Bread Financial Holdings, Inc.
Q2 2008 Earnings Call Transcript

Published: 17 Jul 2008

[Operator:]

Welcome to the Alliance Data second quarter 2008 earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host, Julie Prozeller from Financial Dynamics.

[July Prozeller:]

By now you should have received a copy of the company's second quarter 2008 earnings release. If you haven't, please call Financial Dynamics at 212-850-5721. On the call today we have Mike Parks, Chairman and Chief Executive Officer and Ed Heffernan, Chief Financial Officer of Alliance Data. 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 has no obligation to update the information presented on the call. Also on today's call are speakers who 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.alliancedata.com. With that, I'd like to turn the call over to Mike Parks.

[Mike Parks:]

If you will turn to the agenda slide you’ll see we are going to hit the company highlights and a full-year outlook. We’ll get some more details and info from Ed on the financials and then we’ll take your questions. So let’s go ahead and turn and jump off with the second quarter highlights page. I am obviously very pleased to announce our second quarter results. We expected the first half to be a bit challenging and it was. Even so our teams have certainly stepped up to the challenge and we delivered ahead of our guidance. As you will see our revenue was an increase of about 5% up to about $507 million. Operating EBITDA decreased a little bit 3% due to timing but still remains on track for our normal $30-40 million. You should expect that. Adjusted EBITDA increased 7% to $162 million and cash earnings per share was up $1.04, $0.04 ahead of our guidance and 14% increase over the previous year. Before I move on to some of the highlights in the core businesses I do want to make a few extra comments. There are a few items. Most notably we completed the sale of our Network Services group to Heartland Payments. This is a great fit for both groups and better aligns our Network Services team with more traditional merchant services and transaction processor and by the way if any former associates are listening to the call today I wish you great success and thank you for your service and long-term commitment to Alliance Data as being part of the founding organization back in 1996. Also we just announced we signed a definitive agreement with VerTec, a UK based utility services provider, to purchase our utility business. We expect to close this in the third quarter. I also thank the Utility Services team for their commitment and dedication. You have been true professionals through this process. Lastly I want to congratulate our Technology Information Group. They recently were awarded the 2007 Stevie Award for Best IT Organization in the U.S. by the American Business awards. So nice work with that team. Alright. Let’s turn to the specific highlights. Let’s start with our Loyalty Services Division on the next slide. They posted an outstanding quarter, another record quarter both in revenue and adjusted EBITDA with revenue over $200 million for the first time ever. This quarter we were also pleased to announce a substantial long-term renewal and expansion with one of our founding sponsors and largest client, Bank of Montreal. In addition to this long-term commitment the agreement reflects a significant new structure which we announced earlier to include responsibility for managing the redemption trust cash associated with the reward miles awarded by Bank of Montreal. This new structure benefiting both the bank and Alliance Data is how we manage the process for the vast majority of our other sponsor relationships. Moving on. During the quarter we also renewed another top five sponsor of air miles, Rona. They are Canada’s largest retailer of hardware and home renovation with stores across Canada upwards of 700. We continue to see very strong growth in miles issued and redeemed. Both had double-digit growth this quarter clearly demonstrating our collectors’ continued excitement in the program even after 15 years as the network effect continues to ramp up. Also last week we announced the re-branding of our Loyalty Services Group who runs Air Miles program in Canada. They are now called Loyalty One. This signals our desire for global expansion to leverage our 15+ years of expertise in working with retailers characterized by high frequency, non-discretionary spend such as grocery, gas and pharmacy, all cornerstone retail categories in our Air Miles program. The launch and expansion is being managed within the current infrastructure with no additional capital required and will include a broad set of loyalty services from design and analytics to one-to-one and even sponsor coalition programs. Congratulations team on a great quarter. The next slide, our Epsilon group delivered a very solid, double-digit organic growth quarter in adjusted EBITDA. This continues to be the hallmark of the growth of this business driven by our ability to renew and expand those key customer relationships. Last week we announced an extension with a major client, National Geographic, to continue to provide permission based email marketing throughout 2011. They have been a client since 1997 and our solution provides them a holistic view of their members, customers and prospects, driving marketing programs to build profitable and loyal relationships. We also signed a multi-year extension with Nestle Purina Pet Care. We will continue to host and manage their multi-brand, interactive marketing database. We also manage their permission based email program and provide consulting to support their CRM programs. Finally there has been a great deal of discussion centered around the impact of the recession on our marketing business and marketing spend in the marketplace. From our vantage point we are seeing companies quite willing to invest in transaction based solutions where there is real value and measurable ROI’s from these programs. Our commitments from existing customers as well as securing a number of new clients so far this year is clearly a testament to these services as being recession resilient. We have a very solid pipeline that includes companies spanning key verticals in healthcare, insurance, retail computer services and financial services. Epsilon remains nicely on track for another year of double-digit growth. Let’s turn to Private Label. Clearly a strong quarter in securing new business while maintaining our existing clients’ confidence and renewing through their key relationships their Private Label card holders. In the quarter we signed an agreement with web and catalog retailer Peach Direct, a fast growing retailer of high end brands of electronics, beauty and fashion accessories, and jewelry and home products. We will provide Private Label services designed to build customer loyalty and drive repeat purchasing and the program will launch under the name Venue to coincide with their re-branding initiative for both their web and catalog channels. We also successfully renewed several key clients. Just last week we announced that New York and Co., a long time client since 1996. We also announced the renewal of one of our top ten clients, Dress Barn and Maurices. Together both brands operate nearly 1,500 stores. Lastly we announced a multi-year renewal with Crate and Barrel, a leading multi-channel home furnishings retailer operating through stores, their website and more than 15 million catalogs being delivered to active home shoppers. Our business development activities are at an all time high. Given the current pipeline and other significant renewals with existing clients we expect 67 new announcements this year. As you have heard from us in the past our normal is more like four or five so we are clearly excited about this year. We believe a full back by financial services players may offer us a unique opportunity to expand our sand box a bit and clearly the signings so far and what we expect to have will bear this out. Even though we faced some tough comps the first part of the year we fully expect things to normalize in the latter half. With a return to more normalized metrics and a solid pipeline for growth we have a great jumping off point for 2009. Congratulations retail team. Lastly let’s turn to the full-year outlook. We will be raising guidance as you see. For the full year we remain confident about the company’s overall performance and I am pleased how our teams have stepped up and delivered. In the latter half of the year we expect Loyalty One to continue to over perform. Epsilon remains solidly on track having seen an impressive number of new clients to add to existing clients who renew as well. Finally we see momentum building, albeit slowly in Private Label, as the result of client ramp ups, our success in securing lower funding costs and the upcoming anniversaries of Lane Bryant and [inaudible]. The net result, for those of you who know us we are true to form. Regardless of the macroeconomic environment we are going to raise guidance and momentum will continue to build. I want to thank our teams for another job well done. We’ve got a great deal of work to do but I am confident with the talent and energy of our associates we will deliver on our promises. I’ll turn it over to Ed now for a more detailed review of the financials and we will review the top five questions to help clean up some of the noise in the marketplace.

