Bread Financial Holdings Inc (BFH) 2011 Q3 法說會逐字稿

Good afternoon, and welcome to the Alliance Data Systems Third Quarter Earnings Call. At this time, all parties have been placed on a listen-only mode. Following today's presentation, the floor will be opened 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.

It is now my pleasure to introduce your host, Ms. Julie Prozeller of FTI Consulting. Ma'am, the floor is yours.

Thank you, operator. By now you should have received a copy of the Company's third-quarter 2011 earnings release. If you haven't, please call FTI at (212) 850-5721. On the call today we have Ed Heffernan, President and Chief Executive Officer, and Charles Horn, Chief Financial Officer of Alliance Data, and Bryan Kennedy, President of Epsilon.

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 the 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'd like to turn the call over to Ed Heffernan. Ed?

Thanks, Julie. All right, why don't we dive right in here. Joining me today, again, is the ever-popular Charles Horn, and our main man at Epsilon, Bryan Kennedy, who is President, and we're going to just dive right in. Charles?

Thanks, Ed. It was another strong quarter, a record quarter. Momentum continued to build, as all 3 segments reported double-digit revenue and adjusted EBITDA growth. Consolidated revenue increased 20% to $845 million. As previously discussed, all 3 businesses achieved double-digit revenue growth, with Epsilon increasing 46% compared to the third quarter of 2010. Core EPS increased 39% to $2.16, considerably beating the Company's guidance of $1.85 for the quarter, while GAAP EPS increased an even better 67% to $1.60 per share.

Both increases were achieved despite a 3.6 million share increase in diluted share count due to phantom shares associated with our convertible notes. A [reminder] -- phantom shares recovered by economic hedges with counter-parties. The Company has no obligation now or in the future to issue these shares.

Adjusted EBITDA increased 29% to $283 million, while adjusted EBITDA net of funding costs increased an even stronger 47% to $247 million. Funding costs benefited from a $9 million mark-to-market gain on interest rate derivatives. As discussed in our earnings release, this benefit of approximately $0.09 was excluded from core EPS for the quarter. In summary for the third quarter, we more than achieved our targets of double-digit revenue, adjusted EBITDA, and EPS growth.

Let's move on to Loyalty One on the next page. Overall, Loyalty One had a strong third quarter, with results exceeding expectations. Notably, revenue increased 8% if you take out the foreign exchange translation gains, adjusted EBITDA increased 22%, again, excluding foreign exchange translation gains, and adjusted margin for Canada grew to a robust 29%. In addition, miles issued grew 9% for the third quarter, the strongest quarter of the year thus far.

Issuance growth is attributable to 3 main areas. The first is favorable spend levels on credit card products, combined with robust acquisition for premium cards. Second, the signing of several new specialty retail sponsors earlier this year continue to drive positive issuance momentum. Third is 1-to-1 marketing initiatives that have increased customer or collector engagement, and expanded promotional activity with key sponsors. All 3 are keeping the air miles reward program well on track to meet or exceed mid-single-digit issuance growth for the year.

Lastly, miles redeemed increased 3%. The burn rate, defined as current period redemptions over current period issuances was 71%, in line with our expectations. As we have talked about for years, the air miles reward program is a dynamic program whereby we routinely make program changes to enhance the value proposition of the program, but also meet certain program designs. In the later case, this means modulated redemptions to keep it tracking toward our ultimate redemption rate of 72%. Our current cumulative redemption rate is about 60%, moving up 1% to 2% per year, trending consistent with our expectations. In summary, all the trends are favorable for LoyaltyOne.

Let's turn to the next page. In our last earnings call, we outlined 3 initiatives, the Dotz Loyalty Coalition Program in Brazil. The team has delivered on each of these initiatives to propel the growth of this program. Let's review the 3 initiatives and early results. One, we launched Banco do Brasil as a national anchor sponsor this past quarter. Conversion of a portion of Banco's 20 million accounts has begun, and we have already met near-term expectations. We're on track to exceed 2 to 3 million accounts by the end of 2012.

Two, we've rolled out the second coalition market, which is Brasilia. This market has over 200 locations issuing dotz. This is a continuation of our commitment of a phased and measured roll-out of markets throughout Brazil. We continue to monitor results to align future market expansion with financial and strategic considerations. Three, we continue to sign or renew agreements with high-frequency partners in all major categories, including grocery. These signings facilitate our ability to achieve and exceed our desired enrollment in the issuance metrics by year end.

During the quarter, we increased our ownership share in the dotz entity to 37%. In addition, we maintain our goal for dotz to reach EPS accretion towards the end of 2013. We continue to look for opportunities to make similar measured investments in other attractive markets. Our investment in Direxions Global Solutions in the second quarter has boosted our activity toward a pilot launch in India.

Moving on, Bryan Kennedy is with us to give you an update on Epsilon.

All right, thanks, Charles. Solid results at Epsilon this quarter. And now with the full effect of Aspen in our numbers, we produced a record again for top- and bottom-line results. When compared to the third quarter of 2010, revenue grew to $248 million, up 46%, while adjusted EBITDA increased to $59 million, up 33%. So if you back out the benefit that Aspen contributed, organic growth was moderated a little, primarily by softness in data, while adjusted EBITDA was up 6% for the quarter. However, year to date, with 3 quarters of 2011 in the books, Epsilon has produced very strong organic growth, 15% top line, 13% bottom line, continuing to show excellent strength and momentum.

Breaking down the business lines first, Database Digital put in a very healthy 15% growth in revenue, continuing a trend of strong double-digit momentum. This business line, just as a reminder, includes large outsourced marketing platforms that Epsilon operates to drive measurable data-driven and client marketing programs across multiple consumer channels. It continues to be fueled by key new relationships such as Kellogg's, along with growth in existing clients in core verticals, including financial services, retail, consumer packaged goods, and pharma. In addition, digital volumes, which is permission-based e-mail marketing, have contributed to growth, up double-digits, again, over prior year.

