Bread Financial Holdings Inc (BFH) 2008 Q2 法說會逐字稿

Good afternoon, and welcome to the Alliance Data second quarter 2008 earnings conference call. At this time, all parties have been placed on a listen-only mode. Following today's presentation, the floor will be opened for your questions. (OPERATOR INSTRUCTIONS) In order to view the company's presentation on their website, please remember to turn off the pop-up blocker on your computer. It is now my pleasure to introduce your host, Ms. Julie Prozeller from Financial Dynamics.

Thank you, operator. 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. 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, our speakers will reference certain non-GAAP financial measures which we believe will provide useful information for investors. Reconciliation of those measures to GAAP with be posted on the Investor Relations website at www.alliancedata.com. With that, I would like to turn the call over to Mike Parks. Mike?

Thanks, Julie. Welcome everybody. If you will turn to the agenda slide you'll see we're going to hit the company highlights and a full year outlook. We'll get some more details, info, from Ed on the financials. And then we'll take your questions. So let's go ahead and turn and jump onto the second quarter highlights page.

I'm 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've delivered ahead of our guidance. As you'll see, our revenue was an increase of about 5%, up to $507 million. Operating EBITDA decreased a little bit, 3% due to timing, but still remains on track for our normal $30 million to $40 million, and 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 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. This better aligns our network services team with a more traditional merchant services and transaction processor. If any former associates are listening to the call today, I wish you great success and want to thank you for your service and long-term commitment to Alliance Data as being part of the founding organization back in '96. Also, we just announced that we signed a definitive agreement with Vertex, a UK based utility services provider to purchase our utility business. We expect to close this in the third quarter. And I also thank utility service team for their commitment and dedication. You've been true professionals through this process. Lastly, I want to congratulate our information technology group. They recently were awarded the 2007 Stevie Award for the Best It Organization in the US by the American Business Awards, so nice work with that, team.

All right. 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 in 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 the 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 managed the process for the vast majority of our other sponsor relationships.

All right, moving on, during the quarter we also renewed another top five sponsor of AIR MILES, RONA. They're Canada's largest retailer of hardware and home renovation with stores across Canada in 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 collector's continued excitement in the program even after 15 years as the network effect continues to ramp up. Also last week we announced the rebranding 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 plus 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 multi-sponsor coalition programs. Congratulations, team, on a great quarter.

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 e-mail marketing throughout 2011. They've 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 e-mail program and provide consulting to support their CRM programs.

Finally, there's 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're seeing companies quite willing to invest in transaction based solutions where there is real value and measurable ROIs 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.

All right. 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, jewelry and home products. We'll 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 rebranding initiative for both their web and catalog channels. We also successfully renewed several key clients. Just last week we announced New York & Company, 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 & Barrel, a leading multichannel 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 six to seven new announcements this year. As you have heard from us in the past, our normal is more like four or five, so we're clearly excited about this year. We believe a pullback by financial services players may offer us a unique opportunity to expand our sandbox a bit and clearly the signing so far and what we expect to have will bear this out. Even though we face 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. So congratulations to the retail team.

Lastly, let's turn to the full year outlook. We'll be raising guidance. As you see for the full year, we remain confident about the company's overall performance. I'm pleased how our teams have stepped up and delivered. In the latter half of the year, we expect Loyalty One to continue to overperform. Epsilon remains solidly on track, having seen an impressive number of new clients commit and existing clients renew as well. Finally, we see momentum building, albeit slowly, in Private Label, as a result of the client ramp-ups, our success in securing lower funding costs, and the upcoming anniversaries of Lane Bryant and loss rates.

Net results -- for those of you who know us, we're true to form. Regardless of the macro environment, we're 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'm 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 financials, and we'll review the top five questions to help clean up some of the noise in the marketplace. Ed?

Thanks, Mike. If you could turn to the slide titled Second Quarter Consolidated Results, we'll 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 overdelivering primarily on our promises. And 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.

All right. Before we dive in let's first review the headwinds that we faced so far this year. It's important because these headwinds will naturally dissipate by Q4. And this is a key point. All right. We had four headwinds in Q1. Mike talked about the loss of Lane Bryant, started to see higher credit losses without the funding saves yet in place. We had seasonally light quarters for Loyalty and Epsilon. And quite frankly, brutal comps in Private Label. And now we're only down to one. And that's the Lane Bryant one. So, specifically the difficult loss of Lane Bryant has and will continue to be a drag on results in our Private Label Group until it's anniversary in Q4.

Nonetheless, the model as a whole still holds firm and I think if we were to bubble down the quarter we'd 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 a share. Q2 came in $1.04, up 14% from prior year. Q3 we'll see earnings pop to around $1.15 and 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-off to 2009. Again, despite macro concerns, our business model has come through the toughest comp which was Q1, acceleration has begun and all signals point to a strong '09. 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 if Lane Bryant were excluded -- again, setting the stage for Q4 in 2009. And 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's the big picture.

Let's turn the page and hit the segments. Second quarter segment results, first on deck is Loyalty which posted its highest revenues and highest EBITDA in its history. Top line and EBITDA grew 31 and 65% respectively, which drove up margins over 500 basis points versus last year. What's behind the continued overperformance up north? Four items. First, the pricing is firm to quote unquote firm plus on the revenue side and due to our huge size we continue to gain traction on the expense side. Second, we continue to see expanded commitments from our long-term existing sponsors as well as our transaction based data intensive Loyalty program continues crowding out more traditional channels. Third, the network effect continues, which is nothing more than saying that our 70% share of the nation's households is driving people to frequent more and more of these retailers who can offer them our program. And finally, the Looney, the Canadian dollar added modestly to results and this benefit will taper off as progresses. But, to run ahead of a question I know I'm going to get, even factoring out the Canadian dollar, organic growth was still north of 20% on revs and north of 50% on EBITDA. Based on these drivers, Loyalty Services is clearly outperforming expectations and we expect overperformance to continue for the remainder of the year. Because such a large portion of our Loyalty revenues and earnings are based off of consumer non-discretionary spend, gas, grocery, pharmacy, home improvement, et cetera, there is nothing to suggest that 2009 should be anything other than another fabulous year for the program.

