Bread Financial Holdings Inc (BFH) 2012 Q4 法說會逐字稿

Good morning, and welcome to the Alliance Data fourth-quarter and full-year 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 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, By now you should have received a copy of the Company's fourth-quarter and full-year 2012 earnings release. If you haven't, please call FTI Consulting 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.

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?

Great. Thank you, Julie. Everyone, welcome to the early morning edition of Alliance's Q4 earnings call. And joining me today, of course, is Charles Horn, our always insightful CFO, and Charles is going to talk about our segment and consolidated results, and I'll wrap up with a financial scorecard and our 2013 outlook. Also, I know a lot of folks are in the middle of earnings season right now but we'll most likely go back and look at the transcripts or listen to the call, so at the very end I am going to give a few minutes discussion, just in terms of where we see the Company from a longer-term perspective, give a little bit of a strategic view of looking at where he we want to be, as we move through 2013, into 2014 and into 2015. That being said, Charles, your show.

Thanks, Ed. 2012 was another tremendous year, with double-digit revenue, adjusted EBITDA net of funding cost, and core EPS growth. The growth was balanced as all three segments contributed 9% or better to top line and bottom line growth to the year. Organically, revenue grew 9% in 2012, driven by 9% growth at LoyaltyOne, and 12% growth at Private Label. Epsilon had a somewhat off year with organic growth of 4%. However, importantly, after negative organic revenue growth in Q3 2012, Epsilon returned to 3% growth in Q4 2012, as it played through the air pocket created by the lack of new wins early in 2012.

Our Q4 results, aside from the increase in diluted share count, closely mirror full-year 2012. Revenue up 15% to $972 million, adjusted EBITDA, net of funding costs, up 26% to $245 million, and core EPS up 8% to $1.84, or 14% to $2.15 on an economic basis, which excludes phantom shares. The acquisition of Hyper Marketing, completed on November 30, 2012, added approximately $0.04 to Q4 and full-year 2012. Our share count continued to move against us, as diluted shares for Q4 increased 6.9 million shares, driven by a $3.5 million increase in phantom shares, and $3.7 million increase in warrants associated with our convertible debt, both driven by higher ADS average share price, as partially offset by share repurchases we made. Looking forward, approximately $4.6 million of the phantom shares at year-end disappear August 1, 2013, as the first tranche of convertible debt matures.

Let's turn to the next slide and talk about LoyaltyOne. LoyaltyOne had a strong fourth quarter, with revenue up 1% and adjusted EBITDA up a notable 24%. Excluding the benefit of favorable foreign exchange translation rates, revenue decreased 2%, while adjusted EBITDA increased a robust 20%, compared to the fourth quarter of 2011. Operating losses associated with our international expansion efforts were consistent between years, creating no incremental drag on the quarter. Revenue growth, which was essentially flat in the fourth quarter, was slightly below our expectations due to a lower-than-anticipated burn rate. A reminder that the burn rate is defined as current quarter, or year, redemptions over current quarter or year issuances.

Our guidance for Q4 was approximately 65% burn rate, whereas actual was about 60%. As seen on this slide, redemption activity steadily moderated as 2012 progressed. This unusual trend, which we now believe is behind us, was prompted by the announcement of a five year expiry program at the end of 2011. This triggered what we call a run on the bank in the first half of 2012, as certain collectors accelerated redemption activity into the first half of the year, which normally would have occurred somewhat ratably during the year. The falloff of redemption from the back half of 2012 was expected, although in Q4, it was slightly steeper than anticipated, but it mitigated the bulk of the excess first half redemptions. As previously discussed adjusted EBITDA was up $11 million, or 24% over the fourth quarter of 2011. Favorable translation rates added approximately $2 million, while higher gross margins on redemptions primarily drove the remainder.

Adjusted EBITDA margins for the AIR MILES program was 29% for the quarter, up 400 basis points, compared to the fourth quarter of 2011. Miles issued bounced back solidly from a weak third quarter, increasing 6% in the fourth quarter, driven by strong promotional activity from certain sponsors. Due to the factors discussed above, miles redeemed were down 8% in the quarter, as the burn rate for the quarter dropped to 60% from 69% in the fourth quarter of 2011. With the effects of the expiry announcement largely behind us, we project that redemption activity in 2013 will return to a more normal level of approximately 72% to 73%, which is slightly below our royalty and redemption rate assumption of 73%.

As you have probably noticed, there's something new on the slide. We are lowering the breakage rate from 28% in 2012 to 27% in 2013. Why? Simply put, the announcement of the expiry policy caused certain collectors to redeem that we previously assumed would not. Accordingly, we trued up our product liability December 31, 2012, and lowered the rate we will use in 2013. The economic impact to us really is expected to be none.

The nice thing about a coalition program such as ours is that we make money from three ways. One, marketing servicing revenue, which is what we receive for running the program. Two, breakage revenue, money we receive from miles never redeemed. And three, gross margins and redemptions, driven not only by the cost of the product but also how many miles are required for desired redemption. In 2013, we expect to offset any lost breakage income with higher product margins.

Moving on, we did add an instant reward program called AIR MILES Cash in 2012. It finished 2012 with over 1 million collectors enrolled, so it is starting to ramp up. We added two additional sponsors during the fourth quarter, namely Sobeys in the Grocery category, and Lawtons in the pharmacy category, both in the Eastern region of Canada. The addition of these sponsors to the program increased the participating sponsor count to seven at year end. The program continues to gain momentum with collectors enrolling daily. We anticipate adding additional sponsors and category to the program over time, and to increase the number of locations where AIR MILE cash redemptions are accepted. The timing of the roll-out is not completely within our control, as in many cases, it requires point of sale programming changes on the part of our sponsors. To date, miles issued under this program are not material.

