Bread Financial Holdings Inc (BFH) 2002 Q4 法說會逐字稿

Good afternoon. My name is Kelly and I will be your conference facilitator. At this time I would like to welcome everyone to the Alliance Data Systems Fourth Quarter 2002 Conference Call. (Caller Instructions.) I would like to introduce Stephanie Prince with FD Morgen-Walke. Ms. Prince, you may begin your conference.

Thank you, operator, and good afternoon everyone. By now you should have received a copy of the Company's fourth 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 Edward Heffernan, Chief Financial Officer of the 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, Stephanie, and good afternoon everyone. Thanks for joining us. We've got a lot to cover today so let's hit the agenda and we'll press on. We got a full 20 or 30 minutes here to get through. We want to start with the reviewing the fourth quarter highlights and then we'll spend a few minutes reviewing the major accomplishments for the entire year. And as in previous calls we'll provide a high-level overview of one of our three growth engines. Today we're going to highlight the utility services business. Afterwards, I'll turn it over to Ed. He will review the financials and reiterate our guidance and then we'll take your questions.

If we'll turn to the next slide, you'll see we had a great fourth quarter. Very pleased to announce record performance again. We reached nearly 237 million for the quarter, a 12 percent growth over the same period last year. EBITDA was just over 42 million, a strong 16 percent growth over last year. Each of our segments also continued to contribute as planned. Key metrics are strong, demonstrating for us that our businesses are on track and growing nicely. One key driver I do want to highlight is our credit sales, which increased 22 percent over fourth quarter last year. Despite some sagging retail sales reports we continue to see strong growth in our credit sales. We attribute this increase to the maturation of several of our private label programs and new start up accounts and the emphasis our retailers place on their private label programs. We saw an increase in wallet share as well across many of our private label programs, proving once again that the private label card is the most effective loyalty tool out there.

Turning to the next slide, we also announced through the fourth quarter some exciting new. We announced some new clients. First with Gordmans, a family-owned specialty-clothing retailer, operating stores across nine Midwestern states. We'll provide a full private labeled program for them including credit, funding, customer acquisition and retention, customer service, statement generation and remittance processing. They selected us because of our strong retail heritage and our reputation and our great track record for proven results.

Also and very exciting to announce is the Direct Energy new client relationship as a new sponsor on our AIR MILES reward program. This continues our expansion into some of the new categories we've been talking about, giving collectors the opportunity to earn reward miles for their natural gas usage. Direct Energy will become the only natural gas marketer in Ontario and Manitoba to offer our loyalty program as part of their strategic business plan.

In the last quarter we renewed three of our top ten clients -- Brylane, which we announced last week, Safeway Canada and Georgia National Gas. I'd like to note that in addition to our billing our servicing for GNG and their 550,000 deregulated customers, we expanded our services to include database marketing for the first time. This quarter we reached critical mass in our utility operation. We completed all of the integration activities from our client signings and now have a solid based from which to build the business and leverage the infrastructure.

And lastly we strengthened the Company's financial positioning as a result of the $600m asset-backed transaction we completed this past quarter. The five-year asset-backed notes are part of the securitization program for our private label business and we locked in very attractive fixed rates for the next five years. It will benefit both through lower operating expenses and enhanced cash flow.

Turning now to 2002, we had a tremendous year. I'm very proud of the hard work and commitment our management team and our associates across the board contributed to this success. And I want to take a moment to recap a few of our accomplishments. This year we exceeded all of our financial targets. Revenue came in at 871 million and EBITDA just over 150 million. The strong performance was achieved despite the uncertain economic times and conditions and we executed very well on our business model and additionally proved that the business has a number of safeguards which allows us to weather a sluggish economy like this. In a moment Ed will review in more detail our financial results.

Our success in building strong relationships with our clients is also underscored by contract renewals through the year. We signed renewal agreements with many of our long-termed clients like Dress Barn, Avenue stores and Marathon. But most notably we renewed seven of our top ten clients, including Limited Brands, Brylane, Bank of Montreal, American Express, Georgia Natural Gas, Citgo and Safeway. These renewals provide a strong base of recurring predictable revenue for the next several years.

We also add major relationships with these strong partners by expanding those relationships with new products and services. We recently announced relationships with BB and [indiscernible] and [Thasoro] [ph] to start using our new Dynamic Value card. As I mentioned a moment ago, we also extended database services with Georgia Natural. Additionally, we find a number of new clients in all three segments. We've added some marquee names to our already impressive list of clients like Pottery Barn, Ann Taylor, Restoration Hardware, Duke Energy, Subsidiaries Union Gas and Pacific Northern Gas.

And lastly, I want to highlight our success in gaining confidence with the investor community thanks to our solid business model and strong execution. We consistently have delivered on our promise to shareholders. We've exceeded our targets and remain confident about our future.

Let's turn now, and as you know in our previous calls, we spend some time talking about our three growth engines. And today we're going to highlight the Utility Services Group. As you know our entire business plan and philosophy is built around helping customers develop strategic and loyal relationships with their customers, improving their customer experience while enhancing operating efficiencies across the board. In 1999 we determined that this expertise could be extended and leveraged into the utility industry and we've successfully executed on this strategy the past several years.

Turning to the next slide, you'll see a graph of the market -- our market's success. We recognize this opportunity -- really started our research back in '97 -- and began to offer services in the '99 timeframe. Since then we've tripled our business and have plans to reach $120m in revenue in 2003. This makes us one of the largest providers of outsourced billing and customer care services in North America. We provide customer information system, operations and billing, payment processing, call center care services, marketing and loyalty programs. We believe that offering this complimentary suite of services has allowed us to secure contracts with some of the largest energy providers across North America. And you'll see those listed on the next slide.

Our core offering is attractive to both deregulated providers and the regulated industry and our client base is a healthy mix of both. We've had some major wins including Georgia Natural, a major deregulated provider, Puget Sound Energy, a large and well-respected regulated utility. Both are industry leaders and at the forefront of this change. We've been successful in securing utility clients and achieving rapid growth even as the energy industry is experiencing a major transformation.

And as you turn to the next slide, we'll take a look at how the deregulation is changing the utility industry and creating an environment well suited for our business model. As you know the most significant trend to affect the energy industry in the past decade is deregulation. Like most major markets that have been deregulated, whether it's airlines or trucking or telecom, the reason for deregulations were similar and compelling, essentially regulators and deregulation proponents believe that encouraging utilities to compete for customers would reduce prices, improve service and spur innovation.

