Bread Financial Holdings Inc (BFH) 2009 Q2 法說會逐字稿

Good afternoon, and welcome to the Alliance Data second 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 open 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 of Financial Dynamics. Ma'am, the floor is yours.

Thank you, operator.

By now you should have received a copy of the Company's second 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 Pearson, President of Loyalty One and our Canadian air miles business.

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

With that I'd like to turn the call over to Ed Heffernan. Ed?

Thanks, Julie.

Good afternoon, everyone. Welcome to our second quarter call; and today, if you're on the agenda page, we'll obviously go through Q2 results. We'll also, of course, give you a look-see at Q3, and our full-year outlook; and then, as we've been--as we started last quarter, we have, down here from the up-north, Bryan Pearson, leaving the lovely weather up there, for our 105 degree weather down here . So he will be going through the Canadian business, that we call Loyalty One, and talk at length about results and the various key metrics. And then will kick it back to me, and I'll wrap up Q3 and full-year outlook.

All right. Why don't we go ahead and turn to the second quarter consolidated results. Needless to say, with us, there are a few ins and outs, I think, overall. However, we're going to try to get a general theme across; and that theme is one of, we are definitely headed in the right direction despite the macro environment. All the trends seem to be heading in the right way; and that's what we're going to build on over the next quarter or so; and hopefully have a very strong back half and a nice jump for 2010.

So on the consolidated results for the second quarter, again, the goal today is to talk about the overall business so our focus will be results that are directly comparable to last year's second quarter. That is, we'll be using constant currency numbers; and when we do move to the next slide, be assured we will delve deeply into the fascinating world of FX.

All right. On a constant currency basis, revenues of $486 million were down slightly from last year's second quarter. We expected growth to return to Epsilon, which it did; and we expected Private Label to continue to drag versus prior year, which it did. Loyalty's top line was, however, a bit soft. We were about U.S., call it $20 million, $25 million short of expectations on top line at Loyalty because our collectors decided to seriously cut back on redeeming their air miles currency for rewards. One could call it a certain type of courting. Lower reward redemptions drive lower revenues, but conversely, they drive margins higher since any redemption is largely--the revenues are largely offset by cost of goods sold.

All right. Some good news here. Operating EBITDA, back on track and came in at U.S. $31 million, above our reported EBITDA. Since operating EBITDA is a good measure of operating cash flow, it was nice to see it bounce back during the second quarter. Needless to say, this can be a severely choppy metric over the quarters. Witness--I think we were negative $13 million adjustment last quarter, and it's due primarily because this is a cash flow metric, and so it does rely on the timing of cash receipts and disbursements. But the good news halfway through the year is on an annual basis we do tend to run about $40 million ahead of what we report as EBITDA, and it looks like we're nicely back on track. So that's one of the nice positives of the quarter.

Constant currency EBITDA was down $13 million from last year. Growth in Loyalty, Epsilon and contributions from Private Labels' portfolio and credit sales growth could, in total, mitigate about two-thirds of the drags caused by the higher credit losses and the IO grow-over. For all three businesses, the trends are going our way; and by Q4, we should be in positive territory to jump off into 2010 on all of our businesses.

Finally, tighter controls on CapEx, and operating expenses as well as the continuation of our buy-back program allowed for cash EPS to come in at a $1.21 on a constant currency basis, up 16% from prior year. So overall, what we said came through, which was this was our toughest seasonal quarter, and it is over and the toughest half of the year is behind us. We are, in fact, chipping away at the headwinds and getting some added help from the buy-back. Things should now begin to accelerate.

All right. Why don't we move on and talk a little bit about foreign exchange and foreign exchange impact? Because it is a little bit different than you would normally anticipate. So hopefully it will make sense when we're done here.

You start with guidance, which is our first call. In April we had given guidance of a $1.05 cash EPS for the quarter. This assumed an exchange rate of $0.80 U.S. for every dollar Canadian and translated into $1.18 on a constant currency basis. That's our starting point.

The next column is what we'll call the proforma results, and that layers in our actual results both in constant currency, as well as in U.S. dollars and assumes the FX rate was, indeed, the $0.80 that we had given out as our guidance. So the net result was--using the FX that was used from our guidance, our actual results came in $0.04 ahead. Translating it a different way, we overperformed by about $0.04 against the $1.05.

Okay. The final column, actual results using the actual exchange rate. During the quarter, the Canadian dollar shot through the roof, and normally you would think that could only be a good thing for businesses in Canada, which are translated into U.S. dollars, and you would be right. A stronger Canadian dollar is good and will make the business and its result more valuable. Specifically, the Canadian dollar soared to $0.86 U.S. for every dollar Canadian from $0.80 at the end of last quarter and from $0.80 assumed in the guidance.

This appreciation resulted in a $3 million FX translation pickup in EBITDA from operating results when compared to guidance. And if you look on the chart, you'll see that our guidance had us off from operations about $11 million versus prior-year that was only off about $8 million. If everything stopped there, it would be a very easy discussion.

The downside to the rise in the Canadian dollar during the quarter is its impact on U.S. dollar denominated assets held in Canada. Let's call it about a couple hundred million dollars. Those assets are marked to the spot rate at the end of each quarter. In this instance, the impact on reported EBITDA was a negative $16 million. This timing difference will be largely offset during Q3 and Q4 as operations continue to benefit from the higher Canadian rates, but we won't have any further sequential foreign exchange hit related to the U.S. dollar investments.

Bottom line against guidance, we had a net $0.14 hit, worth $13 million in adjusted EBITDA to earnings due solely to changes in the FX rate, versus our guidance FX rate. Note, however, that on a constant currency basis, obviously the results were identical, and came in at $149 million of EBITDA, and $1.21 in cash EPS. So summing up, what's it all mean, using the FX rate assumed in guidance, we beat guidance by $0.04, and that beat can be primarily attributed to the overperformance at Epsilon, which is good news. Actual results got hit by $0.14, and adjusted EBITDA by $13 million from the FX translation loss versus what our guidance was. Constant currency results are the same regardless of whether you use our guidance rate or the actual rate.

The key thing here is the $0.14 with which we were hit will not be lost. It's a timing issue only. The stronger Canadian dollar will lift results in Q3 and Q4; and also since we've already taken the hit, we're not going to get hit again on the mark to market on the U.S. investments. Finally looking ahead a little bit, if the stronger Canadian dollar does persist, it will turn this year's headwind into a very nice tail wind for 2010.

One final thing before we move on, and this is sort of a side note, because I've heard a couple of questions come up about FX volatility and how that impacts the results. The good news is, going forward, we're really not going to see very much volatility. The reason being that the largest single driver of this volatility was an intercompany loan over a $100 million between Canada and the U.S. I do need to stress here, because there does seem to be some confusion, that this intercompany loan was not, nor ever was it in the trust account; but rather was nothing more than a temporary bridge to upstream earnings to the parent on a tax efficient basis. This interco-loan position was settled, meaning we wound it down at the end of the second second quarter; and, therefore, no longer exists and the cash flow was upstreamed to the parent permanently. So this whole volatility issue should be over at this point.

All right. At this point, we are going to turn it over to Bryan Pearson, the President of Loyalty One, our Canadian air miles business. Bryan has been here from the beginning, back in 1992.

So he's been there, seen it, done it, built it; and--for 17 years.

And that being said, I will turn it over to

Thanks, Ed.

Appreciate, really, the opportunity to enjoy a little 100 degree summer weather instead of the nice 80 degree summer weather up in Canada. So thanks to inviting me down to Dallas for this. Nonetheless, why don't we talk about the quarter. If everyone can turn to the Loyalty One Canada slide, we'll kick that off.

As Ed mentioned, financially we did have another strong quarter, and I'll address the actual metrics of that quarter on the next slide. Constant currency revenues were relatively flat due to lower redemptions of points for rewards. Now, since these revenues would have been largely offset by our cost of rewards any ways, and that cost is already sitted--sitting, fully funded in our redemption settlement assets, the actual magnitude of redemptions is actually not the key driver in our cash flow.

So if we turn now to that cash flow, operating EBITDA, which is a decent measure for our operating cash flow, since it reflects the actual cash received as profits; however, they are deferred and brought into the P&L over a period of years. What we looked at in Q2 was that operating EBITDA was actually up by 50%, to $93 million versus $62 million last year. In other words, our operating cash flow was $31 million higher than it was last year; and this measure actual jumps around quite a bit, since it's influenced by the timing of our cash receipts and disbursement, as Ed mentioned earlier. The net result, we're going to track towards the $40 million of cash flow above our reported adjusted EBITDA for the year, and everybody should basically take that as good news.

Turning to our adjusted EBITDA figures, we were up a solid 17% through the quarter, as we had strong prior-year's issuance that flowed into earnings; and combined with our firm issuance pricing, virtually a 100% client retention and our fully built out infrastructure, and finally strong leverage on rewards yielded the growth that we saw in the quarter. Strong EBITDA, also combined with lower redemption revenues, drove our margins up by about 500 basis points; and as redemptions pick up again in the second half of 2009, we should expect that margins will return to a more historical level in the future. So on the full-year basis, if you look at the outlook, our revenues should be in the single digit growth range. Our EBITDA growth should be in double digits; and our margins will continue to remain strong for the year.

Now, why don't we turn to the next slide, and we'll go through the metrics. So (inaudible) is a key driver of future growth, and we like to see that in the high single digit range for this metric; which when you combine it with a strong pricing model, this will yield the double digit topline and mid teen EBITDA growth that we desire for the business. Starting in Q4 of last year and continuing through the first half of this year, what we've seen is that this metric has been weak with either negative or no growth.

Well, the recession, just as it's hit the U.S., also hit Canada quite hard. We were just a few months after the U.S. experience. And where we've seen it primarily is in the consumer discretionary spend categories, which is primarily reflected in lower spending on our sponsors' credit card programs. I'm referring there to the Bank of Montreal and our American Express credit card programs. Additionally, what we saw was lower gas prices through 2009, which have created a drag in miles issued for--in that category, and I'll come back to that a little more in a little while.

While the first quarter of 2009 showed a weak -4% issuance growth, I think we're very happy to see that in Q2 we cut that in half to -2%, and we're very excited about a second half of this year and the jump off that it will presently for us for 2010. Q3, we should see ourselves getting our heads above water, and there's two real key items of interest in this. One is credit card, and the second one is gas.