Secondly, Data, comprised of Epsilon's rich information assets, including demographic, transactional, behavioral, and psychographic attributes on consumers and businesses, principally in the US. This segment was down 3%, relatively flat in spite of headwinds late in Q2 that carried into Q3 as clients pulled back on volumes, in light of soft results in the summer, mixed with some concerns stemming from market volatility and broader macro trends. In spite of the softness among the consumer prospecting budgets, we continue to see strength and potential for our integrated data assets among loyalty marketers and also in many of the emerging digital channels.

Then finally, Agency Analytics, the last business line, which includes Aspen marketing services, grew from $24 million to $89 million, over 35% of Epsilon's revenue for the quarter, bringing strong growth and promising new presence in the automotive and telco verticals, as well as strengthening our footprint in consumer packaged goods and financial services. The integration of Aspen is complete, as Epsilon's agency, our strategic consulting and analytic offerings have been merged into Aspen, and market traction has been very good. Overall, strong quarter and a good picture of the balanced model that Epsilon has built. In spite of some softness in data, and the full impact of Aspen's run rate, the business maintains robust adjusted EBITDA margins at 24%, and has a great outlook for 2012.

So, let's turn to the next page and just shift to Epsilon's business model again for a minute. What we've been doing is carefully constructing a balanced, scalable business that meets the complex marketing requirements of the world's largest, most sophisticated global brands. Specifically, we bring deep expertise to today's CMO in each of these key categories -- agency, data, database, analytics, and distribution -- covering everything from the development and design of marketing strategies and programs, to the real-time provisioning of unique off-line and online data, critical for identifying, understanding, and personalizing the treatment of a customer. To the complex, large-scale data processing and data-based management platforms that power loyalty, customer retention, and prospecting engines, to the complex algorithms and analytic models that are constantly refined to drive ROI and optimize marketing spend. And to the distribution technologies that enable us to deliver highly targeted relevant communications to all the marketing channels, whether on the web, in the in box, the mail box, the call center, point of sale, or mobile device.

So we've got the ability to offer clients point solutions in any of these key categories, but our strategy continues to be to go to market as a comprehensive integrated platform, bringing all of those capabilities together. When you think about that from a growth perspective, we look to a balance of, number 1, adding new client logos. Number 2, growing existing client relationships as their needs for additional services expand. And 3, ongoing investments and offerings that address new channels, new applications, verticals, or geographies where we can drive strong quality, good marketing results, and steady margins. Whether that investment comes from organic development or through selective M&A, such as our acquisition of Aspen marketing.

What we're seeing is that demand from existing clients remains strong, as does opportunity with new clients, such as our recently announced relationship with Kellogg Company. Kellogg Company asked us to build a comprehensive CRM platform to drive personalized, relevant, data-driven brand experiences for consumers in North America, Latin America, Europe, and Asia Pacific across the web, e-mail, and mobile channels. This one is a good example of the kind of demand for analytics-driven, data-centric marketing investments from sectors that traditionally invested primarily in general media categories, such as TV, print, outdoor, and in-store trade promotions. Epsilon's broad portfolio of services and assets, along with our global footprint give us a compelling advantage in pursuing, winning, and delivering these kinds of solutions, so this is where we continue to focus.

Okay, that wraps up Epsilon. Let's move on to private labels -- back to Charles.

Thanks, Bryan. Let's flip to page 8. As we've pretty much seen all year, private label continues its strong 2011 performance, with revenue up 11% and adjusted EBITDA net of funding costs up 62% for the third quarter of 2011. Excluding a $9 million mark-to-market gain on interest rate swaps, which lowered funding costs, adjusted EBITDA net still increased a stellar 52% compared to the third quarter of 2010.

Revenue increased 11%, despite a 1% decrease in average credit card receivables, primarily because of a higher gross yield. The gross yield is up year over year due to program changes made throughout 2010, and now in the mid-29% range approximates the normal run rate. The provision for loan loss expense decreased 21% year over year to $71 million, due to a 230 basis point improvement in charge-off rates. As portfolio quality improves further, the provision rate is expected to decline. Lastly, funding cost dropped from the third quarter of 2010 due to a 40 basis point improvement in cash funding rates, lower average credit card balances, and the mark-to-market gain discussed before.

Looking at the key fundamentals for private label, cardholder spending continued to gain momentum and grew by 10% for the quarter, following a 9% gain in Q2 and a 5% gain in Q1. This consisted of 11% growth from our active clients, less than 1% drag from terminated defunct clients. Year over year, there was solid improvement in most areas of the retail world, with specialty retailers showing the largest gains. Average credit card receivables decreased by 1% during the quarter. Customer payment rates moderated during the third quarter, in the mid-17% range, and in September 2011 finally matched the payment rate of September 2010. The lack of headwind from the increase in payment rates, coupled with continued strong cardholder spending, led to a 1% growth in ending credit card receivables. Accordingly, we are still targeting 5% growth in ending credit card receivables as of December 31, 2011.

Delinquency rates decreased to 4.9% of credit card receivables, a 120 basis point improvement compared to the same quarter last year. Falling delinquency rates are a leading indicator that charge-off rates will decline in the future. The principal charge-off rate was 6% for the third quarter of 2011, representing a 230 basis point improvement over the prior respective quarter. Our allowance for loan loss reserve of 9.1% of ending receivables is expected to trend down if the charge-off rates continue to improve.

