Bread Financial Holdings Inc (BFH) 2012 Q3 法說會逐字稿

Good morning and welcome to the Alliance Data third-quarter 2012 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.

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 2012 earnings release. If you haven't, please call FTI Consulting at 212-850-5721.

On the call today from Alliance Data we have Ed Heffernan, President and Chief Executive Officer; Charles Horn, Chief Financial Officer; and Melissa Miller, President of Retail Credit Services.

Before we began 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 would like to turn the call over to Ed Heffernan. Ed?

Thanks, Julie. Why don't we go ahead and get started? Hopefully, everyone has the slides that were made available.

Today, as usual, we are going to start with the third-quarter results and then we will move into what our full-year outlook seems to be at this point. And then, as it has been tradition for us over the last dozen years, we will give our initial looksee at 2013.

I think overall as we get started, as has been the case with us for the last few quarters at least, it looks like things are running strongly and, therefore, we, once again, feel comfortable bumping up guidance pretty much across all the metrics, even with the headwinds of higher shares flowing in from the converts and the phantoms. So it looks to be a good run to the end of the year and we are looking at a very nice jump for 2013. We all know it is a little bit early to say 2013 looks like another rock-solid year, but we will try to give at least a little color as to what the trends are.

Obviously Charles, the ever popular CFO, will be kicking things off. Then for the first time we have Melissa Miller, who has been in charge of our Private Label group over the last year. For those of you who have not had the opportunity to meet Melissa, she has been with us at ADS for going on seven years now and prior to that she spent 22 years at Experian and was the big cheese who ran sales for all of their commercial credit division.

So, again very, very strong background in the industry and I think, quite frankly, a big reason for the tremendous performance that we are seeing out of Private Label this year. And I think you will find we are equally excited about the next couple of years as well. So you can look forward to that.

With that I will turn it over to Charles.

Thanks, Ed. I will first walk you through the consolidated results before we move to the segments.

Overall another terrific quarter for ADS. An 8% increase in revenue drove a 15% increase in EPS and a 10% increase in core EPS. This was accomplished despite the continuing dampening effect of phantom shares which added 3.9 million shares to our diluted share count for the quarter. Excluding the phantom shares from both periods, core EPS was $2.75 for the quarter, up an even stronger 16% compared to last year.

We beat core EPS guidance for the quarter by $0.16 if we exclude the benefit of the tax reserve release. In our updated 2012 guidance you will see that we are flowing through this over performance to our core EPS guidance for the year. In summary, Q3 results were driven by solid performance at Private Label and LoyaltyOne with mixed results at Epsilon.

Let's flip to the next page and discuss LoyaltyOne's results.

LoyaltyOne had a solid third quarter with both the revenue and adjusted EBITDA up mid-single digits when we exclude the unfavorable impact of foreign exchange translation and operating losses in Brazil and India. Consistent with our expectations, top-line growth moderated on a sequential quarter basis due to the decrease in the burn rate to 73% from 78% in the second quarter of 2012.

As discussed in last quarter's earnings call, the burn rate was artificially high during the first half of 2012 due to the introduction of an expiring policy at the end of last year. The effect of this notification, which created a pull-forward of redemptions, is now waning and burn rates are returning to more typical levels. As a reminder, burn rate is calculated as miles redeemed during the quarter divided by miles issued during the quarter.

As discussed before, adjusted EBITDA in the third quarter was up mid-single digits over the same quarter last year when we take away the drag of unfavorable exchange translation and operating losses associated with our international expansion efforts. Importantly though, if we look through to the base airlines AIR MILES Rewards Program and our margins, EBITDA margins, increased to slightly over 30% for the quarter. So your base Canadian business is doing very well.

Miles issued were down slightly compared to the third quarter of 2011, primarily due to the timing of promotional activity by certain key sponsors. We believe this is merely a timing issue and that issuance growth will bounce back to mid-single-digit range in the fourth quarter.

Miles redeemed were up 2% compared to the third quarter of 2011, essentially in line with our expectations. We expect the burn rates for the fourth quarter will drop into the mid-60% range, which will likely cause miles redeemed to be less than the fourth quarter of 2011.

A new instant award program, AIR MILES Cash, was added to the AIR MILES Rewards Program during the first quarter of 2012. To date approximately 850,000 collectors have enrolled in the program which is being offered at five sponsors. We plan to add additional sponsors and categories to the program over time and to increase the number of locations where miles cash redemptions are accepted.

Our original target was to have 10 sponsors in the program by year-end, but seven is now a more likely number. The timing of the rollout is not completely within our control as it requires point-of-sale programming changes on the part of the sponsors. To date miles issued under the program are not material.

Now a quick update on dotz. Nationally we have seen our total collectors enrolled in the program grow to over 4.5 million at the end of the third quarter, already exceeding our year-end target of 4 million. Our goal is for dotz to enter an additional two markets during the fourth quarter, ending the year with six total markets, and these markets would cover approximately 25% of Brazil's total population.

Let's turn to the next page and talk about Epsilon. Epsilon's overall performance for the quarter was mixed with strong growth in adjusted EBITDA which increased 10% on a disappointing revenue decline of 3% for the third quarter of 2012.

By line of business, database digital revenue was down 2%, due primarily to the previously discussed weakness in healthcare and pharmaceutical vertical. Data revenue was off 1% as improved performance in compiled data offerings was offset by unexpected softness in our cooperative data offering, primarily for the B2B vertical. Agency analytics revenue decreased 5% due to what we believe is a temporary pullback by one of our largest agency clients.