But the reality of deregulation of the electric and gas industry has had mixed results. For example, while some electricity and gas customers have experience attractive savings, others have had significant price increases. I think it's important to note that many of these price increases have been driven by transmission bottlenecks and problems and really not just capacity issues. Likewise, while it's believed that competition for customers would increase service, many deregulator markets have been plagued by billing errors, reduced customer satisfaction and a growing consumer mistrust. In the end what was thought to be an industry with a relatively simple business processes and data transactions turned out to be much more complex.

Despite these challenges deregulation certainly had produced some needed and beneficial changes. For example utility commissions have become much more aggressive about policing quality and spending, which is forcing utilities to take a hard look at their business practices and internal operating costs. And the benefits reliance put in motion the events which have expanded the market for our services to include regulated utilities as well.

If you turn to the next slide -- although slower than many of the original performance predicted, there has been significant change within the industry and we've capitalized on those changes by winning key contracts and becoming a dominant player. And we see strong support by the industry to make deregulation models successful. A recent example is the announcement by the Federal Energy regulators to make the transmission business more profitable and independent, which will remove the transmission bottlenecks I spoke of a bit ago. This should greatly enhance the stability and the visibility of this market.

What we've seen happen since our entry into the market three years ago is the emergence of two distinct customer groups. And on the next slide we'll speak to their motivation for change. In the deregulated world there are several reasons to outsource. Since many of the deregulated companies are starting with a small customer base, they're looking to avoid big capital expenditures so our ability to offer them a transaction-based service is very appealing. Furthermore, our track record of delivering best in class billing and customer service assures them quality is achieved from day one. Also since we have a strong retail heritage, we can bring to bear on the market our marketing and loyalty experiences and help our client differentiate themselves from their competitors. And finally since our solution is comprehensive and being used in virtually every deregulated region in North America, we can enable our deregulated clients to enter new markets much more quickly than many competitors.

The value proposition for regulated utilities is consistent with what I would call the classic outsourcing model and this model companies look to outsource functions to reliable partners and refocus their attention on what really creates value for them. Resources and capital can be redirected to core business operations and, while doing so, improve non-core operation, gaining operating efficiencies and improving their capital structures. We find these issues really hit home when we discuss outsourcing with many of the regulated companies.

Turning to the next slide I want to demonstrate the value Alliance brings to this market through a case study. Georgia Natural Gas is one of our largest deregulated clients and the largest in Georgia's gas market. As you may know, we recently extended our contract with them. We took over their operation in early 2001.

During the first several months in taking over responsibilities for their billing and customer care operation, we began to knock down problems one-by-one. By enhancing the underlying billing platform, billing exceptions were cut by more than half. Billing exceptions are errors on individual accounts requiring manual intervention to research and correct. In that effect, bills were going out the door either late or incorrect. Systematically correcting the root cause of these errors and user training brought down these exceptions and at the same time we did this reduced headcount.

While we were improving the billing performance, we improved the call center level by nearly 500 percent. Other call center metrics, such as average speed to answer and average handling time had similar and dramatic improvement. By outsourcing non-core operations, Georgia Natural Gas realized the benefits of having a partner like Alliance whose understanding of the differences and deregulation billing systems and operation allowed them to focus on building their business.

I want to quote real quick on our recent announcement with regard to the renewal. Georgia Natural Gas basically stated the reason for renewing this new contract was and I quote, "Alliance Data has been providing Georgia Natural Gas with a full range of customer care services for several years now from hosting our billing system to providing customer care, remittance processing and statement generation. When it came time to renew our contract we decided to explore all of our options, including evaluating top shelf vendors in different service categories. In the end we concluded that Alliance Data offered the optimal combination of value-based and quality oriented products and we demonstrated our confidence in Alliance by extending our relationship another five years."

Turning to the next slide we're well positioned now from that case study and others to serve both the deregulated and regulated markets. Our growth from deregulated providers will be slower as the ramp up period, much like the private label start up, is about building customer bases. The long-term growth potential is high and almost exclusively an outsourcing model. We expect the regulated utilities to provide us with a much more close-end opportunity and more immediate and significant revenue streams as we convert existing customer bases to our platforms. As a result, the growth will be steady and more predictable from the onset.

The good news is we're well positioned for this opportunity and it's a big one. As you'll see on the next slide, we estimate that providing CIS and billing, payment processing and customer care, including marketing services in North America alone is a $3 billion market. And we're not alone in believing that this market is a great opportunity. The Gartner Group recently stated in August of 2002, "Deregulation, tighter margins and shareholder expectations have helped transform the competitive landscape and mindset of utility executives regarding the use of outsourced IT and VPO services."

We're very excited about this market. We've had some early success and we fully expect this to continue. We've done our homework. We've demonstrated results and by doing so, we've gained the trust of G&G, our other utility clients, and Alliance Data Systems has become a recognized and trusted name in the industry. Our business model is a great fit for the utility market and it will provide our company with a long-term growth engine for the foreseeable future.

I'd like to ask Ed now to take a review of the financial performance and reiterate our guidance for '03 and then I'll be back on for a wrap up. Ed.

Thank, Mike. You can turn to the slide with the heading "Fourth Quarter Consolidated Results." I'll start there. The fourth quarter marked our seventh quarter as a public company and like the previous six quarters, we continued to solidify our track record of delivering on what we've promised. This past quarter it's a pretty simply story. Simply put, the quarter was our strongest ever with all-time highs posted for key metrics including revenues, EBITDA and cash earnings.

Revenues of 237 million were up a bit over 12 percent. Driving this were double digit growth rates in all three growth engines which, as a reminder, consist of the private label, the utility, and the loyalty air miles businesses. The continued impact of our previously discussed pruning in our traditional merchant acquiring business kept a check on overall consolidated growth, resulting in our overall 12 percent rate.

For the full year, also a record of just north of 870 million, up 12 percent. Operating EBITDA, which we believe is our best measure of operating cash flow came in on track at 44 million and on a full-year basis operating EBITDA came in at $170m or roughly 20 million higher than reported EBITDA, again, tracking to where we thought. This so-called "extra 20 million" reflects certain cash received and profits earned but not yet flowed through the P&L, i.e. it's hung up on the balance sheet.

