Bread Financial Holdings Inc (BFH) 2006 Q2 法說會逐字稿

Good afternoon. My name is Eduardo, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Alliance Data Second Quarter 2006 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. 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, please press the pound key. Thank you.

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

Thank you, Operator.

By now, you should have received a copy of the Company's second quarter 2006 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.

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

Also on today's call, our speakers will reference certain non-GAAP financial measures, which we believe will provide useful information for investors. Reconciliations of those measures to GAAP will be posted on the Investor Relations website at www.AllianceDataSystems.com.

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

Thanks, Julie.

Good afternoon, everyone, and thanks for joining us. I'll take a few minutes here at the beginning to review the highlights of the quarter. We'll focus on our three growth engines, as normal, and then I'm going to spend a little bit of time talking about 2006 and beyond. Ed will review in greater detail at the end, and we'll take your questions, as we normally do.

Let's turn to the next slide. We had a tremendous quarter, and we posted our largest top-line quarter in our Company's history with revenue of 491 million, a 32% increase over last year. It was an enormous growth rate and was driven by double-digit growth in all three of our reporting segments and the continued impact of new clients ramping up throughout the beginning and the remainder of this year.

Our adjusted EBITDA was 128 million, 54% increase over last year. While Ed will go into some detail in a moment, we see generally favorable business trends and continue to see up side as a result of credit quality of our portfolios and the loyal nature of our client's consumer relationships and their spending patterns.

Cash earnings per share was up 57% to $0.77, further underscoring a very strong quarter from all divisions.

Now, let's take a look at a few of the quarter's highlights by the segment, starting with Utility Services on the next slide.

Utility group had an impressive quarter. They delivered double-digit top-line growth, and we announced an agreement with Sacramento Municipal Utility District to provide bill print and mailing services, electronic bill presentment, and payment processing for their 560,000 residential and business customers. They're the sixth-largest publicly owned utility, serving customers in Northern California.

We also renewed our agreement with Duke Energy's Union Gas to provide CIS hosting, application development, and management/online bill presentment for their 1.2 million customers in Ontario. This is the third contract extension for us. We're proud of our ongoing partnership and their continued confidence and endorsement of our Company.

While we remain focused on growth, we're also focused on ensuring smooth and timely conversions of our new business and new clients. In the last month, we completed the conversions for Wisconsin Public Resources' recent acquisition of natural gas customers in both Michigan and Minnesota. We have begun servicing their 360,000-plus customers on our proprietary platform and in our Scotts Bluff, Nebraska call center.

For the year, we're ahead of normal, with two to three wins our normal, with Sacramento, Wisconsin, and Green Mountain, and we expect to end the year with a total of four or five new announcements. So congratulations to the Utility group for a great quarter.

Let's turn to the Card Services on the next slide, our Private Label group. They had a strong quarter, as well, building on momentum gain from the first quarter.

We announced a five-year agreement to provide Private Label services for Friedman's Jewelers of Savannah, Georgia. Friedman's is the country's third-largest jewelry retailer, with 422 locations, offering moderately priced items. They view our integrated credit and marketing services as valuable tools to increase sales, grow their business, and attract new consumer segments.

We also announced a five-year agreement with Beall's and Burke's outlet stores to provide turnkey Private Label services. They're a leading Private Label -- they are a leading retailer of value-priced apparel, accessories, and home furnishings, with over 600 million in sales, 500 stores in 14 states, and expansion plans to open at least 40 new stores over the coming 12 months.

One of our Company's top-10 clients, Stage Stores, recently acquired B.C. Moore, a 78-store chain in Southeast U.S. with about 100 million in sales. The acquired stores expand their presence in the targeted Southeast market, and they'll be converting to the Peebles brand beginning this month through October, and we'll extend our full Private Label services as the new markets convert.

This quarter, we extended our relationship with one of the top specialty retailers in the country, Abercrombie and Fitch. A&F has been a client since our inception 10 years ago.

We also announced a long-term renewal with Harlem Furniture, one of the top-10 U.S. furniture retailers.

As we said last quarter, we expect another strong year of Private Label. We are on track to deliver four to five announcements in 2006.

Aside from new business activity, credit quality remains high and credit sales are strong, driving healthy operating profits. All in all, a very nice quarter.

Let's now turn to the Marketing Services group, consisting of our AIR MILES Will Work program and our U.S.-based businesses, Epsilon and Epsilon Interactive.

Our Marketing group had a great quarter, the result of strong program fundamentals and market demand for our services. AIR MILES Will Work program, our coalition Loyalty service in Canada, had a very nice 20% organic growth rate in the quarter and strong performance in both miles issued and redeemed. These strong metrics continue to validate the success of the AIR MILES program and speak to its embedded ability to remain dynamic and robust for our collectors, sponsors, and suppliers.

We extended our relationship with one of our longstanding cornerstone sponsors, grocer A&P Canada. A&P operates 235 stores and has a 24% market share in Ontario.

Let's switch now to U.S. Marketing.

Epsilon had a strong quarter as well, signing an agreement with Circuit City to provide permission-based e-mail marketing services to one of the nation's largest multi-channel consumer electronics retailers. The initial phase of service will include optimizing and deploying and delivering e-mail marketing campaigns through our proprietary e-mail platform. In phase two, we'll also provide analytics and customer segmentation services for a micro-targeted e-mail campaign.

We also expanded our relationship with one of our largest database clients, AARP, an Epsilon client since 1980. We'll continue to provide database, consulting, and infrastructure services while we expand these services to help them gain greater performance in their prospecting programs and campaigns.

We also extended our relationship with Citicorp, a credit services group, to include permission-based e-mail services, which follows up the announcement we made last quarter to provide our comprehensive Loyalty solution to support their points-based reward program, the ThankYou Network.

One final note -- Epsilon released a study with GfK NOP, a worldwide market research group, sampling 175 U.S.-based marketing executives. The study revealed a growing reliance on cross-channel integrated campaigns and technology and a shift to more consumer insight-based marketing from our -- from the traditional mass media efforts. This trend further validates our Company's business strategy as we focus on using customer insight to develop solutions that help our clients grow. A copy of the research can be obtained by going to Epsilon.com.

