Bread Financial Holdings Inc (BFH) 2002 Q3 法說會逐字稿

Good afternoon and welcome to the Alliance Data Systems Third Quarter 2002 Conference Call. My name is [Julie] and I will be your conference facilitator today. All lines have been placed on mute to prevent any backwards noise. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press "*" then the number "1" on your telephone keypad. If you would like to withdraw your question, press the "#" key. I would now like to turn the call over to Ms. Stephanie Prince of FD Morgen-Walke. You may begin your conference.

Thank you operator and good afternoon everyone. By now you should have received a copy of the company's Third Quarter Earnings Release. If you haven't please call FD Morgen-Walke at 212-850-5664. On the call today, we have Mike Parks, Chairman and CEO and Ed Heffernan, Chief Financial Officer of Alliance Data Systems. 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 as described in the company's earnings release and other filings with the SEC. I'd now like to turn the call over to Mike. Please go ahead.

Thanks. Thanks Stephanie and good afternoon everyone and thank you for joining us. If you take a look at the agenda, first I'll touch on some of our quarter's highlight then I'd like to spend a few minutes reviewing our Loyalty Group's AIR Miles Reward Program. As we started last quarter and during each of these calls, we plan to provide you with a high level overview of each of the three growth engines as we started last quarter with a private label credit business, this quarter the AIR MILES Reward Program and then the utility processing services next quarter. Then Ed will review our financial performance and then we'll take questions. Turning to the next slide, I'm very pleased to announce this quarter was the strongest quarter in our company's history. We generated a record top line of 219 million for the quarter, EBITDA just under 40 million and earnings per share of $0.17, a 55% growth over last year. Each of our three growth engines private label, AIR MILES and utility processing came in with double-digit growth for the quarter. I want to take a minute to thank my management team and all of our associates for their hard work and commitment to deliver all three products. Congratulations on a job well done. Turning to the next slide, we continue to focus on growth and visibility and our third quarter was another strong performance. As we announced last month we saw increased growth. We provide customer acquisition and activation programs, receivables funding, statement in remittance processing and customer service for their stores, catalog and online. They are looking to us to assist them in strengthening their customer relationships with a complete turnkey program across all channels. We also link -- entered arrangement with Duke Energy to provide customer information and billing system processing for their two Canadian subsidiaries, Union gas and Pacific Northern gas. This agreement provides an entry into the Canadian utility marketplace and also provides us with sales and development resources, with which to enhance our utility processing services across all of North America. We also signed United Refining, petroleum marketer in the Northeast, who will provide network services, authorization settlement in fleet services for their 380 locations. Our model as you know was built on strategic and loyal relationships and given our success in renewing several long term agreements particularly with our -- two of our top three clients our outlook is very positive. With our largest client, the limited brands, we extended our agreement with all limited divisions through August of 2009. In the marketing services segment, we extended the retail AIR MILES agreement with the Bank of Montreal, our third largest client as well as extending our relationship with Abercrombie and Fitch with a new two-year agreement for database marketing services. One other item worth listing, we lost the frequent guest loyalty program for [indiscernible] motel chain providing program strategy in design, database analytics, implementation of a networked partner strategy to enhance the program benefits and all of this is being driven by our FMI loyalty processing system. All in all it's been a great quarter. We turn to the next slide, we'll move now to -- as we discussed earlier, review the AIR MILES Reward program. As I mentioned earlier, we started with our private label credit, our regional service offering at the inception of Alliance Data and now I would take a moment and review the AIR MILES program. It is a multi-sponsor based coalition loyalty program. Rewarding consumers as they shop across to wide range of category exclusive retailers. The program works because it allows the broad middle market of consumers to built points or as we refer to them as miles. It's fast enough to earn many aspirational rewards from vacation to tickets for a ball game. We have over 300 choices in all and it allows the program to build much faster than any one single loyalty program. The AIR MILES loyal program is the largest coalition program in Canada, and we believe in North America with approximately 60% of households in Canada actively participating. If you turn to the next slide, our clients or sponsors as we call them pay us to run the program because it delivers results. The program attracts a wide variety of the sponsors because it is proven to increase their sales and profits. For instance, in this slide, Pharma plus, the pharmacy chain in Ontario launched our AIR MILES in January of 1999. Prior to that launch they had a market share of 9.4$. However, within the first year of our launch, the market share increased by 33$ to 12.5% of the market. While there may have been other market conditions that contributed to this growth, this is certainly a testament to our program's ability to track new customers for our sponsors. Moreover, this graph demonstrates the power of the AIR MILES program to maintain our relationships with our sponsors' customers. At the end of the year 2000, the largest pharmacy in Ontario launched their own single loyalty program with virtually no impact to pharma plus market share. With results like this and similar results with others, we successfully established long-term relationships with our sponsors and deepen those relationships as we entered other areas of their business. Simply put, the reason for our success, it works for both sponsors and collectors. Let's start by looking at the next slide as we talk about the fundamentals of the business. We drive the business as miles issued and miles redeemed. Every time a mile is issued, we're paid by the sponsor. The number of reward miles issued is a function of the number of members who've shopped at our sponsor location. In order to grow our business and expand the number of miles issued, we focused on three objectives. First, we look to increase the number of active members or collectors. Second, increase the collection opportunity with our current sponsors. And third, develop partnerships with new sponsors or basically new clients. This three-pronged approach derives double-digit growth and great visibility. And I'll take a minute to touch on the dynamics of each of these on the next slide. This slide depicts a varying penetration in Canada's four geographic regions. Three of the regions including the two most populous, the western region in Ontario have over 60% penetration in terms of household. While still adding new collectors to these regions, our biggest opportunity is in Quebec. Quebec represents a significant portion of Canada's population and was just under 38% of households, actively participating in our program, it is an area of opportunity for growth. The four most highly utilized sponsors in our program and in the categories of grocery, credit card, gas and department stores. In late '99, we signed IGA Quebec completing our anchor sponsors in that province. Since that time, our member base has grown from 20% to the current 38% household penetration. Another target of collection growth is to focus on motivating existing members to collect more miles at current sponsors and at more sponsor locations they've never visited before. We successfully move members up, this collection continuum through our quarterly stiffening activities, through semiannual bonus promotion periods and through other direct marketing activities we undertake on our own and with our sponsors. That result, more active members, more miles issued and an increase in our top line. Turning to the next slide, our second opportunity is with our current roster of sponsors developing new avenues of AIR MILES collection by offering miles on products not previously offered to our members. An excellent case study is the Bank of Montreal as you see in the slide. BMO is one of our largest clients and original sponsors of the AIR MILES program. They offer a broad range of banking products as you can see with services for AIR MILES offered and continues to look for new opportunities to expand in the retail-banking sector. Beginning with just one program, now 15 BMO products and services have AIR MILES attached, most recently with the launch of the debit card program in 2000, and a small business banking offer last year. Like Bank of Montreal, we work with other sponsors to increase collection opportunities, for example, our Ontario grocer partner A&P recently added AIR MILES offers to a new banner, the Barns, and other change in the Ontario region. And turning to the last slide, the third growth areas, which we pursue, is new sponsor development activities, which is simply adding new partners to the program. In 1992, AIR MILES was launched with 13 sponsors, today we have over 130 leading brand name sponsors representing over 12,000 retail and service locations across Canada. There are many categories of consumer spend beyond our existing sponsor base where we see opportunity. And you've heard us talk about these before often described as tier two or three sponsors, adding [Rexcel] and [Manulight] in the last few months are perfect examples of this new sector. And there are still other categories like ladies and men fashion chains, automotive sales, and deregulated utility services. On final note, we have seen an evolution of this program. In the first five years we've been establishing the program and gaining critical mass. In the second stage, adding sponsors across all of our provinces, and now we are beginning to fill out the program with new categories. Overall, we believe the combination of one, more active members, two, more collection opportunities with existing sponsors and, three, new sponsor developments will continue to propel this program at a double-digit growth rate with great visibility. Ed, will you review the financial performance now. Thanks.