Now on to reported EBITDA of 42 million. It was up 16 percent for the quarter. And for the year we hit 150 million, an increase just north of 15 percent. The continued success of our strategy of focusing on growth engines and markets where pricing power is strong can be seen in the continued expansion in our margin. Specifically '02's full year EBITDA margin came in at 17.2 percent, representing a 50 basis point improvement over '01 and consistent with our goal of 50 basis points or better improvement every year, year in and year out. Finally, cash earnings per share of $0.18 was on target and brought the full year in at $0.62 or just under a 20 percent growth rate.

Overall, a strong quarter, strong year and '03 is shaping up to be another good one.

Let's turn now to the segments. First up transaction services which houses two of three growth engines -- private label services and utility services -- also is the home of our traditional merchant acquiring business. Both of the growth engines grew nicely in the quarter as both revenue per statement as well as the total number of statements grew, which are the two key drivers for these businesses. Dampening overall segment growth, however, was the continuing impact of our pruning strategy and our traditional merchant acquiring segment. Certain non-core accounts were pruned, if you recall, during the third quarter as we continued to move away from commodity-like businesses such as plain vanilla merchant acquiring and focus more on areas with strong pricing power such as that found in the utility and private label growth engines.

For the full year transaction services posted top line growth of seven percent. Looking to 2003, we expect solid double-digit top line growth to resume by summer as we approach the end of this merchant acquiring grow-over period.

Turning now to EBITDA, cash flow and profits remain solid. From additional costs related to ramping up or absorbing new business we had to bid on a segment during the quarter, but these costs are ones that will pay significant dividends throughout 2003 and beyond.

Now let's talk about specifically in the private label world. If you recall we were brining up Crate and Barrel as well as insuring a successful first holiday season for Pottery Barn, Restoration Hardware and Ann Taylor. Finally, some minor clean-up transition costs coincided with the completion of our first full quarter of the utility processing client, Duke Energy, up in Canada. For the full year, transaction services posted EBITDA growth of ten percent and we expect solid double-digit growth during 2003 as well.

Next up credit services. And I'm going to spend a little bit more time on this than the other ones mainly because it tended to be the questions that investors seem to be most curious about over the last couple of quarters. Overall credit services absolutely flew through the quarter. And that hopefully demonstrates our ability to weather a slow down by the consumer.

For the quarter our top line surged 24 percent and EBITDA rocketed 64 percent. Again, to understand the results let's step back for a moment and walk through the four key drivers of the P&L and they are credit sales, portfolio growth, funding costs, and credit losses. The first, credit sales, continued to vastly exceed all expectations. While consumer spending and the general economy seemed to take a breather during the quarter, our business in contrast generated a 22 percent increase in sales, which also brought the full year sales growth to over 20 percent. Behind that were three key factors. First our sales are driven by a client's total sales, not the more widely reported same store comps. Thus, while comps might be lousy, total sales might actually be decent. Second, wallet share. In a nutshell, the card works, whereas a year ago perhaps $0.25 of every dollar spent at one of our client's was spend on our card. Today that number may be more like $0.28 or even $0.30. Why? Again, customer loyalty works. These programs work and the client knows this, values this and will pay for this. And finally our growth was driven by our best year ever in terms of bringing on new clients including Ann Taylor, Pottery Barn, Restoration Hardware and Crate and Barrel. Put altogether, we wind up with a pretty nice story.

Next up -- portfolio growth, which came in at 12 percent for the quarter and 11 percent for the year. We continue to see the consumer pay down balances, which is a healthy indication that sufficient consumer liquidity still exists out there.

Turning now to expenses. Our funding costs continue to benefit as we successfully refinanced 600 million in maturing asset-backed bonds. Not only did we refinance them at lower rates, but we extended their maturity and locked in historically low fixed rates for the next fives years. As they say it's the gift that will keep on giving for some time to come.

And just to remind folks our cards are all fixed rate and we fund with fixed rate funds. And as these funds mature over time, we merely roll it over and lock up new term money.

Okay. Last credit segment driver is credit losses. Short version, results were very good again. Specifically, our losses -- credit losses came in at just under the 7.5 percent level, which continued this year's trend of improvement. This compares favorably to last year's fourth quarter where losses were approximately eight percent.

In here we've had lots of questions over the past year as to why our portfolio continues to strengthen when many others seem to be suffering as the economy remains weak. The answer, we believe, makes a lot of sense. First, we have a high quality portfolio with a 700 FICO score and no sub-prime targeting. As such, these accounts should hold up longer than lesser quality ones and, in fact, they did. And second, don't forget the recession of 2001. Our losses did move up moderately to eight percent during the recession. And from there one should expect improvement from eight percent down to, call it, seven percent during the robust recovery. And given the economy's somewhere in the middle today, you'd expect us to be as well and we are in fact right in the middle of that seven to 8.5 -- eight percent range.

For 2003, our budget assumes sluggish macro economic growth to continue and as such we expect our losses to hover in the same range. Delinquency trends at this point to just the same or perhaps slightly better results. Also, so people don't get tripped up, I should mention that delinquency trends are, in fact, seasonal, with Q1 typically trending up a bit as the holiday portfolio, receivable surge starts running off. Delinquencies then tend to level off by Q2, move back up over the summer and then down again during Q4's holiday surge.

That's it for credit. Tremendous quarter, tremendous year and we expect solid double-digit top line and EBITDA throughout 2003.

Finally, marketing services saw a 15 percent surge in new miles issued in our loyalty AIR MILES program in Canada. Combining that with an equally impressive performance in miles redeemed, which increased 27 percent, overall revenue growth was up 21 percent for the quarter and 17 percent for the full year.

Turning to EBITDA. It's important to remember that our profits are earned when a mile is issued. However, even though the cash is received, we cannot book these earnings to the P&L immediately. Rather, these earnings are put on the balance sheet and brought into the P&L over a period of time, such as three plus years. Differing from this, however, are large period experiences, such as marketing and advertising, which could total -- call it, 20 million in any given year. Thus, we have a bit of a mismatch of earnings, which are deferred versus current peered expenses. This tends to cause some choppiness in the quarterly numbers.

