Bread Financial Holdings Inc (BFH) 2005 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to today's Alliance Data Systems' Second Quarter 2005 Earnings Conference Call.

At this time, all lines have been placed on a listen-only mode, and the floor will be opened for questions following today's presentation. If at any point during today's conference you would like to queue up for a question, please press star one on you’re your touchtone telephone.

It is now my pleasure to turn the call over to your host, Julie Prozeller, of Financial Dynamics. Julie, you may begin.

Thank you, Operator.

By now, you should have received a copy of the Company's Second 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 risk 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 website at www.AllianceDataSystems.com.

With that, I'd like to turn the call over to Mike Parks. Mike?

Thanks, Julie.

Good afternoon, everyone, and thanks for joining us. If you'll turn to the Agenda slide, as usual, I'll spend a few minutes reviewing the highlights of the quarter. Ed will then review our financials in some detail, and we'll take your questions.

So let's start with the highlights. Turning to the next slide, we're excited to announce an outstanding quarter for Alliance Data driven by strong organic growth. Revenues for the quarter increased by 24% to $371 million; EBITDA increased by 22% to $83 million; and cash earnings per share was up 32% to $0.49 per share.

We're obviously very pleased with the performance from all of our business units. It's a result of our ability to deliver our business model, add new clients, and renew key relationships that provide us with further visibility.

Let's take a look at this quarter's accomplishments, starting with Utility Services.

For the Utility group, our focus has been on both growth and margin expansion. Conversion and integration activities for new business signed at the end of 2004 are moving forward according to plans for the second half of this year. We've also had a couple of small wins that are a nice fit within our client base. We've entered a long-term arrangement with Greenville Utilities for CIS support services and will provide professional and management services for Hampton Road Sanitation District, Aqua America, City of Toledo, and Quanta Services.

On the renewal side, we extended our relationships with Pepco for another 5 years. Pepco is an unregulated subsidiary of Potomac Electric Power Company in Washington, D.C. We will continue providing them with billing, statement, and remittance services.

We anticipate a couple of additional announcements in the second half that include our traditional CIS billing and customer care work, along with our expanded services of consulting and professional services similar to the suite of offerings that we announced on last quarter's call with Cobb Energy.

In Operations, we've made some nice progress in improving the efficiencies within our Call Center operations, and we remain focused on platform leverage to support our needs to service regulated, deregulated, and municipal clients.

Now, let's turn to Private Label.

It's been a tremendous quarter for our Private Label Group. The key to our growth has been the strength of our proven set of integrated transaction, credit, and marketing tools for our customers.

We've added 2 new retailers this quarter, Crescent Jewelers and Blair Corporation.

Crescent is one of the nation's top 10 jewelry retailers, operating 122 stores in the Southwest. They cater to the mid- and upper-end consumer with unique and exclusive jewelry collections.

We also entered an agreement with Blair Corp., providing a fully integrated Private Label program for their catalog and web brands, including Blair and Urban Park. Blair is among the nation's top 10 apparel catalog retailers, focusing on high value and superior customer service. We will be acquiring their existing portfolio, which consists of over 800,000 monthly statemented accounts and generates in excess of $200 million in annual credit sales.

We've also renewed our agreement with Dress Barn and Maurices, one of our top 15 clients. If you were not aware, in January, Dress Barn acquired Maurices. Both specialty retailers offer quality career and casual fashion for women. We will continue to provide both brands with a comprehensive suite of Private Label products.

This quarter, we're very happy to report that our credit sales growth rate accelerated from 2% in the first quarter to 6% in the second quarter, reflecting the beginning of the ramp-up of new business.

Looking ahead, we expect a very strong finish to 2005, and 2006 is taking shape very nicely. Against our yearly target of around 4 to 5 new clients, we've delivered an equivalent of about 7 and still anticipate another 2 before year-end. Pricing has remained firm, further underscoring the value we deliver to our client.

And, lastly, we're happy to report renewals of all major clients.

Now, let's turn to the Loyalty and Marketing Services Group.

Both our Air Miles program and Epsilon had another outstanding quarter.

Starting with Air Miles, we had an enormous quarter. Growth has accelerated beyond our planned mid-teens growth to 20-plus-percent growth for the quarter. Issuance was also up 18% versus our long-term goal of 10%. This growth was driven by the national expansion of Rona, Canada's largest home-improvement retailer, and the launch of the BMO/WestJet/Tri-Brand Card last year.

As the largest and most successful coalition program in North America, we continue to hold firm to [firm plus] on pricing. Our sponsors receive real value from our ability to help them positively change consumer behavior by increasing customer spend and Loyalty. And because Air Miles offers the broadest selection of sponsors and rewards, we continue to attract and retain collectors to our program.

Now, let's switch to Epsilon. We've got great news coming from this area over the last quarter, reflecting the continued endorsement of Epsilon's capabilities in developing and managing comprehensive database solutions. These endorsements come in the form of several key announcements.

First, the extension with Hilton Honors Worldwide to a 5-year term. This program has currently more than 10 million members, and our services have been extended now to include Doubletree, Embassy Suites, Hampton Inn and Suites, and the Homewood Suites brands.

We've also expanded services to one of Epsilon's top 10 clients, Pfizer, having just completed the build and operational launch of their comprehensive customer database system. This is a great opportunity that has significant leverage as Pfizer adds new drugs to their portfolio.

And, lastly, we have signed a multi-year renewal and expanded our services with Banc of America. We will complete the build and launch of an enhanced consumer marketing database designed to improve B of A's customer acquisition and campaign management programs. The new and highly flexible database program will allow B of A to add future tools and functionality quickly and easily.

All right. Let's turn now to our outlook for the remainder of the year.

