Bread Financial Holdings Inc (BFH) 2010 Q1 法說會逐字稿

Good afternoon, and welcome to the Alliance Data first quarter 2010 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. And now, I would like to turn the call over to Ms. Julie Prozeller. You may begin your conference.

Thank you, Operator. By now, you should have received a copy of the Company's first quarter 2010 earnings release. If you haven't, please call FD at 212-850-5721. On the call today, we have Ed Heffernan, President and Chief Executive Officer, Charles Horn, Chief Financial Officer of Alliance Data, and Ivan Szeftel, President of Retail Credit Services.

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 flames. These statements are subject to the risks and the uncertainties described in the Company's earnings release and other filings with the SEC. Alliance has no obligation to update the information presented on the call. Also on today's call, our speakers will reference certain non-GAAP financial measures which we believe will provide useful information for investors. Reconciliation of those measures to GAAP will be posted on the Investor Relations website at www.Alliance Data .com. With that, I would like to turn the call over to Ed Heffernan. Ed?

Great. Thanks, Julie. We're going to talk a little bit today about our first quarter and full-year outlook and also chat a little bit about the trends that we're seeing from both a macro perspective and also from where we sit here at ADS. Joining me on the call is Ivan Szeftel, who is our President of our Private Label group, which covers both the Credit portion as well as the Services groups, which would be the network and processing, customer care, and marketing and database.

Ivan and I started together way back when, at the beginning, when we were private. So about 12 years ago, and prior to that, within retail for about 18 years prior to that. So he has obviously a very, very deep and rich knowledge of both retail and of the private label business. And then also joining us is the very popular Charles Horn, who is our recently hired CFO, and he will be doing most of the discussion around the financials. Obviously, we rotate our three business heads each quarter, and I think Ivan picked a fabulous quarter to start with. And that being said, I'm going to turn it over to Charles to chat about our first quarter consolidated results.

Thanks, Ed. I will start off with two quick housekeeping notes. One, a quick reminder, that with the adoption of FAS 166 and 167, we are following a commercial presentation for our private label operations as ADS is not a bank holding Company. This new presentation increases reported revenues and adjusted EBITDA, but has no impact on income from continuing operations, net income, or any of our per share metrics. We have provided 2009 revenue and adjusted EBITDA on a pro forma basis to improve comparability. The second is, going forward we will refer to cash earnings per diluted share as core earnings per diluted share in order to avoid any confusion with liquidity metrics as it is a performance metric.

Turning to the quarter, it was an encouraging start to the year. Revenue and adjusted EBITDA of 9% and 10%, respectively, from pro forma 2009. Even stronger, income from continuing operations per share and core earnings per share increased 20% and 16%, respectively. Encouragingly, revenue growth within all segments. LoyaltyOne was up 24%. Epsilon up 7%. And Private Label Services and Credit was up 7%.

In addition, adjusted EBITDA showed strong double digit growth in two of our segments. Epsilon was up 24%, reflecting very strong leveraging of its revenue increase. And Private Label was up 16%. LoyaltyOne was down 2%, primarily due to a $5 million foreign exchange gain recorded in the first quarter of 2009. Excluding the foreign exchange gain from last year, Loyalty was up about 7%. At the same time that we do revenues, we improved our profitability margin. Adjusted EBITDA margin increased 10 basis points to 30.6%. In summary, we had a good start to the year, and it appears that we are developing momentum as the year progresses. I will now turn it over to Ed to talk about LoyaltyOne.

Great. Thanks, Charles. Why don't we turn to the slide LoyaltyOne. Again, that's our Canadian business, and it runs the AIR MILES reward program and has just recently started the expansion efforts outside of Canada and specifically in Brazil. And revenues, as Charles mentioned, increased 24% to about $200 million in the first quarter, due to strong redemption activity by collectors participating in the program, and of course, a stronger Canadian dollar. Adjusted EBITDA of $54 million was up 7%. When you exclude the $5 million foreign exchange gain on US dollar investments, which was recorded in the first quarter of 2009.

As we previously disclosed in our 2010 guidance, the Company expects strong top line growth as collectors once again feel comfortable redeeming miles, which in turn drives the recognition of revenue. And of course, its associated cost of goods sold. Also, operating cash flow was expected to grow solidly, since it is triggered by growth in the other key metric, miles issued. Only adjusted EBITDA -- that's the metric we print -- is expected to be softer in 2010, primarily due to timing issues. And specifically, toward the end of '08 and '09, miles issued, which is the key cash flow and profit driver, experienced weak and even negative growth rates, and due to the deferred recognition of profit for air miles, these weak or negative growth quarters will in fact hit us in our 2010 accounting results. '08-'09 issuance weakness resulted largely from the steep decline in consumer discretionary spend. This type of spend tends to drive our highest margin miles. In addition, the amortization of deferred profit related to the conversion of certain split fee to non-split fee programs is declining as the acquired miles are redeemed. And finally, as we've talked about in the past, our international coalition expenses are borne in this segment. And I think most importantly, the Company believes the weakness in adjusted EBITDA -- the timing issue -- that will recover as issuances and sponsor mix return to historic levels. On a positive note, cash received per mile issued during the first quarter of 2010 increased, reversing a trend experienced during the economic recession.

Let's talk about the metrics. The key metrics for the AIR MILES reward program continue to move in the right directions. Miles redeemed growth is critical to ensure that our collectors continue to value the program. In the first quarter, miles redeemed grew at a double digit pace. Our other metric, miles issued, increased over 5%, representing the third consecutive quarter of growth. It should be noted that issuance tends to be choppy, quarter to quarter, due to client promotional activity, but relatively stable on a yearly basis. In Q1, the grocer segment was actually down versus prior year, because it was less active on the promotional front versus prior year. That usually means they're shifting their spending to later on in the year and doing their promotional activity later. So it probably accounted for a couple of points off of the growth rate. We would assume that this is hopefully just a timing issue. Nonetheless, for the full-year 2010, the Company does expect miles issued to track to historical pre-recession growth rates. And then finally, breakage. We get asked about this question quite a bit. And as most of you know, we do have a reserve that equates to the assumption that 72% of all miles issued will eventually be redeemed. Each year, we have one of the big four validate these assumptions. And the best way is on a vintage basis. Meaning that we look at redemption rates for each card member based upon when he or she signed up since the program's inception back in 1992. The important note here is -- today, even our very first vintage, 18 years ago, is running below our 72% reserve rate. So we're in very good shape on that front.