Let's turn to the next slide, and I'll speak to our forecast for a second. We certainly had a great first half of the year, and we expect a strong second half as well, and as such, we're raising our guidance to a minimum $2.75 cash EPS.

This is driven by all segments delivering on their growth plan; the impact of our recent acquisition, DoubleClick E-Mail, an icon; remaining flexible to engage in projects and invest today for our future; our credit quality normalizing; and lastly, factors in conversions of our recent new business wins.

We've also announced transactions that further strengthen our Company's financial position. We completed a private placement corporate debt offering for 500 million, which frees up additional liquidity, and we've completed the issuance of asset-backed notes worth another 500 million, the latter transaction locking in favorable rates for the next seven years. We believe these recent transactions, along with the solid business drivers I just mentioned, provide a strong foundation for our 2007 performance.

Before I turn it over to Ed, I'd like to mention a recent recognition for the Alliance Data team, the inclusion in BusinessWeek's Information Technology 100. This annual listing ranks the fastest-growing, most profitable technology-related companies. My congratulations to our associates and management team for this distinction, and as always, my thanks for your hard work and commitment to our clients, first, and our shareholders. Ed?

Thanks, Mike.

Why don't we turn to the slide that says Second Quarter Consolidated Results. Q2 marked our 21st quarter as a public company. We further extended our track record of delivering or over-delivering on what we promised.

Regarding Q2, it was our largest quarter in our history in terms of revenue, which came in at just under 0.5 billion, up over 30% from prior year.

Also, similar to Q1, the key takeaway from the quarter is balance, balance, and more balance. Specifically, all three segments posted strong double-digit growth for both revenues and EBITDA, with marketing leading the way with a 40%-plus top-line result.

Also note that our key drivers all grew double-digit as well. Of particular business was our Private Label business where both credit sales and the portfolio showed mid-teens growth, stronger than expected, stronger than our historical growth rate, and especially interesting in light of people's concerns of the slowing macro environment.

Strong top line combined with great leverage to drive EBITDA up over 50% and operating EBITDA, which is kind of a better measure of operating cash flow, up about 46%.

Year to date, operating EBITDA is running 17 million ahead of reported EBITDA and is nicely on track to run at least 25 million ahead for the full year.

And, finally, cash EPS came in at $0.77, up 57% and well ahead of our expectations.

The over-performance was driven by Marketing Services, as both Loyalty in Canada, as well as Epsilon, over-performed. In addition, stronger-than-expected credit sales and portfolio growth, combined with lower-than-expected credit losses, drove over-performance in Private Label.

Similar to Q1 and as promised last year, there's no pause for Alliance this year, so let's go ahead and let's hit the segments.

Second quarter segments results --

First up is Transaction Services, which houses Private Label services, Utility Services, and our traditional Bankcard business. Again, as promised, momentum remains strong, with revenues and EBITDA up 15% and 37%, respectively, driving margin expansion of 250 basis points versus prior year.

The continued ramp-up of last year's Private Label wins, such as the Gallery, Hanover, Blair, Crescent Jewelers, Gander Mountain, Carter, Spiegel, and Newport co-brands, plus solid wins in utility drove the segment's results.

Utility Services' impressive list of recent wins, which included 1st Choice Power, Green Mountain, Wisconsin Power, and Sacramento, suggest a solid run as we go into 2007.

Private Label's wins this year have included new co-brand programs for Goody's and New York & Co., plus new Private Label programs for Beall's and Friedman's, also suggesting that 2007 is beginning to take shape.

Both Utility and Private Label grew double digit, and statements generated, the key driver, also grew double digit for both.

With the first half of the year completed with very strong results, we turn our attention to the back half, which will include additional expenses for all the new client conversion activity, probably no more than a few million for training and set-up, new facilities, etcetera. Nonetheless, our full-year margins should be up, and we expect a good, solid finish and a number of clients fully converted such that they are ready to contribute to 2007 immediately.

Okay, next up, Credit Services. Once again, the results were remarkable. Let's walk through the drivers, the four drivers that are key.

First, credit sales. Very strong. Grew 15% versus our long-term model, which calls for 10%. The growth was the result of the ramp-up of last year's wins plus decent performance by the core.

Next up, portfolio growth. Also tipped the scales at mid-teen's growth, which again significantly exceeded expectations and our long-term target. Clearly, our 11 million-plus households are comfortable retaining their balances, and yields remained very strong in very sharp contrast to the brutal competitive pressures in the bankcard world.

Third, funding costs. Remained slightly better than prior year since we've locked down our rate and should remain relatively immune from any increase in general interest rates certainly through this year and next.

I do want to point out here I saw a note that was put out the other day that suggested that our funding costs rose 7 -- were going up a fair degree. That is not true. That's not the case. In fact, in '07, we expect our funding costs really to be relatively flat. So I wanted to make sure everyone was up to snuff on that one.

And then, finally, let's talk a little bit about credit losses. Continued to benefit from the tailwind of recently enacted bankruptcy law, which caused early filings to hit us in Q4, if you recall last year, and we picked up the bene's in Q1 and Q2 of this year.

Specifically, the loss rate for the quarter was 4.7% versus what we would call a more normalized rate -- that would be our target -- of 6%. As such, the total impact of the tailwind was about $0.08. [If you'll] recall Q1, it was $0.10 in Q1.

Also of note, and separate from the tailwind, was the very low delinquency rate, which gives us a good window into next year already and suggests credit quality will remain quite good for the foreseeable future.

We expect our loss rate to continue to creep back up to its target level of a bit under 6% and then stay stable there for the remainder of '06 and importantly throughout 2007. We are seeing no deterioration whatsoever from our normalized level.

To sum up, our cardholders are spending strongly and are showing the resources to pay for these purchases in a timely fashion. Despite the potential of a macro slowdown, we see no evidence of that whatsoever in our current numbers or future indicators. We believe our focus on mid to upper-income households plus adding a number of new clients each year provide a nice buffer to the impact of a potential macro slowdown.

