Bread Financial Holdings Inc (BFH) 2003 Q2 法說會逐字稿

Good afternoon. My name is [Terri], and I will be your conference facilitator. At this time I would like to welcome everyone to the Alliance Data Systems Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer period. (Caller instructions.) Thank you. 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 second quarter earnings release. If you haven’t, please call FD Morgen-Walke at (212) 850-5608. 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. Alliance Data Systems assumes no obligation to update the information presented on this call.

Also on today’s call our speakers will reference certain non-GAAP financial measures, which we believe provide [inaudible] information for investors. We will post reconciliations to those measures to GAAP on the Investor Relations page of our Web site at AllianceDataSystems.com. Now, with that, I’d like to turn the call over to Mike Parks. Mike?

Thanks Stephanie. Good afternoon everyone, and thank you for joining us. As you see on our agenda slide, we will spend a few minutes reviewing highlights of the last quarter, with a focus on our three growth engines. Ed will then review our financial performance in a little more detail, and the outlook for the remainder of the year. At the end, we will leave some time for questions.

But before we go to the next slide, there is one noteworthy item I’d like to mention. As we strive to make our company the best place it can possibly be, we continually ask, receive, and respond for feedback from our associates on how we can improve. These efforts were recognized in April, when we remained one of the top ten companies to work for in Dallas. And we’re very thankful and appreciative of that award. And it shows that we’re making great progress.

If you’ll now turn with me to the next slide, we’ll look at some of the highlights of the quarter. Certainly our second quarter of ’03 marked the best quarter ever in Alliance’s history in terms of revenue and EBITDA. Revenue for the quarter was $248m, up 20% over last year. EBTIDA increased 45%, to $50m. And our cash earnings per share was $0.21, a 50% increase.

All three growth engines, Private Label services, the AIR MILES® Reward program, and utilities services, continued to drive this strong performance. And I’d like to spend some time highlighting each. As you will see on the next slide, we had tremendous quarter in the Private Label services business unit. We announced the launch of new start-up card programs for the Spiegel Groups divisions, Eddie Bauer, Spiegel Catalog, and Newport News.

Alliance was selected because of our retail experience, systems capabilities, dedication to customer service, and our ability to enhance the customer service and build loyalty. In May we announced a long-term agreement with Stage Stores. Stage operates 362 stores under the Stage, Bealls, and Pallais Royal names in the south central part of the country. Once we receive regulatory approval, we will convert approximately 800,000 active cardholders to our full suite of Private Label services.

We also announced an agreement with American Home Furnishings to provide account acquisition, funding, statement generation, remittance processing, and customer service. This top 100 furnishings retailers has stores located in New Mexico and Arizona.

We recently signed an agreement with Foot Star, one of the largest footwear companies in America, to provide Private Label credit services. They operate over 600 Foot Action and Just for Feet locations in the U.S. This has been an outstanding quarter from our retail team. And congratulations to you all.

Turning to the AIR MILES® Reward program, our loyalty group continues at a very strong pace. This quarter we announced a multi-year agreement with Jean Coutu, the leading pharmacy retailers in Quebec, and second largest in Canada, as our newest AIR MILES® Reward program sponsor. The Jean Coutu group operates 248 stores across Canada.

This agreement demonstrates our commitment to growing the program in all of our geographic regions. Quebec is our least penetrated province. And with the May launch of Jean Coutu, we’ve now filled the critical high-frequency pharmacy category. Pharmacy, along with petroleum, supermarket and financial services are the key underpinnings of the AIR MILES® program.

We are very pleased that we have now filled all of these categories. And particularly in this important region, we know that this will have a positive impact on growing our collector base in Quebec toward the levels we see in our other regions. This quarter we had a nice return to solid mid-teens growth in AIR MILES® redeemed, and along with solid performance in AIR MILES® issued.

Our success in expanding our sponsor base and impressive portfolio of rewards creates the most exciting program for our collectors and sponsors. If you’ll all turn with me to the next slide, and we’ll talk about utility services, as you may recall, we’re coming off a tremendous first quarter in our utility services business group, with the signings of TXU, AEP and Centrica.

These wins in our utility group are on track to deliver their revenue targets for all of 2003, and strongly position us as the leader in the market. Contributing to the strong financial performance this quarter, were the first full quarter of revenue from both AEP and Centrica. Our conversions are complete, and fully operational. Our focus now remains on maintaining operational excellence, with our new and existing utility clients, as we continue to build the premier name in the utility outsourcing market.

Now turning to our outlook for 2003, we are very bullish. We are positioned well for the remainder of the year. And I am confident in our ability to deliver results. We gained tremendous momentum in the first half. And we are very focused on our conversions and launches throughout the rest of the year. Our commitment to clients from day one has been we’ll deliver what we promise.

We will continue to work on delivering additional new business as well, across all segments during the remainder of this year. But most importantly, as you saw in our release earlier today, we are raising guidance for 2003. We’ve had a faster start to the year than we expected, across all three growth engines. And this has fueled our early performance, and we believe will drive our full year results as outlined. Revenue will be up 13%, to a minimum of $980m, EBITDA up 20%, to a minimum of $180m, and cash earnings per share up very nicely, between $0.83 to $0.85 per share.

I’d like to share my personal thanks to our entire senior leadership team, and associates across North America for an outstanding effort this quarter. As you can tell, we’re all very excited about our future. Now I’ll turn it over to Ed for a deeper review of financials, and outlook for the year. Ed?