Okay. Let's talk about Brazil. The launch of the coalition program in Brazil is on track. We currently have over 200,000 members signed on. And a decision regarding further investment in the initiative is anticipated during the third quarter of 2010.

And finally, during the quarter, LoyaltyOne announced a multi-year sponsor and rewards flier agreement with Budget, a subsidiary of Avis Budget Group. The agreement also expanded the program to include miles issued to collector for car rentals in the US. Also, Vision Electronics, Canada's largest, privately-held electronics retailer, signed a multi-year renewal agreement as an AIR MILES sponsor. And finally, you probably just saw it. We renewed one of our largest sponsors, the Liquor Control Board of Ontario, also known as LCBO, for another multi-year term. All right. More on 2010 later. Charles?

Thanks, Ed. If you turn to the Epsilon slide, Epsilon is very nice to talk about this quarter. As they kicked off the year with a wonderful start. Revenue was up 7%, adjusted EBITDA was up 24%. This bodes well for 2010, as Epsilon's results generally improve as the year progresses. Revenue growth in our marketing, database, and digital businesses continues to be strong. Up double digits. This growth -- this continues the growth we experienced during the last two years in the very crux of the recession. The base of new business in database is solid, with a significant number of wins yet to be implemented in 2010. Record signings in 2009 continued into 2010, with large client wins and two expansion agreements, including Kraft which was new, New York and Company expansion, and La Quinta, which was an expansion.

Revenue at Abacus, our catalog business, increased for the quarter, the first growth since early 2008. We had anticipated a flat Q1 2010. This again is a positive for 2010 if this trend continues, as due to Abacus' largely fixed cost operating structure, the incremental revenue largely flows through to adjusted EBITDA. Overall for Epsilon, we experienced excellent leveraging of our revenue growth during the quarter. Adjusted EBITDA margin increased 280 basis points from last year. Epsilon is tracking to the Company's 2010 guidance. As some revenue acceleration is expected as the year progresses, due to the implementation of new wins. I will turn it over to Ivan at this point.

Charles, thank you. If you refer to the retail slide, slide six, you will see that Private Label began 2010 with a strong quarter. Posting revenues of $339 million, and an adjusted EBITDA of $140 million, increases of 7% and 16% respectively, over our pro forma first quarter performance in 2009. Five factors drove our improved performance. First, sales placed on our credit cards increased by 20%. Approximately double our long-term average growth rate. Of particular note is that our sales increases were generated by both our mature core credit programs, and those new programs that have been either recently launched or acquired.

Our portfolio grew by 22%, again about double our long-term growth rate. Our receivables growth was a function of our increased sales growth and the impact of newly acquired portfolios. Our funding costs remain stable. Credit losses came in at 9.4% of outstandings, a bit better than expected. And finally, [bull] gross yield was 24% for the quarter, compared to 25% in the first quarter of 2009. Gross yields dipped temporarily in February 2010, as we transitioned to new card holder terms that only became fully effective in March. Our yields in March returned to normal levels, where we expect them to remain. Accordingly, we are confident that the slight decline in yield in the first quarter of 2010 is not reflective of any adverse longer term trend.

The key drivers of Private Label's performance suggest that our return to growth in the first quarter is both real and sustainable. Specifically, we believe the two-plus years of significantly increasing year-over-year credit losses are on track to stabilize during the second quarter, and then begin to decline during the latter half of the year. Delinquency rates, an important predictor of future losses, have continued to improve at every delinquency level. During the first quarter, delinquencies average 5.9%. A full 50 basis point improvement over the corresponding period last year.

I'd like to draw your attention to a few other important events that occurred during the quarter. First, our loan loss reserve at the beginning of the year was 9.5% of outstandings for principal losses and 10.6% overall after including reserves for non-collectible, both interest and fees. As of March 31, 2010, our reserve levels were similar, with a 9.7% reserve for principal losses and 10.9% overall. The Company believes that it is not yet prudent to lower current reserve levels, and you can expect us to wait until a long-term trend is defined and realized. Having said that, as indicated on slide seven, credit losses are trending down and are still running at levels below the average unemployment rate.

Second, on the regulatory front, two significant events occurred during the first quarter of 2010. With the adoption of the new accounting rules, previously off-balance sheet securitized receivables are now recorded on the Company's financial statements. While the receivables are still contained in bankruptcy remote trusts, the receivables are required to be phased into the calculation of our regulatory capital ratios over the next 12 months. In anticipation of the addition of these assets, $50 million of cash was placed into the Company's subsidiary, World Financial Network Bank -- National Bank on March 25, 2010. This additional cash ensures that WFNB's capital ratios are sufficient to support our robust business plan as we move through 2010 and beyond. The Company does not anticipate that any further capital contributions will be required. WFNB's Tier One capital ratio is currently 15%. Its leverage ratio, 9%. And its total risk base capital ratio 30%. These are all above the defined well capitalized levels.

Finally, in 2010, the Federal Reserve Board released a long-awaited proposed regulations, implementing the next group of the Card Act provisions that will become effective later this year. The Federal Reserve has asked for comments on the late fees that can be charged by financial institutions. And there are still a number of elements that are yet to be defined. At this time, the Company does not believe that there is anything contained in those areas of the Federal Reserve's late fee guidance that appear to be definitive that will cause the Company to change its current earnings guidance. Over to you, Charles.

Thanks, Ivan. I will refer you to slide number eight. And there's really five key points I would like to make for the quarter. One as you can see, our March balance sheet looks substantially different than before, as we consolidated the previously off-balance sheet securitization trust. And you can see what it has done. It has increased the credit card receivables with a corresponding increase in asset-backed securities debt. In addition, the adoption of the accounting rule reduced our stockholders' equity by over $400 million as an adjustment to the 2010 beginning balance sheet.

