Bread Financial Holdings Inc (BFH) 2005 Q1 法說會逐字稿

Good afternoon, and welcome to the Alliance Data Systems first-quarter 2005 earnings conference call. At this time, all parties have been placed on a listen-only mode. Following today's presentation, the call will be open to your questions. (OPERATOR INSTRUCTIONS). It is now my pleasure to introduce your host, Ms. Julie Prozeller of Financial Dynamics. Ma'am, the floor is yours.

Thank you, operator. By now you should have received a copy of the Company's first-quarter 2005 earnings release. If you haven't, please call Financial Dynamics at 212-850-5608.

On the call today we have Mike Parks, Chairman and Chief Executive Officer, and Ed Heffernan, Chief Financial Officer of Alliance Data 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 described in the Company's earnings release and other filings with the SEC. Alliance Data Systems has no obligation to update the information presented on the call.

Also on today's call, our speakers will reference certain non-GAAP financial measures, which we believe will provide useful information for investors. Reconciliation of those measures to GAAP will be posted on the Investor Relations Web site at www.AllianceDataSystems.com. With that, I'd like to turn the call over to Mike Parks. Mike?

Thanks, Julie. Good afternoon, and thank you for joining us today. Turning to our agenda, I'll spend a few moments reviewing our highlights of the quarter. We'll focus on our three growth engines and I will turn it over to Ed to review -- (inaudible) the financials in greater detail and at the end, as usual, we'll take some questions.

Before we move on, however, I wanted to mention a recent leadership conference that Alliance had across all of our divisions. And as we look back at the past five years and focused on our next five years and beyond. We came together to launch our new mission statement, a statement that we believe has one foot firmly planted in our presence and one foot striving ahead towards our future. And it reads, great companies will call Alliance first to create more loyal and profitable customer relationships. We are fortunate to have our clients, some of North America's great companies and our suite of services derive from our core transaction credit and marketing services businesses, which all create more loyal and profitable relationships. This is the answer our new clients as well as our old clients give when asked why Alliance Data. I believe we are well on our way to realizing this vision and our goal is to double the size of our Company over the next five years.

Now, let's turn to the quarter. We're very pleased to announce another record quarter for the Company, our best quarter in history. Revenues reached 376 million, a 20% increase for the quarter over last year. During the same period, EBITDA increased by 13% to approximately 89 million and cash earnings were up 21% and $0.52 per share. Our three growth engines, utility services, private-label processing and our Loyalty AIR MILES group and marketing group continue to drive this strong performance. Let's take a look at each, starting with utility.

As we discussed in February, our focus for the year in utility services is to ensure that we're on track with both our growth and margin expansion plans. In the area of growth, we expanded our core CIS billing and customer care services by now providing a suite of consulting and software implementation services for Cobb Energy. Cobb, the second largest electricity co-op in the country, serves 200,000 customers throughout Georgia. These services broaden Alliance Data's offerings and our capabilities for our utility clients, deepening our strategic relationships and also positions us well for future outsourcing decisions.

As we mentioned last quarter, our focus in 2005 is to enhance our operational effectiveness. Following significant business development activities over the last twenty-four months, we have begun consolidating areas that will result in margin expansion. These activities are on track to be completed by mid-May and we will drive margin in the second half of the year. Also during the second half, we will begin converting Entergy and Direct Energy and all projects are on schedule.

Now if you turn to the next slide, we'll take a look at private-label services. Our private-label group had another solid quarter despite some very tough comps from last year. We're excited by the announcement of a new private-label agreement for Z Gallery, a fast-growing lifestyle and furniture retailer, operating 59 stores with sales approaching 200 million. We will assist Z Gallery in driving sales and increasing customer loyalty through our comprehensive services for their retail stores and Web site.

We also announced a long-term agreement with Hanover Direct for a fully-integrated private-label and cobranded credit card program. Hanover Direct is a leading catalog and Web retailer of home furnishings and accessories, as well as men's and women's apparel. Their brands include The Company Store, Domestications, and Silhouettes. We will initially launch the private-label program for the Hanover brands and we'll later introduce the integrated cobranded program, targeting selected consumers that meet our traditional credit quality standards. The card will offer a loyalty rewards program that recognizes customers for their purchases, including those made on the cobranded card outside of Hanover brands.

Also this quarter, we renewed Pacific Sunwear, a fast-growing specialty retailer for young adult apparel. Our program is recognized for reinforcing their brand and improved loyalty.

We got a solid performance in portfolio growth along with improved credit losses and operating leverage across the business. Credit sales were a bit flat, but all in all, a very nice quarter.

Now let's turn to marketing services. This quarter, both our Loyalty AIR MILES program and Epsilon turned in strong performances. We're seeing some great benefits from the national rollout at the BMO WestJet AIR MILES card, as well as the national rollout of Rona, the leading retailer and distributor of hardware, home renovation, and gardening products in Canada. Since 1992, Rona has been a regional sponsor and we're very happy to include them now as a national sponsor.

We're also pleased that both in client renewals and new sponsor signings, our value proposition remains strong and our pricing remains firm or firm/strong as a result. Programs like AIR MILES that truly deliver results are the key to more loyal and profitable relationships.

Turning to Epsilon, this quarter, we were selected to provide marketing services for the world's largest lawn care services company, TruGreen ChemLawn, serving more than 10 million residential and commercial customers. We'll be implementing their new customer direct marketing strategy, which includes a comprehensive set of direct marketing services from test design to results analysis.