Thanks Mike. If you would turn to the slide, Second Quarter Consolidated Results, as Mike mentioned, for sure we had another good one. Second quarter marked our ninth quarter as a public company. And like the previous eight quarters, we continued to extend our track record, delivering or over-delivering on what we promised.

Just to step back and remind folks, our long-term model calls for top line growth of 12%, EBITDA of 15%, and cash EPS of 18% per year. Importantly, we believe this model holds up, whether it’s a recession like ’01, sluggish recovery, like ’02 and this year, or a robust recovery down the road. Against those targets, we experienced tremendous growth in Q1, followed by continued strong performance throughout Q2.

Walking down the metrics for Q2, let’s start with revenues of a quarter billion, up 20% versus prior year. The message here is pretty simple. All three growth engines – and the growth engines of course are the loyalty AIR MILES® program, Private Label Services, and Utility Services. And hence, all three reporting segments posted strong growth in the mid-teens or higher.

I think the bright spot of the quarter was the earlier than expected return to double-digit growth in our Transaction Services segment. Very strong growth in Private Label Services, and Utility Services, combined to generate solid mid-teens segment growth, which occurred, quite frankly, a few months earlier than originally anticipated, following last year’s pruning of some non-core accounts.

Also in our Marketing Segment, our loyalty AIR MILES® program posted mid-teens top line growth as well, with the future looking quite bright, as evidenced by the return to mid-teens growth in miles redeemed.

Operating EBITDA proxy for cash flow came in at $56m, an increase of 40% versus prior year. And just as a reminder, this measures reflects the effects of certain cash received and profits earned in Canada, but not yet fully reflected in the P&L. And this is why in general our operating cash flow generally runs a few million bucks ahead of our reported EBITDA. And speaking of which, EBITDA surged ahead by 45% in the quarter to $50m.

Perhaps of equal interest was that this large increase in earnings occurred despite a timing issue in our Canadian business, which effectively squeezed current period profits, and deferred them to the future. More on that in a bit.

And finally, cash EPS was up close to 50% to $0.21 a share. As a note, the number excluded a one-time non-cash charge related to the payoff of our high coupon 10% sub-debt. And this completed the payoff of all the old sub-debt, and clears the way for very nice cash flow savings going forward.

So to sum up, despite continued sluggish macro-economic conditions, ADS posed another quarter of stronger than anticipated performance. And all three growth engines are firing on all cylinders. And we expect this to continue.

Let’s turn now to the segment slide. And we’ll – first up we’ll walk through Transaction Services, which houses two of our three growth engines. And those would be Private Label Services and Utility Services, as well as being the home of our traditional merchant acquiring business. Both of the growth engines posted strong, double-digit growth rates, which can be seen in the 20% plus growth in their key driver, which is statements generated.

Also of interest is that our revenue per statement increased as well. This demonstrates a key facet of our model. And that is that we focus on markets where we can not only grow volume, but also preserve pricing power.

Utility Services continued to ramp up from both last year’s wins, as well as the first full quarter of business for this year’s new clients, which included American Electronic Power - AEP, Centrica, PLC, and down here in Texas, TXU.

Private Label Services, meanwhile, also benefited from the continued ramp-up of major 2002 wins, such as Pottery Barn, Restoration Hardware and Crate & Barrel. Additionally, our other clients showed good growth as well, as dedicating more and more of their marketing dollars in efforts to focus on expanding wallet share of their Private label loyalty programs.

So together, these growth engines accounted for over 80% of the segment, or about 40% of the overall company revenues. All right. Looking ahead, we expect more of the same, as the utility pipeline remains robust, and Private Label begins to layer on programs for Eddie Bauer, Spiegel, Newport News, as well as the planned conversion of the existing program at Stage Stores.

Turning now to Credit Services, which continued to out-perform even our increased expectations. And for a decent analysis, you need to walk through the four key drivers of that P&L, which are credit sales, portfolio growth, funding costs and credit losses.

First up, credit sales remain quite healthy, and grew in the low teens, despite a generally difficult environment for our clients. Results were driven by both solid gains in wallet share – that is, the amount of dollars spent using cards, as well as the ramp-up of 2002 signings.

Next up, portfolio growth came in at a solid 8%. And we expect a very solid Q3 and Q4 for this driver, as - as I mentioned earlier – Eddie Bauer, Spiegel, Newport News, and the planned Stage Stores file get added to the mix.

Turning now to operating expenses, we saw a continuation of good news. First up, funding costs, which continued to benefit from the very slow, gradual refinancing of large block of maturing fixed rate funds, which are being locked in at fixed rates for the next five years.

Finally, let’s talk a little bit about credit quality and credit losses. Our guidance for this year has been to ensure average loss rates of around 7-1/2%, and average delinquency rates of around 6-1/2%. Second quarter results added confidence to this guidance.

Stepping back a bit, and trying to put a little color on this thing, second quarter tends to experience a fair degree of seasonality, whereby losses – credit losses – tend to spike up, as some people simply run out of gas post holiday spending, and declare bankruptcy, which hits the P&L immediately.

At the other end of the spectrum, we also see a different group of people becoming current on their payments, perhaps due to all the tax refunds, and hence curing the pre-existing delinquency status. And this causes delinquency rates to improve seasonally. Both trends held in Q2, as losses drifted up a bit north of 7-1/2%, while delinquencies dropped like a stone, well below our 6-1/2% target, and even below 6%.