Turning to the next page, I will conclude the private label discussion with a brief overview of customer renewals and signings over the last several months. On the existing client front, we renewed long-term agreements with Express, Inc., a top-10 client of ADS, and The RoomPlace. This clears the plate of any material renewals set for 2012.

In addition, we stepped up efforts to grow the credit card portfolio by signing 3 new clients. The first, we signed a long-term agreement to provide private label credit and marketing services for franchise-driven pet and animal care retailer, Petland. We believe this new program can grow to about a $50 million file over a 3-year period.

Second, we signed a long-term agreement with Marathon Petroleum to provide private label and co-branded credit card services. We will acquire the existing private label portfolio, about $30 million, and start up a new co-branded program. We believe the combination of the 2 programs can grow to about a $200 million file over a 3-year period.

Third, we signed an agreement to provide private label services for Pier 1 Imports, and to acquire the existing credit card portfolio, about $100 million, with strong prospects for growth. We expect to acquire the file in Q1 2012. These new programs, coupled with existing strong core growth, should drive high-single-digit growth in credit card receivables in 2012.

Let's flip to the next page, and we'll talk about liquidity and capital. At the corporate level, available liquidity at September 30, 2011, was approximately $540 million. Strong financial performance, coupled with the [resumption] of dividends from one of our banks, allowed corporate liquidity to grow over $110 million from the end of Q2 2011.

Our debt levels remained very manageable. The key long-covenant ratio, which is corporate debt to adjusted EBITDA, was 2.3 to 1 at September 30, 2011, substantially below the covenant ratio of 3.5 to 1. During the third quarter, we amended our credit facility to increase the accordion feature by $500 million, providing the Company the rights to raise an additional $915 million of debt under the terms of the existing credit facility. We plan to issue debt under the accordion feature as market conditions permit. Essentially, we are looking just to add to our dry powder.

At the bank level, we have approximately $2.5 billion of available liquidity at September 30, 2011. One conduit facility, aggregating $400 million, was renewed during the quarter at favorable terms. Regulatory ratios at our banks remain strong, with WF&B capital ratios at 15% for tier 1, 15% for leverage, and 16% for total risk base as of September 30, 2011. Again, as in the second quarter, WF&B made a $50 million dividend payment to Alliance Data during the quarter, and we expect similar amounts in future quarters.

I'll now turn to the repurchase program, and as we've talked about before, the repurchase program continues to be one of our anchor strategies. During the third quarter, we spent $71 million, acquiring 810,000 outstanding common shares. Year to date, we have spent $188 million, acquiring 2.3 million outstanding common shares. As of September 30, 2011, we have $140 million available to spend under this program through the end of this year.

Let's turn to the next page, and we'll talk about 2011 and our updated guidance. For the third time this year, we are raising guidance. Our new guidance for 2011 -- revenue up 14% to $3.18 billion, 6% better than original guidance; EPS up 51% to $5.27, 13% better than original guidance. Core EPS up 26% to $7.40, 10% better than original guidance. Lastly, the year-over-year increase in phantom shares is obviously a drag to our 2011 EPS and core EPS guidance. Without the drag, 2011 core EPS would exceed $7.70.

Turning to the fourth quarter, the Company expects -- one, double-digit growth in both revenue and adjusted EBITDA. Two, core earnings up mid-single digits. Three, core EPS down about 6% to $1.46 compared to the fourth quarter of 2010, due to a high-single-digit increase in diluted share count attributable to phantom shares.

If we look at expectations by business segment, for Loyalty One we expect revenue up 2% and adjusted EBITDA up 5%. For reward miles issued, we expect it to increase about 5%, but we do expect 1 headwind, which is unfavorable foreign exchange rates, which we do expect to be down Q4 this year compared to Q4 last year.

For Epsilon, we're looking for revenue growth of approximately 35%, and adjusted EBITDA growth of approximately 25%. Data revenue, which is about 25% of total Epsilon revenue, is expected to be flat or slightly down year over year. Private label -- we're looking for a 5% growth in revenues and adjusted EBITDA net of funding costs. We expect average credit card receivables will grow about 2% for the fourth quarter. We believe the ending credit card receivables will increase about 5% compared to December 31, 2010. We expect principal charge-off rates in the mid-6% range.

Lastly, as what you saw last year, we do expect a build in loan loss reserve, due to the substantial seasonal increase in credit card receivables. Now, this is a headwind, but as we talked about last year, this is timing only. For example, a reserve rate drop of 60 basis points -- let's say we drop from a 9.1 reserve to an 8.5 reserve in Q4, but on a $600 million increase in ending receivables, would still create a reserve build of over $20 million. It is timing because this AR build in Q4 2011 largely benefits Q1 2012 revenues. So again, we talked about this last year, this will be a typical seasonal pattern for us.

With that, I will turn it over to Ed to talk about 2012 expectations.

Great, thanks, Charles. If we could turn to the slide that says 2012 Trends and Expectations, this is where we hopefully give you our view in terms of what we're seeing out there, and what our assumptions are in the guidance that we're going to give for 2012. I guess at a high level, we're all reading the same headlines, we're all seeing a lot of the noise that's out there in the marketplace, and a lot of the concern and uncertainty. We can only address it from our perspective, and what we're seeing in each of our businesses. And it does differ fairly dramatically from the headline risk that you're seeing out there. I think a lot of it has to do with the markets we're in, and also the type of consumer who is a customer of our clients.

While there is a lot of risk in the headlines that are out there, as a general statement for Alliance I think going into 2012, we don't see anything of significance that should knock us off our long-term growth objectives. And therefore, we would expect to have a very strong 2012, with very nice double-digit growth in earnings and free cash flow once again. We feel better about it, having been through the great recession of 2008 and 2009, where I think the headwinds were quite a bit more challenging. And even during the great recession, we grew. So, we feel that in an environment of very, probably weak macroeconomic trends and high unemployment, that once again, the markets in which we play and the consumers who are the customers of our clients should give us a very nice run through 2012 and into 2013.

