Dailystocks.com - Ticker-based level links to all the information for the Stocks you own. Portal for Daytrading and Finance and Investing Web Sites
DailyStocks.com
What's New
Site Map
Help
FAQ
Log In
Home Quotes/Data/Chart Warren Buffett Fund Letters Ticker-based Links Education/Tips Insider Buying Index Quotes Forums Finance Site Directory
OTCBB Investors Daily Glossary News/Edtrl Company Overviews PowerRatings China Stocks Buy/Sell Indicators Company Profiles About Us
Nanotech List Videos Magic Formula Value Investing Daytrading/TA Analysis Activist Stocks Wi-fi List FOREX Quote ETF Quotes Commodities
Make DailyStocks Your Home Page AAII Ranked this System #1 Since 1998 Bookmark and Share


Welcome!
Welcome to the investing community at DailyStocks where we believe we have some of the most intelligent investors around. While we have had an online presence since 1997 as a portal, we are just beginning the forums section now. Our moderators are serious investors with MBA and CFAs with practical experience wwell-versed in fundamental, value, or technical investing. We look forward to your contribution to this community.

Recent Topics
Article by DailyStocks_admin    (01-10-10 11:59 PM)

Filed with the SEC from Dec 24 to Dec 30:

Alliance Data Systems (ADS)
ValueAct Capital reduced its holdings to 2,583,900 shares (4.9%), by selling 661,418 from Dec. 11 through Dec. 28 at prices that ranged from $63.51 to $65.33 per share.

BUSINESS OVERVIEW

Our Company

We are a leading provider of data-driven and transaction-based marketing and customer loyalty solutions. We offer a comprehensive portfolio of integrated outsourced marketing solutions, including customer loyalty programs, database marketing services, marketing strategy consulting, analytics and creative services, permission-based email marketing and private label and co-brand retail credit programs. We focus on facilitating and managing interactions between our clients and their customers through a variety of consumer marketing channels, including in-store, on-line, catalog, mail and telephone. We capture and analyze data created during each customer interaction, leveraging the insight derived from that data to enable clients to identify and acquire new customers and to enhance customer loyalty. We believe that our services are becoming increasingly valuable as businesses shift marketing resources away from traditional mass marketing toward more targeted marketing programs that provide measurable returns on marketing investments.

Our client base of more than 800 companies consists primarily of large consumer-based businesses, including well-known brands such as Bank of Montreal, Citibank, Hilton, Bank of America, Victoria’s Secret, Canada Safeway, Shell Canada, Pottery Barn, Ann Taylor and J. Crew. Our client base is diversified across a broad range of end-markets, including, among others, financial services, specialty retail, grocery and drugstore chains, petroleum retail, technology, hospitality and travel, media and pharmaceuticals. We believe our comprehensive suite of marketing solutions offers us a significant competitive advantage, as many of our competitors offer a more limited range of services. We believe the breadth and quality of our service offerings have enabled us to establish and maintain long-standing client relationships.

We continue to execute on our growth strategy through internal growth and acquisition of new clients. In 2008, we entered into new agreements for private label retail card services with Hot Topic, Inc., PD Financial Corporation, Beall’s Department Stores, Southern Pipe & Supply Company, and with Orchard Brands for their family of specialty brands. We also acquired the existing private label credit card portfolio of HSN, an interactive lifestyle network and retail destination, and entered into a multi-year agreement to provide both private label and co-brand credit card services to HSN. We signed Hilton HHonors ® as a new sponsor in the AIR MILES ® Reward Program. We also signed new contracts with Commerce Bank, N.A., Beech-Nut Nutrition Corporation and Marriott International, Inc. to provide integrated email and marketing solutions.

We further expanded our relationships with several key clients, including AnnTaylor Stores, to launch a new co-brand credit program, Gander Mountain to provide fully integrated private label credit services and MedChoice Financial to provide consumer private label credit card services for veterinary



Optimize our Business Portfolio. We will continue to evaluate our products and services given our strategic direction and demand trends. While we are focused on realizing organic revenue growth and margin expansion, we will consider select acquisitions of complementary businesses that would enhance our product portfolio, market positioning or geographic presence. We have a strong track record of identifying and integrating such targeted acquisitions.

Our Loyalty Services clients are focused on targeting, acquiring and retaining loyal and profitable customers. We use the information gathered through our loyalty programs to help our clients design and implement effective marketing programs. Our clients within this segment include, among others, financial services providers, supermarkets, petroleum retailers, specialty retailers and pharmaceutical companies.

Our AIR MILES Reward Program is the largest coalition loyalty program in Canada, with over 120 sponsors participating in the program. The AIR MILES Reward Program enables consumers to earn AIR MILES reward miles as they shop within a range of retailers and other sponsors participating in the AIR MILES Reward Program. These AIR MILES reward miles operate as points that consumers, who we refer to as collectors, can redeem for travel or other awards. We believe that one of the reasons our AIR MILES Reward Program is so popular, as evidenced by the approximately 70% participation rate for Canadian households, is that it allows consumers to rapidly accumulate AIR MILES reward miles across a significant portion of their day to day spending. The three primary parties involved in our AIR MILES Reward Program are: sponsors, collectors and suppliers, each of which is described below.

Sponsors . More than 120 brand name sponsors participate in our AIR MILES Reward Program, including Canada Safeway, Shell Canada, Jean Coutu, Amex Bank of Canada and Bank of Montreal. The AIR MILES Reward Program is a full service outsourced loyalty program for our sponsors, who pay us a fee per AIR MILES reward mile issued, in return for which we provide all marketing, customer service and rewards and redemption management. We typically grant participating sponsors exclusivity in their market category, enabling them to realize incremental sales and increase market share as a result of their participation in the AIR MILES Reward Program coalition.

Collectors . Collectors earn AIR MILES reward miles at thousands of retail and service locations in addition to the many locations where collectors can use certain cards issued by Bank of Montreal and Amex Bank of Canada to earn AIR MILES reward miles. The AIR MILES Reward Program offers a reward structure that provides a quick, easy and free way for collectors to earn a broad selection of travel, entertainment and other lifestyle rewards through their day to day shopping at participating sponsors.

Suppliers . We enter into agreements with airlines, movie theaters and manufacturers of consumer electronics and other providers to supply rewards for the AIR MILES Reward Program, with over 300 suppliers using the AIR MILES Reward Program as an additional distribution channel for their products. Suppliers include such well-recognized companies as Apple, Starbucks and Sony.

Marketing Database Services . We provide design and management of outsourced loyalty programs, integrated marketing databases, customer and prospect data integration and data hygiene, campaign management and marketing application integration and web design and development.

Interactive Communications . We provide strategic, permission-based email communication solutions and marketing technologies. Our end-to-end suite of industry specific products and services includes scalable email campaign technology, delivery optimization, marketing automation tools, turnkey integration solutions, strategic consulting and creative expertise to produce email programs that generate measurable results throughout the customer lifecycle.



Private Label Services

Our Private Label Services segment assists some of the best known retailers in extending their brand with a private label and/or co-brand credit account that can be used by customers at the clients’ store locations, or through on-line or catalog purchases. Our co-brand credit accounts can also be used by customers outside of our clients’ store locations. Our clients include Victoria’s Secret, Ann Taylor, Eddie Bauer, Pottery Barn, Pac Sun and The Buckle. We provide service and maintenance to our clients’ private label credit and co-brand credit programs and assist our clients in acquiring, retaining and managing valuable repeat customers. Our Private Label Services segment performs processing services for our Private Label Credit segment in connection with that segment’s private label credit and co-brand programs. These inter-segment services accounted for approximately 97.1% of Private Label Services’ revenue for the year ended December 31, 2008. We have developed a proprietary credit system designed specifically for retailers that has the flexibility to be customized to accommodate our clients’ specific needs. We have also built into the system marketing tools to assist our clients in increasing sales. We use our Quick Credit and On-Line Prescreen products to originate new private label and co-brand credit accounts. We believe that these products provide an effective marketing advantage over competing services.

We use automated technology for bill preparation, printing and mailing, and also offer consumers the ability to view, print and pay their bills on-line. By doing so, we improve the funds availability for both our clients and for those private label and co-brand credit receivables that we own or securitize. Our customer care operations are influenced by our retail heritage. We focus our training programs in all areas to achieve the highest possible standards and monitor our performance by conducting surveys with our clients and their customers. Our call centers are equipped to handle phone, mail, fax and on-line inquiries. We also provide collection activities on delinquent accounts to support our private label and co-brand credit programs.

Private Label Credit

Our Private Label Credit segment provides risk management solutions, account origination and funding services for our more than 100 private label and co-brand retail credit programs. Through these programs, we managed approximately $4.1 billion in average receivables from approximately 22 million active accounts for the year ended December 31, 2008, with an average balance during that period of approximately $394 for accounts with outstanding balances. We process millions of credit applications each year using automated proprietary scoring technology and verification procedures to make risk-based origination decisions when approving new account-holders and establishing their credit limits. These procedures help us segment prospects into narrower ranges within each risk score provided by credit bureaus, allowing us to better evaluate individual credit risk and tailor our risk-based pricing accordingly. Our accountholder base consists primarily of middle- to upper-income individuals, in particular 35 to 49 year-old married females who use our accounts primarily as brand affinity tools rather than pure financing instruments, resulting in lower average balances compared to balances on general purpose credit cards. We focus our sales efforts on prime borrowers and do not target sub-prime borrowers.

