Bread Financial Holdings Inc (BFH) 2009 Q1 法說會逐字稿

Good afternoon. Welcome to the Alliance Data first quarter 2009 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 the 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 of Financial Dynamics. Ma'am, the floor is yours.

Thank you, operator. By now you should have received a copy of the Company's first quarter 2009 earnings release. If you haven't, please call Financial Dynamics at (212)850-5721. On the call today, we have Ed Heffernan, President and Chief Executive Officer of Alliance Data, and Bryan Kennedy, President of Epsilon.

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, our speakers will reference certain non-GAAP financial measures, which we believe will provide useful information for investors. A reconciliation of those measures to GAAP will be posted on the Investor Relations website at www.alliancedata.com.

With that, I would like to turn the call over to Ed Heffernan. Ed.

Thanks Julie. Hopefully, you all have your slides up and available. We will start with the agenda. As always we will go through the quarter results at a high level, then we will drop down into the segments, and finish up with guidance. Also we are mixing things up a little bit here, in the sense we have invited as our guest today, the President of Epsilon, Bryan Kennedy, who is here by popular demand. And we will most likely rotate the business unit heads on each subsequent call. So next call would either be Private Label or Canada, and then vice versa on the third quarter call.

Being the case today, we thought we would hit Epsilon in some detail, and Bryan can give you a very good view of where things stand, and where things are heading. Why don't we first go to first quarter consolidated results, and as we had mentioned on our last call, we are going to be spending a fair amount of time until Q4, chatting about our results, both reported and also in constant currency, because we do have such a gap between where the US dollar and the Canadian dollar are today versus a year ago. That of course, will disappear in Q4.

The first quarter essentially I think boiled down to the following five bullet points. First, guidance was exceeded by $0.09 as we posted $1.19 versus guidance of $1.10, to make it real easy to get there, just take our EBITDA which excludes the noncash stock comp. It is about 152 million. Take out depreciation, which we use as a proxy for the cash spent on CapEx. That would be about 15 million. Our cash interest was about 20 million. Toss on a tax rate of about 37%. Divide by about 62 million shares, and you should get $1.19. And this is a pretty good calculation of our cash flow, which has always been our preferred metric, since it is always apples to apples, and cash will always remain king. The final adjustment we do make would be our Canadian adjustments, and we will discuss that in just a bit.

Second from a cash EPS perspective Q1 was our best first quarter in our history with cash earnings per share up around 20% on a reported basis, and up close to 30% of a constant currency basis. Third, since I had a number of questions on this, let's talk about the quality of earnings. And I think you will find it to be quite high. Specifically, today's results do in fact include $4 million, or $0.04 of foreign exchange translation gains, resulting from certain US denominated positions, which partially offset a declining Canadian dollar, so that is $0.04.

Against that $0.04 benefit however, we had to play through $0.10 of an I/O gain growover, that is the I/O gain was 10 million last year, and zero this year. As well as $0.13 of an FX hit, as the Canadian dollar tanked to $0.80 from $1.00 last year. So in total, we played through $0.23, or $23 million pretax of I/O and FX translation hits, versus a $0.04 bene on the investments translation gain, and still managed to grow our cash EPS close to 20%.

Fourth, let's talk about our Canadian cash flow adjustment, which drives operating EBITDA. It was actually negative by about $13 million. As you know for those of you who have covered us, this adjustment is very choppy quarter to quarter, and Q1 reflects both a timing issue, that is when the cash is received or sent out, as well as some impact from the weak issuance of miles. We have seen this negative cash flow adjustment before, for example in Q1 of '04, and Q1 of '07.

Regarding timing, you may recall that Q4 of this past year was abnormally large at a plus 23 million adjustment, against our average quarterly adjustment of about plus 10. And regarding the weak issuance of miles, we have also seen that before in 2001 and 2002 quarters. But what does it all mean? The bottom line is we still expect a 30 million or $40 million positive adjustment for the year. Again, this is more of a timing issue.

And finally, the fifth point, the quick version of the quarter is very simply this, that Loyalty in Canada is leading the pack, Epsilon hung tough, it is now past is toughest comp, and Private Label is showing good progress on portfolio and sales growth and funding rates, but is still not yet strong enough to mitigate rising losses, and the I/O growover issue. Buyback has mitigated the FX and I/O drags, and will continue to do so until the anniversary at year end or before. After that as credit losses begin to stabilize, and we realize the full impact of the buyback, we look forward to a slingshot in our growth rate in 2010. All right. That is it.

Let's hit the segments. I will start off with Canada. Our Loyalty AIR MILES program in Canada continued to dominate our results, as is posted it's strongest first quarter in it's 17-year history. Additionally we renewed Shell-Canada, a Top 10 ADS client, and a Top 5 Loyalty client, as well as Goodyear in Canada. In constant currency, revenues grew 17% to 200 million Canadian, while EBITDA rocketed ahead at over a 50% clip.

Let's talk about what keeps driving top line and bottom line, as well as margin expansion. Probably five things, one, it is clear that our sponsors and households love the program, as evidenced by the fact that over 70% of all households in the entire nation are active in the program. Two, we continue to have firm to 'firm plus' pricing on our miles issued. Three, continued cost leverage on the miles redeemed side, as we become a larger and larger customer to our 100-plus suppliers. Four, an infrastructure that is fully built out nationwide. And five, always nice to have 100% client retention.

Let's talk about a couple of the key drivers, Miles redeemed, miles issued, we would note they went in opposite directions. Miles redeemed clocked in at a 12% growth rate, which tracked closely with our expectation. There didn't seem to be any impact from the recession, as we didn't see either a surge in redemptions, or a pullback as someone might to hoard the miles.

Miles issued however were weak. We have seen this behavior before during '01 and '02 and at the very end of last year, so it is not too surprising. Simply put, non-discretionary spend categories, such as gas and grocery and pharmacy, et cetera, did extremely well, but were more than offset by soft spending on credit cards which issue Loyalty AIR MILES.

The important thing is we fully expect a nice snapback as the summer approaches, and specifically four events are expected to trigger the rebound. The first while we can't name names, there are a number of our major sponsors who are planning new Loyalty launches, that are offer more valuable reward offers with the goal to spur spending. Second, in Q3 we will anniversary the high gas prices, which drove strong issuance during the first half of last year, and if you recall, miles issued are a function of dollars spent.

Three, recently enacted new tax incentives will provide credits to homeowners who decide to spend on home improvements, which is a very large category for us. And finally, time is our friend. The full snapback should be realized in Q4, as the weakness first seen in miles issued is fully anniversaried. So the miles issued train will begin to pick up speed as the year progresses. While it doesn't affect this year's financial results, due to the deferred nature of the accounting, it is important that we get it back on track, so that our financials don't slow in 2010 or beyond.

On another note, we don't want to sweat the burn rate, no pun intended. The program to-date, about 53% of all miles issued have been redeemed. While we reserve at 72%. That 53% moves up about one point a year, so roughly speaking, we still have a couple of decades to go before we even approach the reserve rate itself. All right.

Finishing up in constant currency, we expect Loyalty to continue to rip it, in the solid double-digit organic growth range for both top line and EBITDA. The increased FX hit of roughly 140 million top line and a total of 40 million on EBITDA takes a bit of fun out of it. But it should be largely gone by Q4. In fact, it should be a non-event in Q4.

And finally, look for new sponsor additions to be announced in the hotel, liquor, and petroleum sectors. And we are also excited about the opportunity to expand the coalition concept outside of Canada, and stay tuned for that discussion. All right.

Now let's turn to Epsilon, and I will turn it over to Epsilon's President, who is a 16-year veteran of Epsilon, and the former Epsilon COO, Bryan Kennedy.

Good afternoon. Well for Epsilon, we were pleased that Q1 results tracked to our expectations, with relatively flat performance year-over-year, and note that Q1 was a very strong quarter for us in 2008, and as a result this quarter is our toughest comp for the year.

Specifically on that, our agency business and our data business were still performing very well in Q1 last year, before growth began to taper off through the remainder of the year. In spite of that we were able to hold financial results steady at flat during our toughest comp, and that leaves us in a position to generate decent growth for the remainder of the year. As such, we are maintaining our guidance of 7% organic top and bottom line growth for 2009.

Let me take a minute to break down our business into two big groupings, that essentially tell the story of this year, and explain how we are going to get there. First technology based business offerings, which is about 60% of the total Epsilon business. This consists of database, analytic, and digital offerings, when I say digital, think permission based e-mail marketing solutions.

