Bread Financial Holdings Inc (BFH) 2007 Q1 法說會逐字稿

Good afternoon. Welcome to the Alliance Data first quarter 2007 earnings conference call. At this time, all parties have been placed on a listen-only mode. Following today's presentation the floor will be open for your questions. [OPERATOR INSTRUCTIONS] In order to view the Company's presentation on their website, please remember to turn off the pop-up blocker on your computer. Thank you.

It is now my pleasure to introduce your host, Ms. Julie Prozeller, of Financial Dynamics.

Thank you, operator. By now you should have received a copy of the Company's first quarter 2007 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 would like to remind you that some of the comments made on today's call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and uncertainties described in the Company's earnings release and other filings with the SEC. Alliance Data has no obligation to update the information presented on the call.

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

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

Thanks, Julie. Good afternoon, everyone. Thanks for joining us today. As usual, we will start with the agenda. I will go through the highlights of the quarter. We will talk about the full year outlook, and then I will ask Ed to dive into the financials in some more detail. Let's turnover and start with the first quarter on the next slide.

I am very pleased to announce that we posted our best quarter ever, turning in record revenue, EBITDA and cash EPS. This marks our 24th quarter as a public company, and our 24th consecutive quarter of delivering or exceeding our plan. In the first quarter our revenue reached 549 million, an increase of 15%, and EBITDA increased by 19% to 160 million.

Cash earnings was $0.95 per share, up 12%. This 12% growth was in addition to growing through a very difficult comp from the first quarter of last year. You will recall with our abnormally low credit losses, which was a result from bankruptcy reform legislation enacted in 2005, created a $0.10 grow-over issue. If you were to normalize this, cash EPS growth would be 27%.

Now let's take a look at a few highlights, and we will start with the AIR MILES program. Turning to the next slide, our marketing service division in Canada which manages our AIR MILES reward program had another great quarter, delivering strong double-digit organic top line, and 20% plus EBITDA growth. This quarter we announced a multi-year agreement with Newfoundland and Labrador Liquor Corporation.

In Canada the sale of alcohol you will remember is regulated by a Provincial government, and sold primarily through government-owned stores. Liquor is one of the top five sponsored categories in the program, along with financial services, gas stations, supermarkets and pharmacies. Expansion into this category is a focus for our growth, as we have only four of the ten provinces in the program.

AIR MILES program enjoys market dominance as the largest and most successful and recognizable coalition program in North America, and this provides sufficient leverage and margin expansion. When asked about our ability to sustain this pace, we point to our unique business model that consistently demonstrates real value for our sponsors and collectors alike, and as a result, we have our breadth of our sponsor base, the wide variety of rewards and two-thirds of Canadian households as active collectors, which cannot be easily duplicated, our ability to keep the AIR MILES reward programming dynamic and relevant further ensures this pace of growth.

Let's turn now to the next slide in our U.S. Marketing Services division. Even excluding Abacus, we had a tremendous quarter with 30% plus top line and approximately 60% EBITDA growth. We successfully signed a number of new clients for our database services, analytics and permission based e-mail Marketing Services. While due to our client's wishes, they cannot be announced just yet, they are a very well known national brand, and we are pleased to include them in our list of marquee clients.

The Abacus acquisition closed in early February. We are very excited about their depth of expertise, and experience in delivering data, data management, and analytical services to over 1500 retailers. This is a significant expansion of our U.S. marketing group into the retail and catalog verticals, and expands our geographical footprint in the U.K. and Europe.

Additionally, we expect to leverage this acquisition through cross-selling of other services within Epsilon, and also other Alliance Data businesses. We believe we now hold a formidable leadership position in Marketing Services, and I want to briefly walk you through the five core areas of comprehensive, end-to-end Marketing Services. Let's turn to the next slide.

Epsilon has become one of the most robust and comprehensive providers of multi-channel data-driven marketing technologies and services worldwide. Our core offerings help leading marketers design, build and execute highly profitable marketing programs across all channels, and throughout the customer life cycle. Now what makes us unique in this space? First, we provide five critical services. It includes initial consulting and design through our strategic consulting and creating services group.

We provide data services using proprietary, client-specific and third-party data to accelerate the success of marketing programs. We design, build, and manage transaction rich databases on their behalf. We provide analytic services that lead to real insight into consumer behavior, and the delivery of highly targeted marketing programs through our multi-channel interactive services.

Secondly, we have the expertise and scale in all five of these areas, and lastly, our core services align with our client strategic initiatives, which creates a stickiness in our relationship and in return creates a more predictable revenue stream for Alliance Data.

Let's now turn to private Private Label services. Our Private Label group had another stellar performance in signing and operating metrics. Last week we announced two long-term agreements with Orchard Supply Hardware, a regional home improvement retailer with 85 stores in California. We will provide a comprehensive credit and marketing solution for both their consumer and commercial customers.

Additionally, we signed an agreement with Sportsman's Guide for a new co-brand program. Sportsman's Guide is a leading catalog and internet retailer offering quality, name brand outdoor gear and merchandise. We also announced the renewal and expansion of our long-term relationship with one of our largest clients, Redcats USA. They are one of the largest multi-channel retailers in North America, and a top-five client for Alliance.

In addition to a ten-year agreement to provide integrated Private Label and credit marketing, the agreement also includes co-brand credit card services for twelve of their catalog brands. By offering co-brand we believe Redcats can broaden the reach of its loyalty-building programs by attracting new segment of customers.

Our key operating metrics performed very nicely as well despite the $13 million or $0.10 growover I mentioned earlier, which came from abnormally low credit losses in '06. We had very positive results. Portfolio growth came in just under 10%, and combine that with rock solid credit quality and stable funding costs, and you have a very strong quarter. Print and sales were decent, but we believe we'll see stronger growth as programs signed in '06 and beyond will start to ramp up. Once again, a very nice quarter.

Let's turn to Utility Services page next. Last month we signed a six-year agreement with Pinellas County Utilities. They are a municipal water utility providing services to over 100,000 homes and businesses in Florida's mid-Gulf coast. We will implement a new customer information system, provide ongoing application management, hosting bill print and mail services.