Historically, we have used a securitization program as our primary funding vehicle for retail credit receivables. Securitizations involve the packaging and selling of both current and future receivable balances of credit accounts to a special purpose entity that then sells them to a master trust. Our securitizations are treated as sales for accounting purposes and, accordingly, the receivables are removed from our balance sheet. We retain an ownership interest in the receivables, which is commonly referred to as a seller’s interest, and a residual interest in the trust, which is commonly referred to as an interest-only strip. As of December 31, 2008, Limited Brands accounted for approximately 18.8% of the receivables in the trust portfolio.

Safeguards to Our Business; Disaster and Contingency Planning

We operate multiple data processing centers to process and store our customer transaction data. Given the significant amount of data that we manage, much of which is real-time data to support our clients’ commerce

initiatives, we have established redundant capabilities for our data centers. We have a number of safeguards in place that are designed to protect our company from data related risks and in the event of a disaster, to restore our data centers’ systems.

Protection of Intellectual Property and Other Proprietary Rights

We rely on a combination of copyright, trade secret and trademark laws, confidentiality procedures, contractual provisions and other similar measures to protect our proprietary information and technology used in each segment of our business. We currently have seven patent applications pending with the U.S. Patent and Trademark Office and one international application. We generally enter into confidentiality or license agreements with our employees, consultants and corporate partners, and generally control access to and distribution of our technology, documentation and other proprietary information. Despite the efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain the use of our products or technology that we consider proprietary and third parties may attempt to develop similar technology independently. We pursue registration and protection of our trademarks primarily in the United States and Canada, although we also have either registered trademarks or applications pending in Argentina, New Zealand, the European Union and the Madrid Protocol, Peru, Mexico, Venezuela, Brazil, United Kingdom, Australia, China, Hong Kong, Japan and Singapore.

Effective protection of intellectual property rights may be unavailable or limited in some countries. The laws of some countries do not protect our proprietary rights to the same extent as in the United States and Canada. We are the exclusive Canadian licensee of the AIR MILES family of trademarks pursuant to a perpetual license agreement with Air Miles International Trading B.V., for which we pay a royalty fee. We believe that the AIR MILES family of trademarks and our other trademarks are important for our branding, corporate identification and marketing of our services in each business segment.

Competition

The markets for our products and services are highly competitive. We compete with marketing services companies, credit card issuers, and data processing companies, as well as with the in-house staffs of our current and potential clients.

Loyalty Services. As a provider of marketing services, our Loyalty Services segment generally competes with advertising and other promotional and loyalty programs, both traditional and on-line, for a portion of a client’s total marketing budget. In addition, we compete against internally developed products and services created by our existing and potential clients. We expect competition to intensify as more competitors enter our market. Competitors with our AIR MILES Reward Program may target our sponsors and collectors as well as draw rewards from our rewards suppliers. Our ability to generate significant revenue from clients and loyalty partners will depend on our ability to differentiate ourselves through the products and services we provide and the attractiveness of our loyalty and rewards programs to consumers. The continued attractiveness of our loyalty and rewards programs will also depend on our ability to remain affiliated with sponsors that are desirable to consumers and to offer rewards that are both attainable and attractive to consumers. Intensifying competition may make it more difficult for us to do this.

Epsilon Marketing Services. Our Epsilon Marketing Services segment generally competes with a variety of niche providers. These competitors’ focus has primarily been on one or two services within the marketing value chain, rather than the full spectrum of data-driven marketing services used for both traditional and on-line advertising and promotional programs. In addition, Epsilon Marketing Services also competes against internally developed products and services created by our existing clients and others. We expect competition to intensify as more competitors enter our market. For our targeted direct marketing services offerings, our ability to continue to capture detailed customer transaction data is critical in providing effective customer relationship management strategies for our clients. Our ability to differentiate the mix of products and services that we offer, together with the effective delivery of those products and services, are also important factors in meeting our clients’ objective to continually improve their return on marketing investment.

Private Label Services and Private Label Credit. Our Private Label Credit and Private Label Services segments generally compete primarily with financial institutions whose marketing focus has been on developing credit card programs with large revolving balances. These competitors further drive their businesses by cross selling their other financial products to their cardholders. Our focus has primarily been on targeting specialty retailers that understand the competitive advantage of developing loyal customers. Typically these retailers have customers that make more frequent and smaller transactions. As a result, we are able to analyze card-based transaction data we obtain through managing our card programs, including customer specific transaction data and overall consumer spending patterns, to develop and implement targeted marketing strategies and to develop successful customer relationship management strategies for our clients. As an issuer of private label retail cards, we compete with other payment methods, primarily general purpose credit cards like Visa and MasterCard, which we also issue primarily as co-branded private label retail cards, American Express and Discover Card, as well as cash, checks and debit cards.

Regulation

Federal and state laws and regulations extensively regulate the operations of our credit card services bank subsidiary, World Financial Network National Bank, and our industrial bank subsidiary, World Financial Capital Bank. Many of these laws and regulations are intended to maintain the safety and soundness of World Financial Network National Bank and World Financial Capital Bank, and they impose significant restraints on those companies to which other non-regulated companies are not subject. Because World Financial Network National Bank is deemed a credit card bank and World Financial Capital Bank is an industrial bank within the meaning of the Bank Holding Company Act, we are not subject to regulation as a bank holding company. If we were subject to regulation as a bank holding company, we would be constrained in our operations to a limited number of activities that are closely related to banking or financial services in nature. Nevertheless, as a national bank, World Financial Network National Bank is still subject to overlapping supervision by the Office of the Comptroller of the Currency, or OCC, and the Federal Deposit Insurance Corporation, or FDIC; and, as an industrial bank, World Financial Capital Bank is still subject to overlapping supervision by the FDIC and the State of Utah.

World Financial Network National Bank and World Financial Capital Bank must maintain minimum amounts of regulatory capital. If World Financial Network National Bank or World Financial Capital Bank does not meet these capital requirements, their respective regulators have broad discretion to institute a number of corrective actions that could have a direct material effect on our financial statements. World Financial Capital Bank, as an institution insured by the FDIC, must maintain certain capital ratios, paid-in capital minimums and adequate allowances for loan losses. World Financial Network National Bank must meet specific guidelines that involve measures and ratios of its assets, liabilities, regulatory capital, interest rate exposure and certain off-balance sheet items under regulatory accounting standards, among other factors. Under the National Bank Act, if the capital stock of World Financial Network National Bank is impaired by losses or otherwise, we, as the sole shareholder, may be assessed the deficiency. To the extent necessary, if a deficiency in capital still exists, the FDIC may be appointed as a receiver to wind up World Financial Network National Bank’s affairs.

Before World Financial Network National Bank can pay dividends to us, it must obtain prior regulatory approval if all dividends declared in any calendar year would exceed its net profits for that year plus its retained net profits for the preceding two calendar years, less any transfers to surplus. In addition, World Financial Network National Bank may only pay dividends to the extent that retained net profits, including the portion transferred to surplus, exceed bad debts. Moreover, to pay any dividend, World Financial Network National Bank must maintain adequate capital above regulatory guidelines. Further, if a regulatory authority believes that World Financial Network National Bank is engaged in or is about to engage in an unsafe or unsound banking practice, which, depending on its financial condition, could include the payment of dividends, that regulatory authority may require, after notice and hearing, that World Financial Network National Bank also cease and desist from the unsafe practice. To pay any dividend, World Financial Capital Bank must also maintain adequate capital above regulatory guidelines.

CEO BACKGROUND

DIRECTORS, EXECUTIVE OFFICERS AND OTHER KEY EMPLOYEES

The following table sets forth the name, age and positions of each of our directors, nominees for director, executive officers, business unit presidents and certain other key employees as of April 16, 2009:




Name Age

Positions

Bruce K. Anderson 69 Director


Robert P. Armiak 47 Senior Vice President and Treasurer


Roger H. Ballou 58 Director


Lawrence M. Benveniste, Ph. D. 58 Director


D. Keith Cobb 68 Director


E. Linn Draper, Jr., Ph.D. 67 Director


Edward J. Heffernan 46 Director Nominee, President and Chief Executive Officer


Kenneth R. Jensen 65 Director


Bryan J. Kennedy 41 Executive Vice President and President, Marketing Services


Michael D. Kubic 53 Senior Vice President, Interim Chief Financial Officer, Corporate Controller and Chief Accounting Officer


Robert A. Minicucci 56 Director


J. Michael Parks 58 Chairman of the Board


Bryan A. Pearson 45 Executive Vice President and President, Loyalty Services


Richard E. Schumacher, Jr. 42 Senior Vice President, Tax


Ivan M. Szeftel 55 Executive Vice President and President, Retail Credit Services


Dwayne H. Tucker 52 Executive Vice President, Human Resources


Alan M. Utay 44 Executive Vice President, General Counsel, Chief Administrative Officer and Secretary

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

We are a leading provider of data-driven and transaction-based marketing and customer loyalty solutions. We offer a comprehensive portfolio of integrated outsourced marketing solutions, including customer loyalty programs, database marketing services, marketing strategy consulting, analytics and creative services, permission-based email marketing and private label retail credit card programs. We focus on facilitating and managing interactions between our clients and their customers through a variety of consumer marketing channels, including in-store, catalog, mail, telephone and on-line. We capture data created during each customer interaction, analyze the data and leverage the insight derived from that data to enable clients to identify and acquire new customers, as well as to enhance customer loyalty. We believe that our services are becoming increasingly valuable as companies continue to shift their marketing resources away from traditional mass marketing campaigns toward more targeted marketing programs that provide measurable returns on marketing investments. We operate in the following business segments: Loyalty Services, Epsilon Marketing Services, Private Label Credit and Private Label Services.