So, looking ahead, we expect continued strong results in Q3 and Q4, as losses seasonally start slowly drifting down again, as the holiday season approaches, and delinquencies drift back up a bit. All right. That’s it for credit. Simply put, all four key drivers are trending positively. And we expect solid growth for the remainder of the year.

Finally, marketing services, which essentially is our loyalty AIR MILES® program in Canada. As noted earlier, the business fundamentals remain strong. The program continues to absolutely dominate the loyalty space in Canada. And, as Mike mentioned, the signing of the Jean Coutu pharmacy group in Quebec cements the last element of key sponsors needed to further penetrate that region.

While some parts of Canada have as much as 80% of household active in our program, Quebec has traditionally lagged behind, in part due to the absence of an anchor sponsor in the pharmacy sector. This has now been addressed. And we’re excited about the new growth in Canada’s second largest province.

Turning now to the business drivers, Q2 was very strong, with miles redeemed snapping back to solid mid-teens growth, and miles issued remaining solidly on track. The snap back in redemptions demonstrates the flexibility and versatility of the program, and specifically despite a weak air travel market further, exacerbated by the SARS issue in Canada, our program members nonetheless redeemed at a robust rate across other categories. And miles redeemed for non-air rewards now represent over 60% of all of our redemptions.

Now as a quick note, or reminder, our goal is for higher and higher redemption levels, since this ensures that the program remains successful and valuable. This doesn’t at all hurt our profits, because we already reserved for a high level of redemptions. And therefore, our goal is the same as that of our sponsors – drive redemptions, and thus increase loyalty.

Turning to our top line, revenues surged to $67m in the quarter, up 16%. And the outlook is for strong top line growth to continue throughout the year. Turning now to cash flow, first it’s important to note that the operating EBITDA adjustment of a few million each quarter that we spoke of earlier, it all relates to this segment. So in Q2, this resulted in roughly $17m in operating cash flow in this segment alone. And that would be the reported EBITDA, plus the operating EBITDA adjustment.

Finally, I’m going to spend a little bit of time discussing the reported EBITDA number. While the segment posted solid results, that performance still understated the true strength of the business. We’ve tried to illustrate this by showing growth on a constant currency basis versus last year. And the key point can be seen in the constant currency number we also provided.

Specifically, excluding the very dramatic impact from the run-up in the Canadian dollar during the back half of Q2, the core business results showed an even more impressive 40% growth rate in EBITDA. And we expect strong core performance to continue throughout the year.

Now, from an accounting perspective, the deferred nature of the revenues ends up squeezing near term reported profits, and pushes them onto the balance sheet to be recognized in the future. And I’ll walk through an example next. All right. To wrap up the segment results, real simple, all three engines firing on all cylinders. And expect more of the same going forward.

Now, let’s talk a little bit about the spike in the Canadian dollar. Everyone should have the slide that says Marketing Services AIR MILES® Program. As I’m sure everyone knows, the U.S. dollar fell off a cliff this year. In Canada, the Canadian dollar skyrocketed 15% in 2003, with the most dramatic move coming during the latter part of Q2. Now normally the Canadian dollar/U.S. dollar relationship is pretty stable. But in Q2 that changed, as the Canadian dollar spiked to levels not seen in over six years.

First question – good or bad for Alliance? Put simply, the stronger Canadian dollar is beneficial to us, as it means more revenues, cash flow and profits when translated back into U.S. dollars. That’s pretty much all common sense. But what’s different for us is the timing of when those profits flow into earnings.

Specifically, our Canadian program follows deferral accounting. So, for example, when a mile was issued a couple of years ago at the gas station or the grocery store, we update our cash up front. We’re required to book that revenue to the balance sheet. This was then translated back to U.S. dollars at the then current rate – oh, let’s make it up - $0.68. That would be one dollar Canadian was worth $0.68 U.S.

Let’s fast forward to today. That mile is now moving off of the balance sheet and into the P&L. But it’s moving off at $0.68, while my expenses are being booked at the higher and more expensive spot rate of $0.71. Simply stated, the Canadian dollar appreciated.

The result is a squeeze on reported earnings. Clearly this is an accounting mechanism only, and doesn’t change at all the cash flow of the business. So that’s why we’ll also show the constant currency growth rate to indicate the true health of the business.

All right, if you’re following the math, what squeezes now will actually reverse over time. Hence, the timing issue. So, while Q2 still looks very strong, even with the squeeze, the impact becomes a bit more onerous in Q3 and Q4, as you have the full quarter impact of the higher Canadian dollar, rather than just half the quarter, as was the case in Q2.

All right. Let’s turn to the next slide, and quickly summarize the impact. Long-term, the rise in Canadian dollar is positive for us. Higher revenues, cash flow and profits when translated. But short-term, it squeezes EBITDA, due to a timing mismatch. Our EBITDA was squeezed probably about $3m in Q2. That number is probably going to be closer to $4-5m in Q3, and $4-5m in Q4. This will anniversary in Q2 of ’04. And growth rates will return to normal.

What’s interesting is then growth actually accelerates going into 2005, as the weighted average rate coming off the balance sheet continues to move up. So the next big question, if it’s not in the P&L, where’s the excess profits.

The answer is very simple. It’s on the balance sheet. And it’s found in the deferred revenue accounts, which had skyrocketed $50m this year, versus a normal $20m. So it’s moved up more than double the average increase in prior years. Next, constant currency basis reflects business health. Q2 was up 39%. And finally, cash flow is unaffected by the EBITDA squeeze.