Lastly, we're very pleased with the smooth transition of Epsilon to the Alliance Data family. The Epsilon team has a rich history in database marketing services and a tradition of delivering what they promise, a perfect fit with the Alliance model. I want to congratulate both Loyalty and Epsilon teams for a great job this quarter.

Turning to the next slide, the outlook -- we're off to a great start. As a result, we're raising our earnings guidance to $1.87 to $1.90. We're comfortable that our solid performance will continue throughout the year. However, there is plenty of work that remains. Our focus will be as follows -- first, streamlining the operations in utility services to further increase our efficiency and effectiveness to bring on new business. Second, secure new signings across all growth engines. We expect to see two or three new signings in utility this year. For private-label, the pipeline is very strong and we are optimistic that we will get more than our usual share of signings. And so you can expect to see another three or maybe four announcements in addition to Z Gallery and Hanover.

For marketing services, we also expect three to four announcement in 2005. And lastly, we'll continue to look for potential synergy throughout Alliance with our Epsilon team. By delivering on these focused items, we'll be nicely positioned for 2006.

I want to recognize the entire Alliance Data team for their outstanding results. Thanks for another record performance. There's still a great deal of work to do, but I'm confident in our ability to deliver. Ed, if you'll review the financials now.

Great. Thanks, Mike. You should have in front of you the first-quarter consolidated results. Q1 marked our 16th quarter as a public company and further extended our track record of delivering or overdelivering on what we promised. Overall, things came in better than expected across all four of our key financial metrics. And I want to start with a couple of general comments.

First, top line was quite strong despite four headwinds. One, very tough year-over-year comps in private-label. Two, a grow-over issue from our one telecom client, Pegasus, which went bankrupt. Three, continuing growth difficulties at one of our large private-label clients. And four, we did some pruning of noncore accounts in our traditional merchant bankcard acquiring business.

Despite all this, revenue surged ahead 20% as our Loyalty AIR MILES and Epsilon businesses overperformed as well as welcome overperformance in our private-label despite the brutal comps. EBITDA had a healthy increase but lagged revenue growth due to two items. EBITDA last year was higher than normal due to certain marketing costs in Canada, which were not spent but delayed until later in '04. And second, this year carried additional expense associated with the utility streamlining effort. Despite both items, midteens growth was realized.

With (ph) operating cash flow, also called operating EBITDA, as well as cash EPS, both up over 20%, it appears that we are once again off to a great start. Cash EPS exceeded our prior expectations by $0.06 a share.

While it's still a bit premature to say that "we're off to the races" for the full year, we are nonetheless comfortable with raising our full-year guidance due to the expectations of overperformance in Loyalty AIR MILES, Epsilon, and again, most welcome in private-label. All right. Let's hit the segments. Next slide.

We'll start with the toughest, move to the easiest. First up, Transaction Services, which houses private-label, utility services, and our traditional merchant bankcard processing businesses. A tough quarter with no revenue growth and a 4 million decline in EBITDA versus the same period a year ago. The lack of revenue growth can be attributed to the following items -- first and probably the biggest were the brutal comps in private-label versus very strong results overall last year, as well as continuing growth issues at one very large private-label client, whose own comps were down 20% plus. What does that mean? Well, less sales activities mean fewer active accounts, which means fewer statements generated, and hence, pressure on revenues.

Now the good news is that both items will clean themselves up in the second half due to easier comps and the ramp up of new private-label wins that Mike talked about.

Second, Pegasus Communications for the utility client which went bankrupt in Q4 last year, so we have a grow-over issue of a few million a quarter as well. This kept overall utility roughly top line flat versus prior year.

The good news, again, is that this anniversaries in Q4 and in addition, both Entergy and Direct Energy are slated to convert late summer, early fall, which will also start momentum going into year end and into '06.

Finally, we continue to prune non-core, low-margin accounts from our traditional merchant bankcard acquiring business. We'll do this from time to time since we're focused on clients where we can drive long-term value and avoid price pressure.

From an EBITDA perspective, the same items drove weak results, but in addition, we did expense a few million related to our utility streamlining effort. This effort will be completed at the latest by June and we expect to see a very nice margin pop by Q3 and into '06.

Summing up, tough quarter, but as noted, it should very nicely clean itself up as the year unfolds with the goal being positioned for a very strong jump off in '06.

All right. Let's move on to credit services, which continues to perform above expectations. Against a backdrop of very difficult comps and weak results at one major client, revenue grew 7% and EBITDA surged 20%. How come?

It should first be noted that the reliance on any one driver such as retail sales or credit sales as a predictor of our financial performance does not work. Rather, one must look at all five of the drivers. They are credit sales, portfolio growth, funding costs, credit losses, and operating leverage.

Let's start with credit sales growth, which was poor at only 2%. Excluding the one trouble client, it would have been somewhere in the mid single digits. While this one hurt '05's results, did (ph) offsets elsewhere, we do want to start seeing that move up in the second half, which it should, due to easier comps, '04 and new client ramp-ups and '05 new client wins.

Now, overwhelming the weakness in credit sales were all of the other drivers. First, the portfolio continued to grow nicely. Second, credit losses continued to improve and are now in the low 6s. Third, despite sharp increases in macro interest rates, our funding costs were not impacted since we had previously locked down our exposure. And last, operating leverage continues to improve.