Loyalty Services. The Loyalty Services segment generates revenue primarily from our coalition loyalty program in Canada.

In our AIR MILES Reward Program, we primarily collect fees from our clients based on the number of AIR MILES reward miles issued and, in limited circumstances, the number of AIR MILES reward miles redeemed. All of the fees collected for AIR MILES reward miles issued are deferred and recognized over time. AIR MILES reward miles issued and AIR MILES reward miles redeemed are the two primary drivers of Loyalty Services’ revenue and indicators of the success of the program. These two drivers are also important in the revenue recognition process.




AIR MILES Reward Miles Issued: The number of AIR MILES reward miles issued reflects the buying activity of the collectors at our participating sponsors, who pay us a fee per AIR MILES reward mile issued. The fees collected from sponsors for the issuance of AIR MILES reward miles represent future revenue and earnings for us. The revenue related to the service element of the AIR MILES reward miles (which consists of marketing and administrative services provided to sponsors) is initially deferred and amortized over a period of 42 months, which is the estimated life of an AIR MILES reward mile, beginning with the issuance of the AIR MILES reward mile and ending upon its expected redemption.




AIR MILES Reward Miles Redeemed: Redemptions show that collectors are redeeming AIR MILES reward miles to collect the rewards that are offered through our programs, which is an indicator of the success of the program. We also recognize revenue from the redemptions of AIR MILES reward miles by collectors. The revenue related to the redemption element is deferred until the collector redeems the AIR MILES reward miles or over the estimated life of an AIR MILES reward mile in the case of AIR MILES reward miles that we estimate will go unused by the collector base or “breakage.” We currently estimate breakage to be 28% of AIR MILES reward miles issued. There have been no changes to management’s estimate of the life of a mile in the periods presented. Our estimated breakage changed from one-third to 28% effective June 1, 2008. See Note 10 “Deferred Revenue” of our consolidated financial statements for additional information.

Our AIR MILES Reward Program tends to be more resilient to economic swings, because many of our sponsors are in non-discretionary retail categories such as grocery stores, gas stations and pharmacies. Additionally, we target the sponsors’ most loyal customers, who we believe are unlikely to significantly change their spending patterns. We are impacted by changes in the exchange rate between the U.S. dollar and the Canadian dollar.



Epsilon Marketing Services . Epsilon Marketing Services is a leader in providing integrated direct marketing solutions that combine database marketing technology and analytics with a broad range of direct marketing services. Epsilon Marketing Services has over 500 clients, primarily in the financial services, specialty retail, hospitality and pharmaceutical end-markets.

Private Label Services. The Private Label Services segment primarily generates revenue based on the number of statements generated, customer calls handled, remittance processing, customer care and various marketing services. Statements generated represent the number of statements generated for our credit cards. The number of statements generated in any given period is a fairly reliable indicator of the number of active account holders during that period.

Companies are increasingly outsourcing their non-core processes such as billing and customer care. The Private Label Services segment is primarily affected by those industry trends that affect our Private Label Credit segment as discussed below.

Private Label Credit. The Private Label Credit segment provides risk management solutions, account origination and funding services for our more than 100 private label retail and co-branded credit card programs. Private Label Credit primarily generates revenue from securitization income, servicing fees from our securitization trusts and merchant discount fees. Private label credit sales and average managed receivables are the two primary drivers of revenue for this segment.




Private Label Credit Sales: This represents the dollar value of private label retail card sales that occur at our clients’ point of sale terminals or through catalogs or web sites. Generally, we are paid a percentage of these sales, referred to as merchant discount, from the retailers that utilize our program. Private label credit sales typically lead to higher portfolio balances as cardholders finance their purchases through our credit card banks.




Average Managed Receivables: This represents the average balance of outstanding receivables from our cardholders at the beginning of each month during the period in question. Customers are assessed a finance charge based on their outstanding balance at the end of a billing cycle. There are many factors that drive the outstanding balances, such as payment rates, charge-offs, recoveries and delinquencies. Management actively monitors all of these factors.

The Private Label Credit segment is affected by increased outsourcing in targeted industries. The growing trend of outsourcing private label retail card programs leads to increased accounts and balances to finance. We focus our sales efforts on prime borrowers and do not target sub-prime borrowers. Additionally, economic trends can impact this segment. Interest expense is a significant component of operating costs for the securitization trusts.

Corporate/Other. This includes corporate overhead which is not allocated to our segments, as well as all other immaterial businesses.

When there are areas in our business units that no longer align with our strategy, we may explore the sale of those assets. On November 7, 2007 we sold ADS MB Corporation, which operated our mail services business. These mail services included personalized customer communications and intelligent inserting and commingling capabilities for clients in the financial services, healthcare, retail, government and utilities end markets.

In March 2008, we determined that our merchant services and utility services businesses were not aligned with our long-term strategy and committed to a disposition plan for these businesses. In May 2008, we sold our merchant services business; in July 2008, we sold the majority of our utility services business; and in February 2009, we completed the sale of the remainder of our utility services business.



2009 Outlook

Despite the difficult current macro-environment, we expect solid growth to continue during 2009. We expect that Loyalty Services will have growth, in local currency, in revenue and adjusted EBITDA in the mid-teens, more in line with its historical growth rates. We expect relationships with our sponsors to expand and grow, while adding new sponsors and expanding into new categories. However, we expect that our results will be negatively impacted by changes in the value of the Canadian dollar. We expect Epsilon Marketing Services will have growth rates in revenue and adjusted EBITDA in a similar range as achieved during 2008, as the demand for database, analytics and interactive services should continue. For Private Label Credit, we expect credit losses to average approximately 9.2%, in line with expected unemployment rate movement. However, we expect to mitigate the impact of higher credit losses with portfolio growth from 2008 signings coupled with the benefit of a lower cost of funds as spreads continue to narrow in 2009. In addition, we expect strong cash flow generation, with capital expenditures of approximately 3% of revenue. We also expect our earnings per share to benefit from the share repurchase programs. Overall, we expect to see moderate Adjusted EBITDA growth overall, despite the difficult macro-environment.

Discussion of Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting policies that are described in the Notes to the Consolidated Financial Statements. The preparation of the consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continually evaluate our judgments and estimates in determination of our financial condition and operating results. Estimates are based on information available as of the date of the financial statements and, accordingly, actual results could differ from these estimates, sometimes materially. Critical accounting policies and estimates are defined as those that are both most important to the portrayal of our financial condition and operating results and require management’s most subjective judgments. The most critical accounting policies and estimates are described below.

Securitization of credit card receivables. We utilize a securitization program to finance a majority of the credit card receivables that we underwrite. We use our off-balance sheet securitization program to lower our cost of funds and more efficiently use capital. In a securitization transaction, we sell credit card receivables originated by our Private Label Credit segment to a trust and retain servicing rights to those receivables, an equity interest in the trust, an interest in the receivables and retained interests in our subordinated notes. Our securitization trusts allow us to sell credit card receivables to the trusts on a daily basis. The securitization trusts are deemed to be qualifying special purpose entities under GAAP and are appropriately not included in our consolidated financial statements. Our interest in our securitization program is represented on our consolidated balance sheets as seller’s interest (our interest in the receivables) and due from securitizations (our retained interests and credit enhancement components).

The trusts issue bonds in the capital markets and notes in private transactions. The proceeds from the bonds and other debt are used to fund the receivables, while cash collected from cardholders is used to finance new receivables and repay borrowings and related borrowing costs. The excess spread is remitted to us as securitization income.

Our residual interest, often referred to as an interest-only strip, is recorded at fair value. The fair value of our interest-only strip represents the present value of the anticipated cash flows we will receive over the estimated life of the receivables, which ranges from 9.25 months to 11 months. This anticipated excess cash flow consists of the excess of finance charges and past-due fees net of the sum of the return paid to bond and note holders, estimated contractual servicing fees and credit losses. Because there is not a highly liquid market for these assets, we estimate the fair value of the interest-only strip primarily based upon discount, payment and default rates, which is the method we assume that another market participant would use to purchase the interest-only strip. The fair value of the interest-only strip, and the corresponding gain or loss, will be impacted by the estimated excess spread over the following two or three quarters. The excess spread is impacted primarily by finance and late fees collected, net charge-offs and interest rates.

