Bread Financial Holdings Inc (BFH) 2006 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. At this time, I would like to welcome everyone to the Alliance Data Corporation third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS).

It is now my pleasure to turn the floor over to your host, Ms. 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 third 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. The reconciliation of those measures to GAAP will be posted on the investor relations website at www.AllianceData.com.

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

Thanks, Julie. Good afternoon, everyone, and thanks for joining us this afternoon. Today, I'll spend a few moments reviewing the highlights of our third quarter. We'll focus on our three growth engine and we'll talk a little bit about the remainder of this year from a forecast and outlook perspective and we'll also talk about 2007. I'll turn it over to Ed and he'll get into some details around our financials. So let's get started.

If you'll turn to the next slide, hitting the highlights -- as you know, the Company hit an all-time high, we think a milestone this quarter, posting ever $500 million in revenue for the quarter, a 32% increase over this time last year. Strong performance was driven by both the continued impact of new clients and growth in our core account. That's double-digit growth in all key drivers. Our adjusted EBITDA was $133 million, a 54% increase over last year. Cash earnings per share was up 59% to $0.81, further underscoring a very strong performance from all of our businesses.

Earlier this month, we announced that our Board approved a new stock repurchase program authorizing the purchase of up to an additional 600 million of outstanding common stock through 2008. This new program, along with the two programs announced previously, brings our total authorization to 900 million. To date, we've used approximately 30% of that amount.

Also, last week, we announced Welsh Carson's final distribution of their shares [of] their limited partners. They've been great investor partners for 10 years now and I'm very pleased that our two Board members will continue to give us their support and guidance in the future. I'm also very pleased that the overhang of the pending distributions is now over and investors can sleep a little easier at night.

Now, let's take a look at the utility services group to start among the growth engine, turning to the next slide. The group had a very solid quarter. We announced an agreement to provide CIS and billing services for New England gas customers in Massachusetts.

New England Gas is a division of Southern Union, one of the nation's leading and largest natural gas company. With this announcement, we are slightly ahead of plan this year with a total of four new clients. This added to the previous announced Sacramento Municipal, Wisconsin Public Services, and Green Mountain Energy. We expect to have at least one more announcement before the end of the year.

This level of sales activity speaks to the increasing acceptance by the utility companies of Alliance Data's outsourcing services. The number of new client wins over the last 18 months has been great, but it comes with a price tag on the conversion side, so expect to see some additional conversion in ramp-up expenses, which we discussed on our last quarter's call to be primarily absorbed in Q4.

Let's turn to the next slide and talk about the Private Label core group. They had an outstanding quarter as key metrics outperformed plan. Most notably were credit sales and portfolio growth, both in the midteens over last year.

There was also a benefit from lower than planned bankruptcy levels, which we've discussed before, but overall loss rates continued to move towards our more normalized level. This quarter, we also extended our relationship with one of the largest furniture retailers in the country, American Signature. A client since our inception 10 years ago, they operate 128 locations through Value City Furniture, Rooms Today, and the American Signature furniture brand. We will continue to provide them with a full suite of credit marketing tools.

Looking ahead, we expect a strong finish to 2006 for Private Label business and the momentum will carry into 2007. Earlier this year, we announced new Private Label signings with Friedman's and Belk as well as new co-branded programs for New York & Co. and Goody's. We expect one or two more announcement yet this year.

One final comment -- from time to time, we get questions about our future in the Private Label business. We remain very upbeat. This business is very strong for several reasons. First, we see double-digit growth in credit sales and portfolio growth. Even other providers in the industry are growing as well.

Second, retailers in general -- we believe ours in particular -- see tremendous value from a strong Private Label program driving loyal, recurring customer sales with their core customer set. And finally, we're seeing new segment emerge where our powerful suite of credit marketing tools can help companies grow and prosper.

All right, let's turn to the next slide and talk about the Marketing Services business which, as you know, consists of both AIR MILES Reward Program in Canada and the Epsilon business here in the U.S. The marketing group had a great quarter as well, the result of strong fundamentals and market demand for our services.

Continuing the trend of the last two quarters, our AIR MILES group had 20% plus organic growth. We also added 20 new retailers to our online AIR MILES Mall, we call airmilesshops.ca, bringing the total to 75 lifestyle, home decor, electronic, entertainment and fashion retailers. By going through airmilesshops.ca, collectors have additional opportunities to earn miles when they shop online.

Some of our new retailers include Disney Shopping, Toys "R" Us Canada, and Office Depot, joining an extensive list including Canadian sites Amazon, Dell, Lands' End, Apple, eBay, and more.

On another note, we extended our relationship with one of our long-standing partners, Jean Coutu. They are one of our top ten sponsors, operating 320 drugstores in Québec, New Brunswick, and Ontario. Also, we extended our relationship with Hudson Bay, currently a national sponsor and now with an expanded relationship, a new reward supplier. Collectors can now redeem rewards for Hudson Bay gift cards. As you know, Hudson Bay is the largest diversified general retailer, operating 575 locations under the brand the Bay, Zellers, and Home Outfitters.

Now let's switch to the U.S. business. The big news this quarter was the acquisition of CPC Associates, a leading provider of data products that are used to increase the effectiveness of direct marketing programs with our Epsilon group. This acquisition adds new capabilities, particularly in the data field and completes our comprehensive marketing database and low [entry] solution.

