Jan 31, 2007
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Executives
Julie Prozeller - Financial Dynamics Mike Parks - Chairman and Chief Executive Officer Ed Heffernan - Chief Financial Officer
Analysts
Jim Kissane - Bear Stearns Greg Smith - Merrill Lynch Tien-Tsin Huang - JP Morgan Andrew Jeffrey - Robertson Humphrey Wayne Johnson - Raymond James Larry Berlin - First Analysis Dan Perlin - Wachovia Colin Gillis - Canaccord Paul Bartolai - Credit Suisse
Operator
Good afternoon. My name is Anthony and I will be your conference facilitator today.
At this time, I would like to welcome everyone to the Alliance Data Systems fourth quarter and year-end 2006 earnings conference call. All lines have been placed on mute to prevent any background noise.
After the speaker's remarks, there will be a question-and-answer period. [Operator Instructions].
It is now my pleasure to turn the floor over to your host, Julie Prozeller of Financial Dynamics. Madam, you may begin your conference.
Julie Prozeller
Thank you, operator. By now you should have received a copy of the Company's fourth quarter and year-end 2006 earnings release.
If you haven't, please call Financial Dynamics at 212-850-5608. On the call today, we have Mike Parks, Chairman and Chief Executive Officer, and Ed Heffernan, Chief Financial Officer of Alliance Data.
Before we begin, I'd 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.
Reconciliations of those measures to GAAP will be posted on the Investor Relations website at www.AllianceData.com. With that, I'd like to turn the call over to Mike Parks.
Mike?
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Mike Parks
Thanks, Julie. Good afternoon, everyone.
Thanks for joining us. If you'll turn to the agenda page, as usual, you will see we start with company highlights.
I'll touch on that, both for the fourth quarter and for the year. We'll then chat quickly about '07 and guidance and I'm going to take a few minutes to talk about our overall strategic outlook on the marketing side of the business, then Ed is going to take us into a little bit more detail on financials and then we'll do questions as usual.
So if you turn on to the next slide, fourth quarter highlights, as you would expect, we're very excited to announce record fourth quarter numbers. Revenue 524, up 25%, EBITDA 121 million, up 30, and cash EPS $0.70 a share, up $0.30 as well.
I would just like to take a second to thank the entire management team and our associates all across North America, outstanding performance for the fourth quarter and the year, my personal thanks. Let's take a look at a few highlights, starting with the AIR MILES group.
Our marketing services division in Canada runs the AIR MILES program, which you're aware of. They once again turned in an outstanding performance, 20% plus topline growth.
This quarter, we also announced a multi-year agreement with Budget Rent a Car. Budget customers can now earn reward miles at 300 car and truck locations across Canada.
Additionally, Budget will be a reward supplier, where collectors can now redeem miles for car rentals as well. The division also delivered above expectations as the fundamentals of AIR MILES program continued to perform very strongly.
The largest and most successful correlation program in North America, we continue to hold firm and firm plus pricing, because our sponsors receive real value from our ability to change customer behavior, thereby increasing their spend and loyalty. Because the AIR MILES offers the broadest selection of sponsors and awards, we continue to attract and retain collectors to the program.
That's indicated, as you know, our key drivers, both miles issued and miles redeemed, very healthy and successful in the fourth quarter as well due to the entire year double digits in both categories. Let's now turn to the marketing services group in the US, also known as Epsilon.
Another great quarter, both organic growth and strategic acquisitions drove our performance this quarter. November we announced the signing of MyFamily.com, a leading online resource for family networking tools, including seven different family-related websites, such as ancestry.com.
We believe this will be continued growth area for us and we'll continue to provide e-mail communications, web analytics, strategic consulting services along with broad line of services in our Epsilon Group. Also in December, we announced the acquisition of Abacus, a leading provider of data and multi-channel direct marketing services.
We're obviously very excited about this. They provide data, data management, and analytic services to 1,500 retail and catalog clients.
And a fit for our company, as you expect, is almost perfect. One, we have a significant expansion into our US marketing group into new verticals in retail, predominantly and catalog.
Secondly, expands our entry into UK and Europe, alongside our recent acquisition earlier in the year of DoubleClick. And thirdly, provides upside opportunities to sell services to our Private Label clients and sell our Private Label services to the Abacus client list.
We couldn't be more pleased, as you would expect. I would like to welcome the Abacus management team and their 500 plus marketing and data professionals.
We expect to close this transaction yet this quarter. This announcement further strengthens the leadership position in marketing services.
Over the last few months, Ed and I have talked about five core areas necessary to provide comprehensive end-to-end marketing services and I want to chat with you a few minutes about that. Just turn to the next slide.
Over the past two years, we have become one of the most robust and comprehensive providers of multi-channel data-driven marketing technologies and services worldwide. We have invested a lot of money, both through organic growth and acquisitions, and we're excited to continue to expand around the world.
Our core offerings help leading marketers design, build, and execute highly profitable marketing programs across all channels and throughout the customer life cycle. Those five delivery components include, one, initial consulting and design work through our strategic consulting and creative services team; two, data services using proprietary, client-specific, and third party data to accelerate the success of marketing programs for our clients; thirdly, the design, build, and management of transaction-rich database systems; fourthly, analytic services that lead to real insight into customer behavior and deliver results; and finally, the delivery of highly-targeted marketing programs through our multi-channel and interactive services offerings.
Our clients in the marketplace recognize the significant value of data rich services and are replacing traditional media spin with these services. And while there are companies that provide pieces of the end-to-end solution, we have expertise and scale on all five.
We may see competition in the form of traditional advertising or marketing agencies for consulting and creative. We may see a Fair Issac or Experian type company for data, or Axiom or Harte-Hanks for data based services as well as many other companies providing analytics and e-mail marketing.
We believe there is no other single provider who can match us for the breadth, quality, and integration of these five critical services of the direct marketing value chain. That makes us truly unique and gives us a true competitive advantage.
As you can tell, we're pretty excited about this and we'll spend more time talking about that in '07. Let's turn -- chat a minute about Private Label.
Our Private Label group had another stellar performance this quarter, particularly in new business activity. We announced three new signings.
We added Cruise Management International, as a new client and our first entry into the travel industry with credit service offering. They operate leading travel agencies that specialize in cruise packages.
It's a $32 billion industry, by the way, and will provide an integrated co-branded credit card along with a loyalty awards program. We also announced the signing of two new Private Label clients.
In the retail space, Pamida, a general merchandise retailer with about 200 stores in the Midwest and Rocky Mountain states, and Dunlaps, a Texas-based department store chain serving medium-sized cities throughout the south and southwest. Another highlight of the quarter was the healthy growth in both credit sales and portfolio balances.