All right. Let's wrap up with Marketing Services, which picked up even more steam and grew north of 40% top line, replacing Credit Services as our fastest-growing segment.

Leading the charge once again was our Loyalty AIR MILES business in Canada, which posted 20%-plus organic growth, driven by strong double-digit growth in its key metrics, miles issued and miles redeemed. More and more, consumers are viewing our product as a must-have in their wallets and purses. We expect this strong performance to continue, and 2007 is already shaping up nicely, as well. Look for a couple of new sponsor announcements before year-end.

Our U.S. business, Epsilon, also had an extremely strong quarter. The Citibank Internal Coalition program, that is, the ThankYou Network, is off and running. Also, we expanded our relationship with AARP and added Circuit City to the fold. Expect more good news to flow in the back half of 2006 and well into 2007. The integration of our permission-based e-mail providers, Bigfoot and DoubleClick, have been completed, and results have been better than expected.

From a margin perspective, the sequential margin moved up over 200 basis points, and we expect full-year margins to be up nicely versus prior year.

All right. Enough about the segments. Let's talk a little bit about the balance sheet. If you could turn to that slide, just two quick things.

First, deferred revenue, the balance, which relates to our AIR MILES, grew to over $660 million, which is up over $100 million from this time last year, and that's versus a normal trend rate of only about 40 million a year. This is extremely positive news for '07, '08, and 2009 as this deferred revenue and these earnings must flow into the P&L.

Second, our core debt to trailing cash flow remained at a very modest 1.2 times. During the quarter, we placed 500 million in corporate bonds at long-term fixed rates. This allowed us to pay down existing facilities and free up that liquidity source. Our capital structure now allows for tremendous flexibility to lever up a bit more, if prudent, to fund tuck-in acquisitions or continued share repurchases.

Okay, let's turn to guidance.

As Mike mentioned, we did, in fact, raise guidance again. As you know, we raised it last quarter. We're raising it again.

The new guidance on the top line should read at a minimum or at least 1.84 billion for EBITDA, a minimum or at least 465 million and cash EPS of at least or a minimum of $2.75.

As we look at Q3, we're establishing a minimum cash EPS of $0.62, which would be up 22% versus last year. What we're basically saying is very strong business performance is expected to continue but moderated by the fact that Private Label credit losses will fully normalize. In other words, they were 4.2% in the first quarter, 4.7 in the second quarter, and they're going to creep up to a little bit under 6%, which is our target for the year.

Conversion expenses, which are expenses we'll spend all day long to bring on new clients -- specifically, Wisconsin, that Mike talked about, and 1st Choice, Green Mountain, and also, we should add Direct Energy towards the end of the year -- and also potential investments to drive future growth. For those of you who have known us for years, you know that each year we do select a number of projects that we will spend a few million dollars on to see if they "stick to the wall" as a potential new growth source for us in the future.

Before anyone asks, let me throw out there, there is no cliff that we're facing. The new guidance represents minimums. You can call them conservative, but we do want the flexibility to invest in the future. So as you know, again for those of you who have known us for years, we tend to be a bit on the conservative side. If there's additional good news to flow through, that would be great. But, again, we do want to retain the flexibility to invest in the future. So we probably would expect a little bit of good news to flow out in Q3 and Q4. It's just unclear how much at this time.

All right, next slide. We are known again for posting free cash flow that exceeds our reported earnings, and in this case, if we were looking at $2.75 of cash EPS, our free cash flow per share is more like 2.95. The only difference or the big difference is really in Canada, where we have about 25 to 30 million bucks a year in profit earned, cash received but not recognized. That's why it's deferred. So, again, we're just -- we're coming in just under 3 bucks in free cash flow, and that's a nice growth rate from last year.

Moving along to the slide that has the pretty bars, operating leverage, we have always stated a goal; we'd like our EBITDA margin to expand about 50 basis points a year. Really, since '99, over the last 7 years, it's been more like 100 basis points.

This year is going to be pretty interesting. We could potentially do somewhere between two and 300 basis points. We see all three segments having margin expansion, marketing, transaction, and credit. So, again, as we mentioned, across the board, the machine is cranking at this point.

All right. Let's turn to my favorite part, which is the tough questions that we've received for the quarter. Only four made the list this time.

I get a lot of questions whenever the MasterTrust data comes out. Again, the MasterTrust provides various statistics related to the performance of a good chunk of our Private Label business as per agreements in our bond covenants when we sell public bonds to investors.

Long story short, it gives you a sense of where our losses have been and where they're heading. But there's always going to be a little difference between the MasterTrust and what we actually incur, and that delta is the difference between what's publicly available and what's on our balance sheet or in a private conduit.

There's not a huge difference normally, but a lot of people ask precise questions about loss rates to the tenth of the percent, so just for their records, Q1, our loss rate was 4.2%; Q2, it's 4.7%; and Q3 and Q4, as we've talked about, we'll drift up to what we think is our normalized level. I would say at this point we don't even expect it to hit 6%. But let's just say less than or equal to 6%.

And then next to that, for all of '07 because the delinquency rate gives us a very nice window already into the first quarter of '07, once again, there's nothing to suggest that we're going to see a deterioration, and we would expect that in '07 the loss rate should be less than or equal to 6%, as well.

So very, very good news, and again, seems to go a bit at odds with some of the stories that you're seeing out there, but once again, I think it's because of the quality of the 11.5 million consumers active -- who actively use our card.

Second, there was also a note out the other day which talked about the impact of the Canadian dollar on our business that didn't quite get it right. So just to make sure everyone's on the same page, the impact of the rising Canadian dollar in 2005 was only about $0.04 and for the first half of '06 is only about $0.03. So it's relatively minimal, and should the Canadian dollar strengthen or retreat, you're talking a couple pennies here or there, so I wouldn't get too worked up about it.

Next question, of course, on everyone's lips is the whole macro slowdown, the economy's slowing and the consumer's rolling over. I think we had this discussion last fall, and usually once a year we talk about it. Again, that's the beauty of our model, as we've now completed 21 straight quarters since going public without any blips.