Second, our liquidity remains strong. At the corporate level, we have about $300 million of liquidity, including available borrowing capacity as of March 31, 2010. Our key financial covenants, the leverage ratio, is 2.34 to 1.00 at March 31, 2010, which is below the 3.75 to 1.00 required covenant, and well below our 3.0 to 1.0 comfort level. At the bank subsidiary level, available capacity is approximately $2.6 billion. We expect liquidity to improve as the year progresses due to the significant free cash flow we generate from operations.

Third, we knocked out concerns regarding regulatory capital at our banks by moving $50 million of cash to our largest bank. This contribution covers the transition of previously off-balance sheet receivables into our regulatory capital over the course of 2010, as well as providing cushion for anticipated growth in accounts receivable. We did this without having to raise external capital.

Fourth, the securitization funding markets seem to be improving. During the quarter, two securitization financings were completed and announced. The Company renewed a $550 million conduit facility on better terms than previously, reflecting the general improvement in the marketplace. In addition, $100 million of fixed rate term, asset-backed securities were issued. This issuance marks the first time since September, 2008, that the securities were issued without the benefit of TALF. In addition, it marks the first time since April, 2006, that we were able to true tranches to the BBB level. The average lock is just under three years and carries a weighted average fixed rate of just under 5%.

Lastly, we repurchased 15 million of our outstanding shares during the quarter under our Board-approved $275 million share repurchase program. We were not very active during the quarter, as we finalized the capital requirement at our bank subsidiaries. With that matter complete, moving forward, we are more comfortable viewing the repurchase program as a key potential use of our capital. In summary, our balance sheet, liquidity, and capital remain strong. Let's move to 2010 guidance, and I will turn it over to Ed.

All right. Let's finish up with guidance for Q2. A little chat about guidance for full-year 2010. And some general comments. And then we will do Q&A.

You should be on the slide, second quarter 2010. We do expect second quarter to be a good one, and from what we're seeing thus far, it certainly looks like it is heading that way. We expect continued double digit revenue growth for the Company and there is a very strong possibility that all three segments will each generate double digit growth compared to the prior year. Consistent with the first quarter of 2010, we also expect Private Label and Epsilon to provide positive double digit EBITDA growth. And Loyalty is also expected to report significant year-over-year EBITDA growth, but in reality, its results will really be more flattish when you exclude the foreign exchange translation loss on US investments that hit Q2 last year.

Historically, second quarter tends to be seasonally the softest of our four quarters. Primarily for two reasons. One is Epsilon is strongest in the back half of the year. And then Private Label, seasonally tends to have losses peak in Q2. Effectively what happens is people who shop till they drop during the holiday season run out of gas by Q2, and if they don't go current, they tend to go under. And that's usually what happens in Q2. And also for those folks who get their tax refunds and everything else, and do go current. They move from a revolving behavior to transactor behavior, and that means that we don't get finance charges and gross yields tend to compress. This year, however, we are not seeing a significant seasonal increase in our loss rate. So we actually expect Q2 losses to be somewhere in the 9.5%, 9.7% range, to reflect just a small seasonal uptick. And more importantly, we will not just anniversary higher loss rates for the first time in 2007, but we should actually come in better than last year's 10% rate. And I will tell you, that's going to be quite a milestone here. Because once that train leaves the station, we would expect the normalization of losses in earnings to begin to pick up. Accordingly, the momentum and trends are quite strong and as such, the Company expects a very strong quarter, with core or cash EPS of $1.30, an increase of 38% versus prior year's second quarter.

All right. Let's go over to full-year guidance. Anticipated adjusted EBITDA for 2010 is a bit under $800 million. Or $650 million before the accounting reclass, which essentially took the securitization funding expense and moved it below EBITDA. It reflects our expectations of some earnings acceleration in the back half of 2010, and we are maintaining our full-year core or cash earnings per share guidance of $6.00, which is a 16% increase compared to the prior year period. Or perhaps more importantly, approximately a 30% increase if 2009's non-recurring items are in fact excluded.

All right. From a trend perspective, you can look at it as either one half, or maybe even slightly over one half of our business, is discretionary, as opposed to the other half being non-discretionary. And on the discretionary side, it hits all three businesses. Some harder than others. Obviously, it will hit Private Label. The discretionary piece hits Private Label sales and hence, style growth very hard. And also the high unemployment rate hits the losses very hard. Also, in Abacus, which is part of Epsilon, cataloguers tend to be the first to turn off the switch on dropping books. And that hits Abacus, which has 1,800 of the country's largest catalogs. And then even in our Canadian program, the card sponsors, BMO and AMEX, obviously to the extent there is discretionary spend on those cards -- that tends to suffer during a recession.

Across all of these areas, on the discretionary side -- obviously the non-discretionary continues to roll on. But across all three of these areas on the discretionary side, the ship has either turned or is turning. And we expect positive momentum as the year progresses, and we will focus on every single quarter this year being pristine earnings. And that is our goal, starting with today's quarter. And we expect as the rest of the quarters play out for the year, you should plan on additional quarters of pristine performance and also exceptional performance.

All right. Why don't we turn to some general comments and then we can get into Q&A. Some of these comments have come from questions that we've heard. Some of these comments, I think, are appropriate to bring to your attention -- to provide a little bit more insight into the Company. We start with the first one, the regulatory environment. As Ivan talked about, we have buttressed the capital levels and are now well above the defined, well capitalized minimums that are out there. So we feel pretty good about that. Also, there are a lot of -- there was a lot of chatter over the last year or so about a big outside capital raise -- equity raise. We had mentioned it that is not going to happen. It didn't happen. It won't happen. And so, hopefully, that's been put to bed. And also, we do believe that there has been no impact on our original growth plans, whether it is M&A or our share repurchase program. So I think we have weathered this storm pretty nicely, and we can move forward.