Okay, turning now to the balance sheet, a couple of points to discuss. Showing you the deferred revenue, all of which relates to the loyalty AIR MILES® program. As we mentioned, the jump goes to $30m during the quarter, stands at over $400m, and is up close to $50m since the year began. This is more than twice the normal increase of the past years and, as we just discussed, represents new revenues and earnings that are being put on the balance sheet at the new, much higher Canadian exchange rate. In the future, this excess will flow into the P&L.

All right, turning to capital structure, we had four key initiatives this year. Thus far we’ve number one, completed a new $400m credit facility, which provides tremendous additional liquidity, by not only increasing our lines, but also carving any CD borrowings out from our debt covenants. In other words, we borrowed CDs to fund on balance sheet receivables, until we’re ready to securitize.

Number two, we completed a very successful secondary offering, which hopefully has now taken care of the major concern out there, which was the illiquid nature of our stock. Including the [shoe] [ph], 10.3 million shares were sold, of which Limited Brands sold half of their stake, or seven million. And AES took the remainder. Our net proceeds were used to pay off our remaining 10% sub-debt.

So pretty good news all around. Remaining on our list is the refinancing maturing asset-backed bonds sometime this summer. And again, we’re going to look to lock in five year money at fixed rates. Right now the market for high quality paper like ours is quite strong. And we’re very bullish on the deal.

Finally, our last objective is to ensure that we maintain an investment grade profile which, as a benchmark for us, means we need to keep our core debt at two times or less trailing cash flow. As of the end of Q2, we actually came in at only one times.

And for those of us who were here a few years ago, when it was five to six times leverage, this was a huge and enormous milestone for us. To wrap up, balance sheet and capital structure are getting stronger every year, as the business model continues to generate double-digit growth, while throwing off significant free cash flow.

Okay. Guidance Got a few questions on this one over the last quarter. So here it is. A couple of quick points first. As mentioned earlier, all three growth engines were firing on all cylinders in Q1 and Q2. And we expect the strong performance to continue. And second, we spent a fair amount of time – probably a little bit of overkill – but we – with discussing the temporary timing squeeze on the reported results from Canada that clipped Q2, and will clip Q3 and Q4 as well.

However, despite this, we are still very comfortable and confident that we will considerably exceed our initial guidance for the year, across all key metrics. As such, we’ve upgraded guidance as follows. Revenues to come in at $980m or higher. EBITDA at $180m or higher. Cash EPS to come in between $0.83 and $0.85.

Versus last year, that puts us on track to be growing in the teens on revenue, 205 on EBITDA, and 34-37% on cash EPS. A key thing to note here is this follows a cash EPS growth rate of close to 20% last year, and 30% the year before that.

Turning now to free cash flow – next slide – we’re also raising guidance there to at least $1.10 per share versus just over a buck previously. The $1.10 of free cash flow includes the expenses associated with cap ex and interest and taxes. And it also includes the benefit of certain profits earned and cash received in our loyalty program, which are hung up on the balance sheet, and will flow in over the next three years.

All right. We’re almost at the end here. Next slide. Mike and I have added our sort of top five questions list that we got during the quarter. We thought we would share that with everyone. The impact of the Canadian dollar – clearly some folks were asking about that. I think we’ve covered that in enough detail. Long-term goods, short-term squeeze, no change to cash flow. And the squeeze reverses as we approach ’05.

Credit quality in our credit business is right on target. Additional announcements – since we were so front-end loaded this year, some folks were wondering whether we’re done. We’re not. My guess would be you could see announcements from all three of our growth engines as the year progresses. So pipelines are looking pretty good.

Next one up is a question Mike and I get all the time, which is hey folks, if you were to look out five years, how would you break your business down between the three segments? Are you trying to emphasize or deemphasize one over the other? The very short answer is no, we’re not. What we try to do at a very, very high level is to say I think transaction services should be roughly half the company.

We think that credit should be roughly a quarter of the company. And we think that marketing should be about a quarter of the company as well. And if you were to look at the segments from the point of view of throwing off cash flow – operating cash flow – you would see we’re pretty close to that. This will cycle through each segment, depending upon the year. But so far so good. We’re tracking pretty nicely to sort of our long-term goal of 50/25/25.

And finally, guidance – I think we’ve been through that. All the metrics are running pretty strong at this point. So summing up, the final slide gives you a little picture of where we’ve been and where we’re going. And we spend an awful lot of time on the quarter, or even on the current year. But we always want to look at the longer-term picture when assessing our performance. And over the last four years, it’s been a pretty solid run. And we certainly expect a lot more to come. With that being said, I’ll turn it back to Mike.

Thanks Ed. And again, very strong quarter. Excited about the year. And we’ll be prepared to take your questions now. [Terri], I think you’re – charge it along.

(Caller instructions.) We’ll pause for just a moment to compile the q-and-a roster. The first question comes from David Scharf of JMP Securities.

Hi. Good afternoon.

Hi.

Mike, just curious on the Private Label side, are there a lot of Stage Store type opportunities out there? Is it mostly just the Sears and the Circuit City’s that are shell-shocked in their credit programs? Or are there a lot of these kind of middle-tier private label programs out there that are actually looking for an exit?

There are – if you look at kind of the industry tracking device, the Nielson Report, it does list quite a number, probably at least 25 or 50, that have relatively decent sized in-house programs. But our focus has never been targeting the big 300 million kind of receivables. That happened to be a little bit of an anomaly. But if they come about, and the opportunity is right, we certainly will take them on.

