Bread Financial Holdings Inc (BFH) 2011 Q2 法說會逐字稿

Good morning, my name is Jennifer and I will be your conference operator today. At this time I would like to welcome everyone to the Alliance Data second-quarter 2011 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions) At this time, I'd like to turn the call over to Ms Julie Prozeller of Financial Dynamics. Please go ahead.

Thank you operator. By now you should have received a copy of the Company's second quarter 2011 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 and Charles Horn, Chief Financial Officer of Alliance Data. Before we begin I would like to remind you that some of the comments made on today's call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and the uncertainties described in the Company's earnings release and other filings with the SEC. Alliance Data has no obligation to update the information presented on the call. Also on today's call our speakers will reference certain non-GAAP financial measures which we believe will provide useful information for investors. Reconciliation of those measures to GAAP 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. I appreciate everyone getting up early especially on the West Coast. Hopefully you have a nice bowl of Cheerios going and we are going to get right after it here today. I'm going to turn it over immediately to Charles Horn, our CFO, who is once again back by popular demand to take us through the quarter. Then I will talk a little bit about our outlook for the remainder of the year and then give a little bit of a viewpoint into where we see 2012 and 2013. That being said, Charles?

Thanks Ed. After a great start to 2011 with a record first quarter, we continued strong, building momentum for the back half of 2011. Of note, Epsilon achieved record revenue and adjusted EBITDA for the quarter while Private Label continued to exceed our expectations regarding its portfolio performance.

In total, consolidated revenue increased 11% to $740 million. All three segments achieved revenue growth with Epsilon increasing 38% compared to the second quarter of 2010. In addition Epsilon again achieved double digit organic revenue growth. Core EPS increased 27% to $1.75, considerably beating the Company's guidance of $1.60 while GAAP EPS increased an even better 43% to $1.19 per share. Both increases were achieved despite a $2.4 million increase in diluted share count due to phantom shares associated with our convertible notes. The reason we call them phantom shares is that these particular shares are covered by economic hedges with counter parties. The Company has no obligation now or in the future to issue these shares. It is purely an accounting convention that places them in the diluted share count. Upon maturity of the convertible notes, phantom shares disappear from the diluted share count. Said another way, until the convertible notes mature our true EPS numbers will be understated.

Adjusted EBITDA increased 15% to $239 million while adjusted EBITDA net of funding costs increased an even stronger 27% to $198 million. Funding costs benefited from a $5 million mark-to-market gain on the interest rate derivatives. As discussed in our earnings release, this benefit of approximately $0.05 was excluded from core EPS. In summary, for the second quarter we more than achieved our targets of double-digit revenue, adjusted EBITDA, and EPS growth.

Let's turn to the next page and talk about LoyaltyOne. Overall, LoyaltyOne met expectations for the second quarter. Notably, miles issued increased 5%. Revenue increased 5% if you exclude the foreign exchange translation gains and the negative grow-over to deferred revenue which fully amortized in the second quarter 2010. Adjusted EBITDA increased 1%, again excluding the foreign exchange translation gain and the negative grow-over of deferred revenue. Adjusted EBITDA margin for Canada remained strong at 28%. The margin for this segment was reduced nominally due to higher operating losses associated with our international expansion activities. Miles redeemed increased 2%, dropping the current period redemption rate to 67% in line with our expectations for the remainder of 2011. As discussed before, miles issued grew 5% for the quarter keeping LoyaltyOne on track for a mid-single digit increase for the year.

The growth was a balance of credit card spending, high frequency and specialty retail growth, and the return of some promotional activity in the grocery space. Miles redeemed increased 2% as certain routine changes made to the AIR MILES reward program during the first half of 2011 dampens collector redemptions during the quarter. As discussed during our last earnings call, we fully expected this. While the changes made slightly lower revenue growth, they will likely create higher [SDA] margins in the future as well as support our ultimate redemption rate of 72%.

The Dotz loyalty program in Brazil continues to meet our expectations. With the signing of Banco do Brasil as a national anchor sponsor, we are looking to take the platform to a national level. It will be done in the following steps -- First, during the third quarter of this year, we will complete the acquisition and conversion of a portion of Banco's over 30 million accounts into the program. We currently estimate 2 million to 3 million of these accounts will participate in the Dotz program over the near-term.