And that's because if you look at the business itself, on a consolidated basis, 60% of our revenue is effectively nondiscretionary. It relates to our Canadian business, where this is mom and dad going in to buy groceries and gas and going to the pharmacy, which is going to be done every single week. In our Epsilon business, this relates to all the Loyalty programs, like the Hilton Honors Reward program, and quite frankly, when times are tough, there's much more capacity at these clients, and therefore, they're more willing to be pushing very strong on the Loyalty to get some people to fill some rooms, for example, and as a result, can almost be said to be counter against -- counter-cyclical against the slowdown.

Our utility business -- people have the utility bills at the top of the pile to pay, and we get paid per every statement that's sent in. So when you have 60% of your top line that's nondiscretionary, you're left with 40%, which is essentially our Private Label business. It's very high quality credit. We have found that along with the high quality credit, the huge book of business we signed last year that's still ramping up, the book of business that you've seen thus far this year, I would say, is modest at best, but we can also say that what's in the pipe right now that has yet to be announced actually is quite exciting.

So we would expect the two of those combined to certainly handle any type of macro slowdown that's out there. Wrap it all together, and our view of a macro slowdown is we don't really think it will have much impact on us at all.

And that leads, of course, to the final question. There was another note that was out there the other day that -- and I've gotten this question quite a bit -- the grow-over. "Hey, it's been a great year -- record earnings, record this, raising guidance, but, boy, you're going to have a real tough '07 because you have all these tailwinds that are turning into headwinds, and let's just keep expectations reasonable."

We would disagree with that. Our view is that we fully expect to hit the grow-over and just roll right through it. We do not believe we need to do a major acquisition to do it. We do not believe we need to do a major stock buyback to do it. The pipeline is very strong. The momentum is strong. The macro situation we've already talked about. We're going very hard now to get all our utility clients converted.

And so, to sum up, we fully expect to maintain our traditional model as we go into 2007, and our traditional model has always called for at least 12% top line, of which 10 -- double-digit is organic; 15%, EBITDA; and 18% on cash EPS.

To sum up, and then we'll get to Q&A, we did raise guidance again for 2006. We're looking for over 30% growth. The guidance that we offered were minimums. You could view them as a bit on the conservative case, but we feel we need to have the flexibility to invest and grow for '07 and beyond. And there could be some more news to come and good flow-through if and when appropriate, but we're not in the business of out-chasing numbers. Rather, we want to remain rock-solid for 2007, play through any grow-over issue or macro slowdown, and we believe strongly that, in fact, 2007 will not disappoint and that our 12-15-18 model, including double-digit organic growth, remains intact as our minimum hurdles. And I think the last piece will be I think you'll find a switchover in leadership in growth, obviously, from Credit to what we believe Marketing Services, as they continue to just absolutely power along.

That's about it on the questions. The last slide essentially slows what we've done through good times and bad times, and I think we're beginning to get that -- as they say, that warm, fuzzy feeling about 2007.

And that being said, I'll turn it back over to Mike.

Thanks, Ed.

And, as you can all tell, we're very excited about our year and our prospects.

So let's take the time now to take your questions. Operator, would you start the Q&A, please?

Thank you. [OPERATOR INSTRUCTIONS]

James Kissane, Bear Stearns.

Hey, Mike and Ed, and great job on the quarter again.

Thanks, Jim.

Ed, can you talk about the sustainability of the 20% internal or organic growth up in Canada? I know you touched on marketing becoming a bigger portion of the earnings next year, but is that contingent upon the 20% being sustained?

No. I think, quite frankly, we've been a little bit -- we've been more than a little bit -- we've been pleasantly surprised over the -- really the last two years that it's been 20% plus organic. Miles issued has been extremely strong. What we're finding is that it's almost similar to the network effect, where the bigger it gets, the more people who are involved, the more sponsors who are involved, the more the card gets used, and it keeps growing and growing. But to be safe, Jim, what I would say is we would view this business as probably a mid-teens organic long-term growth vehicle for us for many years to come with a little bit higher than that, call it 18, on the EBITDA side.

Okay. And what portion of marketing is now AIR MILES, and what portion are some of the newer marketing businesses?

I'd say the general rule, it's probably 2/3, 1/3.

2/3, obviously, are miles, and then 1/3 is Epsilon. How fast is Epsilon growing on an organic basis?

Epsilon, if we were to sort of pro forma Epsilon, Bigfoot, DoubleClick and sort of roll them all together, I would say probably 20-ish, 20-plus. Long term, probably closer to high teens, with 20-plus on the EBITDA side.

Okay. I know during -- with your comments, you talked a lot about the macro, but what's your current read on consumer spending?

And, also, on credit quality, you're saying it's going to bump up towards 6 in the third quarter, but your June numbers, as of the other day, said, I think, 4.4 for the MasterTrust. So what's going to cause it to spike that fast?

Yes, it's a fair question. I think there are two parts to the question. Let me take the second part first, and then I'll try to remember the first part.

But the second part, actually, our -- as we mentioned, our overall loss rate was 4.7, right --

Yes.

-- for the Company. We believe, normalized, it should be less than or equal to 6%. What we're saying is at this point, Jim, at some point this year, it should get up there. Do we think it's going to rocket through the roof to 6% immediately? No. We're not seeing anything like that out there. But if you look between first quarter and second quarter, it did move up 50 basis points. You know, is it going to move up 130 basis points in a quarter? Absolutely not, but it will move up some. And then in Q4, it will probably finally level out.

And the good news is that delinquencies, which you know is not a P&L item but gives great insight 180 days from now as to what's eventually going to roll to write-off, is the lowest we've ever see it. So the quality of the portfolio is just fabulous.

Part A of the question, I think you said, is consumer spending?

Yes, just your current read or pulse.