As I mentioned last quarter, our focus has and will be on operations. We had higher than expected expenses in this area due to delays in system conversions and some penalties associated with these delays. Along with that, costs were also impacted by the opening of a new call center here in Texas, to handle the growth experienced in the last twelve to eighteen months, as well as our future growth. We anticipate this to be completed in the second half of '07, and then see a return to more normalized expenses. The good news is these additional expenses are far outweighed by the expected overperformance in our other three business units.

Let's move ahead to talk about the remainder of 2007 and our outlook. Looking at the full year we are very excited about the Company's overall performance, and based on the overperformance in the first quarter, we are flowing through Q1's overperformance and thus upgrading our guidance. We expect strong momentum to continue from AIR MILES, Epsilon, and our Private Label group, and believe this positions us very nicely for the year.

To the extent overperformance continues, we will upgrade guidance as we go. I want to thank our teams for an outstanding quarter, still a lot of work to do as we are still early in '07, but I am confident we will deliver on your promises. Thanks again.

Ed, would you take over now?

Thanks, Mike. If you can turn to the slide first quarter consolidated results. As Mike mentioned, Q1 marked our 24th quarter as a public company, and further extended our track record of overdelivering on what we have promised. Q1 was also our best quarter in our history with record revenues, operating EBITDA, adjusted EBITDA, and cash EPS. All of this despite battling a $0.10 or $13 million growover from last year's abnormally low credit losses, resulting from a temporary benefit from the enactment of new bankruptcy legislation in late '05.

Revenues were up strongly at 15% to about 550 million, which happens to be approximately what we made for the entire year in 1999. EBITDA was at 160 million, up 19%, and more than we made in all of 2002. Cash EPS of 12% reflected some increased depreciation run rate, but also the funding costs associated with the Abacus transaction which closed in February. Excluding the temporary growover issue, cash EPS would have been up 27%. Alright.

Let's talk about five key takeaways from the quarter, the first one that AIR MILES, Epsilon, and Private Label all had better than anticipated quarters. Organic growth rates were double-digit in either revenues, EBITDA, or both, across all three units, with Epsilon and AIR MILES leading the pack. Second, our traditional non-core merchant bank card business continued to attrite as expected, and the utility business quite frankly had a disappointing quarter due to higher costs.

Third, a strong overperformance of the "Big Three", AIR MILES, Epsilon, and Private Private Label will more than offset the two lagging units since the Big Three represent about 85% of consolidated revenues, and well over 90% of cash flow. Fourth, because of this, we are flowing through Q1's overperformance, and thus raising guidance and expect an upward bias to our numbers as the year progresses. As promised, we fully expect to grow through the $0.25 full year growover issue, as well as put up additional impressive growth numbers on top of that.

Finally, note that consolidated EBITDA margins are off to a good start by increasing 100 basis points plus versus prior year. We expect even stronger expansion for the full year.

In summary, it is a solid quarter and a great start to the year. Let's now hit the segments, if you will move to that slide. Alright. Segments which I grade as two A's, and as they used to say a gentleman's C, which is where we will start.

The Transaction Services segment houses Private Label, utility, and our traditional merchant bank card business. Revenues were flat as our non-core merchant bank card business continued to attrite, which offset growth in Private Label and a flat performance in utility. Overall revs were roughly in-line with expectations. EBITDA, however, was below our expectations by around $4 million. The shortfall came from the utility business and consisted of 1) penalties for delays and conversions, 2) additional operating expenses due to conversion delays, and 3) the ramp-up of our new call center in Ennis, Texas.

Looking ahead, most of these items will most likely carry into Q2, and then should begin to dissipate in the back half of the year. On our last call we estimated single digit growth in top line and EBITDA for the full year, and this expectation remains the same. Alright. Next up.

Credit Services which had a fabulous first quarter despite phasing a $13 million growover, essentially monies spent in Q4 of last year to drive holiday marketing campaigns paid off big in Q1 through higher card revenues. Q1 is now by far our largest quarter for Private Label as cardholders don't tend to pay down balances, or stock revolving until Q2. The margins shot through the roof and came in above 40% versus 28% Q4.

Let's talk about the four key drivers, which are portfolio growth, credit sales, funding costs, and credit quality. First, portfolio growth was solid at just under 10%, which is our long-term target. Driving growth was decent performance in the core portfolio, that is portfolios over three years old, plus solid growth from the '04, '05, and '06 vintages, that is the new signings which continue to ramp up. We expect solid growth to continue.

Second, credit sales came in at 6% which was expected and should gradually creep up to 10% by year end, as again the '04, '05, '06 signings continue to gain momentum. Third, our funding rate remained stable and is on-track to be flat this year versus 2006, which was flat to 2005, regardless of fed actions. At current levels, 2008 will also be roughly flat to this year, which is both good news and new news, as the cost of five-year money, our preferred funding term hasn't budged.

Finally, credit quality remained rock solid and losses remained flat to Q4 at around 6%. As noted in the past, we view this as a run rate for the year, and based on another metric delinquency rates, which gives us a 180-day view into the future, that is through most of the rest of this year, we are quite confident about having no "surprises." This past quarter should finally put to bed, the noise that has surrounded us for years questioning the true "prime" quality claim of our portfolio. As subprime has blown up, we have not seen even a ripple in our portfolio. So as this continues throughout the year, we hope the questions regarding the quality of our 12 million active cardholders, are put to rest once and for all.

Wrapping up, expect typical seasonal downturn in Q2, and then a nice snap back in Q3. It happens every year. In any event, we are expecting another strong year in Private Label, even in the face of a $0.25 full year growover. Can we do double-digit on both top and bottom line? Certainly possible. Okay.

Finally, the monster, Marketing Services which consists of our loyalty AIR MILES program in Canada, and our Epsilon business here in the States. We expect these businesses to account for about 50% of our consolidated revenues this year. Based on Q1 we are getting there in a hurry. First, Canada which had strong double-digit organic top line growth, and 20% plus bottom line organic growth. We continue to see such strong growth due to 1) strong pricing power, 2) deeper commitments from existing sponsors, and 3) new sponsor ramp-ups, such as Budget Rent A Car and Newfoundland Liquor.