Great. Thanks Mike. If you turn now to third quarter, slide should say consolidated results at the top. Third quarter marked our six-quarter as a public company unlike all the quarters before it, continue to build on our track record of delivering on what we promised. If you step back our original goal was for third quarter to contribute about 25% of our full year targets. This goal was met for revenues and was exceeded for both EBITDA and earnings per share. Running down the results, revenues of 219 million were up about 8.5%. Our three growth engines, which are Private Label Processing/Credit, Utility Services Processing and the Loyalty AIR MILES group in Canada, each kicked in double-digit growth. Against that on selective pruning of low or zero margin accounts in our traditional merchant acquiring business brought the company's consolidated growth to around the 8.5% for the quarter and up 12% in the first nine months of the year. Again nicely tracking to plan. Operating EBITDA, which is our best measure of true operating cash flow, came in at 45 million, up about 16%. Through the first three quarters of this year operating EBITDA is running about 15 million above reported EBITDA and on track to come in roughly 20 million ahead for the full year. Reported EBITDA of about 40 million was also up 16% versus prior year and came in a bit ahead of plan despite the selective pruning of accounts in our merchant acquiring business EBITDA was unaffected, as all three of our segments marketing, transaction and credit notched double-digit gains in EBITDA. Our margin expanded to 18%, representing over 100 basis point increase from third quarter a year ago, as a dual benefits of strong across the board growth in our three engines combined with the effects of pruning non strategic low margin accounts. And finally, cash earnings per share of $0.17; 55% growth rate also came in a bit better than anticipated, overall, a pretty good quarter. Let's turn now -- get into the individual segments. First up, the Transaction Services, which houses two of our three growth engines Private Label processing and Utility processing as well as being the home of our traditional merchant acquiring business. During the quarter, we selectively pruned non-core low margin accounts, which included the lying down of Shell from our merchant acquiring segment. While top line was somewhat impacted, this had no negative impact on the segment's EBITDA. The pruning process is now completed, and we expect the remaining merchant acquiring core clients plus a few new signings to generate moderate growth going forward. These core merchant clients generated about 450 million transaction in Q3, represented a mid-teens transaction growth rate from prior year. Finally, as we've grown and focused more and more on our higher value added growth engines, the remaining traditional acquiring business has declined from 25% of the company back in 2000 to just over 20% of the company last year, and is tracking to about 15% of Alliance this year. We would expect the remaining core business to represent somewhere north of 10% of the company going forward, as mentioned earlier grow that about 10% per year. All right, moving across the pruning in the merchant acquiring group, the fundamentals of the overall segment remain solid. Both utility processing and private label processing kicked in double digit top line and EBITDA growth as the core client base continue to grow and new clients such as Ann Taylor, Pottery Barn and Restoration Hardware in the private label group and Duke Energy in the utility group began to ramp up. Overall, the effective replacement of lower zero margin merchant business with more value added private label and utility clients resulted in a very strong jump in margin versus prior year in last quarter. Our outlook remains positive as we expect continued double digit growth in the segments EBITDA, with top line essentially catching up over the next couple of quarters or so as our new clients continue to ramp up. Next up would be credit services, which continue to pick up speed as top line grew 20 percent and EBITDA surged over 24%. Let's now walk through the four drivers of this segment: credit sales, portfolio growth, funding costs and credit losses. First credit sales, continue to outpace all expectations. We normally target 12-15% growth in sales, this year Q1 and Q2 both came in at 20%; a very nice surprise, and Q3 showed an ever more impressive 23% growth rate. This seems to fly in the fate of all the talk about a consumer slowdown. However in our case you need to break down the components one by one. First, we make money based on a client's total sales, not comparable store or "comp sales" as they are called. Thus a client could have lousy comps but decent total sales if a bunch of new stores were opened. But to assume this component alone gives us mid single digit growth. Add another few clients due to increased wallet share as we've seen the share of each dollar spent at the client continued to shift to private label. Combine these two and you've got roughly 10% in our credit sales. The final piece of growth comes from new clients. It's key to note that these new clients represent new signings that have been ramping up from as long as 18 months ago. These ramp-ups have added another 10 points to our growth rate to give us an all in 20% range. To sum up, we've had solid growth from the base plus tremendous success in new client signings. Turning next to portfolio growth, we have been tracking to expectations and seeing around a 10% overall growth as consumers continue to spend but remain cautious about bringing on excessive debt at least as it relates to our private label cards. Next, we turn to two of the segments major operating expenses, funding costs and credit losses. Funding cost will continue to improve as half the portfolio's debt matures over the next year. Since we fund our fixed rates cards with fixed rate debt the maturing debt will be replaced with new long term that is potentially five-year money at more favorable rates. This is the gift that we'll keep on giving for many years so you lower operating expenses. And finally, credit losses continue to improve. At this time last year, our losses were around 8% at the peak of the recession. We've seen steady improvement this year with Q3 coming in a bit better than 7.5%. Delinquency trends are also tracking well below year-ago levels, which strongly suggest these positive results will continue. Okay, wrapping the credit segment, all four drivers are pointing in the right direction, Q3 was very strong and we expect more of the same going forward. Quickly I'll touch on marketing services Mike spent fair amount of time on loyalty program up in Canada