All right. Turning to the US, Epsilon Marketing Services posted a good quarter with double-digit organic EBITDA growth and it's currently tracking to plan for full year. Again, anticipating a question, all I'll say is results do chop by quarter, but year-to-date results show double-digit growth in both revenues and EBITDA. More importantly, over 60% of Epsilon's EBITDA comes in the back half of the year as our customers ramp up their micro targeting efforts starting about now and not stopping until early January. Thus far, we have seen no evidence to suggest that there is any pullback associated due to general macro concerns.

From last call, we do continue to kick around ideas for the easiest ways to provide comfort regarding Epsilon's growth potential. We're going to take first cut here today, and at the highest levels we think there are three variables. First, renewals, or as I like to say how much of last year's revenue and earnings are being dragged into this year. Let's be conservative. Let's say 95% of last year's performance is dragged into this year. Like I say, being conservative. And that we want to get double-digit organic revenue growth and mid-teens organic EBITDA growth. You factor in a 5% attrition factor, that means we need to grow top line about $60 million and EBITDA about $20 million.

All right. Second variable is the existing client base. Over the years, we found that 60% of Epsilon's growth comes from existing customers adding more and more services or divisions to the mix. Since over half of our earnings come from our top 50 clients, renewals are critical. And this year we announced renewals with major customers such as National Geographic, Nestle and Citi. Note that Citi has included a major expansion of services. This is very, very common. Assuming we knock down a handful of these expansions, we've got that piece covered.

That leaves new clients which ramp up either the year before or in the current year, depending upon the complexity of the program. If you assume on average about $3 million in revenues annually per client, which is about the midpoint of our top 50, we would need to sign about eight of these a year. All right. You put that all in the pot and stir it and basically that should give you some color on the model. As of right now, we are about two-thirds of the way through those goals and we feel very comfortable that we'll be in good shape for '09 as well. To sum up, Epsilon is doing well and we expect it to finish the year with double-digit organic growth in both revenues and EBITDA.

Moving along. We next turn to Private Label Services which provides processing, high end customer care and marketing programs associated with the company's approximately 90 Private Label clients. Revenues and EBITDA increased 5% and 22% respectively, while statement growth excluding Lane Bryant was flat. The growth in both revenues and EBITDA is quite frankly more of a true-up from last year when a decision was made to beef up customer care and collections. At that time it added $4 million to $5 million a quarter of expenses, starting in Q2 of '07. These incremental expenses were not, however, passed along as intercompany costs to the Private Label Credit segment, since that charge is set only once a year. So last year essentially Private Label Services suffered through below market pricing for its services. This year we adjusted for it and as such, this year's revenues and margins more accurately reflect market based pricing. Looking ahead, we should also begin to see growth coming from the continued ramp-up of our 2005, '06 and '07 signings as well as the elimination of the Lane Bryant growover in Q4.

And finally, we come to Private Label Credit. For those of you over the last seven and-a-half years who have always wanted the credit segment to become a smaller and smaller portion of our earnings, well, you're getting your wish, as credit is now only 38% of operating EBITDA. For other folks, all we can say is that the results are pretty straightforward. They're a bit ugly, but the trend's our friend on this one. Revenues, they were down 9%. Excluding Lane Bryant, however, revenues would have been flat. Additionally, we mentioned earlier in the year that higher credit losses would be mitigated by lower funding costs.

Now we get into geography. That remains the case. The geography, however, is a bit different. Specifically all losses are netted against revenues and [enhance] EBITDA as well. On the other hand, funding saves are only partially netted against revenues and EBITDA, with the remaining savings showing up below the line or below EBITDA, since these are savings associated with debt held on our books. If one were to adjust for this and factoring in Lane Bryant, revenues would have actually been up 2%.

EBITDA initially looks even uglier, declining 29% from prior year. But again, let's normalize it. Let's factor in the loss of Lane Bryant, the adjustment for funding saves which were down below EBITDA, as well as the higher but more accurate intercompany charge. Adding those in would have resulted in only a 7% EBITDA decline. This decline was real and reflects a slightly lower level of late fee income as customers seem to be becoming a bit more vigilant about making at least their minimum payments on time. Financing can remain solid.

All right. Where is it all going? Let's move to the metrics. They tell a better story. Delinquencies, which are the best predictor of future loss rates, because you need to be delinquent for 180 days before you hit the P&L as a write-off -- they have now remained stable at 5.5% or less for 11 straight months. And as we're in July, I think we can safely say this will make it a full year. What does that mean for losses? It means that after the initial leg-up in losses towards the end of last year, losses have remained stable and should remain stable into 2009. Speaking of loss rates, Q2 actually came in 20 basis points better than Q1. While losses are still above last year, we are more comfortable than ever that our rate will continue around the 6.5% guidance level that we made I think last October.

The bottom line here is that yes, we got hit with higher losses at the end of last year and losses have remained at this elevated level so far this year, and based on delinquency flows we expect similar behavior in the back half of this year and into '09. What's key is that things are exceptionally stable at these levels and our guidance has been right on the money all year. As such, we'll anniversary these higher loss rates in Q4, along with the anniversary of Lane Bryant. Combine those two with the continued ramp-up of the '05 and '06 and '07 vintages, also portfolio growth already running at 7% excluding Lane Bryant and a potentially record year of new client signings and we are getting that warm, fuzzy feeling that Private Label Credit will be both a positive contributor in Q4 and a significant contributor in 2009.

Mike mentioned the sales pipeline was absolutely huge. I've been here 10 years. I've never seen more activity than this year. Mike mentioned that instead of the four or five, he sees six or seven. I'm going to bump that up and I think we'll actually do nine or 10 signings this year. We've announced four. There's a couple more that haven't signed, unannounced, there's a couple that I believe are under contract, and I'm going to throw in a couple because there's plenty of time left in the year.

All right. So let's sum up the overall performance. Loyalty killed it, Epsilon and Private Label Services tracked to plan, and Private Label Credit dragged. End result was a 14% organic earnings growth. No reason for this to slow down. So Q3 is our last quarter of headwinds and after Q3, we will let the dogs loose.