So overall, added up, you have four pluses and one minus, which nets to solid financial results with more to come. Based on what we signed so far this year plus the activity in our pipeline, we're feeling pretty comfortable right now for sure that the one minus will start picking up steam in the back half and be ready for prime time as we move into '06.

All right. Let's finish up with marketing services, which, as expected, took over the leadership role for 2005. On top of that, both Loyalty AIR MILES and Epsilon performed exceptionally well right out of the gate. Loyalty AIR MILES powered ahead with 20% plus organic top line growth, driven by the rollouts of two huge national deals signed last year, The Bank of Montreal WestJet deal and the deal with Rona, Canada's largest home improvement chain. Also, pricing remains what we call "firm plus," thus driving incremental revenues.

Turning to Epsilon, never missed a beat since joining us. Even on a pro forma basis, its revenue growth was up 20% plus. On the EBITDA side, strong results as well. Additionally, it's important to recall that last year, EBITDA was much higher than normal due to significant marketing expenses that were delayed until the back half of '04.

All right. Let's summarize. Before we move on, I'd like to make one more observation. Overall, very strong quarter and well above expectations and that's great. Peeling back the onion a bit, so to speak, and how we got there may look a little bit uneven. That's the nature of our model, always has been, always will be. You are seeing a leadership change from private-label to marketing, while also taking the time to streamline utility so that it can step up big in '06 and '07. But leadership change does not mean private-label is dead. Rather, it's merely returning to very solid, low double-digit growth. That's why we're comfortable moving up guidance despite some headwinds.

All right. Onto the balance sheet. Real quick, a couple of things. First, deferred revenue of 550 million is up 85 million versus Q1 of last year, about double the historical rate. Strong growth in our AIR MILES business plus a strong Canadian dollar suggests solid P&L results as this slows into the financials going forward.

And second, despite the all-cash purchase of Epsilon late last year, the free cash flow generation of the business has already enabled us to post a core debt-to-operating-cash-flow ratio of less than 1 times. Core debt improved 40 million from year end while cash improved 75 million, for a net pickup of 115 million during the quarter.

All right. Moving onto guidance, next slide. As noted earlier, we're off to a very strong start and as such, we're comfortable raising guidance to $1.87 to $1.90 from $1.81 to $1.83 previously. The midpoint suggests a growth rate in excess of 22% versus the $1.54 we posted last year.

Now I'll talk a little bit about Q2. Q2 seasonally is our weakest quarter. It should run at around let's call it 85% of where Q1 came in or near our initial guidance of roughly $0.44, which would suggest a 20% growth rate versus last year. How come? Q2 experiences significant seasonality as cardholder finance income drops as more people become current on their bounces. For example, tax refunds kick in. On the other hand, we always see an uptick in losses during Q2 as some other folks go the other way and run out of gas by Q2 following too much spending during the holidays.

And finally, we need to finish up our utility streamlining effort during Q2. And note also that revenue and EBITDA will also experience this seasonality and expectations should be tempered accordingly. This seasonality starts to reverse as we enter Q3. Combined with the conclusion of our utility cleanup and the ramping of new client signings, the back half of the year looks even more promising. To conclude, great start, still a lot of work to be done.

All right. Almost there. Let's turn to '05 estimated free cash flow. Our initial guidance way back in October called for 2 bucks per share. We moved that up to $2.05 during our Q4 call in January due to the strength in our Canadian business and we're now comfortable moving it up again to $2.10 per share for roughly 180 million as private-label continues to exceed expectations.

All right. 2005 themes -- I think we've covered all of them, but again, very briefly on Transaction Services, what we're going to see is some tough first half comps on the private-label side; second half becomes easier, plus we have a bunch of new clients and new signings and a few more to announce before then, so they rampups should very nicely flow into the latter part of this year and into next year.

Utility -- we need to finish up our streamlining effort and move into the second half, where we can convert Entergy and Direct Energy and also look for margin pop. Our old merchant bankcard acquiring business -- we've done this a couple of times before. We will continue pruning the non-core, low-margin accounts.

Now moving to Credit Services, portfolio growth, credit losses, funding costs, operating leverage all are heading in the right direction. And as we talked ,about credit sales will be a little tough in the first half and we get some good momentum for the second half.

Finally, Marketing Services as expected, Loyalty and Epsilon are tracking very nicely. What's unexpected is they are tracking so far ahead of where we initially anticipated. They are the overperformance leader of the year. An overall great start in raising guidance.

Now just a general comment, we're hearing concerns out there about slowing consumer spending. What does that mean to us? And I guess what we'd have to say is we believe our model can handle this just like we zipped through the recession of '01. Why? Well first, the non-consumer focus parts of the Company, such as Loyalty AIR MILES, which is geared towards nondiscretionary spend by the consumer, Epsilon and utility services should play right through.

Regarding private-label, positive trends in credit losses and funding costs and operating leverage should continue even in a macro slowdown.

And finally, our private-label pipeline is as active as we've ever seen it, suggesting that new wins should very nicely counteract the slowing consumer in the core portfolio. Overall, that's why we're comfortable raising '05's guidance and with our visibility, '06 is shaping up nicely as well.

That's about it for me. We had a couple more slides here. One is showing our operating leverage. Our goal is to do roughly do about 50 bits a year. We've been averaging over 100 over the last six, seven years. Nonetheless, we do expect that expansion to continue through this year and into next year. And then finally, the 2005 results we've done over the past. That being said, I'll kick it back over to Mike.