and it extended its impressive track record by posting another quarter of double-digit growth in both top line and EBITDA. Specifically, top line was up 15 and EBITDA was up 17%. Now this year it came in just under 10%, right in line with expectations and the other driver miles redeemed came in the high teens. This driver varies widely but year-to-date redemptions are up 28% versus last year, which is quite a bit better than our goal of 20% on an annual basis. Outlook here simple and exciting expect more of the same; post [op]. All right, that finishes the vast bulk of the quarter story now lets quickly move through the remainder of the presentation. If you can turn now to the balance sheet, no major changes from last quarter or from plan. Capital structure remained extremely sounds. Revolver key bank covenants tracks are debt, during the cash flow or operating EBITDA. We have the flexibility to have up to three times debt to cash flow. At the end of Q3, this ratio was considerably within our comfort zone and came in at less than two times. Finally deferred revenue of $350 million reflects the net activity from new AIR MILES issued less those redeemed. Over the last 12 months, deferred revenues have grown a net $34 million bit ahead of plan. These revenues and earnings will flow into the P&L over the course of the next few years. Again, balance sheet is in good shape. Moving right along here to 2002 outlook, next slide, we'll keep this very short and sweet. Our three growth engines are all firing on all cylinders, and our pruning in merchant acquiring is done. We believe our top line EBITDA and cash EPS are all tracking ahead of our original expectations. Specifically, we expect full year top line of 870 million, EBITDA of 148 million, cash EPS $0.62. In sum, we're looking to close out another year on a very, very strong note. Updating our free cash flow slide -- next slide, operating EBITDA of 168 million represents cash flow from operations. It combines both reported EBITDA as well as roughly 20 million of gross profits from our loyalty program in Canada, which have been earned, cash received but the revenues and profits are required to be hung up on the balance sheet and brought into the P&L over roughly three years. If one were to burden operating cash flow with other core costs such as CAPEX, interest and taxes resulting free cash flow of 71 million equates to $0.92 per share versus reported earnings of $0.62. This free cash flow can then be used to fund a couple of small tucking acquisitions, which would further bolster growth or to pay down debt. All right, we're getting near the end here, so let's move on to 2003 and finish up the slide titled consumer spending. Before we do wrap up, we did want to spend just a couple of moments on the number one questions we've been asked in the last few months starting probably around July and specifically the question is what's the risk to the business model, should the consumer finally call it quits. We at Alliance believe that the risk is quite manageable and to understand why, let's walk through the segments. On the slide, you'll see our first segment, loyalty program in Canada this quarter of the company. Let's take a look at how we make money up there. We make money based on consumers non-discretionary spend going to a gas station, buying groceries, going to the pharmacy, buying life insurance. Again, we would expect minimal impact with the consumer slowdown. Moving to transaction, it's about half the company, again we don't see a big hit from a consumer spending slowdown. First, big chunk of that segment is consumer non-discretionary spend, people going to the gas station, people paying their utility bills. To the extent, revenues are derived from private label processing. Again, doesn't really matter whether or not you shop in the store in a given month, if you carry a balance, we'll be sending you a statement, we'll be servicing the account, we'll get paid. Turning now to the final piece, credit which is about a quarter of the company. It's a significant piece of our company but not an overwhelming piece. We think that any consumer spending slowdown would probably impact this segment. However, we do feel comfortable that we've this mitigated by roughly four factors. As we talked about earlier, we make our money on a client's growth sales not on comps. On a nutshell give us single digit growth sales and we're off to the races. Next, startups continued to ramp up although, there are great announcements to make this year to start our programs we talked about really don't move the financial needle to well into next year. And those are already been signed and booked. Next, turning to operating expenses, credit losses are in fact improving. I think people sometime scratch their head and say, "I don't understand in this tough macro environment how our credit losses could be improving." Again recall that we do not designate nor do we target any subprime accounts and versus the peak of the recession last year where our losses peaked to 8%, you should expect to see some improvement and that's exactly what we're seeing. We are not all the way there yet, which gives us upside should the economy really take off, but we think we're in very good shape. And finally, funding costs, unlike most bankcard issuers, our cards are fixed rate. We fund with fixed rate funds with maturity stated over three years period. And as such, we expect to continue to see incremental benefits from today's low interest rates as we roll over half of our funding in the next 12 months. So to wrap up, even if consumer spending slows we believe we are well positioned to weather the storm. That being said, last slide for me at least, let's turn to our specific '03 guidance and I'll kick it back over to Mike. We believe that our results will remain strong despite the difficult macro environment. The trends in all three-growth engines are strongly positive including the new business pipeline. That said we are looking for top line or roughly 970 million, up roughly 12%. EBIDTA of 170 million, up 15%, cash EPS of $0.73 up 18%. Other metric of interest are operating cash flow also called operating EBIDTA, which should come in around 190 million and free cash flow defined as operating cash flow and including core expense such as CAPEX and interest and taxes, which is certainly coming north of $1 per share. We'll be refining these metrics over the next quarter. To sum up, based on the company's performance during '01s recession and the trends, we're currently seeing -- we're bullish on '03 and expect to continue to track for our long term business goals of 12% growth for top line, 15% for EBITDA, and high teens on per share. That's it from me; kick it back over to Mike.