Next up, I don't think it is something that people talk about too much, but we're going to go ahead and hit it straight on, which is exec comp. In 2009, despite 100% achievement of the metric on which we get paid, which is cash EPS -- and you probably saw this in the proxy that was mailed out just recently. Rather than 100% payout, the compensation committee looked at the composition of that earnings per share, and the numbers did include a number of non-recurring benefits. And as a result, the comp committee decided to use downward discretion, and therefore haircut not only the amount of equity that got vested but also the amount of cash that was paid out in the form of incentive compensation. So again, despite 100% achievement, we took a haircut on both IC and the equity vest.

In 2010, again we're trying for a balanced approach here. In light of the 2009 downward adjustment, I think our plan allows for over 100% payout if we hit our $6.00 of core earnings per diluted share achieved. And I think the number that was in there was [$5.68] or something like that. So essentially, if we hit our guidance, we have a chance essentially to recapture much of that downward adjustment from the prior year. However, there are a few strings attached, and those are the earnings must be pristine, as defined as it will exclude any unusual items. Any accretion from a large M&A deal would be excluded. And any incremental buyback benefits for the year would be excluded as well. So if we bought any more shares during this year, any of those, that accretion would not be counted. So I think overall, it is a comment about where the Board feels that management should be compensated. And quite simply, it's let's have nice pristine earnings. Let's focus less on some of the non-recurring benefits, and focus on getting our organic growth rate back to the double digit level that we're used to. And so that is the game plan. And that's -- that helps hopefully explain some of it.

Finally, stock comp expense was $54 million, in noncash comp last year. That will be significantly cut this year and will go down approximately 30% to $40 million, as the estimate for noncash stock comp expense. $40 million will also probably be a pretty decent run rate on a go-forward basis. And that is the result of a couple of things primarily. One, there was a chunk of the $54 million in '09 that had to do with some retention equity associated with the Blackstone deal. There is none of that left. And then second, we have pared back significantly some of the higher priced folks on the executive team. And we have made I think a much leaner meaner organization here, and that resulted obviously in less equity being issued. So that's pretty much where we are on exec comp and stock comp.

And finally, the slide on general comments about the macro environment. We talked about discretionary portions of ADS have either turned or turning, and again, to give you a sense for it, at Epsilon, Abacus was down in '09. It was flat year-end of '09. And it was up in Q1 of 2010. So that is quite a turn there. At LoyaltyOne, miles issued were down in Q1 and Q2, of '09, they were up in Q3, Q4, and Q1. Now, into this year. Private Label Credit sales were a whopping plus 1% in Q1 of '09. And yet today, they're running at 20% or higher for Q1 of 2010.

And finally, I think we called it last May. Private Label Credit losses did peak in Q2 at 10%. We think May was the high water mark. And on a go-forward basis, we have been below that level ever since -- in Q3 of last year, Q4 of last year, Q1 of this year, and Q2 of this year -- will give us a full year of stability. And Q2 will actually be below Q2 of last year. And as Ivan said, and we pick up steam after that. So guidance, we will report $6.00 against last year's reported number. It's up 16%, against last year's -- if you want to call it number that excluded the non-recurring benefits. It is more like a 30% growth rate.

So I think we're off to a good start. I think the ship has finally turned, and we're going to look forward to a good run this year. And hopefully, a continuation as we move into '11 and '12. That being said, I'm going to open it up to Q&A. As we are going to try to do is 45 minutes of presentation, and then 45 minutes of Q&A, and cut it off there. So I will ask that -- we seem to have a fairly large backlog -- that if anyone who gets on the phone to ask a question, if you could keep it as an A or B. Or no more than just two questions as opposed to A through Z. We'd really appreciate it, and we will try to cycle through as many of you folks as we can. But we do have a hard stop in about 45 minutes. So that being said, Operator, why don't we open it up to questions and have some fun.

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

Thanks, Ed, and I will keep it brief. Good job. Ed, you're saying that the miles issued will accelerate through the year. What is going to drive the acceleration? Especially in the back half, we have more difficult comps?

He is asking if the miles will accelerate as the year -- the miles issued will accelerate as the year progresses.

Yes, You have got a couple of things. The big thing that kept miles issued at 5% and not more like our 7% or 8% was the fact that the grocer segment was actually down versus last year. So their promotional activity was significantly below where it ran last year. That jumps all over the place. So we're assuming that it will pop back in. If not Q2, then in Q3 or Q4. So that is some of the chop. And the second thing is, as Canada continues to recover, a huge chunk of the miles that are issued obviously come from Bank of Montreal and AmEx, and that's discretionary spend. And as Canada continues to recover, that discretionary spend should continue to pick up. You might have seen Bank of Canada is already giving signals that it is getting ready to start raising its rates. So Canada is cooking along pretty good. So those two items. Grocer and card discretionary spend are two huge drivers which should pick up steam as the year progresses.

Okay, and a quick question for Ivan. The gross yields, maybe a normalized gross yield? And then the status of the statement fees?

Jim, what is the question on the gross yield?

It seems like it is breaking up. The line is breaking up. That's better. Sorry. Maybe what normalized gross yields will be. They dipped in the quarter. But what would you expect longer term?

As I think we said, they would come back to the 25%, 26% gross reyield range which is what you've seen. We had a dip in February as we transitioned to the new terms. That was a one-time dip. And we expect it to normalize.

And the status of statement fees? And I'll end it there, thanks.

As I think you are aware, Jim, we have implemented the processing fee on a portion of the file. At this point, it is less than two months into it. Things are proceeding with the processing fee as we expected. We're not seeing any untoward consumer reaction that had not been anticipated. Okay, great. Good job, thanks.

And I think just to clarify the master trust itself -- Ivan, correct me if I'm wrong -- tends to have a yield more like a 28%-ish.

Right.

So we expect that to be hanging around. And it has been around the 28% for the last nine months or so. So we should have a fairly consistent there, if not a little bit higher. And then when we finish testing with the late fees, rollout would start some time late summer, I guess.

Thank you.

The next question is from Sanjay Sakhrani.