Moving to the international front, dotz continues to exceed our expectations. Collectors enrolled in the program exceeded 6 million at year end, 2 million more than our original expectation for 2012. In the fourth quarter, we launched, Recife, a region with a population of over 3.7 million, bringing the total market count to five covering approximately 10% of Brazil's total population. With many of the building blocks in Brazil firmly in place, we are now positioned for growth. While we currently do not consolidate dotz, thus we do not recognize any revenue associated with it, as a frame of reference, revenues have grown from minimal amounts at the pilot in 2009 to an expected run rate that will exceed $100 million in 2013. dotz remains focused on expanding in its new markets, increasing quality enrollments, and growing its roster of sponsors with the end goal of securing a national presence in the near future. dotz anticipates financial results to continue to accelerate, as the program grows within existing markets, we launch in new regions, we secure new partners, and we gain further momentum and engagement with consumers throughout the Brazilian market.

Let's turn over to the next slide and talk about Epsilon. Epsilon's revenue rebounded back in the fourth quarter, increasing 15% compared to last year. Importantly, what Ed and I really look at, organic revenue growth returned, increasing 3% for the fourth quarter of 2012, primarily due to strength in the auto and telco verticals. Revenue growth for the fourth quarter was augmented by the acquisition of Hyper Marketing, what we call HMI, which added $31 million or 12% to the top line growth. Adjusted EBITDA increased 9% for the fourth quarter. Excluding approximately $5 million of restructuring expenses, organic adjusted EBITDA growth was approximately 10% for the fourth quarter.

Overall, it was a mixed year for Epsilon. The good, top and bottom line growth of 18% and 14% respectively. The bad, organic revenue growth of 4%, which is below our target of high single digits. We have talked extensively in the past about what happens. In a nutshell, new client signings were soft in the first half of 2012, which meant fewer projects moving into production in the back half of 2012. As a result, we were unable to overcome weakness in the healthcare pharmaceutical vertical, coupled with a temporary pullback in marketing spend by one of our big clients.

This air pocket, as we call it, pressured back-half revenue growth. However, it also afforded us an opportunity to make changes we would not have made during a hyper growth phase. Accordingly, we made the decision to make an EBITDA investment in Epsilon to further bolster its long-term prospects. In 2012 we incurred over $11 million of expense, restructuring and realigning Epsilon's business. These expenses should not repeat in 2013.

The benefit of the actions we took should be two-fold. One, the realignment of sales and client services staffing into industry verticals that deliver solutions across all Epsilon offering areas should drive additional client wins. We are already seeing results, with a backlog at year-end up double digits compared to the same time last year. And two, rationalization of underperforming product lines, and the elimination of redundant costs associated with old product structure, should drive operational efficiencies, enhance margin expansion, in the future. We are already seeing benefits, as even with the restructuring cost, adjusted EBITDA margins for the back half of 2012 were 140 basis points better than the same period last year.

During the fourth quarter, we took another step to bolster Epsilon's capabilities with the acquisition of Hyper Marketing. HMI brings to Epsilon a strong digital presence, creating within Epsilon one of the largest digital agencies in the US. Importantly, this acquisition dramatically increases Epsilon's critical mass within agency, expands our presence in key verticals such as CPG and retail, adds tremendous talent in multiple disciplines, and greatly expands Epsilon's digital capabilities in key channels such as mobile, social, targeted display, and web development. During the fourth quarter, Epsilon announced several exciting client engagements that support our outlook for a solid 2013. KeyBanc, an Epsilon client for over 18 years, signed a multi-year renewal with Agency Services. Regis, a Fortune 1,000 beauty industry leader, signed a multi-year deal for Epsilon to provide database services. Finally, we rolled out the Walgreen's Balanced Rewards Loyalty platform, supporting dynamic real-time loyalty transactions in over 7,900 stores at the point of sale, kiosk, pharmacy and online. These wins are representative of Epsilon's go-to-market strategy, where there is a healthy blend of data, agency, and technology wrapped into each deal.

Let's flip over now and talk about Private Label. Private Label continued its outstanding year, or what Ed would call a boomer of a year, with revenue and adjusted EBITDA growth in excess of 20% for the fourth quarter. Revenue increased 23% for the quarter, driven by a 31% increase in average card receivables. The difference between the two growth rates is primarily due to the on-boarding of new programs in 2012, which usually suppressed gross yields for a period of up to 12 months. Adjusted EBITDA, net of funding costs, was up an even stronger 38% compared to the fourth quarter of 2011, as we benefited from lower cash funding rates, which dropped to 2.1% in the fourth quarter.

Let's now turn and look at the key drivers of our performance. There's really four of them. One, card receivables growth, which accelerated each quarter during 2012. Our success in signing new business throughout the year, coupled with strength in the core business, produced 31% growth in average credit card receivables compared to the fourth quarter of 2011. Importantly, the growth was balanced. 16% growth in the core portfolio, and 15% growth from new programs. The same growth rate of 31% and ending card receivables provides a very strong jump-off point entering 2013.

Number two, cardholder spending remains strong, up 38% from the third quarter of 2011. Excluding new programs, cardholder spending grew 12%, despite moderate retailer sales growth and the effects of Superstorm Sandy. Essentially, we are gaining wallet share. Approximately 60% of the year-over-year growth can be attributed to increases in tender share with our retail partners. We expect to continue this trend in 2013 with new partnerships, increases in tender share, and underlying retailer performance driving a strong year.