Thanks Ed. And for the last slide. And then we'll get to Q&A. As you'll see our graph of performance each of our years from 2000 and through our expected performance in '03 shows revenue, EBITDA, cash earnings per share, the average annual growth rate of each of these 13, 17, and 22% respectively. And I really just want to point out two things; first, this illustrateS how we continue to deliver on our promise of solid double-digit growth ranging from the low teens on revenue to high teens on cash EPS. And secondly, our performance demonstrates a highly visible and predictable business model. We are optimistic about our future, and we will continue to focus on the basics that being steady organic growth and high visibility, and effectively use our cash were appropriate to look at strategic tucking acquisitions to continue much as we have in the past two years. Now, let's turn it over to question and answers. Operator, if you begin to take calls.

Yes sir. At this time, I would once again like to remind everyone in order to ask a question, please press "*" then the number "1" on your telephone keypad. We will pause for a moment to compile the Q&A roster. Your first question comes from the line of Jim Kissane with Bear Stearns.

Thanks. And hi, Mike. Done a great job on another really good quarter.

Thanks Jim.

Can you talk about the new programs, and how they ramp relative to your expectations? You know my sense is they ramp faster than normal, and can you -- if that's the case, can you comment on why?

Sure. They're really two pieces I assume you're talking about the Private Label Business.

Yes, sorry the Private Label business. The deals you sign late last June and early this year.

Yes, sure. As you know in the credit services part of the company, we make money in two ways, one is through merchant discount and the other is through the net finance charge on the portfolio. Merchant discount is may be a quarter of that revenue stream, the other three quarters is coming through the net finance charge. So you're exactly right, when you crank up a program within 6-9 months get and going, you should have some pretty decent sales growth, and you should have some pretty decent merchant discount. However, it takes longer then that for the portfolio to catch up. So that's why I would say stuff that we sign in the first couple of quarters of this year really don't have a nice impact to us meaning both merchant discount and good finance charge of the portfolio for at least 12 months.

Okay, so that's still to come in. And how does the pipeline of new programs look, potential new programs -- potential new programs?

We continue to have a strong pipeline of new customers. Our successes this year have been great door openers for additional new prospects. I do want to mention to your question of the ramp-up process too, Jim. The -- as you know the Pottery Barn and others have just had a tremendous rollout and it's going after and actually it's slightly ahead of lot of our expectations. So, it's going very well.