We put out a press release outlining the Bank of Montreal's powerful new launch of its value proposition on the bulk of its credit cards, a proposition that will provide our collectors with more opportunity to earn miles and rewards. And for those of you who don't track the Canadian banking system, the Bank of Montreal is the largest issuer of MasterCards in the nation, with millions of cards outstanding; and it is, in fact, the number one credit card issuer in Canada.

It's also Alliance Data's largest client. The bulk of those cards are linked to our air miles program. By launching this new program, which in many cases will actually double the issuance on existing customer spend, we expect to see a nice ramp-up in miles issued starting in August. We expect the program, coupled with something of a recovery in the back half of the year, will also drive spend, which will further benefit the program for this year and in the long run.

The second item, gas, is also a big category for us; and if you recall, gas prices were quite high through the second quarter of last year. We probably all suffered a little bit driving up to the pumps. High gas prices is equivalent to higher spending by consumers to fill their tanks, which means that we're going to have a higher number of miles issued. So that's positive.

Subsequently, when gas prices weakened through Q3 and dropped dramatically in the fourth quarter of last year, we were clearly impacted in the issuance category. So the first half of this year was a tough compare versus last year; and with that behind us and our GAAP partner's commitment to increase promotional activity, the back half should see some good growth for the business.

Putting the gas price drag behind us and adding in the new Bank of Montreal launch, should drive issuance back into the positive territory for third quarter; and additionally, given that the fourth quarter of last year was the first quarter where we saw weakness from consumer spend, that drag is eliminated as well. So we see this as a strong ramp-up in issuance growth starting in August and ending with strong Q4 and a good jump off for 2010.

Why don't we switch gears now and talk a little bit about miles redeemed. As I've explained it to Ed, let's just call it a cultural thing for now. While Americans might have used the recession to utilize any sort of liquidity, Canadians may be a little perverse in that they do the reverse. Oh that rhymes.

Essentially next to the national currency, air miles could be considered the next most common source of currency that's successful for Canadians. Rather than a run on the vault, what we saw was actually the reverse. Canadians were hoarding their miles for a rainy day. And I understand that here in the states, the rains that have come down in buckets may have impacted consumers and their mind-sets differently, but Canadians are holding fast in their saving.

There was a statistic that actually came out the other day that noted that while Americans are actually saving more as evidenced by their cash balances growing about 4%; in Canada, the same statistics show that cash balances were growing 12% or triple the rate of the American consumer. And also we've also seen that some Canadians, those that are spending money, are actually having success finding pretty good travel deals and flight--seat sales on the open market; and clearly while that's not an obvious long-term solution for the airlines, it's another reason why our flight redemptions particularly are down.

What's it all mean? Well, our program is based on being the most valued loyalty coalition in the Americas. Our annual increases in our collector base and continued strength in consumer perception of our program are a testament to that fact. Our collectors feel that the program is working for them, and we feel that by enhancing the reward portfolio, we will drive our collectors to redeem in order to ensure that they receive value from the program.

Now, from a financial sense, driving redemptions higher shouldn't be an issue for anyone. Over the 17-year life of our program, we've reserved a 100% of our estimated redemption costs so that we ensure that our collectors are able to receive value in the future. You'll recall we expect to redeem about 72% of our miles. And today, after about 17 years, about 54% of miles have been redeemed. That really gives us a fair amount of runway well into the future.

We believe our cash reserve levels are the most robust in the world; and therefore, driving higher redemptions won't impact our cash flow, but it serves to bolster the value of the program in the eyes of the consumer, and that can only be a positive thing in the long run. So stay tuned, and why don't we move to the final slide.

So on the final slide about Loyalty One, I thought you might want to hear a little bit more about where we see future growth coming from within the Company. We'd like to think about our growth as coming in three areas. So let me first cover the one which is probably the most critical in your eyes, which is can we continue to grow our core business, the air miles reward program in Canada?

As I mentioned before, the program remains very strong. And even though our membership includes 70% of all households, our active base continues to grow. To maintain that growth and to continue to build the engagement of those consumers, our collectors, we are continually introducing new program offerings. For example, we've been pioneering new ways of interacting with our collectors, leveraging opportunities opened up by online and mobile technologies so that we can more effectively communicate with our collectors in a timely relevant manner with targeted offers, promotions, and messaging, which drives them to spend more money with our sponsors and to redeem more miles with us.

One of our most exciting recent innovations is our launch of the MyPlanet initiative just this spring. This is an opportunity within the air miles program for our collectors to redeem for environmentally friendly products and services, to contribute to environmental causes and to learn in one place everything they need to know about becoming more green in their everyday lives. This initiative was designed to address the growing environmental consciousness of Canadian consumers. Just to put this in perspective, one recent survey reinforced that now over 50% of Canadian consumers buy as many green products as they can.

We have been pleased with the program's reception to date, and we plan to expand our MyPlanet offering through the back half of this year. We believe the MyPlanet initiative will lift redemptions, it will increase the issuance of currency, and it adds a new platform for our business development discussions with new sponsors and new partners. Now, speaking of new sponsors, we also believe there's more growth to come from covering a greater share of wallet of our collectors. We have a number of promising conversations currently underway, in traditional categories like hotels and liquor retailers, but also in new categories for us like telecom and quick service restaurant.

Moving on to the second avenue of growth. This really focuses on leveraging our traditional strengths to build out a complementary suite of services for high frequency retailers, which would include things such as grocery, gas, and drugstore retailers. These are categories where we've been traditionally very strong partners and have deep knowledge. For example, given our 17 years experience in optimizing Loyalty programs, we're really in a very good position to help our grocers understand how to analyze the data they collect through their Loyalty cards to make better decisions about marketing, promotions, merchandising and pricing.

We built out a suite of services that include our boutique Loyalty consulting business, a customer-centric data analytic business, which we call Pressima, and a growing direct marketing agency. We have had a strong success in the past years in building relationships with leaders retailers across North America, and we believe this will translate into incremental positive EBITDA contributions for not only Loyalty One, but also for other Alliance Data business. Together these services help us need the needs of not only our air-mile sponsors, but also non-sponsors, companies we can work with in Canada and the United States.

Now, I've left the most significant growth opportunity for last, and that is international expansion. At the last earnings call, Ed hinted at our strategy. And while I still can not share explicit detail, I can say that we've identified a number of priority areas, and we're in advanced discussions in two major regions. Our goal to build out coalitions similar to the Canadian model in markets where none exist today. Our preliminary model suggests that if either occurs, and we have confidence that both will occur, the potential for long-term impact is significant, possibly contributing over $250 million in Canadian dollars in annual operating cash flow after they ramp-up; and with double digit organic growth potential over time.

Before I hand it back to Ed, let me reiterate why I am so excited about our cap forward. We have a tremendous track record over the past 17 years in building the leading retail coalition on a global basis, and we're definitely not finished yet. As I said, we still see lots of potential to grow within the core mile's business. Particularly by launching new areas and new ventures like MyPlanet that help us capture new areas of consumer spend. And we're equally confident in our other two avenues of growth: building out complementary services for retailers and looking to optimize the value of their data and Loyalty programs, and translating the success we've had in Canada in building coalitions into attractive new markets.

Of course, I also need to take this opportunity just to thank the Loyalty One team. Achieving these results in this economic environment is a testament to the team's commitment and their engagement, and none of our past successes or our future vision would happen without them. So thanks to the team.

Back to you, Ed.

All right. Thanks, Bryan.

Why don't we go ahead and turn to Epsilon, and as I mentioned just a few things to mention. Here last quarter the President of Epsilon Services, also a Bryan--Bryan Kennedy, that is, you'll recall, was on the call and walked you through the reasons why Epsilon should be able to maintain stable financial performance in light of the worst downturn in marketing, advertising, spend in decades. And then additionally he felt comfortable in saying that stability wasn't enough, rather based on the huge number of Loyalty program wins, encompassing creative data, database, analytics, and digital solutions, he actually foresaw a growth this year.

And here we are in Q2, with high single digit topline and 15% adjusted EBITDA growth. We have long believed that there would be a secular shift in how the $700 billion in North America marketing spend is allocated. More and more of the fortune 1,000 is looking for the ability to capture transactional based information and use it to micro segment huge populations into manageable cells for targeting.

Further, each campaign can be ROI based so the client knows exactly what they're getting. In summary, there really isn't much else to say. The numbers, considering the environment, are great. They're fabulous. The pipeline and the wins are at records.

We will not see, however, the full run rate of Epsilon until we get a little further along in the macro cycle. But as such, we are maintaining our 7% topline, bottom-line full-year guidance and expect an even stronger jumpoff as we move into 2010. So a very nice job to the Epsilon folks. All right.

Let's turn to Private Label, and you should have a slide "Private Label's Services and Credit". And thus far we've covered Loyalty and Epsilon, which, again, very different from year's past. Loyalty and Epsilon now account for two-thirds of our operating cash flow or operating EBITDA, and that was the case this quarter, and now we're going to talk about the final third when you combine both services and credit for Private Label. Just to remind you, Private label services and credit involve services which cover things like network and other processing, remittance processing, statementing, customer care and marketing as well as database services and, of course, credit covers the extension of credit. Which in Q2 averaged about $400 per active account for our roughly 11 million active accounts during the quarter.

On a combined basis, revenues were off 16% and EBITDA was down a third, or $30 million from Q2 of last year. The drag was entirely due to two items: credit losses, which hit us for $30 million alone as well as the IO grow-over, that is we had a moderate gain last year, which didn't occur this year.

Big question is when will this drag end? We believe Q4 and we believe we're going to get there a piece in Q3 and then finally get there completely in Q4. The big question is why? And unlike the bank card industry--and this is the critical piece, we are behaving differently from the bank card world, which, of course, is much bigger and gets the headlines and everything else. But our performance is, in fact, quite a bit different; and specifically all of our metrics except for loss rates, are trending in the right direction, and actually loss rates we'll cover in a little bit.

And specifically credit sales. Everyone else is shrinking out there. And, in fact, we were in negative territory for all of last year. In Q1, sales were up 3% versus last year. So we went from negative to +3% and in Q2 we doubled that again to +6%. And in fact, having looked today just briefly--and even though it's premature, July is up from Q2's growth rate. So again, the acceleration continues. Sales should continue to climb as new clients ramp up and easier comps start flowing through later in the second half. And what does that mean? With sales comes merchant fees and growth in balances, and growth in balances drive finance charge, etc., etc., etc.