And for those offerings, we are focused on serving primarily Fortune 1000 clients, where we are managing very large Loyalty and acquisition marketing platforms. This is the business that has really performed well over the past couple of years, and is booming with strong double-digit organic growth in Q1, and we have got expectations for the full year to remain at that same level, very robust. And I will spend a minute on that.

What is driving this robust growth for our technology segment? Three trends, first the relationships we have in our technology business are sticky, and they typically don't have discretionary spend from a client perspective. Whether we are helping acquire new customers, or whether we are helping our clients keep existing customers, such as with the large Loyalty program we manage for clients like Hilton Honors or Citibank ThankYou, these are not episodic programs, and again, not really discretionary spend categories.

In fact, these kinds of programs are in a perpetual state of executing ROI-based microtargeted communications and offers. And these offers all depend on a constant and growing stream of transactional data from our clients' customers. What that means is that every minute of every day, we are capturing and tracking billings of transactions for our clients, and those transactions in turn enable a systematic dynamic data-driven approach, that enables those campaigns, or interactions if you will, to take place.

As we do that, we are able to measure return and refine those programs, which drives up ROI. So really whether we are in good times or bad times from a macro perspective, the feeding of that underlying engine of capturing the data and driving those communications and interactions continues to chug along, and that is exactly what we are seeing today.

Second trend is that we are continuing to see a shift of the roughly $700 billion of overall marketing spend out of general spending categories and general media, into the kinds of measurable programs and channels that Epsilon supports. Why is that? Because those programs and channels we support have the attraction of accountability.

By that I mean unlike traditional mass media marketing channels, such as TV, radio, general media, et cetera, which are continuing to be challenged from a share perspective, by definition ROI driven targeted marketing programs, give the ability to determine whether you marketing dollar is really paying you back in the form of changed consumer behavior. Those would be things like greater loyalty, increased share of wallet, higher acquisition rates, and increased frequency of transaction, et cetera. And that is really the sweet spot, and where Epsilon plays very well.

And then lastly, the third trend we are seeing for our technology business, is that the shift in spend towards lower cost marketing channels benefits us, because we have the pleasure of owning the delivery platform for permission based e-mail marketing. In fact, Epsilon is the largest permission-based email marketer in the world. And as a result, that channel attracts a lot of the shift in spend, and we benefit from that. In fact, Q1 was a record quarter for us in e-mail output. And we expect to see growth in that channel through volume, as well as and new signings of clients.

On that note, shifting to our other businesses both our data business as well as our agency business have a closer linkage to traditional channels, such as direct mail, and as a result suffered in Q1 with that shift in spend. Although we performed very well relative to the competition in these businesses, and have actually gained market share, those gains were offset by lower volumes, which are primarily related to customer bankruptcies.

So again, the trends for our technology business, our largest segment is sticky. Those offerings that we are supporting are gaining share from a budget perspective, and as a result we are seeing very, very healthy traction in our pipeline. In fact, we had 20 deals signed in Q1 alone. That is a record quarter for Epsilon. That puts us in a position of now having nine of the Top 10 global pharmaceutical companies, nine of the Top 10 commercial banks, and we are very well positioned from those wins to have future growth.

As such, we are confident about our Q2 and our full year outlook, and the wins we have captured in the first quarter will ramp up over the course of the year. Our largest segment will continue to grow nicely throughout the year for those regions I have mentioned. And on a positive note, we are already beginning to see a return to growth with positive momentum in data and in agency. Thus I feel comfortable reaffirming our full year guidance, which calls for 7% top and bottom line growth.

Moving on to the next slide, I will touch very quickly on a couple of key points about Epsilon's business model, and what we are excited about as we look into the future. Again the fact that we are facing and have actually been in a period of economic downturn, and yet are able to produce decent growth and maintain strong margins, I think illustrates a critical aspect of our business model. That is that even in a period like the one that we are facing, the demand for measurable, or what I call, accountable marketing, actually increases. That is when budgets are squeezed or scrutinized from a marketing perspective, the investments that yield a measurable return, are going to get the attention, and they are going to attract marketing dollars, and that is where we play.

At a very high level, there are three critical ingredients that have been carefully developed, are difficult to mimic, and that bring together what marketers are looking for today, and Epsilon delivers on these three ingredients. In fact, we have the ability to really capture this budget concentration, because we have the full range of capabilities under one roof, delivered through one integrated delivery team.

Very briefly, those three ingredients are data, which is a critical ingredient for identifying customers for understanding who customers are, and more importantly how they behave. It is strategy which is the set of agency and consulting capabilities, to design marketing programs, to analyze those programs, to measure their effectiveness, and to execute them across channels, again based on an understanding of consumer behavior, and driven in a very quantitative way from the data that we have, and the transactions that we collect.

And finally, technology which is the set of Best-in-Class assets and services that manage those marketing programs and platforms. This is really the engine if you will, this includes Loyalty technologies, E-mail delivery technologies, realtime marketing technologies, that ultimately enable clients to deliver intelligent and relevant insight at the point of sale, with every customer interaction.

So when you put those three together, and you are able to seamlessly integrate them, from our view, that is what the best marketers and the best organizations around the world are looking for today. And it is what enables us to deliver comprehensive marketing operations for our clients. Ultimately, we end up taking the position of a trusted partner, and a marketing enabler, that enables our clients to connect with their customers, whether it be across the web, e-mail, mobile, direct mail, or the call center, helping them to get more value out of each and every transaction.

So that is a compelling value proposition for marketers. That is why we are seeing growth in our business, and the ability to sustain our performance, and in fact, we believe that as spending ramps up, the concentration and focus on these kinds of programs is going to stay in place, and drive growth for future quarters, and in fact, we already see evidence of this in a number of the key verticals that we are focused on serving. As the marketers around the country are looking with new intensity, and new urgency for the most effective ways to invest their marketing dollars. And that is Epsilon.

Back to you, Ed. Thanks.

Thanks, Bryan. Why don't we turn and pick up with Private Label. And you will see we are including both Services and Credit on the same slide. First Private Label Services just to remind folks, that provides the network, the billing, remittance, processing, collections, customer care, the marketing, and the database services to our 100 Private Label programs. Q1 revenues and EBITDA were up slightly, reflecting the return to growth of the segment's driver, statements issued. And full year expectations continue to be mid-single digit growth in this segment, excluding any impact from potential portfolio acquisitions.

Next, let's talk about Private Label Credit, which saw both revenues and EBITDA down as higher credit losses, and a $10 million I/O gain growover from Q1 of '08, swamped the beginning of some good news in sales, portfolio growth, and funding rates. If you were to combine both services and credit, you produced a Q1 with revenues down 10%, and EBITDA down a bit over 20% versus Q1 last year. All right, let's break it down.

Take a look at EBITDA. The 20% decline corresponded to about $25 million versus last year, we talked about the fact that there was no I/O gain for the first quarter, versus $10 million last year. You combine that with first quarter credit losses being about $20 million higher than last year, that is essentially where you get the $30 million of total drag.

And against this drag, we are just slowly beginning to chip away. And we saw the first signs of good news in quite some time, and first, due to the record signings over the past year, the portfolio is back. It is in growth mode, notching a 10% growth rate for the quarter. The impact on earnings will be felt later in the year, as these new card holders ramp up, and will move naturally, from paying off each month, into more of revolving type behavior, thus creating income for us. Sales were also in positive growth territory for the first time since 2007, and finally, our refinancing activities in March and April, will begin to produce benefits as the year plays out. Summary, key metrics are finally showing some life again, but will not be sufficient to truly mitigate the I/O growover, and the higher credit losses until the second half.

Let's go to the outlook on the next slides. Credit losses in the first quarter came in at 8.8%. We expect losses to behave in their usual seasonal manner in Q2, which is typically the time when certain cardholders run out of room following the holiday shop, and go under either through bankruptcy or age writeoff, and may cause losses to seasonally drift up about 70 basis points for the quarter, which should put Q2 losses at 9.5.

And this usually happens right away, so expect April and then you will see stability in May and June, very similar to what you saw in Q1, where by month I think it was an 8.8, 8.5, 8.9, something like that. You will see pretty much a 9.5 across the board. And this is something that we see every single year, year after year after year. And then what happens after Q2 is losses tend to drop back down in Q3. For the sake of this discussion, we are going to hold them flat to Q2, as we think warrants, with higher unemployment expecting to wipe out the benefit.

And then normally, you would have a bit of a tickup in Q4. Roughly speaking, we are looking at about an 8.8, we did an 8.8 in Q1, then a 9.5, due to seasonality in Q2, a 9.5 in Q3, where it would normally drop back down, mitigated by higher unemployment, and then a bit higher in Q4, for an overall annual rate of about 9.5%.