Changes in the fair value of the interest-only strip are reflected in our financial statements as additional gains related to new receivables originated and securitized or other comprehensive income related to mark-to-market changes of our residual interest.

In recording and accounting for interest-only strips, we make assumptions about rates of payments and defaults that we believe reasonably reflect economic and other relevant conditions that affect fair value. Due to subsequent changes in economic and other relevant conditions, the actual rates of principal payments and defaults generally differ from our initial estimates, and these differences could sometimes be material. If actual payment and default rates are higher than previously assumed, the value of the interest-only strip could be impaired and the decline in the fair value would be recorded in earnings.

If management used different assumptions in estimating the value of the interest-only strip, the impact could have a significant effect on our consolidated financial statements. For example, a 10% change in the net charge-off rate assumption for our securitized credit card receivables could have resulted in a change of approximately $12.0 million in the value of the interest-only strip as of December 31, 2008.

We also retain certain subordinated beneficial interests in our securitized assets, primarily Class M, Class B and Class C notes issued by the securitization trusts as well as seller’s interest.

Seller’s interest ranks pari passu with investors’ interests in the securitization trusts and is carried on our consolidated financial statements at their estimated fair values. Changes in the fair values of our seller’s interest are recorded through securitization income and finance charges, net, on our consolidated statements of income. We determine the fair value of our seller’s interest through discounted cash flow models. The estimated cash flows used include assumptions related to rates of payments and defaults, which reflect economic and other relevant conditions. The discount rate used is based on an interest rate curve that is observable in the market place plus a credit spread. If management used different assumptions in estimating the value of seller’s interest, it could have an impact on our consolidated financial statements. For example a 10% change in the net charge-off rate assumption could have resulted in a decrease of approximately $0.6 million in the value of the seller’s interest as of December 31, 2008.

Our retained interests are classified as available-for-sale investment securities and are carried on our consolidated financial statements at their estimated fair values. Changes in the fair values of these notes are recorded in other comprehensive income within stockholders’ equity. The fair value of these securities are estimated utilizing discounted cash flow models, where the interest and principal payments are discounted at assumed current market rates for the same or comparable transactions. In doing these valuations, management makes certain assumptions about the credit spreads the market participants would demand on the same or similar investments given the currently inactive market for credit card asset-backed securities. Assumed discount rates are derived from indicative pricing observed in the most recent active market for such instruments, adjusted for changes occurring thereafter in relative credit spreads and liquidity risk premiums. If management used different assumptions in estimating the value of our retained interests, it could have an impact on our consolidated financial statements. For example, a 10% change in the discount rate could have resulted in a decrease of approximately $6.2 million in the value of the retained interest as of December 31, 2008.

See Note 7 “Securitization of Credit Card Receivables” of our consolidated financial statements for additional information.

We recognize the implicit forward contract to sell new receivables during a revolving period at its fair value at the time of sale. The implicit forward contract is entered into at the market rate and thus, its initial measure is zero at inception. In addition, we do not mark the forward contract to fair value in accounting periods following the securitization because management has concluded that the fair value of the implicit forward contract in subsequent periods is not material. We believe that servicing fees received represent adequate compensation based on the amount currently demanded by the marketplace. Additionally, these fees are the same as would fairly compensate a substitute servicer should one be required and, thus, we neither record a servicing asset nor servicing liability.

AIR MILES Reward Program. Because management has determined that the earnings process is not complete at the time an AIR MILES reward mile is issued, the recognition of revenue on all fees received based on issuance is deferred. We allocate the proceeds from issuances of AIR MILES reward miles into two components based on the relative fair value of the related element:




Redemption element. The redemption element is the larger of the two components. For this component, we recognize revenue at the time an AIR MILES reward mile is redeemed, or, for those AIR MILES reward miles that we estimate will go unredeemed by the collector base, known as “breakage,” over the estimated life of an AIR MILES reward mile.




Service element. For this component, which consists of marketing and administrative services provided to sponsors, we recognize revenue pro rata over the estimated life of an AIR MILES reward mile.

Under certain of our contracts, a portion of the proceeds is paid to us at the issuance of AIR MILES reward miles and a portion is paid at the time of redemption. Under such contracts the proceeds received at issuance are initially deferred as service revenue and the revenue and earnings are recognized pro rata over the estimated life of an AIR MILES reward mile.

The amount of revenue recognized in a period is subject to the estimated life of an AIR MILES reward mile. Based on our historical analysis, we make a determination as to average life of an AIR MILES reward mile. The estimated life of an AIR MILES reward mile of 42 months and a breakage rate of 28% subsequent to June 1, 2008 and one-third for previous periods presented.

In May 2008, we secured a comprehensive long-term renewal and expansion agreement with Bank of Montreal as a sponsor in the AIR MILES Reward Program, pursuant to which Bank of Montreal transferred to us the responsibility of reserving for costs associated with the redemption of AIR MILES reward miles issued by Bank of Montreal as a sponsor. We received $369.9 million for the assumption of this liability. Historically, AIR MILES reward miles issued by Bank of Montreal have been excluded from our estimate of breakage as Bank of Montreal had the responsibility of redemption, and therefore no breakage estimate was required. However, changing the nature of our agreement required us to include these miles in our analysis, which impacted both the redemption rate and our estimate of breakage. After evaluating the impact of this transaction, we adjusted our estimate of breakage from one-third to 28%. The decline in the breakage rate assumption was due to greater redemption activity by collectors who use Bank of Montreal credit cards. The change in estimate had no impact on the total redemption liability, but reduced the amount of deferred breakage within the redemption liability that is expected to be recognized over the expected life of the AIR MILES reward mile.

Breakage and the life of an AIR MILES reward mile is based on management’s estimate after viewing and analyzing various historical trends including vintage analysis, current run rates and other pertinent factors. The estimated life of an AIR MILES reward mile and breakage are actively monitored by management and subject to external influences that may cause actual performance to differ from estimates.

We believe that the issuance and redemption of AIR MILES reward miles is influenced by the nature and volume of sponsors, the type of rewards offered, the overall health of the Canadian economy, the nature and extent of AIR MILES Reward Program promotional activity in the marketplace and the extent of competing loyalty programs. These influences will primarily affect the average life of an AIR MILES reward mile. We do not believe that the estimated life will vary significantly over time, consistent with historical trends. The shortening of the life of an AIR MILES reward mile would accelerate the recognition of revenue and may affect the breakage rate. As of December 31, 2008, we had $995.6 million in deferred revenue related to the AIR MILES Reward Program that will be recognized in the future. Further information is provided in Note 10 “Deferred Revenue” of our consolidated financial statements.

Stock-based compensation. On January 1, 2006, we adopted the provisions of, and account for stock-based compensation in accordance with, Statement of Financial Accounting Standards No. 123 (revised 2004), “Share- Based Payment” (“SFAS No. 123R”). We elected the modified-prospective method, under which prior periods are not revised for comparative purposes. Under the fair value recognition provisions of SFAS No. 123R, stock based compensation cost is measured at the grant date based on the fair value of the award and is recognized ratably over the requisite service period.

We used a binomial lattice option pricing model to determine the fair value of stock options. The determination of the fair value of stock-based payment awards on the date of grant using an option pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables included our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.

We estimated the expected term of options granted by calculating the average term from our historical stock option exercise experience. We estimated the volatility of our common stock by using an implied volatility. We based the risk-free interest rate that we used in the option pricing model on a forward curve of risk free interest rates based on constant maturity rates provided by the U.S. Treasury. We have not paid and do not anticipate paying any cash dividends in the foreseeable future and therefore used an expected dividend yield of zero in the option pricing model. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We used historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. All share-based payment awards are amortized on a straight-line basis over the awards’ requisite service periods, which are generally the vesting periods. No options were issued during 2008.

If factors change and we employ different assumptions for estimating stock-based compensation expense, the future periods may differ from what we have recorded in the current period and could affect our operating income, net income and net income per share.

See Note 14 “Stock Compensation Plans” of our consolidated financial statements for further information regarding the SFAS No. 123R disclosures.

Income Taxes. We account for uncertain tax positions in accordance with Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” an interpretation of Statement of Financial Accounting Standards No. 109 (“FIN No. 48”). The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous. As such, we are required to make many subjective assumptions and judgments regarding our income tax exposures. Interpretations of, and guidance surrounding, income tax laws and regulations change over time. As such, changes in our subjective assumptions and judgments can materially affect amounts recognized in the consolidated balance sheets and statements of income. See Note 12 “Income Taxes” of our consolidated financial statements for additional detail on our uncertain tax positions and further information regarding FIN No. 48.