A perfect example of this could be seen in Q4 as we took the opportunity to completely refresh our branding for our loyalty AIR MILES program. Much of the expense was for advertising such as TV and radio and newspapers as well as for creative work. We expect this investment to pay off handsomely over of the next few years.

Another way to look at this is the following. The huge performance we were seeing in our credit services segment in Q4 allowed us the luxury of accelerating and completing the complete brand refresh in our marketing services segment in just one quarter rather than pushing into '03 or stringing it out over the next two or three. Overall, marketing services still came in at a healthy 12 percent EBITDA growth for the year and we expect continued double-digit growth during '03.

Okay. That's the long part. Now let's very quickly move from the quarter to the full year.

As we step back a bit on our next slide and away from some of the choppiness that one sees on a quarterly basis, so a clearer picture of the business emerges over a full year.

First, transaction services moved ahead at a double-digit clip in EBITDA and slightly less so on top line as the pruning of non-core low margin merchant acquiring accounts somewhat tempered the strong double digit growth generated in utility and private label. For '03 expect continued double-digit growth in EBITDA with top line to follow by summer.

Second, credit services over-performed and was the primary reason for us raising our full year guidance last October. Extremely strong credit sales growth and solid portfolio growth were only half the story. The other half came from favorable operating expenses due to both lower credit losses as well as lower funding costs. All these factors pushed revenue up 18 percent and EBITDA up over 30 percent. For '03 strong performance will switch a little bit from credit sales growth to portfolio yield as the new clients finish ramping up and the accounts now seasoned throw off more finance charge income as these receivables "stick more." In any event, expect overall double-digit gains in both top line and EBITDA.

Finally, marketing services posted another solid year with top line and EBITDA coming in at 17 and 12 percent respectively. We ended the year strongly as issued miles popped up to a mid-teens growth rate while redeemed miles stayed very strong in the 20 percent plus growth. Our refresh of the brand was also completed and with $360m of deferred revenues sitting on the balance sheet, many more years of solid performance are expected. For 2003 double-digit again in revenue and EBITDA.

Now that we've covered Q4 and the full year we want to take just a moment and step back a bit to review the strength and consistency of the business model for the past two years that we've been public.

Turning to the historical review over the past couple of years, a look at the company and its segments show a remarkable level of consistent, solid growth. During this period, the economy experienced the first recession in a decade, its subsequent sluggish recovery and ended with tepid business spending in an uncertain consumer. Despite this, ADS posted top line and EBITDA growth of 13 percent and 19 percent respectively as well as cash earnings per share growth of 25 percent.

Perhaps of more interest are the performances of the company's segments during that period and specifically each of the growth engines cycled through their peaks at differing times. Recall that during the 2001 recession private label got stung a bit in its credit business. More than offsetting it however, were over performances in marketing services due to the loyalty AIR MILES program as well as transaction services due to the utility services group.

Then, during the following year, the cycle shifted as 2002 was driven by over performance in private label as both extremely strong sales combined with improving credit losses and funding costs. Utility services and loyalty air miles kicked in solid performances as well, which, when combined with private label's results, allowed the overall company the luxury of pruning some low margin business and set the stage for a strong '03.

As we look into 2003, still too early to call which growth engine will take the lead and cycle to a peak. However, we do expect some exciting announcements out of all three as the year progresses and you've already seen a couple during January.

Let's up '02 with our balance sheet, review '03's previously released guidance and wrap it up with Q&A.

Turning now to the balance sheet, a couple of points to discuss. First, debt remained flat to Q3 while cash came down a bit from last quarter due to the typical year-end requirements. Specifically at year-end there is always a surge in private label card receivables around the holidays and we are required to hold receivables or segregate cash on our balance sheet until the holiday surge passes by the end of Q3.

Also of interest is our debt to trailing cash flow ratio, i.e. debt to operating EBITDA ratio, which is used in all of our bank covenants. At year-end, we came in just below two times, which is consistent with our goal of maintaining a profile, which would be viewed as investment grade. For those of us who've been around here for a few years, it also marks a remarkable improvement from just a few years back such as the 1999, when our debt-to-cash flow was four times or double today's numbers. Let alone in '98 when, believe it or not, it was closer to six times. In any event, it's a lot more enjoyable for sure at today's level.

Another area to look at is deferred revenue related to our loyalty AIR MILES program in Canada, which is now $360m. This is a 30 million increase since a year ago. When netted against our change in our trust account cash yields a good first approximation of the difference between operating EBITDA and reporting EBITDA, which is about 20 million bucks. This deferred revenue has been earned and will flow into the P&L over time.

Alright. Let's step back, talk very briefly about our 2003 goals relating to our capital structure. In general, we're in good shape. Specifically, look for three items. One, we're looking to renew our current credit facility with an emphasis on adding flexibility during the seasonal needs at year-end. Two, our goal will be to pay off the remaining 52 million of high priced sub-debt. And three, refinance the maturing $350m asset-backed deal this spring at favorable rates and potentially going out long-term.

That's it. Let's finish up with '03 guidance. Bear with us, folks. We have about three or four minutes left.

2003 outlook -- real simple. It's the same as we discussed our during our Q3 call last October. Specifically, revenues, EBITDA and cash EPS of 970 million, 170 million and $0.73, respectively. For Q1 we're off and running and on track to do between $0.15 to $0.16 versus $0.13 prior year.

Next free cash flow. Finishing up our '03 outlook, we expect to do about $1.04, since where we're going to put the stake in the ground ,per share, which includes the expenses associated with Capex, interest in taxes. Also, it includes the benefit of certain profits earned and cash received in our loyalty air miles business which are hung up on our balance sheet and flow into the P&L over the next three plus years. Overall this 80 million in free cash can be used to bring on new assets or to do a small tuck-in M&A deals or to just pay down debt. We'll see how things unfold. That's it for 2003.

We finish up here with a snapshot showing some of our key metrics and the performance between '00 and ending in '02 and what we expect for '03. That should do it from our end. I'll kick it back over to Mike and then we'll do some Q&A.

Thanks, Ed. Wrap up real quick, 2002 was a great year. Again, I want to reiterate my thanks to our management team and all our associates for a job well done. 2003 is starting off well. I'm very confident in another strong year. And our focus on innovation and client growth will continue to fuel our loyalty-based transaction and processing multiple and drives superior results for shareholders and that's why you're all here today. Let's open up to questions and we'll get this wrapped up.