Can a program with 70% of the population active in it, continue to post this type of organic growth? You bet. For 17 years the program has dominated all other loyalty programs, yet even after all this time, we believe only 60% of the addressable sponsor market, that is the folks who pay us, has been penetrated by AIR MILES. Areas such as auto, liquor, insurance, and the internet, are but a few of the many categories that we are just now entering.

Additionally, we continue to garner a larger and larger share of our clients' marketing budgets, as our transaction-based and ROI-based loyalty coalition, continues to offer a better alternative than traditional marketing channels. This is also the case in the U.S., as our U.S. marketing business called Epsilon, came out of the gates very strong, growing top line north of 60% and EBITDA 100%. If you want to exclude Abacus to get a feel for rough organic growth, Epsilon grew somewhere in the mid-30% range top line, and approximately 60% on the bottom line.

Epsilon stands poised at the front of the wave of full service transactional and ROI-based marketing programs, which again are displacing traditional marketing channels. The combo of creative, proprietary data, database, analytics, and distribution via Epsilon Interactive, our e-mail engine, creates an unbeatable and truly unique offering.

How to model Epsilon is a common question. Probably minimum long-term organic growth of mid-teens top line, and a bit higher bottom line would be a good place to start. Growth comes from solid pricing, additional commitments from existing clients, which is probably 60% of the growth, and finally new clients of which we signed half a dozen in Q1 alone. As Mike mentioned, unfortunately we haven't been able to release their names, due to the client's request, but we are working on that one, too.

Nonetheless overall marketing and loyalty services is off to a tremendous start for the year, with better than expected top and bottom line growth, and a Q1 margin expansion of 300 plus basis points. Expect strong growth to continue. All right. Enough of that.

Let's move on to the balance sheet. A couple of notes here, probably three things. First, changes in deferred revenues, less changes in the trust account additions drove operating EBITDA actually down 8 million below reported EBITDA. But as we noted last quarter, there was a timing difference that caused Q4's operating EBITDA to be abnormally high at $20 million above reported EBITDA. This has reversed in Q1 causing a smaller than normal operating EBITDA number. What does it all mean? Well, just take a look at the trailing four quarters as a better trend metric, and we are still running about $30 million ahead of reported. This is a good run rate to use on a go-forward basis.

Second, leverage continues to be minimal as core debt to LTM operating EBITDA which is our key credit covenant came in at 2 times. Finally, we have announced a total of $900 million in stock buybacks, through Q1 of this year we spent approximately 400 million, buying around 8.5 million shares with a weighted average price of $47.00. This included spending roughly 108 million in Q1 at an average price of $60.00. We will continue to utilize our liquidity for both opportunistic acquisitions and/or additional share buybacks. Okay. Let's move to the fun stuff.

Guidance. If everyone can move to that slide, we'll start with the full year, talk a little bit about the quarters. As we tend to do and have done over the past 24 quarters, we overperformed by about $0.05, over and above what we thought we would do in the first quarter. We have no problem flowing that through to our full year guidance and establishing new guidance again, which would say at least 2.2 billion of top line, EBITDA will tweak up to at least 615 million, and cash EPS will tweak up to a minimum of $3.60 from 3.55 below. Again, this includes playing through at least $0.25 of growover suggesting a normalized growth rate right now at this point in the year of 25%.

Also note that right now we do have a full year bias to the upside, suggesting that as the quarters roll out, similar to prior years, our expectation is that our overperformance is not done at this point. Now, we usually don't spend a lot of time on the quarters themselves, but I think because the business has changed fairly radically over the last two or three years in terms of seasonality, and where the cash flow is coming from, in addition to the fact that last year we had that abnormal credit benefit that we probably should spend a little bit of time on the flow over the quarters, Q2, Q3, and Q4. Specifically in Q2 what we are going to see is we will have about an $0.80 quarter. That reflects a normal seasonal downturn in Private Label.

In other words, cardholders paying down their revolving balances, and if you were to compare it to Q1, Q2 usually runs about 80% of Q1, so that is about from a Private Label perspective, a $0.15 hit versus Q1 with the seasonality. In addition, we will have about $0.08 of growover, and we think utility will also be dragging a few extra expenses into Q2. Really nothing out of the ordinary, other than the fact that we need to factor in that $0.15 seasonal downturn in Private Label. We then turn to the back half of the year, and this is where things start getting pretty exciting.

We would certainly expect to see a seasonal bounce back in Private Label, it happens every year, you know, usually it has to do with the Back-to-School, and in the fourth quarter the holiday period. It usually bounces back if you were to compare it to Q2, about $0.10 each quarter, so sequentially expect that to go up $0.10. That would put us at about $0.90 for each quarter. In addition, what we are now seeing is the seasonally strongest quarters for our Marketing Services businesses are now going to be Q3 and Q4, again because of all the business with the Back-to-School and the holiday spending, so toss in another call it $0.05.

You will have a lessening of the growover in utility drag, and therefore you are going to see a very strong second half. You know, minimum of low, probably close to mid-90 cash earnings per share in Q3 and Q4, so hopefully that gives a little bit more color on the seasonality of the business. We don't see any brick walls heading our way at this point. Everything looks to be flowing pretty nicely in the overperformance in our Big Three engines, certainly seem to be continuing on. And as we said, that gives us comfort in the upward bias that we will flow through overperformance as we achieve it.

And then finally, just we can turn now to estimated free cash flow which is your next slide. Again, those of you who have been around for a while, we do this every quarter as well with our EBITDA, and then that extra 30 million in Canada of profits that are earned, cash received, but not yet flowed through the P&L, will flow down to about 310 million of pure free cash flow after CapEx, interest and taxes, or about $3.80 per share. Okay.

Let's hit our top questions of the quarter. Really weren't that many. I would say by far the #1 question to top the list had everything to do with credit quality, credit losses, delinquency rates, all because of the blowup in subprime. As Mike and I have been pounding the table forever it seems, since we have gone public, and noted that we do not target subprime.