Second, during the fourth quarter of this year, we will proceed with a staged rollout with our national partners and third, during 2012, we will look to secure additional high-frequency partners and look to move into new geographic regions. As we have talked about before we currently own about 35% of Dotz. We increase our ownership position as we inject capital into Dotz to fund growth and could eventually take majority ownership. Our goal for Dotz is to reach EPS accretion in 2013. With a target population of more than 70 million collectors in the country's 200 million residents, we believe the long-term potential of Brazil equates to a similar level to what we have experienced in Canada, which currently generates over $250 million a year in operating cash flow. We continue to look for opportunities to make similar measured investments in other attractive markets. During the second quarter, we did just that, acquiring a minority interest in Direxions Global Solutions, a leading loyalty, customer relations management and data analytics company in India.

Let's go to the next page and talk about Epsilon. Epsilon posted excellent results once again this quarter and with the Aspen acquisition contributing to a record quarter for Epsilon both top- and bottom-line. Revenue increased to $188 million up 38% and adjusted EBITDA increased to $39 million, up 26%, both compared to the second quarter of 2010.

If we break it down by business line, the database digital revenue grew 20% compared to the second quarter of 2010, continuing the standard set in first quarter of this year. This business line is composed primarily of large contracts with local brands, to support data-driven marketing platforms. These platforms are utilized by Epsilon clients to drive relevant marketing messages and programs across various consumer channels including websites, call centers, point-of-sale, mobile, email, social, and direct mail. Growth in this core business is well balanced, driven by a combination of new clients, up-sell, cross-sell projects with existing clients and growth in digital volumes.

Digital volumes which is our permission-based email, powered through a temporary slow down in conjunction with the security incident discussed in our last earnings call and quickly return to double-digit growth as plans continue to shift marketing dollars into the data-driven, direct communication channel such as permission-based email.

Additionally, since this security incident, Epsilon has continued to move forward with a number of key enhancements to the security of its email platform following through on our commitment to put in place the best security measures in the industry. What Ed refers to as our Fort Knox strategy. While for obvious reasons we will not broadcast these additions, they include enhanced authentication requirements for our global user base along with sophisticated custom technology that monitors in near real-time malicious IP hits and suspicious behavior patterns in and around Epsilon's network. We are pleased that clients remain supportive and our outlook for this business is strong.

On the second business line which is data, the data revenue grew 28% for the quarter. The data business principally includes our Abacus, which is a market leading data cooperative for retailers, catalogers and other verticals and DMS, a consumer demographic business acquired in July of 2010. Excluding DMS, revenue growth was essentially flat year-over-year, as Abacus' second quarter 2010 revenue was stimulated by discounted postage rates to major retail catalogers. The third business line which is agency analytics revenue grew 140% primarily due to the acquisition of Aspen on May 31, 2011. Excluding Aspen, revenue growth was still solid at 6%, due to initiatives previously undertaken. We will discuss Aspen in more detail in a few minutes.

Summing up, all components of the Epsilon platform are performing well, with earnings coming in at all-time highs. We weathered the security incident back in March 2011 with no material impact on digital volumes or client relationships.

Let's turn to the night next page and we'll talk briefly about the Epsilon business model. If we take a step back, before Aspen, Epsilon through organic growth and previous acquisition [had deep] capabilities in 4 of our 5 key product offerings. The first is data, which provides unique insights to help clients identify consumers and businesses and communicate with relevance to them. The second is database, which is the heavy lifting required to process and store massive amounts of data and provide sophisticated marketing and loyalty tools to operate programs. The third is analytics, which is applying real-time segmentation models in predictive algorithms to optimize client's dialogue with their consumers. And fourth, distribution, which utilizes analytics to enable communications across all channels, both traditional and emerging digital channels. And the fifth is agency/creative, and this is where Aspen brings significant size and capability to this category. Agency/creative includes working with a Fortune 1000 Chief Marketing Officers to develop and design the marketing programs that the other product offerings execute.

In addition, Aspen brings significant presence in new verticals, and creates a strong opportunity for Epsilon to up-sell and cross-sell this broader service offering into existing clients. In summary, with the closing of Aspen, Epsilon is in a strong position with a well-rounded and more balanced business model.

Overall, Epsilon stands today with a combined pipeline at an all-time high and is well underway with the Aspen integration. Each of the core offerings are driving growth and are benefiting from the ongoing macro trends as global clients continued to shift money into the measurable ROI- based marketing categories Epsilon supports. With the addition of Aspen, we expect Epsilon to have a strong finish to 2011 with both top-and bottom-line acceleration. For 2012, Epsilon is in position to top $1 billion in top-line and $0.25 billion in adjusted EBITDA.