Number three is portfolio quality, which we talk at length about. It improved on a year-over-year basis, and has now likely reached bottom. The principal charge-off rate was 4.7% for the fourth quarter, compared to 6.3% last year. Normalized for purchase accounting associated with the acquisition of portfolios, the pro forma principal charge-off rate was 5.1% for the fourth quarter, and 5% for the full-year 2012. Looking into 2013, we expect continued strong credit performance, with only a slight increase in charge-off rates for 2013.

Lastly, and number four, funding costs continue to improve, with cash funding rates down 80 basis points for the fourth quarter on a year-over-year basis, and 20 basis points on a sequential quarter basis. During 2012 we have steadily taken advantage of a robust asset-backed securities market to extend out maturities as long as seven years, at rates on average below 2.5%. The laddering of maturities, one, three, five and seven-year maturities, at record low fixed interest rates, provide funding certainty for the next several years. Overall the outlook for Private Label entering 2013 looks good.

Let's move to the next slide and talk about our liquidity. Liquidity for ADS and its bank subs is substantial, aggregating over $4.2 billion at December 31, 2012, which is more than sufficient to execute or capital allocation plans in 2013. If we break it down further, corporate liquidity increased to $1.8 billion at December 31, 2012, of which approximately $900 million is cash on hand. During the fourth quarter, we raised $400 million of new 5.25% high yield debt, which was primarily used to finance the Hyper Marketing acquisition. Our leverage ratio, which is corporate debt over adjusted EBITDA, was 2.3x at year-end, which is well below our maximum leverage coverage ratio of 3.5x.

At the bank level, we have approximately $2.4 billion of available liquidity at December 31, 2012. As can be seen on this slide, we actively attempt to diversify our funding sources, as well as ladder out maturity dates. Currently we estimate a duration of approximately 27 months on all outstanding borrowings, or about 41 months on term ABS, with over 75% being fixed rate. With the APRs in our cards being variable rate tied to prime rate, and the related borrowings being largely fixed rate with an extended duration, it means we are positive rate sensitive. Continuing our dividend trend, our two banks paid $57.5 million in dividends to ADS parent during the fourth quarter, while maintaining strong regulatory capital ratios. We expect similar quarterly dividends in 2013. I'll now turn it over to Edward, who will wrap up with a discussion -- final discussion of 2012, and discuss our revised 2013 outlook.

Good. Thanks, Charles. Let's turn to the slide, 2012 wrap-up, obviously Charles has covered everything in-depth, but again, stepping away and looking at what are the key messages that we take away from 2012, obviously the financial performance, always important. What we note is very, very strong double-digit growth across all of our key metrics, and I would say, moving on to probably one of the key highlights is the second bullet point, which is, 9% of this is organic growth. And in this environment of new, new and even assuming yesterday's GDP was a bit of a timing issue, if you're looking at 2%, 2.5% real GDP growth, and you're doing organic growth of 8%, 9%, quite frankly, we think that is a very, very attractive model, and that's why we will continue to focus very, very intently on the organic growth rate of our businesses.

That being said, having incremental M&A activity and share buyback round out what we call the three-pronged strategy that we have. What was also nice in 2012 was the growth was nicely balanced across all three of our engines. For those of you who have been around for a dozen years and have followed us, you'll notice that sometimes we have years in which we have, one, just blown the doors off, and another segment is a little bit soft, and that also works with the model. But 2012 was notable, because all three of the engines contributed nicely to the record results. Same on the EBITDA or free cash flow side. Again, ranging from anywhere just under 10% to 20%, in the range.

As you looked at the individual businesses, Private Label obviously was the primary engine of over-performance during 2012, where you had record portfolio growth of $1 billion, up 20%, which is the best I've seen it in my 15 years here. Combine that with very strong credit quality, funding costs, and as Charles mentioned, we did use some overperformance, and plowed that back into higher-rate, but longer-term fixed rate funding, that gives us better visibility into future earnings. A couple of notes on the Private Label business itself. For those of you who don't live and breathe this stuff every day, the overall market in the card industry itself has essentially been a tough place to be over the past few years. The market itself peaked at about $1 trillion of receivables, and has been declining ever since, all the way down to $850 billion. And this was a market that grew 7% a year, so it was a fairly dramatic swing from a nice growth market into essentially a free-fall. The market had flattened out during 2012, but it's still well, well below its peak of $1 trillion.

Against this backdrop, we actually had the best growth in our file in our history. And the growth came from not only our core clients stepping up, but record wins, and quite frankly, high-quality wins, which is always important going forward. I mean, we're talking the Pier 1s, the Talbots, the Bon-Tons, the dotz, and a number of our other clients that really should be solid contributors, not only today, but going forward. Also, you're beginning to see why the model that we have here, quote unquote, works. And if you look at nothing other than just the folks using our cards, the credit sales numbers, our credit sales were up 30% year-over-year. And not only did that come against a backdrop of relatively weak overall industry growth, but if you look at our core clients, those clients who have been with us for quite some time, they had a relatively modest holiday, 3%, 4% sales growth. For those clients, we actually were growing double-digit. So that essentially means that our tender share at those clients moved up very nicely, which again would suggest that perhaps this Private Label tool is one heck of a loyalty program for our clients' customers.

So you put it all together and where do we stand right now? As we said in the past, we do think it is a you unique offering. We do think that we play in a fairly unique sandbox in terms of the clients that we focus on. And we do believe that we do have the best integrated mouse trap, so-to-speak, that's out there, which combines the benefits of having your own processing and network, providing the credit, the very, very high end customer care which is why we keep our folks on-shore, and then you put it all together in a marketing wrapper where we are collecting, because of the closed loop network, all sorts of data, down to the category and sometimes SKU level, which can then be used for very, very sophisticated marketing programs on behalf of our clients. So it's been a long time in terms of getting the message across, but more and more our clients are taking a look at the richness of the data, the uniqueness of our marketing programs, and saying hey, you know what? This thing seems to work. And they're coming on-board.