[Ed Heffernan:]

If you could turn to the slide titled “Second Quarter Consolidated Results” we will dive right in. As always we like to kick it off by noting that the second quarter now marks our 29th quarter since our IPO and 29 in a row of delivering or over-delivering primarily on our promises. While we are clearly very cognizant of everyone’s deep concerns regarding the turmoil in the markets we do hope that our call today will be a bit of a respite from that and will serve as a reminder that certain business models perform well even under adverse macro conditions. Before we dive in let’s first review the headwinds that we have faced so far this year. It is important because these headwinds will naturally dissipate by Q4. This is a key point. We had four headwinds in Q1. Mike talked about the loss of Lane Bryant, started to see higher credit losses, without the funding stays yet in place, we had seasonally light quarters for Loyalty and Epsilon and quite frankly brutal comps in Private Label. Now we are only down to one and that is Lane Bryant. Specifically the difficult loss of Lane Bryant has and will continue to be a drag on results in our Private Label group until its anniversary in Q4. Nonetheless the model as a whole still holds firm and I think if we were to bubble down the quarter we would say at a very high level we had four key take aways. The first would be, as promised, earnings acceleration has begun. Q1’s earnings were flat to prior year at $1.00 per share. Q2 came in at $1.04, up 14% from prior year. Q3 we will see earnings pop to about $1.15. Q4 with the anniversary of Lane Bryant in November will certainly be ahead of Q3. Two, earnings acceleration will place the company in an excellent trajectory for its jump up to 2009. Again, despite macro concerns our business model has come through the toughest comps which was Q1, acceleration has begun and all signals point to a strong 2009. Three, the results are 100% organic. Q2 had double-digit organic earnings growth which should remain a comfortable level for us going forward as well. Looking at EBITDA, organic growth accelerated from 3% in Q1 to 7% this quarter. Furthermore, the high single-digit growth posted would have been double-digit had Lane Bryant been excluded. Again, setting the stage for Q4 in 2009. Finally, capital structure. We pounced on the opportunity to take out close to 8 million shares at close to 10% as allowed for under our current buyback program. While the impact was immaterial for Q2, the buyback will add an additional buffer to results going forward and additional flexibility to the company to potentially trade off some accretion and lock down future visibility. Overall, minimal leverage, double-digit organic growth and significant free cash flow generation are the key aspects of our model. In times like these the benefits will be magnified. That is the big picture. Let’s turn the page and hit the segments. Second quarter segment results

[Mike Parks:]

Blackstone litigation, aell, we recognize this is something of interest but at this time there is really nothing we can add to what everybody doesn’t already know. That is that Blackstone has not lived up to its obligations under its agreements with us. We have had to sue them as a result. That is where we are today. Be assured that we are confident in the merit of our claim and intend to aggressively pursue all of our rights and claims against Blackstone. Regardless of the outcome at the end of this economic cycle there will be firms that will have protected and enhanced their brand and others that will forever be changed and I will leave it at that. We’ll turn to the last slide, our favorite chart, the bar chart. Certainly this representative of our historical for many of you who have known us compared to the S&P since 2001 when we went public. It is certainly a lot prettier given the S&P is a lot flat or even below where we were in June of 2001. We have clearly been a better investment. 20+ compounded growth, good times and challenging ones and it is all in the model and the execution of our team. We intend to continue to do that. We will now take questions.

[Operator:]

(Operator Instructions) Your take our first question comes from Jim Kissane – Bank of America Securities.

[Jim Kissane:]

Can you talk about the competitive environment a little bit in the Private Label business? Have the two big guys in the Private Label business stepped back at all?