Second, portfolio growth. Again, I can't think of one participant in the bank card world that is growing. We are, however. And, in fact, we're growing in the double digits. The file grew a solid 10% in the second quarter; and again the question is how did that happen? And the answer is, well, it wasn't from our longer-term clients. But it's from our business model, where we signed 20 or so clients over the last three years. And these client, regardless of what is likely were declines in their own sales, still provided us with huge growth as our programs ramped from 0% wallet share up to a third of all sales, and this process takes three years to accomplish.

Next are yields. Holding up nicely. Fourth, funding rates. We spent, gosh, probably 90% of the phone calls on funding a year ago in liquidity. Now we can zip right through it. So I certainly view that as a huge positive, but funding rates continue to improve.

Everyone knows the base rate, such as LIBOR and treasuries have little room to move down. But borrowing costs are based not just on base rates, but spreads on those base rates; and as liquidity has continued to pour into the marketplace, spreads have indeed come in quite a bit. As such, our weighted average borrowing rate for the entire portfolio has improved versus last year. We're using part of that pickup to trade for a longer term fixed rate money. Specifically we're beginning to extend the maturities, and lock in fixed rate on our funding.

Most recently through our $700 million term fixed rate, asset backed deal, via the (inaudible) program, and we'll give you a little bit of an insight into the back half. You should be looking for more of that as well. We have nothing else to do this year in terms of things that are coming due on the bond side, but what we would like to do is begin to stretch out the maturity and lock down the rates for the future. So look for some of that going forward.

Let's return to the metrics. Fifth, delinquency rates, which are a key predictor of future losses. They have been stable for four straight quarters or full year, with rates ranging in a very tight range from just under 6% to 6.5%. Obviously this has implications to credit losses that we'll discuss shortly.

And finally growth. We've announced five deals so far this year, HSN, Haband, Springstone Financial, Justice and Big M, which is Mandy and (inaudible) says. Both HSN and Big M came with an existing program, and we have an extremely robust pipeline of potential new clients, including both start-up programs as well as existing programs with established portfolios.

Due to our robust liquidity position at the bank and the favorable competitive landscape, we will continue to be opportunistic when it comes to growth. We do see a two to three year window right now that offers us a very unique shot at higher than normal growth at very, very reasonable prices. And we will take advantage of it.

One of the key points that I think is lost on folks that it's important to emphasize here, mainly because I get asked the question quite a bit is the whole concept of, Gee, we understand that it's a heck of a good opportunity given the lack of competitors in the marketplace at the moment to grow Private Label, and have an additional acceleration; but don't you think that's a risky strategy in a tough macro environment?

And, again, it really comes down to how different we are from bank cards. Bank cards in this environment probably generate profits of--call it 200 basis points, maybe 250 basis points as a percent of assets. So if unemployment goes up another couple hundred basis points they're at breakeven.

We're very different. Because of the way we're structured and the way we offer our loyalty cards our business, right now, even at unemployment rates approaching at 10%. They're still throwing off profit or free cash flow of over 800 basis points on assets, just a huge number. In a good time it's 1,200 basis points.

So we are making the bet that unemployment is not going to 20%; and unless it does, we're going to make a lot of money here. And that's why we're growing and confident that it's a good part of our growth strategy.

All right. Bottom line. Positive trends in sales growth, portfolio growth, funding rates and new client wins, combined with stability and yields and delinquencies together suggest that a tipping point is finally coming. Right now these trends are chipping away maybe a third of the drag on the higher credit losses in IO grow over. The $30 million annual IO grow over anniversary is in Q4, so we'll left with just the drag of credit losses after that, which as we'll talk about, should be quite a bit smaller.

So time has now become our friend as the positive metrics continue to advance, and the drags will eventually run out of steam. The IO is done by Q4, and we believe our strategy of growth will allow Private Label to overcome a 100% of earnings drag by Q4. We've discussed the growth side. Let's turn to see what's impacting earnings, next slide.

Should say "Private Label Services and Credit" the outlook. Again, the overall outlook from a financial perspective is a $30 million drag that you're seeing today, which should gradually lesson, and then by Q4, we should be flat versus prior year. I think what you'll find on this slide is something that is new news to everyone. We weren't confident in putting it out probably last quarter, although we suspected as much. But now, based on what we've been seeing the last few months, we feel pretty comfortable with making a few assertions here.

Obviously Q2 was a tough one, and tends to be our seasonally most challenging quarter as our holiday shoppers either get their houses in order or they got to write-off. And this quarter's write-off soared 300 basis points versus prior year. We came in at 9.8%, versus just under 7% last year; and that stung. That's the $30 million stinger right there. Combined with the IO drag, it made for a very, very tough quarter.

All right. Let's take a look at a couple of things. First, over the years--and we've been saying this for the past year. Our losses have tended to track somewhere between a 100 and 120 basis points above the unemployment rate. With the incredibly fast and brutal job cuts and just the length of this recession, which I believe is now the longest since the great depression or World War II, I can't recall. The relationship itself seems to be changing.

Specifically, in Q1, the spread was not a 100 to 120 basis points, and it narrowed to 70 basis points. In Q2, it narrowed further to only 50 basis points above unemployment. Again, giving a little look-see into what we're seeing today. In July, I believe--or when we left June you'll notice that June's unemployment rate was 9.5% and June's loss rate was was roughly 9.5%, I think it was 9.6%. So we were flat with unemployment.

And having looked at July's numbers today, we are continuing to track at that type of level. So that entire spread has now disappeared. And as we look out to the rest of the year, Q3 losses actually come down versus Q2 due to seasonal factors. But let's just assume seasonal improvements are offset by continuing increases in the unemployment rate.

Regardless of that, expect Q3 losses to be actually stable with Q2 losses. This would also suggest Q3 losses will, in fact, be equal to the unemployment rate, assuming it creeps up slowly. In other words, no spread anymore.

How can this be happening? Our belief is that two factors are driving this. First, growth. And again, this is what makes us different.

We are--if you think about it, we're continuing to grow the file at 10%, adding new retailers and new accounts which have, "made it through" the recession and thus far, and as such has qualified for an account with us. In other words, these are very seasoned tough accounts as we call them.

And, second, the sheer duration of this recession is so long, that it's finally beginning to burn off, through write-offs those accounts which were most vulnerable. The result is a growing portfolio of stronger accounts.

The bottom line, the macro unemployment will no doubt continue to creep upwards. Our loss rate, however, should continue to narrow the spread over unemployment, and we think will be equal to it as soon as this current quarter. And if so, that means stability has returned.

Also, by Q4, we'll no longer be looking at losses 300 basis points above prior year. Rather, in Q4 we'll be looking at losses at half that amount. So the drag should be greatly reduced. The IO goes away, and we should be looking at the very, very strong cash flow coming from the 10% growth in the file.

And finally, as the unemployment rate, while not falling, begins to slow its upward movement and our spread above it disappears, grower will be completed and then all the new growth put on the file will finally flow to earnings. So the loss rate in Q3, we expect to be flat to Q2, despite increased unemployment rate. We expect the drag to be reduced and in Q4, we expect our Private Label business to finally turn the corner and be breakeven versus last year.

Jump off for 2010 Private Label becomes a contributor again, side-by-side with Loyalty and Epsilon, and based on what we're seeing in our models, we're liking the scenarios. Thank you for being patient. We're moving as quickly as we can.

Let's hit the balance sheet, Canada first. Deferred revenues increased over $80 million to $1 billion from Q1. To remind you, these are monies that have been earned but not yet recognized in the current period. They will be recognized over subsequent quarters, and the trust cash was up $10 million to a bit north of $0.5 billion.

All right, next up, corporate liquidity seems to be on some people's minds. Our net core debt or a key measure of leverage was $1.6 billion, with LTM operating EBITDA of around $660 million. So our key measure of leverage, the ratio came in at a modest 2.4 times, which was well within our self-imposed ceiling of 3 times. Also, we kept right on going with the buy back and picked up over 5 million shares for around $225 million. The program to date, we have now purchased 27 million shares or one-third of fully diluted shares when the program began for around $1.4 billion.

How about going forward? At the corporate level, we have bank loan facilities with $300 million of unused capacity. We have $120 million of cash on hand, and we would expect roughly $200 million of free cash flow from operations expected in the back half for a total of more than $600 million of liquidity. We have the liquidity. We strongly believe the buyback is the best use of our liquidity. And I believe that one is covered by now.

Separate from corporate, the bank, which handles our Private Label business has been extremely successful on the liquidity front. Currently we have 5.5 billion in committed facilities, which given our $4.2 billion portfolio, leaves us with $1.3 billion of excess liquidity at this point, and we're not done yet. I will make a comment that having been on the front lines of this liquidity mess over the last year and a half, a general comment is that it's a whole different ballgame today than it was a year ago. At the corporate level, high-quality companies can much more easily access liquidity in a number of ways: bank loans, converts, private placements, rated bonds, etc. And at the bank level, FDIC insured CDs, bank conduits. In the term market, via the TALF program have providing huge in flows of liquidity. So clearly liquidity is back, and we think that should point the economy in the right direction.

Let's go to guidance on the next page. Simply stated, no change. We're maintaining our 515 cash EPS, which is up 17%; and on a constant currency basis, it would be up 25%. How are we going to get there?

We'll walk you from Q2 to Q3, and we mentioned that Q2 came in about $0.04 ahead of guidance. Nonetheless, we got dinged by $0.14 on the FX issue. Since the $0.14 is timing, we should effectively make that up in Q3 and Q4 and be in decent shape on the 515. With the Bank of Montreal launching its program for air miles, Epsilon growing again, Private Label looking to lessen the drag each quarter and the buyback continuing, I think we're most of the way there. The final piece would be to complete the purchase of a moderate sized Private Label file to bolster Q4 and to get us there completely.

Now for Q3, I think we've discussed the FX and Private Label seasonality. That is, in Q3 yields drift upwards while losses shouldn't move. Also Epsilon tends to have its biggest quarter in Q3 due to all the activities surrounding back to school and an early jump by clients on the upcoming Thanksgiving and the holiday season. So you take Q2, there won't be a U.S. FX mark. We'll have the typical seasonality in Epsilon, the typical seasonality in Private Label. Stock repurchase will help, and that should bring us right in around a $1.34, up 10%, and $1.40 of 15% constant currency.