This is a perfect example and a perfect test case, that bears out exactly what we have been saying for the last six years. We have not seen even a ripple in our portfolio. Our delinquency rates are absolutely fabulous, and delinquency rates means that we know exactly what our credit losses are going to be in Q2 and Q3 and the beginning of Q4, and they look great as well, so we normalize out at just around 6% in Q4, just under 6% in Q1, and it is going to be, you know, we are even more comfortable now 6% the rest of the year, so again whatever is going on in the subprime sector, it is just not hitting us at all.

Second, getting a lot of questions about a shift in the business mix. We expect that to accelerate. Our fastest growing engines are both up in Canada and our Epsilon business, again from an organic growth rate perspective you are really talking low to mid-teens top line, and mid-to high teens on EBITDA, also we would guess we would put our capital if we were to buy something additionally into one of those two units.

Always surprising to people is the fact that our Canadian business, which is 17 years old is still posting very strong double-digit organic growth rates, no reason why that should change over the next few years. And then specifically as a percent of consolidated revenues, these two fastest-growing engines will account for about half of our consolidated revs versus just 30% in '04, and Private Label which is the third growth engine is beginning to sort of hit its long-term growth rate of call it 9 or 10% organically, and it will probably stay there for the next few years. As a result, it will become a smaller portion of our overall business, at probably about 35% this year versus almost half a couple of years ago.

Guidance overall. With all of that being said, marketing for sure could do 30% top line growth. Transaction relatively minimal top line growth. We talked about sort of the attrition in our non-core merchant bank card business, and kind of sluggish performance in utility. We will see some decent growth from the Private Label side, but my guess is that will be largely mitigated by the other two. In credit, despite the growover, we think it could do 10% top line, and excluding the growover, you are really talking somewhere in the teens.

On a consolidated basis, as we talked about, the AIR MILES, Epsilon, and Private Label overperformance should more than offset lagging utility in the merchant bank card group, and very much on track to grow through $0.25, plus post excellent additional growth and once again we expect to have a very strong year.

As we finish up here, let's turn to the slide of operating leverage. Although we had a nice start to the year, we think actually our leverage is going to increase as the year progresses especially in the back half, and we could see our overall consolidated margin increase almost 200 basis points this year, which is over the last seven years let's see we have averaged, boy, close to 200 basis points over that period of time as well.

We now turn to the slide that is sort of our on-going representation as we call it, it's about a one pager of who we are and what we do, and with that being said, I will kick it over to Mike.

Thanks, Ed. We're just going to wrap up here and I will make a few closing comments, and it is all around the transformation that really you have seen in terms of the industry. Alliance Data has created a unique leadership position in loyalty and marketing solutions. I don't care where you look at -- you can look at it from an external coalition perspective, or internal coalition, or a variety of individual models.

Our clients and the marketplace clearly recognize the value of transaction-rich services, and we are replacing their traditional marketing budgets and spend with measurable ROI-based programs, and they drive long-term sustainable results, thus the loyalty effect that we have been talking about for ten years. We believe there is no other single provider who can match us for our breadth and depth of these services, and as a result, we have staked out a truly unique position, and we are very excited about the future.

That said, let's wrap up and go to Q&A, Operator?

Thank you. [OPERATOR INSTRUCTIONS] Your first question comes from Jim Kissane of Bear, Stearns.

Thanks. Hey Mike & Ed! Can you provide a little more color in terms of the challenges in the utility business, and then your confidence level, that you have handle on the challenges of the problems in utility so that it kind of goes away by the end of the second quarter?

Yes. You look back to the last twelve to eighteen months. We had a very strong sales year. Instead of our normal two to three, I think you look back, and we had five or six last year. Frankly as I tell my kids, I think our eyes got a little bit bigger than our stomachs, and while we made through most all of our conversions, some of the unique characteristics, and some of the customizations that our clients wanted has caused us to be delayed on a couple of them. We have gotten the majority converted, but we still have got some work to do. I am very confident we will be through this mid-year.

Okay. And you said you used the word decent when you were describing credit sales. I just got the sense maybe you weren't as satisfied with the ramping of some of your newer programs. Can you comment on that or give a little more color?

I wouldn't -- I didn't mean to --

I think Ed said it, too.

I would say that the credit growth if you look at our growover, and look at the opportunities there, we're right on-track according to our plan and our guidance. It wasn't, hasn't been a blowout quarter or year as we have had in the past couple, and as we've talked about we're getting back to our more normal and steady-state kind of long-term growth on 9 or 10% growth, so I would say we are in good shape. The signings from the last few years are going as planned.

I would say since apparently I got -- you dragged me into this, too, Jim, that I think it is more of a timing thing. It is just this stuff is cranking up, and we have been through this I don't know how many times in over the past years, where it bounces up and down, but we expect certainly as we exit Q2 at the latest, we should be hitting double-digits with the way the ramp-ups are heading, and then the portfolio itself is just chugging right along around 10%. That's what's throwing it off so much of the cash flow.

I think the key point I think we probably beat it to death, but you will hear us say one more time maybe we're a little sensitive to it, but I think the key story here this year, when you've seen the subprime blow ups in mortgage, and some of the big bank card issuers I think we have -- hopefully we are finally vindicated as to the quality of the model.

And just on the credit sales, to give a little bit of insight into the 12 million consumers that we do see, you know, I would say obviously we can't talk about one specific retailer, but across the 80 or 85 programs that we have, I would say right now I like to use the word decent, because what we are seeing is I don't think the retailers feel comfortable it is going to be a blowout year, but they are certainly not saying it is going to be a dismal year.

I think they're basically and what we're seeing is a decent year, which is probably, you know, 4 or 5% type of sales growth from the established players, and then you throw in the new vintages, and that's where you get up to the 9 or 10% where we are going to run.

Great. Just one last question. Just the early performance of Abacus and the integration of Abacus and your thoughts?

Couldn't have gone smoother. Mike Iaccarino has done a great job. Brian Rainey who leads the Abacus Group, is now direct report along with -- as he reorganized his team basically with the head of each of the service offerings if you think about the database business, the interactive business, the data business, we have created a consolidated cross-team salesforce.