Additionally, credit quality remains very strong and we return to our normalized charge-off rate of about 6%. We expect this level to continue throughout '07.
All in all, a very nice quarter. Now let's turn to utility services.
During the fourth quarter and much of '06, we continue to invest in the long-term growth of utility market. There are two segments, as you've heard us talk about before in the outsourcing market.
First, the deregulated utilities who need our systems and infrastructure and expertise to compete. And secondly, regulated and municipal utilities needing to replace legacy systems.
We continue to be very upbeat about this business, as shown by our new business signings for the year with Green Mountain, Wisconsin Public Services, Sacramento Municipal Utility, and New England Gas. During the fourth quarter and much of the latter half of '06, we have been focusing on our operational capabilities and improving our enhancements.
We announced the ground breaking of a new call center facility here in Texas as well. This state-of-the-art center was needed to handle the expected growth experienced from the signings that I referred to in over - in the coming 12 to 18 months.
We had a successful conversion activity over the past year as well with signing -- excuse me -- converting both of Wisconsin Power's portfolios to our ECIS platform and we will continue to spend some additional investment to enhance those capabilities and position it to serve as a key platform for the future. Looking ahead, we have two very important conversions with First Choice Power and Green Mountain on the plate for the first quarter and will be focused on delivering a smooth conversion for these clients.
If you'll turn to the next slide, we'll chat a little bit about the full year of 2006. And as you can see on that page, our outstanding results, we finished the year at $2 billion in revenue, $515 million in EBITDA, cash earnings per share was $3.14, a 52% increase over last year.
Our focus has and will continue to be on markets that have solid organic growth potential and we had a great year in forging new relationship, adding 13 new clients. We also worked hard to ensure we'd deliver on our promises to drive results for our clients and those results drive their confidence in us as we renewed a key number of relationships throughout the year.
We've made significant investments in the marketing services business, and I believe we hold an enviable leadership position in US and Canada. And now for the first time, we are entering international markets.
All in all, 2006 was a great year for Alliance Data. Having said that, it's over and we're excited about our prospects for 2007.
And I want to take the next slide for a second to talk about our unique strategy and the evolution of our company. We continue to grow and evolve as a company and our founding strategy of integrating transaction and marketing services to help our clients be more successful has been spot-on, and it continues to be.
Today, we are driving loyalty through a variety of transaction-rich businesses, and the face of our company is changing. It reflects increased demand in the market and our strategic emphasis on expanding our marketing capabilities and services.
Our loyalty and marketing revenues less than one-third of the consolidated results three years ago is now half and growing. Private Label services will grow at solid rates, but will decline from 45% of consolidated revenues to about 35% of the business this year.
Utility will be nicely in the 10% range. What remains consistent is that our services cut across many industries.
Offering data-driven loyalty solutions to help increase customer loyalty and profitability and enhance the overall customer experience in ways that are meaningful. This was our founding mission.
Our vision today is for Alliance Data to be the one company that great companies call first to help them create more loyal and profitable customer relationships. Whether it's an external coalition like our AIR MILES Reward Program or Abacus in the retail space, an internal coalition program like the Citibank Thank You Network, an individual loyalty program like Hilton Honors, loyalty that includes a financing component, like one of our 80 private label programs are helping utilities in creating more satisfied, long-term customer experiences.
Essentially, we offer a variety of fully-integrated services, one-stop shopping, if you like, which help our clients drive customer acquisition, expansion, and long-term loyal relationships, which enhance both our revenues and profits. It has been a unique strategy and it continues to be what will drive our company.
As a result, we are excited about our future and specifically 2007. So let's talk a minute about our guidance for the year.
Turning to the next slide. Our outlook for 2007 continues to be very positive.
The momentum we have early in '07 added with a very attractive business trend and expected addition of Abacus allowed us to upgrade our guidance for the year. We expect revenue to be at least $2.2 billion versus our prior guidance.
We are raising EBITDA to at least $610 million and cash earnings to be at least $3.55 per share. All in all, 2007 is looking to be another strong year for Alliance and that despite a significant growover hurdle.
Ed, let's talk a little bit more detail about the financials.
Ed Heffernan
Thanks, Mike. If you could pull up to slide that says "Fourth Quarter Consolidated Results," we'll start there.
Q4 marked our 23rd quarter as a public company and further extended our track record of over-delivering on what we've promised. 2006 marked an important milestone for Alliance Data.
We posted $2 billion in revenues for the first time. This equates to 3 times what we made back in 2000 and twice what we made just three years ago.
Also, full-year cash EPS of $3.14 was twice what we made two years ago and 8 times what we made back in 2000. Let's talk about the quarter itself.
I'd say four things really stand out. First, with topline growth in the mid-20s and bottomline growth in the 30s, we feel evermore confident that '07 will be another strong year, growover or no growover.
Second, all five of our key metrics came in at double digit growth levels. This includes miles issued, miles redeemed, statements generated, credit sales, and portfolio growth.
This demonstrates not just strong growth but balanced growth across the business. Third, we saw double digit organic growth led by Canada, US marketing, and private label.
And finally, as Mike mentioned, overall marketing services has continued to increase its share of consolidated revenues, while private label stayed roughly flat in the mid-30s percent of consolidated revs, marketing moved from the low 40s to the high 40% level versus last year. This trend will continue through 2007 and we expect it to continue right into '08 and '09 as well.
A couple of nits and nets. Operating EBITDA is about $10 million higher than normal due solely to timing of cash flows.
So while full year operating EBITDA is $43 million ahead of reported EBITDA, the true number or normalized number would be about $33 million. That extra $10 million, again, is nothing but timing since it's a cash flow measure and as such will ding us in Q1 of '07.
So let's just keep that in mind as '07 rolls out. Next, full year margins were up smartly across the board, including 100 basis points expansion in transaction services and 250 basis points expansion in marketing.
In summary, solid quarter, great year, good momentum into '07. So let's turn to the next slide and talk a little bit about the segments.
First up is transaction services, which houses private label, utility services, and our traditional bank card business. Statement growth is a key driver for both private label and utility, which together account for about 85% of the segment and continued along at a nice double-digit pace in the quarter, while revenues associated with this driver came in a bit under double-digit.
Lack of growth in the remaining non-core business, the traditional merchant bank card processing business, dampened overall revenue growth. More importantly, the full year results show solid double-digit revenue growth matching nicely with double-digit statement growth.
Turning to EBITDA. As expected, growth was below previous periods, as utility services chewed through an extra few million gearing up for upcoming conversions as well as the costs associated with our new state-of-the-art customer care call center soon to be opened in Ennis, Texas.
Again, stepping back from the quarterly fluctuations, how are we doing on a full year basis? Revenues were up double-digit.
Statement growth was up double-digit. EBITDA was up 20%.
Margins were up 100 basis points. Not too shabby.