Finishing up. Free cash flow, again, no change on the per share. We still think we're going to do $6.00 per share, and I think that's about $350 million of pure free cash flow, and we are tracking to that as we speak.

All right. Final page, I promise, is the big picture. At a very, very high level, it's fairly straightforward. The great recession that we're in, we are facing roughly $160 million in EBITDA headwinds between credit losses, foreign exchange and the IO. That equates to a $1.75 per share.

So it's--it's quite a group of headwinds. Thus far, however, we seem to be playing through. Loyalty, we expect double digit EBITDA growth for the year. Epsilon, which has moved from no growth to very nice growth, and will stay 7% for the year.

And then Private Label, the portfolio is looking at double digit growth. Credit sales have accelerated from negative to 0% to 3% to 6%; and they're still accelerating. The spreads are improving on funding. We've announced five new wins, I would expect three to four more.

And probably the biggest new news is our losses are very quickly converging with the unemployment rate, which is very good news. We have the accretive buy back. So really I think the only thing left to do is we want to pop on a moderate size file, which we feel pretty good about to make sure that Q4 is in solid shape.

The end of that would be 17% cash EPS growth, 25% constant currency growth; and while that would be, we think, an excellent year for us, I can tell you everyone here is looking towards what we call the slingshot of 2010. Because at that point, you're now going to have all three engines are in growth mode, the headwinds will be effectively gone, or largely gone, and you'll have a much lower share count. You throw that altogether, and it should be a heck of a 2010 and going into 2011. That being said, thank you for your patience, we'll open it up for questions.

Operator?

We'll pause for a moment to compile the Q&A roster.

Your first question comes from James Kissane of Banc of America, Merrill Lynch.

Thanks. Hi, Ed and Bryan.

Bryan, since you're there, I got to ask, and since you brought it up. How fast could you ramp a new market on the Loyalty side and maybe add--what kind of cost would be involved in ramping a new program?

I'll take a crack at that.

The fact is, is we've got all the infrastructure in place clearly in running the Canadian program. It's just a question of creating an iteration of that to get a market up and running. The real key is finding the willing players who are going to sign on. And so, it's more of an up-front sales process to work, to identify and get those contracts done and then push forward from there.

So we know what it takes to actually launch and get these programs going and don't anticipate that--it's a matter of months once you get the signed agreements in place. So I think that answers the first part.

Do you want me to take a crack at the second one? The second part is, I'll answer that piece. The fun part about these programs is that they cost a fair amount of money to get up and running. Despite the fact that we have the leverage of all the existing infrastructure, you still have the marketing cost, the enrollment cost, and you have to get the consumer a collection device of some form in their hand.

So with the accounting methodology, the recognition of revenue, the challenge you have is you load the expenses to launch the program, and you have to recognize that revenue over sort of the life of a point. So the key here is to really keep our eye on the future goal, which is the size of the long-term profitability of these businesses, and you have to weather your way through the up-front challenges financially, recognizing that these things are highly profitable and sustainable.

Yes.

I think, just to put some fences around this thing, from a P&L perspective, obviously as you're starting this up, you're going to have a P&L drag. However, from cash flow, we would expect to be effectively cash flow neutral to cash flow positive very quickly out of the gate. The way these things, as you know, we get the cash in the door right up front. So cash flow shouldn't be an issue. The question is how big of an issue is the P&L going to be. That would be something during structuring. But right now, Bryan needs to get a couple more signatures and get this thing announced and going .

Okay.

Just on the quarter, the Loyalty EBITDA growth was very good, but issuance has been lagging for the past several quarters. Can you give us a little more insight in terms of what drove the EBITDA growth year to year?

Remember that revenues and profitability is recognized over time, so it bleeds in as we roll along. So we're benefiting from past years, really superior performance over the past number of years. But on top of that, you've got to recognize a couple other moving parts. One is that we've got some discretionary spending in our business in terms of how we grow it. So we have obviously continued to invest behind the big moving pieces that are going to drive future growth, but we've also been careful around our expense base, and the last piece is to remember that we have looked for efficiencies given the market that's out there with respect to the cost of rewards. So that's generating some positive results for us on that side as well.

Okay, great.

Just one last question. Portfolio acquisitions, are they going slower than you originally thought? I think you said in the release you need to do a moderate size portfolio acquisition to meet guidance for '09. Can you kind of define what moderate is?

Yes, I would say it would be north of $200 million, and I think that would put us in pretty good shape. I mean we're pretty close right now. I think that one extra kiss would be what we would need to really lock down the nums for the year. Where are we in the process? Obviously I can't give you specifics. There is a lot of product out in the market right now, and we have been pretty stingy about what we're looking at, and that has carved out a huge number of the stuff that's out there.

The last thing we want to do is bring something on that gives us grief. So I would say, right now, there is a very--we're in pretty good shape. I would expect an announcement sometime in Q3 the way things are progressing right now. And so I think we're in decent shape there.

Great. Thanks, Ed.

Your next question comes from Bob Napoli from Piper Jaffray.

Good morning. Or good afternoon. Good night. A long season already.

But the question, I guess, on--just on capital, Ed, I was hoping you could address--I mean, obviously the first quarter right now, from an accounting standpoint, you're going to have to move the off balance sheet to on balance sheet. And regulators may or may not stagger in, it seems like they may. But obviously you've got to prepare for a worst case scenario. How comfortable are you with capital? How much capital do you have at the end of the second quarter in the bank, and what are your thoughts on being prepared for a worst-case outcome from regulators?

Yes, good question.

It seems to pop up quite a bit lately. For those of you who do not live and die by FASB or regulatory requirements, what Bob is talking about is the--from an accounting perspective, the new 140 regs are essentially requiring us to bring on balance sheet that portion of our Private Label business that has been funded off balance sheet, and what does that do to capital. And from an accounting perspective only, we right now, I believe, ended Q2 with a tier one ratio of about 23%, 24%, which is a solidly capitalized bank is somewhere around 7%.

So I would say, from that perspective, we are certainly in the driver's seat there. Now we went through all the ins and outs of what all these requirements would be, should we bring everything on balance sheet and the 23%, 24% came down to around an 8% or 9% tier one level. So again, without having to raise any capital, we would be considered solidly capitalized if it were required day one. So I think that's in good shape.

I will make the comment, however, that, look, you look at some of the big banks out there, even the most solid banks, I think, even like JPMorgan. Their tier one today is 7% while we're at 24%. So it's going to be a tough putt for the big guys to start, pulling in 2 or 3 trillion, and having to get to those regulatory levels. So all I can say is it is our opinion, it has not changed over the last year. There are no regulations out at this point.

So again, this is all speculation, and it's--we're heading into August at this point. So from a regulatory perspective, we do feel very comfortable in saying that, Look, with no regulatory requirements, we can only guess and our guess needs to factor in this 3 trillion of this stuff out there. We certainly will be fine if we have to do it immediately. But the preponderance of evidence would suggest that there will be a burn-in period of two or three years, would be our guess. It's the only thing that would make sense. And, again, that's our opinion; and--but given all the facts that we know at this point, we're ready to go either way.

Thanks.

And on the U.S. dollar assets in Canada, I think I heard you clearly, there are no more U.S. dollar assets remaining in Canada?

No.

What I said was, we had a couple hundred million dollars up there. The bulk of which was this interco-loan between Canada and the U.S. that we put in place for a tax--as part of our tax strategy. That has been closed out with the funds now fully upstreamed to the parent. There was some confusion about, Hey, was that in the trust or something like that. It had nothing to do with the trust. It was completely outside the trust. So that's out, and that was the biggest chunk.

So what's left is you do have some U.S. dollar denominated investments that are in the trust. But those have been capped out, and any movement in the dollar should not adversely effect the financials for the quarter because they'll be relatively small.

And it's about a hundred million left in there?

Yes.

Okay. And then the servicing business, the revenues and then one last quick one. The servicing revenues for the credit card business were off this quarter. Was there anything unusual in there?

There wasn't anything unusual. I think the servicing business, because all we do is essentially lump all the costs together, and mark it up to come up with an approximation. It's going to chop between the quarter depending on things like marketing expenses and stuff like that. So what I would do is I'd look at it at a full-year basis, and let's assume we're going to grow our statements by a certain amount, somewhere in the single digits most likely for the year. I would expect revenue and EBITDA to follow that.

Thanks. And last question.

Can you give any more color on 2010? I guess you will more next quarter, but your share count will be down about 20%. On average it looks like, going into next year, your typical--I mean, you look to grow earnings, I guess generally 15% or more. But the slingshot is--I mean, do you feel comfortable growing--given what you see today, and a lot can change; but, would you be disappointed if you didn't grow at least that much on the earnings per share into next year? Can you give any thoughts around that?

At least how much?

Well, the 15%. The share count's going to be down 20%.

Yes. I'd be pretty disappointed.

Any more color on that, or--?

Well, look, you've got Loyalty, right, it grows. The thing just keeps growing, and Bryan is down here. He won't cough up any number at this point, but if you ask him, maybe he will. Epsilon, right, they're back in growth mode, and they're just growing at a moderate pace right now.

Once the--if you think this is affirming in the macro environment, yes, the advertising marketing space hasn't been this bad in decades, and yet they're still growing. So you have two of the engines growing, and then finally if things come together in Private Label, which it looks more and more like they will, you're going to have a file growth that's well into double digits. Sales have gone from negative to we're hitting in the high single digits at this point.

And the losses--the longer this recession goes on, and the more we add on the front end for new accounts, we're just burning off the weak layers. So the grow over is less and less. I would fully expect Private Label to go from a big drag to a positive contributor in 2010. So you've got three businesses all contributing a positive growth rate. I can't say what those growth rates are now, they're probably not going to be fully up to what it would be during the good times, but somewhere in the middle.

But if you get three engines doing that, you no longer have an IO grow over to worry about, and you've got a $40 million foreign exchange headwind going away, and actually may be a tail wind. You combine that with the lower share count. That's the color. It's kind of math at this point.

Yes. And you're 515 for this year so that would be well over 6, I guess. Anyway, thank you. I'll let somebody else ask questions. I appreciate it.

Your next question comes from Dan Leben of Robert W. Baird.

Great. Thanks.