[Ed Heffernan:]

We have our own sandbox as you know which tends to be the higher end retailers between a few hundred million and a couple of billion in sales to wing it to spend on brand. That sort of gave us our 300 type clients in our sandbox, which less than half have a program today and we have about 90 of them. That will be the bulk once again this year where we get half a dozen or so singings that we were talking about earlier. To your point you are absolutely dead on. One of the larger players out there is trying to exit the business. One of the others is having a very challenging year. Another one has been told to pull in its horns from what we can tell. So is there an opportunity for us to defer our till outside of our comfort zone in our sandbox to see if we can pick up a few who are not having such a good time? Absolutely. I think that you will see that a couple of signings we announce this year are exactly coming from that source.

[Jim Kissane:]

So the 9-10 you were talking about includes 3-4 outside your sandbox? Is that right?

[Ed Heffernan:]

It could come from in or out Jim and obviously you can tell based on the guidance there who is the one that tends to like to under-deliver versus over promise. I don’t think we are over promising. We have got a strong pipeline. The key here, I’d like you to focus a little bit more also on the history. I’ve been in this business for 20+ years. The players in the financial services tend to go up and down like a roller coaster. In good times they give out money like there is no tomorrow and in not good times they pull back. You can go back and look at the 2001/2002 time frame. Look at the number of signings we had in those years. We are reliving what was going on then. You’ll see us have a strong year and we are going to stay in line with what we do in terms of our lending criteria. One of the questions I got the other day was why aren’t the banks and the annexes and others having higher delinquencies than you? Our growth in that area are 50-60% compared to theirs and it is strictly because we have a very disciplined approach and we don’t grill by mass mailing and balance transfers and we are very disciplined. All in all we are going to have a good year on the Private Label side and we will continue to see that into 2009 and beyond based on the outlook of some of the banks.

[Jim Kissane:]

Can you provide a little more color on the funding environment? You talked about locking in longer term funding and higher costs. Can you put some numbers around that?

[Ed Heffernan:]

Sure. For a second I’m going to go back to my 9-10 for the year. Mark can take the low end on that one. Anyhow on the fund side you bet. Again there is all this concern out there about the liquidity in the market access and this came up at the beginning of the year and we just ripped it and had a real good time doing it as well and saved a bunch of money. There is, if we were to go out and try to do a long-term, fixed rate, asset backed deal versus funding at the short end of the curve you are probably talking 150-200 basis points incremental cost if you were to fund all the way through the BBB’s. Now let’s trim that down a little and say maybe we don’t fund all the way through the BBB’s which are about 10% of any issue, you are still probably going to be 100 basis points or so above where we are funding today. So that is sort of the trade off we are going to look at and the question is do we want to do maybe $600 million or $1 billion this year along with the $1.5 billion we have already locked down just to make sure things are in real good shape for 2009 or do we let it drift a little and hopefully the spreads will come in a bit. You know us. I think we are going to have a little bit of room here so my guess is we are probably going to go out and tap the markets.

[Jim Kissane:]

Then that would give you until when? Late 2009? I think you were talking earlier about the first part of 2009 and this would theoretically take you to late 2009?

[Ed Heffernan:]

You bet.

[Jim Kissane:]

The last question you talked about the pipeline in Epsilon being at record levels. I know you signed some new business with existing customers but what has been your success in converting the rest of the pipeline especially with new clients?

[Ed Heffernan:]

The problem we run into is most of them don’t give us permission to talk about new signings. Obviously Citi was a huge expansion from what we were doing with them already. Nestle and National Geographic were renewals. I think we have probably pushing 3-4 new clients that I believe are going to let us do at least an 8K and maybe a press release. All we can say is we have signed a whole bunch of new folks and they are not small.

[Operator:]

Your next question comes from Andrew Jeffery – Sun Trust Robinson Humphrey.

[Andrew Jeffery:]

You are obviously out performing pretty significantly in Air Miles and there is a currency component there as well which is good for underlying business. Could you talk about what you think the long-term sustainable revenue growth is in that business and then also clarify or amplify what the actual P&L impacts are of any of the Bank of Montreal transaction?

[Ed Heffernan:]

Yes to the first. Probably not to the second. On the first one again even if you factor out the FX bene you are still talking mid 20’s organic top line growth at over 50% EBITDA growth. You have known us long enough. We have been all saying I wonder when that beast will finally slow. I think the folks in Canada would be comfortable with us saying low double-digit top line, 12-13% and somewhere between 15-18% organic growth on EBITDA and that is essentially our 5-year model. You are going to continue to get double-digit growth in Miles issued plus you are going to get very good pricing and as we bring on more sponsors that are smaller than the original folks obviously they will be paying us at a different rate. On the expense side we are so big up there that we can trade off to different vendors and we are getting very nice leverage on the cost side as well. Unlike a lot of the programs in North America and especially in the states where you open up your statement and just found all of your points got devalued we don’t do that up there. So it is considered a very, very high quality program and because of its size I think we are very comfortable with those organic growth rates. On the BMO stuff I think we said it all in the press release. The key is they obviously are our largest client. They moved incremental work to us and as such we would expect to get paid for some incremental work and we are. That’s about all.

[Andrew Jeffery:]

On the credit quality, the charge off’s, Ed are you talking about charge offs on the whole account receivables portfolio or is that just a master trust data you were quoting in the prepared remarks?

[Ed Heffernan:]

The stability is basically the same. Since everyone seems to watch Master Trust as you know every month we want to make sure everyone is on the same page with the Master Trust. So the Master Trust is the stuff and since that does account for probably 85% or whatever of the portfolio that is a pretty good metric when it comes to delinquencies and losses because those are our most seasoned clients. They don’t have the huge spikes up and down that new vintages have. They can have either zero loss rates at the beginning or 10% loss rates when they hit their peak at 18-24 months. But on average you are going to see the difference between Master Trust and total losses to be anywhere between 30-50 basis points depending on where they are in the ramp up cycle.