In fact, we just had 150 of the sales and service organization in for a three-day exchange and sharing and kind of a sales strategy, so we are very pleased with our new associates, as well as the plan for the future.

I think to finish on Mike's note, if I got the numbers right, only about 10% of Epsilon's clients are in fact clients of Abacus, and in Private Label, only 20% of Private Label clients are currently clients of Abacus, and there is 1500 retailers in there, so we are getting pretty psyched up to get our meat hooks in there as well.

We have already had at least a half dozen new business signings with those relationships either in the interactive space or the data space as we begin to consolidate.

Great. Good job. Thanks.

Thanks, Jim.

Thank you. Your next question comes from Greg Smith of Merrill Lynch.

Hi, guys.

Hi, Greg.

The Marketing Services revenue just sequentially fell a little more than we were expecting, especially considering that you had Abacus in there. Can you just remind us of the seasonality in that overall segment, and why that fell sequentially?

You bet. As we talked about or I tried to walk you through right now the way the seasonality is working, Q3 and Q4 will be by far our largest and strongest quarters, primarily, Greg, to do with a lot of the Back-to-School work we do, and then of course all of the holiday work that we do for our clients as well.

It is just an enormous spending period for them, so, you know, while you are seeing, you know, 245 last year going down to 230, you're going to see a -- when you compare Q4 of last year to Q4 of this year, you know, you're going to see a spike up I am guessing north of 20%.

Okay. That is perfect. That explains it. We should really expect a big pickup in Q3 and Q4.

I mean that gets back to, you know, when I droned on about trying to explain the seasonality by quarter this year, things have really changed over the past two or three years, so Q1 is obviously going to be very strong because of Private Label, but Q3, Q4 is going to be very strong, primarily because of Marketing Services.

Yes. Okay. That explains it. The Utility revenue you said was flattish. Given all the signings, I still would have thought the revenue would be higher. Why is that only flat?

Even though we have had a lot of signings, we are just now in the process of getting those converted. We did pick up last year a good portion of the revenue from -- associated with all of the call center Customer Service and back office support that we were doing even while they were on their previous system, so we actually picked up a good portion of the revenue last year already as well.

Okay. Okay. And then credit margins were just unbelievable. Obviously all the credit quality and everything flows in through the revenue line. Are we just seeing very good operating leverage in the core credit business? How do you just explain such a great margin number?

Yes. I mean we tried to tell folks last quarter when there was some concern that our credit margins, you know, were dropping from the low 30's into 28, that that had to do with marketing spend for the holidays, and that should immediately translate -- when I say immediate into Q1 behavior from cardholders that would generate overperformance, and people I think just needed to wait and see.

What we are finding is Q1 is not indicative of the full year. Q1 is the quarter where it is post-holiday season, and we have over 12 million cardholders, that's when you tend to see the highest of what we call revolving rate behavior, and that is folks who for whatever reason, sloppy pay, they didn't get around to it, it just wasn't high on their list of things to do, they revolve whereas for the most of the rest of the year they don't, and that's where we get a huge amount of our income in Q1, but I would think, Greg, as we go and look throughout the remainder of the year, it is not going to drop off a cliff for sure.

I think it will probably revert back to probably somewhere in the mid-30's, maybe a little bit better than that, and we wind up the year around the mid-30's, with Q1 being the strongest, so it is the program that we for every dollar we spent in Q4, we probably got $4 back in Q1.

Just real quickly, I was thinking about it on a year-over-year basis, so comparing it to the strong Q1 a year ago, it was even, the EBITDA margin up nicely, is that operating leverage plus a little heavier marketing spend in 4Q of just this last year?

You bet.

Okay.

It's a great point. If you went back to '05, right, we weren't dumping the kind of cash we did last year in Q4 into the programs. It was still more of a test cycle, but this past Q4 we dumped a bunch of cash into these holiday programs, and boy, did it drive things through the roof in the first quarter.

Yes. Okay. Thanks a lot, guys.

Thanks, Greg.

Thank you. Your next question comes from Mark Bacurin of Robert W. Baird.

Good afternoon, Mike and Ed, how are you doing?

How are you doing, welcome.

Thank you. Good to be on the call. A couple questions, as you can imagine mostly on the Marketing Services side. Given all the acquisitions you have made over the last 12 to 18 months, you definitely put together the full service solution now, and I am just curious, what are the steps that are needed now to be taken either defining sales channels, et cetera, that will let you really go to market with a full integrated solution, and start to tap into some of those cross-selling opportunities?

Let me address the whole marketing and sales cycle for the U.S. group at Epsilon. Each of the product lines, the major product lines if you talk about the database management, the interactive services, the data services, Abacus, each have their own salesforce, and we will continue to sell those individually, but as I mentioned earlier, the entire group was in here just two weeks ago for this training session.

We have also created a standalone cross-selling sales organization, and it is amazing how quickly the clients recognize and see the opportunity to streamline their operation. As we were talking about in Abacus, just sending out catalogs a few times a year, why not continue to communicate with your consumers via e-mail, et cetera, so we are already seeing the results of just the demand coming from our client side, before we have even rolled out the cross-selling initiatives, so we spent a lot of time in the last 60 days putting that plan together, pulling everybody in, and training them, so we are hitting the ground running now.

All of the consolidation activities around the normal HR and accounting systems and all of those kind of things are behind us, and it is full speed ahead.

I would say, Mark, to Mike's point, you know, there is no real integration that needs to take place at this point. It is pretty much where we have boots on the ground, and we are running at this point. As I mentioned earlier, you know, only 20% of our Private Label installed base are Abacus members, and a huge percentage of the targets that we are looking at for Private Label are in the Abacus camps, so I think that should be a good place where we can get some traction, and also the fact that only 10% of Epsilon's clients, excluding Abacus are Abacus clients as well.