So, let's turn and hit the balance sheet. All right. Just a couple of items of interest. First you'll see an enormous increase in our deferred revenues in cash and our trust account relating to our Canadian business. Specifically, strong growth plus a large cash payment from Bank of Montreal, following our expanded deal with them resulted in both deferred revenues and cash in the trust account, increasing about $370 million respectively. To remind folks, this essentially represents revenues earned, cash received, but not yet recognized in the P&L, due to a requirement that we defer it and bring it in over a period of years. Needless to say, with $1.2 billion in revenues sitting there waiting to flow in, we feel rather comfortable about the outlook in Canada.

Second, you'll note that our net core debt increased by $235 million and now totals $922 million. This increase, plus free cash flow, enabled the company to spend about $450 million and repurchase over 7.7 million shares. We believe this was an excellent use of our cash and cash flow and increased our leverage ratio to a still very modest 1.3 times. At the same time, quite frankly, it allowed us to I believe help cycle out or help hasten the process where those folks who are playing the Blackstone deal got an opportunity to to trade out and we brought in some folks who hopefully are long-term holders in our stock.

As a quick aside, due to the timing of the purchases, the buyback had no meaningful benefit to Q2. At this point I also want to note, again, trying to anticipate a question, that if you recall about six months ago at the beginning of the year, there was a lot of concern about the liquidity meltdown and how we won't be able to refinance. And lo and behold, we got everything done and ended up saving ourselves $35 million or $40 million in the process. The same is true today. There's been concerns I guess out there about whether we can go tap the corporate market and lever up. It's the same thing. For good quality companies with a strong track record, double-digit organic growth, strong free cash flow, there are no issues whatsoever that we would be facing. So I wanted to knock that one down.

Looking at the big picture, we've taken the last year to divest non core businesses, which when combined were declining in size and were a drain on cash flow. Again, I think there was a disconnect out there, people were looking at the fact that hey, this was about $300 million in revs you were talking about. I think what a lot of folks missed is the fact that a lot of revs, no money. These were in total a declining group of businesses, with very little EBITDA and actual negative cash flow. So by divesting them and finding them a good home, which we think we have, it increases our cash flow plus we receive the proceeds. So overall, we're very pleased with these transactions. By eliminating the drain, adding in proceeds from the sale, and the stabilization of CapEx from 5% of revs down to a run rate of 3%, have all contributed to a significant increase in our free cash flow generated by the company. As mentioned, we've thus far used just a bit of it to take advantage of a very poor equity market and invest in our own stock while still maintaining very low leverage.

All right. At this juncture, this covers the entirety of what we can cover regarding our capital use and capital structure and I do want to say any further questions about those two areas will be answered with a firm no comment at this time.

Let's move on to guidance. Always the fun part. We are not unaware of where the Street thinks we should be and we certainly try to be as accurate as possible when providing guidance. To that end, we came in $0.01 ahead of the Street in Q1 and I think it was $0.04 ahead this quarter. So we're running a bit ahead of expectations for the year. More importantly, however, is that our most challenging quarter, that is Q1, is behind us and our story of accelerating earnings has been borne out in Q2. We expect this trend to continue with earnings moving up from $1 in Q1, $1.04 in Q2, $1.15 in Q3 and north of that for Q4. Not only will that demonstrate the sustainability of the model in a difficult macro environment, but it will put us in great shape for strong jump-off in '09. Note again, it's entirely organic. You'll note from the slide that the headwinds that existed going into Q1 are dropping away and that by Q4 the machine should be cooking with the anniversaries of Lane Bryant and our higher but stable loss rates, better funding costs, the continued ramp-up of Private Label clients, and strong quarters for Epsilon and Loyalty. Add those trends to the benefits to our recent buyback activities, and we feel pretty good about the year. For the moment, the company is expecting to deliver Q3 cash EPS of $1.15 and this does include potentially trading off some upside in return for locking in some longer term fixed rate financing that would increase visibility on a go-forward. Some of you may recall, those of you who have been with us for many years, we did this quite a few years ago and the results were borne out in subsequent overperformance.

So the bottom line is, look, we're running a little bit ahead on the year. We popped up guidance by $0.05. We would like to keep Q3 at $1.15 because we do want to lock in some long-term funding and enhanced visibility for '09 to 2010 to 2011, so that's why we would strongly suggest maintaining $1.15, go ahead and raise by $0.05 and we'll see where we wind up in Q3. But for now, I think those are good numbers. Keep revenue and EBITDA as they were before and essentially what we're getting is we're getting a much nicer lift below the line, due to the strong generation of free cash flow. We've done some small securitizations that moves interest expense from below and above, et cetera, et cetera, but at the end of the day, margins are improving, leverage is increasing and that's what's driving higher growth rates on earnings per share.

All right. We're getting there, folks. Couple more slides. 2008 estimated free cash flow, nothing too newsy there. Adjusted EBITDA, Loyalty adjustment, again, that's a cash flow that's earned but not recognized. It's deferred. Our operating cash flow or operating EBITDA should still come in a little north of $730 million. CapEx, interest and taxes, we didn't change, around $330 million. So our free cash flow roughly is around $400 million. Call it $5 a share or a 10% yield, traditionally we traded around $5 or $6. Throw in the asset sales per share and we're at about $660 million in terms of free cash flow generated or a 12 or 13% yield.

All right. Let's hit the questions. I will guarantee you I will save everyone a lot of time by hitting this first one. I'll still get 13 straight questions about it, but I'm going to try anyhow. Delinquencies and loss trends. What if, what if, what if. Our original guidance, which I think was back in October, I mean, it was a while ago, we thought delinquencies would pop to about 5.5% and losses would be about 6.5%. Since I know everyone out there seems to pull the master trust data out every single month, and have it ready to go by 8 o'clock in the morning, we figured we would use those numbers and say hey, how we doing. As we said, the delinquencies did in fact pop up in Q3 of '07, essentially August of last year, and that quarter came in at about a 5.2%. Q4, 5.3. We go into Q1 of this year, 5.3. We go to Q2 of this year, 5.0. So from a delinquency perspective and again, that's what gives you the comfort 180 days from now on what your losses will be, we are actually running a little bit better than we had thought. And notice how stable they are.

Next, let's see how that translates into losses. It takes about two quarters, once delinquencies begin, to actually flow out through losses and again, our guidance was around 6.5%. Lo and behold, Q1 was a 6.4, Q2 was a 6.2 -- again, Q2 being a little bit better than Q1, which seems to go against everything people read about in the papers and it's also running slightly better than guidance. Given that we know where delinquencies are at the end of Q2, we know where losses are going to be the rest of the year, we know what the jump-off is going to be for 2009. We are seeing no evidence whatsoever in the early stage delinquencies that there's another leg coming on this thing.