Our focus, if you look back over the last four years, has typically been 25-75. There’s also the other half of the focus has always been on plenty of accounts - in fact, over half of our potential universe – that have never issued a card before. So it’s really a mix of all three, that’s going to continue to be a driver.

The other point that you’ll note also, just the trend in outsourcing. The Nielson Report just recently put out their 2002 results, that showed growth in private label sales. The whole private label market is growing in the low single digits. But outsources, as a whole group, 9%, almost double-digits. And we had a pretty strong year. It came in at about a 22% sales. So we’re outperforming the market as well. So we see plenty of growth for the foreseeable future in this segment.

Okay. Is it fair to say, is the majority of your backlog of potential new Private Label clients, are they start-up programs? Or would you be [inaudible] base field operations?

They tend to be pretty much like the market opportunity – about 50/50.

Got you. Thanks a lot.

You bet.

Your next question comes from Dirk Godsey of J.P. Morgan. Go ahead Mr. Godsey. Mr. Godsey?

Yes. Hello?

You’re on.

Oh, you can hear me? Good. I guess the Operator can’t. I was wondering – I’m trying to get up to speed here on the [inaudible] year-to date. I mean is there a way to perhaps quantify, maybe in looking out over the last twelve months, at kind of the targeted annualized new business that’s been signed over the three growth engines, and maybe get some sense as to how much of that is currently reflected in the current run rate of the business, in terms of business that’s been ramped up to kind of normalized levels, etc.?

Sure. I’ll take a shot at that. We sort of lay out at the beginning of each year, as you know Dirk, we try to do maybe three to four announcements per each growth engine. I would say from the Utility perspective, all three of those got in the door in the first quarter. All three of those are now running flat out. And we have had our first full quarter, with everything on board. So I’d say Utility is already up and running. And we wouldn’t expect a huge step up as the rest of the year progresses, unless of course there is another announcement or so, which could happen as well.

On the Private Label side, that’s really been a pleasant surprise for us. You have the Stage Stores, which is a fairly large portfolio for us. Our goal is to hopefully get that on board, clearly before the holiday season. So that is not reflected in the Q2 numbers. Also not reflected in there would be the gradual ramp up of the three Spiegel divisions, which would be Eddie Bauer, Spiegel and Newport News. We did complete what we would call a soft start-up during the June and beginning of July timeframe. And the goal there is all sorts of systems check and ops check and everything else, to make sure that thing’s ready for the holiday season.

So you’re still not really seeing the full impact of those one, two, three, four clients at this point. You will begin to see them as the holiday season approaches. And then finally, in Canada, obviously, as Mike talked about, the Jean Coutu signing in Quebec was huge for us – absolutely huge. It was the last huge anchor that we needed in the second largest province of Canada. That is now kicking into gear very nicely. And so we would expect that Utility and loyalty – you’re basically seeing the results of those efforts. Whereas Private Label, you still haven’t seen the full results of all the new signings there.

Just one follow-up. I don’t know if maybe I missed it on the call, if you could maybe comment on tax rate and the expectations going forward. And then as you look at your guidance that you just gave for the second half of the year, anything unusual that we might want to anticipate in terms of the pattern of how that will roll out over the next couple quarters? Or should we see kind of the traditional sequential increases that we saw last year?

No. Actually I think it’s going to be real straightforward this year. Our cash earnings – to compute cash earnings, we use roughly a 36-1/2% I think is our last tax rate. That is going to be flat across all four quarters.

Okay. But just in terms of revenues and EPS as well, should -- sequential increases from here to get to the 83 to 85? Or is there anything unusual in the second half?

I don’t see anything unusual.

Okay great. Thanks. Congratulations guys.

Thanks.

Thanks.

The next question comes from Jim Kissane of Bear Stearns.

Thanks. Hey Mike and Ed, great job.

Thank you.

Thanks.

Ed, just trying to figure out, in terms of the Canadian dollar, I guess it’s $0.08 to $0.10 impact for the full year on reported EPS?

Yes.

Okay. Excellent. And then in terms of the integration of the Utility business, it sounds like it’s on track. Can you kind of give some qualitative expectations in terms of the margins ramifications as you scale and leverage that business over the next couple years? Because right now I assume the margins on Utility are a little bit lower than in the core Transaction business.

Yeah. It’s – if you were to step back a little bit, because this thing’s ramping up pretty fast as you know. In ’01 we hit break-even at roughly $60m top line. In ’02, I think we hit around $80-ish million of top line. We probably had mid-single digits margin. I would say in ’03 we’re very nicely on track to do $120m in the Utility business. I would say we’re probably going to hit low double digits in margin. And then my guess is for the next three, four years, add a couple hundred basis points per year.

Okay. Excellent. And in terms of interest rates, I mean assume they back up over the next couple of years. I mean what’s your exposure, given that you’re locking in these five year deals? Can you try and give us some qualitative view of that?

I’ll try. It’s – I think we’re in pretty good shape. We would probably step back a little bit and say part a of the answer is obviously we try to focus on, as you know, the three segments, three growth engines, that give us nice growth and good pricing power. But from a more macro perspective, the way the model was put together, it’s interesting how things are playing out.

So, for example, should interest rates move up, the bulk of our book, our funding book, is going to be fixed. And that’s why we’re doing five year fixed rate deals. You will get a little bit of the squeeze as rates move up. But it will take three or four years to work its way through.