Hello, thank you. So when I look at the delinquency rate migration in the trust over the last five months, that rate has been declining. Is there something on the on-balance sheet side that causes you to have charge-off guidance to the first quarter? And then, just on the reserve coverage. If indeed losses improved, how should we think about reserve coverage? Will you hold in excess of 12 months of coverage? Or bring it down to at least 12 months of coverage on the go-forward basis. Thanks.

As I think you are aware, that our loan loss calculation is -- think of it as a triangulation. In that we go through a number of analyses to try and ascertain the direction of those losses. And I think as we said in our prepared remarks, we want to see actual losses come down before you see a downward adjustment in the reserve. And clearly, I think you are picking up on the same trends that we've seen. The migration -- the loss migration -- through our various delinquency records. We are seeing a positive direction. But at this point, we have chosen to keep our reserve levels stable until such time as they're realized. I wouldn't think in terms of actual months of coverage. Although clearly historic losses are an important factor in the reserve levels. But many of these additional analyses also try to understand the forward direction of our losses as well in determining our reserve rates.

I think if I can jump in, Sanjay, in terms of Q2 being relative flat to Q1. As you know, Q2 always seasonally is higher than Q1. At least in Private Label. And the fact that it is going to be actually flat -- relatively flat to Q1, I think is a pretty good sign for the back half of the year. And once we get through Q2, if we're seeing the improvement that we think is there and that Ivan mentioned, that would probably begin to move the reserve levels.

Okay. And just one clarification on that revenue yield question. If I look at the sequential change in the revenue yield per my calculation, it was down about 200 basis points in the first quarter. I'm assuming you would expect that to rebound by that same 200 basis points in the second quarter? Is that where you were getting that, Ed?

I'm not sure what you're looking at. Are you talking about Q4 of last year, Sanjay, compared to Q1 of this year?

That's right. On a pro forma basis.

Let me say this to you. Clearly as a percent, yields drop in the first quarter because you've got a higher relative average AR. So when we look at it, we saw about a net 1% drop in first quarter as a result of this transitional change, and we expect it to be a one-time blip. But from an overall situation, we certainly expect yields to stabilize and return to the normal levels as the year progresses.

I guess another way -- you're hearing us sort of stumble all over the place, Sanjay, because we never look at it sequentially. But year-over-year, we actually would expect yields in Q2 to be up versus Q2 of last year.

All right. Great. Thank you very much.

You bet.

Your next question is from Bob Napoli from Piper Jaffray.

Thank you. And good afternoon. I will try to beat a dead horse -- beat this to death. But the gross yield, that includes all -- is this -- in the tranche that is cash-based, this is the first quarter we've seen it on the income. And is this now an accrual-based revenue yield? Does it include interest income and all fee income?

You were correct. It would include all of your finance charge income, late fee income. It would not include supplemental services paid by phone fees, items like that. So anything generating from a finance charge income is there on a billed basis. And it's net of any purification or charge-offs of bills -- finance charge income late fees to get to a net gross yield. That sounds odd. But it is a billed yield net of purification.

And then, the dollar statement processing fee will show up somewhere else but not in that yield? It will show up in other income or something?

That would be correct.

And then, thinking about reserves. How does that -- this is not just you, but it's the whole credit card industry. You set up this new reserve when charge-offs are at their peak and then you are going to have this charge-off decline. Theoretically, assuming the economy continues to rebound, and that is going to spike earnings quite a bit. How does that build into your guidance and a reserve reduction? Are there any thoughts around that as far as the goals for the year, and for next year? Because this is kind of a one-time reserve reduction benefit that you're going to get.

It is a little bit different. Maybe it is just for us. I don't know. But as we mentioned, the reserve we set up was in fact about 9.5% for principal and a little over 10% when you include principal, interest, and fees. We would expect wherever we wind up the year that if you were to look at back at what flowed through the provision, that it would come pretty darn close to what we actually wrote off. So I don't know how the other card companies do it, but we're going to be -- if our losses are coming down 100 basis points a year or so, you will see that being reflected in the reserve. So the actual cash should match up to the reserve level.

I think what you're going to see is purely a timing issue. It is just going to sequence different during the year than what it did before. Historically, you would run up your revenues in Q4 in Private Label, and then the charge-offs would come in Q1 under a cash basis. Now under accrual basis, when you run you up your sales in Q4 and your portfolio in Q4, you will book your bad debt in Q4 and not have that hit come through in Q1. So what you're picking up on Q1 is the initial reserve we set up covered the receivables existing at 12-31 that charged off in Q1. And then we provided bad debt provision against the new originations during the quarter. So it is purely going to sequence a difference -- differently per quarter as the year progresses.

Or in other words, our cash that we write off will be close to -- or should mirror what flows through the provision on a full-year basis.

Pretty close.

Great. Last question. Just on Epsilon, your goal -- you had a [ten-ten] vision for this year, and your margins are up a lot more which is nice to see. But what drove the significant outperformance? Is it all Abacus? And what is the outlook? Thank you.

Yes, that's a key part of it.

Yes.

Thanks.

Your next question is from Robert Dodd with Morgan Keegan.

Hello. At the risk of beating a beaten dead horse, can you walk us through just the difference between the $88.9 million on the P&L, and the $122 million in essentially charge-offs. Obviously, that is cash in Q1. I realize there is timing there, but can you give us a little bit more color on reconciling those two items?

The key thing you're picking up is again the shift from a cash basis to an accrual basis. So when we implemented the new accounting rule January 1st, we had to look at all of the existing receivables as of that date, which had theses seasonal Christmas build in it. And then, we had to provide loan loss reserve against it which we applied about a 10.6% loan loss. Now what happens is you are going to have the charge-offs of in Q1 largely relate to that buildup in Q4. So that is going to go against the reserve. And then your provision for Q1 is going to look for new originations in Q1 that you're putting up some expense against. So the key point that Ed was making is you see the charge-offs coming through in excess of the expense. That will flip by the time Q4 gets here where we book more expense in Q4, and we will have lower charge-offs running through from Q3. So it is purely a sequencing of quarters, but it is the shift to an accrual basis versus the trailing cash basis.