Inter-Segment Sales

Our Private Label Services segment performs card processing and servicing activities related to our Private Label Credit segment. For this, our Private Label Services segment receives a fee equal to its direct costs before corporate overhead plus a margin. The margin is based on current estimated market rates for similar services. This fee represents an operating cost to the Private Label Credit segment and corresponding revenue for our Private Label Services segment. Inter-segment sales are eliminated upon consolidation. Revenues earned by our Private Label Services segment from servicing our Private Label Credit segment, and consequently paid by our Private Label Credit segment to our Private Label Services segment, are set forth under “Eliminations” in the tables presented in the annual comparisons in our “Results of Operations.”

Use of Non-GAAP Financial Measures

Adjusted EBITDA is a non-GAAP financial measure equal to income from continuing operations, the most directly comparable GAAP financial measure, plus stock compensation expense, provision for income taxes, interest expense, net, fair value loss on interest rate derivative, loss on the sale of assets, merger and other costs, depreciation and other amortization and amortization of purchased intangibles.

We use adjusted EBITDA as an integral part of our internal reporting to measure the performance of our reportable segments and to evaluate the performance of our senior management. Adjusted EBITDA is considered an important indicator of the operational strength of our businesses. Adjusted EBITDA eliminates the uneven effect across all business segments of considerable amounts of non-cash depreciation of tangible assets and amortization of certain intangible assets that were recognized in business combinations. A limitation of this measure, however, is that it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our businesses. Management evaluates the costs of such tangible and intangible assets, the impact of related impairments, as well as asset sales through other financial measures, such as capital expenditures, investment spending and return on capital and therefore the effects are excluded from Adjusted EBITDA. Adjusted EBITDA also eliminates the non-cash effect of stock compensation expense. Stock compensation expense is not included in the measurement of segment adjusted EBITDA provided to the chief operating decision maker for purposes of assessing segment performance and decision making with respect to resource allocations. Therefore, we believe that adjusted EBITDA provides useful information to our investors regarding our performance and overall results of operations. Adjusted EBITDA is not intended to be a performance measure that should be regarded as an alternative to, or more meaningful than, either operating income or net income as an indicator of operating performance or to cash flows from operating activities as a measure of liquidity. In addition, adjusted EBITDA is not intended to represent funds available for dividends, reinvestment or other discretionary uses, and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. The adjusted EBITDA measure presented in this Annual Report on Form 10-K may not be comparable to similarly titled measures presented by other companies, and may not be identical to corresponding measures used in our various agreements.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes thereto presented in this quarterly report and the audited consolidated financial statements and related notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 2, 2009, and our Current Report on Form 8-K, filed with the SEC on May 22, 2009, which re-issued certain items of our Annual Report on Form 10-K.

In October 2009, we announced an expansion agreement with tobacco company, R.J. Reynolds, for Epsilon to host its consumer database and support its consumer communication programs and that LoyaltyOne acquired a 29 percent interest in CBSM – Companhia Brasileira De Servicos De Marketing, operator of Brazil’s dotz loyalty program.

Critical Accounting Policies and Estimates

There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in our Annual Report on Form 10-K for the year ended December 31, 2008.

Use of Non-GAAP Financial Measures

Adjusted EBITDA is a non-GAAP financial measure equal to income from continuing operations, the most directly comparable GAAP financial measure, plus stock compensation expense, provision for income taxes, interest expense, net, loss on the sale of assets, merger and other costs, depreciation and other amortization and amortization of purchased intangibles.

We use adjusted EBITDA as an integral part of our internal reporting to measure the performance of our reportable segments and to evaluate the performance of our senior management. Adjusted EBITDA is considered

an important indicator of the operational strength of our businesses. Adjusted EBITDA eliminates the uneven effect across all business segments of considerable amounts of non-cash depreciation of tangible assets and amortization of certain intangible assets that were recognized in business combinations. A limitation of this measure, however, is that it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our businesses. Management evaluates the costs of such tangible and intangible assets, the impact of related impairments, as well as asset sales through other financial measures, such as capital expenditures, investment spending and return on capital and therefore the effects are excluded from adjusted EBITDA. Adjusted EBITDA also eliminates the non-cash effect of stock compensation expense. Stock compensation expense is not included in the measurement of segment adjusted EBITDA provided to the chief operating decision maker for purposes of assessing segment performance and decision making with respect to resource allocations. Therefore, we believe that adjusted EBITDA provides useful information to our investors regarding our performance and overall results of operations. Adjusted EBITDA is not intended to be a performance measure that should be regarded as an alternative to, or more meaningful than, either operating income or net income as an indicator of operating performance or to cash flows from operating activities as a measure of liquidity. In addition, adjusted EBITDA is not intended to represent funds available for dividends, reinvestment or other discretionary uses, and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. The adjusted EBITDA measures presented in this Quarterly Report on Form 10-Q may not be comparable to similarly titled measures presented by other companies, and may not be identical to corresponding measures used in our various agreements.
Stock compensation expense. Stock compensation expense decreased $2.6 million, or 15.0%, to $14.6 million for the three months ended September 30, 2009. The decrease was the result of a reduction in expense of $6.9 million related to performance-based restricted stock unit awards that are no longer expected to vest and for which no expense was recognized during the three months ended September 30, 2009. This increase was partially offset by an increase in expense of $3.1 million related to equity awards issued to associates in 2009.

Depreciation and Amortization. Depreciation and amortization decreased $2.9 million, or 8.5%, to $31.2 million for the three months ended September 30, 2009 primarily due to a $2.0 million decrease in depreciation and other amortization and a $0.9 million decrease in amortization of purchased intangibles as certain assets became fully amortized.

Merger and other costs. Merger and other costs were $0.9 million for the three months ended September 30, 2009 compared to income of $1.1 million for the comparable period in 2008. Merger and other costs for the three months ended September 30, 2009 represent compensation charges related to the severance of a certain executive. For the comparable period in 2008, amounts include the receipt of $(3.0) million for reimbursement of costs incurred by us related to the Blackstone entities’ financing of the proposed merger offset by $0.9 million of expenditures directly associated with the proposed merger of us with an affiliate of The Blackstone Group and approximately $1.0 million of other non-routine costs associated with the disposition of non-core operations.

Operating Income. Operating income decreased $25.0 million, or 20.9%, to $94.8 million for the three months ended September 30, 2009 from $119.8 million for the comparable period in 2008. Operating income decreased due to the revenue and expense factors discussed above.

Interest Expense, net. Interest expense, net increased $15.7 million, or 67.4%, to $39.0 million for the three months ended September 30, 2009 from $23.3 million for the comparable period in 2008. This increase can be attributed in part to additional interest expense of $13.5 million associated with our convertible senior notes due 2013 and 2014, which were issued in July 2008 and June 2009, respectively. Interest expense on certificates of deposit also increased $4.7 million as a result of higher average balances during the three months ended September 30, 2009 than during the comparable period in 2008. Interest expense on our credit facilities and senior notes decreased $5.3 million as a result of lower interest rates and the repayment of $250.0 million aggregate principal amount of 6.00% Series A senior notes in May 2009. Interest income decreased $2.3 million due to lower average balances of our short term cash investments, as well as a decrease in the yield earned on those short term cash investments.

Taxes. Income tax expense decreased $27.7 million to $9.9 million for the three months ended September 30, 2009 from $37.6 million for the comparable period in 2008 due to a decrease in taxable income and a decrease in our effective tax rate to 17.8% for the three months ended September 30, 2009 from 38.9% for the comparable period in 2008. During the three months ended September 30, 2009, we recognized an $11.7 million tax benefit related to previously established tax reserves to cover various uncertain tax positions, including the potential impact related to the timing of certain taxable income recognition. Based on a recent United States Tax Court decision, statute of limitations expirations, and other factors, the uncertainty around this taxable income recognition has been removed and, as such, the related reserve, primarily associated with accrued interest, is no longer required.

Discontinued Operations

In February 2009, we completed the plan to dispose of our merchant services and utility services businesses. As a result, there was no activity associated with discontinued operations in our unaudited condensed consolidated statement of income for the three months ended September 30, 2009. In the comparable period in 2008, income from discontinued operations was $5.9 million, which was the result of a tax benefit resulting from our ability to utilize previously unrealized tax benefits due to the sale of the majority of our utility services business.

Adjusted EBITDA. For purposes of the discussion below, adjusted EBITDA is equal to income from continuing operations, plus stock compensation expense, provision for income taxes, interest expense, net, loss on the sale of assets, merger and other costs, depreciation and amortization. Adjusted EBITDA decreased $78.4 million, or 15.8%, to $418.0 million for the nine months ended September 30, 2009. Adjusted EBITDA margin, which for purposes of the discussion below is equal to adjusted EBITDA divided by revenue, decreased to 29.4% for the nine months ended September 30, 2009 from 32.7% for the comparable period in 2008. The changes in adjusted EBITDA and adjusted EBITDA margin are due to the following:
Stock compensation expense. Stock compensation expense increased $12.1 million, or 38.7%, to $43.3 million for the nine months ended September 30, 2009. The increase is the result of the issuance of restricted stock toward the end of the second quarter of 2008, which increased expense by $11.5 million for the nine months ended September 30, 2009.