Overall, Epsilon's results reflect what we expected -- a slowdown in top-line revenue growth for the back half of 2012. Historically, new wins would cover any vertical or client weaknesses that didn't happen in the first half of 2012 as we experienced delays in closing pipeline opportunities. Fortunately, we have been able to rectify this situation as our backlog of wins is now double digits year over year, building a healthy ramp for 2013 as these new wins on board and drive revenue growth.

At the same time, Epsilon's strong adjusted EBITDA growth coupled with substantial EBITDA margin expansion demonstrates both sound discipline and the impact of Epsilon's 2012 focus on restructuring and realigning the business around a unified go-to-market strategy that aligns all sales and client services into industry verticals that delivers solutions across all Epsilon areas. This restructuring has unified the Company's diverse offerings and simplified service delivery in order to maximize both benefits to the clients as well as the identification and capture of growth opportunities within clients which should benefit us in 2013.

With that I will turn it over to Melissa to talk about Private Label.

Thank you, Charles. Good morning. Private Label's strong revenue and EBITDA growth was killed by large increases in cardholder spending and a number of new signings.

For the quarter, revenue increased 17% and adjusted EBITDA, net of funding costs, increased 21% compared to the third quarter of 2011. So let's take a look at some of the fundamentals driving these results. In the area of receivables growth, average credit card receivables increased 26% compared to the third quarter of 2011 while ending credit card receivables increased 32% from September of 2011.

Now much of this growth we attribute to the success we have had signing and on-boarding new clients during the year with our notable successes being Pier 1, Bon Ton, and Talbots. And we are seeing that our prospective clients are really responding to our marketing and loyalty approach to growing our joint programs. However, even without that new business, our core file saw strong growth with average and ending receivables up 14% and 17%, respectively.

Our cardholder spending remains very, very strong, up 40% from the third quarter of 2011, and excluding the new programs, the core growth rate was still a very strong 20%.

So this performance to us signals that the investments we have made in customer care and advanced analytics and really our multichannel approach to cardholder communication is driving more trips, more visits, and more spend per trip. With strong spending and improved retention from existing cardholders, a number of new partnerships fully backing these credit programs, and a strong pipeline of potential new clients we expect this growth to continue to accelerate well into 2013.

We have built a marketing-oriented customized environment and our philosophy of really leveraging all of the data and the possible touch points as a means to promote these programs continues to pay us big dividends in the form of cardholder and loyalty.

Portfolio quality continues to improve. The principal charge-off rate was 4.3% for Q3 2012 compared to 6% for Q3 2011 and 4.9% for Q2 2012. So this is an improvement on both a year-over-year basis as well as a sequential basis and the trends are now suggesting a 180 to 200 basis point improvement in charge-off rates for the full year 2012 opposite 2011.

Funding rates continue to improve as older tranches of debt mature and are replaced with cheaper, new paper. Our cash funding rate for all card-related borrowings, which excludes non-cash items, was 2.5% in Q3 2012, 120 basis points better than last year. So overall the outlook for 2012 remains positive with very strong receivables and revenue growth, low principal charge-off rates, and improving funding costs. Entering into 2013, the outlook remains equally strong supported by a very, very solid pipeline of new prospects.

Charles, I will turn it back to you.

Thanks, Melissa. We are flipping to the next page and we will talk about liquidity. I will start off with our corporate liquidity, which continues to build, increasing to $1.7 billion at September 30, 2012. Cash has increased to almost $800 million, while available borrowing capacity approximates $900 million. So what we have is basically a very substantial war chest.

Net corporate debt was approximately $1.7 billion at September 30, 2012, with our leverage ratio, which is defined as corporate debt to adjusted EBITDA, of 2.1 times compared to our maximum loan covenant of 3.5 times. At the bank subsidiary level we have approximately $2.4 billion of available liquidity at September 30, 2012.

Since Q2 we have renewed one conduit totaling $300 million in commitments at favorable terms and issued $1.2 billion of term asset-backed securities with an average life slightly over six years and a weighted average coupon of about 2.2%. This is the best execution ever for ADS.

Our focus in 2012 has been to take advantage of the robust financing market to lock in long-term fixed-rate money. While we give up some current period rate opportunity by going further out in the yield curve, we gain long-term certainty and latter maturity dates.

Continuing our dividend trend our two banks paid $32.5 million in dividends to the ADS parent during the third quarter. We reduce the dividend by $25 million compared to the second quarter of this year due to the acquisition of approximately $600 million of credit card portfolios, coupled with our desire to maintain strong regulatory capital ratios. We expect dividends to return to the mid-$50 million range next quarter.

I will now turn it over to Ed to walk you through our updated guidance and our initial 2013 guidance.

Great. Why don't we turn to the slide titled 2012 Full Year Scorecard? This is where we get a chance to step back. We are in the waning months of the year and so there shouldn't be too many surprises, or, frankly, any at all, as the rest of the year plays out.

And so this gives us an opportunity to step back and say, all right, how does the full year shape up? What have we been happy about? What has been a disappointment to us? And all of this should come together and help easily signal our entry into 2013.

So let's start off first with a division-by-division look, and as we have talked about, let's start with Epsilon.

Epsilon for the year is going to post very nice top-line and EBITDA growth rates in the mid-teens, roughly 13% top, 13% bottom, of which we are very pleased with one and not pleased with another. Quite frankly, we are disappointed with the organic top-line growth rate. We, frankly, missed the organic target of 7% to 8%. It looks like we are going to be coming in more like 3% and that means we were off top line by about $40 million. That is as simple as I can make it.