We've got a tremendous momentum starting in the first half, and as we see it, continuing through the second half. As such, we're comfortable raising guidance to $1.92 to $1.95 for cash EPS, representing over a 25 to 26% increase over last year. Our strong finish will be fueled by the outstanding performance of the first 6 months, 22% top-line growth, and 26% cash EPS. And in the second half of the year, we will also start to see the impact of some large ramp-ups of our early 2005 wins.

Our sales activities are headed where we thought they'd be, and that's great news, but we also expect to announce a few more before the year's over.

So looking ahead, 2006 is shaping up nicely. Our businesses, each with strong organic growth, have never been stronger. Client relationships never better, and our associates highly motivated to deliver what we promise. My personal thanks for all for an outstanding quarter, and I look forward to the rest of the year.

Ed, I'll turn it over to you for some more detail on the financials and the guidance.

Great. Thanks, Mike.

The slide everyone should have up is titled, Second Quarter Consolidated Results. Q2 marked our 17th quarter as a public company and further extended our track record, delivering or over-delivering on what we've promised.

Overall results came in better than expected, highlighted by the following three items.

First, for the Company as a whole, the 20%-plus revenue growth included strong organic growth.

Second, in Private Label, the growth rate in credit sales, which is a key driver of future growth, tripled from 2% in Q1 to 6% in Q2 and is well on its way to double-digit growth by year-end and for all of 2006.

And, finally, three, in Marketing Services, our Canadian Air Miles business continued its above-trend growth rate and posted over 20% during the quarter.

Top-line growth was driven by stronger-than-expected performances at Private Label, Air Miles, and Epsilon. This performance more than offset the continuing but diminishing headwinds from -- 1, tough year-over-year Private Label comps; 2, the [grow ratio] from Pegasus, the client which went bankrupt last Q4; 3, some pruning of non-core accounts in our traditional merchant-acquiring business; and, 4, continuing growth challenges at one of our Private Label clients.

Despite these headwinds, which become less and less impactful as the year rolls forward, revenues surged 24%, including strong organic growth.

EBITDA also had a healthy 22% increase despite incurring some final clean-up costs in utility, which were completed on schedule.

Operating cash flow, also called operating EBITDA, surged 13 million ahead of reported EBITDA as Air Miles posted enormous gains in miles issued, which, in turn, generated immediate free cash flow but is deferred for reporting purposes.

I will say the 13 million was about 3 million overstated due to some timing of cash flows, so I'd probably use about 10 million as a better indicator. Nonetheless, it's well on its way to run about 25 million ahead of reported EBITDA for the full year.

And, finally, dropping it down, cash EPS was up over 30%.

In summary, another good one, so let's turn now to the segments.

First up, Transaction Services, which houses Private Label services, utility services, and our traditional merchant bankcard processing business. Very simply, it looked a lot like it did last quarter. Top line was flat to last quarter, while EBITDA moved ahead a couple of million. Top line was flat to last quarter and last year as growth suffered from the 4 items we talked about before -- the grow-over from the Pegasus bankruptcy, [indiscernible] anniversaries in Q4, the continuing large double-digit comp declines at one of our major Private Label clients, those two anniversaries in Q4, very tough comps in general in our Private Label business, which also get easier going forward; and, finally, the impact of some pruning and non-core, low-margin accounts in our merchant bankcard business.

EBITDA is inching its way back with some progress versus Q1, and it was impacted by our utility clean-up effort, which, as stated before, is now complete.

The segments' outlook? The segment will start to gain some traction in the back half of the year, primarily in Q4.

The ramp-ups of utility clients Entergy and Direct Energy, as well as the ramp-ups of Private Label's record number of signings, should give the segment a nice head of steam and a nice jump-off point for 2006.

All right. Next up, Credit Services, which continues to perform above expectations against a backdrop of very tough comps and weak results at one major client. Revenues still grew 8%, and EBITDA shot ahead almost 30%. Let's walk through the 4 drivers.

First, credit sales. Growth has started its acceleration as it grew at a 6% rate during the quarter versus only 2% in Q1. Based on the huge book of new business now ramping up, plus the upcoming anniversaries of some headwinds noted earlier, this key driver is well on its way to double-digit growth towards the latter part of the year and for all of 2006.

Portfolio growth will also start moving up, but it does tend to lag credit sales by a few months. So, again, expect this to build towards a strong jump-off for '06.

Next, funding costs remained stable, and we expect no impact for the remainder of 2005, as well as for all of 2006 and 2007 from rising rates. Rather, we expect to grow the business nicely while maintaining a stable cost of funds rate due to our hedging programs and reliance on long-term funding.

And, finally, credit losses improved 80 basis points to around 6.5% and helped the quarter's over-performance.

Delinquency levels, which are a good window into future losses, came in the best we've ever seen, and [to just] 2006 is in good shape.

Overall, improving credit losses, along with growth in both sales as well as in the portfolio itself, combined with stable funding costs to produce solid results.

Now, going forward, the results will be driven more and more by the acceleration in sales and portfolio growth and less by improving launches, which are expected to bottom out and then remain stable through 2006.

Okay, finally, let's finish up with Marketing Services, where both Loyalty Air Miles and Epsilon overperformed, resulting in 70%-plus top-line growth and 90% EBITDA growth.

Starting with Epsilon, it continues to zip along in deals with Hilton, Pfizer, B of A, all announced during the quarter. Suggest a strong finish to the year and great visibility for 2006.

Setting aside Epsilon, the real story for the quarter was up north in Canada. The Air Miles business, simply put, just crushed the numbers. A key driver for future growth, miles issued, normally runs at around a 10% growth rate. In Q1, it accelerated to 14%, and in Q2, it topped 18%.

A national rollout to Rona and the Bank of Montreal WestJet card continued to fuel performance at Air Miles. And Air Miles itself, despite being a 13-year-old program, with two-thirds of the country already active, went ahead and posted 20%-plus growth for Q2 on top of 20-plus in Q1.

