to the extent you've got a consumer private label card that's say generating 30% market share, in other words, $0.30 to every dollar is going on that card, we would expect the co-brand to perhaps have an incremental, as Mike said, 5 points. So, it's another nice hook-in for the retailer. What's also nice about it is these are folks that are inactive in the sense of we've already screened them before so we know who they are. We know from a credit quality perspective.

And they actually tend to have a little bit higher FICO profile than the consumer private label. It's more of a question can a loyalty program that offers 5 points or 5%, when you use it within that store, and then another point or 2 when you use it outside of that store, is that exciting enough for someone to put it in their purse or wallet? And we'll see.

I guess what I want to get a sense is, you know, to what percent of your existing customer base would be reached out to with this program? You know, is this something that you're going to continue to be offering in '06?

Oh, you bet. I think if we have what's called 75 clients, I'll probably get the number wrong, but we probably have no more than four or five co-brand programs going at this time. In addition, we launched the commercial card which I think we only have about two customers who took that, as well.

And, you know, at the end of the day, when you're talking about adding up a retailer sales and where they go, if we can get 30% on a consumer private label card, 5 points on a co-brand, 5 points on a commercial card, and then you toss in a gift card, that could be a pretty exciting program for the retailer.

Okay. And then on the income trust side, is it a given that you'd include Epsilon and Bigfoot into the trust structure?

Haven't thought about it.

Okay. And then just, finally, on acquisitions in the marketing arena, you know, what are you looking for there? Are you looking for, is there other pieces of technology that you'd be interested in? Or would it be customer acquisitions?

Our focus will continue to be on first leveraging our capability. We think we've got a great base platform. We've now added the e-mail platform for existing customers, so, yes, we are then looking at different acquisition or similar service companies that do what we do but don't know how to do it as well and we do, and we can put it over the top of ours and lever those contracts and drive some margin out of that.

Congratulations on another fine quarter.

Thanks, Colin.

Next question, please?

Thank you. Your next question comes from Mark Marostica with Piper Jaffray.

Good afternoon, guys. Congratulations on the quarter.

Thank you.

You know, the first question relates to the utility business. Just trying to get a sense for what inning we're in regarding utility outsourcing, and if you could review your pipeline with us? I know you talked about perhaps two to three signings this year.

You bet. We're still very much in the early innings of the utility outsourcing world. By far the majority, 90 some I suspect percent are in-house. They are typically pretty large transactions that take a little bit longer from a sales perspective. We are pretty much the only third-party servicer in that. We still compete with in-house software, in-house software development, software packages off the street, so to speak, and that need a lot of custom development and interface work.

So, we continue to have more and more doors open to us. These last signings in the fourth quarter have opened a lot of new doors for us. We're excited about the next year, very comfortable with our two or three deals, and I think you'll see a nice announcement here fairly early in the year.

I think, also, Mark, if you were to look at the product package that we've put together I think we've finally completed the grid, so to speak, from the point of view if you look at an X, Y, and Z sort of type axis, on one hand do we have an offering for regulated and now deregulated? Yes, we do. Another axis would be do we have offerings that can cover both the IOUs, the investor and utilities and the munis, municipalities? Yes, we do. And then finally the third axis would be can we cover gas, water, electric, and sewer? And the answer would be, yes, we can. So, we're pretty jazzed up from the point of view, it took awhile, but we now have all those blocks filled in in terms of the ability to offer services into all those different spaces.

Great. Thanks for the color there. A more specific question on Q1 guidance, could you quantify for us your debt, credit loss expectation for Q1 as built into the guidance? And perhaps give us a sense for how January went on the credit losses? Thanks. I'll turn it over.

I think we're probably going to stay away from giving guidance on forward-looking credit losses. I think from a general perspective as enough people have been sort of sniffing in the direction that we're headed. We're certainly not seeing things get worse. And, you know, it's too early to tell right now, quite frankly, whether there'll actually be an improvement versus last year as opposed to just very, very stable at 6.5%. But based on delinquency flows and everything else, things are heading in the right direction.

And when we gave our guidance last October that wasn't quite the assumption we had, so we're seeing a little bit of good news on that front along with the funding front. So, that with the ramp-up of the private label accounts I think really triggered the comment we had which is we fully expect this year to over-perform, once again. We're just trying to stay away from this quarterly guidance, a penny here, a penny there stuff.

Fair enough. Thank you.

And the next question comes from Wayne Johnson with Raymond James.

Hi. Yes, good afternoon.

Hi, Wayne.

Hi. I just had a follow-up question on Epsilon, and could you give us a sense of how many new contracts we should be thinking about in '06, that will be directly related to Epsilon and Bigfoot, for that matter?

We're not going to try to break them out by each of the different Divisions, but generally speaking as we mentioned, we'll do four to six in the marketing service segment. Epsilon will be the majority of those major signings. Probably at least four.

And then, in addition, Wayne, one of the other big areas of growth within Epsilon is expansion of services within the existing customer base whereas before we might have done X for Bank of America, now we're doing X plus Y.

And that's a great point. So, can you give us a little bit of color on the cross-selling? Where you guys stand and where you guys want it to be?

We talked about this a little bit earlier. There's no question that the existing Epsilon Interactive guys are well across all of our client base. Just as a reminder, the integration process had Al DeGuido, who is President of Bigfoot Interactive, taking over all sales responsibility for all of Epsilon, not only the interactive products but all of the database and marketing services products. So, be assured that we're focusing across all of those existing clients.