[Andrew Jeffery:]

So you continue, I assume, to experience the seasoning of the on balance sheet receivables then?

[Ed Heffernan:]

Yes. You’ll always see that because as soon as they get fully seasoned we move them off and put them in the Master Trust.

[Andrew Jeffery:]

Final one, just housekeeping given the timing of the share buyback should we be thinking about 73 or 74 million shares outstanding in the third quarter?

[Mike Parks:]

I would say about…yes that is probably a good number related to the buyback we just completed, yes.

[Operator:]

Your next question comes from Daniel Perlin – Wachovia Securities.

[Daniel Perlin:]

I want to go back to the funding question that Jim talked about. It looks like I’m doing the numbers right on $1 billion you are going to give up about $10 million EBITDA or about $0.12 or $0.13 earnings for the year. Is that about right? To me it looks like that is what the buyback would cover.

[Ed Heffernan:]

Well the math is right. It would only be for two quarters but that would be the math.

[Daniel Perlin:]

So you are thinking about it in the context of giving up $10 million of EBITDA and the buyback basically in a lot of ways opportunistic would also kind of cover that if you will, right?

[Ed Heffernan:]

If you want to look at it that way that is fine. I mean, what we are basically saying is we flowed through some over performance thus far this year and we are in a recession and we feel very good about the rest of the year and to the extent we have upside, which we think we will, we would like the opportunity to use and I like to be firm on this some of it to lock down some future visibility. By no means are we saying that come Q4 when we let the dogs loose there may not be some additional room in there as well and we wouldn’t be using that.

[Daniel Perlin:]

Is that incremental $10 million EBITDA is that like when we look at the guidance no longer greater than $700 million on adjusted EBITDA, it is just $700 million?

[Ed Heffernan:]

I don’t think anything was done on purpose there. I think it is just…greater than, equal to, whatever you want. I will tell you we have securitized over the past quarter. We have moved $150 million you’ll see on our on balance sheet we moved it to some off balance sheet and what that does is it takes the interest expense from below the line and puts it in the EBITDA. So a lower EBITDA but you’ll have the improvement below the line.

[Daniel Perlin:]

Is this security that you are looking at doing is that going to be public or private do you think?

[Ed Heffernan:]

We don’t know yet. Public looks okay right now. It is really a question…look we can walk out tomorrow and we file the shelf and we can blow out AAA’s and single A’s without a problem. The B’s are kind of expensive. Do we want to keep them? Do we want to push them out? Those are some of the things we need to think about during the quarter but we just don’t want people running away on raising numbers in Q3 when we are also looking at really hammering down visibility on 2009. Q4 is a different story.

[Daniel Perlin:]

Are there any other restricted covenants on buying back stock either in this funding or your existing?

[Ed Heffernan:]

If they were they have been removed.

[Daniel Perlin:]

Lastly, this is more just a nit picky question for myself but why not be able to comment on your capital structure? Is there a legal issue going on with Blackstone or something?

[Ed Heffernan:]

Not with Blackstone. It has nothing to do with Blackstone and we’re just not going to get into talking about it right now.

[Operator:]

Your next question comes from David Scharf – JMP Securities.

[David Scharf:]

Ed I just wanted to make sure I heard correctly on the margin explanation and Private Label Credit. After you collect from Lane Bryant and some of the interest cost that is below the line are you essentially saying that some of the increased investment in call center staff, both customer support and collections, sort of historically understated margins in Private Label Service and over stated Private Label Credit?

[Ed Heffernan:]

Yes. That is the easiest way of saying it. If you went back to last year and you looked at I’m sure it is in the transcript we said we are ramping up call center and especially collections on the back office side and that is about $4-5 million a quarter but because as you know this is a charge that is made for services over to credit we only set that charge once a year so therefore last year it had to eat it. This year we got fair market value for it and essentially that is why you saw growth in the Private Label Services segment when essentially if it was done right last year and not just once a year there wouldn’t have been any growth. So, this year more accurately reflects the margin in Private Label Credit and hopefully that answered your question.

[David Scharf:]

So going forward obviously when we think about margins in that business and where we are in this part of the consumer cycle we don’t necessarily have to see loss rates spiking dramatically to see a little bit of margin. It sounds like you probably wisely spent on more collections staff in advance of what would be a weakening consumer. Is there any additional staffing up on the collections front in house?

[Ed Heffernan:]

No. We bulked up really starting Q2 and into Q3. Quite honestly we’ve started seeing the early stages of delinquencies starting to tick up and as you know by August of last year that is when our delinquencies hopped up from about 4.6 to 5.2 and I think we are a little bit ahead of the game which was good. No, there is nothing more to beef up. We are at full staff, full capacity and I would say when you normalize for that, adjust for Lane Bryant and adjust for the funding you are still going to see, David quite frankly, a slight decline in the earnings of that business even though the portfolio hasn’t changed that much and that is because we are seeing a bit of a hit on the late fees. Nothing huge but a few million here and a few million there and people seem to actually be paying attention even if they are rolling their balances to making sure they are paying more on time. Maybe it is the folks who have been writing off at a higher rate over the last year that were the ones who were also paying us more in late fees. I don’t know. I would say that is probably a real and maybe a permanent change.