So, let's talk a little bit about why that makes sense to us. In terms of trends, as you've heard us talk forever about where we play in the market, all 3 of our businesses play in the area of the $400 billion of annual spend in marketing and advertising. Specifically, there are all sorts of different pieces that go into that $400 billion, but as an overall trend, what we're seeing, of course, is the continuation of a shift away from sort of the general marketing, and toward the very sophisticated direct data-intensive targeted marketing, which we're glad that's happening, because that's our sweet spot.

We specifically play in the direct marketing categories covered under what are called digital and direct. Digital for us would include 4 areas. We play in permission-based e-mail, mobile, social, and display. And they're growing a combined about 15%-plus annually. But let's not forget, I guess what we would call the old-school stuff, which is, surprising to some, direct mail continues to be a very important channel for a lot of our clients, and is growing 4% annually.

Overall, the markets in which we play are growing a very healthy 7% clip, and as we all know, it's a lot more fun to compete in markets that are growing, as opposed to stagnant or shrinking. So, I think we've found the sweet spot in the market, and all 3 of our businesses are heavily involved in both the direct and the digital spaces.

Number 2, international data-driven marketing opportunities will continue to expand. We're seeing a lot of interest, a lot of demand on the international front. Bryan mentioned earlier our deal with Kellogg, which is a global agreement with Kellogg. So we are beginning the process of following these large global 1000 companies across the footprint, whether it's in the US or overseas, and we expect that to continue as well.

We're also seeing more sophistication on the part of consumers in a number of countries, and then specifically that leads into what's going on in Brazil. As Charles mentioned, we couldn't be happier with how that's rolling out, and we're in 2 markets right now -- Belo Horizonte and Brasilia, as well as beginning to tap into the very significant household base that the Banco do Brasil has as clients. We'll continue those 3 efforts, and we would look in 2012 to also roll into another 2 markets in Brazil. That would give us about coverage of about half of what we eventually expect to get in the country, so we're looking at about 8 regions that should really complete our efforts in Brazil. So again, it's a very disciplined phased rollout. And right now, I couldn't be more pleased with the results thus far.

Next, again, very different from what we're seeing or you're seeing in the headlines is that on the consumer side, specifically as it relates to our private label business, you're seeing a very clear distinction between those folks who were not successful making it through the great recession. Chances are, most of them are still not gainfully employed, versus those who have made it through the recession, and also are benefiting from low interest rates, lower gas prices, lower mortgage rates, et cetera.

So what's developing in the country from what we're seeing is a very, very distinct barbell. That barbell is broken into -- as we talked about, those who have made it through and are benefiting from additional tailwinds, and those that don't. What happened during the great recession -- and we're not alone in this -- is the fact that it was so deep, so severe, that when we would normally write off or charge off or burn off a layer or 2 of the weakest credit quality, during this great recession you probably tripled or quadrupled the amount we had to write off. So, what's left is a pristine file of the so-called folks who are spending freely. They are also very cautious about increasing their balances. And essentially what you have now is -- we're looking at a super prime portfolio. That's not our intent long term, it's just the way it is today, since all those layers have burned off during the great recession.

And you can see that in a couple things. First, you're seeing very strong spending by the consumer. As Charles mentioned, we're looking at strong double-digit spending growth from our cardholders, which is great. They're slowly beginning to start building balances again. We were down probably -- the file was down 4% in Q1, it's now up 1%, we expect to be up 5% by the end of the year, and we should be in the high single digits, if not broaching 10% in 2012. We feel comfortable about that.

And then credit losses, which historically you could tie very closely to the unemployment rate, we usually trade at about 130 basis points higher than the unemployment rate. That, in theory, would suggest that we should be at about over 10% in losses; in effect, we're heading the other way, and that is, we're 300 basis points or more underneath the unemployment rate. That shouldn't surprise a lot of folks, given the burn off that took place during the great recession.

So, while some other folks out there have suggested that the loss rates will really begin to flatten out over the next quarter or 2 versus prior year, we're not seeing that. That is also consistent with what we said before, which is -- during the great recession, we didn't get hit nearly as hard as the general bank cards. And during the recovery, our improvement wasn't going to be as quick as the bank cards. It's just the way the private label works. So we still have a fair amount of room to run on the credit improvement side, and that's why, despite the assumption of unemployment hanging up in the 9%-ish, there is no reason why our losses should not continue to trend downward, and we expect that for 2012 as well.

Finally, if you've got a super prime file where you've got strong consumer spend, but they're cautious about growing balances, and you've got lowering losses and lower funding rates, the question comes -- well, how the heck are you going to grow the file? The answer is -- we are beginning to see growth resume. Again, we expect 5 points of growth over prior year. By the end of this year, at the same time, we have had a very successful final push this year with Marathon, Pier 1, and Petland added to cycle, and J. Jill earlier in the year. We've got another one signed that we haven't announced yet, so the pipeline looks very robust, and so between the existing and the new, we would expect a very strong 2012.

Finally, to sum it all up, you've got these positive trends. You combine that with, let's face it, it's very, very exciting times if you're borrowing money, because it's the lowest rates we've ever seen. So that certainly helps us. So you have the positive business trends, you have record low borrowing costs. At the end of the day, we feel very comfortable in saying -- we expect a record 2012. All segments of the business are growing. We once again expect double-digit earnings growth and double-digit free cash flow growth. Overall, as you can tell, we're on the camp of the bullish side.