And this equates to our typical 100 basis points above average unemployment, which going back and using the very latest numbers from the experts out there, is expected to average about 8.5 for the year, which assumes a move from the mid-7s in January, to the mid-9% by year end. If you go back you will notice that our original estimate of credit losses was light. We were heading more towards the high 8s, now we are heading into the mid-9s. We are getting comfortable with the mid-9s at this point. So we are looking at an increase of 70 basis points against our original plan, which equates to a $30 million hit.

The good news however, and we will talk about this in a little bit, is liquidity is flooding. And you have seen it in the deals that we have just done. And we have moved from a position where we thought there would be a headwind in our funding rates versus 2008, to the last call we thought we were going to be flat to 2008. Now we are absolutely looking at a pickup in funding rates versus 2008, and right now we are pretty comfortable saying that pickup is about $30 million.

So you are going to have an uptick in the loss estimate, and an improvement in the funding estimate, and quite frankly, that is the way it is supposed to be during a recession. So we are finally back to normal behavior, with the net result being zero. What does it all mean? It means that we will be slogging it out for the first half, as higher losses and I/O growovers overwhelm the brightening picture of sales, portfolio, and funding.

But as revolving behavior from new accounts begins to kick in, and the portfolio and sales continue to grow, the growover begins to lessen. Further financing rates have already started to come in, as evidenced by tighter spreads on renewals of deals, and this should continue as liquidity continues to be added back to the system.

The positive news from the portfolio and sales growth, combined with the declining funding rate environment, should all point to momentum building in the back half. Add in two final items, one year-over-year loss rates should narrow, as Q4 of last year was the first major spikeup. And two, the I/O growover ends in Q4, and for the year it is a total of $30 million. All right. The bottom line very straight forward. It is going to be a tough front half, but lots of momentum and progress in the back half. And then a heck of a strong jump into 2010.

Balance sheet, just a couple of items to mention. First relating to our Canadian business, note that our deferred revenue balance declined $50 million from year end. About 3/4 of that was just FX translation loss, as the Canadian dollar declined between year end and the end of Q1.

Based on current forecasts, we expect the FX rate to settle in for the year where it is now, around $0.80. And the remaining decline was due to redemptions, that is, we took money off the balance sheet, and booked it as revenue as people redeemed. And opposite deferred revenue is the trust account, which declined about $15 million, and it was entirely due to FX.

What is missing is due to the timing of cash flows, the trust itself didn't decline due to redemption activity, and again, it is a timing thing of when the money gets pulled out. So it should normalize itself out in Q2 and Q3 and Q4. Finally, our debt position increased a little bit. This increase along with the quarter's free cash flow was utilized to buy back just under 5 million shares of stock. Since the beginning of 2008, we spent a bit under $1.2 billion, to take out 27% of the shares outstanding. We have an additional 600 million plus left on the program.

Despite the significant buy back, our leverage remains comfortably around 2 times. We do have an internal guidepost of maintaining an investment grade profile, which we believe is self-imposed leverage at a 3 times or less. Given our ongoing free cash flow generation, plus room on our leverage ratio, we expect to continue to take advantage of what we believe is a favorable value for our stock. We believe that currently this is the best use of our capital, and as the saying goes, it is a gift that will keep on giving to our shareholders for years to come. All right. The fun part.

Let's talk about guidance. If everyone could pull out their guidance sheet. It should be pretty straight forward, I was a little bit surprised. I did take a peek on First Call, and noted that most people had Q2 a little bit higher than I had anticipated. We hadn't given Q2 guidance, so that is fine.

Just to remind folks that haven't been covering us that long, Q2 versus Q1, you always have the seasonality in our Private Label business. And just to remind folks what happens is people shop in the fourth quarter, we make finance charge income in the first quarter, which makes it a strong quarter, and then people tend to pay off revolving balances. And they may keep shopping and may be a transactor, but we lose a good chunk of finance income, which then swings back in Q3.

So you have seasonality on your top line, and in addition, and in addition, we talked about the fact that people who shop during the holidays, by the time second quarter arrives, they have either run out of gas and gone bankrupt, or aged to writeoff, or they have become current. So we get squeezed on both ends, Q2 typically runs for Private Level at about at an 80% level of Q1. Which if you did the math would be about an $0.18 seasonal dip, with lower finance charge income and higher credit losses, that then reverses in Q3 and in Q4. So that is essentially what happens seasonally.

Secondly, we will not have, assuming the Canadian dollar stays where it is today, we will lack the FX benefit on the US investments of about $0.04. That won't be here this quarter. And against that you have positives, obviously Canada will continue to do well. Epsilon as Bryan mentioned is back in growth mode. And also the benefits of an ongoing buyback. If you took Q1 actuals of $1.19, factor in seasonality, the FX piece, and against that some positive news out of Epsilon, and the buyback, you will get to about $1.05 per share for second quarter. We are comfortable with that number, on a constant currency basis you are looking at $1.18.

And now we move to full year outlook. Given the strong performance in Q1, factoring in where we think we are in Q2, despite all of the puts and takes that we talked about today, we do think we are comfortable maintaining our cash EPS of at least $5.15, up 17% for that year. And that includes factoring an FX hit in total of about $140 million off the top line, and on revenues, and $40 million in adjusted EBITDA, as you are talking about the Canadian dollar full year, going from around $0.95 to about $0.80, or maybe a little less. We had factored in most of that but not all of it until today.

And then we talked about credit losses will hit us for an extra $30 million, and bring us to a 9.5% loss rate. But that will be mitigated by funding costs, which are right now, we are comfortably running about 30 million better. And when you see it hitting both EBITDA and revenues, you will note that we net credit and funding, along with finance charge income in our revenue line. So it leaves us with basically feeling first quarter, we did a little better than we had thought. Second quarter seems to be tracking decently with seasonality.

And as we go into Q3 and Q4 we are feeling pretty good about things. We continue to slug ahead here. The front half would come in at about $2.24. So it is about 45% of the year, and the back half would be about 55% of the year. And I think that is reasonable given the heavy duty hit from FX on the front half, as well as the benefits in the back half of Epsilon being very strong seasonally. FX tapering off. The portfolio really cranking up, and the buyback continuing. We think these are reasonable numbers. We are getting a little bit more comfortable each time that we are doing this, and see no reason to change our outlook at this point.

Let's move on to free cash flow. Again not a lot changed here. We did bump up because of the impact of the buyback that our per share free cash flow, which was I think last call, about $5.75, is now up around $6.00. And you will see our EBITDA, we tweaked that down a little bit. The Loyalty adjustment should still come in. So Operating EBITDA around 700, we take out all the other cash items that we have. And we are left with about $360 million of cash or about $6.00 a share, which is around a 15% yield on the stock, not too bad. All right.

Picking up some speed here, I do want to hit our top investor questions, and then we will open it up to Q&A. The top investor question had clearly been liquidity. It seems to be people were extremely nervous out in the marketplace about liquidity, and can we access it, and where do we stand on it? I would like to think at this point we have put this thing to bed for good.

At the bank level, we now have access to the three sources of funding that we needed. The first was the FDIC insured CDs, which is a $1.4 trillion market. The second is the bank conduit market has opened wide up again, that is essentially bank supported asset backed vehicles. And third, you probably saw that the new government TALF program, which offers term fixed rate funding.

And to fund our $4.3 billion file, we have about $1 billion of CDs, about $1 billion of bonds still outstanding that are not maturing this year. We did a 700 million deal with TALF, which is three year fixed. We had 500 million in the bank as equity. And we have got a couple of billion in conduit capacity.

If you add it all up, call it about a billion in excess capacity at this point. As the year progresses, we have nothing out there that we have to do. But we will look to shift more assets out of shorter term funding, and into the longer three year term TALF program. It helps our visibility and creates additional capacity by freeing up the conduits. Mu guess is at this point the excess liquidity, or excess capacity will probably be closer to 2 billion by the end of this year.

From a liquidity perspective, as we had hoped and what we had seen on our last call, in fact did take place. You throw 3 trillion into the system, it is finally going to start getting moving. And our access to liquidity has never been better. We are going to pick away at probably terming out our stuff a little bit longer. Other than that, no more excitement on the liquidity side.

Credit losses as noted we have used the most recent unemployment projections, which calls for unemployment to move from mid-7s to mid-9s in December, with an average of 8.5. Adding about 100 basis points for our losses, you will get about a 9.5% loss rate. That seems reasonable, it is up 70 bips from our plan, which is 30 million. And fortunately the return of the lower cost funding and liquidity has completely offset that bumpup.