So I wanted to spend just a little time on Private Label and why it seemed to work so well. I'll move on quickly to Epsilon. Charles went through the nums, which were obviously from an overall perspective, very good. What I look at obviously is what's going on deep with inside the business itself, and that means take a hard look at organic growth. We have talked at length about the air pocket. We wanted to make sure it was just an air pocket and not something more than that. It looks like that is the case, and we saw a nice turn begin in Q4. If you recall in Q3, our organic earnings growth was a minus 3% on top line Q4. That swung 6 points to a plus 3, and as we're sitting here looking into Q1, we expect that to continue to accelerate as Q1 is beginning to play out pretty nicely for us.

The big move on Epsilon obviously has been the large bet that we've made between the Aspen acquisition and the HMI acquisition, in what we call the big pivot. And the pivot is nothing more than recognizing the fact that a Company such as Epsilon, which relied exclusively in the past on having the best engineering, the best systems and everything else, and chatting with the CIO and CTOs, that marketplace has changed, where the CMO, Chief Marketing Officer, has a bigger and bigger say in where the dollars are being allocated, and as a result, we did put in place Operation Pivot, so-to-speak, which again made us very, very front-loaded in terms of digital agency assets, and as a result, we now have a presence in all the C-suites, where we can sell not only digital agency products, creative products, strategy, but also pull through the more traditional Epsilon services such as data, database, analytics and distribution. So we expect to see this pivot strategy play out really right away as 2013 unfolds.

Turning finally to Loyalty. Charles went through the numbers. Again, very solid year. I was very pleased to see the very strong resurgence in miles issued, which let's face it, that's how we make our money, and that looks like that's going to continue through 2013. Also very pleased to see how the Brazil joint venture has pulled up faster than we had anticipated, and always nice to start off the year with a new sponsor by the name of GM, as well as renewals of not only Loyalty's largest client, but Alliance's largest client, Bank of Montreal, as well as a top-five sponsor, American Express.

So overall, very pleased with the way things are going. The four take-aways for 2012, again, the double-digit growth across all the key metrics, the very high level of organic running at 3 times GDP, balance across all three of our businesses, and then obviously very strong momentum setting the stage for 2013, which we can now move to on the next slide. We are of course going ahead, and increasing our 2013 guidance. There's probably four moving pieces here. The big ones being you have, as Charles talked about, we have additional shares in our denominator, resulting from share price accretion, and that will cause a number of new phantom shares to flow in, as well as some real shares as well.

We also took the opportunity, which I would do all day long, to go out and raise additional liquidity. Any time we can get long-term fixed rate money at 5 points, we will do that all day long. And so we are bolstering, again, the warchest, and that came in quite handy because it took care of the HMI deal. And finally, you've got, against the high yield offering, which will put a drag for the first part on our 2013 numbers, because of the extra interest charge and higher share count will drag it as well, we are looking at nice accretion from the HMI acquisition, and already we're seeing additional Private Label overperformance. So you get a couple of drags, couple big pluses, the net result is an overall nice step-up in our guidance.

Specifically, if you looked at just using the overall share counts, we'll increase our core EPS about $0.15 versus initial guidance, but what we look at obviously is those phantoms are going to eventually be dropped away, with nothing we need to do, other than having the converts mature, and excluding the phantoms, we're actually bumping guidance up $0.35. So it's quite a big bump to start the year off, but that gives you a sense of how we feel. The guidance itself, it's all about growth this year, and again, while you'll see double-digit growth across all of the metrics, which we like to see with revenues and EBITDA and earnings and EPS, I again call attention to the fact that we are looking at organic growth rate of as much as 8% for this year. And again, we think that type of model with 8% combined with some moderate M&A activity, and some share buyback activity, should be very appealing to lots of folks.

The themes, same four themes as 2012. We're looking at double-digit growth across all of our key metrics, very strong organic growth of high single digits, and balance where we expect all the businesses to contribute. And then obviously, where I'll spend my time is building the momentum for 2014 and 2015. I think, why don't we continue to move on? That should give you a nice snapshot for 2013.

I'm not going to spend a ton of time on this slide, which is the outlook. We had the prior guidance. And then if you want to tick and tie and figure out how we got to bumping up our economic earnings per share by $0.35, essentially you're adding in the benefit of the HMI acquisition, which accretive. You're taking away from that the cash expense from adding additional liquidity. You're also dinging us for the higher denominator from the share count. Then you're adding in what we're beginning to see already, which is overperformance in Private Label. You swish it all together and you come out with a pretty decent, nice bump to start off the year.

Okay, last page here, we go into 2013 updated guidance. Again, we do have a few moving parts, so we wanted to make sure everyone was crystal clear on what's going on. What you're basically seeing is the revenue has increased by roughly $300 million. That is almost all attributable to the HMI acquisition. That will flow through to adjusted EBITDA which also includes some overperformance from Private Label.

Core earnings will also be moved up, but will reflect the cash interest from the high yield deal, and then you look at diluted shares outstanding. You'll see those have crept up a bit because of the stock movement and our core EPS, again, as we talked about, has gone up $0.15. When you exclude the phantom shares, which thankfully will start peeling off the middle of this year, and completely peel off by May of next year, then we won't have this fascinating thing to chat about. You'll look at what the true earnings, economic earnings are of the business, and essentially, we're looking at an economic EPS number of roughly $11. So again, those phantoms, I can't wait to say good-bye to them.