The original Epsilon business for the database services area and then adding on the marketing services and the analytics is also an example of what Ed was describing of expanding client relationships and revenue associated with that, much like we do in the AIR MILES business when we talk about expanding collector opportunities from, in the case of [Bemo] we always use it as an example of moving from the credit card, to the debit card, to the mortgage lending area, et cetera. So, we cover all of those fronts.

Right. And how has pricing been in Epsilon's business?

Solid. Great business. Very, very sticky. I think our typical large client has been with us, what, 10 years?

You bet. I'd recommend you go read, if you haven't already, the Forester [wave] that goes into a great deal of detail about the quality of our products, the extent of our products, and how firm we are. We're known as a high priced offering, and people come to us because of our expertise and service levels, and we can command good prices.

Right. And I had read that, and that was educational. And I appreciate that. Just swinging back a little bit to the sales side, could you at least talk a little bit about RFPs, you know, anything that you can say on how many contracts you're potentially looking at?

Again, we talked to four to five in the retail area. We talked to two to three in the utility area. And we'll do, you know, as we talk about four to six in the marketing services area.

And I think to give you some level of comfort the fact that, you know, based on the eight or nine years Mike and I have been here, based on the way they flow through the pipeline the numbers that are in the pipeline right now we're pretty comfortable that those eventual contracts will pop out the other side this year. It's, there's some good stuff out there.

All right. Perfect. Thank you.

Thank you.

Two more questions, Operator.

Thank you. Your next question comes from [Robert Botsch] with Morgan Keegan.

Hi, guys. On the last couple of calls you've talked to the extent about expanding the number of verticals in areas that you're targeting with the private label. Could you tell us what you're doing in sort of the sales strategy? Are you recruiting more salespeople with expertise in those areas? Or could you give us some idea of what's going on to target those verticals?

Fortunately, if you think about the, as we talked about 300 potential that fit into our universe of potential client, it doesn't take a large sales force. You know, a lot of people talk about having hundreds of sales folks. We can cover that 300 targeted areas with 10 to 12 people very easily, and it's very much a personal, one-to-one relationship development strategy.

Certainly, we use other marketing materials through our conferences and mailings and that kind of thing, but we always focus on getting vertical industry expertise so that they know very, whether it be, again, in our marketing business, in Epsilon, or loyalty, or any of our fields, we strongly believe in vertical industry knowledge. So, the marketing capabilities and sales capabilities is well within reason based on the size of the sales force we have.

And so I think to Mike's point, what he is saying is that to the extent we enter a new vertical, such as when we went into Gander Mountain, or someone like that, you'll get someone who actually has that industry expertise. And we'll continue to add that. But again, as Mike said, these are not adding dozens of people. You've got one person here, one person there.

Yes, I get that, I mean I get that. The follow on to that would be given the signing a new program is not a quick process, as you find these new salespeople how long do you expect before they're productive, before you really start to see penetration into these new areas?

I don't think we really take more than three to four months to get someone up to speed. We use very much a team selling approach so that we're not reliant solely on just the salesperson closing deals. We have a very strong participation from our finance group, our operational group, so it doesn't take all that long to get somebody up to speed. It's really getting the initial door open before we get productive. So, we feel pretty confident there.

Thank you.

Operator, one more question, please. Then we're going to have to cut her off.

Thank you. Our last question comes from Paul Bartolai with Credit Suisse.

Thanks. Good afternoon.

Hi.

The first question, on the portfolio growth in credit, actually I expected that to be a little bit higher with Blair and some of the other stuff you've ramped on. I mean it looks like excluding Blair that was maybe in the mid single digits. Can you just give us a little color on what you're seeing from the core clients that you've had for greater than a year, maybe?

For greater than a year, let's call it the core clients probably going back, you know, two or three years. We're probably getting maybe 3 points or so out of them. Maybe you get 4 points out of the ramp-up. And then Blair will add a couple of points. Recall, Blair wasn't on for the full quarter. It was only on for a partial quarter.

So, as the ramp-ups continue and hopefully as our largest client continues to show good numbers or at least solid numbers you should continue to see that ramp-up nicely into double digits as we go through 2006.

So, from our perspective, quite frankly, going from sales of 2% in Q1 to 10% in Q4 was a relief. And going from portfolio growth that doubled from 4 to 8 was a relief, as well. So, it's heading in the right direction for sure.

Okay, fair enough. And then curious on the marketplace just about the new minimum payment rules. Have you guys looked at or expect any impact from that on loss rates or fee income?

Good question. We don't. Primarily, you know, there are two ways to look at it, right? Is there an impact to ADS, itself? The answer is, no, primarily because our balances are so small, $285 or something like that, that we never ran afoul of the minimum payment problem that existed out there.

The other – so I think we're in good shape there. The other, I think, question out there is to the extent the big bank card players, you know, have to change their terms and you're really talking about affecting the true financing vehicle of that cardholder who may then have two or three of our private label cards. You know, does it trickle down to the private label? It's too early to tell. We don't know. We haven't seen anything. Yields, payment rates, losses, delinquencies, everything looks rock solid right now.

And you'll be able to see that, obviously, through our delinquency, six months out. So we haven't seen anything.

Okay, great.

Appreciate it, Paul. Thanks.

Appreciate everybody's time today. We're looking forward to a great '06, and look forward to seeing you at some of the different conferences. So, have a good day!

Thank you. This concludes today's conference call. You may now disconnect.