For the year -- we've gotten a lot of questions on this -- Air Miles should toss off around $100 million U.S. in operating cash flow, what we call here operating EBITDA. Also note that, as advertised, EBITDA margin popped up 250 basis points versus Q1 and 150 basis points versus Q2 last year.

All right. As we mentioned, we thought it was a pretty good quarter, with the back half looking good, and '06 shaping up nicely.

Let's keep moving along. Quickly turn to the balance sheet. Next slide.

Really, nothing too newsy on the balance sheet side. Total debt continues to decline as we quickly move to pay off borrowings from last year's Epsilon deal.

Also, the quarter included around 17 million in costs from buying back a few hundred thousand shares during June at an average price of about $37.5 a share. The buyback obviously had no meaningful impact on EPS.

Core debt to operating cash flow is running at less than one times, suggesting plenty of liquidity available on a go-forward basis. All in all, very solid.

All right. Let's move to 2005 guidance page. We are once again raising guidance for the second time this year. For the full year, we're raising guidance to $1.92 to $1.95, looking for about 26% growth.

Let's talk specifically about Q3. We're going to go ahead and maintain our prior guidance. Initially, we had put it at about $0.45 a share, and I think we'll tweak it a little to say that's certainly the minimum that we expect in Q3. So let's use the minimum of $0.45, which would suggest a 25% increase versus last year.

This guidance does, in fact, include the expected impact of the new bankruptcy legislation, so let's talk just briefly about that.

Bankruptcy reform legislation was passed and becomes effective this coming October. Simply put, the law makes it more difficult for folks to file and walk away from their obligations. So between now and October, some experts expect an acceleration in bankruptcy filings from cardholders as some try to file before the more rigorous process becomes effective in October.

Now, we haven't seen anything yet, but we're going to go ahead and assume it may ding us for a few million in Q3. If it does, it will reverse out and benefit us by the same amounts in Q4, or it may dribble into Q1 of '06. So we're going to go ahead and maintain our original $0.45 guidance, or 25% growth rate. And, again, we would certainly peg $0.45 as a minimum, and if we don't see anything come through on the bankruptcy side, certainly, there's up side to that number.

All right, next slide, free cash flow. We've tweaked that up again. If you, I think, go back a few months, actually back to last October, we thought we'd be running at about $2.00 for the year. At February, we were looking at $2.05; April, we were looking at $2.10; and I think we're comfortable at this point raising that to our free cash flow of about $2.15 for the year. And, basically, we're getting continued very strong performance out of all the businesses from a free cash flow perspective, so I think the $2.15 also should be viewed as our base case at this point.

Okay, we added a slide in this presentation. Mike and I have been getting a lot of questions over the past few months about uses of cash, the fact that the Company has de-levered to such an extent, and combined with it, certainly is throwing off a lot of free cash flow. What are we going to do with all the money? So we thought this would, hopefully, give people some comfort or some insight into our thinking.

We start with the point of we want to always maintain an investment-grade profile. What does that mean? From our perspective, that means we want to keep our core debt -- that's debt excluding CDs -- at 2 times or less when looked at against operating EBITDA. What does that all mean? It means today we probably have -- oh, we could tap at least 400 million available today, and this would exclude any extra funding available via CDs to fund on-balance sheet Private Label accounts. These funds are carved out of all of our covenants. So really for things separate from the Private Label business, you're looking at about 400 million available plus, you know, 185 or so of free cash flow from ongoing ops. So about 600 million of liquidity available immediately.

Two, we do want to continue to supplement our strong organic growth with selective M&A. And, again, to remind folks, our model is we like to keep a double-digit organic growth profile and then supplement that with some M&A work.

Where would the monies be spent this year? I think if anything, we're probably pretty excited about, obviously, the Loyalty and Marketing Services space. So my guess is at this point, if anything pops out over the next few months, it probably will be in that segment.

Third, we'd use some cash to pay down debt.

And then, fourth, return to shareholders. We have announced up to an $80 million share buyback plan. We are committed to that plan, and we feel on an ongoing basis that the free cash flow from the Company should be sufficient to basically hit all 4 of these items.

So, hopefully, that answers some questions that were out there.

Why don’t we now turn to or step back a little bit and talk about our 2005/2006 outlook. Obviously, we are going to stick with what we've done over the last few years, which is in October, we'll throw out some numbers there and some real guidance. But right now, we wanted to sort of walk some folks through how we see the pieces of the puzzle come together as we move into '06 and through '06. And we start with how are the 3 major drivers of growth. And they are solid at this point. Our renewals of -- we've renewed 100% of all our major customers. Pricing is firm or firm plus. And new signings are very strong and actually a record year for Private Label.

What's that all mean? It means that we're ramping up for '06. In Loyalty in the Epsilon space, we've announced the Hilton, the Pfizer, the B of As, the TruGreens. We would certainly expect 2 to 3 additional signings expected plus some good renewal announcements before the year is out. Private label has had a tremendous year with the Z Gallerie, the Crescent Jewelers, Hanover, which is about twice the size of our normal account, and Blair, which is about 3 times the size of our normal accounts. So as Mike mentioned, we've signed the equivalent of about 7 new clients and certainly expect at least probably a couple more before the year is out versus our long-term goal of 4 or so per year.

And then the utilities, we want to make sure we get moving on Entergy and Direct Energy, Cobb Energy, and some additional deals moving through the pipe.

So, overall, setting the stage for a nice ramp for the rest of this year. What did that translate into as we look into 2006? This is what you're most likely going to hear over the next few quarters. A little bit different from this year. If you turn to the slide that says, Ramping Up for '06 Growth Targets, you'll see what the ramp means. It means that as we exit '05 and we move into '06, we would expect a very balanced year in 2006.