Let's turn to Private Label. Private Label continued its strong 2011 performance with revenue up 2% and adjusted EBITDA, net of funding costs, of 50% for the second quarter in 2011. Excluding a $5 million mark-to-market gain on interest rate swaps which lowered funding costs for the quarter, adjusted EBITDA net still increased a stellar 44% compared to the second quarter of 2010. Revenue increased 2% despite a 3% decrease in credit card receivables because of a higher gross yield. The gross yield is up year-over-year due to program changes made throughout 2010 and now in the mid-27% range approximates the normal run rate.

The provision for loan loss expense decreased 36% year-over-year to $60 million, due to a 180 basis point improvement in charge off price. Lastly, funding cost dropped from the second quarter of 2010 due to a 12 basis point improvement cash funding rates, lower average credit card balances and the mark-to-market gain discussed before.

Looking at the key fundamentals of Private Label, cardholder spending continued to gain momentum and grew by 9% for the quarter following a 5% gain in the first quarter of 2011. This consisted of a 12% growth from our active clients, less a 3% drag from terminated or defunct clients.

Year-over-year there was solid improvement in most areas of the retail world specialty retailers and catalogers were strong this quarter while some of the larger ticket merchants continued to be impacted by the macro environment. Average credit card receivables decreased by 3% during the quarter. Payments continued to be strong in the quarter as consumers continue to push down debt levels. Payment rates have now returned to levels last seen back in 2007. Overall payment rates did moderate during the second quarter in the mid-18% range. Once the higher payment rates anniversary, which we expect in the third quarter of 2011, we believe that the strong cardholder spending will stick and drive receivables growth.

If we look at delinquencies, while higher payment rates do pressure receivables growth, they are beneficial to delinquency levels. For the quarter, average delinquency rates decreased to 4.5% of average credit card receivables. This is a 90 basis point improvement versus the same quarter of last year. Falling delinquency rates are a leading indicator that charge-off rates will decline in the future.

Lastly, the principal charge-off rate was 7.2% for the second quarter of 2011, again representing a 180 basis point improvement over the prior year quarter. Clearly, portfolio performance has delinked from unemployment rates and to some degree the choppy economy.

Let's go to the next page and we will go over a couple of charts. The first one we'll talk about, it tracks Private Label's charge-off rates compared to the Moody's Credit Card Index. A reminder that Moody's Credit Card Index is based upon credit performance data, for approximately 230 individual credit card base for securities rated by Moody's. The index sample includes approximately $290 billion of bank credit card receivables which back securities rated and monitored by Moody's.

As you can see in the chart, our Private Label charge-off rates perform significantly better than the index during the worst of the recession, peaking at about 10% and is now tracking with the index which is consistent with our expectations. Eventually we believe our charge-off rates will normalize below the 6% range. Before then we believe the charge-off rates could dip below 6% on a short-term basis as the charge-off rate trend overshoots a normalized run rate.

Let's flip to the next slide. And this is something you've probably heard Ed talk about before. And that's the concept of a barbell effect in our Private Label program. In essence, on one end of the barbell you have the higher income individuals for spending. They are paying at a higher rate and on a timely basis and this is a fairly big group. In the middle, which is the handle, is the middle income individuals who are sparse, with little opportunity to extend or expand credit to this group. It's a very small group. On the other end of the barbell which is again a large group is lower-income individuals, many chronically unemployed due to length of the recession and have burned through the credit system. So the result is the charge-off rates for us and the industry continue to drop even as high unemployment rates stubbornly persist. Whereas historically charge-off rates would exceed the unemployment rate by about 100 basis points, we have seen a complete decoupling of the two metrics. Accordingly we expect charge-off rates to continue to trend downward regardless of unemployment rates.

Let's turn to the next page and talk about liquidity. Corporate liquidity at June 30, 2011 was approximately $410 million. A new credit facility, coupled with the resumption of dividends from our banks, allowed corporate liquidity to grow from the end of Q1 2011, even though we used approximately $360 million during the quarter to acquire Aspen. Our debt levels remained very manageable. The key long covenant ratio which is corporate debt to adjusted EBITDA was 2.5 to 1 at June 30, 2011, substantially below the covenant ratio of 3.5 to 1.

At the bank level, we have approximately $3.3 billion of available liquidity at June 30. Two conduit facilities aggregating $1.5 billion were renewed during the quarter at favorable terms. Regulatory ratios at our banks remained strong, with WFNNB capital ratios at 15% for Tier 1, 14% for leverage and 17% for total risk base as of June 30, 2011. Importantly, dividends resumed in the second quarter after a 2-year hiatus. WFNNB made a $50 million dividend payment to ADS during the second quarter and we expect similar amounts in future quarters.