Charles talked about a couple of the headwinds that we based and our biggest discussion point right now is is this something that we need to worry about as we go into 2013 or is it more of an air pocket or an air ball or whatever you want to call it for 2012? So top line I would say was disappointing.

What was pleasing on the other side was the fact that our bottom line came in right where we wanted it, if not slightly higher. We expect to do about -- organic bottom line of about 10%, which is what we had expected. It also means that our margins have increased 100 basis points above expectation, so bottom line looks very solid.

Then really what answers the question is how does the pipeline look? What we found was in the first half of this year the pipeline -- and the pipeline is defined very simply as wins, that means ink on paper, plus verbals, getting the verbal lot from a client. That is how we define our commitments.

In the first half of this year our commitments were actually running slightly behind last year, which gave us some pause. That also meant that we knew that the back half of this year was going to be soft. It is pretty simple math.

The really nice news right now is that what we have seen over the past few months is that the pipeline has now jumped dramatically and is now running, as Charles mentioned, double digits ahead of the pipeline last year. So our wins and verbals are up double digit versus where they were last year, which means it looks like this was in fact more of an air pocket for a couple of quarters that will play out in Q3 and Q4. Then we should come back, based on the pipeline of signed deals, very nicely for 2013.

So, again, it is a tale of some disappointment that we are seeing in top line Q3, Q4. It looks like that was an air pocket based on the wins and pipelines, and as a result, we do feel very good about our guidance for Epsilon for next year. But let's not also forget that from an earnings perspective Epsilon did deliver double-digit organic earnings growth and 13% will print as our overall earnings number.

So a bit of a mixed bag, but as I look forward certainly more positive than negative.

LoyaltyOne, don't really have any negatives coming out of that area. Results, again, and this is 100% organic, we are looking at plus 8%, plus 8% which is right where we wanted it to be. Maybe a point better than expected, but top and bottom line is tracking very nicely to expectations despite incurring additional costs with our accelerated rollout in Brazil.

Basically, the Canadian business managed to over perform a bit and offset that additional investment. So very pleased with LoyaltyOne's results overall.

And our key metric, miles issued, just to remind everyone, we don't make any money unless the points get issued or the miles get issued. And we need that to run right around 5%. It is running around 6%, which is good.

Then also one of the key metrics we tracked that Charles talked about is what is called the burn rate. We reserve essentially at 72%, meaning we expect 72% of all the miles that have been issued to eventually be redeemed. Over the last 20 years I think we are somewhere around 60%, so we are quite a bit under our long-term reserve rate.

But more importantly, we also need to keep track of current trends. As Charles mentioned, we had a pull-forward based on some new policy changes at the beginning of the year that jumped the burn rate up to 102%. That is too high.

It has now been drifting down 78% in Q2. This quarter we are right on top of where we wanted to be for the reserve rate and we think Q4 will be somewhere in the [mid 60%s]. So that is good news there.

And then finally, something that we are all eagerly awaiting every quarter to see how the key metric is doing, which is the number of folks signed up. To put it in perspective, Canada over a 20-year period has signed up 10 million households and that business throws off a $0.25 billion of EBITDA.

In Brazil, coming from zero, within a year or so we have already jumped to 4 million folks actively engaged in our program. We expect that to go up dramatically again in 2013 as we enter a couple of very, very large markets. So Brazil is actually running ahead of expectations, which is why we are accelerating the rollout there.

So overall those are the first two businesses. I would say, as a general report card, we are pleased with where we stand.

Finally, obviously the gold star goes to Private Label. Results long term, we are probably looking at a business that will do somewhere in the mid to high single-digit organic growth, but obviously has been running at 2 to 3x that this year with revenues up in the mid-teens and earnings or EBITDA up around 20%.

It has been a heck of a year, as Melissa talked about. The performance obviously well above expectations. But the one thing I would like to call out is the fact that we have never in my 14 years here seen a bigger book of business that has been signed in any given year. You are talking about the big ones like Pier 1 and Talbot's, and Bon-Tons. Newer programs like the True Values, Blue Niles, Premier Designs, Ideal Image, Westgate.

We have never had a mix, since I have been here, of so many large, brand name, big programs that are existing combined with very, very exciting, starting from scratch type programs that will continue to drive growth over the next two, three years. In fact, on a very rough measure, the 212 (sic - see Presentation Slides "2012") vintage is what we call it will add close to $1 billion to the existing AR file of $5 billion, so almost 20%.

Melissa can talk about the trends that are driving that, but clearly what we are seeing are more and more retailers getting excited about the closed loop network that Private Label offers. Again, this is all data driven and comes right back to what we do for a living, which is how do we take SKU level data and turn it to the merchants' benefit for their customers?

That combined with the fact that there are a number of significant programs where, let's just say, folks are less than enthusiastic about their current providers and are looking to come over to us. And then finally, Melissa and her group, being the marketing gurus that they are, are driving very significant wallet share gains within the core. The numbers are staggering when you look at the overall market.

I will spend a little less time on the credit quality and funding. Obviously things are heading -- have continued to head in the right direction there, but as we leave 2012 and go into 2013 we can't count on credit quality or funding rates continuing to improve. And so what we are looking at, again, is sort of the old school growth of let's see how the book of business is growing.