Okay. That's excellent. And Ed, in previous calls you mentioned that you were seeing some early pay down of credit card debt which was I guess, you know, good sign for credit losses. Can you update us on what's going on there?

Sure, yes pretty interesting. It's -- we're seeing the exact same thing we've been seeing whole year. Normally, back on envelope if you were to grow credit sales 12-15% per year the resulting growth in portfolio should be about 10%.

Yes.

We're seeing our 10% growth that we had assumed we would get when we put the budget together. However, that's on credit sales growth, north of 20%. It's a long way of saying that consumers are spending but they seem to still have the liquidity necessary to pay down their debt and that they don't seem to be leveraging up at least as it relates to our private label card, maybe it's because of all the, you know, the home refis and stuff like that but there's definite liquidity out there.

Jim Kissane Okay. I can just have one last one. I'm sorry. Are more and more of the AIR MILES being redeemed from non-AIR products?

Yes, we continue to see movement Jim, from AIR to non-AIR. In fact this quarter for the first time, we have actually had more miles, normally it was more miles on AIR redemptions but this is the first time we've had more miles redeemed on non-AIR transactions. We've always had for the -- well over a year now more numbers of redemptions but actual miles redeemed are -- for the first time higher than AIR.

That's normal. Thanks.

It's going great.

That's great. Thank you.

You bet. Thank you.

Your next question comes from the line of Lauren Fine with Merrill Lynch.

Thank you. Great quarter. Just a couple of questions for you. I guess, you did indicate that underlying transaction would have been up double-digit barring the pruning. I'm wondering, if you could be more specific, and then on the data that you provide what you're now providing core transaction data, I'm wondering is that sort of a number we now use for modeling purposes going forward because its obviously dramatically lower, and so I'm trying to figure out how to use that to project and if the presumption then is that the revenue per transaction now that you've got new lower margin accounts out is higher or lower? I'm having trouble figuring up the trends there?

Okay. Ted, I'll take a shot at it. I reserve the right to start at the end and work my way back if you don't mind. Absolutely, use the core number going forward, we would expect the cores to apples-to-apples year-over-year and I think if you use the 10-12% growth rate in transactions that will get you in the ballpark and probably you know make it simple use the nickel, that will also get you in the ballpark. So that should get you off and running in terms of the quarter itself if you. We did EBIDTA growth I, think 12%, normally we would expect to do 10-12% on top line, which means our top line would have been $10-12 million higher during the quarter. And that would suggest couple of things, one is the pruning did knock top line growth down by a good chunk of that without touching EBIDTA or cash flow and then also the migration out of the Citgo bankcard settlement business also tagged it a little bit. So I think what we would expect going forward is EBIDTA to continue to chug along in the nice double digits low teens area with top line beginning to catch up over the next 2-3 quarters as going back to Jim's question that the Pottery Barns, the Restoration Hardware, the Duke Energy, the Crate and Barrels all begin to ramp up.

That's great. And one last thing, in terms of revenue per statement, it's my understanding with near the recent small acquisition does that number that would then continue to come down. Is that a correct assumption?

No, I think -- I don't think it's going to be big enough to cause it go down. I think during the quarter, we still saw a double digit increase in revenue per statements you know quarter 10% versus Q3 of last year. A lot of it depends on how many statements you actually use related to the Duke signings. Probably a good number to use would be about a million and a half statements per month, would be about right.

Okay. Thank you.

Yes. Thanks Laura.

Your next question comes from the line of Charles Trafton with Adams, Harkness & Hill.

Hi, thanks, good evening. The miles issued were up nicely sequentially and year-over-year, but the trust fund, that that represents was down a little bit to 157 million. Is that over funded and so that you -- did you need to take some money out of there?

The restricted cash accounts of 157 million, Charles.

Yes.

Why is that down? Good question. If you notice sequentially both deferred revenue on liability side and the trust account or redemption settlement asset account were down a little bit. That is 100% attributable to foreign exchange. In other words...

Okay.

We convert the accounts at the end of the month and if you looked at the Canadian dollar or the [luni] as they call it, that was up $0.02 by the end of the quarter which whacked, you know, 5, 7 million in US. Normally, all things being equal it would've been up.

Okay. And looking at the June of the 10-Q for the June quarter, it looks like you've paid down some dept in July and the debt actually though was still up or actually didn't go down by the 50 million in which you paid down some debt. So did you pay some down and then take some more on? I think, you paid down 50 and took another 40 on. And what do you think about the balance sheet going forward on your capital structure?

Sure. I'll take a shot at it. I think we did wipe out about 50 million of very high priced high coupon sub debt in the early part of the year, and what we did is we just refinanced it with much better rates. So we wanted to take advantage of that. Going forward, I'm stretching here a little bit, but between Q2 and Q3 our net debt, I believe improved about $10 million on a net basis, which would suggest we used free cash flow from the company and also used the remaining free cash flow to fund the Duke Energy deal that we did.

Right.

But going forward, you will have in the Q4 a temporary move up in our debt primarily CDs used to fund the holiday receivables. In other words, our receivables go up quite a bit during the holiday season and then go all the way back down by the end of March. So we expect to see a little bit of that and then that comes back down by March.