Depreciation and Amortization. Depreciation and amortization decreased $11.7 million, or 11.4%, to $91.6 million for the nine months ended September 30, 2009 primarily due to a $6.9 million decrease in depreciation and other amortization and a $4.8 million decrease in amortization of purchased intangibles as certain assets became fully amortized.

Merger and other costs. Merger and other costs decreased $4.4 million to $3.9 million for the nine months ended September 30, 2009 from $8.3 million in the comparable period of 2008. During the nine months ended September 30, 2009, we incurred approximately $4.4 million in compensation charges related to the departure of certain executives and approximately $0.2 million of legal costs associated with the termination of our merger with an affiliate of The Blackstone Group. These costs were offset in part by a reimbursement from our insurer in the amount of $(0.7) million related to payments made to settle certain shareholder litigation associated with the proposed merger. During the nine months ended September 30, 2008, we incurred approximately $2.3 million of costs associated with the proposed merger including a $(3.0) million reimbursement of costs incurred by us related to the Blackstone entities’ financing of the proposed merger. In addition, during the nine months ended September 30, 2008, we incurred $6.0 million in compensation charges related to the severance of certain employees and other non-routine costs.

Loss on the sale of assets. In March 2008, we incurred a loss of $1.1 million related to the settlement of certain working capital accounts in connection with the disposition of our mail services business.

Operating Income. Operating income decreased $73.3 million, or 20.8%, to $279.2 million for the nine months ended September 30, 2009 from $352.6 million for the comparable period in 2008. Operating income decreased due to the revenue and expense factors discussed above.

Interest Expense, net. Interest expense, net increased $50.9 million, or 93.5%, to $105.2 million for the nine months ended September 30, 2009 from $54.4 million for the comparable period in 2008. The increase in interest expense was the result of additional interest expense of $43.9 million associated with our convertible senior notes due 2013 and 2014 which were issued in July 2008 and June 2009, respectively. Interest expense on certificates of deposit increased $11.3 million as a result of higher average balances during the nine months ended September 30, 2009 than during the comparable period in 2008 and interest expense from the amortization of debt issuance costs increased $4.2 million. These increases were offset in part by decreases in interest expense on our credit facilities and senior notes of $15.5 million as a result of lower interest rates on our line of credit and the repayment of $250.0 million aggregate principal amount of 6.00% Series A senior notes in May 2009. Interest income decreased $7.2 million due to lower average balances of our short term cash investments, as well as a decrease in the yield earned on those short term cash investments.

Taxes. Income tax expense decreased $58.8 million to $55.8 million for the nine months ended September 30, 2009 from $114.6 million for the comparable period in 2008 due to a decrease in taxable income combined with a decrease in our effective tax rate to 32.1% for the nine months ended September 30, 2009 from 38.4% for the comparable period in 2008. During the nine months ended September 30, 2009, we recognized an $11.7 million tax benefit related to previously established tax reserves to cover various uncertain tax positions, including the potential impact related to the timing of certain taxable income recognition. Based on a recent United States Tax Court decision, statute of limitations expirations, and other factors, the uncertainty around this taxable income recognition has been removed and, as such, the related reserve, associated with accrued interest, is no longer required.

Discontinued Operations

In March 2008, we determined that our merchant services and utility services businesses were not aligned with our long-term strategy and committed to a disposition plan for these businesses. These businesses have been reported as a discontinued operation in our unaudited condensed consolidated financial statements. On an after tax basis, losses from discontinued operations decreased $7.4 million to $15.1 million for the nine months ended September 30, 2009 from $22.5 million in the comparable period in 2008. The loss recorded for the nine months ended September 30, 2009 was the result of an $18.0 million pre-tax loss recognized in connection with the sale of the remaining portion of our utility services business in February 2009. The loss recorded for the comparable period in 2008 resulted from the sale of the core portion of our utility services business, offset in part by a gain attributable to the sale of our merchant services business in May 2008. The sale of the remainder of the utility services business in February 2009 completed the disposition plan.

Asset Quality

Our delinquency and net charge-off rates reflect, among other factors, the credit risk of our private label credit card receivables, the average age of our various private label credit card account portfolios, the success of our collection and recovery efforts, and general economic conditions. The average age of our private label credit card portfolio affects the stability of delinquency and loss rates of the portfolio. We continue to focus resources on refining our credit underwriting standards for new accounts and on collections and post charge-off recovery efforts to minimize net losses.

An older private label credit card portfolio generally drives a more stable performance in the portfolio. At September 30, 2009, 62.1% of our managed accounts with balances and 60.4% of managed receivables were for accounts with origination dates greater than 24 months old. At September 30, 2008, 61.2% of managed accounts with balances and 61.4% of receivables were for managed accounts with origination dates greater than 24 months old.

Delinquencies. A credit card account is contractually delinquent if we do not receive the minimum payment by the specified due date on the cardholder’s statement. When an account becomes delinquent, we print a message on the cardholder’s billing statement requesting payment. After an account becomes 30 days past due, a proprietary collection scoring algorithm automatically scores the risk of the account rolling to a more delinquent status. The collection system then recommends a collection strategy for the past due account based on the collection score and account balance and dictates the contact schedule and collections priority for the account. If we are unable to make a collection after exhausting all in-house efforts, we engage collection agencies and outside attorneys to continue those efforts.


Liquidity and Capital Resources

Operating Activities. We have historically generated cash flows from operations, although such amounts may vary based on fluctuations in working capital and the timing of merchant settlement activity. Our operating cash flow is seasonal, with cash utilization peaking at the end of December due to increased activity in our Private Label Credit segment related to holiday retail sales.

We generated cash flow from operating activities of $306.1 million for the nine months ended September 30, 2009 as compared to $578.4 million for the comparable period in 2008. Cash flows in the nine months ended September 30, 2008 were impacted by an increase in deferred revenue related to a change in contractual terms with BMO Bank of Montreal. In May 2008, we assumed BMO Bank of Montreal’s liability for the cost of redemptions for their outstanding AIR MILES reward miles, for which we received $369.9 million in cash.

We utilize our cash flow from operations for ongoing business operations, acquisitions and capital expenditures.