Thanks, Ed. Again, just to reiterate, good quarter. We are excited about '05 and we've got a lot of positive momentum going into the year and we're looking forward to the rest of the year. So let's turn it over for questions. Operator?

Thank you. (OPERATOR INSTRUCTIONS). Jim Kissane of Bear Stearns.

Hi, Mike and Ed. Great job again. Ed, can you break out the spending on the utility filled (ph) platform consolidation in the quarter -- how much of the margin pressure and transaction was from that and how much was from the lower revenues? And yet you said that should be complete by June. Where do you expect the margins for utility once the streamlining is done?

Sure. I can give you sort of some high-level numbers. I think our target was -- we expected to drop around 8-ish or so on the overall effort. I think it's fair to say you could split it equally between Q1 and Q2. I'll leave you with the math for that. And then secondly, in terms of margin, I think utility was probably running around let's say a 10-ish percent EBITDA margin and we would expect that to pop up to let's call it another 300 basis points around 13% for the back half of the year.

And the pipeline for utility?

Continue to be very active, Jim. Lots of discussions across all three of the segments.

And last quarter, it seemed like it was just one specialty retailer that was a major drag on credit sales. Did you see the weakness spread beyond the one retailer?

No, not really. We were probably doing like you said mid single-digits growth excluding that one large client, so that was -- obviously it was spotty depending on who guessed right I guess on the fashion side. But that was fairly decent. That's probably where we wanted it knowing the tough comps that were out there. And I think what we want to do is, with the 2004 programs ramping up and the '05 signings and what you're going to see over the next three or four months, which is pretty exciting, we want that last driver of private-label. We don't want to rely in '06 on all those other four drivers continuing to do extremely well. We would like that fifth driver to also kick in. So we want to leave this year with a very strong run rate on the credit sales and we think we will.

Okay. And then just one last question. It sounds like the transaction revenue growth will resume in the third quarter. Is that right?

It should start kicking in then, yes.

Okay. Thanks a lot. See you.

Greg Smith of Merrill Lynch.

Good afternoon, guys. I don't think you gave the transactions processed number you typically give in the press release.

Yes, we decided we're not going to provide that driver any more. It relates only to that old traditional bankcard merchant acquiring business. It's not one of the three growth engines. That's now declined down to I'd say probably 7 or 8% of the Company, Greg. So it's no longer really a meaningful driver to understand where the Company is going. That is where we are pruning some of our top line to the tune of 20-ish, probably 25 million of top line of very low-margin stuff that's there. So this thing will probably as the Company grows so quickly will continue to decline as a percent of the Company. And quite frankly what we have found over the past few quarters is it's confusing more people than it's helping, in that statements generated in the key driver because it covers both the utility and private-label.

Okay. And then Spiegel -- how is that ramping? Sort of where are you in the lifespan of that deal?

The Spiegel Group?

Yes.

Yes, and again that would -- they've been -- they've sort of all gone off into different directions, but you have Spiegel. You have Newport News, and you have Eddie Bauer. And obviously, we're not going to comment on a specific client how they've been doing, but I would say in terms of the group, they are probably ramped about halfway between -- starting from zero wallet share to where we eventually want them to be, which is usually somewhere around a third.

Okay. And then with your leverage ratios coming down quite a bit, any -- do you still have a decent appetite for acquisitions now that S1 is kind of in there? Or any other thoughts about a buyback -- how are you thinking about free cash flow usage going forward?

First priority would be some tuck-in acquisitions, as we've historically done, Greg. If another Epsilon were to come along that had that strong a fit in terms of business model and processing and marketing services, we'd certainly look at it, but we don't see anything on the horizon that size right now. So growth continues to be our primary focus.

Yes, and I would say, to echo Mike's point, our model is we want double-digit organic top line growth, obviously more that drops to the bottom line, plus hopefully an additional kiss (ph) from either the tuck-in acquisitions that we do on occasion or every other year or so or every three years if there's an Epsilon floating around. Right now in the pipe, there's nothing big, but we'll probably keep our powder dry for a little bit here.

Okay. Thanks, guys.

Tien-Tsin Huang of J.P. Morgan.

Now that we've -- I guess we've established a new revenue base in marketing, should we expect that to grow sequentially from here or is there some seasonality we need to think about?

In the marketing segment, there sure is some seasonality. Q1 tends to be very strong for the Epsilon business because of all the marketing work that they do. So seasonally, again, you're not going to see Epsilon sequentially grow. From a loyalty perspective sequentially, yes you will probably see a little bit of growth there. But to be safe, I'd keep it relatively flat and my guess is that should give you some very healthy growth rates versus Q2 of last year.

Okay, got you. And then Ed, where did charge-offs end up in the quarter?

6.2.

6.2? So structurally, now that I guess FICO averages are higher for the overall firm, I mean should we assume then that the long-term target loss rate is now closer to maybe 7% instead of the 7.5 we've been talking about?

Well, that's a great question. We haven't moved it internally. There's been a lot of discussions. Obviously, what's driving the super performance these days, probably three things. One is, we've done -- the guys have done a tremendous job on the back-end collection activity and getting in front of any problems. That's helped. To your point, for sure, I think the types of clients we brought on over the last couple of years has probably tweaked up the typical customer in the file. That certainly helped. And then third, let's face it, the macroenvironment hasn't hurt. So we haven't made a conscious decision that boy, we want to target 6.1 or 6.2. We've always said 7.5 is kind of where we like to be.