But overall very, very good year. In summary, if you were to look at the over performance, I think we have beat and raised now every quarter. This one, of course, will be no exception.

We see Private Label as driving the over performance for this year. We see LoyaltyOne very nicely tracking to expectations, and that is after absorbing some additional expenses for Brazil. Brazil is, in fact, ramping up faster than anticipated. We were hoping to have about 4 million folks by year-end. It looks like we are going to be closer to 5 million, which is great.

Then the mixed bag at Epsilon -- solid bottom line, disappointing top line. But the pipeline having turned very dramatically in the back half suggests that we are heading in the right direction.

On the how much more can we confuse folks in terms of phantom shares and warrants, we have had very significant price appreciation in the stock which causes dilutive effects as phantom shares and warrants flow into the share count. That being said, if you looked at 2011 we had about 4.5 million of these phantom shares that will effectively go away when the converts mature at no cost to us. That was 8% of our shares outstanding.

Right now we are looking at right around 9 million of these phantoms or almost 15% of our shares, so that is a heck of a headwind to overcome and still raise guidance. However, we feel comfortable, of course, doing both and so the net result is significant over performance versus our expectations. And once again we are raising guidance, so let's turn to 2012 full-year guidance.

We expect revenues -- we are bumping up revenues almost I guess from our initial guidance of about $3.5 billion we are bumping it up to $3.6 billion, about $100 million. That will be about a 13% top-line growth rate.

If you were to do an apples-to-apples and have the one M&A deal, which was Aspen, in for a full year you would still see roughly 11% year-over-year top line. So a very, very strong from an organic growth rate perspective.

Core earnings we expect to be up in the mid 20%s. Again, the fun stuff with the phantoms come into our shares outstanding as share count has gone up 11%, but overall core EPS we have taken from initially an $8.30; we are raising it to $8.60. So whether it is revenue, core earnings, or core EPS, everything is being bumped up.

What I, of course, focus on is if you were to take the phantoms out, since they will be going away, how much are we really earning on a core EPS perspective. And it is about $10 a share, which is up 20% year over year, and that is something that I think is pretty exciting.

And so we leave you with 13% top, 26% on core EPS and 20% on economic EPS as we exit this year and move into 2013.

So if you will flip the page, let's talk about -- and again, we know it is early and there are a lot of things that can change. But as you folks who have known us over the years, we have a pretty good view as to what is going to unfold over the next 12 months or so. So once again, we feel pretty good throwing out some of our targets and these will be reflected in our budget and, therefore, what we get paid on.

So from a financial growth perspective, based upon again what we have seen -- the very strong pickup in signed deals and verbal commitments -- Epsilon should snap back pretty nicely to the organic growth that we have targeted, which is about 7% top, 9% on EBITDA. And the key initiatives is obviously let's translate those ink deals and the verbals into revenue and earnings, and we are off and running there.

The other big initiative is, again, we believe we are building a very unique model with Epsilon where it is the classic what we believe is the one throat to choke for the Chief Marketing Officer, the Chief Information Officer of the global brands who are looking for someone to pull together everything from the creative or digital agency perspective, to also have data assets, database assets, analytic capabilities, and the ability to distribute the brand's message through all sorts of different channels, be it direct mail, point of sale, permission-based e-mail, mobile, social, targeted display, whatever it may be. And this one-stop shop is what we have built.

So now it is on us to make sure that our clients will look to us for all of their needs as opposed to just one or two, and that is what we have been putting together for the past year.

Turning to loyalty, no one thinks that it can't keep rolling and so we believe sort of around 6% top organic and about 8% adjusted EBITDA seems about right. To get there we would also need about two to three new AIR MILES sponsors. We think that are in very good shape.

Renewals look to be running at 100%, as usual. This is a very critical year, 2013, for the Brazilian program. Specifically, we will be looking to enter the two big markets down there, Rio and Sao Paulo. And so that combined with all the markets we have entered to date would suggest we get critical mass as 2013 unfolds, which means hopefully the fun can begin at the end of 2013 going into 2014. Also, you won't see the drag that you have had in 2012 in 2013.

Finally, on the Private Label side, 10% top, 10% EBITDA. Again, running slightly ahead of our long-term growth expectations. For that we will probably need about six new startups to keep the train running in 2014 and 2015. There is a number of opportunities for new portfolios.

The bottom line of all of this is that we don't believe and we are not counting on any help from either charge- off improvements or funding rate improvements. In fact, we have baked in a slight drift up to maybe the mid-5% charge-offs from about 5.2% is what we are going to run for this year. Whether or not we will see that it is still unclear.

Everything looks to be fairly pristine at this point, but we want to emphasize the fact that the growth here is going to be, as I mentioned, old-school growth. You throw on $1 billion of AR, you are going to get nice growth here.

So the big difference here is that if you were to look at other participants in the card industry, you are really talking about bank cards. And you look at the key metric, which is consumer revolving debt, which for years had been growing 7%, topped out at $1 trillion, and then fell off a cliff for three years in 2009, 2010, and through three quarters of 2011. Went from $1 trillion down to $800 billion and has now flattened out at about $800 billion over the last three quarters, which is good news. But it also means consumers aren't loading back up and that is why I think you are seeing with big card companies it is very hard for them to get any type of growth.

Obviously that is completely irrelevant to us. As you can see in the numbers, our ability to gain growth is driven by retailers who are coming on board because of the data. It is increased wallet share at our core clients and it is the abnormally high number of wins that Melissa and her team are getting.