But against that, you have, again, as I mentioned, most of the book is fixed rate. And then on a secondary level, if rates are going up, chances are that’s an indication that the economy is strengthening. Unemployment starts moving down. Our credit losses tends to offset that. So it’s almost a – it’s a very nice little natural hedge there, in addition to the fixed rate book.

And then finally, if you really want to reach a little bit Jim, one of the reasons the Canadian dollar skyrocketed so much is the spread between Canadian rates and U.S. rates, a couple of hundred basis points. As U.S. rates start to move up, that starts to squeeze. The Canadian dollar starts coming down a little bit, to more normal levels. We actually get the pick-up. So rates go up – I would say for the most part that’s mitigated by a fixed rate book, lower credit losses and probably a strengthening U.S. dollar.

Excellent. And any early read in Quebec on Jean Coutu? And just your sense of the penetration along the term in Quebec. Do you think that demographics or dynamics are different there than the Western provinces?

The rollout has been very strong, and worked very much as we expected. Long-term forecast, the AIR MILES® program has been around 10 years. The Western province is well over 75%. It will take some to reach those kinds of levels in Quebec. But you might say, because the Quebec area may be a little different profile, might not reach that kind of success. But we still see strong opportunity there Jim.

Okay. Thanks. Great job.

The next question comes from Jeff Baker of Piper Jaffray.

Hi guys. Excellent quarter. Can you talk a little bit, Ed, about the credit quality trends that we should expect to see in the next data here? I assume it will be released soon. But you mentioned about the seasonality that we see. Does it continue over into June? Or is May where we start to see the inflection point?

Yeah. I – gosh, I haven’t broken out the June numbers yet. But my guess is they’re probably going to start drifting down a little bit, Jeff, on the loss side. And you’ll see sort of that very slow, gradual seasonality begin to wane. And then obviously as we hit the holiday season, we would expect losses of south of 7-1/2%.

On the delinquency side, they came in – our guidance is 6-1/2%, I think, for the quarter. We came in closer to 5-1/2%. So that would suggest going forward, things look pretty good on sort of the aged write-offs. What is interesting right now is that the piece of credit losses that relates to personal bankruptcies is running pretty high. So to the extent the economy does catch into gear and get moving again, that should be a nice kiss for that piece of the credit losses. But for the 75% of losses that are aged, and therefore you can get a pretty good view based on delinquencies, we think we’re going to be right on top of that, right in the zone on the 7-1/2% level.

Okay. And on the bankruptcies, any thought or word out of Washington on the Bankruptcy Reform Bill? And your thoughts on impact to you guys?

The last word I saw, and I haven’t seen anything for a couple of weeks, but it’s like a roller coaster. The last notice was that it’s back off again and dead. It goes all the way from it’s back on and back off. We really can’t predict.

Typically, don’t expect from that back off any increasing write-offs as a result of that. Typically, when they put a stake in the ground and commit to a date, we see a lot of the legal firms do a lot of direct marketing to try and give us a little bit of a spike of the hit. But we haven’t seen that even for -- oh gosh it was 18 months ago when we saw a lot of that publication. But don’t really see any impact at all on the legislation for the foreseeable future.

We’re not counting on it.

Yeah, and Ed, a little housekeeping. Cap ex for the quarter – do you have that number?

Yeah. Tracking pretty close to 5% of the revenue. So I think we probably came in about $12-14m.

Okay. And then last question, and I’ll let somebody else jump on. Do you want to even begin to talk about 2004 guidance there, at least at a high level?

Thanks Jeff. But I think we’ll actually see how the rest of the year comes out. Again, our normal model tries to track it at our steady state growth. And I think we’ll leave it at that for now.

Okay. So you – on your targeted goals, even despite the strong performance you’re having this year, you could still see a grow-over in line with your targeted goals for next year safe enough?

Yes.

Okay great. Thanks a lot.

The next question comes from Don McArthur of Stifel Nicolaus.

Hi guys. Good quarter. Can you break out, Ed, the – in the financing cost, the swap portion in the interest expense?

Sure. We had a $2m mark to mark – non-cash mark to mark gain, which of course we back out of cash earnings. What’s left is about $9-ish million of cash interest expense. I would say split about $2-1/2m for the cash swap payment. And the remainder being sort of our normal interest.

Didn’t that spike up quite a bit?

It spiked up a little bit. What we did as part of the credit facility is we had a long-term interest rate swap on a piece of our debt. And what we did is we decided to get out of it, and make a cash payment, so that our run rate should come down very nicely. Think of it as sort of refinancing your house. We did a little bit of that. So that was probably about – that was a couple million bucks.

Okay. So that will come back down to normalized levels?

Correct.

Okay. Great. And then for your guidance, does that include Stage? And when do you expect that to close now? How’s that going through the regulatory approval?

The OCC is going through their very diligent process. And I don’t have a particular good feel for exactly the speed with which that will happen. We would hope that by Fall we would be able to get that conversion done. And some portion of that is in the guidance, as a conversion in the late Fall.

We sort of cut it down the middle from the point of view of there shouldn’t be an issue. But what we did is we took a pretty conservative stance, and basically said all right, we just want to make sure it’s on board for the holiday season.

Okay. And then on the Utility section, can you say how much in the quarter that AEP and Centrica added?

No. But I can give you a general sense in terms of a typical Utility client. If we’re going to do, call it $120m or so of revenue this year, my guess would be that roughly equates to about a dozen clients. We tend to make about $10m or so in revenue per client. I would say AEP and Centrica would be a little bit north of that.