Do we see the good news continuing for now? We sure do. Obviously you expect your seasonal uptick in Q2 and then it would start trending back down. But we're just going about our business. We're not going to go out and start opening up the spigots and opening up the credit quality to get that credit loss number back up. So right now, we're just going to ride the wave and enjoy our good fortune.

Okay. And one last question maybe on that. How does rolling out from these cobranding initiatives sort of change the credit equation?

Another real good question. It won't. We announced one deal with the co-brand. As Mike alluded to, with that deal, boy, we're not even going to go take a look at it for another 12 or 15 months. Essentially, we're waiting to see how private-label rolls out. And as you probably all know, with a private-label type deal, make up a number -- one out of every three new accounts, they use it once and then put it in the closet somewhere. So what we want to do is 12 or 15 months from now, go into that file of inactive accounts, which usually tend to be pretty high on the credit quality spectrum -- usually even sometimes higher than our private-label accounts -- and see if we could entice them with a more broad-based, general-purpose card with a nice reward or a loyalty program attached to it. So it's quite a ways off down the road. It will be a niche (ph) in terms of the financials for probably the next few years. So as much as we'd love to say it's a great new product offering, in terms of moving the needle on the financials, probably not much for awhile.

Tien-Tsin, the other comment is unlike the past couple of years where some of the financial services kinds of companies have tried to go after a thin slice to drive balances way high and then pay a big kind of upfront bounty as an alternative to their direct marketing spend for accounts -- and by the way, very seldom has that worked -- our approach is much different. Our approach isn't to drive big balances. It's another way to get a segment of the client base into a loyalty vehicle. And we'll have very similar dynamics due to our private-label. So we're not in it like the banks. Remember this is -- and back even to the credit score and charge-offs, we don't choose in a direct marketing mode and mass mailing like the banks do. Our client customer base really drives what the average score is and average kind of client we bring on. So don't think of this as some of the things you've seen in the industry for the last couple of years around a big co-brand balance ploy (ph).

Okay, great. That's helpful. Thanks a lot.

Paul Bartolai of Credit Suisse First Boston.

Thanks, guys. Good job on the quarter. In the marketing segment, the top line was certainly pretty strong, but a little bit harder to get a read on margins. Just give us some of the delayed (inaudible) spending from last year. So I was just hoping you could give us some of your expectations for marketing margins for the full year.

Sure. We obviously expect big things out of it. I think last year, what you saw -- trying to remember back a little bit -- but what you saw was probably obviously very large margin in Q1, which declined actually fairly dramatically as the year progressed, especially on the back end as a lot of that marketing expense was shifted to the Q3, Q4 to coincide with the big bank of Montreal and Rona rollouts. This year it's going to be a little bit of the reverse, or I would say a lot more normal rollout. So from an EBITDA margin expectation, we would certainly expect to see about 150 basis point expansion in the EBITDA margin for that segment for the year, which would suggest you're going to see a nice snap as the year progresses, if for no other reason than last year it was really front-end loaded and this year it's going to be more normal.

Was the spending last year then pretty evenly spread out over the last three quarters so that the year-on-year increase should be pretty steady in the second half of this year?

It was pretty heavy actually in the second half of last year.

The second half?

Yes.

Okay, and then in the private-label side, definitely (ph) saw (ph) what the pipeline is, continued to be pretty strong. Just wondering if you could talk about the expected timing of some of these signings and kind of the makeup of some of the companies in the pipeline?

Sure. The makeup in general, as we historically talk about is both a mix of startups that have never had a card program before and some with existing programs and balances that will probably be 50/50 maybe -- maybe a little bit more toward the startup. It just depends on which ones happen to fall. And I guess that's as detailed as I think I'm comfortable getting.

Yes, I think, obviously, I don't think you're going to see anything way out of bounds for us. Obviously, the areas that we're very strong in, obviously the apparel, soft goods, and jewelry, furniture, -- those types of things obviously will probably dominate what we see right now. But to Mike's point, and we're still trying to understand exactly why it's so busy right now, maybe because last year we just needed a little more time to get through the pipe, but it's pretty darn busy out there.

All right, great. Then last, just on transaction, with the spending utility in the first half, should we still expect margins for the full year to be kind of flat to up slightly?

Good question. I would think the margins would be up on the full year, would be my guess. I'd love to sit here and say it's only because we're going to see a huge pop in utility. That's certainly one of the things we're expecting, but to be honest, part of it will also be due to some of the pruning that we're doing in our very low margin or no margin old merchant bankcard clients, which will basically mute the top-line growth in the segment and therefore keep the more profitable clients and hence margin expansion on the back end.

All right, great. Thank you.

Wayne Johnson of SunTrust Robinson.

Hi. Good afternoon. Just a follow-up on the pruning for the non-core on that merchant processing business. How much more do you have to go? We went through this last year. We're going through it again this year. Is it a rolling issue regarding contracts? What should we expect over the next three years per se?

I don't know if I can quantify it for you, Wayne. But you know that the business is very competitive. A lot of price pressure in that particular segment. We have some very deep, long-term relationships with some of our major petroleum and convenience store clients that have some ancillary services, but it kind of just depends on where the market goes over the next two or three years.

Okay. And can you give us a sense of where you think the margins are now in that particular service?

Probably low teens at this point.

And also, on the dollar value basis, do you recall how much was postponed in the first quarter '04 and how much was included in the first quarter of '05 regarding marketing, in the marketing segment?