Do you have any update you want to provide on Texaco, Shell, Chevron situation? I think that was going to expire in December '02.

Yes, Charles, this is Mike. The -- that has basically been taken into account in the transaction growth we've been talking about Shell now for about a year and a half and they...

Right.

So finally begin to move off -- onto their own in-house that Texaco platform that represented really -- frankly over half of the transaction graph. When we talked earlier about pruning those transactions come in from smaller customers that had the contract expiring really only represented about a 15% prune so to speak of the customer base. The big one was the Shell in-house move as they try and leverage that plant that had been build by Texaco.

Right.

And that will be all done by the end of this year.

And last question how much revenue did you get this quarter from utility clients, and do you have a comparable figure from the year ago?

I don't think we breakout specifically utility but we can probably get you in the ballpark. I would say on the utility base -- on the utility clients that we have, it was up probably above 20% versus prior year.

Right.

And utility represents -- we'll call it -- about 15% of the segment.

Okay.

That gets to the mass.

Yes. Great thank you very much.

Thanks Charles.

Mr. Parks you now have a question from the line of Jeff Baker with US Bancorp.

Hi Jeff.

Hi guys. Nice quarter. Just of couple of house -- one housekeeping -- CAPEX during the quarter, Ed?

CAPEX during the quarter was about 10 million.

And going forward expectations?

Yes, same drill as before. We expect CAPEX to be 5% of top line. So, we're going to do a, you know, 170 million this year. We, sort of, expect CAPEX certainly not to be north of 43 million.

Okay and then, I guess in your '03 guidance what are your assumptions as far as your -- as it relates to the refinancing of the $1 billion in receivables, as well as your net charge-offs? Where do you -- where are you looking for those to go?

As we look into '03, obviously those are two big operating expenses. We're assuming a pretty tough macro economic environment. If credit losses, let's say, went from 8% at the peak of the recession to 7.5% that we're running at this year we would expect a more moderate improvement going into next year than a full 50 basis points. On the funding side, we would expect that we would pick up, you know, between 50 and 100 basis points on the refinancing.

Okay and then you said in the -- on the call that your delinquencies and charge-offs improved. Do you have any specific numbers?

No. In terms of charge-offs, again which is the one that impacts the P&L, the year ago quarter we did roughly 8%. This quarter we talked about a little bit better than 7.5%, probably closer to about 7.3%. So it was quite a nice quarter. On the delinquency side very much the same story, last year a little over 7% -- this quarter more in the range of about 6.5%. So directionally, both are heading the same way. For those of you who don't live and breathe credit everyday usually your third quarter is your summer quarter, and that tends to be, on a seasonal basis, a little bit higher than your second, and a little bit higher potentially than your fourth mainly because of sloppy phase, but overall same trends.

And your visibility six months out is that what...

Sure. Delinquencies, which accounts -- when you look at credit losses the vast bulk of them, you can take a good view of when you look at how are your delinquencies. An account needs to be delinquent 180 days before we finally write it off to the P&L, which would suggest we should have a pretty good clue as to where we're heading over the next couple of quarters.

Okay. And then I guess the last question is, it sounds like everything is doing good, I mean, what keeps you up at night?

You know, we all -- I guess, we're going to keep close eye on the consumer week. We'd certainly love to have a stronger fourth quarter than what a lot of people are predicting. We're, I think, well positioned -- even if it doesn't, but we keep an eye on that. And we just continue to want to make sure we keep our sales force bringing on new business like we have this year, and we'll continue to have a '03.

Yes, I think, to Mikes point, as we budgeted and put together our '03 numbers, we assumed really that the tepid recovery continues. You know, the overall macro environment is sort of limping through at least in the first part of '03. What will keep us up at night, of course, is that everything comes to a full grinding halt, and there is a full-blown heavy-duty recession, but barring that, I think we are in descent shape.

And then the last thing in '03, can you give us right now what you expect to sign up new -- as far as large contract lengths like you did this year? How many you expect to do?

We'll probably do again 10-12 range of accounts again which is our typical.

Okay. Great. Hey, thanks a lot and nice quarter.

Thanks.

You now have a question from the line of Art Bender with CSFB.

Hi, this is Sam John in for Art Bender. Nice quarter guys.

Thanks.

Thanks.

Couple of questions. First, what impact, if any, are you seeing from the credit crunch that the US electric power industry is facing? What impact does that have on your utility business with respect to possibly new clients signing to help with your customers or the possible gain of loss of customers due to industry consolidation?

The credit crunch really doesn't affect any of our existing customers. They continue to chuck along at, you know, mid single digit growth rates in at themselves. We've talked about this before in some of our conferences. Really turmoil in that industry benefits us. Whenever there is turmoil really in any business as people look to drive cost out of their business, look for new ways of providing service, there's a lot of PUCs beating up on utilities for providing better levels of service. Those are all kinds of things that drive potential clients to us. Really we look at it more as an opportunity.

Okay. And the other concern that occurs from clients is, the trend or what appears to be a trend amongst the retailers whether they're promoting their co-branded cards like Target or Sears as opposed to the private label cards seems to fly in the face of the strength you seem to be having in the private label type?