My current read or pulse would be that, again, it seems to differ a lot from what you're reading, but across our 75, 76 clients, obviously, some of it depends on who picked right and who picked wrong. But on average, we're not seeing pockets of weakness. What we're seeing is very strong spending and not just because of all the folks who are ramping up from last year. The core itself, those [of folks 3, 4] years old, is actually doing quite well. So what we're seeing in our sort of select group is strong spending as I look at July, only partially through July, but it doesn't seem to explode at all.

So our view is that, unfortunately, the economy or the households in the U.S. probably one needs to bifurcate between sort of sub-prime and prime, if you want to call it, and we deal with the latter, the prime. And right now, the prime looks great, and the delinquency levels suggest a very nice jump for '07.

That's great. And just one last -- I mean you're $0.62 for the third quarter. I know it's a minimum, but in your slides, it says that assumes that charge-offs fully normalize.

Right.

I assume it's a 6% number you're plugging in or a high 5?

Yes, just under 6, yes.

Okay, great. Thank you.

You bet. Thanks, Jim. One clarification I also wanted to focus on. You will recall our bankruptcies typically used to be at 200%, and you talk about now a 2% 200 basis points. You know, what's the -- how's it going to spike? You know, it continues to climb back to normalcy, so this continual growth isn't a deterioration from our historical levels; it is a returning to normalcy, to some degree, as we watch how close it ultimately will get back to our historical rates based on the new bankruptcy law.

So, anyway, let's take the next question.

Gregory Smith, Merrill Lynch.

Yes, hi, guys. Just, first, want to be sure as you're looking out towards maintaining your model in '07, on an EPS basis, that's just looking at whatever your cash EPS ends up in '06. You're confident from where you are sitting today that we'll get that 18% potential growth over that, is that correct? You're not X-ing out any of the bankruptcy benefit or anything like that, is that correct?

Yes. I mean, basically what we're saying, to make sure we're crystal clear, is we give guidance, and have for the last 5 years, on our Q3 call, so what we'll do on our Q3 call is we'll say, "Here's where we think we're going to wind up for the year for 2006. If for some reason there's more good news that flows through in Q3, that would be added to it." And then 12-15-18, slap it on and call it a day.

And to your point, even though the grow-over is fairly significant, we think the momentum in the other businesses is extremely strong and the drivers in our Private Label business, like sales and portfolio growth and the lack of seeing any type of indication of a spike coming in credit quality, would suggest that we should be able to play through it and at a minimum, hit our model.

Okay, great. And then the stock comp expense was up quite a bit in the quarter. How should we think about that going forward from a modeling perspective?

I think it's going to be relatively flat over the next -- 11 to 12 million a quarter.

Okay. And then, lastly, just the deal with Citigroup on the Epsilon side, obviously that gets you pretty intertwined with a big organization, and they're also a competitor on the card side. Is there just a strict Chinese wall there, or are there maybe some -- even some opportunities there that could come down the road? How should we sort of think about that potential and the competition there?

You bet. We're very much a Chinese wall. We don't see them as much in our space on the Private Label side. We very much work closely with them on both their bankcard sides, as well as their other consumer products, so we continue to believe that there's up side to that relationship, and they're excited about the relationship.

Okay. Thank you.

You bet.

Tien-Tsin Huang, J.P. Morgan.

Great, thanks. It sounds like Epsilon is definitely performing very well and we're underestimating the ramp. Is there any way you can give us some metrics on U.S. marketing and how we should think about the revenue and earnings contribution of a typical win or win like Circuit City just to better understand how that business ramps up?

Yes. As the saying goes, "I feel your pain," but we can't really give out specific client information. I think what we would feel comfortable saying is anything that we announce is a multi-million-dollar annual client for us. I would say, Tien-Tsin, that the typical client is probably somewhere between 3 and 8 million of annual revenue to us, and then you will have certainly some of the real big dogs that are out there. Obviously, this year would be a Citicorp or someone like that, which is quite a bit bigger, but somewhere between 3 and 8, and we only announce things that hit the radar screen, so we're not trying to get in any scrawny little deals.

Also, what Epsilon and its sister companies, DoubleClick and Bigfoot, are very good at is the ability to extend and expand the existing relationships like we did with AARP. So whereas someone may be a client that's bringing in 5 or 7 million a year, three years from now, it could be 10 to 12. Ten years from now, it could be 20 or 30. So that's the typical style of let's bring on some new folks and let's really try to expand the service offering to the existing folks.

Got you. So where are we in terms of, I guess, cross-selling the U.S. marketing services into the Private Label client base? Have you started that process or--?

We've displaced -- and I'll kick it to Mike -- we've displaced a number of existing vendors from the Private Label client list, and this is not Private Label permission-based e-mail; this is really the whole --

Retail [inaudible].

-- retail selling cycle, and we're just really starting the process. Also, it's -- we're getting ready and we are beginning to use the entire Epsilon machine to help in our utility business as that utility business starts developing very strong Loyalty and direct one-to-one customer acquisition and retention programs in the deregulated space. Those are two off the top of my head.

And I don't want to take the focus off of, also, the cross-selling that goes on between the interactive clients, from our old name, Bigfoot, to Epsilon Interactive with our existing Epsilon clients, and now our new DoubleClick clients that we welcome to the family. There are a number of services now, as Ed said, that we can provide a full range of services as opposed to only a portion of it. So there are probably bigger opportunities, and there's probably bigger emphasis on driving those first.

Got you. Then quickly on the utility front, any unusual -- anything unusual we should think about from the client conversion activity that you alluded to in the second half in terms of risk management or cost overruns, anything challenging there?

And maybe if you can comment on First Data's planned acquisition of Peace Software.

I'll take part A, and Mike, fortunately, gets part B.

But part A is -- it's strictly numbers. I'm hoping there won't be cost overrun, but there's probably -- you know, we said a few million that won't be capitalized. It will be expensed. We don't really have the numbers firmed up at this point, but let's call it 6 million bucks split evenly between the quarters, and that covers Wisconsin, Green Mountain, 1st Choice, and the new Direct Energy portfolio, and that would cover things like all the training we need to do. We're going to have to expand -- we're bursting at the seams at our facilities -- to get a couple new facilities in place. Again, all good money that we want to spend all day long, but we want to get this stuff done and behind us this year so we can rock into next year.