Start with the key drivers -- miles issued, miles redeemed. They're just chugging along comfortably in the double-digit. We would expect that to continue through 2006 as well.

Credit sales, which started a little bit weak in the year at 2, have now tripled to 6%. We expect that to hit double-digit by the end of the year just based on the book of business that has been signed and is ramping, and double digits for all of '06.

Portfolio growth will lag the credit sales' ramp-up by a few months, but certainly, we'll start seeing some movement into the high-single digits by the end of the year, if not tripping over double-digit, and then double-digit for all of '06.

And then statement growth, again, which has lagged and will also lag credit sales growth, will probably wind up the year in the mid-singles and will soon hit double-digit in '06 as well.

So that's the theme for '06. The secondary drivers -- what about funding costs? What about credit losses?

We talked about funding costs being stable for all of this year as well as next year and '07 as well. And then credit losses, which have made up for some of the weakness in credit sales and portfolio growth and statement growth in the first part of this year, you know, that will eventually start bottoming out. But we certainly expect things to remain stable through 2006 versus this year as well. Things look good.

Overall, well-balanced, solid 2006. More on that as we enter the third quarter, and we'll try to give a little bit more color on that in actual numbers.

Then we'll just finish up with our usual charts. Operating leverage continues to improve nicely. And then the final slide being -- reflecting the updated guidance of the higher numbers expected for the year. That being said, I'll kick it back over to Mike.

Thanks, Ed.

Obviously, we're excited about the year, as you can tell probably from the presentation, and we're -- our teams across all businesses are performing very nicely. So, again, thanks to all.

Operator, we'll now take questions.

Thank you. The floor is now open for questions. [CALLER INSTRUCTIONS]

Jim Kissane, Bear, Stearns.

Great job, guys.

Ed, how much of the margin pressure in the transaction segment is related to a utility bill platform consolidation?

I think the numbers that we used, we're probably looking at, you know, a few million each quarter, Jim, and then we would expect utility to probably pop to about a 13% margin, I think, in the back half of the year. So I would say it's certainly probably around 3 million or so.

Okay. So your long-term targets for transaction revenue growth is double-digit, and the margins upper teens? Is that right?

Oh, for sure.

Okay.

For sure.

And you talked about the bankruptcy bill on [a closing] charge-offs to bump up in the third quarter. Any sense on the magnitude so as we see those numbers reported what you're expecting?

Yeah, I've got to tell you, I mean at this point, it's more of we're being safe by putting it into our guidance. We haven't seen anything yet, quite frankly. I don't expect our loss rate to be higher than last year's, even when it's all said and done. So the magnitude of it is probably, you know, 3 or $4 million total. So you're probably -- you know, you're talking 30 basis points maybe, something like that. I certainly wouldn't -- we don't expect it to be a big number, Jim. We're already almost through July, and we haven't seen anything. So to the extent we start seeing a little bit of it in Q3, that -- what that means is it kind of cleans out the pipe for Q4 and Q1, so we're either going to have -- we're not going to see anything and have a very strong Q3 and a very strong Q4 or just a strong Q3 and an exceptionally strong Q4.

Okay. Great. Thanks a lot.

Tien-Tsin Huang, J.P. Morgan.

I guess a question on the Private Label credit sales figure, which is a little bit better than what we thought. How would you layer that 6% growth in credit sales between organic versus growth from the wins, and more importantly, what gives you confidence that you can reach that double-digit target by year-end?

Yes, I'd say start with -- I don't know, Tien-Tsin if we're going to break out, you know, core clients from new clients. There's not a huge chunk that came from the new folks in the second quarter. They're really just getting on and ramping up.

I will tell you that one large client that, although things are getting a little better, still had some difficulties in the quarter, probably cost us about 2 points of growth, so we're probably running at closer to 8%. But, anyhow, we booked around 6. The math is pretty straightforward. We signed up the equivalent of 7 new clients this year. Based on what we're seeing, the way they're ramping up right now, and with Blair coming on in Q4, there's no question this thing will tip over double-digits sometime around November/December for sure.

Okay. Then in Air Miles, were there any unusual marketing efforts employed in the quarter to drive the -- I guess, the 18% growth in miles issued?

No, that's pretty much our normal ramp-up of those major signings that's driving the volume.

Okay, so overall in marketing, are we still looking for EBITDA margins for the year to be up 150 basis points?

Yes.

Very good. Thank you.

Thanks, Tien-Tsin.

Charles Trafton, America Growth Capital.

Ed, how much foreign currency impact did you have on Marketing Services' EBITDA?

About 1 million 4 on EBITDA, which, if I did the math, was about $0.01 after tax.

Okay. How are margins doing at Epsilon? It's been a couple of quarters since you bought them. They signed up a lot of new business. Is there a lot of upfront expense that they need to undertake to get these new clients going?

No, not really. I mean it's sort of an ongoing -- think of it as not a one-timer, but it's sort of an every-timer. It happens every quarter or every month with the string of new clients. So Epsilon is comfortably in the EBITDA margin range that -- probably in the low 20s. So there hasn't been anything big dragging on it right now.

And going back to the last caller's question about credit sales growth toward the end of the year, will you have all of these 4 new clients up by the Christmas selling season? And how much of that is your discretion versus client demand?

It's a pretty strong demand from the client, as you can imagine. They want -- that’s a key part of the deal is it must be up and running in time for the holiday. So, yes, everything will be up and running. And that's nothing unusual, Charles. That's the normal course of the conversion and implementation process over the years. That's their big theme.

Right. Well, the sequential growth in portfolio sales was the best since early '02. What other new clients have come live in the last 6 months that have helped the June quarter that much?

Well, I think, overall, the core seemed to have firmed up a little bit. I think the client that was dragging on us quite a bit dragged a bit less. I think, also, there really hasn't been that much of a meaningful impact from folks we've signed in the last 6 months. I think, in general, we've got a --

With the '04 signings?