All right. Let's talk about 2012 critical goals. You'll hear us updating these goals as the year progresses. It's a handy scorecard for everyone out there to see how we're doing against our goals. At Epsilon, Bryan, we're asking to bring home double-digit top-line and adjusted EBITDA. Again, Epsilon is probably, of our 3 businesses, the business that is benefiting the most from this rapid shift to the data-driven, direct targeted marketing spend, and especially on the digital side. So we would expect double-digit top and EBITDA growth there. For the first time, we expect Epsilon to cross the billion-dollar threshold, which, given where it started a few years ago, is quite an achievement. So we're kind of excited about that.

If you break it down into probably the different areas within Epsilon, about 0.75 of Epsilon we expect to see double-digit growth, and that would be obviously in the digital agency or creative side, the database and analytics, and the digital distribution side. As we talked about, we don't expect to see much growth on the data side, which is about 0.25 of the Company, until people feel more comfortable committing to bigger budgets. But overall, again, that's the smallest share of Epsilon.

At Loyalty One, we expect continued growth there, with single-digit top line and EBITDA growth in Canadian dollars. We expect -- which is a critical driver, which is air miles issued, that needs to grow somewhere in the mid-single digits to ensure that we have very nice growth going forward. We also got very nice traction this year in signing new sponsors, which had been an area where it had been a little bit light in prior years. We came back strong this year with The Children's Place and Zales Canada. We have a fairly robust pipeline, so we would expect 2 to 3 significant new sponsors to join the program. There's still plenty of room up there, so we'd be looking at areas primarily liquor, electronics, telecom, and health and energy.

Brazil, I think we already talked about that. We'd like to see that somewhere between 3 and 4 million members by the end of the year. That would keep us right on track of really cranking this thing up.

Private label, we expect cardholder spending to remain strong. In fact, the latest nums we just looked at for the past month, or the current month, continue to suggest that cardholder spending, again, at the super prime level, is very robust. We're seeing north of 10%, maybe closer to 12% or 13%. It seems to actually be accelerating a little bit, which gives us that warm, comfy feeling for the holiday season. Again, that's just in our little pond in which we play. There are obviously going to be some strains elsewhere in the economy.

The portfolio we talked about, we have not had the type of signings that we wanted in the past couple of years until really just recently. You throw in what we signed earlier in the year, along with Marathon and Pier 1, and you're talking a really strong 2011 vintage that will ramp through 2012 and give you 4, 5 points of growth right there, along with the core of 4, 5 points of growth.

Average loss rates -- everything we're seeing suggests it will continue to drift downward, so we're looking at continued improvement there, down into the mid-6s as Charles said. Funding costs -- again, a lot of our book is fixed, but we also expect when refinancings come up to actually get a kiss on the refinancings, and then 4 to 5 new retailer signings. Again, our big push for the next couple of years would be -- all right, we've got tons of liquidity down at the bank level, let's start bringing on some new retailers.

Consolidated, record revenue, adjusted EBITDA, core EPS, free cash flow, and we are targeting about $1.5 billion of liquidity at the corporate level by year-end 2012. As Charles mentioned, we are at about $0.5 billion now, and we'd like to, along with free cash flow, raise a little bit more for dry powder, and really build up the war chest, and that will give us lots of flexibility going forward. Again, as we've talked about in terms of liquidity, there is no specific plan in place. However, these are the times we feel very strongly where the right opportunity could come along, either from an M&A perspective or from a buy-back perspective, if there continues to be a disconnect between the market and our performance.

2012 guidance, pretty straightforward. Revenues, we're closing in on $3.5 billion; adjusted EBITDA, $1.1 billion; and having been here for 13 years, seeing $1 billion of EBITDA is truly something that I can't say I ever thought we'd see. Net income, obviously up mid-teens, core EPS also up double digits. Again, a lot of this, especially when it comes to earnings per share, it's a little bit skewed obviously, because you've got these phantom shares that drive everyone nuts, that are going to be hedged away. And when the converts mature, they're gone.

To put it in perspective, right now our phantom shares account for 10% of our 60 million. So as they begin to fade out, as the converts mature in mid-2013 and finish up in mid-2014, you're going to see a real nice bump here. And specifically if you were to look at economic shares versus total shares, just for 2012, you would see the core EPS not at $8.30, but almost $1 higher. So it's a fairly significant drag, and when they expire, things should pop nicely. But from an economic perspective, we know what's going on.

Finally, free cash flow. I won't go through all the ins and outs, but the bottom line is that we are looking at a very strong continuation of our free cash flow growth. Again, you're looking at almost $600 million of pure free cash, almost $10 a share for 2012. That's our model. Our model, again, is we're not out there building a bunch of chip plants. This is a Company that can do extremely well with very limited CapEx. We're in growth markets. I think we're in the sweet spots of all the markets, and therefore, we would expect very strong performance. Again, if you were to take out the phantom shares, you'd be looking at growth well north of $10 in terms of free cash flow.

So to finish up, and we'll go to Q&A, even viewed conservatively, you have stock with the 10% free cash flow yields, and you're growing the free cash flow double digits annually, despite the macro uncertainty. With that, I'll just basically say it's been -- it looks like it's been a heck of a run. We're going to come in strong in Q4. As Charles mentioned, just recall that there are very significant seasonal factors, timing factors. A lot of it is good news in the sense of we're ramping up the file quite a bit in Q4 that requires some reserves that reverses in Q1. So that should be a very good roll into 2012.

So with that, it was nice to very comfortably raise guidance for the third time, and come out with 2012 nums as our first shot of what we're seeing. And hopefully the trend that we've set will continue going forward. That being said, why don't we open it up to questions. We probably have about 15 minutes.

(Operator Instructions) David Scharf with JMP Securities.