Looking into '07, revenue growth will be dampened by additional declines in our non-core traditional bank card merchant processing business. However, we expect solid performance on EBITDA and, hence, additional margin expansion as we continue to focus our efforts on trimming low-margin, non-core businesses and expanding our efforts to drive efficiencies into our utility business.
Okay. Let's take credit services.
What a year it's been. Fourth quarter continues to impress with revenues and EBITDA both up around 20% driven by double digit growth in both sales and portfolio growth.
Now, let's talk about the four key drivers. First, credit sales were up double digit and for the year finished up 13%.
We saw nice, balanced growth from both our longer-term clients as well as from the newer vintages. As we look ahead into 2007, we expect solid performances again from existing clients plus the addition of the 2006 vintage, which was a bit above expectation and included the signings of Bealls, Friedman's Jewelers, Cruise Miles, Dunlap's, Pamida, and co-brand product ads to existing clients New York & Co.
and Goodies. Second, portfolio growth was up in the low teens and finished up 15% on a full-year basis, well ahead of expectations.
Key point here is that yields remained quite strong with no indication whatsoever of any pricing pressure, again demonstrating the difference and behavior behind the consumer who views our programs as loyalty vehicles in contrast as to how bank cards are used, hence, financial vehicles. And hence explains why we're not seeing the pressure that they're under.
Third, funding costs popped up in Q4 as we replaced a maturing deal, which had very favorable rates with a higher market rate deal. This is a temporary timing issue and we'll be mitigated during '07, specifically a large portion of our funding book will continue to step down to lower rates in '07.
Bottom line here is that '07 rates will be roughly flat to '06, which was roughly flat to '05. Finally, credit quality returned to our normal level of about 6%.
Specifically, the timing issues caused by bankruptcy legislation changes in late 2005 have now worked their way through the system. As such, our Q4 loss rate of about 6% also represents our expectation for all of 2007 as well.
In other words, losses have now normalized and based on delinquency flows that give us a nice window through Q1 and Q2 of '07 and other trend data, we see absolute to evidence to suggest that '07 will not conform very nicely to our 6% target. All right.
To wrap up this piece of it, sales were strong, new client signings were strong, and credit quality remained solid. As such, we once again feel comfortable in saying that our $11.5 million quality customers are doing well, spending well, and not showing signs of stretching on credit.
We expect this to continue through 2007. Finally, marketing services continued its stellar performance with revenues up 40%, EBITDA up 86%, and margins up a staggering 500 basis points.
Starting with Canada, the AIR MILES program continued its 20% plus organic growth at a double-digit growth in miles issued and miles redeemed combined with strong pricing to drive growth. New sponsors, such as Budget Rentacar, and the previously announced new retailers who joined our AIR MILES shops.com Website will add incremental volume throughout 2007.
Overall, AIR MILES is expected to have another solid year in '07. In the US, marketing services continued to see explosive growth.
As Mike discussed, we've completed the build out of Epsilon end-to-end solution, which includes the five basic areas: creative, data, database, analytics, and information-based e-mail. The pipeline looks robust for 2007 and we hope to start expanding existing relationships to include more-and-more of Epsilon's end to end solutions.
As we finish up the segments, we hope you're seeing the ongoing strategy take shape. As we finish up the segments, we hope you're seeing the ongoing strategy take shape .Mike mentioned our goal so to be considered the premier provider of marking and loyalty services based on transaction-rich data.
Why? And this is just probably the key point here, because transactional data is the best predictor of future consumer behavior.
Olive stated can choose end-to-end solutions ranging from external solution, internal solution, or programs specific to one industry like utility. In the end, we believe our offerings are unique to the marketplace and so now with that said, let's hit the balance sheet.
First, deferred revenue related to our AIR MILES business declined $27 million from Q3 to Q4 due entirely to the weakening of the Canadian dollar. Same is true on the trust account.
Looking past that from a pure free cash flow perspective, however, cash flow increased by $20 million US, but with math about a market-to-market at not cash quarter's end. Second, leverage continues to be minimal at 1.3 times core debt to trailing cash flow.
In terms of liquidity, our comfort zone would be at or below 2.5 times cash flow, or for '07, 2.5 times $630 million, which is about $1.65 billion in liquidity. Adding in the $300 million plus of expected free cash flow expected to be generated during the year would suggest we have roughly $2 billion in liquidity, of which $1.2 billion is available at this time.
Acquisitions and/or stock buybacks are targeted to tap into this liquidity. And finally, we announced a total of $900 million in stock buybacks through year-end 2006, we spent just under one-third of that by purchasing $6.8 million shares at a weighted average price of about $43.
All right. The fun part.
Let's move to guidance. As Mike mentioned, we are raising guidance from our October phone call.
We're taking revenues up about $100 million to $2.2 billion. Again, it should be read as the absolute minimum or at least $2.2 billion, at least $610 million of EBITDA, and at least $3.55 of cash EPS.
A couple of things to note here is that if you were to include playing through the $0.25 of growover from last year, it would suggest a normalized growth rate of 20%. Next up, Q1, we would certainly expect to do a minimum of $0.90 for the quarter.
And again, that includes playing through about $0.10 of growover from last year, suggesting a normalized growth rate of at least 20%. That being said, a couple of other items.
You'll see that not as much EBITDA is dropping all the way down to cash EPS as prior years. Depreciation and interest will be up substantially during '07.
Combined, they'll be about $150 million as depreciation starts returning to more normal levels and also include the interest on the Abacus deal, which was a cash deal. In any event we do want to say that we believe that although we are raising guidance, this still remains, what we believe, is a conservative base case.
And for those of you who have known us over the past 23 quarters, we like to start there, it gives us tremendous flexibility throughout the year. And then, if all goes well and according to plan, hopefully, we can all share in the benefits as we walk things up throughout the year.
But for now, consider it sort of our worst-case scenario. And quite frankly, if we came in at these numbers, I think both Mike and I would be somewhat disappointed.
So that being said, sort of normal practice for us, let's start here and see how the year starts playing out. And then, as we mentioned, we'll update guidance accordingly as the quarters roll out.
That being said, we do not see anything out there in '07 that gives us cause for concern outside of just making sure that we get through the $0.25 growover, and then having a nice growth year on top of that as well. So I think '07 is going to be a good one.
Let's turn now to estimated free cash flow, which really just factors in, as I like to say, what's left in my pocket at the end of the day. Start with EBITDA, you throw in the $25 million or so up in Canada, pure profit.
That's cash that we can't book. We need to defer, take out CapEx, interest and taxes, and there's $300 plus million of pure free cash being thrown out by the business.
Again, a minimum of about $3.75. All right, finishing up here, appreciate your patience.