First a question for Bryan on the Loyalty business, talking about new markets and thinking about the opportunity there. Help us understand how you sized that opportunity. Is there a way to think about a third of the opportunity of what you're currently doing in Canada? Is that--the economies are a third of the size smaller, or is it just lower assumptions on penetration rates given how great the Canadian business is doing?

It's probably mostly the latter. In fact, most of the markets that we would be looking at would be--we're looking at economies, which would replicate at least the Canadians in the scale of business. Otherwise you really got to wonder why you're going in and doing it.

We tend to look for countries that have the following characteristics: A maturing retail environment, a good usage of financial services and credit cards as payment from a consumer perspective, a strong network of potential partners, and ideally a market which doesn't have another coalition partner program that's in place today.

And, if you put those together, and you think about--and you think about it, to your point, it's unlikely that we're going in the early years have the same level of penetration that we would have in Canada. But the scale of opportunities, as we look at these, we want them to be in a similar sort of range as the Canadian business.

Okay.

And then, just on the BMO deal that you announced here. Back last year, when the BMO reduction assets came on the balance sheet, at that point, we had to have a change in the break for assumptions. Is there something naturally about the BMO miles that get redeemed at a higher rate, and could we see a change in the assumptions when we get to the third or fourth quarter because of that?

Don't anticipate a change. The fact is, is that a credit card carrying customer tends to be a better customer and they tend to redeem at a higher rate essentially.

Actually the way it works is there is no exposure for us there. In other words, think of everything else we reserve at two-thirds. All right. 67%, and that's been the case for--since the beginning, and Bank of Montreal, we thought the redemption rate should be more like 75%, and so we had a weighted average of 72%. So to the extent we are bringing on more and more credit card type miles, it being issued, right? They would be reserved at that rate naturally, and we get compensated for that as well.

And I think it's important to remember that while the credit card deal will grow credit card miles in the mix, we're also seeing growth from other partners, the retail partners like gas and grocery. We're expecting those are going to continue to grow into the future.

Great.

And then just quickly jumping over to the Epsilon business, obviously great performance in the quarter when looking at some of the comparables have not fared quite as well. Could you talk a little bit about--are there certain verticals where you guys have more exposure, that those industries are doing better? Is it the fact that a good portion of the revenues recurring on the data side, or is it just simply adding new clients and this shift towards e-mail and digital within the marketing space?

Yes, yes, yes, and yes.

I think across the board, all good insights into what's going on in the business. Dan, I think it's--obviously the big--as I call him, the big honkin' Loyalty programs, right? You don't turn the light switch off on those. So those continue on.

There is no question that the shift towards digital is continuing; and obviously being, we believe--I think, the largest permission-based e-mailer in the world, with 60% of the share or something like that. We're going to get our share of that. So I think that's helpful.

And then what we saw, which was a little bit interesting, from the first two quarters is in our data business, which includes the big ABACUS asset, those 1,800 catalogers. What we're finding is that, I think the number is 73 of our clients within ABACUS have now decided to use just ABACUS exclusively for all of their data needs. So what we're doing is we're picking up quite a bit of share on the data side.

We're also going into new verticals, such as publishing, and not for profit on the data side. And so data, rather than being a drain in the quarter, was actually relatively flat with the other two pieces, with the other big piece, being up obviously double digits. So I think that's the case. And going into Q3 and Q4, again it's choppy by quarter; but on a full-year basis, the 77 sounds about right for us.

Just a quick follow-up and I'll jump off.

Could you talk about retail and pharma in some of the verticals you've talked about in the past in Epsilon?

I'm sorry.

Retail and pharma, you mentioned some of the things going on in some of those areas. Could you just talk about the performance in Epsilon and those quickly?

Yes.

I think we released the AstraZeneca deal. We do have, I think, virtually all of the global pharmaceutical firms. That has been a very kind vertical to us as they do extensive direct to consumer marketing. That has been a very nice growth area for us.

Also what is surprising to a lot of people is financial services with all the turmoil and things like that, people think these firms are cutting back. They're not. Actually our largest clients have actually committed to significantly more resources to build their Loyalty programs, because let's face it, that's where the action is. You want to hold on to the customers.

So I would say pharma. I would say financial services, packaged goods. We had a good quarter with packaged goods. I think those are probably the big three that performed the best.

Great. Thanks, guys.

Your next question comes from Darrin Peller of Barclays Capital.

Thanks, guys.

Hey, Darrin.

A quick question on the credit business if you wouldn't mind. First of all, delinquency trends looked, I mean, I know you guys said they were stable, but what were they like last quarter? Was it actually 65 last quarter?

Yes.

So it dropped 30 basis points sequentially?

Yes.

And how much of that was actually seasonal versus anything else?

All of it.

It's all just seasonal, nothing associated with the actual quality of the portfolio?

Yes.

I'd love to sit there and tell you something different, but the fact of the matter is seasonally what happens in Q2, right, is as the saying goes, you get your house in order or you go under. So getting your house in order usually means that delinquencies from a seasonal basis hit their low point for the year in Q2, while losses peak from a seasonal perspective in Q2. As you look into Q3, what you'll find is you start reversing that, and losses tend to come back in seasonally, and delinquencies will drift up. I don't think they're going to drift up a ton, so I think you're still going to be in the mid-6s.

Okay.

And then with regard to the recent consumer legislation that was enacted in May, have you guys considered any changes on maybe APRs or any other type of pricing changes ahead of the enactment or implementation of those laws, or implementation of those laws?

That's a great question.

The laws that are going into effect, we obviously have taken a hard look at it, and a lot of it is really geared more towards the bank card industry, specifically related to really the whole business model, which is risk based pricing and how payments are applied, whether they're applied to the teaser rate balances, the deferred balances, etc., etc. And what they're doing is they're essentially moving away from that model, and actually they're moving towards the Private Label model, which is one size fits all.

Right.

And so that's sort of the biggest one. There are no caps on the APR from the legislation. So I think we're in good shape there. I would say the one area that we are watching with interest would be the whole late fee area. That seems to be the only thing that we want to keep our eye on. Late fees for us, we charge $25.00. The bank cards usually charge around $39.00 or $40.00. So we certainly think we're in the zone in terms of well below bank card.

The other thing is people may say, Well, you have a much smaller balance than bank card, but the fact of the matter is the fed has come out and said there does need to be a punitive component to any late fee. So basing it on balances with a very small balance, having a $0.50 late fee doesn't do it either. So right now, we think we're in decent shape on everything, and we will await the fed to give guidance.

Congress kicked it to fed to give guidance on what is considered a reasonable late fee, and based on what they say it would have to be implemented in October, I believe, of 2010. So it's over a year away from now, and I think there will be a comment period. And as soon as--like I said, it's kind of like the FAS 140 stuff on the reg side. As soon as something comes out, we'll let you know. But needless to say, if we do think there's something that's going to ding us, we'll certainly look at all other avenues.

All right.

Quickly, the purchase volume trends. I thought it was a pretty impressive pickup from three to six. How much of that was just portfolio--just business ads, new client wins versus just organics sort of same-store sales pickup?

Again I'd love to tell you it was the core that is turning rapidly. It's not. I would say probably a 100--a 100% of that 6% growth came from those retailers that we've signed up in the past three years.

Okay.

So they're all--let's face it, I mean, it's with a 100 programs there's 80 that have been with us three or more years. I would say 90%+ of those are negative comps in the high single digits, if not some in the double digits. The new programs, again that's the model, that's what's really powering the growth, and it's continuing to pick up steam.

Okay. That's great.

Then to touch on the--for Bryan, the air miles program. We heard there's good color on that, how it really works, but I'm still trying to figure out a little more about the benefits from the BMO changes, just kind of quantifying it. Would you be able to help us kind of understand the potential for additional issuance and cash flow, per se?

Yes. In terms of the issuance in the back half of the year, we're looking at a 4% lift in terms of the growth side of things, I think. I'm trying to think if that's the number. And we've been relatively conservative. What we've done is it's affecting a portion of their portfolio overall.

It's not their whole portfolio. It is the largest number of cards in the portfolio. As they move the cards up, we're expecting that those--remember those customers just have to spend the same amount of money they were in past. And in total what you're going to see is that they will double the number of miles that are coming into their accounts and, therefore, double the revenue from that component of the overall portfolio.

Specifically in terms of the numbers themselves, what we've done is just be conservative, and what we've assumed is the doubling of the points from those customers. But we believe, along with the bank, that what it will do is it will build more cardholders long term and increase the spend of those customers as well once they start getting those points. So it's hard to peg an absolute number. Suffice it to say that as we look at the growth in the back half, we've been conservative around what our expectations are, and that's what we've baked into our third and fourth quarter numbers.

Yes.

I think, Darrin, if you really wanted to look out over the next year--and, Bryan, correct me if I'm wrong. BMO obviously, this is public, is our largest client, it's 15% of our consolidated revenues. It's a big one, and that's a big number, and the program that Bryan is talking about does not--we have both the cards and their retail bank products. It doesn't cover their retail bank products. It's a subset of the cards that are there, albeit, a big subset.

So needless to say this is, hopefully, a win-win for both of us; and as Bryan said if you looked at what's going to allow us to exit the year in the high single-digit growth rates, you anniversary the gas, you anniversary the first week quarter of spend in Q4; and you throw on, we're just going to say a few points of growth related to the BMO, which I think is certainly reasonable.

That's great.

You're going to be up, you know, in the high single digits.

Good. All right. Thanks, guys.

Your next question comes from David Scharf of JMP.

Hi. Good afternoon.

I wanted to follow up with a few more questions for Bryan on the air miles side. One is this BMO change seemed to kind of come out of nowhere and fall in your lap. Without naming any names, just given the current market environment and the tendency of market leaders to try to consolidate market share in sort of a down economy, are there any other major sponsors that you think are materially looking at retooling their rewards programs?

I'm sorry. He just left the room when you said it fell in his lap.

I'll pass your comments along to the account team that worked long and hard in making a change in the deal. I mean, we are constantly working with our sponsors to enhance the offerings that they have in the marketplace. We have a number of sponsors who, for example, don't have an air miles offer across all the banners, even though they have it in one banner.