So, you know, there are examples out there of some of our Private Label clients like Eddie Bauer and J. Crew, and Fortunoff, and Crate & Barrel, and Design Within Reach, that are both sort of Abacus and Private Label clients, and what we would like to do is, boy wouldn't it be great if we could get all 85 into the Abacus family, and alternatively wouldn't it be great if we could get some of those 1,500 folks within Abacus into our Private Label camp, and then as Mike said, we are going to bolt-on the Bigfoot/DoubleClick, or the Epsilon interactive engines, onto all of our businesses north and south of the border.

So I think it is a little bit frustrating on our end because we signed half a dozen really nice names in the first quarter, but the clients were reticent to let us release their names, and as such, we can't talk about them, but you're seeing it in the growth rates, and I would also suggest that roughly 60% of the growth within Epsilon is coming through expanded relationships with existing clients as well.

I want to talk a minute about the inability to kind of announce names. That is just a matter of time. That is not unique. We have had that in the past, the clients don't want to release on contract signing, but once the program has been implemented and rolled out and it is public knowledge, then there will be no problem, but the marketing world is a very competitive world, and no need to signal to competitors any ideas or strategies they have, so business as usual.

Great. I can attest to that. I have seen that from others as well. I guess it does seem like managing that channel, sales channel issue, where you have got a bunch of guys who sold products independently versus now going to this cross-sell solution, is probably the biggest challenge of trying to manage the opportunity.

Can you address, I mean you specifically said you have cross-sell teams now that are looking at those opportunities. Is it fair to say that the 80 plus retailers in the Private Label program are probably the most fertile ground for you guys to go after first?

Absolutely. No question. We also think there is a lot of opportunity on the database side as well, and the interactive.

Great. Just one nit-picky one for you, Ed, could you tell us what the CapEx was for the quarter?

CapEx usually runs about 5% of top line, so I would guess it would be around 27 million would be 5%. I think we actually ran at 22 million. It's a little bit under, a little bit better.

Great. Thanks a lot, guys.

Thanks, Mark.

Thank you. Your next question comes from Wayne Johnson of Raymond James.

Good afternoon.

Hey, Wayne.

Hi. My question was on or is on the Private Label, and if we go back in time, 2001, 2002, 2003, there were certain expectations for penetrating a new customer with Private Label, and my question is, has the ramp rate in those prior years, is that any different, better or worse than the ramp rate of the clients that you signed in '04, '05, and '06?

No. Actually it is a great question. It is interesting that they really haven't changed, that the ramp rates where we go from 0 to about a 33% wallet share, that is a third or one out of every $3 spent flows to our card.

In what period of time?

It still takes about three years, Wayne.

Okay.

It really hasn't changed. Obviously what a lot of it is dependent upon is if the retailer really puts their shoulder into the program, then we can get higher penetration. If the retailer is not that excited about it, then we will have lower penetration, but what we are doing is hopefully every year we are showing a little bit more of what we can do when we can link up SKU with the client's specific name, and do some very serious micro targeting of various segments, so I think that is beginning to bear some fruit, and the fact of the matter is we are offering additional products, such as a co-brand card which could add another 3 or 4 percentage points onto wallet share, a commercial card could offer another 2 or 3 points, so could we get penetration up to 40%, it is certainly possible.

That is great. That is helpful. With the -- now it seems like a full suite of Marketing Services solutions, is it possible not only could the wallet share increase, but the ramp rate also accelerate?

I am not so sure I would see wallet share ramping any faster. I think from the -- particularly if you think about the retail side, we have had a pretty strong database analytic team you recall coming out. Our foundation coming out of The Limited and having a fairly integrated program.

It was a pretty sophisticated operation to begin with. I think the key is really the point Ed made. We would like the retailers to have their #1 priority is signing up new Private Label relationships. Since we get all of our new customers from them walking into the stores and transaction business at the point-of-sale, unlike bank card where it is mass mailing, we are dependent on them at the point-of-sale.

Sometimes they have two or three other priorities, depending on how they're doing with regard to their merchandise pick, and other kind of operational activities going on in their stores, so we have created over the past four or five years a very strong training organization that goes out to the field, making it as easy as possible, but getting those associates at the point-of-sale excited about it is the key to success, and on average it is still growing nicely, and just don't see how we can improve that ramp speed that much.

That is very helpful, and I appreciate that. My last question is can you give us any update or color on Citibank, on how that is progressing for you guys?

Well, we really don't talk specifically about clients. I will talk in generalities, which is it is progressing fine. It is certainly running well ahead of what I think anyone thought the program was going to be.

They are really apparently putting a great deal of their own resources and efforts into promoting the program, and rolling all of their big products into the one common coalition currency, being the ThankYou Network, of course. Quite frankly what we hadn't anticipated was the fact that they're going outside of their own internal coalition, and signing up large partners outside of the coalition such as Expedia, and that is new news.

Certainly we get involved obviously because customers of Expedia, who get rewarded with ThankYou points that flows through our pipes and onto our platform, and is part of our permission-based E-mail type activities, so Citi seems to be really going all out in this program, and we think from a client perspective, it is going to be a very, very significant client over the next couple of years.

Great. Thank you very much.

Thank you. Next question comes from David Scharf of JMP Securities.

Good afternoon.

Hi, David.

Hey, question for you on some of the disclosure, Ed. You know, now that Marketing Services is such a major component in the primary growth driver, we can appreciate the issues of client confidentiality, but are there any usage metrics that on an ongoing basis you will be able to provide to give us a little more transparency, whether it is number of databases managed, number of E-mails per month, you know, for all of the positive shifts in the business, you know, away from so much of a reliance on credit, credit at least there was a lot of transparency, with monthly filings and so forth. Is there anything in the marketing side that we can look forward to that gives us a sense for traction?

Yes. Believe me, we are well, painfully aware of we don't have good drivers for the business. I mean for me to sit there and say, you know, the former Bigfoot/DoubleClick, now Epsilon Interactive, is going to be 25 billion permission based e-mails a year, I don't know how much that is really going to help you gauge what the overall segment is going to be. Where we are heading I think is the fact that this thing is certainly growing so fast, and it is going to be half of our consolidated revs this year.