One of the I items I did want to mention, which is kind of interesting is, if you look at the share counts this year versus last year, you'll see a very interesting trend. And that is, in Q1 of 2013 we had 67 million fully diluted shares versus 62 million last year. So you could see a fair amount of dilution kick in. By Q4 of this year, it's going to flip-flop, with the first convert falling off, and you're actually going the to have 63 million shares in Q4 versus 66 last year.

So what you have is an EPS accelerant here going on, that starts in Q3 and really accelerates in Q4. So when we exit 2013 at 63 million shares, on top of that, you still have another 4 million phantom shares that will go away during 2014, and as a result, your economic share count is really more like 59 million. So bottom line is you get 67 million today. You'll eventually be coming down to 59 million or 12% decline, and that's a nice, nice earnings accelerator as we go forward. Also, we don't really talk too much about free cash flow, which of course is something very, very near and dear to all of us here.

We expect a very strong year on free cash flow. We expect to toss off about $700 million of pure free cash, and that's after taxes and interest and all sorts of other stuff. That's what's left in our pocket, and that of course we look to grow about double-digit, 10%, 12% year after year. So cash flow itself remains quite strong.

And the last piece here, as I promised at the beginning, I do want to take just a couple of minutes to talk strategically about where we are, where we're going, what we worry about, what we think is in good shape, and for those of you who go back and listen to this sometime in the future, you'll know exactly where we're coming from. Overall, if one were to say, okay, how does 2013 look, clearly you can tell from the tone today that we all feel very, very good about 2013. We said the same thing last year, and sure enough, it was a heck of a good year. I think 2013 is all about execution. We have all the pieces in place. It is, what I would call our year to lose, which we won't. What will be of interest going forward is things like how we end up deploying all this liquidity that we have.

What also will be of interest of course is will we follow tradition and tweak our guidance as the year unfolds? Most likely, yes. Today was a good start. But overall, given the visibility that we have with our model, I really don't he see anything that's going to knock us out of the box for this year, and I really feel very, very good about 2013. That being said, I get paid to worry about 2014 and 2015 as well, and if you look at the bigger picture, what are we looking at. What we're looking at is that if we are correct on the pivot at Epsilon, Epsilon will continue to accelerate, and Epsilon, we are counting on to have a very strong 2014 and 2015. There's no reason why it shouldn't.

We expect AIR MILES in Canada continue to be very strong. And against that, we expect Private Label, which has been having the gold star the last couple years, will obviously eventually moderate from enormous growth rates, but eventually, will face a moderation in terms of growth in its file and its credit sales, and also funding costs and credit quality will eventually start creeping back up. That being said, we do view Private Label, if you look out many years, as a very solid mid single digit organic growth engine for us, which means that, combined with Epsilon and AIR MILES, should give us the bulk of what we need. Along with that, Brazil will start kicking in, and Charles talked about the growth rates that we're seeing there, so we expect Brazil to be nicely additive to our earnings as we move into 2014, and certainly 2015 as well. You toss in a tuck-in M&A. You toss in the share counts going down, bringing our share count down 12% from $67 million to $59 million, and you can begin to see that the overall pieces of the puzzle look like they should fit together pretty nicely, not just for 2013, but 2014 and 2015.

It's just we're going to be getting the growth from different areas. Essentially as Private Label moderates, the other two businesses, plus Brazil, will pick up the slack. You throw in a nice decline in the share count, that should be helpful. And what we haven't talked about is the free cash flow generation of the business, the warchest. If you look at our net debt or total debt less cash, we're right around a little bit less than 2 times in terms of leverage. If we grow EBITDA $150 million, $200 million a year, that would automatically bring your leverage ratio to 1.5 times. We're tossing off $700 million in free cash flow. That brings your leverage down to 1 time.

So you're looking at a Company that, if we did nothing, would have its leverage ratio at 1 times by the end of 2013. As Charles said, we don't like to go above 3.5. So that leaves you about $3.5 billion in the warchest, which is nice, and again, our three-pronged strategy is organic, organic, organic, as the first one, but also we do look for a moderate-size M&A opportunity, and then finally, using some of our liquidity to continue to repurchase shares. So that's the long version of our strategy, and that being said, I know everyone's got a bunch of stuff to do, so we'll go ahead and take a few questions here, and we'll let everyone else get on to their next call. Operator?

(Operator Instructions)

Your first question comes from the line of Sanjay Sakhrani with KBW.

Great quarter and year. Seems like, in Epsilon you have a pretty nice set-up given the acquisition, some of the new relationships, and some of the restructuring efforts you've taken. Can you just talk about how much of that's kind of incorporated in your guidance? It seems like there's a fair amount of tailwind. Also, just how much the restructuring charges were for the quarter? And then just on Loyalty, I was hoping you could just talk about the reduction in the breakage rate, and your comfort moving forward that any impacts are manageable to the overall economics of that segment? Thanks.

On Epsilon, Sanjay, in terms of the expense we took this year, realigning, restructuring was about $5 million for the fourth quarter, about $11 million for the entire year. It is not something we've adjusted out of core EPS, that is a reported number that's been decremented for those items. I think on a go-forward basis, what it's going of to do is help us get back on Epsilon to drive close to high single digit organic revenue growth again. In fact, I'm looking for mid single digit at least organic growth in the first quarter of 2013, and maintain double-digit organic EBITDA growth in 2013. I think that's the key focus. Then what we ladder on top from Hyper Marketing is just kind of a plus.

In terms of the breakage reset, we did change it from 28% in 2012 to 27% in 2013. The key take-aways I'd want to make on that is one, we do think it is effects from the announcement of the expiry, meaning we triggered a run on the bank, and we had a few people we had expected not would ever redeem, redeemed, so we adjusted. What that means is we true up our balance sheet, which has now created an immediate P&L hit. We're reducing the amount of deferred revenue at 12/31/2012, that we would amortize into revenue over a multi-year standpoint. What that means is, in any one year it's not overly material.