So I would caution anyone to, for the most part, ignore what you are seeing out of the key metrics at the big card companies, based on the fact that we are growing the file 20%, 30%. And so our sandbox looks extremely attractive now and for the next couple of years.

All that means is we are going to stick to our long-term model and we will put the stake in the ground. Again, this is the base case, so this would be -- I don't want to say conservative, but it is certainly something we feel incredibly comfortable with with 8% organic top, 10% EBITDA, and 10% free cash flow growth. This assumes no M&A and no activity on the share buyback front, which, for those of you who know us, means that it certainly is a fairly conservative view.

So our 2013 guidance, as we move into it on the last page here, you will see a revenue of $3.9 billion, adjusted EBITDA of $1.3 billion so 8% and 10%, respectively, for those two metrics. It is, I would say, four messages that we should deliver.

The first is top and earnings or EBITDA are consistent with our long-term model of 8% and 10%. Also, the fact that in this environment of new new, of what are good growth rates, we are running about 4 times real GDP growth rate from an organic perspective, which we feel is fairly attractive. This does not include any assumptions about M&A or buybacks. Those would be additive.

We did look at where the Street was throwing out their numbers and it looks like we are very consistent on both revenue and EBITDA of 8% and 10%, so we feel comfortable there. Also, the one area where we probably need to spend a little bit of time on is the earnings per share, which right now we are putting down as 10% going from $8.60 to $9.50.

I think what some folks need to do is they had a slightly higher number -- and, again, we are not saying we won't gradually drift up there as the year unfolds, but it needs to factor in the fact that the convert doesn't come off until August and that the share price we are using is $143 versus $132 for 2012. So some folks may need to revisit their model in terms of their share count outstanding. I think some have taken a little bit off the number of shares and I think they may want to revisit that.

Needless to say, we feel that probably the more important metric is that we would end the year at 62 million shares, which gets the noise out of there from that first convert. 62 million shares would put us at a run rate of $9.80, which I think is probably what people are thinking about.

So we have got a little bit of slop below the line. We know the metrics themselves are very comfortable with what folks are anticipating of 8% and 10% top and EBITDA.

And then the earnings per share. Again, we have got some timing issues, a little bit of slop, but once you get through the noise you are looking at about 62 million shares, or about a $9.80 run rate. And I think that is probably the key message here.

To sum up, we are providing a base case. We are providing, as we always do, what I call wiggle room so that we have opportunity to make investments if, for example, there is another market we want to enter that may require some investments. Second, as Charles mentioned, all day long we will trade off short-term benefits on funding to lock down seven-year money at 2.5%, 3%. And if we could do that we certainly would.

I think what we haven't factored in here is, based on the trends that we are seeing, even if we are not getting any help from credit quality or funding costs, my guess is if you are going to see over performance in 2013 it will most likely come primarily from the Private Label group once again. So I guess, overall, my guess is at this point with this base case the earnings per share is set fairly conservatively and as the year plays out you will most likely see this drift up, as is our tendency and has been our tendency over the past year.

So, overall, we see a very strong 2013. If we can run the business at 4 times the growth rate of GDP, we would be very happy and get our EBITDA around 10% and then get our earnings drifting up, probably back into the 12%, 13% as the year plays out. I think that would be a very good year for us.

We would also -- based on almost $2 billion of liquidity and corporate, we are looking at M&A activity as always. Most likely on a tuck-in basis we are not looking at anything huge. Also, we do feel that shares remain very attractive at these levels.

So that being said, I will finally be quiet and we will turn it over to Q&A. Operator?

(Operator Instructions) Jim Kissane, Credit Suisse.

Ed, can you give us a sense on what is behind the temporary slowdown at the large client and why you are confident that business with this client will pick up over the next few quarters?

You mean Epsilon?

At Epsilon, yes.

Yes. It was more of we had a couple of air balls primarily in healthcare, which is a big sector for us; the pharmaceuticals specifically. We had a lot of stuff that went off-patent, there was less marketing.

And, look, we knew about it. So what used to be an area growing double digit basically went backwards and so we needed to cover that off. There was another very large client in the telecom space that for various reasons needed to cut expenses and, therefore, cut marketing dollars.

That all being said dinged us for almost $40 million, which was the shortfall in the top line. We see that stabilizing. But, frankly, we have always had these little air pockets in the past and we have always had some big wins that would make up for it. For whatever reason, in the first part of this year we didn't have them; we just didn't sign them.

Obviously that was an area of concern. What we saw and you will see releases coming out, I would say very shortly, showing that the bounce back has been equally dramatic. So I don't know whether people just like to get me all stressed out in the first half of the year and chill me out in the back half, but the wins in the pipeline, the big missing deals that we had in the first half, are coming in in the second half. And that means 2013 looks pretty good.

Okay, great. Question for Melissa since we have you. You obviously have a great backlog with all the signings. Can you give us a sense on the potential new business pipeline? And maybe while you are at it, can you give us a sense in terms of your go-to-market strategy and how you are differentiated relative to some of your larger competitors? Thank you.

Sure, Jim. In terms of our pipeline, we call it our strategic stack so it is very planned full, very deliberate right now, and filled with startups, startovers, and we call them earn-aways rather than takeaways. So it is really filled across all of our verticals -- specialty retail, hard goods, some of the new areas that we have been testing into.

But I do want to sort of mentioned that we are never really going to compromise on the standards that we have around not chasing after every single shiny object. We want to do business with those partners that see us as a growth vehicle for their brands, and maybe that is a good segue into really what sets us apart.