Is that each, or combined?

Each.

And then final question, and then I’ll get off, is your Shell Canada for your AIR MILES® program came due in July. Is that getting resigned?

We’ve not actually signed the contract yet, but are fully confident that will happen. There was a kind of an illness in the legal department on the other side that has kind of delayed some of the review work. But it’s basically getting their final blessing. So we’re confident that will happen.

Okay great. Thank you.

You’re welcome.

Your next question comes from Andrew Jeffrey of Needham.

Hi. Good afternoon guys.

Hi Andrew.

You’ve had phenomenal new business signings and great momentum. Can you talk a little bit about both capacity with respect to the recent announcements, and potential new announcements, and also, sort of as an adjunct question, talk about any potential investments you might be making in infrastructure or new businesses?

You bet. The – I guess I’d break it down into three or four different pieces of our support group. Certainly the – if you think about our core billing engines, and statement processing production, all highly leveragable. And we don’t see any significant rollouts of cost in that area.

Call center capacity is really the second one you’d look at. We really control all of our call volume through our national call center out of Columbus, to drive calls through that capacity. Plus we’re bringing on a major new call center with Stage Stores. That’s the one that tends to be a little more direct.

Our database marketing platform is the next key component of driving the retail business. And our database marketing - and that is highly leveragable as well. So really, if you look at all segments of the business, it brings on very profitable revenue that people-based businesses can do to not be quite as leveragable.

The last one I guess you could think about that has a lot of leverage in it is the risk management group. Obviously we’re going to bring on all these new businesses on our same risk model that we do for all of our other customers, so we don’t have to reinvent the wheel. In fact, that’s one of the value, as to why they chose to come with us to help them through that. So we’ve got a lot of leverage there.

So we’re really confident in bringing on the new clients, without having a significant impact in our day to day operations.

Okay. And as far as potential new business initiatives, and investments – I’m thinking things like non-credit loyalty or something like that – is that potentially in the offing? Or do you just have so much core business to sign and execute on that it’s sort of back-burner stuff?

If you’re talking about major growth initiatives outside of our three growth engines – is that what you’re focusing on?

Yeah. Or any other significant investments that you might be making.

Yeah. No. Our whole focus is continuing to drive success in our – closing our pipeline of new business. You heard me talk a little bit about some other R&D kinds of – those are typically small, what we call our horizon three product kinds of ideas. But that’s mostly research. We have some small dynamic value we call the prepaid card with a client going on. But nothing that should make any impact really on the financials.

Okay. Thank you very much.

You bet.

Your next question comes from David Tossman of Wachovia Securities.

Hi. Thanks for taking the question. Ed, can you help me understand either the margin, or maybe the expenses in the credit services business? It looks like the margins there didn’t follow the seasonal pattern that we’ve seen over the past couple years. Is there something specific that’s going on there on the cost side?

Yeah. Meaning it did perform quite a bit better?

Quite a bit.

I’d say it was probably a combo of everything. Since last year, on the operating expense side, David, you’ve got at least one large refinancing on the cost of funds side, where we had some stuff maturing. We rolled it over, locked it out five years. That was a big help.

In addition to that, you’ve got operating expense leverage, which is beginning to flow through. And then I would say those are probably the two biggest. And then also, on the yield side, on the top line side, while we’re maintaining very nice merchant discount revenue, we’re also getting – actually we’re seeing a little bit better behavior in terms of the overall yield on the portfolio itself.

So really, stable pricing on merchant discount fees, a little better gross yield on the portfolio. It could be the mix of the new clients ramping up. I’m not really sure. And then on the operating expense side, we’re getting leverage from operations. And we’re also continuing to benefit incrementally really every quarter, from the Fed rate cuts that happened two years ago.

As you know, it takes probably three or four years for it to roll through the portfolio. So we expect more of that to continue through this year, and even into next year.

All right. We’ll do a little bit more on that one later I think. My other question is on the Utility businesses. Were they in – for the whole quarter? Or did they ramp through the quarter, so that by the end of the quarter we’re there the whole time?

No. Well, it’s AEP and Centrica were the two big ones. They were in for the whole quarter. TXU, which is a start-up, is really just – that will be ramping for the next 18-24 months.

But the bulk of it would be AEP and Centrica.

If I remember correctly, those are combined – about 800,000 customers. And would they then translate to something, 2-1/2 million new statements in the June quarter, versus where we were in the March quarter?

That sounds about right.

And so if the number of statements goes up only a little north of a million from 1Q to 2Q, is that because there is some seasonality in the retail side of the business?

We didn’t have tremendous growth on the statements for retail. A lot of it came from the Utility side. Again, in retail, don’t forget we haven’t cranked up Stage. That’s not on board. And Eddie Bauer, Spiegel and Newport – they’re not really up and running yet. So that’s all to come.

But you’re right. The first quarter after a holiday season, we have higher statement volumes, as more and more people build balances, and as some of those pay off in full throughout the second quarter, would tend to drop off a little bit.

Yes. There is some normalcy there.

The next question comes from Lou Miscioscia of Lehman Brothers.

Hi. This is [Julian Bua] for Lou Miscioscia. Hey Ed, a couple of questions. First of all, could you break out the cost of operations, and also the G&A?

The SG&A?

G&A, and the cost of operations.