Three, the other point I would make is since it's a prospective adjustment, as with any coalition program, you've got multiple levers you could pull. So as we look forward, we know what the impact will be over the next 2, 2.5 years, so we can adjust our pricing mechanism in such a way so we can offset it with basically gross margin on the product. So I think from that standpoint, we don't see any impact to earnings for LoyaltyOne in 2013, nor do we anticipate it will affect our guidance for ADS in 2013.

Okay. One more on Epsilon, the restructuring, you mentioned the revenue side of it. Just on the operating margin side, on a legacy basis, do you expect that to be accretive to the operating margin?

I do. So if I look at the base business, again, you have to overlay in Hyper Marketing. Before Hyper Marketing I'm looking for at least a 50 basis point expansion in EBITDA margins for Epsilon. And then of course then you ladder in Hyper Marketing, being a digital agency, it's going to have a little bit lower EBITDA margin. But for the base business, I'm looking for at least 50 basis points of improvement in EBITDA margins.

Thank you.

Your next question comes from the line of Bob Napoli with William Blair.

Nice job. Question on the guidance, is the buyback in the guidance and is your intention to essentially buy back the warrants from the convert when it matures, or will you be buying all during the year?

Yes, there is no -- there's nothing in guidance related to buyback activity. So one could view that as obviously a potential plus. Obviously, we don't want to tip our hand too much, but what we like to do with the buyback, obviously, if you went back in our history, we tend to be extremely active at certain times, and less active at other times. I guess when corporate America bought back the lease, which was Q4 of 2008 through the first half of 2010, is when we backed the truck up and loaded up. So we tend to do things a little bit differently here.

Obviously, we think the price is still attractive. We have a lot of liquidity, but we're not going to be silly and just go out there and back up the truck. If it looks like we have a good opportunity, we absolutely will be there, and we will be there in size. Otherwise, most likely we'll be picking away at it throughout the year, and whether we do it through just purchasing throughout the year or taking out the warrants, we haven't really decided at this point. So --

Okay. Just on the Private Label business, are you seeing, Ed, an increased interest in Private Label cards by retailers? It seems like they're -- like the Target Red Card, just seems like to us that there's more interest in retailers using Private Label cards as loyalty programs, incrementally, than what there has been in the past.

There's no doubt. And as we talked about earlier, the big driver behind it, right, and all you hear out in the marketplace today is data this and digital that, and all that other fancy stuff. This is what we do for a living. And what the benefit of Private Label has for our clients is, quite simply, the fact that you have a closed loop network, and with that closed loop network, and Alliance being a marketing company, you are capturing a level of data that is much richer than what really any other source can capture.

You're down to the category level, the SKU level, and as a result, you can take that richness of the data, and now it's then worthwhile to talk about the various distribution channels, this whole omni-channel approach, whereas before we could put in very sophisticated, fancy, personalized messaging in the statements or inserts or at the point of sale. Well, now we're talking about using the digital channels as well, whether it's permission-based e-mail, whether it's SMS, MMS, things like that. When you have the richness of the data, you have the analytics to segment that information, and then you have the omni-channel distribution system across not only old school, but the new digital channels, I've got to tell you, it's getting people's interest, and when you then filter in the demographic, psychographic data that we have over at Epsilon to overlay the transactional data, it's a pretty fan fancy machine we've got here.

Thank you. Last question just on your guidance for 2013, what are your -- the yield that you saw this quarter on Private Label, is that a reasonable run rate yield or is there more pressure on that yield and what do you have in there from a credit loss perspective?

Bob, from that standpoint the yield always fluctuates during the course of the year with Q4 generally being the lowest, because of what I call the denominator effect. You have a big ramp-up in the NDAR that's not income-producing yet. Looking out into 2013, what I would expect obviously dependent upon any on-boarding of new programs, is a gross yield roughly consistent between years.

Yes. I'd also say that you have obviously seasonality in the yield itself. For Q1, you will tend to have your highest yield because essentially people hopefully shop till they drop in Q4 and in Q1, they go oops, we need to figure out how to pay that off, so folks tend to either miss or a little bit late in January, or they roll the balance during Q1. And then also in Q3 you have the back-to-school seasonality where everyone's coming back from vacation and they're like I'll get around to it, and some folks are a little bit late on their payments, or they decide to roll it. So you tend to have seasonality on the yield itself. But as Charles said, it tends to even out on an annual basis.

Thanks. On credit assumption?

We talked about a little bit, Bob, that probably in 2013 looking for maybe 20, 30 basis points change in a normalized charge-off rate. If our charge-off rate normalized was 5% for 2012, we're looking in that 5%, 3% range for 2013.

I would also say that it's too early to call the ball on this one, but it does seem that, I think that is certainly a very safe bet. It may be even a bit on the conservative side, because we really have yet to see any upward movement in some of our key forward indicators, suggesting that losses are in fact drifting back up to the more normalized 6% level. It will happen at some point. Whether it happens this year or two years from now, right now we're not really sure. Based on delinquency flows, they look fabulous. We're actually seeing improvements in personal bankruptcy rates and recovery rates are staying very stable. So right now, a potential source of incremental upside would in fact be if losses in fact stayed relatively flat to 2012, and right now, it's tracking to that. But we don't mind putting in 20 or 30 BPs, just to be safe.

Thank you.

Your next question comes from the line of Carter Malloy with Stephens.

Congratulations on the quarter. First off, on dotz, I'm not sure how much you can speak to it on the public call, but appreciate all the data you have given us. When can we expect to see that actually on your P&L?