The share repurchase program continues to be one of our anchor strategies. During the second quarter we spent $55 million acquiring 650,000 outstanding common shares. Year-to-date we have spent $117 million acquiring 1.51 million outstanding common shares. As of June 30, 2011 we have $211 million to spend under the program through the end of 2011. In summary for the quarter, we bolstered liquidity, while growing the Company through acquisition and driving shareholder value through our repurchase program. With that, I will turn it over to Ed to talk about our 2011 outlook and our updated guidance.

Thanks Charles. The slide should read 2011 key accomplishments, and frankly, it's been the most productive first half for the Company that I can recall in recent memory. We tend to put together about a dozen critical tasks at the beginning of each year, and obviously try to knock them off one by one as the year progresses. It's only halfway through the year, and I would say we're 90% to 95% of the way through. Which is great news. So specifically, let's talk about the critical deliverables, and how we have knocked them off as the year has progressed.

Let's start first with LoyaltyOne, which is primarily the AIR MILES program in Canada. The most critical item we had up there was the metric that defines essentially how we make money. And that is the ability to issue miles or points or however you want to define them, and that metric had been stagnant for 3 years. 2008, 2009 and 2010 had about 4.5 billion miles. So it was critical that we got this thing going again, there was some concern out there that the business was so big and so dominant in Canada that it had plateaued. We did not feel that. As a result, we put our shoulder into getting this thing going again, and sure enough, our goal is to be running miles issued at about 5%. And sure enough, year-to-date we are running up 5%. We expect that to hold for the remainder of the year. That's extremely good news. If you add the 5% growth with a couple of points for CPI inflators, it essentially translates into high single digits, organic growth top-line and about 10% EBITDA growth over the long term. And that's what we would consider to be a very nice long-term growth outlook for the business up there.

How did we do it? Obviously, we kept everyone, all of our sponsors and we also had a great deal of success for the first time penetrating the retail vertical, specifically Children's Place and Zales Canada. And with all our renewals in very good shape, this new vertical in place, there is a good shot that we may announce 1 or 2 additional new sponsors in the program this year, which of course would bode very well for 2012.

And then finally, as Charles mentioned, with the signing of Banco do Brasil, we are getting ready to launch this coalition nationally across Brazil, and it's been a great success in the first area, Belo Horizonte, that we announced thus far, and have been in pilot for the past year. We have 500,000 or 600,000 households actively engaged and enrolled. We would like to get, by the end of this year, about 1.5 million households enrolled. And that should jump nicely to about 5 million households by the end of 2012. So again, it's going to be a very quick climb in Brazil. And we are looking, also in addition to the national role, of actually rolling out on a regional basis another regional part of Brazil sometime later this year or early next year as well, which could further accelerate the ramp-up down there. Also, as Charles mentioned, if this thing does hit its stride, it certainly could be the size of our Canadian business, which again is about $0.25 billion of operating cash flow. So, very, very pleased with the progress at LoyaltyOne.

Turning now to Epsilon. Look there's not a lot to say about it other than it's just killing it at this point. Double digit organic revenue growth in the mid-teens, along with the acquisition of Aspen, is making this quite a year for Epsilon. One of the things I did want to step back on and talk a little bit about was the data incident, and just give everyone an update on where we are. Probably three items coming out of that.

The first is we've gotten questions about -- is this a big hit? Was there a big cost to it? Putting the security features in place, etc. etc. The answer is no. Essentially this is any of the incremental cost associated with the data incident have been absorbed, and at this point, they are not material.

Second, as Charles also alluded to, we're well on our way or actually we believe we have pretty much completed our Fort Knox strategy. And we are not going to get into a lot of the details of it, but suffice to say, it's fairly impressive. We have also now taken that approach and we are checking and probing other systems within the Company to make sure that there are no gaps or holes, and we will be doing that on an ongoing basis.

And then finally, from the concern about client attrition, at this point we are very pleased to say there has been no significant client who has left us, and you can see that in the volumes that are up well into the double digits for the second quarter. And I think for the first time this year, we will finally get to that $40 billion number of permission-based emails put out for the year. So that is exciting as well.