So I don't know how many different ways we can answer the same question of but, but, but. The fact of the matter is we did get hit with higher losses, but they went up, they stayed up and they've been extremely stable and flat all the way through and we're seeing no evidence at all that there's another leg up here. We have, as I said now, 12 months of data to support exactly what we've been saying. I don't know what else to say at this point. The fact of the matter is, we've got 11 million high quality households that are out there and, again, we are writing off at an elevated level but a very stable level.

So, let's put it in perspective. Given we know where we are in the year and where delinquencies are, 2008 is done. We do not see any incremental hit to 2009. But, since I know we will get the question, what if, what if, what if, here is the answer. If we take another 50 basis point hit on our losses, our losses would be up to 7%. Is that meaningful to us? And for people who are interested in the financial services industry, oh my gosh, it's a big issue. With us, you need to put it in perspective. Even if losses pop up to 7% in 2009, it's $20 million of EBITDA or $0.15 a share, both of which suggest it's less than 3% of our earnings or our cash flow. Like to think we could play to that. So I think the issue here or really what we're trying to say is things have been stable now for now a year. We're seeing no evidence of an additional hit coming in 2009. The rest of '08's in good shape and even though we don't see it, if we were to stress test it, you're talking about less than 3% of our earnings. So that is the first of the top five questions.

The next stage, the second one is capital structure, a lot of questions about that. We've spoken at length about our low leverage and our high free cash flow and we announced the resumption of the $500 million buyback plan. We've announced today that we purchased $450 million so far. And as I mentioned, other than those public comments, we cannot comment further at this time.

This question number three, I promise you will be a bit painful to get through, but in the end, you will all be experts on the potential impact from the new FAS 140 and FIN 46 rules. Believe me, it's as exciting for me as it is for you. So let's bottom line this thing first. Very simply, we do not see any real impact to us, even if it is implemented.

Now, a bit more detail. We've looked at the four areas that could be affected by the potential change in accounting rules which would essentially require us to report as if our off balance sheet items such as our securitizations were brought back on balance sheet. What's that mean? Let's zip through them.

One, financing. We've spoken with the top players in the asset backed market and they all said the same thing, no impact. Essentially, this is accounting only and as such, issuers will still be able to set up trust vehicles and issue bonds out of them. No change, period.

Corporate leverage, meaning hey, does this stuff count against your leverage ratio? Again, we've spoke to all our major banks and we would be able to carve out these asset backed debts from our covenants and leverage ratio. So again, zero impact to us.

The next one is interesting. Regulatory. That's where you hear the stories of Fannie and Freddie and all the major banks needing to come up with hundreds of billions of dollars of new capital to support this new on balance sheet view. Our view quite simply is it ain't going to happen. Certain regulatory officials have already said that this is an accounting issue only, not a regulatory issue. Since risk hasn't changed, why should capital requirements change? Also, in this environment, to expect the big guys to find tens of billions of dollars in new capital just isn't realistic. Our best intelligence would suggest that it would be carved out or assigned 0% weighting for regulatory purposes. By the way, just to be super safe, our current capital levels are at three times plus the levels required per well capitalized bank, so it wouldn't hit us anyway.

And finally, accounting, yes, this would essentially balloon your balance sheet on your asset and liability side and move us from the IO strips to setting up reserves. It is very unclear whether this is a plus or a negative upfront for us since we are cash basis today. So any reserves to set up could have more or less an offset since we would also set up accrued revenues for interest and late fees. In any event, there's no change to cash flow, no change to financing, we don't believe any change to reg, and so it's neutral to us overall.

All right. Hopefully that was fun. So I'll add one more thing on top. We've also got some questions from folks about potential changes by the Federal Reserve or things going on in Congress. They want to change the grace period, double cycle billing and 9 million other things. Again, we've looked at everything, and for example the one that did catch our attention was grace period, 14 days our standard now. The proposal is to go to 21 days. Good news for us, we're already at 25. So again, we don't believe there are any issues out there that could impact us negatively. All right.

Question number four. Macro impact on Loyalty and Epsilon. Are we seeing any impact from the struggling economy on Loyalty and Epsilon? The short answer is no.

And then for the last question, since I have absolutely nothing productive to say about it, I will turn it over to Mike and he can finish up.

Thanks, Ed. Take a rest, man. Blackstone litigation. Well, we recognize this is something of interest to many, but frankly there's really nothing we can add to what everybody doesn't already know. That is that Blackstone is not lived up to its obligations under its agreements with us. We have had to sue them as a result. That's where we are today. Be assured that we are confident in the merit of our claims 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 on to the last slide, our favorite chart, the bar chart. Certainly this is representative of our historical for many of you that have known us, compared to the S&P since 2001 when we went public, it's certainly a lot prettier given the S&P's about flat to maybe even below where we were in June of '01. We have clearly been a better investment, [20] plus compounded growth, good times and challenging ones, and it's all in the model and the execution of our team. We intend to continue to do that. Operator, we will now take questions.

Certainly, sir. (OPERATOR INSTRUCTIONS) We'll pause for just a moment to compile the Q&A roster. (OPERATOR INSTRUCTIONS) Our first question comes from James Kissane from Banc of America Securities. Please go ahead.

Hey, Mike and Ed, great job.

Thanks, Jim.

Hey, Jim.

Hey, Ed. Can you tell me about the competitive environment a little bit and the Private Label business? Have the two big guys in the Private Label market stepped back at all?

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

So the nine to ten that you were talking about includes three to four outside your sandbox? Is that right?

It could come from within or out, Jim, and obviously you can tell, based on the guidance there who is the one that tends to like to underdeliver versus overpromise, so I don't think we're overpromising. We've got a strong pipeline. The key here, this is -- I'd like you to focus a little bit more also on the history. I've been in this business for 20 plus 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's no tomorrow and in not so good times they pull way back. You can go back and look at the 2001 to 2002 timeframe. Look at the number of signings we had in those years. We're reliving what was going on then. You'll see us have a strong year and we're going to stay in line with what we do in terms of our lending criteria. One of the questions that I got the other day, well, why are the banks and the AmExes and others having higher delinquencies and write-offs than you? Our growth in that area, so-to-speak, is 50 to 60% compared to theirs. And it's strictly because we've got a very disciplined approach and we don't grow by mass mailing and balance transfers and we're very disciplined. So all in all, we're going to have a good year on the Private Label side and we'll continue to see that I think into 2009 and beyond, based on the outlook of some of the banks.