Yeah. I mean, again, we primarily focus on revenue and EBITDA, only because of, obviously, the allocations between what’s overhead and not overhead. But at a very high level, [Julian], I think we did about 4-1/2% or so was what we would call overhead, versus about 5% last year, of total expenses.

Okay. That’s great. And also, if I could just follow up on the margins in the credit services unit. Are you suggesting we can essentially expect mid-teens margins going forward in that unit? This quarter it was 15%.

Yeah. I mean it’s in pretty good shape. I’d say that was the – I would say that would be fair.

Okay great. And also, the last one I have is did you say you’re going to refinance some of the asset-backed securities in the Summer?

Yes.

What kind of savings are you expecting?

Yeah. That’s a good question. What we’ve decided to do, quite honestly, since the business is really going so strong at this point, is we have about a $350m of bonds coming due now actually. Normally we would take those, roll them into five year fixed rate money, and therefore lock that up at historical rates for the next five years, and probably pick up a good 100 or so basis points.

What we’re going to do this time around is we’re actually going to take another quarter billion or so, if not another $300m of portfolios that have been growing over the last 18 months, that we’ve been “warehousing” in what’s called conduit financing, funding it at short-term rates, until they get enough maturity that we can plop them very nicely into the math.

So what we’re going to do is trade off the benefits of short-term profits on that piece of the portfolio, and roll it into really a large asset-backed deal of close to $600m over the next couple weeks. So while we normally would pick up 150 basis points on the stuff rolling over, we’ll probably give up 150 basis points on the other stuff. And we’ll probably be about net flat, maybe up a little bit.

And I think the reason we’re doing that – not I think – I know the reason we’re doing that is this five year money and stuff, we’ve just – we’ve got to have it.

Okay. So in terms of the savings, what’s the kind of – what kind of [inaudible] are you looking at?

As I said, we don’t expect any, because of that mix.

Okay.

But we’re going to have very good run rates for the next five years.

Okay great. Congratulations guys.

Thank you.

We have a follow-up question from David Scharf of JMP Securities.

My question has been answered. Thank you.

Thank you sir. We have a follow up from Don McArthur of Stifel Nicolaus.

Hi guys. In the Credit Services segment, what was the finance charge portion of that?

Credit Services – it usually runs about 60%. So I think that’s about right.

Okay. And then delinquencies – is the number just over 7-1/2? Or is it?

No. Losses were just north of 7-1/2. I think it was like 7.7. And then delinquencies, which went the other way, were down to like 5-1/2.

Okay. So 7.7 on charge-offs.

Yes.

Great. Thank you.

Yes.

A couple more minutes Operator. Then we’ll call it quits.

Yes sir. Your final question is from [Nick Trautman] of Adams, Harkness & Hill.

Hi. Thanks. If I try and back into the revenue [per statement] [ph], I get about a $3 number, growing into mid-teens. Does that sound about right? And is significant growth sustainable for the next several quarters here?

I wouldn’t put it at mid-teens. I’d put it in the single digits.

Okay. For this quarter?

Mmm-hmm.

Okay. The other question, it looks like the dollars had a little bounce here. The Canadian dollars kind of rolled back over. Will that $4-5m EBITDA hit be a little high if the current currency rates hold for at least a month or so?

Yeah. Well that’s a good question. What’s interesting is, as we talked a little bit earlier about sort of the global hedge within the corporation, that when the dollar snapped back, interest rates went up on yield curve. Right? They went up 60-70 basis points. So what we gained from an accounting perspective in the Canadian business, we probably – it got taken back in the Credit business, as we get ready to refinance those $600m. So I’d say we’re probably net flat.

So big picture, I would say no change in where we see guidance. But at the same time, it might shift a little between the buckets.

Okay. And could you just give a quick update on Spiegel, where you guys stand there?

Yeah. I think we’re – for the rollout?

Yeah.

As we mentioned earlier, we’re in that process right now, going as predicted. Slow in the start. I don’t know. Did you have any specific numbers?

Yeah. Again, it’s sort of a phased in approach on the Spiegel. If you were to look at, again, the three divisions, the most important thing is to make sure everything is cooking along for the holiday season. So you’ve got Eddie Bauer, Spiegel and Newport News. In June we completed what’s called a soft rollout, where we did some pre-screened mailings to the existing high quality mail order file, for example, spent with the catalogs.

In July we went on line live with the online prescreen piece. And then in August we’re hoping to roll out for Eddie Bauer, since that’s primarily the one with the stores, what we call Quick Credit, which is when you actually go into one of the Eddie Bauer stores, we can, as part of your purchase, within 30 seconds, we can score you and say yea or nay on credit.

So it’s sort of a very measured approach for all three of those divisions. The goal would be to get all the bugs worked out, move a soft rollout to a hard rollout into the Fall, so that when the holiday season comes, we are firing all cylinders.

Okay. So it’s really a Q4 benefit we should be looking at?

Right. I mean it’s going along nicely now. I mean, as you know, with a start-up, you’re probably – you’re dragging the P&L a little bit for the first couple of quarters. But the holiday season is just so important, that sometimes we’ll spend a little bit extra to make sure the thing is rolling.

Right. Okay. Thank you very much.

Ladies and gentlemen, we have reached the end of the allotted time for questions and answers. Mr. Parks, do you have any closing remarks?

Yes. I just want to thank everybody for joining us. Again, we’re excited about the year. And we’ll see you all in the quarter.

Bye-bye.

Thank you. This concludes today’s Alliance Data Systems Second Quarter Earnings Conference Call.