Yes, some of the '04, but for the most part, that stuff will start kicking in really into Q3 and especially into Q4. I mean we did get -- outside of Blair, everyone else is up and running.

And Blair won't be live in Q3?

Correct.

All right.

We've got pretty good organic sales growth across the board for most of the customers. There was a nice uptick in retail sales at the end of the quarter, and then most predictions are that they're going to continue to be pretty decent.

Have you had any major new Air Miles sponsors that have -- I haven't seen any big releases on it, but the volume would imply that the consumer -- cardholders have more places to use it. Have you had any major sponsors you haven't announced yet that have been signed?

No. You know, we've talked about, obviously, Rona and the Tri-Brand card, but remember, we get issuance growth from over 150 different sponsors across the country, and that doesn't mean that every collector goes to all 150. Our job is not only signing new sponsors but to get to -- collectors to go to more and more locations all the time. That's a standard function of a marketing program.

Right. Good [job]; thanks.

Thanks. You bet.

Greg Smith, Merrill Lynch.

Ed, was there anything in this quarter that you feel like pulled in from 3Q at all? I think the answer's no, but I just wanted to be sure of that.

Got pulled in from -- no.

Okay. And then did you buy back any shares during the quarter?

Yes, in the latter part of June, we bought a few hundred thousand at roughly $37.50, so obviously, it didn't really have any meaningful impact on EPS. But, you know, quite frankly, on the share buyback, we were a little late to the party, and we weren't expecting, you know, some of the volatility that was out there. But now it's in place, and, you know, we're ready to go, and we're committed to it.

Good. And then with the number of these Epsilon renewals, it looks like the contracts were significantly expanded with some of these existing clients, like Hilton. Is that the case?

Yes, for sure, and I'll let Mike jump in here. But for sure, I would say more so on the B of A deal, which was quite a nice expansion of the work that we had been doing for them. That relationship continues to grow fairly dramatically.

And on the Pfizer deal, you know, we're in the position of providing a service to all of their -- or a good chunk of their direct-to-consumer-type programs. And as they add more and more of those programs that they want captured and put in the database, revenues will continue to flow with that as well.

Okay.

The B of A one is a particularly strong one, though. Size of the -- you know, 8 years ago when we built the -- built and started operating the system, it was a much smaller, less robust opportunity. There are many more things that we can do to help them grow their business, and it's a much more sophisticated system and ongoing support, as well as they've grown significantly in the last 8 years. So, but the others are just as nice.

Okay, and then, lastly -- I'm surprised no one's asked this -- but, you know, one of your competitors up there in Canada formed an income trust out of their business. Any -- what's your latest thinking on potentially doing a similar structure with the Air Miles business?

I hadn't heard about that, Greg. No, it's -- it is very intriguing, obviously. We've always felt that our Air Miles was a strong franchise that, frankly, the marketplace didn't fully understand maybe or value it. And this certainly gives kind of an external validation of this kind of model even though they're not exactly like ours, but much more of a frequent flyer and much slower growth than ours. But certainly very intriguing. We're going to -- after everything's [called], we're going to spend some time to understand it more and, if appropriate, if it's necessary and the fit is right for our environment, we'll certainly consider it. But we're going to be -- our focus is continue to have a strong '05 and focus on '06 and get educated, and we'll go from there.

Great. Thank you.

Don McArthur, Stifel, Nicolaus.

Congratulations on a good quarter, guys.

Thanks.

Thanks.

Can you break out the revenue from Epsilon during the quarter?

I don't think we break out the revenue in the Marketing Services group. I think it's -- in Marketing Services, recall that you have the Air Miles business in Canada, you have the Epsilon business, and you cut a couple of relatively small database and other marketing businesses. But, you know, what we -- I think we have said before is that if you were to look at our Canadian business, that's roughly two-thirds of the segment, and then what's left over, the bulk of that is Epsilon. We're trying not to get into slicing and dicing.

Gotcha. And then on the expanded deal with B of A, do you cover their credit cards? And if so, would that be expanded to the MBNA relationship?

That portion hasn't been discussed yet, but certainly as they grow their businesses from their other acquisitions, that was anticipated. But this transaction took place prior to that announcement. So that could be some up side down the road.

Gotcha. And then just, finally, Ed, I mean it looks like '06 is being set up for a good year. Any reason why -- that you can see on the horizon for not reiterating your 18% cash EPS growth target?

Since we haven't really given guidance, I would say --

Well, long-term guidance.

Long-term guidance remains in place for sure.

Thanks, guys.

Yes.

Andrew Jeffrey, Robinson Humphrey.

Could you talk a little bit about potential cross-selling between Epsilon and the Private Label business from a Loyalty perspective? Have you made any headway on that, and is that, you know, further potential up side in either business as you look out to '06 or beyond?

Frankly, none of that is baked into our forecast in growth. Again, as we brought the Epsilon guys in, they've got a very strong business model very similar to ours, focused on growth verticals, and want to take any integration and opportunities inside Alliance as a secondary opportunity. So, no, we've not got anything planned, built into the numbers for that. And that potentially could be some up-side growth in '06 and '07.

Are those efforts that are currently underway internally, or is it too early to begin thinking about that from an operational standpoint?

Haven't, frankly, even had it as a near-term priority compared to all of the other opportunities that they have, and most of our focus with them in terms of integration would be more on U.S. marketing opportunities as we begin to look at one-to-one Loyalty programs and coalition models in the U.S. and even some in the utility arrangement ahead of the retail group.

And then just one last follow-up. Could you elaborate a little bit, even in just a couple of sentences, on what you think is driving demand for Epsilon's services?