Ed, can you provide a little more color on the funding environment? You talked about locking in longer term funding at higher costs. Maybe put some numbers around that?

Sure. And first, I am going to go back to my nine or 10 for the year, Jim. I of course can take the low end on that one. On the funding side, you bet. Again, there's all this concern out there about the liquidity in the markets and can you access them, 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, saved a bunch of money. But 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're probably talking 150 to 200 basis points incremental cost, if you were going to fund all the way through the BBBs. Now, let's trim that down a little and say maybe we don't fund all the way through the BBBs which are about 10% of any issue. You're still probably going to be 100 basis points or so above where we're funding today. So that's sort of the trade-off we're 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've already locked down, just to make sure things are in real good shape for '09? Or do we let it drift a little and hopefully the spreads will come in a bit? You know us. I think we're going to have a little bit of room here, so my guess is we're probably going to go out and tap the markets.

And then that would give you till when? Late '09? Because I think you were talking earlier about first part of '09. So this would theoretically take you to late '09?

You bet.

Last question. You talked about the pipeline and Epsilon being at record levels. I know you signed some new business with existing customers. What's been your success in converting the rest of the pipeline, especially with new clients?

The problem problem we run into, it's 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 -- we're pushing on three or four, three or four new clients that I believe are going to let us at least do an 8-K and maybe a press release. So all we can say is we're signing -- we signed a whole bunch of new folks and they are not small.

Okay. Excellent. Thank you.

Our next question comes from Andrew Jeffrey from SunTrust. Please go ahead.

Thanks. Hi, guys.

Hi.

You are obviously outperforming pretty something significantly in AIR MILES and there's a currency component there as well, obviously just good sort of 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, if any, of the BMO transaction?

Yes to the first, probably not to the second. But on the first one, again, even if you factor out the FX bennie, you're still talking mid-20s organic top line growth and over 50% EBITDA growth. Look, you've known us long enough. We've 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% to 13% and somewhere between 15% and 18% organic growth on EBITDA. And that is essentially our five-year model and that's going -- you're going to continue to get double-digit growth in miles issued, plus you're 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. And then on the expense side, we are so big up there that we can trade off the different vendors and we're getting a very good 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 you just found all 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're very comfortable with those organic growth rates.

Okay. And --

On the BMO stuff, look, we can't -- I think we said it all in the press release and the Q&A, is that obviously they're 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, and that's about all.

Okay. Fair enough. On the credit quality, the chargeoffs, Ed, are you talking about chargeoffs on the whole [manage receivables] portfolio or is that just the master trust data you were quoting in the prepared remarks?

The stability is basically the same. Since everyone seems to watch the master trust, as you know, every month we want to make sure everyone's on the same page on the master trust. So the master trust is the stuff, and since that does encompass probably 85% or whatever of the portfolio, that's 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 that can either have 0% loss rates at the beginning or 10% loss rates when they hit their peak at 18 to 24 months. But on average you're going to see the difference between master trust and total losses to be anywhere between 30 and 50 basis points, depending on where they are in the ramp-up cycle.

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

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.

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

I would say about -- yes, that's probably a good number, related to the buyback we just completed, yes.

Okay. Thanks a lot.

Thanks, Andrew.

And our next question comes from Dan Perlin from Wachovia. Please go ahead, sir.

Thanks, guys. The -- I want to go back to the funding question that Jim talked about. It looks like if I'm doing the numbers right, on $1 billion you're going to give up about $10 million of EBITDA, about $0.12 to $0.13 in earnings for the year. Is that about right? To me that looks like what the buyback would cover.

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

Right.

But that would be the math, right.

So just so I'm clear, you're thinking about it in the context of giving up $10 million of EBITDA, and the buyback basically was in a lot of ways was opportunistic but it's also designed to kind of cover that, if we will, right?

If you want to look at it that way, that's fine. I mean, what we're basically saying is we flowed through some overperformance thus far this year and during whatever we're in -- a recession -- and we feel very good about the rest of the year. And to the extent we have upside, we will 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 that there may not be some additional room in there as well and we wouldn't be using that.

Got it.

Got it?

Yes. And then is that -- so that incremental $10 million of EBITDA, is that why when we look at the guidance it's no longer greater than $700 million on adjusted EBITDA, it's just $700 million?

I don't think anything was done on purpose there. I think it's just --

Okay.

Greater than, equal to, whatever you want.

Okay.

I will tell you that we have securitized -- over the past quarter, we've moved $150 million, you'll see on our on-balance sheet, we moved it to some off-balance sheet. And what that does is that takes the interest expense from below the line and nets it into EBITDA. So at a lower EBITDA -- but you'll have the improvement below the line.

Got it. And is this security that you're looking at doing, is that going to be public or private, do you think?

Don't know yet. Public looks okay right now. It's really a question, look, we can walk out tomorrow, we file the shelf, we can blow out AAAs and As without a problem. But BBBs are kind of expensive. So do we want to keep them? Do we want to push them out? Those are some of the things that we need to think about during the quarter. But we just don't want people running away on raising numbers in Q3 when we're also looking at really hammering down visibility on 2009. Q4's a different story.

Got it. And are there any other restrictive covenants on buying back stock either in this funding or in your existing?

Those -- if they were, they have been removed.

They've been removed, right. It's over $300 million. Just lastly, is there -- this is more just a -- I guess a nitpicky question for myself. Why not be able to comment on your capital structure? Is there a legal issue going on with Blackstone or something or are you choosing not to?

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

Fair enough. Thank you, guys.

Our next question comes from David Scharf from JMP Securities. Please go ahead.

Good afternoon. I wanted to make sure I heard correctly on the margin explanation within Private Label Credit. After you correct for Lane Bryant and some of the interest cost that's below the line, are you essentially saying that some of the increased investment in effectively call center staff, both customer support and collections, sort of historically have you understated margins in Private Label service and overstated Private Label Credit?