Part B?

No, business as usual. We're very excited about the market. Obviously, new competitors coming into the market gives a sense that there's a healthy market there for outsourcers, as you've heard me talk about before. It's been historically an in-house. Look, we compete with big guys today -- Accenture, Cap Gemini, and IBM. We have a pretty unique model of the marriage of our processing and services and -- as well as our people-based customer care and marketing services that compete against the traditional processors all day long, and we do very well.

So we're very excited about the future, we've got a strong pipeline, and we'll compete very aggressively. We really only have one client that uses the Peace software, and it is not prevalent throughout our divisions. So thanks, Tien-Tsin.

Great, thanks.

Next question, please? And, obviously, we have a contract.

Sure. Thank you.

Andrew Jeffrey, Robinson Humphrey.

Hi, guys. Good evening.

Hey.

Pretty impressive profitability expansion in marketing this quarter. I guess in EBITDA still trailing a little bit where you were a year ago. Can you talk about what you think the sustainable profitability is in that business and if -- I know you mentioned some investments in the first quarter. Do you think we've troughed and are going to start to see some pretty good operating leverage as you bring on these new clients at Epsilon?

Oh, you bet. I think what you're going to see, Andrew, is a little bit of a flip-flop. Whereas the EBITDA margin -- I mean, obviously, the growth rates are huge, but the EBITDA margin is relatively flat the first half in marketing and up hugely in transaction services. What I think you're going to see in the second half is the complete reverse. You're going to see a real nice snapback in growth and expansion in the EBITDA margins in marketing, while at the same time, you're going to see relatively flat probably margins in transactions because of the conversion costs and a couple of projects we're doing. And at the end of the day, you're going to see full-year margins expand nicely in both segments.

So I think the first -- the bigger driver behind why it's flattish and then it's going to start snapping back is in '06, the marketing spend that we have, which is a big number, is fairly well smoothed throughout the year, whereas in '05, if you recall, it was very much back-ended.

Okay. So in other words, barring any additional changes then, the end of '06 is probably a pretty good starting point or run rate from a profitability standpoint as we look to '07, and you would foresee building on that level of profitability?

You bet. And, again, I would say for 2007, I don't think there's any question that Marketing Services will lead the charge.

Okay. And as far as transaction is concerned, again, a dip as you invest, and then in '07, is there -- and prospectively, should we anticipate an ongoing trade-off between new business wins and profitability whereby there's integration and training and ramp-up so that you will get this sort of jagged quarterly margin performance with sort of annual numbers smoothed and moving higher?

Yes, I think to anticipate the annual -- I’m sorry, the quarterly EBITDA margin by segments would truly be heroic. I would say look at the full-year picture, and it's going to trend pretty nicely to what we thought, probably a little bit better in both segments, and then use that as a nice and helpful jump-off point, as you mentioned, to the following year.

And we're fortunate this year in the sense of we signed more business in utilities this year that's converting in the second half than we've ever signed, and from what Mike -- I think Mike alluded to it -- we ain't done yet. So there could be another two, potentially three announcements coming out of utility, so I think we just have an extraordinary amount of new business that we want to bring over to our existing platforms. And like I said, we're bursting at the seams in terms of facilities. So we would view it as good news. To the extent we start normalizing back to two or three new utilities each year, you're not going to see that spike anymore.

Okay. Thanks a lot.

Thank you.

David Scharf, JMP Securities.

Good afternoon.

Hey, David.

Hey, David.

Just a couple follow-ups. First, Mike, in all the discussion of your pipeline and the companies you've converted and won over the last 12 to 18 months, there's very little discussion of the competitive landscape, and I'm just curious. Can you talk a little bit about within specifically Private Label and utility whether or not you're actually competing for a lot of this business? I mean as you look at your forward pipeline, is most of the battle convincing potential clients to outsource, or are you actually involved in some fairly competitive RFP bidding versus a number of vendors?

Well, there's always competition in the marketplace, but for the most part, our focus is on the in-house provider and the small balance, small to medium-sized retailer. The big guys that tend to go after the billion, $2 billion, I think someone referred to as the Citibanks and some of the others; they're just in it for a different game. For the most part, most of the announcements over the last 12 to 18 months have been around those large players just providing funding and really not doing any processing or servicing or any of that.

So I'm not going to say that there's not competition, but we feel very comfortable with the market, and it hasn't really changed all that much.

The utility side, again, is dominant in-house, up against the CIO and the software providers that are out there. That tends to be nothing new. There is still a variety of types of services, whether it be the large Accenture-type transactions that are doing and wanting to do everything and that will either take on or even sometimes think about -- talk about outsourcing pieces of it. Based on the size of a company like that, they need something like that to move the needle, as opposed to our typical transactions that are going to be 5 and 8 million in annual revenue. It's perfect for our size company, but those kind of transactions aren't going to help 5 and $10 billion companies hit their top-line growth rate. So -- but we tend not to see a great deal of head-to-head competition in that area.

And as we continue to invest in utility, we're finding continued depth of product. One of the things that we invested in is a pretty -- a deep and broad team that has had utility experience, some that have worked in utilities and run utilities, others that have consulted with them for the years, and it's more than just spitting out a statement as we broaden our relationships into their other departments and help them grow and predict the profitability of their business. So beginning to use some of the analytics that we've built through Epsilon is going to be a key add for us, as well.

So the market is maturing in that sense and growing, but all in all, I would say we're in as strong a competitive position as we've ever been. Looking back at it three or four years, we get better and better because of our experiences and the depth of the product that we continue to build. So I’m pleased with our competitive position.

Okay.

And if I think, David -- [I] just pile on for a second here -- on the Private Label side, really, there are different -- folks coming from different viewpoints at the market. If it's a portfolio or something like that and it's of size, one of the big guys will just write a huge check, right? And we're not going to do that. We're after someone who understands the long-term value of investing in marketing and all that other stuff you've heard us talk about forever. Or the other, I guess you could call it, competition would come from a retailer who says, "Look, I don't want -- you know, I just want processing or I just want credit." And we come back and say, "But you have to have the high-end customer care and call center. You have to have the database and marketing piece. It's all or nothing with us." And some folks don't want to do that. And I would say those -- we run into those quite a bit.