Part of the results that we're seeing through the back half of this year will also be related to a couple of banner extensions that we saw with a couple of our grocers. Sobee's brought on the Foodland banner, which is a smaller format grocery store, but it still resulted in some nice growth for that account. In addition to that, we brought on a conversion for our grocer in Ontario Metro who launched the program and the banner called Lobe. We don't get into the small details of that, but we are constantly working on one, extending the program into new locations. Two, enhancing the offer that they have, particularly as it pertains to promotional miles and bonus miles. So it's positive from that end.

Just coming back to the bank for one second, I think what's to be reflected here and really what we're seeing across many accounts is that the bank really wants to be aggressive in these times. They see an opportunity to reach out, try and grab some more share. They've had some great success with their gold product when they put it in the marketplace, and they believe that they can bring the same sort of success despite the macro economic conditions to their entry-level product by enhancing the offering. So that sort of is what we're seeing reflected in all the conversations we're having with most of the partners at this stage.

Okay. In that same vertical is just in terms of number of cards, is the air miles AmEx program, is it half, a tenth, a twentieth the size of the BMO MasterCards that are affected here?

I think, I'm not going to comment on the relative size of the portfolios, because it's something that they try and track through market share data themselves, and we're very careful around what information we share on that. But I think it's enough to say that the last time we went through this, it was when AmEx actually introduced a product into the marketplace after the Bank of Montreal had been a partner for about five years in the program.

I think if you're getting to the underlying question is also whether we expect something to happen in the AmEx portfolios as a result of this. And when AmEx launched, we watched very carefully and saw that the Bank of Montreal actually acquired more cards during that time period because there was more noise in the marketplace from a marketing perspective, and ultimately what we're working on here between the two partners is to replace a Visa in the consumer's wallet.

We want AmEx and MasterCard to be there, so that is the goal, and we will monitor what happens carefully. But you can imagine that American Express at this point is also looking at what they need to do to stay competitive. Does that answer your question?

Yes, yes. No, it did.

And also, Ed, the last two quarters, I think, you made reference to the second-half outlook and miles issuance being hopefully to be impacted by more heavy promotional spending by some of your larger sponsors. Is that pretty much underway?

I think that's it. The BMO deal is the biggie, so that's going to move like we said a few points of growth right there.

Okay.

So that reference kind of looking back at those prior comments, was it mostly related to the knowledge that the BMO deal was going to be announced within months, or is this reflecting some bigger spending commitments by some of your other sponsors.

The bulk of it is the BMO transaction, which I will say didn't quite fall into Bryan 's lap, but he did--they actually put--

--an economic windfall.

They've been putting their shoulder into it for six, nine months or so. So that's the biggie.

Bryan , are there

I think we've got--we're going to see more promotional activity from Shell; and again, I can list a litany of other initiatives that we have, but the largest single component of change in this is going to be the bank offer change. But we expect that we're going to see increased activity in a number of partners.

Okay.

Good and just one more question on the Private Label side, Ed. Where do the conduit lines stand right now? What are the balances there?

On the conduit side, we have--I'm trying to think about it right now. We've got about--let's see--a billion, one or two billion, I guess, and I would say--what do we have in there, Bryan ? About 700? About

I'm sorry. 700 million?

Yes.

Okay.

Your reference to being more opportunistic in the back half of the year on the asset back side with TALF supported funding, is it likely that a new issuance would be as much as $700 million? Is your desire to pretty much completely take out that 365 day paper for now and sort of lock into longer durations?

I'm told I need to be careful about what I say so I don't condition the market or whatever that lingo is. How's that?

But needless to say, we view that we're done from the liquidity perspective in terms of what needed to get done, and so now--and David, you'll remember this years ago, we did the same thing. We are going to take advantage of this environment of low-rate tightening spreads in the largess of the federal government, and you can be assured that we are looking at every opportunity to lengthen the duration of the file, and the lockdown fixed rate term funding. And that would lead you to only one conclusion; and that being said, to the extent we did do one or two more deals, you're freeing up another 700, 800 million--700 million of capacity for sure.

Got you.

And I apologize, actually, just one more quick one, housecleaning. Underlining your guidance. Are you assuming, Ed, that the remaining $400 million of repurchase authorization occurs by the end of this calendar year?

I don't think we can comment on that one.

Got you. Okay. Well, thanks a lot.

Yes.

Your next question comes from Dan Perlin of RBC.

Thanks. Just a couple quick ones.

One, on the expansion of the Loyalty program internationally. Bryan, from what I remember when you launched the program originally lost money in the first five years of it. So I understand there's an up-front cost, but I'm wondering how long is that going to be a drag? And then on that same vein, you said the infrastructure is in place, but I'm wondering what infrastructure are you going to be able used to take something from Canada to somewhere else in Europe or Latin America or something like that?

On the first question, I think there's two pieces to that. First is that in terms of leveraging infrastructure and sort of bringing program efficiencies to it, that should reduce the overall cost. And then the second piece is depending on how you structure the program, what happens is for the life of a point--and that's all dependent on the individual market dynamics, and what would be interesting to the consumer, and how long we anticipate that they will take to get to the type of rewards that they're looking for. All those have dynamics which will impact how you recognize revenue and that would impact how long you'd dig a hole in terms of the profit considerations from reporting. Ed talked about cash flow before.

Ed?

Yes.

You're exactly right. Don't forget, the Canadian program started from scratch and actually I think it took seven years from an accounting perspective to break even. Again, I don't think we know enough about the final structure. Again, we want Bryan to be putting ink on paper. It should be his focus right now.

But from a structuring perspective, what's going to be interesting is hypothetically, of course, there could be a sponsor or two who has their own Loyalty program, or who has an installed base of a number of customers that can be switched over.

And that shortens the lifecycle.

And that shortens the lifecycle. In other words, you get this huge jump-start.

Now, have we all--would we eventually--the first year, of course, you're not looking at a big number. But if you're looking at a bigger number in the second or third year before this thing finally starts cranking out P&L, you're not really looking at a lot of cash flow on the negative side. It should be cash flow neutral. That would be our preferred structure. From a P&L perspective, would we look at having partners take equity stakes or something like that? That's really Bryan's call.

All structuring questions. I think the second piece of your question was really the one around what infrastructure we would leverage. Clearly in order to get one of these programs and manage it, you need a points engine, you need a database, you need background, you need the marketing capabilities from a website, e-mail, and all those things are in existence today and are naturally running a coalition today. So the goal would be to figure out what-- which is virtually all of it you could transfer over into other geographies to help streamline the time it would take to actually launch one of these.

Okay.

And then is there any really implemental costs for BMO? There's been a lot of questions about it, but the question I have is if they double up on the miles issued, what are the incremental costs to you?

Again, we won't get into specifics of that, but all our contracts are structured where when a mile is issued, there's a payment that comes to us. So clearly there's an incremental cost to the bank.

Right. Cost to the bank, but not necessarily to you unless you cut price on that deal?

That would be correct.

Okay.

And what percentage of your gross yield is coming from late fees now ?

That's a good question. I would say--I don't know if we break it out that way.

I thought 5% or 5 points of gross point at one point. Does that seem high?

No. That's probably a little light. Probably a little bit more than that.

So call it 6%, 7%, or 10%?

I don't think it's 10%. That's for sure.

Okay. So we'll say kind of 5% to 8%?

Sure.

Well, I want to be close to accurate. So are you comfortable with that number?

I don't think we give out the number, the split.

Okay.

I can give you--I can tell you if you're in the ballpark.

Okay.

But I don't think we've ever given out that number.

Okay. And then you talk about your core debt to LTM of 2.4. How do you think about that as you go forward for the next 12, 18 month? Are you comfortable holding it at that level, which is to say you'll be opportunistic for other opportunities, or are you going to bring that down as we think about 2010, a slingshot cash flow year?

Boy, that's a good question.

I have to tell you, I think it's in the DNA of the Company, because coming out of Welsh Carson so long ago at 6.5 times. And of course, the fabulous Blackstone deal at 8.5 times or whatever it was. Obviously we have comfort in the model that--a little bit of leverage certainly doesn't spook us. Even moderate leverage doesn't spook us. In the old days, moderate leverage was five to six times. We're not going to go back to those days; but three times for us is certainly--we have a high level of comfort at that level.

So we would prefer, in order of importance to be out there as we finish plowing through the buy back here, and as we move forward and the cash flow starts realizing and we want to return to growth mode that we used to be at. And not dancing around a bunch of, let's take advantage of the cheap equity markets, and get some--a very sweet deal on the equity, which is nice, but it's not really what we do for a living. The portfolio acquisitions and Private Label, they can be done with the liquidity down at the bank, so they don't need help from corporate.

So you're left with--up at the corporate level, and that liquidity, I'd personally would much rather push towards Epsilon or push towards Loyalty, and have them grow even faster, and that always used to be our model. And we desperately all want to get back to a growth company and a lot less chatter about credit and financial engineering and stuff like that. So plan on us using it to grow more, and we're very comfortable at three times or less.

Got it.

And then, Bryan , there had been some talk a while back that you guys had headed further west into Canada, that you would create these non-exclusive relationships with your sponsors. Is that still occurring--is that helping margins; and if it's not, why

Yes.

By non-exclusive, I'm assuming you mean co-exclusive. Where we look at certain categories, and we may have an existing player or we may be looking to develop a category, and understand that we think that two or more players would be there. I think, as I mentioned in the new business development side of things, hotel is the category we're pursuing. Still we had intercontinental hotels in, we launched Hilton last year, and we would like to have another partner in that category come along. So it continues to be part of our strategy. It does not have a margin impact over the long term, because we are growing overall issuance, and new deals on those side; and so in select categories, we'll continue to work at the co-exclusive models.

Got it.

And someone earlier asked about--I guess picking everyone's brain on 2010. But you have $1.75 a share of headwinds. You're in the year at 515. Is it safe to say that you're going to spend some of that $1.75 headwind on these initial growth initiatives or could we actually, conceivably think about some of that flowing through at maybe 80% into next year's number?

Yes.

All else equal.

It's a great question. We'll obviously--we're have some pretty strong growth, slingshoting into 2010. But again, it comes back to what's in our DNA, and a couple of things that we will use some of the excess to, obviously, help launch a couple of these initiatives we talked about, because the PV on those things are just so huge. But that's what we're about.

And secondly, we have a whole bunch of variable rate funding; and because of the lack of liquidity in the term markets over the last couple of years, we got--quite frankly, we're caught right now with way too much short-term money, variable rate money; and while we've got tons of capacity, we're not at the comfort level we want to be, and so we will trade off some upside to extend out the maturity and get some long-term fixed rate money and really lock things down. And we could be completely wrong, and inflation may never rear its ugly head again, but that's not our call. So we'll be using it for those couple of things.