Clearly, I think we were shy when we gave our original guidance on losses. We were light there. I think this is a much more realistic estimate, we feel good, we have pretty good visibility for the rest of the year on that. And the funding clearly is coming in very nicely.

Third, noncash comp, it has not been an investor question up until now. But we all took a vote here, and we are betting that it would be before the call is over. You will see in the press release that noncash comp was $18 million in Q1, versus just $6 million last year. I can assure you it is only a timing thing related to how the stock plans were rolled out, and full year comp will be flat to last year. There is no bump up there.

Finally, a lot of questions about the FAS-140 potential ruling. It is a bit dry, but we are going through it anyhow. In a nut shell, it has to do with the potential of bringing securitized stuff back on your balance sheet. There are three items that we need to discuss. The first has to do with capital or cash flow implications. In other words, if these rules are enacted, does that mean you need to raise more capital? Or does it hit the cash flow in any way?

Very simply, no. And the reason why is, let's step back and look at the big picture. The Top 10 banks are looking at potentially bringing back 2 to $3 trillion of off balance sheet assets, back on to their books. And I am making a bet that anyone who thinks the government is going to say, gee, we need to raise another $200 billion in fresh equity capital because of this accounting rule change, I can't imagine that happening. So we believe very strongly that there will be some type of carve-out if this rule is enacted. For example, the regulators could assess a zero capital waiting, which is done over in Europe.

Otherwise, you are looking to sink the big banks all over again. We are nothing when it comes to this thing. From that perspective, we don't see capital or cash flow implications. But just for grins, we should also note that a well-capitalized bank should have a Tier 1 cap ration of about 8%. Many of the big ones are still trying to get there. For us, against that 8%, we are already at a Tier 1 ratio of 25%. So we have got a secondary layer of protection. Bottom line, we have got plenty of testing room in our capital structure, but are fairly certain that this accounting rule should it be implemented, would have no impact on our cash flow.

What is next? Liquidity, very important. Will this be the end of the asset backed market? Given that is just came back to life, I certainly hope not. Simply put, again, logic would say no.

We expect no impact on liquidity and again, let's think about it, the government is right now in the process of restarting the asset backed market via the TALF program. It would be kind of tough to ramp up to $1 trillion in three-year term deals with TALF, and then say oops, we need a do-over. So the experts think that again if implemented, this accounting change will not at all change the game, and will end up looking like for reporting purposes, nothing more than an on balance sheet master trust, that can issue asset backed bonds as we do today. Bottom line, no impact on liquidity. Also, this would all take place at the bank level, not the company or corporate level. So it is very important to note here, there should be no impact on ADS covenants, our buyback program, et cetera, would all remain unaffected.

The final one which is the wildcard is the accounting. It is tough to say what is going to happen because nothing has been issued yet. This is all guess work. And we have got a couple of pretty smart people floating around, who think they know what is going on here.

So their guess that if issued and implemented, this would constitute what they call an accounting principle change. What that means is hard to say. If there is a one-timer that might hit equity, but again, would most likely be carved out for regulatory purposes, otherwise we are back to the big banks in trouble issue again. So outside of a potential one-timer which is no cash flow or liquidity impact, that is about where we think it stands.

Finally, should we also need to set up a provision for losses. Recall that we are currently cash based, and as such and we would be setting up large accruals for finance, and other feels on the plus side. The only way to get it through my head is that in summary, we don't see an issue with capital, we don't see an issue cash flow, we don't see an issue with liquidity. And again, since we live and die by cash flow, we don't think this will be anything more than an accounting adjustment should it go through. And it doesn't hit any covenants up at corp.

Finally, the buyback we are looking at a $70 million EBITDA hit from the I/O growover of 30 million, and an FX growover of 40 million. Obviously that is a bunch. The good news is that it anniversaries by Q4 or by year end, so 2010 is clean. The other good news is that our buyback program at these prices is a windfall, and should nicely mitigate these headwinds this year, and also while these headwinds will anniversary, the buyback benefit picks up steam in 2010.

So what is left? We have got to get through credit losses. We have already walked through the strength in Loyalty in Epsilon, plus the positive momentum building in Private Label sales and portfolio, plus the declining funding costs. So to finish our buyback should take care of the I/O and the FX. The businesses should take care of higher credit losses, and we should be left with a heck of a good year, with the expected 17% earnings per share growth, and about 25% on a constant currency basis.

And then what is probably getting us more excited here than anything, is the fact that time is now our friend. We have got the liquidity problem well in hand. We think we have the credit losses pretty well sorted out. We have got the portfolio growing. Funding rates coming down, sales positive, Loyalty is doing well, Epsilon is cranking up, and the buyback is working out pretty well. As each quarter ticks by and we are plowing through it at a decent pace, not only are we excited about having 17% earnings growth this year, but the jump-off for 2010 is truly going to be dramatic.

So that is the end of it. We will open it up for questions right now.

(Operator Instructions). Our first question comes from the line of James Kissane with Bank of America.

Thanks Ed and Bryan. And thanks for putting Bryan on the call. That was very helpful. The Loyalty margins were extremely strong. You talked about the $4 million benefit. Were there other non-recurring items in there? What drove the strength there?

Since apparently I did a poor job on the last call of explaining it, which is why I brought Bryan on this call. But no, I made sure everyone scrubbed everything. The only thing that is in there is we took a $13 million hit on EBITDA for FX, and we had a $4 million, or $0.04 gain from the FX translation on US investments. Other than that, it is very straightforward. Price pers are heading in the right directions. Cost pers are heading in the opposite direction. The infrastructure is built out, and the thing is just ripping it, just like it did through last year. There is nothing else in there.

Okay. And there's a lot of talk, especially today about legislation restricting the credit card companies. Would it have any impact on Alliance Data, or is it just on bank card issuers?

That is a great question. Most of this is old news. But the fact that it is actually being implemented is relatively new news. It primarily focuses on things such as a grace period, some folks have grace periods that are only 14 days. They want to extend it to 21. We don't have anything less than 25. That was a big one.

We don't do double cycle billing. They have all of these things these about over the limit fees. We don't have that, since we are Private Label, there is no such thing. So we looked at our 100 programs, and from what we could tell right now, the rules that are going to be implemented, should have no material impact.

Okay. The last question, you talked on the last call about acquiring potentially some Private Label portfolios. What is your appetite now and what are the sellers saying?

It is healthy. I would say at this point given the fact that the conduit got renewed at pricing that was favorable, that was 5.50, and the TALF deal which was now our first term money we have had in years. And with the CDs the whole liquidity issue for us anyhow, is now going to take a backseat to now we can actually get a bit more aggressive upon the acquisition front.

We have got plenty of excess capacity. We are continuing to sniff around. We absolutely would like to land a couple of these puppies before the end of the year. We are being very selective, and right now that is as far as I can go.

Okay, thanks, Ed.

Yes.

Thank you and your next question comes from the line of Wayne Johnson with Raymond James.

Could you talk a little bit about Epsilon margins, and how you expect those to progress throughout the year?

Sure. At this point, we don't expect to see a significant shift in our margins overall from what we did last year. And some of the drivers behind that just to elaborate, in the first quarter of the year typically is our lowest performing quarter for our data business, which is a high margin business. As we ramp up volume over the remainder of the year, the margins in that business will improve, particularly as the overall macro conditions in the economy improve.

Sorry to interrupt, is that predominately Abacus Direct?

It is a collection of data assets, but it is dominated by Abacus, yes.

And what percentage of profits does Abacus Direct represent to Epsilon?

That is not something that we necessarily disclose. As I said, the 60% of our business that comes from technology, roughly that is the same percentage of our margins that are driven by technology. We have the same thing on the data side of our business.

Okay. Terrific. That is great.

What you are looking at is probably pretty similar to last year, because the margins will be somewhere in right around the 20-ish% level in the first half. And just like last year, we would probably right around 30%, pretty similar to last year as well.

Second half, okay. That is really helpful. So you put out a great teaser there on the coalition program being expanded to another country. Is there anything else you want to offer us here on that?

I would love to.

I just thought I would give that a shot, and a good shot it was. Is there ever any separation between the unemployment rate and the charge-off ratio? Is that like a hard and fast rule? Is it always 100 to 110 basis points, no matter which way it goes?

No. I don't think, we had the folks go back and take a hard scrub at it, look at other models and everything else. Clearly, we think we would have a rate that is in excess of the unemployment rate, but a lot of it will be driven by the denominator.