But all told, it doesn't sound like a lot has changed in terms of who you're competing against.

No.

Correct.

Hey, Ed, just shifting to some of the credit numbers, you've obviously walked through what the more normalized outlook is going to be in the second half and beyond. I'm trying to get an understanding of how to think about margins and credit services going forward once we return to normalized loss rates and even if we see an uptick in a down cycle.

And, specifically, is there still more -- is there still more operating leverage in the actual business? I mean just setting aside all the benefit you've gotten from lower loss rates, I'm just wondering, you've piled on so many more new pieces of business in the last 18 months. Has there been a commensurate increase in number of call center staff or call center? I mean, obviously, you're doing all your processing in-house, so there should be leverage there. I mean is there more to go?

Yes. I mean I think we're getting some leverage there. I think you're going to find probably more of it because of the way we do the transfer pricing is captured within the transaction segments, and credit is really driven by sales, AR -- I'm sorry, portfolio growth, losses, and funding costs are going to have a much more dramatic impact. So what I would suggest, and this is sort of what we're looking at here, is the EBITDA margin for the credit segment for 2007 obviously won't be where it is today, and I don't know, make it up, David, call it 30% probably is a good starting point, and that would cover the grow-over that we're going to have. And then you're going to have exceptionally strong growth in Marketing Services, and you're going to have decent growth in transaction. And even with the 30% EBITDA margin in credit, you're going to have strong growth there as well. But I think the grow-over issue on the credit loss side would overwhelm any sort of the benefits of getting leverage. But we are getting leverage on the transaction side.

Got you. Thanks a lot.

Thanks, David.

Cannon Carr, CIBC World Markets.

Hey, guys. Just a quick question. I know, Ed, you talked about guidance being conservative, but I do want to ask. I mean the math, if you just run through for the fourth quarter, looks like EPS -- cash EPS would be down year over year, and I'm assuming given all the drivers you've talked about, that that doesn't look possible, so I'm assuming you would agree with that?

Well, we take it one quarter at a time, and what we do is, as is typical for us for the past 21 quarters, our style is we put out what we think sort of the next quarter very conservatively could look like. To the extent we come in better than that, Cannon, we actually flow that through to the new guidance. But it's rare that we'll go out there and start adding on additional numbers for Q3 and Q4.

Like I said, the 2.75 is probably fairly conservative, and we would probably be a bit disappointed if there wasn't a little bit of up side to that number. But at this point, as we've said, we don't want to be in a position where we're out there chasing numbers at the expense of having the flexibility to invest in the business and getting all those conversions done so we don't have any grow-over problems in 2007.

And I think the folks who are out there are going to have to, I think, factor that in to what you think the back half of the year look like, knowing what the absolute minimum case would be and knowing that we're not going to have the huge blowouts we had in Q1 and Q2. It's probably somewhere in the middle.

Yes, okay. And then just update us a little bit just on the -- maybe the near-term funding requirements for parts of the portfolio that aren't securitized yet and what kind of a schedule or outlook is for the rest of this year on that.

Yes, we have one deal that's scheduled for -- gosh, it's almost the fall -- the fall, which is 450 million coming due. We have already pre-funded that deal. In other words, we've already gone out into the market and locked down that rate for many years. I think it was 5 or 7. I can't quite -- was it 7? -- yes, I can't quite remember, but 7 years. So, basically, when that deal matures, we will roll the new deal into it. In other words, you pay off one set of bondholders, you roll in the new set of bondholders, and that rate's already been locked down.

We up-sized the deal about 50 million, so it's 500 million, not 450, and we moved, I think, about 90 million of portfolios that were not quite ready for prime time, as we call it, that is, being rated by Moody's and S&P. They need a fair amount of history. We migrated them off balance sheet to conduits. And in addition to that, on balance sheet, we probably have another quarter billion dollars or so that's owned portfolio separate from seller's interest that, again, are portfolios that are what we call curing, and that is getting the requisite history and maturity. Whether it's the Blair portfolio, getting all those losses pushed through the pipe and getting it normalized, or the new start-ups, what we'll do is we will add those to the securitization bond deal that matures next year.

Okay.

So it's a very long-winded answer to say there's a few hundred million that you can expect to be added to the maturing deal next year.

Okay. All right. Makes sense. And then, just finally, securitized income; can you give that out now?

Securitized income. I think we give out net SCI, which I believe --

I mean we kind of approximated but just curious if you have --

Yes, you can kind of wing it, I think. Yes, in the credit services segment, you've got, let's see, probably three-quarters of that is your net finance charge income.

Okay.

And you're left to do the math.

Great.

The rest are fees.

Yes, okay. Great. Well, great job on the quarter. Thanks a lot.

I'm sorry; the net SCI also includes late fees as well, so--.

Right. Okay.

Thank you.

Wayne Johnson, Raymond James.

Hi, yes. Good afternoon, everybody. On the transaction services side, can you just give us an update, you know, the investments that you guys made one year ago in the first half of '05 in the different billing platforms? Can you talk a little bit about the -- what kind of functional benefits have you guys been able to reap now and the kind of operational leverage that you guys are benefiting from those investments?

I'll take just the first shot, and then Mike, who knows a lot more about it than I do -- if you'll notice, Wayne, for the first time the signings that we've had, the 1st Choice Power, Green Mountain, Wisconsin, and Direct Energy are all being converted onto an existing platform, whereas if you recall, because you were around, the first few years, what we basically did is we got utilities by also taking platform call centers and everything else with them.

So what we've done is we've made a huge change from not taking on another new platform or call centers or any of that stuff but just converting all the new business onto existing platforms, which will slowly -- which will more than slowly, but fairly quickly give us some nice leverage for '07. And then, Mike?