CONF CALL

Julie Prozeller
Thank you, operator. By now you should have received the copy of the company’s third quarter 2009 earnings release. If you haven’t, please call Financial Dynamics at 212-850-5721. On the call today, we have Ed Heffernan, President and Chief Financial Officer of Alliance Data, and Ivan Szeftel, President, Retail Credit Services which encompasses Private Label Services and Private Label Credit.
Before we begin, I would like to remind you that some of the comments made on today’s call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and uncertainties described in the company’s earnings release, and other filings with the SEC. Alliance Data has no obligation to update the information presented on the call.
Also on today’s call, our speakers will reference certain non-GAAP financial measures, which we believe will provide useful information for investors. Reconciliation of those measures to GAAP will be posted on the Investor Relations website at www.alliancedata.com.
With that, I would like to turn the call over to Ed Heffernan. Ed?
Ed Heffernan
Thanks, Julie. Why don’t we turn to the slide, third quarter consolidated results and get right at it. Obviously, today we will spend a bunch of time thinking over the numbers and that’s fine, but before we begin I think we do want to mention that the theme here today is fairly simply and that is across the board things are firming and momentum is clearly building whether it’s looking at our key metrics such as miles issued, miles redeemed up in Canada, the number of new contracts that have been signed and will be boarded at Epsilon over the next 12 to 18 months or credit sales people using our credit cards hitting double digit for the first time and believe it or not three years combined with almost six months of stability in our losses.
So then finally, our 2010 guidance will be as usual what we think is compelling, but without any major assumptions about any type of big turn in the macro situation, so one could view it also as being more of our base case.
That being said, lets talk about third quarter, produce results which were satisfactory given that headwinds that we have faced, but again as we mentioned the real needs is around the developing trends that have emerged in all three of our businesses and we’ll cover that in plenty of detail in a bit. Specifically to the numbers, the revenues on a constant currency basis were relatively flat year-over-year a bit under 500. We expect to finally pop our head above water in Q4 and for the first time in a year coming with growth on the top line.
The operating EBITDA or operating cash flow, and reported EBITDA were a bid later than initially planned, a good portion of that can be attributed to incremental expenses incurred on our international coalition efforts along with our decision to lock down long term fix rate funding. Nonetheless, and with the revenues look for our first quarter a positive year-over-year growth starting in Q4.
Cash earnings per share were $1.40 versus $1.22 last year, an increase to 15% and $0.06 ahead of our guidance of $1.34. On a constant currency basis, earnings were up $1.44 an 18% increase.
The third quarter results did include a $12 million current tax benefits and as a brief explanation historically, the company has maintained tax reserves to cover the potential impact related to the recognition of certain taxable income. Based on recent tax rulings and other items, there is no longer uncertainty around this taxable income recognition and as such, our reserve on the related tax position is no longer required.
So the third quarter, we were compelled to release that and it reflects an $8 million one time catch up and the remaining $4 million, which is the good news represents an ongoing annual tax benefit, and that’s cash. This annual benefit will result in a reduced effective tax rate going forward.
For the third quarter of 2009, the company’s business performance combined with this tax benefit produced strong over performance which enables the company to reinvest in certain opportunities.
This includes, completing $1 billion of TALF deal where we locked down long term fixed rate money to enhance our long term visibility while effectively trading off short term call a 2% funding for the [bennies] of a long term 4% funding rate and we will always trade some short term benefit to lock down long term visibility.
Next, we are very excited to announce our new loyalty coalition program in Brazil which involved some expense as well as expenses associated with searching for the next Brazil as well and finally, with funding locked and Brazil signed, we also moderated our share repurchase program and used a lower than expected $100 million during the quarter buying a couple of million shares.
This moderation plus the addition of shares on a fully diluted basis as more equity became into money with the stocks rising price, left our share count higher than anticipated. Bottom-line of all this, business was fine, we also received a nice tax penny which allowed us to lock down additional long term visibility, fund our international coalition efforts and moderate our buyback plans in order to avoid crowding out investors coming into the stock during the solid run. When it does so, everything knitted out to over performance of $0.06 against guidance.
As I mentioned we expect Q4 to be our first quarter in a year of top-line and adjusted EBITDA growth joining strong cash EPS growth and providing a strong jump up for 2010.
Much of the remainder of the presentation will be focused on the trends that are solidifying across all three businesses, and which vote extremely well for alliance in 2010 and beyond.
Let’s just highlight a few of them. One, our Canadian Airlines business turned the corner on its key metric miles issue and posted growth in that metric for the first time in a year. Two, our Epsilon business is winning business at double its normal rate suggesting a 10% growth rate for 2010. Three, our private label has seen all metrics with positive trends as credit sales growth move from negative growth in 2008 to up to plus 13% growth in Q3 our best showing in three years.
The portfolio itself is growing double digit. We have plenty of liquidity and losses have been stable for the past six months despite rising unemployment.
And finally, despite some moderation on our share repurchase program in Q3, we have repurchased approximately 30 million shares or 37% of our stock and spent $1.5 billion doing it. We still have 300 million remaining and will continue to pick our spots.
In all, we think the headwinds impacted the last two years coming quickly to an end and we look forward to a return to solid organic growth sooner rather than later, and the buyback of course will serve to enhance that growth.
One other matter, we just received official approval from the regulators to go ahead with the acquisition of Charming Shoppes group of private label programs and we expect to close that very shortly.
Let’s move on. Next slide Loyalty One. The biggest news of the quarter is of course the return to positive growth of miles issued after almost a full year of weak performance very simply miles issued drives our cash flow. We issue a mile we get paid in cash we tuck most of it aside, about 72% into a trust account for future rewards and we pocket the rest.
Our recent double miles deal with the Bank of Montreal was a major contributor to the big turn and issuance during the quarter, despite having it up and running for just August and September.
As we look to Q4 and beyond, the ramp up should continue. Q4 will have a full three months of Bank of Montreal double miles plus will mark the anniversary of our first quarter of weak issuance back in ‘08.
So, Bank of Montreal deal plus easier comps, plus some firming in consumer spent will all contribute to acceleration in issuance, and for those of you who think about our long term model, the way it typically runs is as follows. We look to do high single digit growth in issuance, pop on a couple of points of annual growth in revenue per mile and that will get you to double digit topline growth, and that filters down to low to mid teens organic EBITDA growth. Good news on the issuance front and the trend going forward.
All right, let’s turn to Epsilon. Obviously Epsilon tends to have fairly uneven quarters, but the general trend is I think heading in our direction as we are looking at Q4 right now, but Epsilon continue to hold its own during the quarter. Marketing and advertising spent of the Fortune 1000 is down by at least a third or more and Epsilon continues to buck the trend by holding relatively flat.
Its Q2 results showed a slight up tick in top line and down tick in EBITDA versus last year. On a sequential basis we did see increases in all metrics. Topline EBITA and margin, which is all consistent with what is typical seasonality associated with the business.
Q3 results were similar to prior quarters, simple a tail of two segments. First, our largest segment which is driven by the massive loyalty programs of the Fortune 500. These programs encompass our marketing, database and digital that is our permission based email business and account for two thirds of Epsilon’s financials. Consistent with Q1 and Q2 this segment continue to turn out double digit organic growth and expectations remain equally high for Q4.
The other third of the division consist primarily of our data businesses, the largest paid piece being our Abacus coalition program, which encompasses 1800 catalogers. Simply put, Abacus did well considering the 100% retail exposure it had, but not quite good enough to show growth from last year and finally, there were some other data assets outside of Abacus, which had been in the red, continue to be in the red and are in the process of being streamlined.
I think I’d sum up Epsilon as follows. Couple of items. On a year-to-date basis Epsilon in total is virtually flat versus prior year on both the revenue and EBITDA perspective. Q4 is trending positive and as such we believe Epsilon remains untracked to pose single digit growth in both revenues and earnings for the full year.
Second, while not contributing much to this year Epsilon signings are running at double the pace of prior years as stretched marketing budgets are seeking those programs which can micro target consumers and demonstrate superior ROI results. Signings have increased across the board, including those sectors such as big pharma, not-for-profit, CPG financial services, telecom, B2B and digital.
Consequently, we are looking for a strong finish to the year and then jump to 10% growth in 2010 as Epsilon’s largest segment continues on at a strong pace while the remaining data services segment, anniversary sweet comps begins to recover.
Now, I’d like to turn it over to Ivan Szeftel, our long serving President who handles all private labels including all the processing, customer care, the marketing database, loyalty and all the credit functions. Ivan and I have worked together, I think for ever and certainly since the beginning of ADS around eleven years ago, and I think the best way to think about it is you could say that he and his team have really done through it all.
First, if you look at the results through the first half of this decade that those groups had a heck of a run as many new clients were signed, sales are strong; funding was wonderful in a macro environment that contained losses and of course we have Phase II. In 2007 he and his team had to endure their first major client loss as Lane Bryant was brought in-house by Charming Shoppes.
Finally, over the past few years the private label team has been hit with the liquidity crisis, pull retail environment and credit losses up over 400 basis points or $200 million since 2007.
I think the good news is quickly approaching and we’re going to call that Act III. With the big ramp up in sales and portfolio growth plus the return of Lane Bryant via the Charming deal, plus the availability of liquidity and now stable credit losses we are eagerly awaiting the big run coming soon and increasing in intensity over the next several years, and so with no pressure in that set up, Ivan, your ball.
Ivan Szeftel
Our private label business was indeed Alliance Data’s primary growth engine during our early years. The Group’s financial performance peaked in 2007. The severe’08-09 economic recession has reduced our earnings by about a $115 million since then. Despite this earnings erosion our clear focus, operating discipline and the signing of new clients has enabled us to remain profitable. The same cannot be said for many of our competitors.
Our ability to remain profitable during the worst macro economic environment since the 1930s has created a unique opportunity for us. Specifically, while virtually every other entity providing private label credit card services has cut back to limit their credit exposure or to preserve liquidity we have chosen to grow. We are taking a different approach, and have decided to use this unique situation to build a foundation that will power our growth for many years to come.
We have accumulated a significant amount of excess liquidity through our certificate of deposit programs and our bank and Telbec Securitization Facility. We will, we have and we’ll continue to maintain capital at our two banks at levels well above those required to be considered well capitalized. The combination of our excess liquidity and robust capital levels will enable us to grow through the acquisition of existing private label programs and the launching of new programs. While all the while maintaining our current high credit standards.