In other words, since it is losses divided by your total portfolio, what I think gets folks tripped up is that in the bank card world, and some of the folks who have already reported, they are looking at stagnant, and most likely shrinking files. Whereas we are going in the opposite direction, we are bringing on fresh new retailers, fresh new accounts, and our denominator is growing 10%. Those tend to carry lower losses, based on the pipeline that we are seeing in retail, we could have another boomer of a year in signings, as well as a couple of acquisitions that are in the pipe.

So you could see that denominator expand even more rapidly. So is it 100 basis points? If the denominator starts growing faster than that, my guess is it will be a little less than that. If the denominator starts to slow which we don't see, it would probably be a little bit more than that.

So you could have more than the advertised four to five new Private Label programs this year, potentially closer to the 10 that you have had in the last couple of years?

Better not go out to 10, or I will get a phone call after this. I certainly would look to the high end.

Terrific. And could you remind me the delinquency rate in the first quarter '09, what was that?

I think it was around 6.5. Yes. 6.5.

6.5. Great. Thank you very much Ed.

You bet.

Thank you. And our next question comes from the line of David Scharf, JMP Securities.

Good afternoon. Hey, Ed, let me just key in on some Loyalty questions on AIR MILES. And the first is, when I look at miles issuance down 4%. And I am sure a little bit of that is gas prices, maybe if gas prices were level with last year, it would be flat or down 2%. There is clearly a pretty sizable discretionary spending element. Given that Bank of Montreal it is disclosed in your K, it is over 40% of AIR MILES revenue. How much of that is credit card spending related? Is it fair to say that a third of AIR MILES issuance is related to the dollar amount put on credit cards by your sponsors?

We can't talk about specific sponsors. But BMO specifically, obviously, they are huge, they are our largest client in Canada. I would say about half of the transactions that are done in Canada that generate AIR MILES, are done using a card that is in our program. The other half being people just use cash and check, and use the nonpayment cards to swipe it.

So your BMO card will have both the non-discretionary spend on it, like you go in the grocery store, gas, liquor, hardware store, whatever, but also some of the more discretionary items, and that is where the softness is on the discretionary side. And we would expect as we said without naming names, that a number of our large sponsors would look to enhance the value proposition, and do relaunches of a number of their programs around summertime.

Got you. And that is a good segue into the second question I had. Historically, a lot of times when there are promotional or advertising launches for AIR MILES, it takes the form of co-op advertising. You have agreements that sort of pitch in dollars as well with your sponsors. Are we going to with some of these programs you are referring to, is there going to be a step-up in AIR MILES, marketing expenses, in the second half, or is this pretty much entirely on the back of your sponsors?

It is in our plan at the moment.

Okay.

It is in our guidance.

Thirdly, just so I understand, the first question was related to Loyalty margins, if I were to summarize it, did you effectively say prices are up, and your cost to buy rewards are down? Is that kind of the simple explanation for the upward trend in margins?

And the infrastructure.

The normal operating leverage. Okay.

I would say all three played a role.

Got you. And then lastly, looking at operating EBITDA, you are still I guess forecasting that AIR MILES cash flow adjustment to be positive. I guess 30 million to 40 million. Just I mean structurally, you have to have the growth in miles issued accelerate, and growth in redemption decelerate from current levels. Would that have to take place in the second half to deliver that 30 million to 40 million net change?

Actually redemptions have nothing to do with it. If someone redeems a mile, you may take $0.15 our of deferred revenue, and you will also take $0.15 out of the trust account. That does not affect operating EBITDA at all.

But for sure miles issued, we need to get past and into mid-single digits and high single digits by the end of the year, for us to realize that 30 million or $40 million upwards adjustment to cash flow that you talked about. You are absolutely right. And so the #1 goal of the folks in Canada, is they can tell this year that they are going to have one heck of a good year on reported numbers. But they need to make sure that we are not looking at softness in '10 and '11. Which means all of this stuff that we talked about, needs to take place over the next six months. And then by Q4 your anniversary it anyhow. But we need to get some traction sooner rather than later. And from what I am seeing from the early numbers, it looks like it is heading in the right direction.

Okay. I guess the last question on the same topic. Just hypothetically to get another 30 million to 40 million of cash flow adjustment, and obviously it was negative in the first quarter. It is more line a 50 million or 55 million positive swing for the next nine months. If it ends up being flat, let's say 50 million, sort of below that net 30 million to 40 million gain for the full year, do any of the covenants at the corporate debt and the revolver that are tied to operating EBITDA, does that impact your ability to repurchase stock at plan levels?

The covenants for sure have a cash flow component in it. Where we are right now, you could drive a bus through it.

Got you. All right. Thanks a lot, guys.

Thank you. Our next question comes from the line of Reggie Smith with JPMorgan.

Thank you for taking my question. I wanted to drill down on the Loyalty margins if I could. I guess my question, trying to better understand the different expense buckets, to kind of explain the operating leverage that you guys are squeezing out there? How would you say expenses are kind of divided, between overhead and infrastructure costs versus say redemptions? And then if you could talk a little bit about the trends you are seeing there, and how that might explain the operating leverages you guys are putting up?

Obviously, our biggest expense is cost of miles, right, which would make sense. The rest of it is essentially SG&A for running a national infrastructure. And that carries with it a bunch of marketing expenses, but also customer care, call center, and everything else. The very short version of a question, it is the same answer of the question that was asked earlier, which is what is driving the huge margin expansion when you look at constant currency dollars, and it is pretty straightforward.

If you look at our revs per, those are absolutely going up, and that could be for a number of reasons. It could be new contracts. It could be Tier 2 and Tier 3 sponsors who are joining. Because they don't issue the type of volume that our big folks do, obviously we would like a little spiff on the revenue per.

I would say rev per is more of a driver now than it had been in the past. In the past when the program first started, it was just getting the big anchor tenants up and running, and as much volume as we could. So revenue per is one. Cost per, don't forget how big we are up there. This thing is a monster program. And our folks are doing a fabulous job up there. Getting some very nice deals from our suppliers without, and I have got to say this, because I have been dinged on a couple of my Loyalty programs here, without diluting the value proposition to the folks.

So I think that is a job well done. And third is you have got a fully built done infrastructure, right. So if you put all three of those together, the marginal cost of bringing on, of issuing a new mile, with those three drivers heading in the right direction, it is a pretty significant margin. And that is as far as we are going to go, Reggie.

It is not possible to get a split that maybe 70% of the costs are related to miles, and the remaining is kind of fixed? Can you give me some sense of what the fixed to variable mix is?

I will give you two-thirds, one-third. How is that?

I appreciate it. And I guess my next question on the Private Label side, you guys don't provide all of the information to do the calculation, but I was just looking at my model. It looked as though the gross yield declined a little bit year-over-year. I understand some of that is you don't have the I/O benefit. But I was just curious.

Is there any difference between the interest rate you guys are earning on some of the stuff you purchased recently, versus your legacy portfolio? In the release you suggested that things could be, some of your new signings could be increasing. I am just trying to understand what that is, is it teaser rates? Is it just repricing some of the stuff you might have acquired lately? Any color there would be helpful.

You bet. It is going to be real simple. We are not a bank card issuer, so from that perspective, we do not do teaser rates. We do not do balance transfers. We have for each program, one rate fits all. So we have not rates a bit.

I would say your yield will always tend to drift down a little bit when you are going to growth mode. And the reason for that is pretty straight forward, which is you are getting up to 10% growth now on the file. I can tell you flat out, and this will be a no kidding. But it is not coming from the folks who have been with us for three or four years.

Their comps are minus 8, minus 10. It is coming from the record new signings that we have. And so we can get some decent growth ramping up. But you are not going to get the revolving behavior until probably another 90 to 120 days. So that will dip your yield down. And also the fact that we don't have I/O gain also dips your yield down a little bit. Other than that, we would think it would start creeping up pretty soon.

Okay. And just to be clear, the yield on the acquired stuff is comparable to your base business?

The rates are for sure.

Okay, so the stated rate is comparable.

Right. It just needs to spool up.

And finally, on charge-offs, you guys took your guidance up a little bit there. Just curious, what are you seeing in terms of the source of the charge-off? How much of it, are you seeing a mix change in accounts rolling through delinquencies, versus you guys having to write stuff off from bankruptcy filings, versus fewer recoveries? What is kind of driving the increase there? Or if you can kind of segment that out, or give some color there?

I can give you a lot of color on that. We spend a fair amount of time these days chatting about it. What we are finding is that the delinquency rates at 6.5% are pretty good. And actually, if you look at second quarter, our expectation is that delinquency rates would probably remain flat at about 6.5%. Despite the fact that you are going to see losses spike up. Now what is causing that and what is causing higher losses in general, what is causing the spike is the seasonality.