Additional comments. I would say normally we call it our top questions, but quite frankly, we haven't got a lot of questions this past quarter.
So I think we just called them comments for now. But credit losses, people are still -- seem to be focused a little bit on these monthly master trust numbers and what's its mean.
And we've cautioned people against it for a while, but for people who are looking at the master trust, we had the bankruptcy spike in the fourth quarter of '05, which took losses well above 7%. Then in Q1 and Q2, and even a little bit in Q3, it was nothing more than calling back those bankruptcies that were accelerated in '05.
By Q4 at 5.9%, those losses have now normalized to what we believe should be a straight shot through '07 at around 6%. Difference between master trust, in reported would be those portfolios which are either in private conduits or we're seasoning on balance sheet, and then, we'll eventually move into the master trust.
Segments. We think that for 2007 marketing, that includes both Canada and the US, we'll certainly have the strongest growth rates, 20% plus.
We think that we'll see single digit growth rates in transaction and credit. Again, transaction the non-core merchant bank card business will probably ding it for about $25 million of revs.
And then credit, on a normalized basis, we expect double-digit growth. When you put it all together and mix it together, overall, that's how we expect solid double-digit growth for 2007.
And then, finally, as Mike talked about, we have seen and will continue to see -- and this a trend that we expect to continue well after 2007 -- and that is the shift in the consolidated revs as marketing becomes 50% of the company versus 30% in '04, where it's private label is beginning to moderate its growth rate into probably long-term, 9% or 10% type growth rates. And as a result, it will slow down in terms of its percentage of the company, down about 35% from 45% in '04.
That shift in mix, again, should continue past '07 into '08. What we're finding out in the marketplace is there's just enormous demand for these types of different loyalty programs that we're putting together.
And as such, that's what we're putting our shoulder into and that's where we're putting our capital. So that being said, why don't we finish up with the fact that operating leverage continues to look good considering 2000 we were in the 14s and this year we expect to be close to 28.
It looks like leverage in the model continues to move along nicely. And then the final page is, sort of, our favorite chart of through good times and bad times, the company seems to perform pretty nicely.
And we would expect that to continue this year. It's very early, but from what we can tell from all the trends, we're off to a very strong start.
With that, I'll turn it over to Mike.
Mike Parks
Thanks, Ed. Again, a good '06 and we're excited about '07.
Thanks again to all of the team and best of luck as we attack the market again. So let's turn it over to questions.
Operator?
Operator
Thank you. [Operator Instructions].
Thank you. Our first question comes from Jim Kissane of Bear Stearns.
Jim Kissane - Bear Stearns
Hi Mike. A great job again.
Mike Parks
Thank you.
Ed Heffernan
Thanks, Jim.
Jim Kissane - Bear Stearns
You've been when marketing margins by a very wide margin. Can you -- as you look out and maybe talk about some of the factors that cause the big beat in terms of the margins, because I think they all exceed your expectations, but importantly, kind of, normalized, sustainable operating margins or EBITDA for the marking segment?
Ed Heffernan
Sure. I don't think it was because -- did you ding us last year because we didn't beat what we said we were going to do?
Does that ring a bell?
Jim Kissane - Bear Stearns
I remember.
Ed Heffernan
Yes. Okay.
250 basis points I think is a good number to use. I think that obviously the 500 basis points in fourth quarter tend to offset, sort of, the flatness that we had in the first half.
I mean it's choppy. As you've known for years, the margin here is going to be choppy, but the trend is our friend on this one is it is going up.
And I would expect in 2007, that we'll be seeing obviously 20% plus growth in the segment. And at the same time, we would expect an expansion in EBITDA margin.
Let's be conservative and say, 200 basis points. And the reason we're getting that obviously, is the heart of all of this, right is some types of transaction being processed.
Right, a mile being processed, a mile being redeemed, you know, a Hilton statement being sent out the door or something like that. We're getting the leverage.
The margins on some of the businesses that we've been putting together over the past three years tend to be above the norm of what we're used to, specifically. I think if you want to look at data type companies as well as the permission-based e-mail type companies, very solid margins and very nice growth rates.
So with that shift in mix, I think what you're going to see is a continuation of very nice EBITDA margin expansion along with certainly a 20 plus percent growth well past '07.
Jim Kissane - Bear Stearns
Great. Maybe a question for Mike or Ed.
The acquisition pipeline and your appetite, particularly in the marketing business, I guess. Do you have all the pieces that you need now?
Mike Parks
No question we continue to build out and will have a strong appetite for leveraging up the model that we've built. But we do have the pieces we need.
We cover all five of those critical pillars, and now its leverage. There might be a few, particularly in the data area, that we may choose, like you've seen us do with a few here in the past that we would choose to own versus buy.
But its leverage time from now on.
Ed Heffernan
Yes. I think we're going to put -- as Mike said, we're going to put more muscle on the bone here.
We ought may, also, be doing something maybe on the international side as well. The $1.2 billion or so we spoke of in terms of immediately available liquidity, I think it's safe to say that a portion of that will be devoted towards this marketing bucket.
Jim Kissane - Bear Stearns
Great. If I can get one last one.
Funding costs bit you a little bit in the fourth quarter. Will you have a little bit of that in the first quarter as well, or will you get the benefits of the step-downs?
Ed Heffernan
Shouldn't ding us in the first quarter.
Jim Kissane - Bear Stearns
Thank you.
Operator
Thank you. Our next question is coming from Greg Smith of Merrill Lynch.
Greg Smith - Merrill Lynch
Yes. Hi, guys.
Mike Parks
Hi, Greg.
Greg Smith - Merrill Lynch
Nice quarter.
Mike Parks
Thank you.
Greg Smith - Merrill Lynch
First data seems to be sort of mimicking some of your strategy a little bit on the utility side and this other recent loyalty related acquisition. Are you worried, are you seeing them, what are your thoughts on that?
Ed Heffernan
No, we're not seeing, no we're not worried. Very familiar with both firms and have used both of them.
So we have good insight into the depth and capability. So nope.
Greg Smith - Merrill Lynch
Excellent. How about Aeroplane on the AIR MILES side?
They've had broader ambitions. Anything there?
Obviously, your numbers are great, but as we look ahead, what are your thoughts there?
Mike Parks
Continue to be predominantly a different program. They're just focused on the frequent flier, our broad-based coalition and frankly, nothing has -- we've seen nothing really that different in the marketplace from an execution perspective.
Ed Heffernan
Yeah. I would say, to Mike's point, Greg, if you look at Aeroplane, I would say 90% or more of their revenue is probably come from either Air Canada or CIBC on the credit card side.
So it's kind of -- it's more akin to probably what all of us on the phone are used to carrying around in our wallets or purses. And as a result, it is a high frequency business frequent flier program and continues to be so.