Yes, if you went back to last year, and you looked at -- I'm sure it's in the transcript. We said, look, we're ramping up call center and especially collections on the back office side and that's about $4 million or $5 million a quarter, but because as you know, this is a charge that is made from services over to credit. We only set that charge once a year. And so therefore, last year it had to eat it. This year, we got fair market value for it. And essentially that's 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 margins in Private Label Credit and hopefully that answers your question.

Okay. So going forward, I mean, obviously when we think about margins in that business or 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 hit. 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?

No, we bulked up really starting Q2 and into Q3 and quite honestly, we started seeing the early stage delinquencies beginning to start tick up. As you know by Q4 -- I'm sorry, by August of last year, that's when our delinquencies hopped up from about 4.6% to 5.2% and I think we were a little bit ahead of the game which was good. No, we're not putting any more -- there's nothing more to beef up. We're at full staff, full capacity. And I would say when you normalize for that, you adjust for Lane Bryant, you adjust for the funding -- you're 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's because we are seeing a bit of a hit on late fees. Nothing huge, but a few million here, a few million there and people seem to actually be paying attention even if they're rolling their balances to making sure they're paying more on time, and maybe it's 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. But I would say that's probably a real and maybe a permanent change.

When you look at kinds kind of the year-over-year growth in statements, pulling Lane Bryant out, I mean it was essentially flat, so when we set aside actual plans balances and managed receivables and what people are spending. But if 20 of the 90 programs signed up in the last three years are still ramping up presumably, why isn't statement growth picking up a little more? I mean, are you starting to see more inactive accounts lately?

Boy, that's a great question. I would say that you've got a portfolio that's grown probably 6% or 7% but really, as you say, no growth in statements. So what you're seeing is balances are kind of growing a little bit more than inflation. Up around 6% or 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 '05, '06, '07 vintages that are in fact ramping up. I know for a fact they're showing very nice growth and positive growth, but it's just barely offsetting the negatives. That would be my guess.

Okay. Last question on Private Label. Obviously, there's quite a bit of news flow on G Capital's unsuccessful efforts thus far 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 rumbling that perhaps they would try to entertain bids for one-off brands?

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

Got you. Okay. Thanks a lot, guys.

Appreciate it.

Our next question comes from Robert Dodd from Morgan Keegan. Please go ahead.

Hi, guys. Just going back to Epsilon, if we can can. I know you say choppy quarter-to-quarter, but up 5%. I mean, can you you give us an idea what proportion of revenue or profitability, whichever way you want to chop it, comes from interquarter or intraquarter project work versus the curve in contributions?

I am only going to hazard a guess and it's probably not going to be a very good answer, but I'll throw it out there anyhow. It's actually I think what you'll 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're going to have relatively flat numbers, dollar numbers, in Q1 and in Q2 from both a revenue and EBITDA perspective and last year -- and I would have to go back to what happened last year -- you actually had a pretty nice blip up in Q2 revs and EBITDA was up probably about 10% from Q1. That's a little bit uncommon. What you have is like I said, a pretty flat Q1 to Q2 and then that $25 million ish will flow into Q3 to Q4 and then you pop on another $20 million in Q3 and Q4 and that's traditionally how Epsilon flows out.

So then we can conclude from that that Q2 last year had some project stuff or short-term contracts in it?

Well, a lot of times it's going to be timing. When we particularly start up new major database builds that might take us anywhere from six 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 the last month of the first quarter or did it trip over into the second quarter of last year makes a big difference in terms of did last year's second quarter jump up for some reason. It wouldn't necessarily mean that it was a kind of, quote, discretionary project of a 30 or 60 or 90 day kind of nature. Most of our business' revenues are 80% to 85% long-term stable multi-year kind of things. So I don't think I would put it in project work. I think it would be more around timing of turning on new customers.

Look, if you were to just do the math, because the numbers just aren't big enough. So 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. And on the top line, you know, you're jumping from [17 to 6]. If it were instead of [6], 10% growth or double-digit, you're talking $4 million between quarters. They're just not big enough numbers, since we don't really manage by quarter. We manage on an annual basis.

Thank you.

You bet.

Our next question is from Bob Napoli from Piper Jaffray. Please go ahead, sir.

Thank you. Good afternoon, and nice job. Question on the Loyalty program. Maybe I should understand this. Revenue is 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's exactly the right way to look at it. I was trying to put together the revenue growth metrics and trying to get a sustainability relating that to the miles issued. I was hoping you could help me with that.

Yes. I would say let's talk about revenue. Let's talk about three pieces to the puzzle. The first piece would be -- actually four pieces to the puzzle. The first piece would be miles issued. That's where you start with double-digit growth. Then you make the leap that our pricing in Canada is quite firm, perhaps some CPI inflaters floating around. And that ought to give you a nice base rate. And then over the past few years, we're no longer talking about signing up these monster Fortune 50 companies. We're talking about signing up Tier 2 and Tier 3 players who may have a very strong presence in just one province of Canada or another. Clearly, when their volume is 0.05 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're looking for to solve your puzzle. And then I think if you back out FX, you'll see sort of a 20% type organic growth. Frankly, I think that's a little bit high long-term. We'll take it, of course. But that's how you'll get there.

So as I'm looking at, backing out FX and looking at revenue per mile issued, do you still expect that to kind of -- you would expect that to continue to grow slightly from here, because you've had nice growth in that year -- very strong growth in that year-over-year, some of that due to FX.

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's close enough. In Q3 to Q4, you're about flat -- last year to where you are this year. But I don't see any reason why you shouldn't see a two as the first digit.

Okay. So that's -- you said sequentially in the third and fourth quarter you should be about where you are here on revenue per mile issued?

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

Right. Okay. And you put out a press release a couple days ago about expanding that Loyalty program and changing the branding of it and moving into other countries. I was wondering if you could give a little bit of color on what the plans are there.