I don't offhand. I'm sure if you went back, it's probably somewhere in the order of a few million.

Right. And how much was included this quarter?

That would have been the swing.

Okay. All right. Terrific. Thank you very much.

David Scharf of JMP Securities.

Good afternoon. A few questions. First, in private-label, Ed, can you give us a sense for the seasoning of the receivables? And specifically, do you offhand have a feel for what percentage of the accounts for the receivables on balance now are ones that were originated within the last 12 months and how that would compare to a year ago?

I don't have it offhand. It should be in the K. But I can tell you in terms of the portfolio itself, it's a very seasoned and mature portfolio. I would say -- my guess is that it's somewhere -- 36 to 38 months off the top of my head, I think would probably be a good starting point, which is considered a very seasoned portfolio. If you recall, even when we brought on Stage Stores, which added a lot to our growth, recall, those were accounts that were well seasoned as well. So I think it's not a function -- the low loss rate is certainly not a function of jamming on a whole bunch of new accounts that haven't yet hit their tough part of the cycle. I think it's here to stay.

Perfect. Secondly, staying within credit, just trying to get a handle on segment margins because this was an unusually high EBITDA margin, yet your highest ever, even without a big increase in credit sales. Correct me if I'm wrong, but the other elimination line on your P&L, and that's effectively what your credit business is paying Transaction Services for its processing, collections, call center, the rest. If I divide that line item by your credit services revenue, it looks like those expenses were 67% of credit revenue back in '03. It came down to 61% last year. It was just 53% this first quarter. And that probably speaks to the operating leverage you're talking about credit. But I'm wondering, is 53% a sustainably low number? In some respects, are the EBITDA margins being overstated in credit and actually understated in transaction?

That's a good question. I wouldn't get too far ahead right there because recall that you had very nice growth in the credit segment itself, but the growth wasn't because you had a whole bunch of new activity, active accounts, which drives that cost line. In other words, you had, for example, existing statements and accounts whose balances grew 5 or 6% during the quarter. That didn't require any more operating costs to do it. So to the extent you start putting on portfolios of new business, which we hope to start putting on, especially as we exit this year, what you're going to see is you're going to see more growth in the statements side and hence more expenses going into credit and hence you're not going to get quite that pop. So it's probably somewhere in the middle.

Okay. And lastly, just housecleaning -- do you have a figure for the earnings impact year-over-year for the Canadian dollars appreciation?

Sure do. Probably 5 to 6 million top line, which would have been about 1.2 on EBITDA or roughly one penny.

Perfect. Thank you very much.

Charles Trafton of Americas Growth.

Thanks. Ed, looking at marketing margins and what Epsilon probably contributed, is it safe to say that this year you are not -- that you are front-end loading in a lot of the new expenses -- a lot of the expenses up in Canada that you didn't last year?

Yes, I wouldn't think we are front-end loading this year. What I would say is this year is going to be more of a "normal" rollout for us, whereas last year, you had a huge front-end benefit because we deferred a bunch of marketing expenses. So I guess I'd tweak it just a little bit to say --

It's normalized this year.

This year is a "normal" year and last year was a huge front-end low year in terms of profit.

Do you have some up-front expenses in Canada with respect to the Bank of Montreal WestJet program that might have suppressed margins at AIR MILES last quarter or this quarter?

Certainly the latter part of last year for sure. For both the BMO's, or Bank of Montreal, and the Rona rollouts, there are significant rollout marketing costs that we do expense as incurred. Most of those are beginning to trickle off. So I would say we should be in pretty good shape right now. There is no major national rollout right now that we've signed, so we should start having a pretty nice run there.

You mentioned without the big client that has been going through the tough times that credit sales would have been up mid-single digits without that issue. Based on your pipeline and implementation schedules of new business, what do you think that -- you're talking about acceleration for the second half this year. What do you think that credit sales growth could be at the second half this year? High-single digit?

I'm making a guess right now, but our goal would be we would love to exit this year at double-digit growth in credit sales. That's our goal.

And I understand why you dropped the transaction processed statistic out of the release, but it does make it harder for us to back into a pricing trend, as meaningless as that might have become. You mentioned price plus environment. Can you give us more color on that?

Yes, I'll do it real quick. On the marketing side, for sure, that's what we call firm or firm plus, which means it's either stable or up a little bit. On the private-label side, we haven't seen pressure there. And on our utility side, pricing remains solid as well. So if you were to look at revenue per statement, that was pretty stable for sure versus same period a year ago. And again, what's sort of driving sort of the muted -- or actually no growth in the transaction bucket is some of the pruning we're doing and obviously the Pegasus throw over and the lack of activity due to the tough comps. But pricing is good. Pricing is good.

Any renewals for AIR MILES left in '05?

We have two large renewals across the entire corporation, both large supermarkets up in Canada and I'll kick it over to Mike, but we're feeling pretty warm and fuzzy about it.

You bet. These are long-standing customers and we're very confident that they'll continue the program and those are really the only two out of our top 25 customers that have renewals late this year.

Are they -- do you think you'll get them signed before the renewal dates?

Most likely, sure. Sometimes they trickle over, but that doesn't really impact -- at the end of the day -- impact any of the day-to-day operating activity.

Right. Thanks. Great numbers again, guys.

Lou Miscioscia of Lehman Brothers.

Okay, thank you. Can you actually break out Epsilon for the March quarter -- how much revenue contribution they made?