(Caller Instructions). Your first question comes from Jim Kissane with Bear, Stearns.

Hi, Mike and Ed. Great job. Can you elaborate a little bit on the brand refreshing for AIR MILES -- total cost -- what was actually involved and how recurring is this? I mean, is it every couple of years?

I was going to say the primary expenses both involved in completely redoing all the creative with regard to our marketing, out television advertising, our print advertising and that kind of thing and then we rolled out a pretty major roll out of that -- kick off in the fourth quarter. And we do it -- probably three years -- two to three years. And typically in between a million or two dollars each time.

Okay. So there were no other factors causing the decline in the EBITDA year-to-year?

No.

Okay. And would the refresh have contributed to the big growth in miles issued and redeemed during the quarter or are we going to see that over the next few quarters?

No, a lot of the expenses are associated with the actual development of the creative and then you roll out all of the advertising materials over the life of the program. No, it wasn't -- I don't think it drove an unusual spike in the fourth quarter.

Okay. It seems that -- I mean the credit business -- I mean the strength there should be recurring over the next few quarters at least, I would think. Is that the case?

Yeah. I think, Jim, I kick it back over to the four drivers within that segment. As we mentioned, we're seeing, obviously, great stability in terms of credit losses. That's a key operating expense. Funding cost, unless I'm missing something, we ought to be in pretty good shape on when this next deal comes up in the spring, for sure. And then credit sales and portfolio growths, based on what we're seeing in gains and wallet share as well as these new clients ramping up, we're pretty bullish on that segment for '03. I think the one tweak I would make, Jim, would be, you're not going to see the 22 percent type growth in credit sales. That'll probably moderate a little and you'll see some decent strong growth in the double digits for sure, but you're going to see a little bit stronger results probably on the yield side from the portfolio. In other words, these clients are ramping up, sales are big, but it takes a couple of quarters for a new client, such as Pottery and folks like that, for these sales to translate into finance charge yielding balances on our portfolio. That's the beauty of private label. You kind of get both sides.

Okay. Great. Thank you.

Thanks, Jim.

Your next question comes from Lauren Fine with Merrill Lynch.

Thank you. A couple of quick things administratively. The 360 million asset-backed that will roll over this spring [inaudible] and any sense of what rate you're likely to on it and then I have some follow-up questions.

The 350 -- I'll have to go back in my brain a little bit. I think it was probably around 6.5 all in fixed. And we would probably try to do what we did on the last deal, Lauren, which is that's a three-year deal rolling off. If the yield curve stays as favorable as it is, we may try to extend that out to five years, which will probably cost us a little bit more, but we would expect rates today to be certainly under 6.5 -- is it -- do we expect a couple hundred basis points pick up? Probably not. Do we expect more than 50 basis points? Probably.

Okay. And then -- I'm curious if you could talk about the growth of statements generated. It seemed a little low given that I thought that [indiscernible] deal really kicked in this quarter and so maybe you [indiscernible] how many statements you're getting from them in a quarter or a month or whatever dynamic might have been in there.

Sure. That's an easy one so I'll take it. We saw -- you're exactly right. We saw very nice growth in the utilities sector, for sure, as well as very strong growth in the private label business. What you have here, Lauren, is you have about two million statements that went away when Charming migrated off the platform during the first quarter of 2002. As a result, you're comparing the total number of statements -- whatever it was -- 38 million versus last year, which included an extra two million from Charming Shoppes, who was just a processing client. We'll still see that in our first quarter and by then that'll hit its anniversary and then we should be off to the races.

Okay. And then maybe you could talk about revenue per statement and revenue per transaction in terms of the trend?

Sure. I would say on a full-year basis, I think our total number of statements that we issued as a combination of utility as well as private label -- it also includes one quarter of Charming Shoppes versus four quarter during '01. Despite that, we did see mid-single digits growth in the number of statements that were issued. In terms of revenue per statement, as we continued the shifting away from sort of the plain vanilla stuff, and into the higher margin things, such as utility and some of the nice, juicy retail accounts, we saw revenue per statement grow a little bit north of 10 percent per statement. You get those two combined and that's why you see some nice sort of mid-teens growth in the overall combined growth engines. That, of course, was tempered by the pruning that we started in '03 -- in Q3, I'm sorry -- and completed in Q3, but we still have to hit that grow over, which is going to -- we probably won't come back to double-digit growth on the top line until summer of this year.

Okay. And then just one last one. I think you already addressed this, but I'm not sure I understood. The difference between the operating and reported EBITDA was smaller this quarter than it's been in the past?

Mm-hmm.

I'm curious from a forecasting point of view, if the two million difference is what we should use or the five to six or if there is any way to project it and is there a reason that it came down so much in the fourth quarter?

Yeah, that's a great question. I would say the easiest way to do it is probably we kind of put a stake in the ground and say it's roughly running at about 20 million U.S. per year and it's going to chop a little bit by each quarter. If you want to put a placeholder in of three or four million per quarter, that's probably a good starting point. Why would it chop around? A lot of it has to do with the foreign exchange rate as we translate it back into U.S. dollars as well as some of the accounts, like the deferred revenue that's put on, is using historical rates while the cash and the trust is translated at current spot rates. Depending on what the Canadian dollar does -- I'm probably overdoing this thing -- depending upon what the Canadian dollar does, it could chop it a million or two on any given quarter either way.

Great. That's actually helpful. Thanks.

You're welcome.

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

Hey, guys. Did you give a delinquency rate for the quarter earlier, Ed?

No.

Okay.

Hold on a second. We want to make sure -- the delinquencies in Q4 -- I think if you were to use six flat, that's probably a good number. We may have actually come in even a little bit better than that. Call it six flat versus fourth quarter of 2001, which was about 6.6. It was about 60 basis points pick up.

Wow. And down from September also?

Yeah. A lot of that -- I got to caution folks. A lot of that is seasonal in nature. During Q3 you have what we call the sloppy summer pays -- folks who take vacations and take a pass on getting their payments in on time so the delinquencies tend to go up and then they tend to trend back down in the fourth quarter as the overall portfolio starts ramping up for the holidays. But certainly compared to last year it's a pretty good signal.

Is air miles still about 85 percent of the marketing services segment?

If not more.

If not more, okay. As you renewed a lot of things up there, did you give in a little bit on pricing because these are old clients renewing?