And from a displacement perspective, we're not obviously -- we're obviously not seeing anyone of our sponsors from what we're hearing too concerned about or raising any noise level. What they may end up doing, and this is pure speculation, is that maybe they go after some of the smaller market share participants in some of our categories that we've already locked up.
Greg Smith - Merrill Lynch
Okay. Great.
And then just one last question. How are you feeling about the potential, City has obviously been expanding this Thank You network, they've got Home Depot onboard.
Is this something that we'll probably see them rollout to all of their Private Label customers and you benefit from, or is that a little bit too ambitious to think about at this point?
Ed Heffernan
Well, I think, the fact they decided to convert a monster file like that into a Thank You point so along with Expedia announcing that they're going to be using the Thank You network as well. It's really interesting because, you know, what we're defining as a massive internal coalition program -- and I don't think we have a lot of insight into it, quite frankly, because we don't own the program, unlike Canada.
It's interesting that it looks like they're putting some effort in too, maybe this is more than an internal coalition, maybe this is going to be a fairly significant overall internal/external coalition with uncommon currency. And that's about all we know at this point.
But they're certainly pretty excited about it.
Mike Parks
And obviously we -- as being the kind of engine driving that or try about the growth opportunities that brings as well.
Greg Smith - Merrill Lynch
Yeah. And can you just remind of sort of economic that flow back to you?
I mean there is a direct relationship between Thank You points and your revenues? Correct.
Ed Heffernan
You bet. It's not a one-to-one, like up in Canada where every mile that's issued we get X cents, but it's sort of a fixed variable type setup where of course the more work we do, the more points that are issued, the more volume that's flowing across, the more revenue we get.
If we want to get more -- I don't think we want to get any more specific than that.
Greg Smith - Merrill Lynch
Great. Thank you.
Mike Parks
You bet.
Operator
Thank you. Our next question is coming from Tien-Tsin Huang of JP Morgan.
Tien-Tsin Huang - JP Morgan
Hey. Good afternoon.
Mike Parks
Hey, Tien-Tsin.
Tien-Tsin Huang - JP Morgan
A question on the guidance first. Did your increasing guidance reflect any change in the core business expectations or is it principally coming from the Abacus acquisition?
Mike Parks
It's simple. As we continue to -- the guidance we gave back in October assumed good trends, not outstanding trends, but good trends through '07.
And then what we did is, Tien-Tsin, we just popped on Abacus and called it a day. And then probably on our March quarter, you know, we'll see and have a much better feel of how things are settling out.
And we'll know when Abacus closes and everything else, and we'll be able to update the guidance to be a bit more accurate.
Tien-Tsin Huang - JP Morgan
Yes. Can you give us a rough sketch of what Abacus looks like in terms of revenues, growth profile, margin profile, et cetera?
Mike Parks
Sure. It's -- as we mentioned earlier, it's a very nice deal.
It's probably 100-ish million or so in revs. It's about, I don't know, around 40-ish.
Again, this is not a full-year basis. So it depends when we close, but 40-ish type of EBITDA.
So I think nice, healthy margins there. You know, once you throw in depreciation and interest, that's where you come up with sort of at least a nickel from the deal itself.
And, you know, hopefully, we'd get it boarded and as soon as possible. And we can do better than that.
We have not baked into guidance any type of cross-sell between the other functions within Epsilon into the Abacus and vice versa. For example, Epsilon is known as -- the core Epsilon client base being very strong in like pharmaceuticals and financial services, but not so strong in retail, which gives them a tremendous leg up.
Also, the fact that a great number of our 82 private label clients are only clients of Abacus, the cross-sell there is quite large. So again, these are all upsides that as the year rolls out, hopefully, we'll realize at least some of them and we can all benefit.
Tien-Tsin Huang - JP Morgan
Okay. So no synergy, just layering it in?
Mike Parks
You bet.
Tien-Tsin Huang - JP Morgan
Okay. And then in credit, I was hoping you could maybe help quantify the impact of the higher funding cost in the quarter and its impact on margins, because I was kind of surprised to see margins down over the prior year given the easy charge-off compare and the strong receivables growth.
Am I missing something there?
Mike Parks
Well, it's -- the margin themselves -- correct me if I'm wrong -- were up --.
Tien-Tsin Huang - JP Morgan
Sorry, in the fourth quarter.
Mike Parks
Fourth quarter versus prior year?
Tien-Tsin Huang - JP Morgan
Yes.
Ed Heffernan
Right? But if you're just talking about the fourth quarter, what you have, is the couple of things.
You had obviously the loss is normalizing, which sequentially obviously would drive it down. But at the same time, the bond deal that we replaced probably dinged us for about $5 million in that obviously flows 100%.
Tien-Tsin Huang - JP Morgan
Right.
Ed Heffernan
To EBITDA. So what you'll see is, we start hitting Q1 is the step downs.
On the other $1.7 billion I think it's about $1.7 billion or so of step downs instruments, those start kicking in and you'll see a pop backup in margin.
Tien-Tsin Huang - JP Morgan
Any change in the I/O gain?
Ed Heffernan
No, I mean it's consistent with what we do every quarter. I think for the full year basis, our I/O gain this year will be slightly less than what it was last year.
Tien-Tsin Huang - JP Morgan
Okay. And then I guess lastly, just quickly, expectations for stock-based compensation in 2007?
Ed Heffernan
Still working on that. It's a tough year right now.
In Mike's working it through with the board. You know I grow at 10%, Tien-Tsin.
Tien-Tsin Huang - JP Morgan
Okay. Very good.
Thanks very much.
Ed Heffernan
It's all right.
Operator
Thank you. Our next question is coming from Andrew Jeffrey of Robertson Humphrey.
Andrew Jeffrey - Robertson Humphrey
Hi, good afternoon, guys.
Ed Heffernan
Hey Andrew.
Andrew Jeffrey - Robertson Humphrey
As we look to first quarter, just sequentially, particularly in credit, obviously it was very strong 1Q '06 and it sounds like about $5 million from the bond deal you did in the fourth quarter. Should we be thinking about 1Q '07 as being down versus 1Q '06 on the revenue side, and then obviously margins bounce a little as you were just saying to Tien-Tsin from where we were in the fourth quarter.
Ed Heffernan
Good question. I think -- I don't think we're going to be down in Q1.
Andrew Jeffrey - Robertson Humphrey
Okay.
Ed Heffernan
I think we're going to be roughly flat and slightly up.
Andrew Jeffrey - Robertson Humphrey
And that's a function of strong portfolio growth, I take it? Because it seems like we're seeing a little bit of divergence between credit sales and portfolio growth, at least in the fourth quarter.
Maybe that was just the traditional business.
Ed Heffernan
Yeah. It's going to be about the same in Q1.