Let's be clear. We're not rebranding the AIR MILES Reward Program. It's a great brand. That's a great coalition in Canada. However, there's a strong team in Canada that as we talked about before across the company, we're starting to dip our toe in the water in UK, China and others. And we've been slowly deepening the team in Canada to be able to leverage their expertise, particularly in the high frequency retail area, gas, grocery, pharmacy, et cetera. And we are now looking outside of Canada for all the way from consulting and Loyalty programs, data, use of data to enhance those programs, as well as even store operations and merchandising. There's just a great deal of opportunity here as the -- those high frequency retailers are looking for ways to leverage the data. They've 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 US but also more targeted at the BRICK countries to begin to put a second toe in the water. This is clearly a long-term growth strategy, nothing that we expect to have any immediate significant impact this year or next. It's a natural extension of a pretty unique team and model that we've built there.

Last question, I know on the credit side, just to follow up on that, I hope you're right, I hope you guys are right, that you're right, Ed, that your credit losses have peaked. I would think that would be admirable if you're able to do that given the rise in jobless claims. We'll see where they go from here. Seasonally, wouldn't you expect your delinquencies to pick up? I know they've 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?

All I can tell us is seasonally for sure, which is why Q2 delinquencies were below Q1. That seasonally is our lowest. When you're talking about picking up, I'm talking about like a 5.3%.

Okay.

So I think we're going to be comfortably at 5.5% or less for the entire year. We're just -- look, we're just telling what you the data says and the data is on 11 million active households every single month and we've been tracking it since 1996. So -- or actually when did we start? '85? Long time. And you know, 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. So our guess, and I think it's a pretty good educated guess, based on the data, is that we will -- we are absolutely not saying that things are improving from a macro perspective on our customer base. But we're certainly saying that they're not getting worse. I mean, you're seeing a strip of folks write off every single month that's higher than what they usually have been in our portfolio. It's just not getting any worse and maybe it's because if you go into one of our stores and 10 people apply for something, two or three 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's one of the reasons I think David asked earlier about statements and applications. We're naturally resetting our applications lower and it's just automatic across all our clients because we're keeping the same type of bureau score.

Remember, also, the low balance nature of our business. This is a transaction business where people tend to pay off in six to seven months, unlike the bank card guys that are carrying $3,000 and $4,000 balances that take years to pay off. So those short-term swings in employment affect them much more than us since people have paid off.

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

Great. Thank you very much.

You bet.

Our next question comes from Reggie Smith from JPMorgan. Please go ahead, sir.

Hey, guys, nice quarter.

Hey, Reggie.

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

Certainly didn't say $25 million. But yes, I mean, traditionally, we are looking at Epsilon that does -- I would expect around $135 million 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.

Okay. So you're saying $20 million in revenue.

No, I'm talking EBITDA. In other words, it's running -- if Epi is running around $25 million, $23 million to $25 million in each of the first two quarters, we would expect to see something right around [the $40 millions] in terms of EBITDA for Q3 and Q4. It's quite a ramp-up. And then on revenue, you're going to see essentially $20 million as well. I mean, the margin on this as you can tell, almost 100%.

Okay.

This is all -- this is essentially what you've been -- you've been in the weight room all year and now you're getting ready to hit the field, so it's essentially all the work's been done and it's -- the marginal cost on these things is above zero. That's the analogy I could come up with on the moment.

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

Don't forget, a nice part of Epsilon is our Abacus business. Our co-op of catalogers which is heavily backend weighted where we manage the database all year long, but the actual big mailings of all the catalogs start to hit fall and end of year. So it's not just necessarily bringing on, quote, new customers and expanding relationships that push the back half of the year. It's just the natural course of the business.

I mean, just think of, you spend -- if you want to look at it as simply as Epsilon does its $20 million to $23 million a quarter of EBITDA, $115 million a quarter of EBITDA straight through the year, that's for everything to do with designing, and implementing and maintaining and enhancing and ramping up and all that other stuff. And then it's game time, starting -- well, actually right now. We're beginning to see it crank up as we get moving into back to school and into Halloween, turkey day and the holidays. As Mike said, massive, massive spending on the catalog drops as well as billions and billions of the permission based e-mail. We're going to get to you some way or another, Reggie, even if it's through your permission based e-mail with Barnes & Noble -- or probably not the Citibank Thank You Network but the Hilton Honors or something like that -- either permission based e-mail, direct mail, something in your statement, that's where we make our margin.

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

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 to -- so you get some sense of balances there.

I would say call it $1 billion.

$1 billion is kind of new?

Yeah. Think of it this way -- if our average portfolio is around $50 million and we signed 20 or so new folks, it's around $1 billion that's rolling through each vintage, each year. I'm sorry, not each year, but the three year vintages cumulative is about $1 billion, 20 clients at $50 million each. Once year four hits, they're fully mature. They get moved off into the master trust and then we have the newer vintages as well. I think that's our best -- I've never really thought about it, but that sounds about right. That means if those guys are ramping up and growing 15% or 20%, and the rest of the file is experiencing negative comps, that's where you're going to come out with excluding Lane Bryant single digit -- mid-to low single digit growth right now.

Okay. Then I guess two housekeeping questions. IO gain for the quarter and if I could get the managed loss rates, total loss rate, within the credit segment, please?

Reggie, I would love to give that to you. The IO this quarter was $6 million, last year it was $14 million. And the managed loss rate is 6.68% versus the master trust, which was, what, a 6.2%, something like that.

Close enough.

Close enough.

Okay. Good stuff. Thanks, guys.

Yes. So whether it's the full loss rate or the master trust rate, you're both running about 20 basis points better than first quarter.

Thanks, Reggie.

Our next question comes from Colin Gillis from Canaccord. Please go ahead.

Hey, guys.

Hey, Colin.

Could you give us a sense -- given you have a strong appetite for portfolios, what's the largest portfolio that you think you could swallow in this environment?

$20 billion would be large.

$20 billion. There's one on the market I think for $30 billion.

$30 billion.

We'd only want to do about half of that, I think.

No, I think -- look, we -- as we talked about, if you look at -- we have a $4 billion file today. We have 90 clients. That's 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're comfortable with anything between $50 million, probably up to around $300 million or $400 million. Then we would just immediately securitize it and call it a day. I don't think there's a big appetite here for going after some monster portfolio, even though there's a little blood on the Street right now. It's just we don't want to put -- it's not with our risk profile and quite frankly, we've been getting pounded on for seven years to get the credit segment to be more reasonable, so we're -- I think those are good numbers.

Okay. Got it. Just, 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 receivables on balance sheet or was it right where you expected it to be? I'm looking for the trends for the on balance sheet receivables.