Well, obviously our share of the operating losses will flow through the P&L. That's what you're seeing. In terms of the revenue, all we can say right now is we will continue to keep everyone updated on how revenue is growing, because it has taken off, and our number-one goal right now, right, it's a land grab. Our number one goal right now is to get from -- we went from $0 million to $6 million. We want to get to 10 million folks enrolled and active by the end of this year, which means some big roll-outs. At that point, you're going to see the numbers looking pretty big. At a certain point, Carter, we will obviously take a hard look at, is there an opportunity to recognize that more in the financial statements, as opposed to just a note. That's probably all I can say.

Okay. That's fair. Then on the breakage, going up a little bit this year, I'm sorry, from 28% to 27%, what are the drivers or the triggers that could make that happen again going forward?

I'll jump in and Charles can give you probably the more correct answer. But essentially, when you have the run on the bank, when we announced the expiry policy, we need to reflect that in the breakage calculation, and as a result, we had to move it 1 point. As Charles mentioned, when you own the program as we do, there are a number of levers, as we have said for years, that we can pull. And those levers have already been pulled. So for example, if your breakage rate is a little bit less, then what you do is you will change your pricing accordingly and make it up in margin when folks redeem. And so to us, it really doesn't matter. We just want to make sure all the accounting is right, and we knew we had a run on the bank. That's already been taken care of through pricing mechanisms, and we feel pretty good about that.

As we look forward, it's going to be real interesting. The consumer has really -- we have a bifurcated consumer, in the sense of, we have those who are looking really long term for that fabulous trip down to Florida, when it's minus 20 degrees up there, and we have the others who want instant gratification when they go into the grocery store. And as a result, that's beginning to change the dynamics of the model a little bit, and so we need to change with it. The most important thing is to offer the consumer something that the consumer wants, and then we worry about how the pieces fit together, later on.

The consumer's clearly saying, I want that instant rewards option. That could change the redemption model. What we will do with any change in the redemption model is that we will pull another lever, that will keep us whole in terms of the margins. So bottom line of all of it is that, whether breakage stays within a point or two of where it is now or not, it really doesn't matter from the model and the margin perspective. We'll pull another lever, as we've always said we would, to make sure that we're clean.

Second part of that question would be related to that on the pricing elasticity. How much have you moved it over the last few years, and do you think there's still a lot of potential head room there or just a little bit left?

There seems to be a certain level of comfort with our consumer base. We think that the offering that we have today is a solid 20% premium in value over any other program that's out there in the marketplace, when you look at not only the value of the rewards we offer, but the ability to obtain those rewards without, hey, let's have a blackout period, 364 days a year. That's not helpful to anyone. We don't have those things. So as a result, we've got a very nice premium built into the program today, and as a result, we think there's a fair amount of flexibility, and again, what we would do is, it really will be in reaction to how the consumer chooses to redeem his or her rewards, whether it's instant or whether it's a longer term type approach and we'll adjust accordingly.

Okay. Thanks so much.

Couple more?

Your next question comes from the line of Tim Willi with Wells Fargo. >> <Tim Willi - Analyst - Wells Fargo Securities, LLC> <willitim> Good morning. I wanted to expand a bit on Bob's question about Private Label. Just wondering if you could talk about, in the context of retailers and Private Label, taking that a little bit more to the forefront around their mobile strategies. I'm assuming there's some tie-in. You talked about the Walgreen's platform, which I think is available as a mobile app. Could you just maybe talk about that, and what that might mean for your incremental revenue take over time, with your retailers as opposed to just the number of accounts you might have with retailers on the Private Label business?

Yes. It's a great question. I think we're going to fall into the camp of we don't really know right now the end result of all this stuff. But what we can tell you is what we've seen thus far. And when it's all said and done, do we believe mobile will be an important channel for us? For sure. There's no question about it, but let's not kid ourselves. The huge amount of accounts we're going to get, as people are at the point of sale in the store and places like that, that's still going to be the bulk of our business.

Now, in terms of incremental growth, I'd love to sit there and say that the ability to have folks opt into all of our SMS, MMS and geo-fencing initiatives and all that other fancy stuff that I almost understand, these things are certainly on the -- from an incremental perspective, are helpful. I will tell you one thing that actually has worked, and we can put real numbers to, which has been very helpful, which is using a web-enabled phone or smartphone in the store to secure new applications. And if you know how Private Label works, it's primarily at the point of sale. What we have found is that, we went after some of the clients who tend to cater towards a younger demographic.

And we offered the opportunity as they're walking through the store, shopping, to hey, there's all sorts of signage, call here, you call it up on your phone through your web, and you enter a few pieces of information. It zips up. It gets scored. It comes back. You have a virtual card right there in the store, before you've even gotten to the checkout. And what we have found is that has given us an incremental lift in new active accounts that has been very significant, and we've also found, maybe because you already have your credit line before you go up to the point of sale, we're finding that their first purchase is quite a bit larger than a traditional client.

So I guess, Tim, where we're coming out at is, yes, we will be participating in all the different digital opportunities that exist out there, but right now, I can tell you flat-out, we're going to make a bunch of money based on this new application, or this new account app, with people in the store. I mean, that's the stuff you can take to the bank. It's a nice lift that we have. That's the only thing right now I can say that we feel very, very good about. The other stuff, look, we're like everyone else. We're going to see where it leads.

If I could just ask a quick follow-up around the balance sheet for Charles. Could you just -- if you said it I apologize, but is there a way you can -- number you can give us around the average length of your funding duration, and I guess theoretically, is it a possibility that if we say sometime out there within a two to three year window, if rates rose, would there actually be the potential for spread expansion on your Private Label business for a period of time?