Great. Feels a lot like two years ago.

Yes.

Thanks, guys, I appreciate it.

Look, it's the same gig as a few years ago; and it sort of views some of what we think will be overperformance to take care of things that provide longer-term growth opportunity and better visibility.

Looking forward to it. Thank you.

Your next question comes from Wayne Johnson of Raymond James.

Hi, yes. Good afternoon.

Just a follow-up on a cross-selling opportunity between the three divisions. Could you expand a little bit on that? What do you see as a cross-selling opportunity between Private Label and Epsilon? If Loyalty rewards program would ever be roped into that equation?

Sure.

I would say from a cross-selling perspective, to be quite blunt and honest, I think it's more of an intradivisional cross-sell. So you may have within Epsilon, ABACUS clients that are also sold into some of the Loyalty programs within Epsilon, etc., etc. That's where probably most of the juice is, Wayne. However, have we announced?

Okay. Never mind.

There will be an announcement in the future about a pretty significant Private Label client who also has, because of that experience has decided to be a fairly significant client within Epsilon. Also, there are a number of Private Label clients who are obviously ABACUS, which is an Epsilon customer as well. Bryan , can

I think the other piece on our side is we work closely with Epsilon in that we specialize on the technology side on coalition programs, but our Loyalty consulting operation, multi-one consulting works with companies to reengineer and also design new Loyalty programs. And when we're looking for a back-end provider to help build the database and the points engine, Epsilon is clearly one of the candidates that's part of the evaluation phase. So there is a nice handoff that exists on that side as well.

Would you say that these cross-line opportunities are higher margin or high-margin contracts compared to just Epsilon as a whole, or compared to Private Label? Could you kind of give us a sense of that?

I don't think we should, Wayne.

I thought I'd try. Are you guys going to continue?

Is it your intention to continue the share buy back next year?

Next year?

Yes.

Well, we've still got a bunch to go this year. I think it's way too early at this point. Quite frankly, our viewpoint is the trends are aligning themselves pretty nicely. So we should be looking at a pretty nice story as we exit this year and head into next year.

I would say we would prefer to put the majority of cash flow into the growth opportunities and locking down our visibility. Again, that's where we want to be. That being said, however, if the equity markets continue to really suffer and not really pay us for what we're doing today, then obviously that's an option.

Terrific. Thanks, Ed.

You bet.

Your next question comes from Mike Grondile of Northland Securities .

Yes. Thanks for taking my call.

The first call is for Bryan . Bryan, maybe another way we could think of this new enhanced deal with BMO is they're a 16% customer of ADS. How much of their business that they do with you will actually be affected by this program? The double issuance of

I think that on that side, again, if you back your way into it through any numbers that I provide to you, that's sort of part of the information that we don't really want out there, and I don't think the bank would want out there either. So at this point, I probably can't get into any more specifics.

Yes.

I think you could--look, it's going to add a few points of growth to miles issued. So I would work from that data point and see where you wind up.

Got you. And then Ed, this new portfolio, Big M, Mandy and Annie Says. Can you kind of talk about the pricing or the opportunity as you acquire that and pick up the file. How attractive is that type of an opportunity?

Yes.

I have to be a little careful, again. The client is privately held, and would prefer as little publicity as possible which is why we did an 8K filing so we could at least chat about it as opposed to a press release. What I can tell you is the credit quality is certainly consistent with what you would expect within our Private Label overall portfolio. So we're consistent there. Additionally, the size of the file, obviously, we can't say--but we can say, I believe, that it is also consistent with an average size of a typical file within our existing business today.

So it's not tiny, and it's not huge. It's a nice solid client with similar characteristics to our file and similar demographics as well, and I think they are primarily focused in New Jersey and around that area as well.

Okay. And then, just lastly, the air miles program potentially going to two new regions. Is that an '09 or an '10 or '11 announcement? Can you kind of just handicap which year you think it might fall into?

Handicapping?

How about it would be great if as we--I would be more than happy if we would be in a position that we would be announcing something as we rolled through the end of this year; but it could just as easily fall into 2010. These things are moving targets, and you're talking with big companies who are making commitments to make big expenditures, and so it's a hard one to peg sometimes, but we're making some great progress right now, so we're hopeful.

Okay. Thanks, guys.

Your next question comes from Roger Smith of Fox-Pitt Kelton.

How are you doing?

Hey, Roger, you're going to have to speak up a little bit.

No problem. I just want to make sure I understand something. In the text of the press release you said that you have 1.3 billion of excess capacity. I think you said you have 2 billion of conduits with 700 million drawn. Is that the 1.3 billion?

Yes.

Okay. I didn't know. You still would have other capacity to issue CDs and things on top of that?

Yes.

Okay.

And when I look at the statements generated in there, shouldn't that grow with the sales as well, or is it that the new sales are really higher priced sales? Is there something going on there?

I don't know if there's anything nefarious going on, but I think that what typically happens is statement growth tends to lag sales and portfolio growth by a quarter or two. So I think what you're--what you'll essentially see is the statement growth will tend to tick up as the year progresses. It just tends to lay. If you looked at the last cycle, we went through a--tends to lag a couple of quarters. So I'd be surprised next quarter if we weren't ticking up as well.

Okay.

And then just my last question is really on maybe the collection efforts that are going on. I mean, it seems like these net charge-off numbers look really good to me, especially relative to what you're seeing at the general purpose cards. Is there anything that you guys are doing that might be allowing you to perform better than what you might see at the general purpose cards? Is there potentially any change to the re-aging of the accounts or anything like that?

We have not changed policy if that is your question, on anything. So you are comparing apples-to-apples to prior years. So there have been zero policy changes.

I think what you're seeing is the fact that--and we've kind of said it for years and years which is that we don't change credit policy; and when times are flush, the large participants in the bank card market, they are more likely to open the spigot and really crank things up. And then, when times get tough, they've got to pull in credit lines, and they've got to pull in accounts and everything else, whereas what we do is we just try to maintain a constant, high-quality bureau score across the entire portfolio, and what that means is in good times, if--let's say 10 applicants came into one of our store, maybe six would get approved. And in tougher times like today, if 10 applicants came in, maybe only 2 would get approved, and that's when we talked about the tougher accounts.

So I think the fact that we're growing is a huge part of it, and we're growing without sacrificing the quality on credit, and we're growing with accounts who have whatever you want to call it, toughed it out, made it through, whatever the last 18 months. So they're in pretty good shape, and with that growth, Roger, combined with the length of this recession, you have now burned off so many of the weaker accounts, that I think that denominator effect is fairly important. I think it probably is a big component of it.

Great. Thanks very much.

Yes.

The only other thing is, don't forget, we do it in house.

Right.

So we like to take a great deal of pride in our ability to get it done right.

Great, thanks.

Your next question comes from Robert Dodd of Morgan Keegan.

Hi, guys.

Just a couple of quick ones, simply. The gain, or rather the loss this quarter, the 16 million. Did that go through the revenue in the Loyalty segment as well?

No. Expenses.

On the services piece, you mentioned you grouped together costs; but in the past, I think you've told us that you reprice under the transfer servicing price per account per year. Is this dip down in revenue growth in Q2, is that an artifact of that repricing or something else?

No.

What we did is purely a reflection of the timing of expenses. What we do is we do a margin on the actual expenses that are incurred during the quarter. And like I said, they're going to jump all over the place, throughout the year, depending upon what type of operating expenses are in there, whether it's additional collection, collectors we had to bring on, or whether we shifted marketing expenses around.

So what I would think is, again, over the course of the year, we would probably have our revenue and EBITDA, obviously positive growth, somewhat matching or very close to the growth rate in the statements, and then finally from a sequential basis, expenses traditionally come down between the first and second quarter about $3 million or $4 million.

Okay. Got it.

One more if I can on banking regulation rules. I mean, your CD balance did decline Q1 to Q2 by give or take a couple hundred million. Is that deliberate? Are you taking any approach to reducing that funding given what the FDIC is talking about enforcing bank holding company rules, in short bank balance, etc?

I don't think--no, it has--nothing has--one has nothing to do with the other. The CDs, the conduits and the term money are all what we consider three parts of our funding book, and I think one of the reasons in Q2 was, don't forget we did that huge TALF deal of $700 million. And conduit pricing is also beginning to come in again; but to the extent we're going to build more balances, we may decide to do that on balance sheet and ramp up the CDs again. So they can be all over the place. It has nothing to do with the bank holding company, potential legislation that's so far out there. We don't even understand what it says. I think--I don't know if that answers your question.

It does. Thanks, Ed.

You bet. Anyone else?

(Operator Instructions)

Your next question comes from Colin Gillis of Brigantine Advisors

Hey, Ed.

When you look out at the files that are available, how much above par are they going for? How has that tracked from the past?

You've got to be kidding me. Come on .

We're not going to talk about our bid. But look--you look at the--look at the environment, and you've got--normally we stick to our own sandbox, which we find nice and comfy, and that's where we like to be. But you have an environment where you have the three other potential bidders, who are out there, they're not. And you have a retail environment that is extremely challenging for retailers who have in house programs and are having challenges securitizing those programs. So it's--this crisis, as we've said provides with us a pretty nice opportunity to pick things up at-- I'll just leave it at reasonable prices that will give us a heck of a bang for our

And just looking at the portfolio growth, right? What is any difference that you're seeing in the ramp of the new Private Label customers? What I'm trying to get a sense of is are new customers ramping slowly in what I assume if it was a more new stable economic environment, have you seen another point or even two points on the portfolio growth?

If it were a stable environment, you'd have the whole core growing as well, so it's--you'd be looking not at 10% growth. You'd be looking at something quite a bit higher, because the core itself is not growing. But in terms of the 20 or so new accounts, for sure, because even though we're ramping up dramatically from 0% wallet share to almost as much as a third of their sales, if their sales are coming down 10% a year or 15%, you're going to have a slower ramp.

We're two hours into this and no one has said it yet, but it's pretty clear that you had a very nice quarter.

Well, thank you. We've been waiting. We were going to wait until midnight before someone finally said, "Good".

Thank you.

Thank you.

Okay.

Your next question comes from Chris Brendler of Stifel Nicholas.