We are, first and foremost, a marketing and loyalty company supported by bank secondarily. It is really, as Ed has talked about previously, it is the ability to leverage and use all of the data that we collect with all the data that our clients collect. That helps us create real meaningful insight so that we can improve our wallet share, put more purchases on our cards.

And then, finally, at the end of the day our clients currently are really seeing the value in the incremental sales that we add to their business and they have been terrific supporters and references for us as we explore those clients that may be seeking to leave their current provider. As Ed has previously mentioned, some of our prospects have a point of view and feel a bit bruised about how their experience weathered during the Great Recession. So we hope to change that as we welcome them to our family.

So in general, our pipeline for 2013 is very, very strong. Our win strategy is the same in that we want to partner with companies that are very, very strong and committed to the program. We are really bullish on 2013.

That is outstanding. Thanks, Melissa.

Sanjay Sakhrani, KBW.

You guys talked about the strong liquidity position and I was just wondering if, Charles, maybe you could just walk us through kind of how that liquidity builds over the course of the next year or so, and then kind of what the uses could be. One of the issues that I think I've heard you talk about is the warrants on the converts. Could you just talk about perhaps wanting to buy those back? Thank you.

Sure. So, Sanjay, if you look at where we are right now we have $1.7 billion of liquidity. Let's fast forward it on another 12, 15 months and you are going to add $700 million-plus. So let's say you are in the $2.4 billion to $2.5 billion of liquidity, what that gives us is a very good ability to deploy it in effective means.

So number one priority would be is there a good tuck-in acquisition that makes sense, that fits our strategy. Maybe a new vertical, a new product offering. Number two, we would still have plenty of liquidity to address the warrants that makes sense. We would like to cash settle them if necessary.

Number three, if there is the ability to increase our ownership in our JVs that could make sense, especially down in Brazil. Number four, if we have leftover liquidity we could pay down some debts, but reality is with our leverage ratio being 2.1s that really that is not a high priority for us. So I think we have the ability to consummate all of the first three and still retain liquidity and grow our business. And that is really the focus.

I think to Charles's point, if we were to look at -- we had talked about building up the war chest, which we feel we are done. And as Charles said, if we have got$2.5 billion of readily available liquidity, and because EBITDA is growing double digit and ratios are dropping like a stone, I would say that where you are going to see deployment of that liquidity would be exactly what Charles said, which is there are a couple of areas from a tuck-in perspective that we are looking at. A $400 million or $500 million type deal would be ideal for us.

We are pretty good at those things. Also, we do feel that there may be an opportunity with the warrants to take some action on that front. Again, trying to split the use of liquidity between both providing a couple of additional points of growth over and above organic at the same time returning it to shareholders via some type of equity repurchase. And based on where I see the future going, we are certainly bullish on that.

So those would be the two areas that you are most likely going to see use of liquidity over the next 12 months.

Okay. Then second question is I think, Ed, you mentioned this throughout your speech, but there is a cost that you are incurring for growing Private Label in 2013. So the actual jump off amount is higher in 2014. Am I thinking about that correct?

The reserve build?

I mean, to grow you are building reserves and that is kind of having an adverse impact on 2013, and you would get the full benefit of the growth in 2014, right?

Actually, as you will see, whenever you are growing, as you know oh so well, especially when you are growing in hyper growth mode, you have to set aside reserves based on the growth rate and how much you are putting on in terms of AR. That does have a dampening effect for sure especially in Q4, albeit temporary, but it does have a dampening effect on what flows through to the bottom line. And that is what hypergrowth does.

Now the good news is whenever it tends to moderate, hypergrowth moderates, you're going to get the full flow through which is fine. What we have been able to do at this point is, and I will turn it over to Charles, is that our reserve rate we believe is quite healthy. And as a result, we think we are going to be in very good shape on that front.

Exactly. So if you break it down what happens is this year our reserves have basically stayed stable year over year because our rate has been coming down. As we indicated for next year, our rate will probably stay the same. So if you have substantial growth in your ending AR then you are going to flip to a reserve build, so your reserve will probably increase $40 million, as much as $50 million next year.

Now the key takeaway is that reserve is based at your ending AR, not your average AR, which is what produces the income. So that is that timing effect that Sanjay is talking about is if you have rapid growth in your ending AR, your reserve is going to lead where the finance charge comes through and then that would benefit you in 2014.

So in this initial year of flipping to a steady rate with rapid growth you're going to get a big one-time build and then you will see it start coming through the numbers better in future years.

Got it, perfect. Maybe just one last one for Melissa. When you guys are out there competing on these earn-away deals are you seeing a lot of competition out there? Because it seems that we are getting kind of mixed signals in terms of some of the key players out there.

Then just on the charge-off guidance that you guys have for next year, I mean are you guys being conservative there in assuming a big step up from where you are right now? Thanks.

Sanjay, with respect to competition, I will tell you from our perspective it is fierce in terms of activity. And I think there would be a bit of arrogance to assume that we won't have to work very, very hard to earn away some of these current programs.

What we are finding, just as we take a good deal of pride in our current programs, the legacy or current providers will have invested heavily in the current program so they will fight pretty hard to keep them.

What makes us unique, though, is there is no single provider like Alliance Data where we can string all of our data assets, not just in retail but by leveraging what Epsilon brings to bear as well. And so there is no one provider that is able to string together personnel assets, data assets, and the competencies that we have, and that has really been a winning strategy for us in the marketplace. Our clients want to know that we are singularly focused on helping them build their business.