That's exactly how it would work, Tim. So if you think about it for all funding borrowings, we're about 27 months in duration for just the term ABS, about 41 months duration. If we talked about 75% of it's fixed rate. So to your point, in a rising rate environment you're going to have the majority of your file fixed for a long period of time. At the same time, on your cardholder standpoint you have a variable rate tied to prime. If it's a normal rising rate interest environment, where LIBOR's going up, Treasury rates are going up, and Prime's going up, it will increase in the following billing cycle for your cardholder. At the same time, on the funding costs, until you're replenishing or renewing the debt, you're largely fixed for a long period of time. In a rising rate environment, you're going to get a little bit of a yield expansion, and that will normalize over time as basically the new higher rates burn in and new debt is issued.

Perfect. Thanks very much for taking the questions.

One more.

We will take one more question from the line of David Scharf with JMP Securities.

Wanted to just dig in a little more on the Private Label runway. Ed, I don't know if this is something -- a metric you have top of your head, but when we look at that roughly $7 billion portfolio, can you give us a sense for what percentage of those balances reside at programs, stores in which your wallet share is maybe 15% or less, just to give us a sense for kind of how much market share within those same programs, we can still ride this?

Yes. I would say that you start with the sandbox and say how big is the potential world for us. We think there's about 300 retailers that fit sort of our DNA of a few hundred million to a few billion in sales, right? And they tend to focus on prime quality type customers. They tend to focus on brand. You narrow down that world, there's about 300 or so in our target universe. There's about 150 programs today. We have about, say, 110 of those, and so, we've got about a third of the potential market. We've got well over two-thirds of the programs that are already out there. So this is our sandbox.

If you think that we have roughly a third of the total potential market for $7 billion of receivables, we think the total market for us is obviously 3 times that, or about $21 billion, and that's what we're shooting for. If you look, therefore, okay, how are we going to get there, it's going to be a combination of wallet share, as well as signing new clients. Typical for us, I would say right now that our wallet share varies, depending on how long we have had the customer and the client, and how much the client has put their shoulder into the program itself. Quite frankly, we're no good if the client is not sitting there pounding the table, saying look, this is our loyalty program. We're going to support it, and we're going to push it. Obviously, I'm not going to mention any clients specifically, but overall, what we have found is that it look like our tender share is in the 20s, maybe 25%. We do have some clients that are up around 40% of their sales. So if you were to ask me what the opportunity is, it's somewhere between that 25% and 40%. So there's a good chunk that we can still get through tender share, and obviously a huge chunk we can get through further penetration of the sandbox.

Got it. So is it fair to say that maybe 20% of your portfolio resides at programs in which the -- that tender share or wallet share is well below 40%? I know it's just maybe 20% level. Just trying to get a sense for the organic wallet share opportunity, assuming you never signed up another program, just organic.

I'd say it's probably less than that. I would say it's less than that.

Got it. Switching to loyalty, Charles, is there a figure for what the year-end true-up was in deferred revenue, the one-time true-up to account for the breakage assumption change?

If you look at it, breakage and your product redemption all fall within the same liability. You won't see anything on the balance sheet per se because you defer 100% of the revenue associated with the points you issue. What we'll do is we'll refine before we come out with our 10-K what the projected change in amortization will be over the following few years. That's what we'll talk about. At this time, I'm not really prepared to talk about it. The key takeaway is you won't see anything on the balance sheet. No P&L associated therewith. What you will have is less theoretical breakage revenue amortizing over a multi-year window that will offset margin.

Just closing with Epsilon. Can you give a little update of just perhaps what your vertical concentration is as we look into 2013 and after the acquisition? What your concentration of the top line is along pharma, banking, auto and so forth.

Sure. I mean, obviously the biggies that we're looking at would be, auto would be a very large one for us. You would look at, I would say telecom is a large one for us. Retail CPG is a very large one for us, and then financial services. So I would say those four, auto, health, telecom, retail CPG and financial services, I guess that's five, those would be the vast bulk of the $1.3 billion that we're expecting out of Epsilon. Outside of that, I probably am not going to rank those five. They're all big.

Got it. Got it. Following the acquisition, are there any 10% customers now for Epsilon?

No, not for Epsilon by itself, or for ADS?

For Epsilon.

You've got some 10% customers within Epsilon, but not for ADS.

Got it. And then just lastly, in Epsilon, is there any regulatory update or anything on, the FTC was looking into data brokers which obviously it's not directly related to Epsilon, since you're not selling the data, but has anything progressed since they started requesting information from a number of data miners in the fall?

It's a good question. I would say the regulatory environment is as clear as mud, as always, and what we're doing is, we're trying to make sure that the folks who are asking a bunch of questions get what they need. So we are actually proactive in DC, basically saying hey, look, do you want to understand how all this stuff works? Let us walk you through it. Let us help you understand how all these things work. You can't just sit there and say click the switch, and let's have a do not track, because somebody has to pay for the Internet. So we have to make those linkages crystal clear.

I would say that not only for us, but a number of other firms as well, there will be headline risk probably for quite some time. Right now, we're in the process of hopefully an education process in terms of how all this stuff works, and then we'll go from there. But investors, analysts, everyone should be aware that for this group of companies, ourselves included, you're going to see headlines that pop up and all I can tell you at this point is, you know, it's -- from what we can tell, it's information gathering. There's no one pounding the table, saying we're going to need to do this, we need to do that, it's more of, here's another request and it hits the headlines. But we're on top of it, and if anything changes, we'll certainly let everyone know.

Okay.

Thanks a lot.

We're going to wrap it up. Thank you so much for your time and we'll look forward to a great 2013. Bye.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.