While, our current financial results are yet to reflect a turnaround I believe that we are beginning to see some trends that are indicative of a return to earnings growth in the near term.
Our growth in credit sales was negative last year. Plus 3% in Q1, plus 6% in Q2 and plus 13% in Q3. Of note, Q3 was the first quarter of double digit sales growth in over three years. Q4 will further accelerate this trend since we expect to have the Charming Shoppes programs on board for part of the quarter.
Year-to-date our sales increases have been entirely attributed to the new clients that we have added in the preceding 12 months. During the month of September however this changed, with our sales increases coming from both new and core legacy clients we fully expect the trend we’ve seen in September to continue. With our strong retail clients hosting increased credit sales. These increases will be a function not only of a total sales level as the anniversary re-comparative numbers but also as a result of our increasing market share.
As we look to 2010, we are comfortable that the low double digit portfolio growth we have seen will continue if not accelerate further. The primary drivers will be the addition of the Charming Shoppes programs, new client singing and the growth generated from our core legacy clients.
For sales and portfolio growth to translate into a corresponded growth in earnings, it mush accompanied by stable credit profile. We believe that if we have not already arrived at a point of loss and delinquency stability we are very close to it. Specifically, delinquency, subject to normal seasonal fluctuations have been stable for quite a while and credit losses have been stable since May, all this despite rising unemployment.
The negative impact of year-over-year loss increase will now lessen each quarter before being completely eliminated. This trend is already evidenced. If you consider that while our Q3 earnings were down $20 million from the same quarter a year ago the second quarter was down $30 million to last year. We fully expect our 2009 Q4 earnings to be at or above the last year’s levels.
Let’s turn to the next slide. With credit sales headed in the right direction we need to focus on the outlook for credit loses. Historically our losses have checked about a 100 to a 120 basis points above the unemployment rates. These were the equivalent loss levels that we were experiencing at the beginning of the Great Recession.
However, the longer the recession lasted it became evident that our predominantly small tickets, private label credit cards were less susceptible to the significant run up of balances that the third party and big ticket card programs were experiencing.
In addition, as we have signed new retailers and hence new accounts we were slowly replacing some poorer performing accounts with new accounts attached to consumers who are more creditworthy.
Net result is that our loss rate has moved from a 100 to a 120 basis points above the employment rate to 20 basis points below it. Moreover, our losses have been stable for the past five months and we expect this relative stability to continue.
Let us turn to the final slide and talk about the future. Throughout our company’s history we have been asked why we remain bullish about our private label business. Early on, the view was that it was a shrinking market that private label was not permissive.
This despite our impressive growth now why in the midst of a financial crisis do we plan to grow and invest in private label. Very simply this is a tremendous business with room for solid growth. The reality is that the need for retailers to promote a strong private label credit card program has never been greater.
The financial crisis, new business regulations have significantly reduced the liquidity available to the average American consumer. By some estimates, revolving credit card lines have been cut by over 30% in the last 12 months. The significant reduction in revolving debt levels we have seen is not only a function of the consumer’s desire to de-leverage but is also indicative of a lack of credit availability and the perceived need to preserve some of the diminished liquidity for emergency new use.
What better solution can a retailer have to help facilitate a credit line dedicated for use solely in their store. Couple this with a robust loyalty and marketing capability that our programs provide and you have an unbeatable combination.
Now, let us turn to our addressable marketplace opportunity. Our criteria for a successful partnership are threefold. First, we target mid to large retailers with annual sales of between 200 and a few billion dollars. We look for retailers who are passionate about their brand and see our programs as an extension of their brand. Those potential clients we do see private label as a loyalty and sales program, not just a financing vehicle.
And further, we focus on retailers whose customers have our desired demographics and credit profiles. Using these criteria we have analyzed various retail statements. Clearly apparently there are sweet spots. Particularly woman’s apparel holds the leadership position in all distribution channels. Bricks and Mortar, Catalog and Online. In addition, we have a significant presence in the home furnishings and jewelry segments.
What is common across these verticals is our ability to develop and build loyal relationships between our clients and their customers, and thereby drive incremental sales. By running all possible suspects through this filter we have identified roughly 300 retailers in our addressable market. Of this half of the program about two thirds of those have programs with us.
Even with our significant market share there is plenty of room for growth, more than enough to enable us to return to our historic 8% to 10% annual growth levels. We expect to sign 5 to 16 programs each year coming from retailers who currently do not have a program or perhaps by adding co-brand programs that complement the existing private label program.
In addition, we will also selectively add new programs in adjacent verticals. Spring Stone Financial and Pacific Dental are just two recent examples and finally, our plan includes one to two existing portfolio acquisitions out of a prospect universe of approximately 40. Today, we are in the best position in our history to take advantage of such portfolio acquisitions and we will do just that. All of this gives us a sizable market opportunity where we once again return to our strong historic growth levels.
So, for those of you that still ask why are we committed to this business, and in fact are aggressively investing when others in our space have chosen to restrict their growth or even consider exit strategies. I would again ask you to consider the following.
We know that private label is a highly effective tool to help retailers grow their sales especially in the current environment. We know that our results driven marketing and loyalty strategies coupled with high end customer care would help retailers gain and sustain a great amount of share and finally, we are confident in our ability to manage private label credit card playgrounds in a manner to ensure attractive returns even in this most challenging times.
Thank you. Ed, let me turn it back to you.
Ed Heffernan
Thanks Ivan. Why don’t we move to the balance sheet, just a couple of quick notes here. Our deferred revenue account grew by $100 million, it’s over a $1.1 billion as miles issued, began to crank up and the Canadian dollar continued to strengthen.
Also our trust account now stands just under $600 million, and again, that’s the account we use for when people would cash in for rewards, which is an increase of about $70 million from Q2. The account includes about $500 million in Canadian securities and about a $100 million in investment grade, US securities backed by our card assets, which are now fair valued at just about par.
The trust account is utilized to pay for as I mentioned the reward redemptions on our Air Miles program. It’s been funded assuming 72% or 28% breakage of all miles issued will be redeemed. After 17 years against that 72% our cumulative redemptions rate stands only at 54% and it’s moving up ever so slowly between one or two points a year. So, again, lots and lots of room there.
Turning to debt; no real major changes during the quarter in our net core debt which is core debt, less cash, to LTM operating EBITDA remain at less than 2.5, well under our self imposed three times guideline.
As mentioned earlier we spent about a $100 million during the quarter on share repurchases due to the rise in the stock prices, purchases were largely offset by dilution from the higher impact within the money options and dilution related to the convert.
So, we stand at about 55 million fully diluted shares and we have repurchased approximately 30 million shares over the will go after two years. We have 300 million remaining to go on the existing repurchase program, and as I earlier will be floating around and looking to pick our spots.
Let’s move on. Guidance. We should finish our Q4 in pretty good shape. So we’re going to move very quickly to 2010, nothing real news. In Q4 we would expect losses to sort of be tracking where they have in the past five or six months, somewhere in the mid nine or so. Again, no major improvement, no major degradation. So sort of the three month average is about right for Q4.
But let’s go ahead and move right ahead. It’s October so it’s time of year again. We traditionally give our next year’s guidance during our October call, and this year is no different.
2010 guidance is pretty straight forward with expectations of mid to high single digit growth for both revenues and EBITDA, which will translate into high teens growth in cash EPS due to modest CapEx needs and a lower share count. The guidance assumes no significant improvement in the macro-economy, no improvement in credit quality and it suggests a weak consumer spent and as a result credit losses again in the mid to upper end on that 9% range.
By segment, LoyaltyOne Air Miles in Canada will start off week from a P&L perspective due to the impact of weak issuance of Miles over the pervious year and the fact that the resulting impact doesn’t flow into the P&L until a year or so later due to the accounting, specifically deferred accounting, but as issuance continues to strengthen, the so-called bucket so to speak will be filled again and EBITDA will start to flow in at a greater pace.
On the cash flow side, however, nothing changes. Expect very strong results from the beginning as issuance begins to crank up or continues to crank up, and essentially weak accounting P&L results for a bid. We’ll be overshadowed by strong free cash flow as miles issued ramp up.
The net result is that operating EBITDA or operating cash flow which usually runs about, I don’t know, anywhere from $30 to $40 million of reported EBITDA is going to most likely run closer to $50 to $60 million than reported EBITDA during 2010. Also, expenses from our recently announced Brazilian coalition plus other international efforts will be born in this segment. For competitive reasons we will not be supplying these amounts other than to say that they are moderate.
We expect Epsilon to be around 10% growth as the large numbers of signings in 2009 are ramped up and finally, the combined private label services in credit segments should be back on track which means growth mode. Private label will face a modest credit loss grow over in Q1, but it should show steady improvement after that.
Bottom line a solid growth here for the company is expected. The resulting impact of a weak 2009 miles issued on 2010 earnings in Canada expenses for international coalition expansion and a modest loss over in Q1 will most likely keep top line in EBITDA from the double digit level, but it should not hinder a strong cash flow generation and high teens cash EPS growth, will also be looking to use 2010 to continue to walk down our funding book.
Also of note here is something that I think we’re quite proud of, and that is Lane Bryant has returned to us via the Charming deal, we can once again say that in the 11 years that Ivan and I have been here, we have never lost a major client in Canada at Epsilon or in private label as we look into 2010 there are no major clients that are at risk of leaving that we are aware of, and as a result there is no huge hole to fill as we start out the year.
Again, going to assume there is no benefits from significantly stronger consumer spent for credit improvement, and guidance assumes no incremental benefit from additional buybacks above today’s level and, we’ll update guidance as we’ve done in the past as the year progresses to the extent there is incremental good news to flow through, it will be done on a quarterly basis and we’ll update again as we step through the year.
Let’s finish up with our 2010 free cash flow on the next slide and then we can hit Q&A. Very simply we’re looking at doing about $650 million in EBITDA. As we talked about the difference in Canada between what we book and the actual free cash, we have runs of about 50 million next year.
So we’re looking at about $700 million in operating cash flow take out CapEx interest, taxes and you are looking at about $360 million of pure free cash, which is about $6.5 are around a 10% yield where the stock is today and, I think that’s about it for now, we will try to keep it under the three hours that we did last time.
So we’re going to open it up to Q-&-A. Operator.

SHARE THIS PAGE:  Add to Delicious Delicious  Share    Bookmark and Share



 
Icon Legend Permissions Topic Options
You can comment on this topic
Print Topic

Email Topic

1463 Views