You're exactly right. It falls in two categories, but the call center is where we begin to continue to reap the cost saves and efficiencies, and then the other factors are around the integration of those platforms to the other internal into our clients' systems by automating those and improving those processes. So it's working very well, and we continue to benefit from that investment.

Okay, terrific. And a quick follow-up. Did you provide the -- for Credit Services the delinquencies? Did I not hear that?

I don't know whether you heard it, but I can give it to you. It was right around 4.1.

It was around 4 -- delinquency, so for the second quarter, 4.1. Okay, that's terrific. Thanks a lot.

You bet.

Thanks, Wayne.

Mark Marostica, Piper Jaffray.

Congratulations on the quarter, guys.

Thanks, Mark.

Just quickly here, one simple question. Given the high household penetration rates in Canada for the AIR MILES business, I'm curious how you think you'll still be able to achieve your kind of longer-term mid-teens organic growth in that business. Thanks.

You bet. As we've always talked about, it's not just the numbers of accounts that we sign up, but it's driven by usage, meaning their activity, across more and more sponsors, and it's continuing to expand the sponsor category within which they offer miles to change consumer behavior. We've talked about it generally before, but the basic model starts with one relationship with a sponsor, and the best example being Bank of Montreal and MasterCard and then moving to debit card and checking and savings, etcetera, or in the case of [Rona], where we started in one province and move them across country.

And then the third leg of the stool is by bringing on more sponsors.

So that's really what drives activity. We continue to see both number of active collectors continue to climb year in and year out and their amount of spin, so to speak. So those are the key drivers we monitor internally, and we're very pleased with their performance.

Yes, and I would add to that, if you really want the quick and dirty version, you say, all right, let's say we want mid to high-teens top-line growth there, to Mike's point. Just cut it in thirds, a third from additional cardholder penetration -- I mean household formation growth in Canada by itself is 3 or 4% -- then new sponsors, 4 or 5 or 6%, then deeper relationships and commitments from existing sponsors, another 5 or 6 points. And maybe a little help on the price side.

Thank you.

You bet. Thanks, Mark.

Collin Gillis, Canaccord.

Hey, Ed, I'm just wondering, are we not going to see a portfolio acquisition in '06, or should we really just focus in on new clients in the Private Label side?

That's a great question. I would say that, for the most part, if you were to go back five or six years, you'll find that the -- probably 90% of our new client signings were existing retailers who are starting a brand new program. Occasionally, there's a portfolio floating around like a Stage Stores a couple years ago or Blair last year. That's not really what we count on on any given year. There are a couple out there, we will say, that are of interest to us, and I would say to the extent you see something like that come through, that would really lock down 2007. But we're not counting on it, but at the same time, there's a couple floating around out there, and I'll leave it at that.

Okay, great. And then can you just talk a little bit about how MasterTrust data is going to track to the actual results in the September quarter, you know, from a credit sales and a charge-off perspective?

My guess is the actuals tend to run about 20 or 30 basis points ahead of the MasterTrust in terms of losses, as they did in -- I'd say very similar to Q1 and Q2 in terms of the delta.

In terms of credit sales, man, that's a tough one. It really depends on what's in the trust, what's not in the trust. I think by -- depending on when the deal comes due, the bond deal, we could be adding some additional portfolios to the MasterTrust.

So, look, we would expect the core combined with all our new stuff, whether it's in the MasterTrust, in private conduits, or on our balance sheet, Colin, to certainly register double-digit growth for the remainder of the year.

Great quarter, Ed. Thank you.

Thanks.

Thanks, Colin.

Paul Bartolai, Credit Suisse.

Thanks. Good afternoon, guys.

[Inaudible], Paul.

Just to follow up on the competition question from earlier, can you maybe talk also about what you're seeing in terms of contract terms at renewal in both utility and the Private Label side? And then, also, Ed, you mentioned the EPS impact from Canada -- Canadian dollar, which is helpful, but I also wonder if you'd give us the revenue impact and also the other contribution [inaudible]?

A lot of questions. I'll try. I think the FX impact from -- sorry, the foreign exchange impact on the revenue side -- I'm winging it a little bit, Paul -- is somewhere between 10 and 12 million bucks this quarter and probably about 1.5 to 2 million on EBITDA. And for -- in the first quarter, I think it was more like 7 for the top line and 1.5 million of EBITDA, something like that. Does that get you close enough?

No, that's helpful, perfect.

Okay. And then you talked about -- what was the next one?

Pricing pressure.

Pricing pressure. Oh, the contract terms. Yes, obviously, we're not going to go into specifics, but what we are seeing on the Private Label side is that more of the clients are willing to step up to what we call -- if you want to call it a joint marketing-type fund arrangement, where traditionally, we would take the entire merchant discount, along with the finance charge, and that's what we'd book.

What the clients are asking for now is, hey, if they put in some money and we kicked back or rebated some of the merchant fee into a general marketing pool solely for the benefit of driving card sales, would we be willing to do that? And the answer is you bet. We are making the bet that lower merchant discount income, because of these pools of marketing dollars, will lead to higher wallet share, higher penetration, and eventually an incremental lift in our profitability. But that seems to be the big trend that we're seeing. We're not seeing really any pressure on the APR side at all. It's really the trend towards they want more and more dollars pushed into pushing the program, which, again, it's a bet that at the end of the day, incrementally, we're going to make more money.

Great. And then just the acquisition contribution to marketing?

I don't think we broke out -- I don't think we break out the acquisition piece, but I would say that Epsilon itself, along with Loyalty itself, certainly constituted a nice 20%-plus organic growth, and if you want to throw in 20 million or something of top line for acquisitions, you're probably not that far off. I'd be -- I'm kind of winging it at this point, Paul.

Okay, great. Thank you very much.

Thanks, Paul. Any other questions, Operator?

No, sir. There are no further questions.

Thank you very much. I appreciate everybody sticking around. We had a little bit longer than normal, but we had such a great quarter, we were proud to talk about it. So thanks, and we'll talk to you next quarter. Bye now.

Thank you. This concludes today's Alliance Data Second Quarter 2006 Earnings Conference Call. You may now disconnect your lines, and have a wonderful day.