My guess is as we exit this year and go into next year, we will probably split this segment into two, one for Canada, and one for the U.S. I would say in the interim we will attempt the best we can to break down the organic growth rate. We will strip out; we will give you each quarter, you know, the numbers excluding Abacus, and then within that remaining organic growth rate, you know, where is it coming from and really, David, where I would say 60% of it is coming from is from existing clients.

We are just getting more and more and more commitments from our existing sponsors, and then I think the number of new clients we are signing, we are certainly well ahead of expectations of probably half a dozen a year. I think we did half a dozen in the first quarter. You know, for now we will try to guide you as to whether that long-term sort of mid-teens organic growth rate is looking real good for '08, or whether there is something blocking the way, right now it looks real good for '08.

It is a long-winded basically non-answer, other than we will try to start parsing it a little bit better, but we have looked, believe me, and have not found any single driver or two drivers that can explain the growth rate.

I see. Is there any color you can provide on just how discretionary you would call some of these services that are being purchased, and whether the deeper penetration of existing clients tends to be for lack of a better term sort of recurring, or is it very one-off project oriented?

It is definitely the former, and the nice thing about this business which is why we got into it, you know, it is the same concept as Canada. It is the same concept of Private Label, as we want at the end of the day as we look down the road a few years, we want and Abacus itself is a fairly unique asset, but outside of Abacus, we want people to be signing up for all five legs of the stool, the creative piece, the proprietary data piece, the database piece, the analytics piece, and the distribution through the interactive mechanisms. You know, then you have a relationship that is so deep, that it is kind of like Private Label and kind of like the Canadian relationships that we have today.

In terms of discretionary and non-discretionary, a lot of these programs actually are counter-cyclical. If you think about why, it is because everything we do is the exploitation of the seam between transaction processing and marketing and loyalty, in other words, everything we do is driven from our ability to collect transactional level information, associate it with a specific consumer name, and then utilize that as the best predictor of future behavior, and hence drive the marketing and loyalty programs of those clients, and that is something you can't shut off.

If I know Scharf is out shopping at J. Crew and I get eight records the first year and another eight the second year, the more records I have, the more information I am going to have about you, the more precise I can be about my targeting, and the more effective that targeting and hence the ROI can be.

Got you. Shifting to Utility, I should probably know the answer to this, but the conversion costs running a little over, are any of your conversion costs capitalized, much like a credit card processor, card issuer processor? Or is it all expensed?

It is a little bit of both. If you think about the ramping up of the call center that we talked about, we are training a lot of operators on the system in preparation for the conversion. They are actually going to be expensed and stretched out a little bit longer, before we get the associated revenue, but there is some capitalization of the core conversion, too.

Okay. And based on the experience with ramping up this latest wave of 5 or 6 new signings, is there a targeted operating margin we ought to think about, or rethink about in this segment? You may have been through an initial wave of contract renewals recently. Any sense on where pricing is going?

That's a good question. I don't think we have gone through that many renewals recently. It is more on the expense side. It is not on the revenue per side.

We are running I think quite frankly way too fast on the expenses, and until we can muscle through these conversions, which we will do over the next few months, we are just going to have to eat them, and unfortunately the contracts we signed there were penalties attached to those as well, so we are going to have to eat that as well, and then hopefully we can get back, and get you a better feel for some type of run rate, but right now it is just a question of muscling through.

Is the business more labor intensive than you originally thought with the call center component, or is this really just a phenomenon of how much you are ramping upright now.

It is not call center.

It is not, the model is not any different than we thought in terms of the expectation of the balance between how much is call center, and how much is Customer Service, how much is processing, et cetera, et cetera. Look, as I said earlier, our eyes were bigger than our stomachs. We learned our lesson, and trust me, it is painfully aware of everybody in the organization that is not going to happen again.

I think that, you know, as has been the case in the past six years, we are fortunate in the sense that our three big engines are just running so hard right now, that you know, we can absorb additional expenses, and it won't cause us to slow down the overperformance we have done in the past.

Ultimately signing up more than you thought is a good problem to have. Thanks a lot.

Thanks David.

Thank you. Next question comes from Colin Gillis of Canaccord.

Good afternoon, gentlemen.

Hi, Colin.

Can you just talk a little bit on the Private Label side? What should we think of in terms of the number of new potential clients, and would these all be fresh start programs, or are there any existing portfolios out there that interest you?

Sure. I will take a stab at it, I think right out of the gate you should think about oh 5 to 6, normally we say 4 to 5. Incompetent the pipe looks a little bit stronger this year. I think 5 to 6 seems to be pretty good.

You just look at where we started. You have got Sportsman's Guide, which is a brand new program that will be starting from scratch. You have got Orchard Supply, which is a brand new program starting from scratch.

Then we have the rights, which call this our third client that we have announced, we have the rights to I think 11 or 12 of Brylane's different catalogs, names like Chadwick's and BrylaneHome, and a few of those catalogs that are out there, that we can add a co-brand to, and they have been Private Label for a number of years, so we have signed the equivalent of three thus far. And it is the first quarter, so I am going to go with my gut, and tell me that I think we can probably struggle through another 3 before the end of the year, so there may be some upside to that number as well.

In terms of existing portfolios that are floating around out there, again we are not all that big into that business. There aren't that many really floating around. We are not counting on any. There is one or two that we are always sniffing around and looking at, and if it happens, great, if it doesn't, so be it, but it is really the start-ups that catch our fancy, because those are the ones that, they add to the growth rates in future years.

Great. And just any timing as to when you might access the debt markets again?

Well, I will probably, I am thinking of doing a private, I am sorry, a corporate bond offering some time in the late spring, to free up our credit facility.

Okay.

And I believe in November of this year, one of our asset backed bond deals is coming due, and we will probably, we will be accessing the public markets for that one as well. We do have a $3 billion shelf that is out there, so November we will be rolling over that into new five-year money, and most likely adding into that mix some of the portfolios that have been ramping up, and seasoning over the past sort of 18 to 24 months.

One last one on the AIR MILES. Now sponsor categories that we could be thinking about?

Auto, liquor.

You have liquor out there now, right.