We certainly hope for the year to do double digit portfolio growth and double digit sales growth. What you have in Q1 is you know, we expect again, good portfolio growth, good sales growth.
We expect the funding costs to come back down and normalize. We expect credit quality sequentially, certainly not to be -- certainly to be right in the ballpark of where it was in Q4.
So as a result, you know, you do the math on it and you're going to wind up with a heck of a grow over, but one where I think based on where yields are flowing and credit sales and portfolio growth and funding and credit quality, we're going to be flat to slightly up, I really do.
Andrew Jeffrey - Robertson Humphrey
Okay.
Ed Heffernan
And then it just gets you know the pony gets a little easier to ride after that.
Andrew Jeffrey - Robertson Humphrey
Right, right. Then the sequential are easier to figure, I take it?
Ed Heffernan
Yeah.
Andrew Jeffrey - Robertson Humphrey
Just based on growth in the business. Big jump up in AIR MILES redemptions, the growth rate, the absolute number as well as, the growth rate in the fourth quarter.
I assume that was one of the drivers in marketing. Is that an anomaly; is that a reflection of better uptake or better acceptance?
What happened and what should we expect prospectively here?
Ed Heffernan
I wouldn't read anything into it. I've been saying for I don't know 10 years, forever, it jumps all over the place each quarter.
A lot of it depends on whether sponsors are doing special promotions, for example, with maybe a packaged goods supplier to the grocer that could jump it around. So I wouldn't read anything into it.
I would rather, it would be more appropriate to look at sort of the full-year, where issuance was up sort of 15% and redemptions were up around 20%. I think that's more indicative.
The fact you saw a big jump in redemptions in Q4, what that basically does, is it will drive revenue, but it does not drive any earnings because it's offset by cost of goods sold.
Andrew Jeffrey - Robertson Humphrey
Okay. But it sounds like what you're saying is we should be thinking about redemptions more in the 20% range rather than what you talked about historically has being closer to 15?
Ed Heffernan
For '07, you know what we're modeling quite frankly, is probably low double digits for issuance and low to mid-teen digits for redemptions and then to the extent the trend is as robust as this year, that certainly would be upside news.
Andrew Jeffrey - Robertson Humphrey
Okay. Thanks a lot.
Ed Heffernan
You bet.
Andrew Jeffrey - Robertson Humphrey
Thanks Edward.
Operator
Thank you. Our next question is coming from Wayne Johnson of Raymond James.
Wayne Johnson - Raymond James
Hi, good afternoon.
Ed Heffernan
Hey, Wayne.
Wayne Johnson - Raymond James
If you went over this, I apologize, but what are the transaction processing in '07 expectations again, for new utility wins for this year?
Ed Heffernan
Yeah, let me talk to each of the pipelines, because that's something we normally do at the beginning of each year. You know, we've always talked about 10 to 12 new deals, we're getting a little bigger now.
We'll go probably closer to 12 to 15 deals across the Company. You'll get 4 to 5 out of our US.
marketing services group. We'll pick up 2 or 3 in the AIR MILES sponsor category.
Retail, we'll do 4 or 5, again, and utility will be our 2 to 3. You know, this past year, we happened to do 4, which was a little more than normal.
So we've add all those up, that's kind of 12 to 15 kind of range. Our biggest deals, as Ed mentioned, will be coming from the marketing side.
Wayne Johnson - Raymond James
Okay. That's helpful.
And is there any change in the size of these utility deals compared to prior years, do you think?
Mike Parks
I would say there's probably not a long much different between our '07 expectation and last year.
Wayne Johnson - Raymond James
Okay. And switching to -- switching topics to Abacus, perhaps there was a mention that this is a layer on-type acquisition.
Does that mean that the data center for Abacus is going to remain in its current location? There's not going to be any consolidation costs or anything like that?
Ed Heffernan
For the most part. They do have a -- they're big mainframe and big consolidated cooperative database will remain in tact.
They were getting into the business over the last two or three years into some of the kinds of database marketing kind of platforms that we have at Epsilon. So we're going to take a peak at some of that.
So there may be a little bit of spin there. But for the most part, it's business as usual.
Wayne Johnson - Raymond James
And what's the expected closing date for Abacus?
Ed Heffernan
Sometime this quarter. We expect it fairly quickly.
Wayne Johnson - Raymond James
Terrific. All right.
Thank you.
Ed Heffernan
Thank you.
Operator
Thank you. Our next question is coming from Larry Berlin from First Analysis.
Larry Berlin - First Analysis
Good evening, guys. How you doing today?
Ed Heffernan
Hi, Larry.
Larry Berlin - First Analysis
I just wanted to go back through the old line business that declined a bit in the quarter in card. Are you guys trying to shed that because it's lower margin or is it attrition or just, you know, bad consumer spending in some places?
Ed Heffernan
It's not bad consumer spending. This is our -- gosh, it goes back, by ten years, goes back a long time.
It's the original piece, J.C. Penney merchant bank card business.
And it's primarily large petroleum players and it's seen very nice, you know, growth in transactions by the petroleum players as cash is being displaced by electronic means. But what we're seeing, Larry, why we call it non-core is what you might expect.
I mean look, you look at the big dogs in this area and we're not one of them. And its non-core, it is a business that was 25% of the company when we first were put together and it is obviously a very small piece of the company now.
And what basically is happening is as contracts are coming up, we try to remain competitive. But we're not going to do it at a loss.
And as a result, some of those clients have been peeling off. Mike, I don't know if you have any?
Mike Parks
Yeah. The ones we don't have the expanded relationships in, where we do a lot of extra services other than a basic bank card transaction, those will peel off the others are very sticky.
You know the interesting thing to watch and reason we've continued to kind of stick with it, as you see the convergence of petroleum kind of clients with the grocery sector. We have a deep relationship in Canada and building in the US.
through some R&D efforts in the grocery market, whether they'll be our potential retail card issuing products or whether they be our loyalty products, or whether it be the emerging data products as we evaluate that packaged goods grocer area. And so we have such an interesting and powerful network infrastructure that could be leveraged at that point in time and if that happens, that would be great.
So we're not in any dire hurry either to get out of the business. But it isn't growing like we have in the other sides of the business.
Larry Berlin - First Analysis
Okay. Just to switch track, I just want to make sure that I have it right.
In marketing service, I guess specifically in the US. in the fourth quarter, what was organic growth if we cut out any acquisitions and things like that?
Ed Heffernan
Yeah. You know, again, we said, Canada, we're certainly talking 20 plus.
I think the only comfortable thing that we'll say with US. is certainly 20 plus, as well.
That should be certainly very, very comfortable in that range. I would even venture to say it's probably a fair amount above where Canada is, and we're going to leave it at that.