Hi. I don't want to extend it too long, but I'll try and ask a couple of quick ones here if you don't mind.

On the late fees, you talk about in October 2010, is it implementation, or is that when they're going to give guidance on late fees?

Implementation.

Okay.

Any idea when they're going to start talking about it? Have you heard any of the ratios they're using or anything like that?

Yes.

It's--the only snippet that we have heard out there is that they do agree that a late fee needs to have a punitive component to it, which is nice to hear. But that would suggest that, in our opinion, it's less likely we're going to get dinged because of the size of the balance and given that we're quite a bit lower than bank fees, I think that gives us a little bit more comfort. But, believe me, we're watching it closely, and we're looking at other avenues and other opportunities. But, boy, I'd like to see something if we're going to get programming done and we have to make some changes, and we need to look at other sources as well. I'd sure like to have something out by the end of this year so we can react to it.

Okay.

Have you heard anything?

No, I haven't. Just speculation is all I've heard, so I would think you're right, I think we might get something before the end of the year.

In terms of pricing, I don't think you currently charge over limit fees. Obviously that wouldn't be allowed under the new rules, but are you thinking about maybe some sort of other penalty fees? Because you really want to keep the risk-based pricing aspect if you have to lower your late fees. I'm just trying to think of other ways you could price around it. Because if you think about any sort of solution on this front, I think does put ADS's business model at risk. It's giving you low lines. Are you thinking of maybe just yield or a penalty pricing on the yield?

I guess, first of all, there's nothing out there suggesting that it will have any impact on us whatsoever, since we don't do any risk-based pricing at all. It's one price is the same. Second, I think in terms of putting anything at risk, we don't charge annual fees. You mentioned over the limit fees, clearly in a bank card world that's an issue. In the Private Label world there's no such thing, right, because it's a closed loop environment, so it's impossible to--impossible to be over the limit.

So those don't exist for us. So again, we're back to are the late fees considered reasonable, which is the legislation. And all we know is that it's okay that they have a punitive component and we're well below bank cards, and other than that, we have looked at every other piece of that legislation. There's nothing in it that causes us any type of angst.

And then, obviously, we're not going to go into remedies, should something happen. But the fact that there have been no changes in rate caps, no rate caps required is certainly something that gives us at least comfort that we know it's out there, and we don't charge things like statement fees or anything like that. So there are a number of buffers out there that we would certainly look at, but right now, until we see something, it's tough to know whether there's--it's bigger than a bread box or not, and we'll just go under the assumption that if it is bigger than a bread box, we need to make sure we know how to respond to it. So we don't think the business model is at risk at all.

On the fees, you actually gave us a little color on how big they are as a percent of your yield. What's the other big component of your yield, which is over 30% the last couple of--it was over 30% the last couple of months in the trust? Is that interchange? Is there interchange revenue that flows through there? Because I can't imagine interest revenue would be anywhere close to 20%. You'd have to have a revolving percentage that would be higher given you're charging 20 on those cards. So a 30% yield is still--if only 7% is late fees, where's the other 4 points or so coming from?

It's almost exclusively finance charge and late fees.

Okay.

There's no interchange on those transactions?

Well, we don't have interchange. We have merchant discount, and that would flow into our overall P&L for sure, because that's a percentage of sales, but it's not in our trust--it's not in the trust report.

Okay.

Last question is--the previous caller's question on bank holding company and those kinds of issues. Definitely sounds like it's not happening anytime soon; but in terms of your level of comfort in the buy back, is that--at new highs now just given the progress in the business, are you seeing that the indicators started to switch, but you feel comfortable with your cash flow? And anything that comes out Washington DC, you'll deal with later, or does that actually hit your radar screen, that we need to have actually more capital in our a holding company if what they're talking about goes through?

Boy, that's a good question.

It is so far off the radar screen of Washington right now, but obviously we are keeping a very close eye on it. I'll make a couple of comments for those of you who don't live and breathe by the bank holding companies and being raked by the fed and everything else.

The biggest issue is, are they going to basically sit there and say, You need to be a bank holding company or comply with bank holding company law, and that essentially means that if you make light bulbs, you need to spin off your finance arm; and if you make automobiles, you need to spin off your finance arm, and those are pretty big decisions that are out there. Or if you make tractors, you need to spin off your finance arm. So that would be a fairly painful process.

Now from our perspective, we have looked at the potential implications of this before with another transaction that we won't mention. But the key items to focus on is, are our businesses all considered what they call financial in nature? And we have looked at that, and financial institutions do Loyalty, they do marketing, they do processing, they do all the stuff. So from our perspective, if you really wanted to look at it, if it ever did happen, it would most likely be a positive for us, from the point of view of we would qualify without having to do anything--any type of surgery on the Company because all of our businesses are financial in nature, and meanwhile you're going to have a whole bunch of folks who are going to be spinning stuff off. And think of it, if you're a retailer, there's no way you could hold this stuff.

So it would be kind of a big big run for us if that actually went through. So from that perspective that would be good news, but that being said, what little snippets we know is this is probably--they'd give these big companies or retailers five years to make this change. So it would be more of a long-term play for us.

And in the interim, look, we've got tons of capital down at the bank; and whether it would involve anything up at the holding company, we'd look at it at that point. But it's quite possible that it's the bank that's the critical piece.

Okay. Thanks a lot.

Your final question comes from Reggie Smith of JPMorgan.

Hey, guys.

Thanks for taking my question.

Hey, Reggie.

I guess I've got a few on the credit card segment.

Surprising.

Could you talk a little bit about the receivables that don't show up in a trust? It looked like the trends had gotten worse the first two months of the quarter, and then they kind of rebounded in June. Just curious, what are you seeing there as far as charge-offs, and what's your outlook for that particular slice of your portfolio? If you can talk a little bit about delinquencies there, that would be helpful ,

Yes.

I knew someone was going to have a cow last month when the overall master trust was at or above the trust file. But, look, the numbers aren't big enough, so I know no one listens to it; but again, I would say, on a monthly basis, it doesn't mean squat. So I think we would safely say that the trends that you've seen through the first six months will continue for the remainder of the year, specifically that the trust data tends to run at a higher rate than the overall file. And that would be exactly what we would expect for the remainder of the year.

To the extent, Reggie, and you know this, you have a bankruptcy bubble or something like that. In one month, for a small piece of the business, it can blow out the rates by 50, 75 bips, and that's what happened last month. So I would be looking at the overall rate to continue to be lower and better than the trust rate.

Okay.

As far as the credit card bank, I guess last quarter it looked like you guys retained earnings there. Have you reinstituted the dividend, or what's our thinking there for the remainder of the year for this quarter that just passed as well?

Yes. That's a good question.

I know a couple of people have asked me what the deal is. A couple of comments there. One is if you look at our liquidity, I think we're at about $600 million up at corporate for the remainder of the year, which gives us plenty of room to maneuver and get done what we need to get done.

At the same time, dividend or no dividend, the vast bulk of that $200 million of free cash flow, I'm guessing close to 80% would come up to corporate regardless of whether we dividend or not. And that is because Loyalty and Epsilon are two-thirds of our cash flow, and the taxes at the bank level and the interco charge for processing and everything, those also go up to corporate. So what's leftover is a relatively small piece; and, therefore, doesn't really move the needle for us. So if we were to retain and not dividend up the remaining couple of quarters here, our liquidity would probably be--at the corporate level, would probably be impacted by $50 million, $75 million. That would be it. So it's not a big number.

The second thing is we are not going to discuss our dividend strategy. If you were to look in year's past, there have been years where we haven't done a dividend for certain reasons, there have been years where we've done extra dividends, there have been years where we do one dividend and it's a biggie at the end of the year. And we're going to keep that uncertainty out there, and we're not going to comment on it.

The final and probably most important thing is if--the concern is that we are building capital that has anything to do with upcoming requirements from a regulatory perspective. We've beaten that to death. We know that's not the case. There is one other major reason why you would consider building capital at a bank, and that would be related to growth. So we'll leave it at that.

Got you.

Two quick more questions. In Loyalty, I guess in your Q you guys break out the different components of revenues, and one thing that I've been tracking recently is the redemption revenue that's recognized each quarter relative to the miles redeemed for the quarter, and I noticed that that number has kind of increased the last two or three quarters. Can you talk a little bit about what's going on in the Loyalty segment to kind of drive that increase? I would imagine it's not pricing, because it's--a redemption is from something that happened a while ago, so if you could talk a little bit about that and kind of explain the strength behind that?

Yes.

I guess the only thing is--and I don't think we used to publish this is that the redemption revenue should differ from the cost of goods sold by the amount of breakage, and that's the number that you see. Our breakage component Is part of redemption revenue, even though the breakage itself does not come in immediately, it comes in over a number of years. So I don't think before we used to break that out, and I guess now we're required to.

I don't know if that answers your question. Otherwise I don't know what your question is.

I guess we can catch up afterwards.

I still won't know it then either.

That's fine. And you can talk a little bit about this--and then I'll get off. If you could talk a little bit about the investment income from the Loyalty restricted account.

Yes.

How much of your EBITDA is driven by that? Or what's the contribution from the yield on the 600 to 700 million in restricted assets that you have on the balance sheet?

Okay. It's--it's more than 5 and less than 10 a quarter.

Percent? You're saying million?

Yes. Per quarter.

Okay.

And has that increased in the last year or so? Is there a favorable--?

Yes.

We brought in $380 million from the Bank of Montreal.

Got you.

That's one of the kisses we got from the deal, is we doubled the size of the trust account, and we get to keep the investment income.

Got you.

And then, I guess, folks are curious, you talked about in the intercompany loan not being a part of the trust. You were referring to the restricted account? And if it's not a part of that, where is it on the balance sheet? Where would we find that $100 million or $200 million that was the intercompany loan?

Yes.

It was never part of the restricted cash account trust, settlement assets, whatever we're calling it. It was an intercompany loan, which is eliminated when you consolidate the books, and now it's--it no longer exists. It's been paid off.

Okay. Thank you.

Yes.

I mean, it's -- it was a way to get cash up to the parent, and we needed to do it for a certain period of time. That time expired. We paid it off, and the cash stayed at the parent, and that was it.

Okay?

All right. I think we've now passed the world's longest call, and I appreciate everyone's time, and we'll talk to you next time.

This concludes today's conference call. You may now disconnect.