Yes, in other words, you want to match with the accrual basis your expenses against your revenues, and if you are to look at 12-31 versus March 31, our portfolio had a massive seasonal decline of $500 million or $600 million. So we didn't earn anything because we had a $500 million or $600 million decline. Whereas in Q4, it is going to go the other way, and that's where you will see the flip-flop that Charles was talking about. So on a full-year basis it should come out to be about the same.

Got it. Can you give us -- on late fees as well. Obviously, you mentioned you've got some preliminary testing. What is your approach -- obviously, you haven't rolled it out all the way. You don't have to yet. But can you give us any color there as well, or what the strategy is going to be to adjust to that? And do you expect any net impact on your gross yield in the back half of that last quarter.

I think we need to take a step back. And understand that the processing fee was put it in place as a mitigant against two things. A potential reduction in our late fees coming from provisions of the Card Act. And incremental operating expenses, also as a result of the requirement of the Card Act. So we have implemented it for a portion of the file. Very much those folks that are electing to go with electronically delivered statements are not being charged this fee. And so the approach is to make sure that we understand all of the ramifications of the processing fee. And then as Ed said, we will proceed after that. That's really the approach. It is no more complicated than that.

I think to Ivan's point. Maybe this helps you out a little bit. We haven't seen any negative reaction from the card holder base on the fairly significant group we're testing now. So that's good news for the full rollout. It is too early to tell. Obviously, we're trying to encourage folks to go green and go online. And it is probably a little too early to tell how many folks are going to be doing that. But there has been very little noise on this topic. And the goal, as Ivan said, is to do nothing more than replace that which we will most likely lose when the final late fee legislation rolls in in August.

Got it. Thank you.

Next?

Your next question is from Reggie Smith with JPMorgan.

Hello. Can you hear me?

Yes.

Thanks for taking my question. The first question I get a lot from investors and from clients is -- earlier this quarter, you talked about not having to raise capital -- or infuse capital at your bank level. Just curious, what changed? Or how did your thinking change that made you decide to put $50 million in last month?

I will take it, and then I will kick it over to Ivan. I think the big question that we all got was there is going to be a big outside raise for equity. And that's the thing that we consistently said that is absolutely not going to happen. And that that is not going to happen period going forward. What we did decide to do, however, is we knew we could certainly be at the well capitalized define levels. But we always tend to run quite a bit higher than that, and we wanted to make sure we had a nice cushion in there to handle the type of growth that we're looking at, which is running about double our average. So it is I think a pretty small chunk to give us a little bit more [cush] in terms of our growth plans.

The other thing I would add is that when the final interpretation of how these ratios are to be calculated came out, it was evident that there was more to be included much earlier on. The capital impact on the equity side of the balance sheet was essentially rolled out day one with only the asset side being phased in. And to Ed's point, when we looked at that and looked at what those ratios meant, we just felt that putting that capital in would ensure that we had a comfortable head room to cover any additional growth. I would also point out that certainly the sales levels and sales increases that we are seeing were trending above expectation. And we wanted to make sure that the AR -- our asset levels were fully covered. (inaudible)

Got you. If I could sneak one more in -- to follow up on Robert's question earlier. So just based on the seasonality of the business, and how the portfolio tends to trend throughout the year. If 2Q receivables are down, could you also see another quarter where your loss provision is lower than the actual charge-off that you experienced during the quarter? And then to take that a step further as we get to the end of the year, if charge-offs are in fact better, is it possible that maybe the provision is to expense this year is significantly lower than what actually -- what is actually charged off?

No, I wouldn't think that would happen. I think you will see it being fairly close. And then if you have significant build in the AR toward your end, you could actually see it being a little bit higher. So again, it is just sequencing among the quarters is all you're looking at Reggie. And the one thing I would point at, since everyone is very focused on the charge-offs in Q1, is had we not changed from an accrual basis, we would have collected a lot more income in Q1 as well. But by going to accrual basis, that amount that we billed in the fourth quarter and collected in Q1 did not come through as revenue. So we did not get this pick-up or benefit by going to the accrual basis in Q1 and booking a lower loan loss reserve than what we actually charged off. Because our revenue was actually lower as well as a result of moving to an accrual accounting basis.

Okay. Thank you.

Your next question comes from the line of John Williams with Goldman Sachs.

Good evening. Thanks for taking my questions. To start, you had mentioned -- obviously, that the credit sales were up pretty nicely, around 20%. And you mentioned that that includes the core and the acquired. Ed, is there any chance that we might be able to get a little more detail on the individual growth rates of each of those pieces? Because then it gets important, especially if if we're going to evaluate you relative to the other 'issuers' in the space. Just to know what your core business is doing in terms of a rebound in sales.

Yes, I think our core -- high singles?

Yes.

I'd say, high singles. And then on top of the core, you have the newer vintages, which are those clients that we sign up -- retailers that we sign up. And again, this is another distinction between us and where you like to lump us. And that would be all of those -- the six or so new clients we sign each year. They're ramping up, right? From zero percent to about one third of their sales flow on the card. That would probably bring you up into the low teens. Maybe 13%, 14%. And then, you would have acquired growth that would bring you closer to the 20%. We like to think of one third, one third, one third -- would be ideal.

Got it. That's helpful.

We try.

Another question was on your reserve methodology. It looks like you're seeing a pretty good improvement in delinquencies. And it makes sense that as the year goes by, you should see an easing in terms of both your provisioning and just generally the level of charge-offs-delinquencies that are coming through. How are you thinking about tying delinquencies and charge-offs here? Because on the one hand, it is implied just in the lack of change to the charge-off guidance, that you are really not expecting much of a change. But the delinquency seems to show otherwise. Is that just being conservative in how you think about this? Or are you expecting there might be some more noise in the second and third quarters?

I don't think there will be more noise. I think that, again Q2, we expect to be flat with Q1. And yes, that is primarily seasonal in nature. We do expect it to be below last year. And then, I think it is more of -- we are fairly conservative. And if we continue to see the type of delinquency numbers we're seeing, we're seeing our recovery rate begin to return back to where we wanted it to be. We're seeing a leveling off in terms of the spike-ups in personal bankruptcies. So to your point, it is all heading in the right direction. I don't think having another quarter of relatively flat reserve rates and loss rates is going to kill us. And I think we can still have a very strong Q2. And if we continue to see such good numbers, that should come through in the back half of the year.