Larry Berlin - First Analysis
Okay. Thanks, guys.
Have a great evening.
Ed Heffernan
Okay. Bye.
Mike Parks
Take care.
Larry Berlin - First Analysis
Okay.
Operator
Thank you. Our next question is coming from Dan Perlin of Wachovia.
Dan Perlin - Wachovia
Thanks. Hi, guys.
Ed Heffernan
Hey, Dan.
Mike Parks
Hey, Dan.
Dan Perlin - Wachovia
Just a couple questions. I guess one to expand on Larry's question.
I think in the past you said marketing was like one-third, two-third -- two-third was AIR MILES. Is that still the same mix to think about?
Mike Parks
I think for this year, I think that's fair. I think it's actually spot-on for this year.
I think when we look to next year we're probably talking more on the order of almost half-and-half.
Dan Perlin - Wachovia
Okay.
Mike Parks
Because US marketing is growing so quickly.
Dan Perlin - Wachovia
And in order to get 50-50, you're including Abacus in the Epsilon piece of the business, I'm assuming?
Mike Parks
You bet.
Dan Perlin - Wachovia
Tien-Tsin asked a question about margins, I didn't quite follow it, so I'm going to ask you it again, and I apologize. But the year-over-year credit service margins were actually down, 27.9 versus 28.8.
Ed Heffernan
Right.
Dan Perlin - Wachovia
And I think what I heard is you said the biggest delta there is really the funding costs, because we know that loss rates last year in December were higher.
Ed Heffernan
Right. You know Dan, what we did is we have a timing issue with our funding costs and I think it was almost $5 million, then we had a deal, an asset-backed deal that had stepped down, I think below 1% and we had good funding, and we had to replace it with market rate stuff and like you know, at between 5 and 6%, and I think it was a $5 million hit in the quarter.
And that's 100% margin. That's going to get mitigated right out of the gate in '07 --
Dan Perlin - Wachovia
Was there another step down?
Ed Heffernan
Yeah. Because there was -- no one was stepping down in Q4.
Dan Perlin - Wachovia
Got it. Okay.
You know that begs the question of, are there other roll off step downs? You know like this one was a step down and then it rolled off and you had one roll off.
Is there another one in that kind of $2.7 billion that you talk about having these step down functions, is there another one that rolls off in '07 that would cause that kind of noise?
Ed Heffernan
It's a good question. I think, let me look again at my step downs.
Actually, it's only about $1.7 billion that are stepping down.
Dan Perlin - Wachovia
Okay. Right.
Because you had a $500 million that came off.
Ed Heffernan
You bet. So about $1.7 billion stepping down in 2007, I don't think any of them are coming due.
I think that's why we think we can maintain a nice, flat funding rate for 2007.
Dan Perlin - Wachovia
Okay. So when we think about -- when we think about margins in credit services for all of '07, it should be still kind of in this low 30s?
Which is to say roughly flattish year-over-year?
Ed Heffernan
I don't think it will be --
Dan Perlin - Wachovia
It maybe up a little bit, I guess, but not much.
Ed Heffernan
I think it will be, you know, it's certainly going to be north of 30, for sure.
Dan Perlin - Wachovia
Yeah, Yeah.
Mike Parks
You know, we'll know a lot more after Q1, but I would say --
Dan Perlin - Wachovia
Okay.
Mike Parks
30% and it could go up a little bit from there.
Dan Perlin - Wachovia
Okay. And then in order to get to the kind of $0.90 guidance in the first quarter, so you have to obviously -- I think you've fully exhausted the credit services segment, but what about kind of the bounce back in transaction services?
And you're saying that's just a function of marketing spend that will kind of go away in the first quarter, so margins can get close to 14, 15% range? Is that right?
Did I hear that right?
Mike Parks
I don't think so. I think in Europe the marketing and the transaction, I think that the transaction services margin in the first quarter will be, you know, right around flat to last year as we're getting in, it's ready to go on a bunch of other stuff in utility.
We probably won't see a ton of growth in Q1 in transaction, but I think you're referring to marketing services.
Dan Perlin - Wachovia
Well, I was actually trying to reconcile transaction services. Marketing services clearly had to have a gigantic first quarter in terms of margin.
Mike Parks
Yes.
Dan Perlin - Wachovia
So I think I understand that now. But are there other clients in the core merchant processing business that are in transactions that will expire in '07, and therefore it kind of roll off the entire model?
Mike Parks
There would be a few. I think you also have, as we ramp up for this conversion and turn on the call center, we're loading on a number of call center reps, training them up on the new system, getting ready.
So we're basically funding some labor costs with no revenue for, you know the 45-day period to get them trained up so that we do a good job come conversion. So that's impacting the first quarter a bit too.
Ed Heffernan
Okay. I think, Dan, let's sort of bubble it down here to what's the bottomline.
Bottomline here is in Q1, because of the growover in credit, you're really not going to see much growth there.
Dan Perlin - Wachovia
Right.
Mike Parks
And then that starts to pickup steam. As soon as we hit Q1 and then really gets flying after that in transaction services because of some clients that are rolling off, there's not going to be that much momentum versus prior year in terms of growth there relatively flat margins.
That will start picking up again as, Mike, mentioned once we get Ennis opened and other things. So really what you're talking about Q1 is, as you put it, you're going to have a monster quarter in marketing services, sort of a continuation you know--
Dan Perlin - Wachovia
Like sequentially flat to up with the fourth quarter, I guess, is kind of what ends up having to happen?
Mike Parks
It won't be far off.
Dan Perlin - Wachovia
Yeah.
Mike Parks
I don't know if it will be up sequentially, but it won't be far off. And then you've got, you know the other two sort of holding their own and they start to cycle back up as the year unfolds.
And then, you know if everything hits on all cylinders like we hope it does, there'll be some extra kisses throughout the year.
Dan Perlin - Wachovia
Okay, cool. And then one more question and I'll jump off.
Someone asked me the other day a question about there is the reason for the charge-offs being different in the master trust versus your reported numbers --
Ed Heffernan
Yes.
Dan Perlin - Wachovia
-- given that the private conduit and the balance sheet figures are significantly smaller than the master trust.
Ed Heffernan
Yes.
Dan Perlin - Wachovia
Is that an accounting issue?
Ed Heffernan
No.
Dan Perlin - Wachovia
Can you just -- two seconds on that please?
Ed Heffernan
Yes. It's a primarily of what do we hold on balance sheet or in a conduit.
And our decision to either put in a private conduit or balance sheet really depends on our cost of funds, whatever we can get lower. One is based off a CP.
One is based off a CD. So whatever is cheaper at the moment, we fund it that way.
Dan Perlin - Wachovia
I mean -- Well, Ed, I'm sorry. Like there is a 50 basis point difference in net charge-offs between what's in the trust?