No. I think overall, we'll not see any sort of margin.

Revenue per mile issued is about the same?

Yeah.

You said this year you renewed seven out of your top ten clients.

Right.

Who are the other three and when are they up for renewal?

Who are the other three and when are they up for renewal? Just a second.

Maybe while you're looking, Ed, are you capitalizing on any of those brand refresh numbers or is that all expense?

All expense.

Okay.

In terms of I can off the top of my head name two of the three up in Canada it's the other half of the Bank of Montreal arrangement and then we would be looking to do with something with Shell Oil with Canada as well. [indiscernible]. Those are the two of the three. We'll have to chase down the third one, Charles.

Do you know when you'll file the K, Ed?

Middle of March? How's that?

We guess that's the deadline, right? Last question -- you talked about the utilities business a lot in the presentation. How's the sales pipeline for credit and transaction services for especially retail?

The credit side or from the private label you're talking about?

Yeah.

We have a good pipeline. We hit kind of a few homeruns last year and got more than we expected -- frankly. But we're back to a normal -- what I would call a normal pipeline of accounts and we'll continue, I suspect, to have four or five signings this year.

I would say -- I'll kick in here, too -- to Mike's point, we're still, obviously, unsure of which one is going to cycle to the peak this year, but if I were a betting man, I'd say our private label group will have a good year, but you're not going to get four home runs or three homeruns that we had last year. We'll probably get our standard two or three decent deals in the door and I expect that combined with that monster announcement we did on the Brylane renewal that took us out ten years for a top-five client, that means we're going to have a pretty good year. And then I would expect utility and loyalty to put in very strong years as well.

Did you get the same terms on the Brylane as you have before?

Generally. There were some gives and takes. We added some new services so all in all I think it was a fair trade.

Great. Thank you very much.

Yeah. If you were to move the chess -- we moved the chess pieces around the board a little bit -- end of the day, we think we're in good shape. The key motivation on their end was their parent, which had a big finance subsidiary over in France -- the parent being PPR, decided to exit that business and really wanted to lock up a long-term supplier, which would be us, here in the States. So they were motivated.

Okay. Thank you.

Your next question comes from Art Bender with Credit Suisse First Boston.

Good morning. Can you talk about the competitive environment in the utility business a little bit -- whether any real competitors have emerged and, if so, what's your relative strength and weaknesses are relative to them?

Yeah, Art. This is Mike. There continue to be, as we've talked about before, some remaining kind of start-up companies, although many of them have dropped out of the business. Their value proposition typically is a customized single in-house design system that they're trying to say is better than all other systems out there. Typically, systems-based don't have the servicing capabilities or marketing capability. There's a group of probably four or five of those kinds of companies. Typically small ten to 40, 50 at most made in revenue.

You then have some general outsourcer kinds of companies sniffing around, whether it be the EDSs or the IBMs that are looking to outsource the entire data center operation, not just the billing kind of entity so we'll see them from time to time and some other consulting kinds of companies. You'll see teleservices, telemarketing companies for telemarketing and customer care activities. Generally speaking, none of the competitors are delivering the kind of loyalty-based transaction processing model that we have where we combine all three to have a common [indiscernible] and common strategy for the client. And that's really been our value add.

Okay. Great. And you talked about the brand refresh in AIR MILES and I assume that was mostly aimed at consumers. Can you talk a little bit about any new initiatives you might have to boost AIR MILES issuance by your sponsors?

We continue to focus on our three-pronged approach for growth in that area, not only, obviously, continuing to build consumers, as you've pointed out -- continuing to build new sponsors, particularly in what we call those second-tier -- you noticed announcements in the insurance category, the energy category, we talked about a little bit ago. We have continued focus in the pharmacy category as well. And then we continue as the third-prong, as you know, continuing to add product offerings within the existing client base. Same strategy as before and it's working very well.

Okay. And then finally, with the growth in the utility business, can you give us a revenue breakout, maybe as a percentage of revenues in the transaction of business between private label, utility and then the traditional merchant acquiring business?

I can probably give it a high-level swag. We really don't get into that type of detail. But as we get into 2003, I think when it's all said and done, we would expect utility to be 15 percent of the company overall. We would expect private label to be roughly, call it, half the company -- split relatively equally between transaction processing and credit. We would expect loyalty air miles to be about 25 percent or slightly more of the company. If I did my math right, that should be about 90 percent of the corporation and the remaining ten will be that sort of traditional merchant acquiring business that hopefully is we think we've got leveled off at this point.

Great. Thanks very much.

Your next question comes from Jennifer Scutti with CIBC World Markets.

Hi. Good evening. Most of my questions have been answered, but I was hopefully that maybe, Ed, you could just walk me through, again, the cash number on the balance sheet and why, in fact, that when, if my numbers are correct, it went to roughly 30 million this quarter from 80 million last quarter and a year ago we didn't see that kind of trend and I just didn't really get what you were saying about the receivable numbers of year-end.

Yeah, sure. A couple things going on. First would be the primary holiday requirement that we have out there and that is during the holiday season we are required to hold -- you know the whole bank card private label business -- we're required to hold two percent more of our portfolio on our balance sheet until the holiday season passes in order to cover returns. That two percent of $2.3 billion is probably 45 million bucks. We can either do it by buying in additional receivables or actually segregating cash that you'll see on the account that wasn't on here, but due from securitizations has an additional $40m plus of cash. That's the biggy. And then I would have to look also, Jennifer, I think on the merchant settlement side, I think from a flow perspective, I think we lost a day, depending on what the day the quarter ended on. I'd have to check that.

Okay. So basically though, the swing is in the [inaudible] line item and that would, obviously, go back to kind of normal levels.

Yep.

Why didn't we see that in the year ago -- in the year-end of '01? It looked like the cash was up -- just kind of refresh my memory what happened there and [inaudible] do you recall?

Yeah. I don't recall. Let me track that down. It could be nothing more than the merchant settlement day.

Alright. Thanks.

At the end of every single year, year in and year out, we are required to pull in an additional two percent of the portfolio onto the balance sheet which chews up cash and then it gets released. And then the only other big movement in cash would be, depending on what day the quarter ends, could swing it 30 million buck here or there. I'll go track that down for you.