[David Scharf:]

When you look at the year-over-year growth in statements, pulling Lane Bryant out of it is essentially flat. When we set aside actual balances and receivables and what people are spending but if 20 out of 90 programs signed up in the last three years are still ramping up presumably why isn’t statement growth picking up more? Are you starting to see more inactive accounts lately?

[Ed Heffernan:]

Boy that is a great question. I would say that you have got a portfolio that has grown probably 6-7% but really as you said no growth in statements so what you are seeing is balances are kind of growing a little bit more than inflation at around 6-7%. Honestly, my guess would be if I looked at all 90 of our clients I bet you 90% of them have negative comps or significantly negative comps including some of our big ones that you know and that those negative comps probably also translate into more inactive accounts and that our 2005, 2006, 2007 vintages that are in fact ramping up I know for a fact they are showing very nice growth and positive growth but it is just barely offsetting the negatives. That would be my guess.

[David Scharf:]

Last question on Private Label, obviously there is quite a bit of news flow in G capital’s unsuccessful efforts to unload their portfolio. Are there any individual store brands within that portfolio that you think fit your typical profile of sort of niche, specialty retail? Higher end? Just curious. Is there any rumblings that perhaps they may try and entertain bids from one-off brands?

[Mike Parks:]

No question about it. I think that pretty much was indicated by our stronger pipeline than we normally had historically and we are going to take every advantage of it.

[Operator:]

Your next question comes from Robert Dodd – Morgan, Keegan & Co.

[Robert Dodd:]

Just to get back to Epsilon if we can and I know you are saying it is jumpy quarter to quarter but can you give us an idea of what proportion of revenue or profitability, whichever way you want to chop it, comes from inter quarter or intra quarter project work which is recurring contributions?

[Ed Heffernan:]

I am really going to hazard a guess and it is probably not going to be a very good answer but I’ll throw it out there anyhow. I think what you will find is last year’s second quarter was very, very strong whereas this year’s second quarter, the first half of the year with Epsilon traditionally you are going to have relatively flat dollar numbers in Q1 and Q2 from both a revenue and EBITDA perspective. Last year, and I’d have to go back to what actually happened last year, you actually had a pretty nice flip up in Q2 revenues and EBITDA was up probably about 10% from Q1. That is a little bit uncommon. What you have is like I said a pretty flat Q1 and Q2 and then that sort of 25’ish type million that flow into Q3 and Q4 and then you pop on another $20 million in Q3 and Q4 and that is traditionally how Epsilon flows out.

[Robert Dodd:]

Can we conclude from that Q2 last year had some project stuff or short-term contracts?

[Mike Parks:]

A lot of times it is going to be, when we particularly start up new major database builds that might take us anywhere from 6 months to a year, depending on when we actually turn them on and start providing those services all of a sudden we’ll get a big jump in revenue from a major new client relationship or major expansion. So if the project work happened to conclude and kick off near the last month of the first quarter or trip over into the second quarter of last year it makes a big difference in terms of did last year’s second quarter jump up for some reason? It wouldn’t necessarily mean it was a “discretionary” project of a 30, 60 or 90 day kind of nature. Most of our revenues are 80-85% long-term, stable, multi-year kinds of things. I don’t think I’d put it in project work. I think it would be more around the timing of turning on new customers.

[Ed Heffernan:]

If you were to do the math because the numbers just aren’t big enough I don’t think we can dissect it any further. EBITDA growth has been very consistent in the low teens the first couple of quarters. On the top line you are jumping from 17 to 6. If it were 10% growth or double-digit you are talking $4 million between quarters. They are just not big enough numbers since we don’t really manage by quarter we manage on an annual basis.

[Operator:]

The next question comes from the line of Robert Napoli – Piper Jaffray.

[Robert Napoli:]

A question on the Loyalty Program and maybe I should understand this. Revenues up 30% and your Miles issued are up about 12%. I’m just trying to put together your revenue per mile issued is up a lot year-over-year. I’m not sure if that is the right way to look at it. I was trying to put together the revenue growth metrics and trying to get sustainability relative to the miles issued. I was hoping you could help me with that.

[Ed Heffernan:]

Yes. I’d say let’s talk about revenue. Let’s talk about three pieces of the puzzle, actually four pieces of the puzzle. The first piece would be miles issued. That is where you start with double-digit growth. Then you make the leap that our pricing in Canada is quite firm. Perhaps some CPI inflators floating around. That ought to give you a nice base rate. Then over the past few years we are no longer talking about signing up these monster Fortune 50 companies. We are talking about signing up tier two and tier three players who may have a very strong presence in just one province of Canada. Clearly when their volume is 1/20th of what some of the big guys are doing their pricing is going to reflect that. So revenue per mile issued I think is what you are looking for to solve your puzzle. I think if you back out FX you will see sort of a 20% organic growth. Frankly I think that is a little bit high long term. We’ll take it of course. That is how you will get there.

[Robert Napoli:]

So as I am backing out FX and looking at revenues [inaudible] issues you would expect that to continue to grow slightly from here? You’ve had nice growth, very strong growth in that year-over-year and some of it was due to that FX.

[Ed Heffernan:]

Yes the FX piece is going to disappear and will probably reverse itself a little bit in Q4 if things stay the way they are but that is close enough. Q3 and Q4 you are about flat to last year where you are this year but I don’t see any reason why you shouldn’t see a 2 as the first digit.

[Robert Napoli:]

You said sequentially the third and fourth quarter you should be about where you are here on revenues per mile issued?