I would like to highlight the five key areas. One, strategic consulting and the creative expertise to design programming; two, external data products to supplement client data; three, the technical expertise to build the necessary infrastructure in databases, our core original Epsilon business; four, sophisticated analytics to provide insight into the highest yielding types of programs; and finally, delivery mechanisms that can target down to the individual consumer level through direct-mail, targeted e-mails, and a point of sale.

I would like to welcome the CPC team to the Alliance Data family. With this division, we now have a truly integrated end-to-end marketing platform. Nice work, guys.

Let's turn to the next slide and talk a little bit about the outlook. We've had a tremendous year and based on our strong third quarter results, we continue to track well ahead of our 2006 expectations. We're seeing the impact of strong organic growth across all businesses and assets; we're comfortable raising guidance for the remainder of the year to slightly more than $3 cash EPS representing a 46% increase over last year.

Let's turn to 2007 briefly. It's shaping up very nicely. Our businesses have strong organic growth and we have a highly motivated group of folks to deliver on our promises. We are confident that we'll 0deliver on our long-term model. This, despite the challenging bankruptcy grow-over and other key metrics that [were] outperformed in 2006.

So, for 2007, our revenue we expect to come in about $2 billion or little over. Adjusted EBITDA of $575 million or better, and cash earnings per share of $3.50 or better. My congratulations to all of our associates, particularly management team for another outstanding effort. And, as always, my thanks for your hard work and commitment in helping our clients grow and prosper. Ed? Why don't you [give the financials].

Thanks, Mike. If you could turn to the slide titled Third Quarter Consolidated Results. Third quarter marked our 22nd quarter as a public company and further extended our track record of 22 in a row of overdelivering on what we promised.

As Mike mentioned, Q3 also marked a significant milestone for Alliance Data. It was the first time where our quarterly revenues topped the half billion mark which was more than we made in all of 1998. Also of interest, cash EPS for the quarter was more than we made in all of 2002. I believe that demonstrates both the high growth and strong leverage capabilities of our model.

Just very briefly, I want to talk about four key takeaways from the quarter. First, with revenues up over 30% and cash EPS up nearly 60%, clearly the momentum continues to be exceptionally strong.

Second, inherent in this growth is strong double-digit organic growth, which has always been a key part of the model. Third, once again, we saw a very nice balance across the businesses as demonstrated by double-digit gains for all of our key nonfinancial metrics. Specifically, miles issued, miles redeemed, statements generated, credit sales, and portfolio growth.

And finally, we started to see the growth leadership migrate towards Marketing Services. As credit loss rates continue to gradually normalize in Private Label as we move into Q4 in 2007, Marketing Services will become the fastest growth engine in the Company. Make no mistake, however, the Private Label will continue to be a growth engine in '07 as well.

Regarding the consolidated numbers themselves, strong across the board, obviously well above our expectations as marketing in Private Label significantly outperformed. Operating cash flow or operating EBITDA is running $23 million ahead of reported EBITDA through three quarters and may come in closer to $30 million ahead for the full-year versus the prior estimate of $25 million.

Similar to past quarters, the momentum remains strong and we expect a solid finish to 2006, and are already looking towards a strong 2007 despite some significant grow-over challenges.

Okay, let's turn to the next slide, chat a little bit about the segments. First up would be the Transaction Services segment which houses Private Label services, utility services, and our traditional bankcard business.

The statement growth, which is the key driver for both utility and Private Label, continued along at a double-digit pace. This metric drives north of 80% of the segment's overall revenues. Statement growth for both Private Label and utilities grew double-digit, while segment revenues were tempered a bit by the relatively flat performance in our old traditional Merchant Bankcard acquiring business.

Margins -- they are up again this quarter versus prior year despite the beginning of some spending on utility client conversions. On a year-to-date basis, EBITDA margins are running about 200 basis points ahead of the same period last year. Q4 will have a drop-off due to conversion expenses, but overall for the year as promised, margins should be up nicely.

Looking ahead, the continued ramp-up of Private Labels 2006 and 2007 wins plus upcoming conversions of utility clients should position us for a nice run through 2007.

Next up, credit services -- once again, the results were remarkable. First, credit sales, they were up 17%, which was the fastest growth rate we've experienced in over two and a half years. Driving growth for the continuing ramp-ups of last year's wins -- the Gallery, Hanover, Blair, Crescent Jewelers, [Ander] Mountain, Carter, and the Spiegel and Newport News co-brands, plus this year's additions of Bell's, Friedman's Jewelers, as well as co-brand additions to Goody's in New York & Co.

Additionally, the more mature existing base showed solid growth virtually across the board. These results once again demonstrate that the prime quality consumer, of which we have 11.5 million active each month, is alive and well and showing no signs of strain whatsoever.

Second, portfolio growth also came in well above expectations with 16% growth, powered by the better-than-expected sales growth. Yields remained strong with no indication of any pricing pressure. Again, demonstrating the key difference in behavior between the consumer who views our programs as loyalty vehicles versus how bankcards are viewed -- that is, as financing tools -- and hence, the pressure that they've seen and the pressure that we have not.

Third, funding costs were essentially flat to last year. Now, this key point -- these costs will pop up in Q4 as one of our very low costs -- that is, under 1% funding sources on $450 million comes due and is replaced with market rate funding. This is a temporary timing issue and will go away as we move through 2007. Specifically, a large portion of our funding book will continue to step down to lower rates during 2007.