Yes, I don't -- I think that is an additional opportunity for us as we have had a couple of co-branded opportunities as they focus on some of their non core, non loyal customers. It's kind of a second tier approach to try and activate and get access to some of their inactive accounts. Some of the press that you'll read either focuses -- focusing on really becoming a almost a financial institution. I don't think you will be a mass of retailers heading in that direction, a few of them are being driven by that. But the long term, we think that's really another opportunity before providing a whole new set of services in client relationships to try and attract that second tier of consumer. I think -- I don't think you will see them deteriorate the core strength of the loyal private label customer.

Great. Thanks.

You now have a question from Mathew Fassnacht with J. P. Morgan.

Hi Matt.

Hi there. As a follow up to that last question, would you see yourself underrating in the Visa/MasterCards credit cards?

In our trial programs we had not done that. We basically operated the entire program, marketing customer service, service processing etcetera, and as we look at the customer opportunities we'll make that decision and depending on the type of retailer, their average ticket, what the kind of balances would be. You know, I don't think we have a dominant strategy on that other than our focus of customers, as you know was all around smaller ticket kinds of -- kind of clients.

You mentioned Abercrombie & Fitch bought additional services. Could you elaborate on that, and talk about the opportunity across the other customers for that?

That was actually a renewal. It wasn't a new contract, Matt. It was a two-year extension of our database marketing services. That's the service where we build and maintain a database of consumer information both from the private label card, from some industry purchased information and the SKU level data on what was purchased. We have, as you know, over 100 million of those consumers on file with about four years of data, and that's the renewal of that contract. And yes, we are pursuing other retailers for that kind of offering.

And what do you expect for growth to look like in the transaction processing segment after this pruning -- obviously, to be? And that's another three quarters to annualize that, correct?

Yes, I think our goal is that, you know, at some point next year, hopefully, sooner than later the big signings we did this year really crank up that will get transaction, you know, back up to snuff with the both top line to go along with double digit EBIDTA growth. But I think, it'll be probably be a trend of transition of Q4 we'll get a part of the way there; at Q1 we'll get most of the way there; by Q2 we ought to be rocking both the top line and EBIDTA. But you know, outside of the top line EBIDTA itself in transaction should clip along nicely double digit continuously.

Looked like statement growth slowed in the quarter. Can you talk about what was driving that?

In terms of statement growth, I think part of it had to do -- or not part of it -- I would say 98% of it was the fact that the Charming relationship -- Charming Shoppes relationship...

Yes.

...that we had talked about earlier in the year finally wound down in the statements -- you know, basically went away versus this time last year. So that knocked probably 4 or 5 million statements out of the quarter statements. So again, as we continue on down the path of finishing up that grow over, we should have a nice acceleration into next year.

And then finally on the utility, how many statements are you processing currently?

We would say on a quarterly basis, we're probably, I think, we'll give a range of we're north of 5 and less than 10 million. How is that?

Okay.

About somewhere in the middle.

Okay. Thank you.

On a quarterly basis.

Once again, I would like to remind everyone, in order to ask a question, please press "*" then the number "1" on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Mr. Parks, you now have a question from the line of Wayne Johnson with Sun Trust Robinson Humphrey.

Yes. I was just curious, could you expand on any type of new technology or new functionality that you're hoping to bring as add-on services, you know, particularly, in the transaction processing area? Number one. And number two, do you think that there's anything that you guys can do outside of the debt reduction? And the good job you guys are doing of keeping the bad debt charges-offs low to reduce operating expense any further than what it already is as percentage of sales? Thanks.

Let me try the first part of the question. Our focus in new product opportunities in the transaction segment, which includes private label utility in either primary growth engines and still some continued growth in the point of sales business. In the private label business, as we've mentioned earlier, we continue to rollout web based capabilities, as well as, our co-branded evaluation as something that we're focusing on also beginning to look at some commercial card product offerings. In the utility sector, the recent new contract signing with Duke brought with it some enhancement in the SET banner platform, which we think can leverage into that utility space, as well. And then, thirdly in the point of sale arena, we continue to invest some CAPEX dollars in both our dynamic value product, which is a deposit account in effect for the unbanked to focus in on our petroleum convenience accounts tied with instant recognition and rewards at the point of sales that drives consumers in to the store locations to drive more profitable sales for those accounts. I'd expect we'll begin rolling out several of our new clients at the beginning of the next year in that area and that's kind of an exciting.

Yes. And to follow up, again on Mike's part. The - if you were to look at the chart, we popped in there just to see the results. Our EBITDA margin has moved up nicely from about 15.5% back in 2002. We think, we're in good shape to be about 17.5 next year and we are looking to do about 50 bips a year and then start until we have about 20%. So that's sort of our objective.

Great. Thanks, and congratulations on a terrific quarter.

Thanks, Wayne.

Mr. Parks you now have a question from the line of David Tossman with Wachovia.

Thank you. Mike, when did Bank of Montreal start issuing miles for the debit cards? And do you guys have an opportunity to expand that geographically instead of turn it into a sponsorship group more generally?

The debit card program with Bank of Montreal was started in 2000 for their retail ATM online debit card clients. And I have to get some more detail with you on some of the other thoughts in terms of the plans to expand that program. I'm not familiar with any existing conversations about that right now, David.

Thanks.

You now have a question from the line of Dan Perlin with Legg Mason.