So we have said often if our clients simply want to approach us as an arbitrage on interchange we may not be that very best partner. Competition is fierce; however, we believe that there is no one company that can bring to bear all of the assets that we can.

Then in terms of charge-offs for next year, I don't know that we would tell you that we are being conservative. I think, Sanjay, we are being realistic in that over time those charge-offs will tick up.

We certainly are not doing anything reckless in terms of how we underwrite. In fact, we continue to improve our tools. But over time I think we can expect that we will get to pre-recession or closer to pre-recession rates.

Yes, I think to Melissa's point, if we can give guidance of very strong double-digit growth out of Melissa's shop, and that includes having charge-off rates drift up and I guess passing up short-term funding advantages to lock down long-term, albeit more expensive, fixed rate money, and we are still doing solid double digit, I think that should give everyone a lot of comfort.

And to Melissa's point, and as you know, Sanjay, we don't know when we are going to go from 5.2% to our long-term historical 6%, 6.5%. It may be two, three years, I don't know.

Right now we are not seeing any indications. Personal bankruptcies even look better. We are not seeing anything out there that suggests that there is any immediate drift upward. However, we are putting a plan together saying let's get there the old-fashioned way, which is let's grow.

Perfect, thank you.

Darrin Peller, Barclays.

Starting off on the Epsilon segment, you are calling for 7% revenue growth in Epsilon in 2013, and that is probably on easier year-over-year comps. Just as we head into 2013 versus 2012. So can you give us a sense for what you see the segment doing just longer-term? I mean is this a segment that should grow at some point again in the high, let's call it 10% range? Or what is the long-term growth profile really of this segment?

And then also can we expect margins in the segment to remain sustainably at these strong of levels? I mean, you've reshoveled some things the last couple of quarters, but can they stay this high as you roll on the new pipeline you've talked about going forward?

Yes, all great questions. I think by itself and based on the pipeline and based on the history of Epsilon, I think if you are looking at 7%, 8% organic top, and 8%, 9% EBITDA, I think we would say we are comfortable, certainly comfortable using that as a long-term model for Epsilon.

The one wild card in there is that that would assume that Epsilon functions the way it has functioned for years, which is we win a database deal, we win a digital agency deal, we win a data deal, we win an analytical deal. And a lot of them involve one or two pieces of Epsilon and not all five.

If, in fact, the new organizational structure we put in place this year turns into what we believe the vision is, which is the chief marketing officers, the chief technology officers out there are, in fact, looking for one throat to choke, they're going to look for a partner that can basically offer everything. And so that changes deals from $5 million wins to $30 million annual wins.

And if we are the go-to and we are the only ones out there in the marketplace that covers everything from the creative all of the way through distribution, if we are successful over the next few years of becoming that one go-to party to handle all the digital and direct marketing expenditures from the CMOs, then you are going to see a very significant increase in the growth rates of Epsilon.

We are not comfortable tossing that out at this point because we are just really starting it, but if you start seeing deals begin to flow out in our PR releases saying we are going to be doing everything from creative to data to database distribution, then you know we are on the right track.

So it is still early in the process. We are betting a whole bunch on there is that next leg of growth available if it comes through. Right now we are going to stick with sort of the traditional organic growth that we have seen, and as we become the one throat to choke hopefully that will drift up in the coming years.

And, Darrin, I think from an EBITDA margin standpoint you have to keep a couple of things in mind. One is the base business at Epsilon has been steadily growing its EBITDA margins, but we on-board these new acquisitions it have a little bit of a dampening effect.

The second thing you have to keep in mind is that there is seasonality involved. We tend to be a little bit weaker Q1, Q2 with strength in Q3, Q4. So when you look at the Q3 27% EBITDA margins, don't that to continue straight line into the first and second quarter of next year.

Having said that we are still looking for about 150 basis point increase [to the] mid-25% range next year and I think over time the ability to get it back up 26%, 27%, 28% is there. The timing will be driven by the onboarding of acquisitions if we continue the tuck-ins and then the leveraging that we expect to get as a fully integrate them.

All right, that is helpful. Just to follow up quickly on the growth target.

So, Ed, when you are saying long term you're seeing something particularly better, the 7% number you gave for 2013 that still does really -- that is still really founded in just what you are seeing in your current pipelines? That is not expecting all these big expansions to more holistic offerings right now is it? Is that right?

That is correct.

Okay. All right, thanks. Just a question on your overall guidance now for 2013. If you look at your 10% growth in core earnings for 2013, your business segment guidance alone is roughly about 9% when you put all three pieces together. It just seems that it gives very little, if any, attribution to the much lower funding costs in the year. I think we are turning around 20 or 30 basis points better in 2013 than 2012, given what you've done from a refi standpoint.

And while you are saying -- I now you are saying the dollar amount of the reserve may increase because the portfolio size has grown so much, and I think you said $40 million, Charles. But when you compare that to the more than -- to the roughly, I think it is about $1 billion of receivables growth in 2013 versus 2012, as well as the fact that I think the ratio should come down pretty materially given how consistent and strong delinquencies in our credit has been over the past year and really seem to continue to be, shouldn't those two variables alone get you materially above just 10% core earnings growth?

And I know you are generally conservative, but -- go ahead.