What does this all mean? What's the net result? '07 rates will be roughly flat to '06 which were roughly flat to '05. Good news all around.

Now, finally, credit quality continues to perform better than anticipated but is slowly working its way back to a normalized level of 6%. A key point here is the fact that it is not deteriorating as the year progresses as some people have speculated, but rather it's merely working through the impact of last year's bankruptcy bill which spiked last year's Q4 losses to 7.2%.

This essentially cleared out the pipe for '06, which is Q1 was only 4.2%. Q2 started to see some normalization as it moved up to 4.7%, and Q3 came in right at 5% with the last month being September coming in at 5.4%. We expect Q4 to be at or less than 6%, as we've been saying all along.

Additionally, based on delinquency flows which allow us to see well into 2007, we're talking probably well through the second quarter at this point. We are very confident that losses will remain at or less than 6% throughout 2007. To wrap up, the prime consumer is spending strongly, but maintaining strong discipline as well.

All right, Marketing Services continued to accelerate as topline grew 50% and EBITDA at 90% plus. As anticipated, margins shot upwards by 450 basis points versus prior year, and we fully expect margins to be up strongly on a full-year basis despite a relatively flat margin in the first half.

Again, this should answer a number of questions that we got in the first half of the year where people were asking about margins in marketing, we've said hold onto the second half. Clearly, 450 basis points out of the gate here is a pretty good start for the second half of the year. Basically, things are cooking.

Our Loyalty AIR MILES program in Canada, which represents about two-thirds of the segment, continued to outperform with 20% plus organic growth driven by strong results for miles issued, miles redeemed, and pricing. We have renewed all major sponsors that were due this year, announced that 20 new retailers have joined our airmilesshop.ca that Mike talked about, and we expect a couple of significant new sponsor announcements over the coming month.

In the U.S., Marketing Services continue to crank it up. We added CPC, which is a data company providing the most accurate new mover file in the U.S. This completes our multiyear first phase of our U.S. strategy. I'm going to repeat essentially what Mike went through, but it's fairly important.

Specifically, we've now created a unique offering which cuts through five areas. First, creative -- that means designing the Loyalty programs; second, technology or database creation; third, the ability to populate those databases from clients, CPC, and other services; fourth, the analytics to understand the consumer; and finally, fifth, the distribution mechanism via Bigfoot and Double Click to stay in touch with our clients' customers. All integrations are complete and the results are extremely strong. In some we expect Marketing Services to drive a disproportionate share of our growth in 2007.

All right, let's move along to our balance sheet. Just a couple of items here. First, our deferred revenue balance related to AIR MILES continued to grow to approximately $680 million -- which, to remind folks, is nothing more than revenues and earnings which have been earned, but have not yet been recognized in the P&L and will flow into the P&L over the next several years. Good news there.

Second, core debt to trailing cash flow -- which is how all our bank covenants are written -- remained at a very modest 1.2 times and, as some of you who will recall many, many years ago, I certainly do -- nine or ten years ago when we started, we were levered up six to one. This is a big yawn at this point.

This is a very modest amount of leverage plus continued strong operating cash flow gave us the comfort to announce an additional $600 million to our buyback program, bringing the total to $900 million of what about 30% has been utilized thus far. We believe the buyback is compelling at current price levels and be assured that this thing is accretive well past today's price levels, well into the '60s and also be assured we will be very aggressive and opportunistic in utilizing this program.

Additionally, we feel comfortable that the buyback and our typical tuck-in acquisitions can both be accomplished while maintaining an investment-grade profile.

All right, let's move to the fun stuff -- guidance. 2006 guidance -- normally what we do is we'll take the overperformance from the quarter, flow it through and bump up the guidance for the full-year and leave the other quarters unchanged. Since this is -- we're going into the last quarter of the year, our adjustments today will represent our best shot at where the year is going to come out in total. So this is it.

Revenues will certainly be slightly above $1.9 billion; adjusted EBITDA will be slightly above about $495 million; and cash EPS will be somewhere between $3 and $3.05. A couple of things we want to talk about here. Obviously, if you were to look at the first three quarters of the year, you'd sit here and say that the $3 certainly sounds light. $3.05 may even be a little bit light.

There are a number of things that we want to factor in here since we really do manage to a full-year number, not a quarterly number, and that is, let's walk through what's different in Q4 versus Q3. Roughly $0.10 of it is nothing more than timing.

The common theme that should be understood is that the business performance itself should remain extremely strong and should give us a very nice jump-off into 2007, which we'll talk about in a second. But first, we'll get dinged in Q4 by about $0.05 from the refinancing of the $450 million asset-backed deal I talked a little bit earlier. It's replacing some funding that was done at less than 1% at this point and replacing it with market-based funding. Because a huge chunk of the portfolio will still stepdown over 2007, this is timing only in overall funding for '07 will be flat.

Next up, we continue to see the loss rate normalizing, with September at 5.4% versus roughly -- versus 5% for the entire quarter. Q4 we expected to come in, as we've been talking about, at 6% or slightly less, certainly not more than that. And again, this is just normalizing out where we expected it to be.

Third, utility conversion expenses -- we did have a couple of delays in the conversion of a couple of our clients. We are putting our shoulder into it into the fourth quarter and as a result, probably about $0.03, [that's] about $4 million versus about $1 million that we dropped in Q3.