Bankruptcies, and this happens across the industry. Bankruptcies hit their peak in second quarter. People who are on the edge, don't get their tax refund or whatever. They go over, file bankruptcy, so second quarter always has your highest bankruptcies. We think bankruptcy rates are heading back to where they were pre-legislation a few years ago. So you will see that spike there. But as a general comment, bankruptcies are higher.

As a general comment, delinquencies, the accounts that are not delinquent are in pretty good shape, therefore delinquency rates are relatively moderate at this point at 6.5. So what is flowing through to make the higher losses, it is a combination of higher bankruptcies, people who go 90 days plus past due. It is getting harder and harder to break them back to current. Once they go 90 plus, they go.

And finally on the recovery side, our folks have actually done a very, very good job on the recovery side. But we are seeing our recovery rates a little bit lower than what they usually run at. So think of bankruptcy spikes, severely delinquent accounts have a higher percent that go to write-offs, and a little bit lower on recovery. And that will give you your increase.

Right. Should I expect to see most of this impact in actual trust? So the numbers in the trust for charge-offs are going to probably, would most of the pain be seen there, or is it something that is happening on the balance sheet?

I don't know what the trust numbers will be. I just look at the total managed number. My guess is for sure the trust. You are seeing your more mature accounts. So with a base that really isn't growing, the on balance sheet stiff is growing like weeds, so it is going to be less of an impact there. Overall, we are pretty comfortable with 70 basis points on a total managed basis for the year.

Okay. Thank you.

You bet.

Thank you. Our next question comes from the line of Darrin Peller with Barclays Capital.

On the quarter, looking forward I guess you could say you talked about how the second half of the year, you would see a pretty substantial pickup. I think on slide 10 you laid out the actual items versus $1.19 going down to $1.05 next quarter. You expect a significant pickup. It would have to be at least somewhere $0.20 to $0.30 from Q2 to Q3 in cash EPS. There was a lot said on the call. Can your just walk us through, especially if you think charge-offs will be flat quarter over quarter from second to third. Just itemize the big pick-ups, and what would contribute to that step-up from second to third quarter in a nice easy way?

Bryan, why don't you hit Epsilon? That is our biggest. Epsilon between Q2 and Q3.

For Epsilon it is a fairly easy discussion. Q3 is a very large quarter for us from a volume perspective for our data businesses. Again as I mentioned earlier, that is a high margin business for us. So we get a significant margin pickup in Q3, and we have also been focused on market share in our data business, and some strategies to gain market share.

And we are optimistic that those strategies are going to work. So we will get an added pickup from a growth perspective, as we step up from Q2 to Q3. We additionally have a significant volume increase in the third quarter in our digital business. Again, think permission-based email marketing as we head into the holiday season, which is a high margin business for us. So those pick-ups really explain growth in the last half for Epsilon.

Yes. If I were to bubble it down to let's call it five items, Darrin, you have got what Bryan was talking about, which is we are expecting to see a 10 million EBITDA pick-up between Q2 and Q3 for Epsilon. That is $0.10. Your FX growover isn't going to be 13 million, it is going to be more like 8 or 9 million. So that is $0.08 or $0.09.

You have got no I/O growover in Q3, versus 10 million today and 6 million in Q2. That is another $0.10. How are we doing? Getting pretty close?

So far, so good, yes.

And you have got flat credit losses. Because seasonally losses go down. We are going to hold them flat, because of higher unemployment. So you are going to have flat losses, not increasing losses. And in the meantime you are going to have your portfolio continue to grow, and your yield beginning to kick in from the newer accounts. So you are going to get a kiss there. And then finally, the buyback will continue.

Okay. That was very helpful. And real quickly on the redemption issuance, it was down 4%. On an organic basis, you kind of backed out BMO. I don't know, when was the timing around BMO, that is not anniversaried yet right?

Yes, it was May wasn't it? We don't expect any impact from the anniversary of BMO to affect the ongoing run rate.

Alright, so the 4% dropoff in issuance, just curious what it would have organically would have been without that? You sounded pretty confident that you would see a pickup in issuance in the second half of the year, I didn't quite understand why, other than just new accounts, and activity in business there picking up perhaps? Fair question.

The BMO deal that we did last year has nothing to do with issuance. BMO we always counted in our issuance number. Because in effect, we did issue it, it is just that they are the ones who held the cash for the trust. They were responsible when a redemption takes place. We will send them a bill, and they send us some money. So they were responsible for maintaining essentially a reserve against that issuance. So BMO issuance was always in the numbers. That is why it has no impact from a run rate perspective or anniversary perspective. So essentially, the falloff was the fact that the cards both BMO and Amex have a certain portion that is discretionary spend, and that got very soft in Q1.

My guess is issuance will probably be about flat in Q2. We will probably be up around 5% in Q3, and back to around 10% or so in Q4. That is the current thinking up north. And again, what is driving it, Q4 is easy, because Q4 of last year was pretty lousy. So you have an anniversary bene there. In terms of just getting it going, there are major, major promotional launches ready to go. And as someone mentioned earlier, in this business, those big promotional launches can really move the needle, in terms of consumer spend.

And second, there was some tax legislation pushed through, that encourages folks to do home improvement, and home improvements is probably our #5 category. So that is a biggie. And finally, gas prices were high through second quarter of last year. So in third quarter you are going to anniversary that, and you put those together, and you are going to have between the anniversary of gas prices, the tax bene on home improvement, the major promotional launches, and the anniversary in Q4, you can see pretty clearly to the goal line.

That is great. And quickly, a last question on purchase volume growth, you picked up the 3%, clearly substantially higher than we were seeing in the industry. And part of that must be coming from just new portfolio growth, managed receivable growth? I guess just curious to hear your thoughts on the expectation for volume growth going forward for the next few quarters from the 3% level we saw today?

Boy, that is a great question. Again, our model is so different than the big issuers, who have one static pool to go after, which is the 110 million US homes. Our pool expands as we sign new retailers. It is not like we are going deeper into the existing pool. We are just making the pool a little bit broader, as we saw in those 10 new retailers.

I can tell you flat out that just like on growth of the file, that sales growth for clients who have been with us three years or more who are fully ramped up, were less than exciting. And you are correct to say that 100% plus of the sales growth we can probably attribute to the ramping up of clients that we signed over the past two to three years. And on a go forward basis, we would certainly expect sales to continue to be positive. We would expect sales to be somewhere in the mid-single digits as the year progressed. I would think in the back half of the year, and especially by holiday season, as you know, it is a law of numbers.

Holiday was so poor last year, that we should hit our double-digits certainly by holiday in sales, and perhaps mid-teens in portfolio growth. In the third quarter, I don't know whether we will trip over the goal line to double-digits, if we pick up a file before then, we certainly will. Otherwise, look for mid-singles first half of the year, probably high singles Q3, and then for no other reason than just the anniversary, we will hit double digits in Q4.

Appreciate it, guys.

Thank you. Our next question comes from the line of Dan Perlin with RBC Capital Markets.

Just a couple of quick questions. Ed, I didn't catch why other income was up so strong, it came in at 12 million. Why was that?

Is wasn't income right, it was revenue?

Yes, I am sorry. Other corporate revenue.

I would remember if it was income. It was revenue. Essentially, it is interim servicing processing that we are doing for the discontinued businesses that we sold off.

Okay.

Like network and utility.

Yes. Is that a run rate we should be thinking about?

I would say--

You had 15 million in the back half of last year. And it is pretty strong this quarter, so I just didn't know. They need incremental services now maybe?

No, no, no. These are just interim servicing until they pull off of our platform. I would put no more than 30 million for the year in there. It will start dropping off as the year progresses. Put 6 million or 7 million in for each of the next few quarters.

Got it. And then I am wondering you alluded to the fact that you thought by the end of the year, you would have excess capacity, approaching 2 billion, as opposed to the 1 billion today. Which tells us that you are probably looking to utilize more TALF financing. Is it fair to to assume that is all contemplated in your guidance? Or are you holding that bit in reserve, so to speak if you do it?

Yes, I think you can, we have pretty much factored in that we are going to be doing, let's call it 2 more TALF deals.

Like 500 million traunches apiece the next couple of quarters?

I would say by certainly by July we would like to get another 5 done, and then in the fall, certainly another 5 done, and then we will see by year end. But our viewpoint here which is going to sound a little nutty to a lot of folks, is that if the recession, or the Great Recession, whenever it does decide to finally end, our biggest concern would be on a go forward basis.