And then just as a follow-up -- I think I know the answer to this one anyway, but when it comes to the card business, were you affected at all by the FFIEC guidelines that were put in place for the final guidelines? Did that have any impact on you whatsoever?

Yeah, I mean, that's a good question. It had an impact in the sense of we paid very close attention to it for sure. In terms of where we wound up on the new FFIEC rules, we think we're in real good shape. Some of the items that came out had to do with folks who were accruing up fees and aren't reserving against it. We may bill it but we don't book anything until it's collected. Very conservative there. Over limit fees -- we don't do it. They talked about payments and negative amortization with the payments. We don't do that either. And then the fact that we don't target sub prime I think meant -- that overall, I think we're in real good shape.

Okay. Yeah, I was most concerned, to tell you the truth with the accrual of the fees and you don't even book them until you [indiscernible] the cash. Is that correct?

That's correct.

Great. Thank you.

Yep.

Your next question comes from David Scharf.

Good morning and afternoon. Ed, quick question on private level. As you kind of gauge the visibility of top line growth -- without divulging any kind of names or business plans out there, do you get good insight into the store opening plans of your 50-odd customers as you look at 12, 18 months?

Yeah, very much so. Our [indiscernible] organization goes through the budgeting process with each of the clients and their anticipated store openings and closings and marketing programs and it's a pretty strong bottom's up budget.

And just curious, as you dial back 12 months ago, with kind of the net store openings for your clients pretty much on track with what they budgeted a year ago or was there much variation?

I'd have to get that for you, David. We don't really bring that data for the call.

Got you. Secondly, as you renegotiate private label contracts, is there any pricing pressure at all in terms of the discount fee that's charged to merchants or is that pretty much an industry standard that doesn't move around as much?

Well, if you know retailers who are very strong merchants, they're some of the best debaters in the world. There's always pressure in the contract negotiations. But no, generally speaking we go good value-added programs and yes, we negotiate hard, but at the end of the day, we're very pleased with our outlook.

Okay. In general when you compare, for example, the well-documented, decompression we're seeing in the merchant acquiring space, it's nothing approaching that?

No. Not at all.

Okay. Also strategically, I guess the acquiring, like you said, it'll be down to about ten percent, certainly among national accounts, the margin compression is getting worse and worse. And there's a couple more roll-ups that are out there getting started. Is that a business you want to be in in the next couple of years?

It provides some good cash flow and good sizable customer relationships, particularly in a few -- our directed niches that need points of sale, marketing, loyalty and transaction based kinds of activities. We'll be very specific and targeted with it, but we don't view I'd say general merchant acquiring as a key growth engine. You won't see us branching off into --.

[Alliance Data Systems' Telephone Line Dropped]

Hello.

I think we're all back together now.

Thanks, Kelly. Do we still have our guests?

Yes.

Okay. We've got -- I know we're running a little bit over on your schedule. We've got time for another question or two? Are there any out there?

Yes. We have Jeff Baker with U.S. Bancorp Piper Jaffray.

Great. Hi, Jeff.

The closing bell. Thank you very much. Ed, you mentioned -- did you mention that you guys did continue to prune in the fourth quarter?

No. We had the impact in the Q4. The folks we whacked, we whacked in the third quarter and so we just got sort of a -- we got to let that run out over until it anniversaries.

Right. Right. Any kind of idea of revenue impact this quarter?

Probably about ten -- about 40 on full year base and so probably about ten a quarter is a good number.

Okay. And then going back to I guess David's question on the pricing concessions and on the Q4 renewals, this sounds to me -- correct me if I'm wrong -- you guys are offering maybe marketing services or whatever -- extended services for pretty similar pricing. Is that right?

Yes. Very much so. We're really not in a discounting kind of negotiating mode at all. As I mentioned in the example of the Brylane account, they're owned by a company in France. PPR had a large -- in Europe, private label processing business. We had had some discussions with them -- strategic discussions and then they, as an entity, decided to sell that entire business and out of those early discussions the -- it really lead to a long-term commitment by Brylane because of the long term relationship we've had with them.

Okay. We don't really have to -- and you're signing seven, ten-year, five-year deals. We don't have to worry about the next new technology coming along to offset any other pricing concerns when the renewals come up, right?

No. It's really not -- we always add new technologies with regard whether the electronic bill pay options and some of the new call center technologies and things like that, but there is no major technology that I foresee coming along that would have the impact that the major reduction in telecommunications costs had in the acquiring business.

Okay. And then, Ed, can you give us the Capex for the quarter and what you expect it for in '03?

Yep. Hold on a second. Use ten. That's a good number. Total for the year is about 42, which is just under five percent of our top line, which is our guidance for 2003. I think a good number to use is probably 48 million, which is five percent of our guidance for top line and then we'll tweak it from there. My guess is it certainly won't be higher than that.

Okay. And then last question, on the area of the merchant acquiring you guys are staying with, what are we -- what's specific niche are you targeting there, Mike?

Yeah, the majority of our volume is the -- our long-term petroleum and convenience store market. As you probably saw some of our announcements around Dynamic Value, which is a pre-paid concept type -- couponing and loyalty capability is to drive customers into the convenience store. That industry is also the one where we embed a lot of technology and the netware to monitor tank readings at the pumps and a lot of other data. It's a very deep product offering within that targeted niche.

Okay. Thanks. Nice quarter, guys.

Thank you. Okay. Anyone else?

Yes, sir. We do have some other people in queue. Would you like to continue in taking their calls?

We'll take one more, yeah.

Alright, sir. Your next call is from Dan Perlin with Legg Mason.

Unbelievable. Hi, guys. Did you get cut off because you didn't want to pay by the minute?

We watch our expenses closely.

We got an hour and no more, I guess.

I got you. I understand.

Next quarter 900 numbers.

There you go. The question I have -- I have a couple. One is, Ed, you mentioned your FICO scores now are 700, which is up pretty significantly from numbers that you put out in the past or discussed in the past.

Yep.

I'm wondering if that is an indication and if this is kind of a consistent indication that in that portfolio you're definitely seeing an increase in the credit quality of those customers that are signed up for the product or is that just a seasoning of the portfolio.