Also, it's probably a couple of pennies from certain investments that we expect to make to drive some future growth and then finally, in Q4, we got an F6 [bene] of about $0.02. In Q4, we're not going to have that. Canadian dollar is essentially flat to where it was at this time last year.

So overall, a bunch of stuff -- about $0.19, $0.20 worth that are real items between Q3 and Q4. Again, a big chunk of it's timing and I think overall, what we are saying is that we expect a strong finish to the year, but let's not get overly excited about having another huge blowout in Q4.

Let's turn our attention now to 2007 guidance -- which I think a lot of people were wondering would we come to the table and ask for essentially a hall pass for the $0.25 or $0.30 of benefit we got on our credit quality this year. The answer, as we have said all along, has been no. Either you believe our model or you don't. We do believe it. It has worked for us for many years and we do not look for any type of hall pass as we give guidance.

And, as such, our sort of baseline guidance for next year essentially sticking a pole in the sand would say we expect revenues certainly of at least $2.1 billion, EBITDA of at least $575 and cash EPS of at least $3.50.

Just for grins, if you were going back and actually looked at what it means to play through that $0.25 grow-over, $3.50 for next year essentially effectively means that we're growing about 25 to 30%. So, no deviation from our model.

We expect to play through and overall, that combined with what I would say is one of the strongest pipelines we've ever had would suggest that '07 -- and I know it's extremely early in the game, but as we even start thinking about 2008, we're getting pretty jazzed up here.

So, let's go ahead and turn to free cash flow. What that effectively means is how much the business is tossing off, or as I call it, what's left in my pocket at the end of the year. What we try to do is factor in that extra 25 which this year or even next year may drift up to 30, don't know yet.

Excess profit earned up in Canada that is deferred and not recognized, so our operating cash flow will be about $600 million. Obviously, we have CapEx, we have interest, we have taxes. That will knock about half of that off and we'll be left with about $300 million of pure free cash flow, which is about $3.70 per share. You combine that cash flow with the growth rate in EBITDA, with our liquidity resources that we have out there and you can see how we could easily support a $600 million additional buyback program along with some tuck-in acquisitions and maintain an investment-grade profile.

Let's finish up here with our fabulous top questions that we've received throughout the quarter. As usual, this quarter, I think because people were concerned about the consumer rolling over which, as we clearly showed folks, did not happen and we're not seeing any evidence of it. There seemed to be an undue amount of focus on credit losses and people reading the master trust data. We try to tell folks that at a point in time, it's a cash flow document, depends what day of the month ends on, and how the report is written. So never look at just one month, look at sort of the flowing trends. Factor in also some seasonality versus prior year.

But in a nutshell, the master trust represents the most seasoned portion of our business on the Private Label side. What we actually incur and what is called reported includes both the master trust data and, for the most part, a lot of the new business, new portfolios that need to mature and need to go through sort of their high loss peak before we migrate them into the overall master trust file, which we will do eventually.

So, our true reported number went from 7.2% last Q4 to 4.2 Q1, 4.7 Q2, 5% Q3, and we are running at or less than 6% Q4. Folks are asking well, 2007, how comfortable are you with saying that this will continue at 6% or less? We are extremely comfortable with this.

If you were to do some very quick math based on delinquency flows, that basically means that account needs to be delinquent 180 days before they're written off. You know, if delinquencies are in the 5, 5.5% range, then you can very comfortably say that our losses are going to be right around that 6% that we were talking about. That allows us to see out six months. That's the math behind it. It's that simple. Things are not deteriorating. Things are merely coming back to what we believe are very, very good numbers and basically, I think what we're trying to say here is there are an awful lot of drivers in our business. We don't think people should get hung up with one step like the loss rate moving 20 basis here or 50 basis points here. It's not enough to move the needle for us.

It's an important driver, but we are very comfortable with our ability to manage to these levels next year and hit the numbers that we had talked about overall for the Company.

Second, macro slowdown -- hey, what happens if the economy slows? Again, to remind folks, Private Label is about 40% of our consolidated revenues, but it's very high quality, very strong pipeline, very strong growth at the moment. The other 60% is the program in Canada, which is mom and dad buying gas and groceries; the Loyalty programs here in the states, and Epsilon where many times, clients actually spend more in a downturn in the utility business where obviously people put at the top of their pay list.

So we think we're well-positioned for any type of slowdown. Also, for '06, we got questioned throughout the quarter on the street was running at, I think, $296. We've said certainly greater than $275. It, I think, spooked some people. Obviously [if] we clean that up today we're going to be north of $3. So hopefully, that cleans up that issue.

And then, finally, I think the big question was will they or won't they ask for a hall pass for 2007 on the grow-over issue. Clearly we are not asking for one. We are going to grow right through it.

So that's about it. The next slide -- operating leverage continues to grow nicely. We expect that to continue into '07. And then the final page is just sort of both a historical viewpoint as well as a future outlook of our key financial metrics and where we think we've been and where we think we're going.

That being said, taken up a lot of time. Let's go to questions.

Operator, we'll take questions now.

(OPERATOR INSTRUCTIONS). James Kissane, Bear Stearns.

Great quarter. Just in terms of the '07 guidance, obviously you have a tougher grow-over problem in the first half of the year. Is it safe to assume that this will be a fairly back-end loaded year? In terms of the growth rates?