Yes, we're not -- we said to the last call (ph) when we took it on, we're not going to be slicing and dicing within interest segment. What we can tell you and you can -- you'll probably back into it pretty easily Lou is both Loyalty and Epsilon produced top-line organic growth in excess of 20%. Both of them did that. So you know what Loyalty is last year, you can probably solve for X.

Okay, great. In the add-backs to get to the cash earnings, I think you had 1.4 million of stock compensation expense. Was that options or is that restricted stock? And is there also an option number for that?

It's not option related. It's time-based restricted stock. There has been a slight change in the plan. I'll kick it over to Mike. But last year we had one big bucket bullet that came due at the end of the year. This year, it's going to be sort of a slow trickle of some time-based type executive non-cash comp.

Yes, in past years, not (ph) only time, we've had performance-based restricted stock as well. And we continue to use that as a -- both of those vehicles as well as options -- as a long-term incentive for management.

With results being pretty good here, I was just curious if you want to -- if the plan was to switch over proximal (ph) like some other companies are to just including it in the EPS number. And maybe if you have, what it would actually be for the full year, including options.

Yes, that's a fair comment. What we've tried to do, going way back to, as we were going public and we were levered up to the gills and everything else is we came up with this cash EPS number and this EBITDA number so that every single year, it is pure apples-to-apples. And those are the metrics we use and those are the metrics we get paid on to grow the Company. Now we also provide, obviously, GAAP and 9 million other stats out there and we sort of leave it up to you to figure out which one is the most appropriate. But for us, all we know is pure apples-to-apples; it's revenue; it's the adjusted EBITDA and it's the cash EPS. That gets you a pretty good feel for the trends of the Company and how we're doing. You combine that with sort of that extra cash kiss that we get up in Canada that never hits the P&L of roughly 25 million a year, and you should be able to get a pretty good feel for our free cash flow as well.

Okay. The final question. It looks like with, obviously, the guidance and the overachievement on the first quarter that the second half -- you said business obviously is going to be kicking back in. But right now, it looks like the numbers are pretty modest on a sequential basis. Are you just being very conservative similar to the way I guess it was for over the last year or two?

I'll take a crack at it. I mean it was never our intent to be out there addressing guidance or raising guidance on a quarterly basis. I think initially, way back when, when we started in '01, it was really on an annual basis. Obviously, Q1 came in very strong, but right now, a lot of work to do. We've got -- we want to finish up this utility streamlining. We want to get some more announcements signed and out the door to give us that warm, comfy feeling that the back half of the year. And quite frankly, more honest -- more importantly that '06 is really becoming rock solid, so we need a few more months to make sure everything is in good shape. And as hopefully good news comes through, everyone will be around to share in it.

Okay thank you. Good luck.

Larry Berlin of First Analysis.

Hey, guys, how you doing today? A couple of questions. For one, back on the Epsilon numbers and in that group, your EBITDA margin -- obviously half last quarter sequentially from the quarter before and then came back up. Is the bounce back up due to marketing expenses and things or the inclusion of Epsilon in the revenues for the full quarter this time? Or what's the split between that?

Yes, I think if I were to look back to Q4, I would say that Q4 of last year was probably a bit depressed from what I would call a normal year because if you were to look at Q1 of last year, that was obviously well above what a normal year would have. So it's somewhere in the middle. And if you sort of average the two, you get somewhere around probably in the high 14s; in this quarter, I think we were 15.5. So this is a much more normal year. So we expected sequentially it should have been up. It was. But as the year rolls out, it's going to be against the easier and easier comps from last year.

Okay. And one other thing, do you have any guess on what the -- accounting out-ups (ph) on (ph) what the organic growth was during the quarter year-over-year?

Boy, let's see. Loyalty certainly grew at 20 plus. Epsilon organically, even on a pro forma basis, Larry, grew 20 plus. Private-label did 8. Utility was probably flattish. So I think if you mix it all around there, you're probably going to get pretty close to sort of -- we probably tripped across double digits on the top line. And obviously it flowed through to a much greater extent down at the bottom. But on a full-year basis, there is no question that our goal is to have double-digit top-line organic growth for sure. And then additional growth for the acquisition.

Okay great. Thank you very much, guys. Have a good evening.

David Trossman of Wachovia Securities.

Thanks. I have kind of a niche question here. Have you seen or do you expect to see any changes in the discount relationships that you have with your private-label customers as you sign new or resign contracts?

No, it's our traditional pricing model, David.

And so did the change in that number on a year-over-year basis ought to very closely mirror the change that you're seeing in the card sales?

In the card sales?

In the sales volume on the cards.

Oh, I think what we try to do is, as you know, with new clients or with renewals with others, we always give the merchant the opportunity to trade off between rates that we'll charge their cardholders and the merchant discount that they are willing to pay. And as a result, that will cause things to jump around either up or down. We don't know which one they will choose, but some of them will choose to take a little bigger hit and have a little lower rates on their cardholders and vice versa. So I don't think it's a one to one.

Thanks.

Colin Gillis of Adams Harkness.

Hi, Mike. Hi, Ed. Another great quarter. So just real quickly, obviously Q2 is the quarter where credit losses pick up. Are there any signs that this particular quarter, just given the difficult environment for the consumer, might be a little bit more difficult on the consumer in terms of default rates?