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 its was 50 bips in the first quarter, it will be 50 bips this quarter. It's about a 6.7% versus a 6.2% in the master trust.

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

You bet.

Great. Hey, great quarter, guys.

Thank you.

Our next question comes from Mark Bacurin from Robert W. Baird. Please go ahead.

I know we're running long here. I just wanted to clarify. Ed, I think you're talking about double-digit growth within the Epsilon business. I think Q1 of that 17%, there was still some acquired growth coming out of Abacus. By my math, it was also a mid single digit organic growth number. What I'm trying to delve into, are all these contracts you're seeing in the pipeline from these customers that won't let you give names? What is giving you comfort to let you get back into a double-digit growth rate in the back half of the year?

I would caution you a little bit on the Abacus thing. We did buy that as of Feb 1. So you're really only talking about January. As you know, being a marketing person, Abacus doesn't really do squat in the first part of the year. So I would have to go back and cut the numbers, but I think we probably would be still in the double digits on top line. Certainly maybe not as high as 17%. And that's why I think if it's 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. But in all honesty, what we're trying not to do is do a whole bunch of low margin things like direct mail, targeted mail, things like that, that just -- they're 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 of top line, low margin growth to get longer term juicy margin growth within Epsilon, we're going to do it. And 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 out from that, that's fine. Is it 9%? Is it 12%? I can't really tell you right now. But we're definitely hooked on the margin expansion, cash flow growth, and sort of mid-teens EBITDA growth.

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

You bet.

On the $2.6 million of I guess the other non-recurring charges that showed up in the Epsilon segment, sounds like maybe that was headcount pruning. Wonder if you could give us a little more clarity about what that add-back was on the kind of non recurring side.

You bet. It sort of all goes back to the consolidation process, again, going back -- I'm trying to think. Not a year ago. Two years ago, three years ago, when we were doing a number of acquisitions to fill out Epsilon's capabilities so that they have everything from creative to 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.

Okay, and then just finally, I guess as that relates to Loyalty One, it sounds like a lot of the capabilities you're trying to leverage out of Canada, whether it be some of the creative analytic work or whatever, also overlaps with some of the work that you do at Epsilon. I'm trying to understand, number one, what the go to market strategy will be between the capabilities at Epsilon versus what's within Loyalty One, and secondarily, want to make sure I understand the Loyalty One -- you're not trying to build an AIR MILES-like program in the US that would necessarily maybe compete with the Citi Thank You Network. Sounds like you're going after selective Loyalty-based services inside the U.S.

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 analytics, using data to create insight is what we do throughout the company, whether that's in Private Label or Epsilon or our AIR MILES team. However, we each have in each of those lines of business, some unique customer focuses and sets. In the AIR MILES business, it's around grocery, gas, kind of pharmacy retailing. Deep data analytic kind of capabilities that hasn't been the expertise of our Epsilon team. So that's really what we're leveraging. Two, we're leveraging the potential, not only in the US but around the world, to look at potentially putting together coalition kind 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're not rolling out a nationwide U.S. coalition program. That's 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 in that in expanding -- that could certainly be a potential or other of our clients at B of A and others. I don't see a conflict there at all.

Great. Thank you.

You bet.

Our final question comes from Roger Smith from Foxx-Pitt. Please go ahead.

Hi, Roger.

Just getting back to the FAS 140, on the regulatory side you said that you just don't think that the regulators will impose these capital requirements. Can you give us any more reason around why that other than it does just seem onerous? If it did come on balance sheet, would not the retained interest equal the capital that you would need to have, or how much would we really think about the -- in terms of a capital requirement there?

Both great questions. Unfortunately, nothing's been issued.

Right. That's true. That's true.

It's kind of hard to do more than our best guess at this point. But we don't know really what's going to come out in the issue, but if you go at the logic that reasonable people do reasonable things, the fact that I've heard quotes anywhere between $5 trillion and $15 trillion of off balance sheet assets coming back on at a 10% weighting, that's $0.5 trillion to $1.5 trillion of new capital. You're talking with the Big Boys $100 billion of brand-new capital, and they're barely at 10% right now and having big write-offs. So look, I may be way out of my expertise here, but that I would find hard to believe.

But the two data points that we can give you or reference points are actually pretty good. One is we've actually spoken with our regulators and they didn't seem too, too bothered by it and were focusing more on hey, look, it doesn't change the risk profile of the company at all and that's sort of your first guess as to what that means. And 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 of I can't imagine looking for $1.5 trillion in new capital for the big boys. From our perspective, our Tier 1 is at 35% or something like that. Even if we took it on, there's no incremental capital hit to us. We'd still be 10% or above. It's relatively moot to us. I would be more concerned with the big boys that are out there.

How much do the late fees impact the portfolio yield or really I'm trying to get at is if they do continue to slow, what kind of impact to growth could we even see here?

Well, look, I mean, if you have a $29 or $25 late fee on a balance of $350, that's 7 percentage points of yield and let's say people do that a couple times a year -- two, three, four times a year, -- you could be talking about 1 point or so of yield on the portfolio if it continues to slow. And I think the good news sort of behind it is that we're pretty sure that these are folks who were right on the bubble before the recession or whatever we're in and they're 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, have now either gone bankrupt or have charged off and that means what's left is a little better pool.

Okay. 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. That's -- we shouldn't be assuming that it could become that big of a hit.

No, you asked me if it continues to deteriorate what could happen.

Okay. Fair enough. Got you.

Yes, I think, look, if I -- if we're reading the trends correctly, in Q4 we anniversary Lane Bryant and we anniversary our lower loss rates. We will have a funding advantage at that point. The portfolio is growing excluding Lane Bryant around 6% or 7%. So fourth quarter you should see some pretty nice positive organic growth in Private Label and whether it's six clients signed as Mike said or nine or ten, you're going to have a heck of a jump off for next year. You're probably talking somewhere in the order of the high single digits just to jump off. So that's why I don't think we're getting too bent.

Great. No, that's what I want to hear.

All right. Thank you, much.

Thank you everyone.

We'll wrap up here for those that may still be 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 -- 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's business as usual. Thanks, everybody. Talk to you next quarter.

Thank you, everyone. This does conclude today's conference call. You may disconnect your lines at this time and please have a wonderful day.