I wouldn't quite go that far. I'd say maybe a little bit, Jim, but what we're seeing is that Q1 -- mainly because of the Private Label business -- seems to be getting stronger and stronger every year as the holiday spend seems to drift later and later into Q4. So Q4 seems to be drifting down a little bit and Q1 seems to be drifting up a little bit. So, even though that was the biggest grow-over quarter we had -- I think it was something like $0.10 or something like that -- you may want to knock it down a little bit, but I wouldn't take it a lot below. It's certainly going to be well above flat. So somewhere between probably ten-ish type percent growth would be my guess.

The AIR MILES business up in Canada, you've been saying it should slow below the 20% organic growth and it continues to provide upside on that front. What do you think the long-term growth rate for that business is?

Midteens.

Midteens. And then transaction margins? Definitely lighter but sounds like those convergent costs in there in the merchant business was a bit of a drag. What do you think the transaction margins are longer-term or what's the objective there?

It's a good question. I would say if I were doing the modeling going forward and we actually haven't rolled everything together, we're just very comfortable at the consolidated level. I'd certainly bump up the transaction segment 50 bips a year. I would probably keep the credit segments relatively flat and I would bump up the Marketing Services segment probably about 150 basis points. And I think if you mix that all in the soup, you come up somewhere north of 50 bips on a consolidated level.

Okay, great. Nice job.

Greg Smith, Merrill Lynch.

Needless to say, another nice quarter. The Marketing Services margin -- so I mean it stepped up dramatically. Can we consider that -- I've got a number of questions -- can we consider that a run rate? How is it split between AIR MILES and Epsilon and just -- you're kind of at this new plateau. How do we think about modeling that going forward and the key drivers that got us there?

Okay. I'll probably forget a couple of points C and D but I'll give my best shot here.

Talk about the marketing margin.

You want to talk about the margins? You know, I think 450 basis points -- I'm saying that's an increase in the run rate is probably stretching it a bit. We certainly expect Q4 to be up significantly over Q4 of last year. And given that the first half of the year was relatively flat, I'd like to see us go from roughly 16% last year to probably about -- oh, I would say about 18% this year. We'd like to see about a 200 basis points full-year margin expansion and then going forward, sort of what I mentioned to Jim's question.

But you're going to see some very nice margin expansion and it's coming from a number of areas. First, in Canada, obviously, you've got a program that's got 70% of the country active in it. Every incremental mile that's issued, obviously, the incremental margin on that is quite high when you have really no pricing pressure whatsoever as you can imagine.

Down here in the states, the businesses that we've added such as Double Click, Bigfoot, and CPC, are fast-growing vehicles that have very, very high margins well in excess of where ADS is overall, so again, that will push the overall margins of that segment up as they continue to grow and then finally, obviously, as we get bigger, you would like to think we could get some leverage out of those of us here in Corporate. I think just one CEO and one CFO is enough. So that should help out as well.

Perfect. That's very helpful. On the merchant processing bankcard business, how big is that now? Like percentage of revenue or just total revenues?

It's a little over $100 million.

And why not --

It's not a very big piece, Greg.

It seems to be maybe the one laggard in your portfolio. It's been a recurring issue. Why not potentially dispose of it? A lot of demand for that business potentially.

We continue to use the cash to help support the business, but we'd be open to looking at all alternatives, Greg. But we're in no rush. We're focusing on the growth side of the business and if something comes along, great.

And then last question. Just as we look into '07 and '08, I'm just trying to think that now with the stepped up margins in the marketing and if you give credit for all the cash flow, sort of give you credit for the free cash flow in the AIR MILES business, how do you think about the split between marketing and maybe the entire rest of the business from a percentage of free cash flow perspective? Any guess or target or anything we can think about in the future?

You bet. Don't forget marketing you would add an additional call it $30 million of pure free cash because that includes the Canadian business, right? That's all inherent in the marketing business. That doesn't show up in the reported numbers. So you'd start there and say all right, if you were to really divvy up operating EBITDA, how would that shift? I haven't done the math, quite frankly, but if you have most of your margin expansion coming from marketing plus marketing being the fastest growth engine for '07, '08, you put those two together, toss on your extra $30 million of operating free cash flow, you're going to see a fairly dramatic shift in operating cash really away from, I would say, the credit segment, which is probably going to have relatively flat margins and a decent growth rate. Maybe 10%, 8 to 10%, but it's going to be well below where marketing is. So it's a long-winded answer to say you've got a bunch of stuff that is clearly pointing towards a fairly dramatic shift in cash flow generation and marketing, but I haven't done the math on it yet.

Tien-tsin Huang.

Congrats on the results. I just have a couple questions. The utility business -- what does the backlog look like there? I'm trying to get a better feel for what the incremental annual revenue would be once we get those conversions up and we're at full run rate.

We do a lot of the work already and have the majority of what I'd call the majority of the conversions revenue coming in already. As we go through some additional upgrades on these accounts, which is what Ed was referring to, we'll spend some more money there, so we're not going to get a huge lift all of a sudden. We're not delaying a bunch of revenue. We're doing all the call center work and other things prior to converting from the platform that we took over and operating on their behalf and are now just moving those into our latest platform. So, don't look at it as a delay of the revenue hit.

Should we assume then the margin profile would improve then in 2007 in a material way?