[Ed Heffernan:]

On revenue per mile issued? Yes except for the FX.

[Robert Napoli:]

You put out a press release a couple of days ago about expanding that Loyalty Program and the branding of it and moving into other countries. I was wondering if you could maybe give a little color on what the plans were there?

[Mike Parks:]

Let’s be clear. We are not re-branding the Air Miles Reward program. That is a great brand and a great coalition in Canada. However, there is a strong team in Canada that as we have talked about before across the company we are starting to dip our toe in the water in the UK, China and others and we have been slowly deepening the team in Canada to be able to leverage their expertise particularly in the high frequency retail areas; gas, grocery, pharmacy, etc. and we are now looking outside of Canada all the way from consulting and loyalty programs, use of data to enhance those programs as well as even store operations and merchandising. There is just a great deal of opportunity here as those high frequency retailers are looking for ways to leverage the data. They captured a lot of data over the last years but frankly haven’t found really a good way to leverage and use it. So our thrust is to come both to the U.S. but also more targeted to growth countries to put a second toe in the water. This is clearly a long-term growth strategy and nothing we expect to have an immediate significant impact this year or next but it is just a natural extension of the pretty unique team and model that we have built there.

[Robert Napoli:]

Last question, I guess on the Credit side just to follow-up on that. I hope you guys are right that your credit losses beat…I think that would be very admirable if you were able to do that given the rise in jobless claims and we’ll see where they go from here. Seasonally wouldn’t you expect your delinquency to pick up? I know they have been stable for a good period of time but wouldn’t you seasonally expect them to pick up and doesn’t the rise in jobless claims alarm you somewhat in that outlook?

[Ed Heffernan:]

All I can tell you is seasonally for sure which is why Q2 delinquencies were below Q1. That is seasonally our lowest. But when you are talking about picking up I’m talking about like a 5.3%. I think we are going to be comfortably at 5.5% or less for the entire year which we are just telling you what the data says and the data on 11 million active households every single month and we have been tracking it since 1996 or actually in 1985, a long time, and this is July will be 12 straight months and we are not seeing the beginnings of any type of bubble in the early stage delinquencies. Our guess and I think it is a pretty good educated guess based on the data is that we are absolutely not saying things are improving from a macro perspective on our customer base, but we are certainly saying they are not getting worse. You are seeing a strip of folks write off every single month that is higher than what they usually have been in our portfolio. It is just not getting any worse and maybe it is because if you go into one of our stores and ten people apply for something, 2-3 years ago maybe six would get approved. Today it naturally resets itself so that 10 people apply and those six may be only four today. So that is one of the reasons I think David asked earlier about statements and applications. We are naturally resetting our applications lower and it is just automatic across all our clients because we are keeping the same type of euro score.

[Mike Parks:]

Remember the low balance nature of our business. This is a transaction business where people tend to pay off in 6-7 months unlike the bank card guys who are carrying $3-4,000 balances that take years to pay off and so those type of short term swings in employment affects them much more than us because people can pay it off.

[Ed Heffernan:]

I think actually that is a very good point. Also at the start of any type of big macro downturn you are going to see a big spike up in personal bankruptcies and we certainly saw that at the beginning and what has happened is that has plateaued now. So you don’t have that big run up continuing and what we are seeing is somewhat of a nice, flat…not a nice flat, but it is flat plateau on the personal bankruptcy side as well. So that gives us additional comfort.

[Operator:]

The next question comes from the line of Reggie Smith – JP Morgan.

[Reggie Smith:]

Did I hear you correctly on the marketing services ramp up? Did you say you had $20 million sequential increase in the third quarter and another $20-25 million in the fourth quarter?

[Ed Heffernan:]

Certainly I didn’t say $25. But, yes traditionally we are looking at Epsilon that does I would expect around $135 to $138 million for the year which would suggest about $20 million over and above the first half, right, in each of the last two quarters.

[Reggie Smith:]

So you are saying $20 million revenue…

[Ed Heffernan:]

No, I’m talking EBITDA. In other words if Epi is running around $23-25 million in each of the first two quarters we would expect to see something right around the 40’s in terms of EBITDA for Q3 and Q4. It is quite a ramp up. Then on revenue you are going to see essentially $20 million as well. The margin on this is just, as you can tell, almost 100%. This is essentially what you have been in the weight room all year and now you are ready to hit the field. It is essentially all of the work has been done and the marginal cost on these things is about zero. That’s the best analogy I could come up with.

[Reggie Smith:]

I follow. I guess you made a comment earlier about half or 60% of your growth with Epsilon is related to expansion agreements where customers are doing more with you guys. When you talk about the ramp in the back half of the year and incremental margins there is that kind of tied to the expansion stuff? Are the margins higher on that than say a new win?

[Mike Parks:]

Don’t forget a nice part of Epsilon is our Abacus business. The co-op of catalogers which is heavily back end weighted. When we manage the database all year long but the actual big mailings of all the catalogs start to hit in fall and end of the year. So not just necessarily bringing on “new customers” and expanding relationships that push the back half of the year it is just the natural course of the business.

[Ed Heffernan:]

Just think of you spent…if you want to look at it as simply as Epsilon does $20-23 million a quarter of EBITDA or $150 million a quarter of EBITDA through the year that is for everything to do with designing, implementing and maintaining and enhancing and ramping up and all that other stuff and then it is game time starting right now. Beginning to see crank up as we get moving into back to school and Halloween, Turkey day and the holidays. As Mike said massive, massive spending on the catalog drops as well as billions and billions on the permission based email. We’re going to get to you somewhere or another Reggie even if it is through your permission based email with Barnes and Noble, probably not the Citibank Thank You Network, but the Hilton Owners or something like that either permission based email, direct mail, something in your statement. That is where we make our margin.