Only four of the ten provinces. It is still a high priority in the pipeline.

Okay.

Insurance, electronics, did you say.

Internet.

Consumer electronics?

Yes.

Okay. Beautiful. The Abacus acquisition just keeps looking better and better. Congratulations!

Thanks, Colin.

Thank you. Your next question comes from Larry Berlin of First Analysis.

Good evening, guys, how are you doing today?

Hi, Larry.

Just want to go back to Abacus for a second. I am curious are the EBITDA and EBITDA margins for Abacus about what you have expected?

Yes. I mean I think, you know, it is running about 40%.

Oh.

You know, I think Abacus is off to a very good start. One of the things we are pretty jazzed about is the ability, as Mike talked about, of taking our interactive capabilities so that an Abacus client who may only mail four catalogs a year, there can be ongoing dialog and communication with its client base throughout the quarter through our Epsilon interactive businesses, and offering that to the entire 1,500 client base, I think is going to be a pretty neat service, let alone the fact that only 10% of Epsilon clients are Abacus clients as well, and obviously we talked about Private Label, so overall, I think quite frankly it was a good deal.

Cool. On the guidance for EPS, you raised your low bar by about $0.05, and we expect to you jump the bar rather than limbo under it.

Okay.

You had a $0.04 beat in the quarter, and then that means you have basically a $0.01 raise in guidance. s that a bit conservative being conservative, or how do you guys look at that, beyond the normal it is a low bar?

I am still working on the whole fact that the typical low bar thing, but --

You normally say "at least."

Yes.

I look at it as setting a low bar, rather than like you're not setting a median.

We like to think of it as a very solid base level, Larry.

Okay.

But I think our guidance for Q1 was $0.90. We don't key off of where the Street is, but our guidance was $0.90. We came in $0.95. We flowed through the $0.05 from $3.55 to $3.60.

There is nothing out there that would suggest that, you know, there could be more overperformance as we go throughout the year. I think that is certainly a distinct possibility, more than a distinct possibility. We expect it.

And if and when that happens, we will do what we have always done which is just flow through that overperformance, and it keeps us, it gives us the flexibility if we want to do something with the business to use that extra money, but right now no reason why we can't have more good news as the year progresses.

Okay. Great. Thanks. Have a good evening, guys!

Thanks, Larry.

Thank you. Your next question is from Dan Perlin of Wachovia.

Thanks guys. Just a quick question. I jumped on late, and I heard Greg ask if, but I wanted to make sure I understand it. You probably mentioned it earlier. Credit Services was a whopper on the EBITDA line, and the incremental margins on that look to be almost 80%. So I appreciate the leverage comment, but was there something else in there, like was there a gain that you had to take, or did you have a stepdown in the funding costs that to really help spreads or what?

No. In the leverage comment, I am not really sure where that came from, but it was --

I think Greg said something about incremental operating leverage in the credit business is larger Private Label portfolio insurance and stuff--

Basically we got -- if you recall in Q4 of last year.

Sure.

We got dinged a little bit because people were concerned our operating margin went down 500 basis points.

Yes. Prefunding marketing, I got that.

Right. So the funding of the marketing basically paid off four-fold in the first quarter. Funding costs were flat, credit losses were flat, but what we had was --

Wait a minute. Were funding costs flat year-over-year?

Roughly flat compared to a little bit better than Q4, but flat year-over-year, yes.

Okay. Okay.

Yes.

Got it.

And credit losses were flat. The only other place it can come from, right, is yield. That means that the programs that we put in place generated the type of consumer behavior, where we have a higher revolving percentage of the population therefore generating finance income, and that is what happened in Q1, and that again is something that we have been testing for the last two or three years, and it was a boomer. It worked really well, unfortunately it tends to fall off after Q1, and people tend to get their house in order by Q2.

Understood. And just one other quick question, this is probably a stupid question, but --

No stupid questions.

Did the rates on the Cards change given a mix of retailer, and as a result were the average receivables flowing from those higher?

No.

Okay. Good answer. Thanks.

Thanks, Dan. Have a good evening! I think we have one more, and then we will wrap it up.

Thank you. Your last question comes from Tien-tsin Huang of JPMorgan.

Hey guys. I appreciate that. I don't even bother most of the time any more. I guess a follow-up on the credit side, just to make sure, was there any material change in the I/O gain in the quarter in Q1?

I don't think there was any material change, might have been up a couple. But that was about it.

And I guess in terms of the bank card acquiring business, can you give us some numbers there, in terms of the revenue decline, and maybe also update us on the strategic fit of this business? I am sure that private equity has a lot of interest in that asset.

Yes. No question that top line continues to be impacted by slow early of trading some of the smaller clients in that network business. Probably, I don't know, 25, 30 million on an annual basis is what we expect. And we are getting close to the point of we have such a broad relationship focused in the convenience store and petroleum area, always trying to create a unique loyalty tool that helps them get from the pump to the store.

That is where they make their margins. That is where they make their revenue. We have tried a number of different ideas from prepaid cards and gift cards, and different things along the way, such a large market opportunity. We have been hesitant to be quick to pull the trigger on that kind of business, but at some point in time, I guess we have to maybe begin to see the light. Maybe there is nothing big enough to really make a difference there, and we will have to make that call.

Okay. I will stay tuned for that. Appreciate it. If I can sneak in one more on the Utility front, are the delays principally related to IT or technical issues, or is it just a matter of trying it get to a common platform, I am just trying to better understand what's driving the delays?

It is focused on having enough people to do the work as I mentioned earlier, in terms of absorbing more than we can handle.

Right.

And the job in terms of some scoping some of the custom interfaced work to their client that was bigger than we expected, and so it was more work, so it is really those two, and those typically are one-timers that are not recurring kinds of expenses.

Okay. Understood. Appreciate it.

Thanks, Tien-tsin. Again, wrapping up. Thanks for joining us today, folks. We are looking forward to talking with you again, and we are excited about the year, and talk to you in 90 days. Bye now.

Thank you. This concludes today's Alliance Data first quarter 2007 earnings conference call. You may now disconnect.