It should be coming up. Yes.

You bet.

And then, can you comment on where that margin is today and what we should expect out of utility in 2007?

I think we've always targeted sort of low double-digit eventually rising, hopefully to something with a two over the course of a few years. I don't think we've set sort of some timeframe. What we will do, however, is these conversion expenses we're talking about and all the training expenses -- we are opening up an additional call center as we're cranking this thing up.

You know, that's money that we will spend every year and especially given the amount of cash that's pouring out of Private Label and Marketing Services. We think the life of this utility business is a 20 or 25 year type life. So, we're going to invest in it now and we are pricing the contracts at, we think, a good margin that's accretive to the segments and we'll get there.

Mike, can you actually comment on the acquisition pipeline? And also curious if you're including anything beyond a -- I guess, a tuck-in acquisition or two in your guidance for 2007?

We continue to look at mostly the marketing space. Even though we've described a fully integrated plan now, we think now there's an opportunity to begin to lever on tuck-in. I think the data field will be one we'll focus on. We'll continue to focus on the analytic and Marketing Services area as well. So, that would be our primary focus.

There may be some others in other parts of the Company, but that's where we're focusing and no, there's not any big acquisition, like in Epsilon or something like that built in our guidance.

Yes, it's essentially '07. There may be something small that comes in but anything other than that would be additional to what we've already talked about.

Great. That's helpful. One last question. Are you assuming any share repurchases to get to the 350 plus target for 2007?

No.

Terrific. Thanks. Well done.

But we're going to do them.

Andrew Jeffrey, Robinson Humphrey.

Ed, you mentioned in your comments that you think the pipeline is looking pretty good, I guess particularly in marketing. Could you characterize what the pipeline looks like in Epsilon? Are we talking about the potential for more city type deals or are these more traditional as we'd historically thought of them, Epsilon data kind of contracts?

Yes, it's a fair question. I'll kick it over to Mike as well. I think what you're going to see is, obviously we can't comment on city like deals, but I think what you're going to see is you're going to see more than a one-off deal with what was formally Bigfoot and Double Click now called Epsilon Interactive or a one-off database deal with Epsilon or a one-off data deal with CPC.

What you're more likely to see as we start moving forward are deals that basically combine all the different parts of what is now U.S. Marketing Services -- those five pieces we talked about. That's the whole point of our strategy of putting all those pieces together just like we talked about in Private Label and just like we talked about up in Canada. We're walking through the door basically saying hey, folks, we have a creative team that can create the loyalty or marketing program. We have the technical expertise to build the database. We have and own the data and can get access to outside data and we have the delivery vehicle in Bigfoot and Epsilon and the analytics to analyze it.

It's quite a package. We expect it will probably take some time before most of the majority of our deals are ones where they're utilizing all five pieces. So it will be a combination of hopefully more rather than less deals that have more than just one piece, and then eventually evolving over the next several years to sort of our Private Label model where it's all or nothing, I would think.

As a result, the pipeline has got some deals of size and we think those have already, but we have a lot of nice synergies that are starting to come forth as the great relationships that Dave has with the data clients, now having the ability to add on interactive and database activities and the interactive folks that we didn't have a relationship with in, in database and data side, so we've got a number of people now dealing with existing clients that's helped fueling that growth as well.

Yes, I think, quite frankly, I think before the year is even out, you're going to see three or four significant announcements out of Epsilon of which these are big names. Big names.

And the one thing I noticed which was a little bit out of trend in the AIR MILES business, was the issuing volume and the quarter of the growth therein. Anything going on there of which we should be aware?

No. As we have said for countless years, we're pretty good at figuring out where the annual issuance is in redemptions will come in, but we have yet to crack the code on the quarterly ups and downs. Just to remind folks who are not all that familiar with the business, take a large grocer, for example, who may pay us, make it up, $40 million a year, clearly when Mom and Dad shop there once a week, that makes you up $20 million of that budget, but that other $20 million is pure discretionary spend that they've agreed that they will spend at some point in the year, but they want to have the ability to spend it when they choose to do so.

So, that accounts for a lot of the swing in the quarters. There was leading off huge promotional programs in some of the grocers up in Canada, where they could combine with a package food provider and do two-for-one miles or something like that. So, it's a long-winded answer that basically says don't worry about the quarterly. Worry about the annual.

Wayne Johnson, Raymond James.

Also on Marketing Services, I was wondering, could you remind us -- given the recent acquisitions you guys have made and putting everything together over the last year or so, is there any seasonality to this business? And if so, what are the peaks? What are the valleys?

I don't really think so. I think it's pretty straightforward. I would say at this point, unlike Private Label where you know Q1 is probably going to be our strongest and then Q2 is probably going to be our weakest. Other than that, I'd say probably Q1 in Marketing Services is a little bit lighter than later on in the year, but I don't think it's enough to get too excited about.

And you mentioned the potential to add big names to Marketing Services between now and the end of the year. Is there any upfront costs to Alliance Data to board them?

No.

Mark Marostica, Piper Jaffray.

Thank you. This is actually A.J. for Mark. Congratulations on your quarter. Just going back and maybe you discussed this in a prior question, but when you look on Marketing Services, which has been talked about a lot, how much of this topline growth is coming from new client signings? How much of it is from existing clients? For '07, that is?