[Reggie Smith:]

If I could move I guess to Private Label for a second have you guys ever talked about what percentage of your portfolio was kind of tied to these new ramp ups? Is it 7%? 10%? 15%? Could you kind of size that for us?

[Mike Parks:]

If you think about the Master Trust versus the on balance sheet the on balance sheet tends to be the majority of the newer customers until they season and move off. So you get some sense of balances there.

[Ed Heffernan:]

I would say call it $1 billion.

[Reggie Smith:]

$1 billion is kind of new?

[Ed Heffernan:]

Yes. Put it this way. If our average portfolio is around $50 million and we sign 20 or so new folks it is around $1 billion that is rolling through the three-year vintages cumulative is probably about $1 billion with 20 clients at $50 million each. Once year four hits they are fully mature. They get moved off into the Master Trust and then we have the newer vintages as well. I think that is our best…I never really thought about it but that sounds about right and that means if those guys are ramping up and growing 15-20% and the rest of the file is experiencing negative comps that is where you are going to come out with, excluding Lane Bryant, kind of single digit mid to low single digit growth right now.

[Reggie Smith:]

I have two housekeeping questions. IO gain for the quarter. If I could get the managed loss rate, the total loss rate for the second?

[Ed Heffernan:]

Reggie I’d love to give that to you. The IO this quarter was $6 million, last year it was $14 million. The managed loss rate is 668 versus the Master Trust which was 6.2 or something like that. So whether it is the full loss rate or the Master Trust rate you are both running about 20 basis points better than first quarter.

[Operator:]

the line of Colin Gillis – Canaccord Adams.

[Colin Gillis:]

Could you give us a sense, given your strong appetite portfolios what is the largest portfolio you think you could swallow in this environment?

[Ed Heffernan:]

$20 billion, there is one on the market I think for about $30 billion. We’d only want to do about half of that.

[Mike Parks:]

We have a $4 billion file today. We have 90 clients. That is a whopping total of about $50 million per client. They do range from smaller than that obviously to the few hundreds of millions for some of our larger clients. I would say we are comfortable with anything between $50 million and probably up to around $300-400 million and then we would just immediately securitized it and call it a day. I don’t think there is a big appetite here for going after some monster portfolio even though there is a little blood on the street right now. It is just we don’t want to put…it’s not with our risk profile and quite frankly we have been getting pounded on for seven years to get the credit segment to be more reasonable. I think those are good numbers.

[Colin Gillis:]

I know we scrutinize the Master Trust data but could you just talk about any delta between the full loss rate and the MT data in the June quarter. Did you see a spike up on some of the balance sheet? Was it right where you expected it to be? I’m looking for the trends on the on balance sheet receivables.

[Ed Heffernan:]

No, the on balance sheet is going to remain very consistent Colin. It varies between 30 and 50 bips higher than the Master Trust. I think it was 50 bips in the first quarter and it will be 50 bips this quarter. It is about a 6.7 versus a 6.2 in the Master Trust.

[Colin Gillis:]

Should we expect 2009 guidance in the September quarter conference call?

[Operator:]

The next question comes from the line of Mark Bacurin – R.W. Baird.

[Mark Bacurin:]

I just wanted to clarify, Ed, I think you are talking about double-digit growth within the Epsilon business and I think in Q1 that 17% there was still some acquired growth coming out of Abacus and by my math it looks like maybe it was also a mid single-digit organic growth number. What I’m trying to delve into is all these contracts you are seeing in the pipeline customers that won’t let you give the names giving you comfort into being able to get back to kind of a double-digit growth rate in the back half of the year?

[Ed Heffernan:]

Yes, I would say I would caution you a little bit on the Abacus thing. We did buy that as of February 1 so you are really only talking about January and as being a marketing person Abacus doesn’t really do squat in the first part of the year. I’d have to go back and cut the numbers but I think we probably would be still in the double digit on top line. Certainly maybe not quite as high as 17 and that is why I think if it is running around, let’s say it did 12 and we did 6 this quarter we’ll probably do 10 and 10 the last couple of quarters. In all honesty what we are trying not to do is do a whole bunch of low margin things like direct mail, targeted mail and things like that which are just not sustainable. We are after margin growth. We are after double-digit organic EBITDA growth and for us if we want to give up a couple of points top line, low margin growth to get longer term juicy margin growth within Epsilon we are going to do it. In fact our margin this year in Epsilon we would expect that margin to be up 100 basis points and along with that we would expect low to mid-teens sort of organic growth in EBITDA and whatever revenue comes up from that is fine. Is it 9%, is it 12%? I can’t really tell you right now. We are definitely hooked on the margin expansion, cash flow growth and sort of mid teen EBITDA growth.

[Mark Bacurin:]

So nothing you saw from a client spending perspective that would give you concern over the Q1 organic growth trend and the Q2? It sounds like it is more selective, higher margin business you are going after in the tough comp you mentioned earlier?

[Ed Heffernan:]

You bet.

[Mark Bacurin:]

On the $2.6 million of other non-recurring charges that showed up in the Epsilon segment it sounds like that was maybe some headcount burning? I was wondering if you could just give us a bit more clarity on what that add back was on the non-recurring side?