Ed Heffernan
Yeah, it depends. It fluctuates throughout the year, but it's anywhere between 30 and 50.
Dan Perlin - Wachovia
Okay.
Ed Heffernan
What you need to remember is what are we holding in the conduits or on balance sheet. What we're holding are primarily the newer vintages of that are ramping up that are getting seasoned, because in order for them to migrate into the master trust and have let us maintain our nice AAA ratings from the rating agencies, they like to have a nice track record, a nice history And the way cards work is there is a bubble of losses that comes through, you know, after around 18 months or something like that, maybe 15 months.
And that spikes the losses. Once you pass that point, then losses begin to normalize.
And that's when we usually migrate them over to the master trust. Secondly, yes, there is a slight accounting difference in the sense of the master trust is principal only write-offs, we do not do accruals.
Whereas on balance sheet, you're talking about accruing for interest and late fees. So when you're writing-off, you're going to have a little bigger number.
Dan Perlin - Wachovia
Got it. And any expectation this year, you know, given the bankruptcy bubble behind you.
There is some of those people that went and -- you when, bankrupt may actually come back on and will not have actually qualified for bankruptcy, so your recovery rates go up?
Ed Heffernan
What we're seeing -- you're dead on. I mean that we're actually seeing, and I'd be surprised if some other folks haven't seen it either, the relationship between our delinquencies and our charge-offs is changing.
We are having a lower overall bankruptcy rate. And what that signifies or suggests, because everything is normalized now, is that it is more onerous for people to file bankruptcy or it's more expensive or lawyers aren't taking the cases, I don't know.
But bankruptcy filings for us are down. But in its instead, what's happening is people are, rather than filing bankruptcy, just flowing through the pipe for 180 days, and then writing off.
But that affords us the opportunity for recoveries exactly as you said. So we believe that the overall result of this bankruptcy legislation much maligned as it has been will be some type of relatively permanent pickup to our loss rate -- I don't know, 10, 15 basis points because of the recoveries.
Dan Perlin - Wachovia
Yes. Got it.
Understood. Thank you so much.
Mike Parks
Thanks.
Operator
Thank you. Our next question is coming from Colin Gillis from Canaccord.
Colin Gillis - Canaccord
Hi, Mike. Hi, Ed.
Mike Parks
Hi, Colin.
Ed Heffernan
Hi, Colin.
Colin Gillis - Canaccord
Can you just talk a little bit about your appetite to -- or where you stand right now in terms of generating leads for your customers, sort of, the CPC side of the house?
Mike Parks
We love the acquisition side of the business as much as we do of the loyalty side of the business. And that data merged, by the way, with some of the data we expect to get with the Abacus acquisition might even jump start that even more.
So we're very excited about it.
Colin Gillis - Canaccord
Going forward, would you consider this a growing offering in 2007?
Mike Parks
Yes.
Colin Gillis - Canaccord
Got it. And just, in terms of Abacus, can you give us in color as to why now?
Mike Parks
Why now? It's a perfect fit for us.
Colin Gillis - Canaccord
The availability of the property, the price of the property, that kind of thing?
Mike Parks
Sure, you bet.
Colin Gillis - Canaccord
Okay.
Ed Heffernan
I think, for those of you who don't know, we did a transaction to purchase the double-click permission based email business and the same owners owned ABACUS. And so we got to know the folks quite well.
And as a result, we thought it would be a great fit and a perfect fit and so did it. We got a great price.
Colin Gillis - Canaccord
Okay. Thank you.
Mike Parks
Thanks Colin.
Operator
Thank you. Our final questioner is Paul Bartolai of Credit Suisse.
Paul Bartolai - Credit Suisse
Thanks, guys. Good afternoon.
Mike Parks
Hey, Paul.
Ed Heffernan
Hey, Paul.
Paul Bartolai - Credit Suisse
First question, just -- sorry to be the gentle horse, but on the credit margins I'm still not quite clear. I mean given the pickup in loss rates and even offsetting that with the funding costs, it seems like you should have about $10 million to $11 million pickup in EBITDA, but EBITDA only up $8 million.
So I was hoping you could address that. And then, just as a follow-up, given the AIR MILES breakage or the miles issued versus deemed, I mean is the breakage something we need to start to be worried about here?
It looks like with those trends that gap is changing.
Mike Parks
Yeah, let me take the latter one first. And that is the -- you're talking about the current year burn rate of the miles issued -- miles redeemed to miles issued.
The important measure is after 15 years of running the program, if you were to look at the total miles that have been redeemed divided by the total miles that have been issued, it's somewhere in the mid-40s percent, and we are reserving at 67%. That number is moving up probably at most one point per year, which would suggest, it's going to be 20 years, Paul, before potentially that reserve rate would be hit.
Because again, one minus breakage rate is a reserve rate, so that's in the mid-40s is going up about a point a year. And then, obviously the key thing here is given the fact that we own the program.
We have the right to change the reward structure at any time, and obviously, we are loathe to do that because, you know, we don't want to ding the consumer. But be assured that that breakage rate is fixed.
And that's -- hopefully we can drive redemptions to that level in the next 15 years or so. We're going to try, but that we will not change the breakage rate because that is our model, and as such we would change the consumer offering first.
So with that's answers your question there. That there's -- I mean we're so far away and so over reserved on that one it's, you know, it's a decade or two before we've got to worry about it.
On the sec one, in terms of the credit services, again, it is what it is. The funding cost, you know, dinged us for the $5 million in the quarter.
Also, typically in fourth quarter we have a fair amount of expenses as we throw everything in the kitchen sink at the business, because that is our busiest quarter. And I think we're very comfortable with were the margin came out.
Paul Bartolai - Credit Suisse
Right. But just on the year-to-year comparison that I mean, you know, the loss rate was 150 bps better.
So I mean that's $14 million to $15 million you pick up there. I'm still not sure I understand.
Was there something else that hit on the year-over-year comparison?
Mike Parks
There were a number of marketing programs that were worth probably a few million in fourth quarter. But quite frankly, the difference between -- you know, the fact of the matter is still went up 18% and the difference between $28.8 million and $27.9 million is about $1 million or something like that.
So I'd say between the funding costs and probably, we ran a number of marketing promotions and plans on behalf of our clients that might have dinged it a little bit. But other than that, no.
Ed Heffernan
Thanks, Paul.
Paul Bartolai - Credit Suisse
Thanks, guys.
Ed Heffernan
Any other questions? I think that's the last one.
All right, everybody. Thanks for sticking with us.
We're little about 15 minutes over our normal allotted time. So we'll talk to you again next quarter and look forward to a good year.
Bye now.
Operator
Thank you. That does conclude today's conference call.
You may disconnect your lines at this time and have a wonderful day.
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