For '07, I would say if you were to look at our business in Canada which, again, is about two-thirds of the segment. We have often talked about the three ways to grow -- either expanding relationships with existing sponsors; adding new sponsors; and finally, somewhat deeper penetration, a few points of additional penetration of the population base and we've kind of split them in thirds, quite frankly, five points each.

So, if household formation in Canada has grown three or four points, we can grow a number of members maybe 5% a year, if a Bank of Montreal decides hey, I want to use it for more than just my credit card and my retail base but want to roll it into my small business programs, that's another five points of growth. And then if we add something in the auto section or expand something else, that would add another five points coming from (indiscernible). So a third, a third, a third in Epsilon, what do you think, half and half?

Probably. Much like the card business, the systems and services we're building now drive next year's revenue. So we already have good insight as to the majority of that growth.

Also, just I guess on the Epsilon business, how about your deal with City, the Thank You network? I know you don't like to get too specific with clients, but how is that deal progressed? Can you talk about anything quantitative or qualitative about that network?

I think we keep it at a high level and say it's a great relationship. It's growing nicely. It's higher than we originally expected and I'll leave it at that.

Using that as an example, have you had to make an incremental spend in order to grow that relationship? Or is it just been as you had kind of built it as you built it out in the past?

No different than any other kind of new service that we would bring on -- much like we started with the Loyalty platform, then we added Interactive Services. No, there's no unusual spin to deliver the services that we have already in our standard platforms.

Okay, final question here. Just, I know with the expansion of the Epsilon business, one of the opportunities was to cross-sell your services into your Private Label. Can you just kind of maybe talk to us about either quantitative and/or qualitative about how that's been going, in terms of cross-selling those services into your Private Label customer base? Thank you.

[I'll take you to Mike], but obviously we can't talk about specific clients, but there have been significant inroads in our ability to take the former Bigfoot and Double Click -- which is our permission based e-mail engines -- and sell into our existing Private Label client base and not just as it relates to the Private Label business itself, but really their overall marketing campaigns.

You bet. And particularly as you think about the catalog retailers and others that use interactive e-mail and others, we've had nice additions. So the retail marketplace in terms of database and data analytics, if you look at the traditional brick and mortar retailers, is much different than some of the banking and financial services that is a lot more cross-sell and direct marketing based.

So they don't typically spend as much in that area as the majority of our other verticals that Epsilon group is in anyway; but for that particular area, it's growing nicely.

Yes, and also, don't forget that in our utility business, specifically our deregulated space where it's important, there's a great opportunity for the Epsilon folks to be working with the utility folks to start developing customer acquisition, customer retention type database programs and then also have Bigfoot, Double Click do distribution. So you can almost think of it as the tentacles from Marketing Services are reaching out deeper and deeper into the Company.

Thank you. Congratulations.

Colin Gillis, Canaccord.

So, Ed, I know you spend a lot of time sort of coaching us not to spend too much effort on one month's individual master trust data, but looking at September, we noticed the charge-offs, you picked up a little bit as you gave some commentary, but I also saw that the delinquencies in the 90-day plus category dipped down quite a bit as well. Anything driving that?

Delinquencies overall I think have been fairly consistent across the board. What I think what you're basically seeing, Colin, is that if I'm not mistaken, I think our delinquencies overall were just under 5% for the month of September, which was up a little bit from prior month and that was up a little bit from the month before.

What you're seeing, which is good news -- we just don't how it's going to play out in '07 and '08 -- is that very few people, fewer and fewer people are filing bankruptcies or it really hasn't even come close to normalizing bankruptcy filings where, as you know, you can't recover anything. So, and it may be because the process is too complex, too expensive, the lawyers don't want to take it, whatever, but what's happening is these people who would normally file bankruptcy are just rolling through the delinquency buckets and breaking out the back end as normal losses, which means we have an opportunity to recover against that.

So that may help us in the future, but in terms of the individual dips during the month, no, we're not noticing anything of significance that would lead us astray from what we've been guiding to all along.

Is there anything --

If you even look at previous year, we're still down from previous year. I mean better. We're 40 basis points better than two years ago, so it's strong. And September, typically, frankly is a little bit higher delinquency month than any other month of the year. So you've got to look at the seasonality on that too.

Yes, absolutely. Is there any data that suggests the bankruptcy bill has encouraged the client base to become a faster pay?

We have not seen any change in our payment rates. Gosh, I think in the nine years I've been here, I think the only time we ever saw a blip was really post-911 was a little bit of a speed up. But other than that, our payment rates have been flat for about nine years.

The bigger change is coming from the minimum pay. You see a lot of the bankcard people talking about a faster payment rate and more payment. That's because most of them had to change their payment rates. We didn't. We were already at that, collected the high amount anyway. That's more a driver of higher payment than bankruptcy.

Yes, and in fact, I think our yields, which have been extremely stable over the years, have actually even crept up a little bit.

And then can you give us a sense as to the percent of receivables that are not in the master trust right now and when you might -- if you're looking to go to market?

Sure. We have probably about $3.6 billion total receivables of which approximately $3 billion I believe is in the master trust. So there's about $600 million that's not in the master trust, so 6 out of 3.6 -- about 15%. What we will do as those receivables mature and that means they get through their peak loss period, which is anywhere from 18 to 24 months, we will probably lump them onto a maturing asset-backed deal in the late fall of next year, I believe. Or they're large enough right now, we could probably even do a single deal of $500 million or so. But normally, we like to just plop them on top of a maturing deal.