The one thing we couldn't control would be hyperinflation. And although it would be great for credit sales and everything else, on the funding side it would get a little scary. We are preemptively moving our tenor of our file on our funding side, back out to fixed rate term money as fast as we can, without hurting our funding costs. So you are going to see more and more of our funding book being termed out to three years, hopefully five years over the next year or so.

If we run that scenario, you would end the year roughly with 3 billion kind of termed out, and you would still have roughly 1 billion floating, or coming due short term?

We would have 1 billion in bonds that were still outstanding. And you would have about 1.5 billion or so.

1.5 billion.

2.5 billion sort of termed out, and then don't forget your CDs can change from 12 months to 36 months. But your conduits for sure are 360 [for consolidated days]. It is just a function of we have got to scoop them out of the conduits, and slap them into TALF. Not sure if that is a financial term, Scoop and slap.

We will use it anyway. Are you seeing any mix shift in the Loyalty business, when it come to the type of cost of goods sold that you are paying for? Consumer behavior has changed a bit in terms of what they are redeeming, and as a result, you are getting by virtue of the buckets that they are redeeming, a lower cost of goods sold. Since that is such a large cost of miles.

That is a great question. We are seeing the short answer to the cost question, is we try to make the reward structure such that we are indifferent between whatever someone chooses to redeem. Whether it is a hockey ticket, a movie pass, or a plane ticket, you can move the miles required to redeem around, such that the cost to us is the same.

Right.

Across all categories. And that is what we try to do. We try to be this impartial, indifferent, not indifferent, objective party sitting there saying, go to the hockey game, go to Florida, we don't care, just enjoy yourself. However from a mix perspective, the one thing we have noticed in the recession is that there seems to be a falloff in the plane travel.

Okay.

Especially down to Florida, and places like that, and more focus on things such as merchandise certificates, things like that, that could actually essentially take the place of non-discretionary spend. But other than that, it has been pretty stable.

And in that mix shift that doesn't have an impact beneficially on margins from a cost standpoint? Just modestly even? I would think it might, since airline tickets tend not to be the most conducive from a cost standpoint, but a cash certificate from a cash-back retailer that you are already servicing might.

Don't forget we will fix the points required to redeem for that, such that if we get a good deal on something, it will require fewer points right to get that. It costs us the same.

So you are dynamically changing that anyway?

Dynamically sounds good, yes.

Okay. You mentioned infrastructure a couple of times as it pertains to Loyalty. I am wondering two things, when you brought over BMO, was there some sort of incremental requirement from an infrastructure standpoint, that was part of the deal for them to get comfortable being brought over, and is that having an impact on lower unit costs?

I can't comment on that.

I remember at the time that it converted there was this discussion, that in order for them to get comfortable your kind of had to give them something on the security side, or something that they felt was more than adequate. Anyway, if you can't comment it, you can't comment. But is seems to me that that would lower your unit cost.

Certainly a lot of volume.

And then let's see what the other one was.

How about something for Bryan?

Bryan, let see. How is the thank you-- (laughter) I am just kidding. Absolutely.

Actually, Bryan, one thing you can tell us quickly, is within the 60% that you call technology driven in that business. Can you hit on the incremental margin benefit through growing the database, because your clients are getting larger and providing you data, relative to the digital output? Is there a huge difference there?

Sure. We do have some leverage in our database business as relationships grow. Obviously, we have the ability to leverage assets and products and capabilities that we have developed over time, and so with more volume of clients running across those, we get some incremental margin benefit. As you might expect, it is not as much as the incremental margin benefit we get on the digital business. As that grows that is a very transaction driven business. The more volume that flows through, essentially the better that we do over the long run in that business.

So the type of volume you would prefer to have is more digital output, as opposed to just the database growth. If you were trying to hit your bogey as an example, which would you rather have in the quarter?

We model growth in both of those categories, and they actually feed each other. As we bring on new database clients, there is always a digital services delivery component to that. Right now we expect to hit our numbers based on pretty much the same kind of growth we have seen in the past couple of years. So we are not expecting a huge shift in the overall mix of digital versus database.

Got it. I think I am good. Thank you very much.

Thank you. Our next question comes from the line of Bob Napoli with Piper Jaffray.

Thank you. I just wanted to dig into the Loyalty margins, just kidding. I think we got everything out of you we can on Loyalty margins today. I would like to know since we have Bryan here, the Citibank ThankYou network, that is a pretty important program for you guys. And with the challenges at Citigroup, I was wondering if you can give any update on that program? And how concentrated are you with larger programs?

Clearly I can't comment on Citi's strategy, and what they intend to do with the program. I can tell you that the relationship that we have, and the level of investment that they are making with us is constant. And we don't anticipate seeing any significant changes in that. I can also tell you that Citi, like many of our clients, again looking back at our digital business. They are looking for every opportunity possible to invest in low cost marketing channels, and so the fact that we have a very significant digital business from an e-mail delivery perspective, is a pretty logical place for many of those large programs to look.

Overall if you look at our Top 50 clients, they represent about 50% of our revenue. Citi is clearly in that number. But our concentration in any individual client is not significant enough to really move the needle for us.

There is no one even close to 10%.

Okay. Ed, how much stock have you bought back so far in April? Is that something you can tell us?

No. I honestly don't know the answer to that. I don't know.

Is your strategy to buy back through the quarters, through the year?

We are taking this thing and dumbing it down pretty quickly, which is we have got a bunch of money. We have got a game plan. We have got what we think is cheap stock. And we are just going to quietly pick away at it. And obviously, as things pull back, we will pick at it more.

If things jump ahead which we haven't really seen, we will pick away less. We were buying heavily a year ago in the 60s. And there really isn't, we have told our M&A folks, if you have anything even approaching the accretion of a buyback, let me know. And it has been very quiet. So think of it as just a very, very quiet execution on our plan. And we will continue to do so.

Okay. Would the retailers obviously having a lot of financial problems across the industry. And you lost somebody, a significant retailer out of the Epsilon business last quarter. What are you seeing from the health of the retailers? Is the group of retailers that you are concerned about growing? And have you lost any, were there any significant bankruptcies for you this quarter?

I will hit from our side actually it is in pretty decent shape. You are exactly correct. Last year Goody's Clothing and Fortunoff were two clients that we lost, that either went bankrupt or reorged or liquidated. And on the Epsilon side I think we had Circuit City and Charter Communications. So all four of those were last year. At this point, Bryan, anything heavy in your group?

No.

We don't have anything. Canada is in real good shape. We think there is no one of size on our Private Label business that is on the bubble. And then Bryan doesn't have anyone major. He is probably looking at a handful of Abacus catalogers that may go, but they are pretty small.

Okay. And just I guess a numbers question. You added back in the cash EPS for the first time the convert interest expense. And you also break that to amortization of deal costs are also in there. Is that all in interest expense on the balance sheet? And can you give the break out between the convert interest and the amortization of costs? That is $12 million I think is the add-back?

It is like 10.5 for interest, and 1.5 for the deal.

Okay. Let's see. The discontinued operations, the losses you are taking in discontinued ops, what is that continuing from? Because you sold the businesses last year. What else is in discontinued ops?

Yes. We had one major client, DE, Direct Energy, which was in our utility business, that was a special case, that wasn't part of the sale of the utility business. It is being unwound off of our platform, I mean off of us, probably I would hope by the end of Q2. So you should see that type of cost eventually go away. But there was one major client from last year that needed some type of special treatment.

And then last question, on the retail spending, as you look at your customer base, and as you are looking at same store and new customers, what kind of trend are you seeing essentially in your same customer sales? Did you see a dramatic dropoff I would imagine in the fourth quarter, and have you seen stabilization at all in the first quarter? Or no signs of stabilization in the older file? And the year-over-year sales growth, what was March, did it trend up during the quarter?

That is a whole bunch of questions. As a general rule, from the more mature files or clients, for the most part we are not seeing a recovery. But we are also not seeing it really getting any worse. So we are not seeing the sunshine yet, but we are not seeing it continuing to fall. So it seems to have stabilized at an unexciting level, but at a level nonetheless.

Okay. And I lied. I have only covered you a year and a half. Your portfolio growth, one thing I like about your Company is that you have never had rapid growth of your portfolio. The financial services industry is littered with people who grew their portfolio too fast. Have you ever grown? You are looking at double-digit growth through new programs, and not through your current base. But have you ever grown at a double-digit, are you comfortable growing at the pace you are talking about, in this kind of an environment?

That is a good question. If you actually went back 10 years, which I can do, I have been here. We have averaged I think on our last asset backed we had to give this stat, we have averaged almost on right on the dot, 10% portfolio growth over a 10 year period. I would say, I can't remember a time where we have done 20, but certainly between 10 and 15, we are certainly very comfortable. 10 being sort of our long term growth rate in the file.