Well I'll tell you what we're seeing so far. We're certainly -- we had typical seasonality. I don't think it's any worse than other years. I think the nice thing we're relying on -- and we saw this back in '01 as well, is the fact that this is a prime portfolio with a 700 score. You're not going to see these huge spikes up and down. So I think what you'll see is probably our pretty normal seasonal spike up in Q2. Listen, one thing to keep in the back of your mind is with this bankruptcy legislation that's imminent, there may be a period between signing and when it actually goes into effect.

With your rise in bankruptcies, right?

Yes, try to, as we call it, run for the courthouse (technical difficulty) back. But right now, this seasonality (ph) is pretty straightforward.

Okay, great. And just as a follow-up, on the Epsilon TruGreen win, is there any other part of the Company that was involved in helping that deal get landed?

No, that was a stand-alone traditional sales cycle out of the Epsilon team.

And what is that sales cycle right now?

I'm sorry. Say it again.

What is the sales cycle for them?

It depends on the kind of program. But it could be anywhere from 120 days to nine months.

Okay, great. Thank you.

Dan Perlin of Legg Mason.

I wanted to go back to the margins at Credit Services for a second if I could. I'm wondering I guess two things. Ed, I thought I heard you say for David's question that you thought that the other and elimination line was going to be -- did you say flat on an absolute basis sequentially?

No, what I tried to say was you shouldn't draw a direct conclusion that it should be the operating expense level should be that low, because a lot of it is determined by new account and account activity, which drives statement generation. Whereas in the first quarter versus last year, there basically was no incremental activity on the account. And therefore there was no incremental expense. Now, as we shift into all the new business that's coming through the door, start ramping them up, plus we get through some of these tough comps, there's going to be a lot more activity on the statement growth line, which means the expenses will start moving up their entico (ph).

But from a margin perspective, a lot of folks really thought last year we had peaked. And we tried to give comfort that we didn't think it was going to go the other way, so we're off to a pretty good start. We don't think all the good news is over yet.

Well that leads me to my next question, which is, in this quarter, for your funding costs, was there the step down at all, or is that going to occur in the second quarter?

Second quarter.

Is that in the early part or the end of the second quarter? Is it one month, is it two months, is it three months?

I don't know. It's somewhere in the middle. I haven't looked yet. Because it's not -- be careful. It's not on all 2 billion out of the 3 billion, right?

I understand. But I don't think you're bringing on the credit sales as fast as that piece that steps down.

Okay.

So what were charge-offs last year versus the 6.2 that you quoted for this quarter?

6.9.

And the Epsilon run rate sounds like it's significantly higher than it was maybe even three months ago when I talked to you. Is that accurate?

I think they're off to a pretty good start. Mike and I will always raise our hand and say let's be a little careful again because we talked initially when we did the deal -- last October I think is when we announced it -- that there are a couple of verticals. There's one vertical specifically that may not be where we want to be long-term because it tends to have very light margins and it's an awful lot of work to get those accounts in. So we may proactively get out there and do some pruning there as well, Dan. So I'd be a little careful there. Again, our whole model is we're not out for everyone. It's pretty much a few clients and deep relationships. And so we'll prune if we don't think there's a long-term relationship there.

Is there any reason for us to believe that the magnitude of the margin step-down in Credit Services would be any different than last year? (multiple speakers) 28.1 versus 22.5 sequentially?

I honestly haven't looked at it. It's certainly in the right direction.

That's fair. And the last question -- you talked about two large renewals occurring in the AIR MILES program. And they're within the top 25 of your clients? Is that right?

Yes.

So therefore, if we assume that you also get cost plus with those two, would those alone be meaningful to your margins?

No.

I think that's it. Thank you.

Moshe Katri of S.G. Cowen.

Hi, guys. Finally. Two questions. One follow-up to Jim Kissane's question. On the beginning of the call, you've indicated that EBITDA margins on the utility services could go up to about 13% during the second half. Is that a good number to use looking at '06 at this point? Just trying to get a feel on what sort of a normalized EBITDA margin number we should expect there?

And then suddenly, with respect to your private-label client that's having some difficulties as we speak, you guys know them pretty well. Maybe you can talk about some of the actions that the client is undertaking to turn things around internally. Thanks.

I'll take A.

Why don't I take B?

Mike can take B. On the A, I think if we pop margin and utility up to say 13 points in the second half of the year, that's a great jump up for '06. But as we have said all along, if we think this is a 20, 22% type EBITDA margin business, we need to get from A to B. So this is the first step up and then as '06 and '07 unfolds, it will gradually rise as well. Probably not in the big 300 point chunks that we were talking about, but it should drift up.

We'll continue to balance that against growth and bringing on new business and new business expenses. So depending on how the pipeline comes in and out there too.

In terms of the client (indiscernible) like in any apparel retailer, if you go back to last year, it was a home run. I mean they picked the right merchandise; they picked the right colors. The consumers really went overboard. They don't always do that. And you've certainly seen that this year. So as they cycle through and replan for their fall, as they are actively doing, we are hopeful that they have some uptick.

Other than that, that's the key from that perspective. We continue to work with them to focus again on that loyal retail client and make sure they're staying in touch with that consumer even though they may not have picked right with regard to the merchandise to get them back in the store. That's really the function there.

Great. Thanks.

Any more, operator? Or is that it?

That's all the questions we have, sir.

All right. Again, thank you, everybody. I appreciate you spending the time with us and we'll look forward to seeing you at conferences and next quarter. Take care. Bye now.

Thank you. This does conclude this afternoon's teleconference. You may disconnect your lines and enjoy your day.