We shouldn't read anything into that other than maybe a little conservatism? Nothing relating to anything else then, I guess?

No. The one point I'd add, if you follow the ramification of the methodology that Charles laid out. By definition, in those quarters where the receivables climb, the reserve as an absolute percentage will tend to decline slightly. And in those quarters where receivables drop, you will see good reserve as an absolute percentage go up a bit. So our second and third quarter, generally receivables tend to be flat. So you should see somewhat consistent levels of reserve. You should see the reserve percentage drop a bit in the fourth quarter, as receivables peak. And then climb in the first. And that's all other things being equal.

And so to bottom line this thing, and since we've beaten it to death. And then beaten it to death a few more times, which is fine. A, no, there is nothing ominous to read into it other than -- look, it has been a long couple of years, and things certainly look like they're heading in the right direction. So let's keep flowing the way we're flowing, and it should be a pretty nice run in the first half and a stronger run in the second half. And second, whether it is accrual or whether it is cash, as Charles mentioned, the number itself on a full-year basis will effectively be virtually the same.

Okay. Thanks.

Yes.

The next question is from David Scharf with JMP Securities.

Hello, good afternoon. Thanks for taking the call. I will try to be brief here. First, just curious. Ed, within Loyalty, you have yet to anniversary the restructuring of that Bank of Montreal business in terms of their increased miles issuance per dollar spent. Just curious on the 5% issuance growth. On an aggregate basis, have you seen issuance growth out of your -- all of your non-BOM client -- sponsor base?

Well, as I mentioned the grocer segment was net down in the first quarter due to promotional. I would say that gas, petroleum was certainly up, pharmacy was up, and cards were up. And so really, it was just grocer that was down. And that was promotion.

So it sounds like you're seeing much broader recovery beyond just BOM over the last few quarters?

Yes, I have got to tell you though -- we're still -- there has got to be -- we're not seeing yet, David, the real strong push on the discretionary part of card spend. We're seeing a nice start, but we're not seeing -- we've yet to see I think the next shoe drop in terms of the consumer really opening up the wallet. And I think that is where our largest sponsor is hoping that this double mile offer will have them be pulling out their card first.

Right, right. Sort of housecleaning. But inherent in your loyalty guidance, are you making any changes to your currency or exchange rate assumptions? The Canadian dollar is at practically a parity right now.

No.

So we shouldn't overthink any kind of cushion there?

We haven't.

Last question, just on Private Label. Obviously, the last 18 month -- the focus is predictably and justifiably been unemployment trends, credit trends, and so forth. And therefore, so what we haven't focused on as much is the old traditional drivers of new program signings. Where is that? And how does the backlog look right now? And just as importantly, as we start looking out 12, 18 months --, a little more normalized environment for you. Has the law of big numbers caught up in terms of a $5 billion plus portfolio? The number of $100 million plus in sales retailers that are still out there that don't have programs? How are you feeling about the size of the market opportunity?

The market is there. The pipeline is robust. I think at this point, we are being selective. I think there are more opportunities out there that -- than we are interested in, quite frankly. We get a lot of calls that typically go something like this. We are not happy with our current issuer. If you can match the current deal, please, we're interested in talking to you about the business. But we have to recognize that the market has changed. Whether it is a result of the revenues on the Card Act side -- so we are being selective in ensuring that the kinds of folks that we are talking to fit with our core and would strengthen the business and provide long-term relationships. So certainly, it is out there, and you can expect to see us at least add 5% plus a year in terms of new signings.

Got you.

So what we're -- 20%-type growth, I think, is a little bit heady. And I think we will probably -- our long-term growth for the file is what? Around 10% or 11%, which I think is probably -- if it is 2012 or whatever. That is probably where we're going to head back to, but you combine that along with as losses normalize from 10%, 6%. You can get some -- a pretty nice run-up on Private Label for the next few years for sure.

Great. Thanks a lot.

You bet. All right. A couple more.

The next question is from Wayne Johnson with Raymond James.

Hello. Yes, good afternoon.

Hello, Wayne.

Hello. Could you just talk a little bit about the -- on the Loyalty side, the split-non-split fees? Can you just give us a little color on how we should think about that in totality for all the customers up in Canada?

Yes, I think -- what are we down to, one?

One.

We have one left that is split fee. And everyone else is basically non-split fee. Meaning that we will get paid up front in its entirety. So I think that seems to be the model that most of our sponsors like.

Absolutely. So we're down to one. The last one we did is we talked about in the press release, when we did it, we had a little bit of a deferred profit that we capitalized and amortized in over the estimated life of the miles. And that's what we alluded to in the press release.

Right. Okay. And how much longer is that split fee contract going to be in force? And is it a major customer?

Well, the split fee is gone. This is the conversion of the split fee to a non-split fee I think you're referring to.

Yes.

And it is just a tail that is running out.

Okay. So the time line is what I was trying to get at. Okay. Perfect. Secondly, this is just more of a [nit]. But on a tax rate basis, how should we think about that going forward?

About 38.2%.

38.2%. All right. Great. Thank you.

The next question is from Dan Leben with Robert W. Baird.

Great, thanks for squeezing me in. Just to jump over to the Epsilon business. You have had a lot of really large deal signings. Can you help us understand what the pipeline of new opportunities looks like after landing a lot of these?

Sure. Obviously, the Q4 and Q1 have been very, very strong. For example, New York and Co. that we announced, is a very large Private Label client for Ivan. And we just did a little bit of work for them on Epsilon. Now it is going to be a very, very significant client for Epsilon as that ramps up.