Thanks. Couple of quick questions. Do you have a transaction history once you purchase accounts, can you just give to us real quick and -- rather than kind of e-mail out a letter?

I'm sorry I'm not tracking with the question.

You did 446 million transactions, in terms of transaction volume this quarter.

Yes.

Do you -- may be it's in the press release as you obviously did. What is it for second quarter, first quarter, and fourth quarter?

Sure.

Can you give us that real quick.

Yes. Same quarter this year 423, first quarter 362, last year second quarter 366, last year first quarter 350.

Okay. Great. I appreciate that. And of the 18% growth that you guys are forecasting for '03, what roughly percentage is going to come from the kind of this portfolio refinancing which, I think, is going to be done in October. Is that right, this month?

Yes. In fact we're often running on that.

Okay

We...

Part of it this quarter, and another part in next year.

Yes, we have about 600 million coming due this month, and I could say we are often running, and we've between now and probably March to get a deal completed there and then the other piece would be in the spring of next year.

Okay.

You know, let's keep it sample, let's say, who knows where interests rate are going, but we'll be able to pick up, you know, a minimum of a 100 basis points on these refinancing. And I think, the key thing is not just that it gives us a little bit of something in our hip pocket for next year. If in fact the consumer really does fall off the cliff, but it's more of -- we have the opportunity to take one of our big operating expenses and lock it in for as much as five years at rates that chances are -- we're not going to see again for a long, long time. So, it's not just next year but we're pretty excited about getting this stuff in for five years, because again our assets or cards are fixed rate. So we fund them with fixed rate money, very much-- very dissimilar to bankcards.

I got you. And do you have the G&A for the quarter?

G&A for the quarter usually runs around 6-6.5% of our sales and if you want to...

Okay.

...follow up I can certainly give you the schedule.

That's good.

But nothing too exciting to report on that end.

Okay. And lastly, in terms of kind of where the private label business is today for their customers that you have signed up thus far, and those guys ramping up, you know -- are we kind of like 10% done in terms of ramping those things up, 20% done or even earlier than that?

I don't know how we put it on a percentage. In terms of the roll out of the signed contracts both the, what I'd call startups of the systems and the conversions is 100% complete. As you now operate the system and go through the sign up process for new consumers throughout this year and leading up to the fourth quarter, which Ed was referring to that really drives the balances. Those are the real drivers that take place in the fourth quarter. Our recent finding of Crate and Barrel isn't converted yet or hasn't started up, and we're beginning to have that, let’s see if I can find that…

November.

The conversion, yes, October 28th is our conversions. We actually have started loading on some new accounts as of the 1st of this month. The primary conversion is in October.

Okay.

[indiscernible]

Thank you.

You bet. Thanks a lot.

You now have a question from the line of Barrie Stesis with CIBC World Markets.

Hi Good afternoon. Actually It's Jennifer Scutti. You know you had answered most of my questions I just wanted to ask something more about macro basis. You talked a couple of times during your formal presentations about tucking acquisition and the possibility for that. Could you maybe give us a little bit more insight as to, you know, what you see there? What the opportunities are? I know you've done one in the past, is it more of the same what you see in businesses to get into, and then secondly, an unrelated type of question. It seems that in the last few months, certainly, the rate at which you've added a utility client has increased, and I'm wondering if you're finding that you're gaining some visibility and market presence in the space and if, you know, the -- your ability to sign new customers incrementally is becoming a little bit easier as you gain a foothold in that market? Thanks.

Thank you. Yes, the utility, as we've talked about before, is a huge market, $3 billion or so. It's really a driver that will continue to fuel our growth for, you know, the next five to ten years. It's a nice, steady growth. I think, certainly, we have stepped out in front of a very fragmented servicing market and Alliance Data is now a very well known name. So we've got great momentum in that sector and I'm very pleased with that.

The tucking -- tucking inside.

We're -- as you can imagine, in this kind of economic times and credit crunches, we're seeing a lot of different ideas come across our table, but very few of them are very interesting or anywhere near what the value of what someone would like to buy. We are still actively looking. We will continue to focus on, again, small and similar to the FMI transaction where we think we can accomplish bringing on a new strategic kind of service offering that fits our business model and that being loyalty driven transaction processing kinds of relationships, long-term contracts, and allows us to get to a strategic level with our key kind of accounts. Ed, do you have any other?

Yes --no, I think that's -- you know, pretty much sums it up. I think at a very high level, you know -- again, we're an organic shop. A vast bulk of our stuff is organic. To the extent, we supplement it with a little bit of tucking work. Chances are, if you looked at, for example, the signing of the Duke deal in Canada, great signing, but it was really -- we did have some capital that we used there. So it may be less of an acquisition focus going for more of where you're going to use your capital. And up there, it gave us a platform, gave us feet on the street in Canada, which allows us to expand the utility group all throughout Canada. So, maybe, a little bit more of use of capital versus just an acquisition.

Great thank you.

Thanks Jenn.

All right. Golly, it's almost [indiscernible] after the hour. I think we'll wrap it up. Thank you everybody for being on the call. We're excited about the rest of the year, and we look forward to seeing you at about the end of the quarter. Thanks again.

This concludes today's Morgan-Walke conference call, you may now disconnect.

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