Generally speaking, as our world gets very competitive, clients are looking for that competitive edge. And that [indiscernible] getting at data and marrying the data from sophisticated segmentation capabilities and then married with some, what we call internally, married to insight. How do we take that data and create insights to drive something sophisticated and unique for each of our clients to help them grow their business? So our key driver for the future is that -- what we call the marriage of data and our client insight. So we think it's a strong model, and none of our competitors are pursuing that approach. It tends to be either a kind of technology approach or an advertising approach, and we think we've got a key strategy that's driving success.

Great. Thank you.

You bet.

David Scharf, JMP Securities.

Ed, what are the -- just to get a little better feel for how the margins are expected to ramp with the new facility, you know, first, maybe focusing on pricing, you mentioned the Pepco renewal. I think in the course of our checks, utility seems to be the only client base you have where there may ultimately be some degree of decompression. Did you see that in your latest renewals, or is the pricing even in utility outsourcing of any firm?

I think -- you know, we don't want to talk about individual contracts, but generally speaking, the utility industry, as you point out, is still in the emergence of looking at software packages, in-house packages, and the traditional processing.

As we move toward marrying our traditional processing services with customer care and marketing, we see firm and firm-plus pricing. The less and the more commoditized approaches we get, there is pricing pressure. But there's also a high degree of cost to convert. And so we've not seen any impact, significant impact, on our proposal process.

Okay. And you mentioned a few more professional services consulting-type arrangements within utility. Can you give us a feel for what a typical deal size is and whether these are, you know, one-off engagements or part of a broader relationship where you'd expect to see a little more recurring nature out of that type of revenue stream?

Yes, I mean, unfortunately, the short answer is they're all over the place, probably anywhere from 1 million or so a year up to 10 million a year. The deal we announced was Cobb -- with Cobb was probably more in the higher side of that. Some of the smaller ones that Mike hit in his call were certainly at the lower end of that.

So usually if it's a few million or more a year, we'll usually put out some type of press release, so maybe that's a decent indicator of the size of it. Otherwise, we'll just sort of collect all the little ones and talk in general about it on the call.

In terms of where we're heading with it, absolutely. This is a key focus of ours. We've talked for years now about the fact that, you know, within any given year, maybe there's 8 or 9 decisions of size being made out there, and the question is, who's going to get the win? And what we found is, for the most part, the bulk of the decisions are still in favor of keeping it in-house and upgrading the system, and doing it that way, and therefore, we view our biggest competitor as the in-house player in trying to convince the utility that it's okay to come with us. So a lot of the effort is focused on if the utility is not comfortable making that leap right out of the gate, let's start establishing relationships right from the get-go and start helping them understand the systems and some of the platform consolidations they're going through with all the M&A activity. And then when the time comes, hopefully, they'll be favorably disposed toward -- to bring it to us.

And the consulting services range all the way from selection and integration to ongoing management of their CIS and billing systems, but yet, leaving, in effect, the hardware sitting on their site. So we're actually running it for them remotely. And then, ultimately, as Ed talked about, getting that confidence to move completely to a full BPO kind of relationship.

I see. And, Mike, you know, much like large credit card issuers started requiring card processors to sort of foot the bill for the big conversion costs, you know, when they made the initial decision to outsource their processing operation, have any of the utilities proposed that, or have you proposed that as a way to jump-start their efforts to abandon upgrading their in-house capabilities and just send it off-site to you guys?

Sure. Early on, we even not only did that, but we actually --

[Inaudible] for the acquisitions.

-- if you'll recall, took over some of their internal real estate and call center operations and things like that. So each deal is unique, though, to solve for their particular target.

Okay. And, lastly, on utility, with respect to operating leverage, is the statementing metric you provide going to correlate directly with, you know, revenue and margin growth? And what I’m getting at is how much of the business now is just statementing and billing metering versus actual call center operations, you know, outbound telesales, collections, customer care work? I would imagine pure labor-intensive call center work isn't as leverageable as the -- more recurring processing work.

Well, certainly, if you compare -- think of the card business, and think of the processors in that world versus the full-service Private Label that we do. Do you know that the processing in and of itself typically is less than 50% of the overall revenue for running a program? So, yes, we get significant revenues from call center, customer care, and Marketing Services as well. But that's still very leverageable as well. If you think about the facilities, the call center expertise, staffing, ARU, systems and software. But you're right; the true processing statementing thing is even a more leverageable environment. We don't break out the specific percentages, but it would be more similar to a Private Label in the long run as we look at full BPO in terms of that balance between call center and processing services.

Yes, I'd say maybe another way of quickly looking at it is the fact that whatever the mix is today and the mix was last year, we're not seeing -- as we look down the road towards growth, we're not seeing any change up or down in terms of revenue per statement. So statement count is a good indicator, along with assuming it's very firm in terms of revenue per.

Gotcha. Thank you, and outstanding results.

Thank you.

Colin Gillis, Adams, Harkness.

So you guys tell me what's keeping the investment-grade profile. The newspapers that we get up here seem to indicate that that's already been lost. Is it possible that they got their facts wrong?

Already been lost?

Just -- I guess we can move on to the next one! What's -- let's talk about what's driving the strong performance in delinquencies and charge-offs. You know, has there been any changes in the underwriting algorithm that the companies used or maybe an increase in the FICA score cut-offs?

Yes, that's a great question, Colin. In fact, a larger question that we sometimes get is, to the extent, you know, there's some big downturn in the economy, what's the implication for us? And I think what we're seeing is the result of, for sure, some of the improvement over the past couple years has been from the macro environment, but I would say the majority of the improvement that we have seen have come from probably two things.

First, if you were to look at the credit quality of the portfolio, it has crept up from, if I go back a few years, from about a 680 in FICO to about a 700 today. So that's sort of a permanent difference. I can't tell you we're out there doing it on purpose; it just happens to be the type of clients we sign and the type of customers who frequent their stores. But it benefits, on the credit quality side. Does it take away from maybe some additional fee growth? That's always possible. But that's a big driver of it.