And just the last one -- I met with a lot of European e-marketing companies. It was interesting. They all cited ADS, specifically Epsilon, as their main competition. Do you think that you are positioning as an e-marketing powerhouses out there? Are you going to put any efforts into increasing that awareness going forward?

You bet. The Epsilon interactive business is a very strong business. It's given us the opening to actually provide some international services for the first time. We've got offices in Europe, China, and Ed talked a little bit about the R&D spending we're doing as we're looking at a variety of places. So it's a very active product and we're very excited about it. It also opens up broader relationships as you look at the full suite of services that Epsilon can bring.

Great. Nice quarter.

Can we get a couple more?

Cannon Carr, CIBC World Markets.

Congrats on the quarter. Most of the questions have been answered, but just curious, this year, for '06 most of the growth drivers look fairly balanced across each of the businesses. In '07, it's the same kind of assumption on an organic basis generally fair to assume that will continue to be that way? Or is there one driver that particularly stays strong or ramps up a little bit?

Good question. I would say that the driver -- an answer you're probably not going to be thrilled with -- but the driver that ramps up is a driver that doesn't exist, which is essentially saying that the U.S. Marketing Services business, the Epsilon business, is going to be our fastest growth vehicle next year followed behind by our Canadian business which we do supply drivers on. And then, you've got utility and Private Label behind that. So what I would suggest for 2007 is the growth rate in Marketing Services will be significantly higher than unfortunately the two drivers that we have there today would indicate. And that's primarily because the U.S. Marketing Services business is going to become a bigger and bigger piece of ADS, a bigger piece of the Marketing Services group, and by far, our fastest growth engine.

So, it's not a good answer for you. We have been searching to find a driver that could encompass sort of all of our U.S. marketing business and, quite frankly, we haven't come up with one yet. It's just not clean enough, so maybe we will in the future.

So we will try from a disclosure perspective in 2007 to continue to provide [hey] Canada is two-thirds, U.S. is one-third right now. As that shifts we'll provide that to you as well and you'll be able to back into the growth rate.

That helps. So in other words, kind of the key organic drivers are if you're running 20% now, maybe it will become 15% and there -- like you've mentioned, there are some contract wins coming up out of the U.S. that start materializing later this year and ramp into next year and provide the additional growth engine.

You bet. And a deal that may have just been a Double Click e-mail deal may now be a Double Click combined with a database deal with Epsilon. That's what's beginning to fill the pipe.

One more, operator.

Paul Bartolai, Credit Suisse.

Couple quick questions here. You talked about the strong growth in the Private Label credit sales and coming from both existing and new clients. Anyway we can quantify that a little bit, what you're seeing in terms of organic growth?

You bet. Well, it's all organic for 17%. But if you were to say what percentage is coming from folks who've been with us for more than three years, that is the more mature folks versus some of the newer vintages that are still ramping up, what we're seeing -- and it's pretty easy to check, I mean, I will mention one name, look at Limited. Limited Brands was doing double-digit comps, I believe, last month. So the core mature business is doing quite well. Maybe they usually used to run at 5% or so. Now they're probably more like eight-ish percent and the remaining 9% is probably coming from the vintages that we have signed and that have been ramping up since '03, '04, '05, and now '06.

Great. That's helpful. And then just -- it makes sense what you said about the delinquency rates moving into loss rates and then giving you comfort as we look at the first half of '07, but how do we get comfortable that we're not going to see loss rates continue to creep up? I know historically it's been more in the 7.5% range and now it seems like you're saying that 6% is a better long-term target. What has kind of caused that to come down?

Yes, I'd say if you said 7.5% was the old loss rate in the old days, and we're seeing 6% now, that's 150 basis point delta. I would say probably two-thirds of that delta is absolutely permanent, half of which being that the quality of the portfolio, quite frankly not done on purpose, but more driven by the clients that we've signed, has crept the credit quality up from -- you know, if it's a bureau score of 680 a few years ago, it's 700 or so today. That's a permanent difference.

Also, we have poured tens of millions of dollars into the back office on the collection side and that has also shown up as much better production on that side. That's permanent. So you're really left with 50 basis points difference as opposed to 150. So, 50 bips is something we can easily play through if, in fact, this thing drifts up just over 6%. But I've got to tell you, we're getting that real warm fuzzy feeling based on the delinquency flows that -- we're already looking into next summer and we're just not seeing a pop.

Just have the currency and acquisition contribution in marketing? Thanks.

You bet. Currency was about $8 million topline and about $1.8 million on EBITDA, so I think that's about $0.2. And in terms of the acquisition breakout, I don't have that. What I will say is that Canada grew well north of 20% and the core Epsilon business with Double Click and Bigfoot were also in that range as well. So whatever left over was the newer stuff.

Thank you. I want to wrap now and thank everybody for joining us for the call and we've run a little bit longer than we normally do, but I appreciate your joining in. I think you can see that we're really in a sweet spot. Our services are in high demand. We're partnering with clients that both at the strategic and operating levels which create long-term relationships and from a leverage operating model, it's certainly proving out in the financial. So we're excited about next year and we'll talk to you in January. Thanks.

Thank you. And this concludes today's Alliance Data Corporation third quarter earnings conference call. You may now disconnect and have a pleasant evening.