I don't think it's seasoning. I think a lot of it has to do with the folks that we've brought on over the last 18 months. As folks such as Pottery Barn and Crate and Barrel and Restoration and Ann Taylor get added to the mix and start ramping up, we have found that our new accounts that we're opening are actually being opened with a FICO of -- actually north of 700 -- more like 725. I guess -- I don't want to raise my hand and say we specifically went out there to go raise the FICO, but the fact the matter is the product offering that we have today, which is signing up for the whole nine yards seems to be attracting folks that tend to have a little bit higher FICO.

Okay. And what is the timing when you think about paying off this $52m sub-note, which is 10.5 percent?

Yep. In terms of timing, I don't really have one right now. I think -- how's summer.

Okay. And is that -- you're just thinking that's coming from cash on the balance sheet -- free cash flow or some other potential offering that comes down the road?

Yeah, it's either going to be -- listen, we want to -- there are some nice little values out there that if we're going to do a couple small tuck-ins, we want to give the flexibility to use some of our free cash flow for that. Barring that, we are in the process of renegotiating -- or not renegotiating -- renewing and adding a couple of bells and whistles on our existing credit facility. And our goal is to get that done by late spring. So my guess is late second quarter, maybe beginning of third quarter at the latest would be when we'd finally get rid of that fabulous 52 million.

Okay. This decision by Air Canada to sell about a little over a third of its stake in this [indiscernible] program, in the quarter. Do you view that as any kind of competitive threat at all? I know it's a different -- a little different business, but it seems as though you're getting other players in that business.

They have done a lot of talking in the press and other things for two years about expanding their program. Who knows? There are a lot of competitors of different kinds out there where there would be one-up programs or others. We're not concerned about the competition. My immediate read is that if Canada is just needing some cash and until they really do spin it off and create an entity that's got the kind of program or tries to build a kind of program like ours, I don't see any immediate threat.

Okay. And just lastly, do you have the SG&A in the quarter or are you going to make me wait?

Yeah. Can I zap that out to you?

That's fine.

Okay.

That's all I have. Thank you.

Before we move on to another question, if Jennifer of CIBC is still on the phone, we actually checked back to her cash flow question of December of 2001 -- had to go back into the files here. Turns out December of '01 ended where we got three days worth of cash from merchant flow. That means our cash balance was higher than normal at the end of 2001, hence offsetting the cash we needed to set aside for the holiday receivables. Where you would see that is on the balance sheet balloons on the liability sides as well with the due to merchants sell. Hopefully that gets that answered.

Kelly, we'll take another call if there's still people. I know they've been waiting and we kind of cut them off so.

Certainly, sir. Your next question comes from David Tossman with Wachovia Securities.

Actually this is Chris Gate for David. Your credit sales grew 22 percent [indiscernible]. I wonder if you give us some idea of how much of that is from growth and existing customers and how much of that is from new card programs?

Sure. I guess it depends on what you call new card programs. We will probably say folks that have been put on in the last 18 -- perhaps as much as 24 months, but a minimum of 18 months ago -- so last year and a half accounted for roughly half of that. The other half came from folks who have been with us longer than 18 months. Call that ten percent of the 20 percent growth. And then if you want to get into even more detail, if you were to break down that ten percent into growth [inaudible] just gross sales from the client -- maybe that's half -- their total sales were up five percent. And the other half, quite honestly, came from pretty much across the board increases in wallet share so that more dollars being spent -- that are clients are being spent on our card. I break it into those three pieces.

Great. Thanks.

Another, Kelly?

Your next question comes from Don McArthur with Stifel, Nicolaus.

Hi, guys. Ed, can you break out how much of the financing cost was for your swap payment and how much was from straight interest expense?

Sure. Again, he's referring to below the line interest expense in the fourth quarter. The actual cash interest expense that we paid out was pretty typical about 2.5 million. Then we had another five million in sort of other cash interest expense -- about 7.5 million. And then we actually had a million dollar non-cash gain from the swap, effectively when the yield curve didn't really move at all, but this swap is heading towards maturity. We're essentially walking down the yield curve and picking up a gain as we go.

Okay. And then in your credit services segment, what was the finance charge portion of the revenue? Do you have that number?

I do.

Great.

In our credit services group, our finance charge out of the -- what did we do, 100 million?

Yeah.

Finance charge was roughly 60 percent of that with the remaining being split between merchant discount and trust processing fees.

Okay. And then on the costs in your transaction services segment -- the cost relating to your private label and utility customer ramp-up, is that completed or what percentage is completed and do you expect more going forward?

Yeah. For the Duke Energy thing, obviously, that's done. That was their first full quarter. In terms of making sure we had a pretty good holiday season for the new folks, since everyone knows it was a shortened holiday season, we made sure everything was squeaky clean so, quite honestly, we threw some more bodies --..

Both in our customer service new account, beta center and all that kind of stuff, we just wanted to make sure we had a real clean and smooth holiday so that will cycle back through.

Okay. And I assume it was smooth?

Yes. Very smooth. Good holiday.

Great. And then your [indiscernible] number of utilities -- customers signed in '03, do you have a number of what you're targeting and then is that skewed towards regulated or deregulated?

We'll target obviously both. We'll probably have two or three signings, again, this year. And, in fact, you'll see one announcement coming very relatively shortly.

Great. Thank you very much.

Your final question comes from [Dirk Gotsy] [ph] with J.P. Morgan.

I didn't realize I was still on. Thanks a lot guys. Just do a follow-up here with a question on the renewals you've talked about. You talked about two of the three that -- in the top ten that you haven't renewed. But it wasn't clear to me whether those are 2003 events or whether they're further out in time.

They're out into '06, '04 and '11.

So maybe a way to simplify it then is do you have any sense as to what percentage of your business is -- just rough order of magnitude -- is up for renewal during the course of 2003?

I don't have that. We'll get back with you on that one.

Okay. Just one last question on this topic then. Can you talk a little bit about the protections that you build into these long-term contracts in terms of pricing protection, things related to change-in-control provisions, that type of thing?

We normally have pretty standard provisions in contracts that have, depending on the type of customer, minimum revenue streams or exclusives, that kind of thing. Pretty standard transaction processing oriented contract.

Okay. That's good. Alright. Well, thank you.

Thank you.

Thanks everybody.

Thanks everybody. Kelly, we're going to wrap it up. I appreciate your support this year. We're looking for a great '03. We'll talk to you later.

Thank you, sir. This concludes today's Alliance Data Systems conference call. You may now disconnect.