I think the second big chunk of it is that while we always had a pretty good back-end part of the shop, over the past few years, we have spent millions and brought in some very, very talented folks to make sure we are on the cutting edge of the back-end collection process, whether it's investing in auto dialers or other things like that.

So those are also certain permanent shifts that we expect to continue to benefit us regardless of the macro environment.

Okay, great. And then just, you know, looking out on the Air Miles side of things into 2006, can you see other major sponsors out there that might have a similar impact to a Rona or a WestJet? And could you just talk a little bit about what categories you see still open to such sponsors, you know, automotive or liquor?

Yes, I think you hit on 2 of them -- auto, liquor. I think consumer electronics is also a big area that we have some interest in. I'd say, overall, after 13 years, a lot of folks think that we're done and it's saturated. It's actually not from the sponsor's side. We believe we've only hit about 60% penetration of what we believe is the addressable market up there in terms of retailers who could participate in our programs. So we've got many, many more years to go. But those would be the key categories to look for.

Okay, great. Thank you.

Yes.

Dan Perlin, Legg Mason.

My question is for Ed. What are your assumptions for interest rates in order for you to have a stable funding cost given your swap program?

Yes, what we expect would be -- let's say we want to grow the portfolio, oh, call it 10 to 12% a year for the next couple of years. Clearly, that growth, if in fact rates have moved up -- and, again, when we talk rates, we're talking about 5-year rates. We don't really care about the short end. Our big interest is at the 5-year. But assuming the 5-year moved up, you know, 150 or 200 basis points from where it is today, which is an awful lot for the 5-year to move, certainly, it would cost us more to bring on the new business, but because we have those step-down interest rates on two-thirds of the existing portfolio, we would expect that to mitigate those rising rates.

So trying to get to the bottom line of your question, let's suppose we grow the portfolio 10 to 12% a year. That's going to cost us more. Let's suppose the 5-year moves up 150 or 200 basis points. We still do not see our overall cost of funds rate budging.

That's great. Is there a period during the year where you have multiple traunches that step down, or is it just once a year?

A couple times a year, and I hope you don't ask me what time because I don't know.

That's fine. [Often], I won't. The other question I had was as it pertains -- I think Jim asked the question first. Utility platform consolidation -- I thought I heard you say $3 million of incremental expenses in this quarter? I thought it was 6.

No, for the full program.

For the full program, it's 6?

Yes, I think we said 6 to 8 was around the number that we gave out for the first half of the year.

For the first half. So you spent $3 million this quarter?

Around $3 million.

Okay, so was that -- if we just add that back to the EBITDA number, that's the kind of margin expectations we should really have for transactions the rest of the year?

From the utility perspective, we certainly expect a bump. I don't know from the other businesses yet how the rest of the year's going to flow out. I mean --

Right.

We'll see how it goes. But --

But we should see no incremental expenses from that type of program in the second half?

Correct.

So did you go to 5 platforms from 7, or do you still have 7 and you're just more efficient on them?

Yes, as we talked about before, we will continue to look at leveraging the platforms that we have, but we're not going to track the numbers per se. It is mostly efficiencies within the existing platforms and around the peripheral systems that support the call center maintenance and program management activities.

Okay.

In the long run, you know, in the next 10 years, you know, you might see getting down to 1 platform per type, whether it be 1 for regulated, 1 for deregulated, 1 for municipal.

Right.

But we're way too early to try to begin predict how fast that's appropriate. We're going to focus on client growth and supporting whatever platforms over that long-term period as that makes sense.

Okay. The margins on marketing is -- can you just give me a sense of what was really from pricing versus volume? And, hopefully, the answer isn't a little of both. Is there one that's predominantly contributing to that margin?

Yes, I mean the overall growth on the top line, of course, was driven by, you know, stronger pricing and huge volume growth. The EBITDA margin, as we tried to communicate, you know, last quarter, can jump all over the place in this business depending on, for example, when we're doing a huge marketing spend on any given year. And that's why I think last quarter there was some concern that, you know, the margin was down; this quarter it's up fairly dramatically.

What we're basically saying is we look for the full-year basis, and it is both firmer pricing and huge growth in volume. We do expect EBITDA margin on a full-year basis to be up 150 basis points versus the prior year. But I caution you against trying to take a margin from any quarter in the marketing group and just spread it out the rest of the year. I would try to focus on, let's get a nice list of 150 BPs in this segment on a full-year basis, and I think you'll be pretty close.

Okay. And then, lastly, as it pertains, are you finding it harder to sign what you might consider or others might consider marquee names in the Private Label business? And, you know, First Data and [Tesis] keep saying, you know, Private Label -- First Data, in particular, but [Tesis], also on their call today talked about Private Label. And I know you're in different businesses, but I would just like to get your perspective as to what, if any, you're seeing when you talk to clients. Are they even in the bidding for a part of it and your clients don't want to go with them because they prefer the Loyalty and the funding component?

Yes, and --

You know, just any insight on that would be helpful.

Yes, what we're finding is a little bit of the opposite. We're finding, you know, with us, the pipe is full. It is very, very active, very, very busy out there. I mean you can look at the types of yields that are out there. You take, as you call it, a marquee name, like a Nieman's or something, they did a very different type of deal where they said, okay, take the non-strategic pieces, but, hey, I'm going to keep the high-end customer care and the marketing and Loyalty programs in-house. And as you know with our model, that's the secret sauce to the whole business. That's why the margins hold up and the growth is there and we don't lose people and the yield is high.

What we're finding is if you look at the number of deals this year, it would suggest and what we have in the pipe that I would say things are accelerating rather than going the other way.

Said another way, I've not seen one RFP request looking for processing only.