Additionally, obviously Kraft. I think the number two food company in the world. Bringing them on and doing a lot of their transactional-based marketing and campaign and permission-based e-mail and everything else. That is another very, very large client for us. And even La Quinta -- enhancing that business with really running their entire loyalty program is also additive. So the bottom line is if you looked in Q4 and you looked in Q1, and you looked at some of these deals, like RJR, Visa, for sure, Kraft, and New York and Co. What you're talking about is the size of the prize here is these are the types of deals that are not insignificant to Epsilon. Will they be sufficient to replace or displace the existing top five within Epsilon? I don't know exactly. But I have got to tell you, they are of that magnitude.

I apologize. I was talking about with all the big signings -- as you work through a little bit of the pipeline-- and we should the next couple of quarters not really expect much? And then maybe see a pick-up again in the back half of the year, and then going into 2011?

No.

Okay, great. And then, one follow-up for Ivan. Could you talk about bringing the collections in-house? What the performance has been there? And if that contributed to the loss rates in the first quarter being better than expected?

Sorry, when you say the collections in-house, are you talking about the fact that we have migrated more of our recovery collectors in-house? Is that what you're referring to?

Yes.

We are certainly seeing more than the anticipated pick-up from the effectiveness of our own in-house recovery unit versus using third party collections. But remember, we still do both. We just changed the mix that we are working more of the post-charge-off recoveries in-house than we did historically.

Great. Thanks.

The next question is from Andrew Jeffrey with SunTrust.

Hello. Thanks for taking my questions. Snuck in under the wire here. Could you talk a little bit about the Target announcement the other day that it is moving to a proprietary private label program away from a Visa co-brand? Should we be thinking that as a broad market signal one way or the other vis-a-vis your Private Label positioning? Or is that truly a one-off kind of development?

It is absolutely not a one-off. I would read that in conjunction with a Wall Street Journal article that a major issuer had cut about 50% of their co-brand programs out. What it really is is an absolute reinforcement that the private label product that everyone had assumed was dead and buried is by far the greatest driver of incremental sales for most retailers. There clearly are still some retail verticals or retail segments out there for which co-brand is a viable alternative. But quite frankly, our experience has been that private labels drives -- even with our own co-brand programs, private label drives greater incrementality because you have got a dedicated credit line for that retailer.

What we see is, some of the folks who have taken over on credit cards perform at or below what the private label customers do in-store. Then run up the credit lines outside of the store, and losses, in fact, are greater with the co-brand programs than there are with the private label. And that's what I think you've seen throughout the industry over the last 18 months, as to why the major Visa-Master Card issuers -- losses have increased at a greater factor that ours have -- is that people have run these lines up significantly before declaring bankruptcy or being unable to pay. So we do see it as being significant. Let me be clear. We will maintain and remain in the co-brand business because we think it is important that we do so. But we clearly feel that for the vast majority of our clients, Private Label is the lead product, and the greatest benefit to them in terms of driving incremental sales.

Yes. I think to Ivan's point, Andrew. Co-brand is maybe 5% or so of Ivan's business. On the -- I think one of the things that came glaringly obvious during this -- the mega-recession we just went through is -- sure, our losses went from 6% to 10%. But the bank card industry went from 4.5% to 11% or 12%. And so, I think that got a lot of people thinking about the [bottle], and do co-brands, are they even priced correctly? They're not. And as a result, you're just not going to see those types of deals getting done. People are cutting back on them, and as a result, the retailers are saying -- look, I just want someone to be able to use this card where I am. That's what we're seeing.

Ed, I calculate your all-in funding costs around 5.5% annualized in the quarter. Should we be thinking about spreads, or LIBOR notwithstanding -- any changes in LIBOR notwithstanding. Should we be thinking about those funding costs being flat or down for the full year?

I think they will be down.

Okay. By order of magnitude?

I don't know where the 5.5% -- that seems awfully high. We're not near 5.5%. But I still think the deals we just did, and renegotiated, definitely are driving funding costs down this year.

That includes your noncash interest expense. That's why it sounds high. If I assume noncash interest expense as kind of flattish -- funding costs down 25, 30 basis points on the year?

Yes.

Yes.

Okay. Thanks.

The next question is from Dan Salmon with BMO Capital Markets.

Okay, this will be our last question, Operator.

Yes, sir.

You just made it.

Thanks for taking the question. I'm just going to ask you about Epsilon and sort of a double-barreled question. The growth you're seeing there in light of the new signings. How much of that growth is from the new clients versus existing clients increasing spend? And then with regards to the backlog, are you seeing more interest from any specific industry verticals -- less interest from some? Or does that look fairly similar to your distribution of clients as it is currently.

You bet. That is a good question. We don't obviously break out a current quarter where the growth comes from. But as a general rule, roughly two thirds historically of Epsilon's growth has come from larger commitments from existing clients. And the remaining one third comes from new clients themselves. The fact that in Q4 and Q1, we signed such significant new clients will skew that a little bit/ Hopefully in favor of even greater growth. But it is usually a two thirds-one-third is about right for us. In terms of the sectors that are there, that are really stepping up to the plate -- in terms of the signing. There is obviously a huge amount of continuing interest in Big Pharma.

Big Pharma obviously does an awful lot of work direct to consumer. And we have nine of the ten largest pharmaceutical firms in the world as partners. And obviously, the direct to consumer approach as opposed to hundreds of thousands of sales folks going to doctors is the preferred approach today. And as they bring additional drugs online, obviously that flows into additional opportunity for us. So Big Pharma is certainly big. Financial Services -- the ability to put together a loyalty platform that can cut across, not only cards, but into their retail banks, is obviously very important as typified by looking at some of the big programs we do. Like Citi ThankYou, and some of those. So Financial Services has also been quite active. And then finally on the CPG side -- packaged goods. We're seeing some pretty good momentum there as well. I would say those are probably your biggies.

Okay. That's great. Thank you.

Okay. Well, I wanted to say thank you to everyone. It is has hopefully been a very nice start to a nice long trend here at the Company. And it is nice to see balanced growth returning to all of our businesses. And especially now that Ivan is sitting with us here tonight, we're especially pleased that we're off and running there. And we have, we think, navigated a lot of the issues that have popped up over the last 12 months, or 24 months, or 36 months. So that being said, thank you. And we will talk to you next quarter. Goodbye.

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