Number one, obviously, as Ed talked about before, we always like to keep a little flexibility within our guidance. Number two, and this is a key takeaway and you saw it addressed in our press release, when you onboard a new program generally it does not perform as well as what our program does after two or three years under our operation. Number two, you get the dampening effect of basically the accounting for the acquired program as well.

So what that does is you saw it in Q3 where you saw the gross yields drop a little bit. If we continue to grow at these high rates, during the short term you are going to see depression or some dampening on the gross field and so that is part of the issue.

Now the flip side of it is, again, I go back to the reserve build. If my ending AR is $500 million higher than my average AR, my yield comes off f average, my reserve comes off ending. So if not I am not getting improvement in that charge-off rate and I have a stable reserve rate, I am basically -- my provision is leading my future revenue stream from that growth.

So those are the key takeaways you have to take in your model in evaluating 2013.

I think, Darrin, your point is well taken. It is October and we will probably have a few more refinements in January. And as you correctly pointed out, we like to offer something that you can take to the bank.

Then let's see how things play out during the year, and if it is another year like this year, hopefully there will be more good news to bleed out as the year progresses.

Okay, great, guys. Thanks a lot.

Daniel Perlin, RBC Capital Markets.

Thanks, guys. So I have maybe a bit of a more strategic question for you guys. How do you balance the opportunity that you see in front of you for these opportunistic Private Label portfolios that might come into view this year given all your liquidity, despite the fact that that has become a meaningful and a larger growing part of the business, but also have a lot of the visibility going into the next couple of years, as others have pointed out, versus opportunities that are going to come into what has been an underperforming unit in Epsilon?

So I am just trying to reconcile how we should be thinking about this capital redeployment. I know you talk about tuck-ins at $400 million to $500 million, but with $2.5 billion you did clearly a lot more than that this year. And you had less liquidity starting, I think, last year. So I don't want to run through the uses of cash but I do want to kind of understand how you are thinking of balancing redeployment of that in areas that are more visible versus less visible? Thanks.

That is a great question. It is very simple, people ask us all the time, as you know, Dan, going back many, many years of how big should Private Label be versus the other two. And, frankly, we are at the point, as we have always been, of we are not shy to take advantage of opportunities in the marketplace.

Right now this is a golden time for us in Private Label for a number of reasons. I will stick to the noncontroversial one, which is everyone knows data is what it is all about. Retailers are discovering after all this time that having a closed loop network with SKU level information is, hey, that is a pretty good idea.

So we are getting a lot of interest there and that is helping to drive, along with Melissa's sales programs, much larger wallet share gains at existing clients. The more, I guess you would say, politically sensitive side of it is that there are a number of potential clients who are very unhappy with where they are today, whether it is in-house or with someone else. And we certainly are going to bend over backwards to welcome them into our family.

So we think this is a fairly unique opportunity for us, which is a 2012, 2013, and probably a 2014 opportunity, and we are going to take full advantage of it. That means that Private Label will continue to grow above historic norms over the next two, three years and that throws off an awful lot of cash and, liquidity.

Against that, of course, we are seeing Brazil which will be huge as it continues to spool up as Private Label will eventually start moderating, let's say, two, three years from now. Well before then you will see Brazil kick in very significantly, let's say in 2014, and so that will start balancing the ship the other way.

And from an M&A perspective there are a couple of slots in Epsilon where we could certainly see a couple of tuck-ins that will help also rebalance the ship. So, overall, that combined -- if you look at Brazil, if you look at, let's say, two tuck-ins of $0.5 billion or so in Epsilon over the next couple of years, the growth in both of those businesses, and then some liquidity being returned to shareholders.

If you look at all those pieces combined with sort of this unique trend in Private Label, what I think you will find is we can maintain a pretty decent balance. It just will be a little bit heavier on the Private Label side for the next 18 months.

Okay. So what I am hearing, just to make sure I got that, there is nothing so big out there that it is transformative, even though there are some possible deals out there that could fall into that camp.

But it sounds like your strategy is going to be more consistent tuck-in, as you said the old-school growth, and not likely to go down the path of these, I forget what was said earlier, these shiny objects that you need to chase that are much, much bigger in scope but you could certainly afford. It just doesn't sound like that is what you are going after.

Yes, never say never, but the uber deal I would think is, look, we have been around the block enough times that those are tough to do and get right. We are pretty darn good with the tuck-ins.

Yes. Can I just ask Charles a quick question on what he views as the triggers to ultimately get Brazil beyond that kind of 50% ownership so you can kind of bring it back in and we can start to really see that firsthand?

I wouldn't say there are any triggers. It will just be on a one-off negotiation basis over time to get to a majority ownership.

Okay. So there is nothing that is occurring, say, in that Brazilian family right now that would cause a trigger?

No, I stay with what I said, which is it will be a one-off negotiation that if the opportunity presents itself we will take advantage of it.

Okay. Then just one little nuance, if I could ask. You mentioned in AIR MILES the timing of a rollout is going to be dictated by the point-of-sale programming changes. Is that just this innocuous statement that you are throwing out or is there actually something that we need to be aware of at the point of sale?

Thanks, I will stop now.

No, it is just a matter of some of the big retailers that could utilize the program have to modify their POS, which can take time and so it is not necessarily within our control. I think the sponsors want it, the collectors want it. It is a matter of somewhat substantial programming changes that need to be made.

Excellent. Thanks, guys.

Okay. I think we will probably stop it there. I know everyone has got jobs to do, so we are excited, as you can tell, and hopefully everyone else is as well. So we will talk to you next time, thank you.

Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation. You may now disconnect.