Okay. Thank you very much. I appreciate it.

You bet.

Thanks.

David Trossman, Wachovia Securities.

I've got two quick ones. First, can you help me understand the ramp in the utility statement business by telling us roughly what kind of monthly run rate you are in utility statements now and where you expect to be at the end of the year?

Probably not. I don't think -- you know, we don't break out the statements between the two. I would say, you know, as a general rule of thumb, your Private Label is going to be around two-thirds, or between 60 and two-thirds as a percent of overall statements, and the rest is utility. And you're going to see a gradual blip up as we bring on Entergy and then eventually the Direct Energy deal. But I don't think we're comfortable, David, getting into the weeds on breaking up the statements.

Can you tell me when Entergy comes up and when Direct Energy comes up?

Scheduled for --

October?

Right, October, and different pieces of Direct Energy will be being implemented through -- right now toward the end of the year, maybe the beginning of next year, depending on which piece. But we're still working out how best plan [inaudible] on that.

That's good. That's good. Yes, that helps. And, Ed, help me understand how the Canadian dollar's going to impact you through this second half of the year. That gets tougher? Is it tougher by a couple million bucks versus where it is today?

For sure.

On a year-over-year comparison?

Oh, for sure. There's no question that, you know, while we may have picked up a penny or so on the first quarter and a penny or so in the second quarter, I think a good safe place to be would -- let's assume that's not going to be there in Q3 and certainly by Q4, that will fully anniversary. I think that will give you some comfort.

You don't do any -- you know, that's just straight translation, right? There's no hedging --

Yes.

-- or anything that goes on there?

No.

Okay, good. Thank you.

Thanks, David.

Larry Berlin, First Analysis.

I have to ask the very obvious question. You mentioned organic growth being strong about 4 times in the presentation. What do you guys calculate your organic growth as?

Well, in our long-term business model, you've all -- you've heard us talk about this year after year after year, the 12, 15, 18 model, and our organic growth is always double-digit in nature and an extra couple of points come from some tuck-in acquisitions or things like that, and that's no different now or no different in the future. This is very typical quarter for us in that sense.

And so this quarter, you're just going to say that it was a typical quarter in your normal sense. You don't want to put a number to it or --?

Yes, we can't really get into the details --

Okay.

-- without backing up with all sorts of tables and stuff, so we're just not going to.

Okay, thanks very much. I've got to fly.

Yes, that's all right, Larry. Appreciate it.

Okay, no problem.

Any more, Operator?

Paul Bartolai, Credit Suisse First Boston.

You mentioned the currency. In fact, what was that on the revenue line? Was that about $9 million in the quarter?

I think it was around 8.

Eight million? Okay. And as we look at them, the EBITDA margin in the marketing segment, you know, you have the higher-margin business in Epsilon. You've had the currency benefit. With the 150-basis-point margin improvement that you guys expect, how should we think about that from the non-currency/non-Epsilon part of the business?

Yes, you mentioned that you viewed Epsilon as a higher-margin business. It is not higher margin than Loyalty. What you're probably getting a little tripped up on is after you allocate corporate overhead, that obviously brings the margin in both businesses down to where we report. But Loyalty itself has a very strong EBITDA margin pre-corporate overhead.

In terms of excluding currency, you know, in terms of growth rates, I don't see it really slowing things down very much. I mean it's 1 million, $1.5 million, the EBITDA this quarter, so if it's a little bit less than that in Q3 and probably nothing in Q4, I don't think it's enough, Paul, to really make that big a difference, and that's why we're comfortable with the 150-basis-point expansion for the year.

All right. What's the total corporate overhead for marketing?

I don't know if we've -- have we ever split that up? I don't think we've ever split that out. But I think if you wanted to, you know, you could start with maybe the G&A and divide by 3.

All right. Good enough. Switching to Private Label, you know, looking at some of the recent deals that have been signed, it looks like some of your competitors are doing things like sharing the economics, sharing the merchant discount in order to win deals. Just curious if you guys have seen any of that type of stuff in bidding on deals and if you guys have done any of that in any of your contracts?

Yes, again, from the -- you mentioned the competitors that are out there. Again, we don't usually or typically -- when we win a deal, it doesn't typically come down to us versus one of the other folks out there. It's usually the decision is made closer to up-front about whether they'd want to go with Alliance and the whole soup to nuts, which is the high-end customer care or the Loyalty and Marketing database work. You know, take a look at, for example, the Nieman's deal. But for what we're seeing in the deals that we've announced, what we try to do is we think the special sauce that we have there, the whole value proposition is the ability to drive incremental sales. So the answer is no.

All right. But like do you guys see like HSBC, a company like that? I just wonder if you guys bid on the Bon-Ton deal?

Look, generally, no, and we did not. It's a typical high -- big-finance company, high-balance guys, whether it be the MBNAs or the HSBCs, are looking to fund financing. That's what they do. That's how they grow. They're looking for big balances. And they don't care whether they do the processing and the marketing and everything else, and they've done that several times. It's just a different model, Paul, and that's where and why we don't see them and compete in those kinds of deals.

All right. And then just a last question, housekeeping item. The D&A was down sequentially. What drove that?

I'm sorry; what was the question?

The D&A was down sequentially from 1Q. Just curious what drove that decline?

I have depreciation amortization at about 14 million. Is that what you're talking about? I think it's just -- there's nothing of significance there. It's just rolling off some old stuff. And my guess is it will creep back up to probably Q1's level in Q3.

All right. Great. Thanks.

Operator, any more questions? Any more callers?

No, sir. We have no further questions at this time.

Great. Well, I appreciate everybody lasting the hour and 15 minutes with us. We've had a great quarter and looking forward to a strong year. And we'll talk to you next quarter. Thanks.

Thank you. This concludes today's teleconference. Please disconnect all lines, and have a great day.