This year we would certainly like to see it higher than that, mid-teens. That will provide an incremental mitigant against the higher losses, and we can finally turn the tide on that one. I don't think there are any issues there. In terms of why would you want to grow in this environment, the answer is because we have a very narrow patch of that pool we talked about, as we expand the retailers who are interested in our program, we can still get very, very high quality credit customers on board. So it is a great environment for us.

Bank cards may have what are called excess spreads, after your factor in funding costs and credit losses of 200 or 300 basis points. We are up around a 1,000 to 1,200. So unless unemployment goes up to 20%, incrementally it makes sense for us to add on at a measured pace, which is exactly what we are doing. And then if you think about it a little longer term, assuming losses begin to stabilize in 2010, boy when this thing turns, and you have got much fewer shares outstanding, and with the other two businesses cooking, it is going to be a little bit of fun, that is for sure.

Great. Thank you.

Thank you, our next question comes from the line of Dan Leben with Robert Baird.

Thanks a lot. Ed, it sounds like you need a break. All my questions are for Bryan. Could you talk about the performance in Epsilon by vertical industry? I know pharma was an area that was pretty hot in the fourth quarter.

Sure, Dan. Epsilon overall is spread out across a number of verticals. Because of our concentration in data, retail is the largest vertical that we serve, it is about a quarter of our business overall. Beyond that, financial services and pharma are two of the larger verticals.

And those are two of the verticals that we see very stable spending, and good growth going forward. As I mentioned, we are in a position now, we have got 9 of the Top 10 global pharmaceuticals, this is a category that is critical for us, because the budgets for the pharmas, in terms of direct to consumer marketing continues to grow, and in fact we believe we have got the dominant market share in that category. So a really positive outlook for us going forward.

And in financial services, which is roughly 20 to 25% of our business, again those are mostly programs that we manage that are very sticky, not discretionary spend. We have long line of sight on the kinds of budgets that flow our way. And so even though a lot of our clients are hurting, the kind of marketing that they are doing with us is very stable.

Okay. Great. And you made the comment that the data at agency businesses, you were starting to see some upticking and feeling better about those in the second half. How much of that is driven by new clients that you guys have signed, and some market share gains, versus seeing an uptick in the overall market?

It is a little bit of both, although frankly, we are looking more at just overall growth. And now remember last year our data business really trailed off in the third and fourth quarter. So as we projected out for the remainder of this year, we were essentially looking at flat performance towards the end of the year, that ramps up through the course of the year.

And what is positive for us right now, is that the kind of momentum that we are forecasting, we are actually already beginning to see that in Q2. And there is no better sign for us than actually seeing that flow through. There are pieces of it that come from the new signings, and particularly as we put these businesses together over the past couple of years, our ability to cross-sell our data services into digital relationships, and the database relationships as a driver, but mostly we are starting to see that spending return.

Okay. And then just one other, what are you seeing in terms of customers focused on Loyalty and retention type services, versus new customer acquisitions? Is there a large focus on the retention side?

Absolutely. The Loyalty side of our business is the most solid, it is the least discretionary. So those programs that we manage are very stable and strong, and we don't see any significant change there.

And just to follow on that, relating that back to the vertical markets, where do you do the majority of the new acquisition versus Loyalty, are there any strengths or weaknesses there? Or is it pretty similar across the board?

Pretty similar across the board. I mean acquisition, we are heavy in acquisition in the Financial Services arena. We are heavy in acquisition in the retail and catalog arena. And those would be probably the two dominant ones from an acquisition perspective. Loyalty runs across all of the verticals that we serve.

Okay, great. Thanks guys.

Why don't we take two more, and call it a night?

Thank you. Our next question comes from the line of Larry Berlin with First Analysis.

Sorry Ed, these are for you, not for Bryan. I just want to make sure I understand a couple of things from the report. First, in the revenue for loyalty, the run-up in revenue on constant currency while miles decelerated, is because of the general accounting mumbo jumbo the Canadians and the US make you go through, is that correct?

Yes, and the fact that redemptions were quite strong. So whenever you have a mile redeemed, you will be removing it from the balance sheet, and booking it as revenue.

Okay, cool. The other thing, can you give a quick primer for those of us with feeble minds on the Internet, on the I/O strip, and it's dynamics, and what happened last year that we now have the growover?

It is a fascinating topic.

I know. (laughter).

Essentially, for off balance sheet type financing, rather than setting up provisions and allowances, and all of that stuff, you do on balance sheet what you essentially do, is you present value the future cash flows of the off balance sheet assets, and to the extent you get a figure that is either higher or lower, than what it was in the prior quarter sequentially, you will book a gain or a loss. And by doing so, that would technically be the same thing as adding to your allowance or taking it out of your allowance.

Usually in a steady state environment that we usually live in, you have 10% portfolio growth. You have fixed rate assets, since all of our rates are fixed for the most part. You have funding that is usually term and fixed. And you don't have a lot of variability on losses. So your I/O will tend to be gains all of the time, because the file is essentially growing, and you cash flow is growing, and you may look at 15 to 18 million a year in gains. To the extent that the file does not grow, and you have yields that are flat, and you have funding costs which are down, that will all help, but you may have losses that have gone up.

And so essentially, last year we had the benefits before the losses really started to ramp up. And those benefits allowed us to book around $30 million in I/O gain. This year, however, since we are growing away from the trust, we are growing on balance sheet, what you have is a portfolio that is left over that is not growing. You have on the negative side, higher losses. On the neutral side, you have no growth in the file, and you have yields which are relatively flat.

And then on the positive side, you have funding rates which are coming down, and also the fact typical in a recession, is the life of a receivable, it moves out. In other words, payment rates tend to come down a little bit. People take a little bit longer to pay off, so your present value of the cash flow has a little more life to it. The net result is bottom line is we do not see any chance for an I/O gain at all to be booked this year. Unless we decide to put all of our growth that we are funding very cheaply on our balance sheet, into one of those trusts. And right now we are not going to do that. So we are left with a $30 million growover.

Thank you very much. Detailed, and very helpful.

Hey, any time you want to rap on 40, you talk.

You got it. If I need it, I will give you a buzz. Thanks so much, have a good night.

Our final question comes from the line of Robert Dodd with Morgan Keegan.

Hi, guys.

Hey, Robert.

Just two quick ones. At the risk of being repetitive for the Nth time, on the redemption issues, just to clarify, you are not actually lowering the yield to the consumer, or to the redeemer, right? It is just that you are getting a better deal in purchasing, whatever it is going to be redeemed for, than you were a year ago?

I think I heard you right. It sounds like you are under a pillow. Yes. If your question was, are we diluting the value proposition to the consumer, the answer is absolutely not. What we are doing is one of the benes of being so big in Canada, is we can negotiate very nice deals on the supplier side, and keep the value proposition where it has always been. Unlike most of us here in the States, who have seen their Loyalty points or whatever program they are in, except for Bryan's programs of course, get somewhat dinged, like on the airline side.

Got it, and then last one on Springstone, they financed anywhere from 2 to 40 grand at lower yields than you guys have done historically. Are you going to change anything about your underwriting or even your funding for those receivables, given that their range of pricing seems to start at about 7%?

Again, we should be a little bit careful about reading too much into Springstone. I think it is one of the verticals that we're looking at. The Butler deal that we did on the vet side seems to be going pretty well. What we are looking to do, is to diversify where it is prudent, away from just our typical specialty apparel, which focuses on women between 25 and 49. And by doing so, we have moved into with Gander Mountain, into sort of some more of a focus on mens. We have moved into some grocers for some tests. We have moved into medical to see how it goes. We have moved into jewelry. And then home furnishings, like pottery, and Crate & Barrel. So we are expanding the footprint.

Springstone is going to be more of a good test for us, to find out whether this is a good niche for us to be in. The credit profiles that we are looking at are actually quite good. So we think the loss profile of these accounts will be a little bit better than our overall file. It is stay tuned. We are going to continue to launch into different verticals as the years go by, until we are well diversified away from just relying upon womens specialty apparel.

Got it. Thanks a lot.

Okay. Why don't we wrap it up, and again, thank you for those who have not fallen asleep for staying with us. It is going to be an interesting year. Times are tough. But I think we had a good start. And right now the year looks like we are in decent shape, and as we said, each quarter that goes by is going to get a little bit easier.

And we are looking forward to chatting next time. Thank you.

Thank you.

This does conclude today's conference call. You may now disconnect.