Hi, good morning. Thank you for taking the call. A couple things, and I wanted -- I know you addressed the issue of portfolio growth quite a bit. Setting aside the new programs, my sense is in the past you've always had some segment of your portfolio that was super prime. What I'm wondering is, are the payment rates you're seeing now overall even higher than what you would see at the high end of your portfolio in the past? Ultimately, I'm trying to get a sense for when does this consistent increase in credit sales ultimately result in balances? Or do you think you are looking at payment rates that are even higher than what your super prime credits had in the past and that it might not translate into as much?

Yes, that's a great question. Again, for those of you who don't live and breathe this stuff, payment rates basically mean our folks paying off a bigger chunk every month and becoming more of a charger as opposed to a revolver or transactor. What we've seen is payment rates have now moved up to the point where they're actually slightly above where they were at the very peak of very strong economic growth back in 2006 and 2007.

If you consider that the high-water mark for consumers feeling really good about things, payment rates are actually a little bit higher right now, although the delta between now and where it was a year ago, has been pretty much closed and therefore those sales should begin to stick as they have this month. It's not much, it's plus 1 this month -- but you should see it starting to stick right now because we have now officially anniversaried, and we're not seeing it creep up much more. We think that's been played out.

If you look at consumer revolving behavior out there in the marketplace, right, it dropped from $1 trillion to $800 billion, and it has been leveling off. I think we're seeing sort of the last pieces of these consumers paying off everything every month, and what we're seeing now is a little bit of stickiness. We would expect to get about five points of growth out of the core and probably another 5 out of [incremental] files.

Got you. No, that's helpful. Can you also help me -- this is more just accounting, but I want to make sure I have the allowances correctly, because in your press release it looked like your ending receivables were $4.5 billion to $6 billion, that was net of allowances. I think in the presentation materials, before allowances, it was $4.907 [billion]. That implies that the total allowances were $381 million at September 30? Does that sound correct?

No. It would actually be over -- well over $400 million, so somewhere we have a disconnect there. It was about 9.1% reserve, David, at the end of the quarter.

That's exactly why I was asking, because the difference between those 2 numbers implied $380 million, which was a far lower provision rate.

So I can bridge that for you. I'll send you something after the call, but the reserve was 9.1% at the end of the quarter.

Okay, perfect. Lastly within Epsilon, the data services, is that primarily the segment that was acquired from Equifax?

There's several pieces in there that does include the piece we picked up from Equifax. Actually, there was a couple of components from Equifax, a data business as well as a database business, so a piece of Equifax is in that segment, but also a number of prior acquisitions, including Abacus, if you recall, which makes up the dominant amount of revenue in that segment.

Still does, okay. Just kind of curious, Brian, I mean clearly, that part of Epsilon is the most cyclical -- or the least secular. I guess we're hearing -- I know you provided some cautious Q4 guidance, and we're here at the end of October, but have the patterns that kind of kicked in the summer remained through the end of October in terms of dial-back spending? Are there any kind of rays of light there?

Yes. David, I mean specifically early in the quarter, we saw our clients pull back, and that started to stabilize at the end of the third quarter. So I think we are being cautious about the fourth quarter, but the trends are positive. I would also say if you think back to the third quarter of 2010, it was an exceptionally strong growth actually through the entire back half of last year. You've got a little bit of a grow-over challenge, if you think about the market overall. As you said, this is the sector of our client base that tends to be the most sensitive to and reactive to results news in the marketplace. We're confident, but we're being cautious about Q4.

Okay, thank you.

Dan Perlin with RBC Capital Markets.

Thanks. I have a couple questions, briefly. The first is on Epsilon's backlog for database businesses. Where do you guys stand in terms of launching some of those new programs as we think about the first half of 2012? Can you also comment on the pace of wins there that maybe aren't announced, given some of the things that have recently occurred around the breach? That's my first question, I'll follow up with a couple, thanks.

Sure, Dan. First, to the question about the backlog, our backlog, both in terms of the pace of clients that we brought on board this year, versus say prior-year, has accelerated. What we see rolling into 2012 is pretty much a continuation of that trend. So very strong from the perspective of the pace of bringing on new clients. We also tend to look at the size of our pipeline. The pipeline is actually up significant double digits over where it was last year at this time, so we feel confident about the trend and where that portion of our business is headed.

As it relates to announcements, there is no secret there. This has been a quiet year for public announcements at Epsilon, I think for obvious reasons, as you alluded. We're starting to see that soften up and you should start to see more public announcements as we finish out this year and go into next year.

The pipeline I'm referring to is the 1 where you actually -- you're launching these databases and that's when you can actually start to recognize revenue, as opposed to some of the other kind of data, which is maybe a little bit more -- it bounces around a little bit more. So you're telling me the pipeline as we think about first half of 2012 for database and launching those new clients, which is actually when you can recognize the dollars, is strong, and better than probably we can even see at this point? Or no?

Yes, I was specifically referring to the database pipeline.

Okay, cool. Charles, the funding cost expectations coming down for next year. 30, 40 basis points, 50 basis points, is that still kind of the run rate number that we should be thinking about as we stand here in this current environment?

Dan, I think conservatively 20 bips, but we'll look to try to do a little bit better. This year we're tracking at 40 bips in Q3, so I think it's very realistic to do 20 with a target of trying to get up as high as 40 bips.

And then just lastly on the large sponsor in Canada; the promotional activity that we saw them start to kind of come back to. Is that a benefit as we go into 2012, or have we seen that promotional activity kind of ramp back up to normalized levels and therefore, we've already -- we'll already enjoy it in 2011?