[Ed Heffernan:]

You bet. It sort of all goes back to the consolidation process again going back two years ago, three years ago when we were doing a number of acquisitions to fill out Epsilon’s capability so they had everything from creative data to database analytics to the distribution vehicles. We had a bunch of different platforms and we finally after much toil got those integrated and as such we had some room to do some pruning which we did.

[Mark Bacurin:]

Just following that I guess as it relates to Loyalty One it sounds like a lot of capability you are trying to leverage out of Canada whether it be some of the creative analytic work, whatever, also overlaps some of the work you do at Epsilon. I guess I’m trying to understand number one, what the go-to-market strategy will be between the capabilities at Epsilon versus what is within Loyalty One and secondarily I just want to make sure I understand…the Loyalty One you are not trying to build an Air Miles like program in the U.S. that would necessarily compete with the Citi Thank You Network? It sounds like you are maybe going after more selective, loyalty based services inside the U.S.?

[Mike Parks:]

Yes, let’s hit the first one. If you think about our business and you heard us talk about our model, designing marketing programs, using the analytics, using data to create insight is what we do throughout the company whether that is in Private Label, Epsilon or our Air Miles team. However, we each have in each of those lines of business have unique customer focuses and sets. In the Air Miles business it is around grocery, gas and pharmacy retail. Deep data analytic kind of capabilities that haven’t been the expertise of our Epsilon team. So that is really what we are leveraging. Two, we are leveraging the potential not only in the U.S. but around the world to look at potentially putting together coalition kinds of programs around the world. Loyalty One is not going to be in a name the coalition brand. That is really just a calling card for the management team that is assigned the task of getting outside of Canada new business cards frankly and a brand to go to market with. So no, we are not rolling out a nationwide U.S. coalition program. That is not to say that at some point in time if a number of our customers as we expand into those high frequencies want us to put together a model for them and if Citibank wants to be a partner for expanding that it could certainly have potential or other of our clients at B of A and others. I don’t see a conflict there at all.

[Operator:]

The final question comes from Roger Smith – Fox-Pitt Cochran Caronia.

[Roger Smith:]

Just getting back to the FAS 140 on the regulatory side you said you just don’t think the regulators will impose these capital requirements. Can you give us any more reason around why that other than it just does seem onerous? Then if it did come on balance sheet would not the retained interest eat all the capital you would need to have? How much should we really think about the terms of the capital requirement there?

[Ed Heffernan:]

Both great questions. Unfortunately nothing has been issued. It is kind of hard to do more than our best guess at this point. We don’t know really what is going to come out in the issuance. If you go with the logic that reasonable people do reasonable things the fact that I’ve heard quotes anywhere from $5-15 trillion of off balance sheet assets coming back on at a 10% weighting that is $0.5 trillion to $1.5 trillion in new capital. You are talking with the big boys $100 billion of brand new capital and they are barely at 10% right now and having big write offs. Look, I may be way out of my expertise here but that I would find hard to believe but the two data points we can give you or reference points are actually pretty good. One is we have actually spoken with our regulators and they didn’t seem too bothered by it and we are focusing more on hey look it doesn’t change the risk profile of the company at all. That is sort of your first guess as to what that means. Secondly if you look over in Europe if the goal is to get similar standards globally Europe does that today. They bring it on and they carve out or give a zero weighting to these types of structures. So I think those are pretty good leading indicators along with the fact that I can’t imagine looking for $1.5 trillion or whatever in new capital for the big boys. From our perspective look our tier one are like 35% or something like that. Even if we took it on there is no incremental capital hit to us. We’d still be 10% or above. It is relatively moot for us but I obviously would be more concerned with the big boys that are out there.

[Roger Smith:]

On the late fees, how much do the late fees impact the portfolio yield? What I’m really trying to get at is if they do slow what kind of impact to growth can you even see here?

[Ed Heffernan:]

Look, if you have a $29 or $25 late fee on a balance of $350 that is 7 percentage points of yield. Let’s say people do that a couple of times a year, 2-4 times a year, you could be talking about a point or so of yield on the portfolio if it continues to slow. I think the good news sort of behind it is we are pretty sure that these are folks who were right on the bubble before the recession or whatever we are in and they are now charging off. So that gives us sort of added confidence that our delinquencies and losses really are stabilizing because the folks who were paying us finance fees and late fees more than once or twice a year are most likely the ones who were on the bubble to begin with who now either have gone bankrupt or have charged off and that means what is left is a little better pool.

[Roger Smith:]

But then if I think about that, if I took a 1% off of my portfolio yield that would equal something like $40 million of EBITDA. We shouldn’t be assuming it could become that big of a hit.

[Ed Heffernan:]

No. You asked me if it continues to deteriorate what could happen. Look, if we are reading the trends correctly in Q4 we anniversary Lane Bryant and we anniversary for our lower loss rates we will have a funding advantage at that point. The portfolio is growing excluding Lane and Bryant around 6-7%. So fourth quarter you should see some nice positive, organic growth in Private Label and whether it is six clients signed as Mike said or 9-10, you are going to have a heck of a jump off for next year. You are probably talking somewhere in the order of high single-digits just to jump off. So that is why I don’t think we are getting too bent.

[Mike Parks:]

We’ll wrap up here. For those still hanging on I guess the key messages are the same four constant ones; double-digit organic growth, not many people doing that in good times and bad. Strong free cash flow and we’re going to put it to good use. Visibility for the future. All of our new business is really being brought on this year to secure 2009 and it is business as usual.