It's one where we've had some benefit coming through. As we talked about on the Loyalty One discussion, we've been doing quite a bit of 1-to-1 marketing. And in doing the 1-to-1 marketing, we have a little skin in the game, but it's also allowing them to promote a little bit further. I do think that has stimulated some promotional growth, but not nearly to the level as what we saw back in 2009. But I do think it still has some potential going into 2012, and we feel very good about the mid-single-digit issuance growth guidance, and could do a little bit better.

Okay. But just to be clear, this client in particular was a 4% drag back then, and you clearly haven't re-couped all that yet?

We would not be back to that quite that same level but we are getting some support from that client.

Okay, super. Thanks, guys.

Sanjay Sakhrani with KBW.

Just wanted to get a little bit more color maybe from Brian on Brazil, and just thinking about earnings implications. I know you guys are assuming pretty high breakage rates, but where does it stand in terms of contribution if we were to assume reasonable rates here? Maybe Charles, when does it actually flow into the P&L as profitable? Then secondarily, I was just wondering, Charles, if you could just talk about the reserve coverage assumptions that you have for 2012 in terms of reserves to charge-offs or whatever it may be? Then just a yield in the card business? It seems to have held up pretty well, or actually it was up a fair amount. I just wanted to talk through what was driving that? Thank you.

On Brazil, we've done nothing in terms of breakage at this point. We're still waiting for our 2-year window to ascertain what breakage will be. It's frankly based upon split fee versus non-split fee -- I don't it's going to be a huge number, so at this point you're seeing nothing -- no benefits coming through in our net loss pick up. On the second one from a reserve expectation, I think we closed the quarter at 9.1% reserve, that compares to a trailing 12-month charge-off rate of about 7.5%, so we do have 150, 160 basis points difference.

Going into next year, we're going to be again looking at a trailing 12-month charge-off rate. That difference could drop some from the 150, 160 basis points to 120, 130. It's really going to be dependent on what the environment we're operating in, Sanjay. The third, I think in Q3 you finally saw the final burn-in of all the changes we made during the course of 2010 on the gross yield. I think hanging out in the 28% gross yield range will be pretty consistent going forward.

Okay, great. 1 last one, just in terms of the extra liquidity that you guys are looking to raise, is there anything specific that you would look to allocate that towards, or is it just more opportunistic?

It's just cash, and any borrowings you have under the revolver you pay off, and you're just keeping additional liquidity on hand. It's not going to materially change your leverage ratio, so funded debt EBITDA would still be about 2.3x to 1, but primarily you're just paying off existing debt or you're adding some incremental cash.

Yes, I think -- this is Ed, Sanjay -- I think from the liquidity perspective, given our free cash flow and our growth rate, you're basically seeing your leverage ratios just coming down naturally from that. Do we have anything major in the pipeline from an M&A perspective? The answer is no. Are there a number of properties that we're looking and keeping our eye on? Absolutely. We do feel that in this environment, there are going to be certain opportunities that pop up. I don't think you'll see anything huge, more akin to what you're used to seeing with us, sort of moderate-size type deals.

But we want to be ready to go, and frankly, we prefer that private equity doesn't get all the nice juicy stuff. We want to make sure we get our share as well. So think of it as we're building a war chest. If there is still a disconnect with certain properties and what we think they're worth, we'll probably jump in. Or if there is a disconnect with how we think the market is treating us from a stock price perspective and where we think given our growth rates it should be, then we will step in there as well -- probably a combination of both.

Okay, great. Thank you, good quarter.

Robert Dodd with Morgan Keegan.

Hi, guys. Just looking at the credit sales growth, how -- could you give us some color on how that breaks down in terms of between an individual consumer retailer relationship? Is it same-store -- not same retailer spending, but is it same consumer spending growth, or where do you stand in saturation versus target wallet share with a given retailer? Obviously you're adding new retailers as well, but could you give us a little bit more color on how that breaks down of where the spending -- who's doing the spending, with which retailers?

Well, we're not --

Without specific names, obviously.

Yes, for sure. What we're basically seeing -- and this fairly typical, Robert -- when you have a tougher environment, is that the wallet share of the private-label card creeps up. So that if retailers are putting through comps of 4%, 5% normally, or 3%, 4% normally, we'll capture a bigger and bigger share of that, which will get us up to that 8-ish, 8, 9 points of growth because of the increased wallet share. And then you've got your vintages from 2009 and 2010 still ramping up, which will add a couple of points, and that gets you over the double-digit level.

So it's a combination of a little bit higher wallet share. We have been very effective with our clients at promoting the card and spend, and having the clients come on board with promotional programs, and the 1-to-1 marketing is certainly working. So it's a little bit of existing cardholder increasing their spend, additional wallet share, and then the new vintages, you mix it all in the pot, and you get up to the sort of 10% to 12% sales growth.

Got it. Thank you.

Bob Napoli with William Blair.

Thank you, good morning. I understand the phantom shares well, but a question on the -- you have 2 converts. The first one, I think the larger one, a little over $800 million, you're going to refinance in 2013. That has an interest rate of 1.75%, I think the implied for GAAP is 11%. What are your thoughts on the cost as it's the type of capital you would use to refund -- to refinance those securities? And what's the associated cost you would expect?

To your point, Bob, there could be it little bit of a negative arbitrage on rates, but I don't it's going to be very much. We can do it in a couple of ways. We can do cash as being a key element to base on the free cash flow we generate. Or it could be cash plus some new obviously bank debt, which is fairly cheap, in the low 2% range. Or it could be something where we go out with a little bit longer-term capital that's a little bit more expensive, but again, not appreciably.

I think again, based upon our free cash flow, gives us a lot of flexibility. So between the combination of both of the converts maturing, which have an average rate of about 3% and 3.75%, I think the ability to refinance both of them pretty close to that range is pretty solid. So overall, I'm not looking for any big or any appreciable negative interest rate arbitrages coming from the refinance.

Okay. So you're looking at more shorter-term funding as opposed to some long-term permanent type of debt capital?

Could be. Or we'd just use some of our free cash flow to pay it down, and then we use obviously a little bit of longer-term debt as well. I mean, you still have the ability within our existing facility, to go out and do 5, 7 year pay per under our credit facility, so I think we can manage it very well.

Okay. Question on the loyalty program, the adjustments you made earlier in the year. What kind of response -- I mean, looking at the numbers over the past couple quarters, it looks like that the program -- the miles issues have accelerated, the miles redeemed have decelerated, which is the mix that you want. But what kind of response have you had from the cardholders and from your clients on the adjustments? I was wondering if you could talk a little bit maybe about what types of adjustments you made?

I would say nominal. If you look again, we talked about this program, it is a dynamic program. We're always making some modifications to improve collector experience as well as to keep attracting where we want it to be. The only thing I would say that was appreciable that occurred last year would have been in Q4 2010, where we started to expire inactive miles, which was something we need to do, but again it's had nominal effect. So if you look at the changes we've routinely made, you still see the issuance growth coming through now, you can see it's really not had any negative impact to the program.

Yes, I think I'll jump in with this one. The program itself, the goal is to always make sure that the value on an apples-to-apples basis, is at a significant premium to any other program in the marketplace. So the tweaks that we've put in really hasn't changed the value proposition that much. Unlike down here in the states where anyone who has like an airline program knows full well it's been very painful over the past few years. With AIR MILES, what we're trying to do is just put a tweak here, tweak there. At the same time, as we've been saying for years, since we do own the program, the model will not change.

It's -- our goal is to make sure that we have a 28% breakage rate, a 72% reserve rate, and that reserve rate is only at 60% today, But we want to make sure that we can have a premium value program up there, maybe a 20%, 25% more value than the other programs, while at the same time making sure we have plenty of cushion when it comes to what we are reserving and what the ultimate redemption will be. We haven't heard any screaming at this point, and we expect that to be the case going forward.

Thanks. Your interest expense was down a lot this quarter from last quarter. Was there anything unusual or was the mix -- are there more deposits? What caused the interest expense to drop as much as it did from 2Q to 3Q?

It's the change in the non-cash interest expense, where were netting out that mark-to-market gain on the slots.

Okay.

Which doesn't go into core EPS.

And this is a comment out of Citigroup's CEO. They took the private label business out of the bad bank and put it back in the good bank, and explained the reason for that is A, the profitability has improved quite a bit. But he said they were seeing demand for private label cards from consumers going up because the general-purpose card issuers were offering smaller credit lines, and so consumers are -- is that what you're seeing in yours, and starting to drive some of the growth? Does that make sense to you?

No. It's interesting. I don't know what to say, bad bank, good bank, whatever bank. But from our perspective, no, we're not seeing that. What we are seeing is on a retailer basis -- retailers I think have had enough fun with this bunch of co-brands and all this general spending type programs. They are definitely -- the demand for very specific marketing programs driven by a private label card, which can only be used in that store, has come back in vogue. Again, what you're seeing is this is a loyalty program for the retailer.

The retailers that we've been talking to are really, quite frankly, very interested in not only the older school type benefits of distributing 1-to-1marketing through point-of-sale and call center and direct mail. But permission-based e-mail is beginning to catch on, and then of course a lot of the other areas within digital, social, mobile, and display, there's a heck of a lot of interest in those areas as well. And with Epsilon bolted together with private label, frankly what we're seeing is, hopefully, a very unique product offering in the market that takes -- gives us a nice leg up on anyone. Long story short is, we would probably not agree with the other comment, but we have our own view.

Thank you.

1 more.

Dan Leben with Robert W. Baird.

Great. Thanks, guys, for squeezing me in. First 1 for Brian. Could you talk a little bit about the seasonality in the business in Epsilon in fourth quarter, both agency business and data business, seasonal strengths there, and how that's kind of impacting the outlook?

Sure, Dan. I think that as we grow the business, and have grown it through acquisition over the past several years, seasonality becomes less and less a critical piece. But for our data business, you see a much higher level of spend in the last half of the year, specifically with respect to the Abacus business. Then the other piece that you tend to see in the back half of the year is, as we head into the holiday season, our digital business picks up quite a bit of pre-holiday volume. But again, once you begin to add all the piece components together, that is increasingly blending itself out.

Okay, great. Charles, you walked through a little bit of the math with -- if the rate goes to 8.5%, and even with the seasonal increase and the receivables, you'd have a $20-million headwind. Are those assumptions that are embedded into the guidance?

That's just an example. Probably wouldn't be too far off, but it's just an example.

Okay. Are there any other kind of 1-time factors in the 4Q, a significant step-down from the third quarter, other than just the seasonality of some of these businesses that change, and share count up modestly?

Obviously, the biggest change is that reserve build. Last year, if you look from Q3 to Q4, the AR did not increase nearly as much as what we anticipate it will this year. So with that higher reserve build against, say, receivable that's not yet generating revenue, that's why you see that pressure come through in Q4. Then as Ed talks about in Q1, you're not getting the revenue stream with no reserve against it. So it's a little bit of timing issue, it's a little bit odd, but it's just a quirk of GAAP.

Okay, great. Thanks, guys.

Okay. I think we're going to cut it off there. I know everyone wants to get at it, so again, we appreciate your time. Obviously, you can tell we're pretty excited here to finish out the year on a strong note, and despite the headlines, we are -- the bull is riding here in terms of how we think about 2012 and 2013. So we look forward to a good finish on 2011, and a strong jump off for 2012. Thank you.

This does conclude today's conference call. You may now disconnect.