And then finally, the last piece of the puzzle that we talked about in the 5 pieces of Epsilon, which include the digital agency, the creative piece, the data piece, the database piece, the analytical piece and then the distribution channels that we have out there. We were light on one piece, which was the digital agency piece. And we needed to bolster that to the point where all 5 pieces of the puzzle had critical mass, and with the Aspen acquisition, we believe we are there. Aspen brings bulk, it brings a great reputation, it brings some unique verticals to us, and also, it extends and it greatly expands our presence in the digital arena and again, a lot of people talk about it. But we are talking here is obviously we're -- digital would involve email, social, mobile, and the web channels. And obviously we are very, very strong on email to begin with. But the other 3, this will give us some nice help there.

Also, if you were to look at our overall business, which is transactional based micro-targeted marketing, that blanket statement covers the entire Company, and that marketplace is about $300 billion today, marketing and advertising spend. If you start slicing and dicing it, and you get the distinction between direct marketing versus general marketing, we play only in direct, that actually is a market that is taking share away from general. And you have heard me talk about that a lot. And then specifically, within direct, if you drill down deep enough, you will find that there are really only 2 areas of direct that are growing with any consistency.

One would be considered old world, and one is new world. And old world would be very targeted direct mail, and people are sometimes surprised at that but it is growing 4 or 5 points year. And then the other would be all the different digital channels, which are growing somewhere in the mid- to high teens. If you put them together for our businesses, we are playing across the board in a market that is about $80 billion today, and it will be growing double-digit organically for the foreseeable future. So, we're big fans of finding markets that have nice growth, and that's a critical part of our strategy going forward. That is where we are going to play.

Finally we turn to our Private Label business. Again, as Charles mentioned, very, very nice acceleration on the use of our cards, as found in our credit sales metric. Moving from plus 5% in Q1 to plus 9% in Q1. We expect the back half to finally tip over into double digit. And we expect our file in August to finally pass the point where it starts growing again and we would expect about up 5% for the year.

We are realizing significant over-achievement in credit quality, despite the macro conditions. Again, Charles spent some time on what we believe is in fact going on out there, which is the barbell effect. The recession was so long and so severe that what happened is you burned off so many different layers of credit that what is left is a very, very pristine file and what you also have left is a situation where the long-term relationship between unemployment and credit losses has broken down. And we see no reason for that relationship to reestablish itself in the near future. Essentially what you have at a very high level is if you assumed in the good times unemployment was 5%, well maybe 1% of that was what we would call structural unemployment, long-term, chronic unemployment. And those are folks who would not be in our file. What you have today is an unemployment rate at 9%, but some folks are suggesting anywhere between 4 to 5 points of that rather than 1 point has to do with the long-term structural unemployed which have already been burned out of the file. So, it's a very interesting and unique situation, and I frankly have never seen such a complete decoupling between the two. But there's no reason to think it won't continue and we are seeing it in all of our metrics as well.

Okay, finishing up at the ADS corporate level. We are very pleased to secure $1.6 billion credit facility, very nice deal, we had had a lot of folks in the global banking community participate. The deal was a very, very nice deal for us. And we are pleased to get that done.

And then finally, this is a little bit of a commercial but I will do it anyhow. We did celebrate our 10 year anniversary of going public last June. And we got to go down there and bang the hammer at the Exchange, which was very exciting for all of us and our associates. But the goal that we had going into it is; we wanted to be considered among the absolutely top -- best top performers of all public companies and sure enough, by the time the 10 year anniversary came around, after going public at $12 a share, we wound up in the top 1% of all public companies over the last decade. So, thank you to our associates, thank you to the shareholders who have hung with us through quote-unquote some interesting times over the years. And more importantly, I guess to the folks on the phone, we're pretty jazzed up about the rest of this year and going into 2012 and 2013.

So let's turn the page and talk about -- well, we think we've got just about everything done, with got a couple more things on our plate, probably the biggest thing that's hanging out there is we continue to be disappointed with our signings at Private Label. We do still expect to have 6 new clients signed. We've signed 2 thus far during the year. And we expect the other 4 to come out, we think we've got 2 coming out in the next month or so, and that will leave us with 2 left. So it's moving through the pipeline, but it's slow. And we are a little disappointed at the progress. We expect to get that going again. We're putting additional resources against it to take advantage of some of the turmoil in the marketplace, between other players out there.

So if you think about it, if we get our file up to about 5% growth by year-end, if we add about 6 new clients, that is a vintage as we call it, and whether they are start up or existing files, eventually those 6 clients will typically spool off into about a $300 million total portfolio for those 6 clients. You add it to the 5% from the existing business, and that's where you get our long-term 10% file growth rate. So, it's very important we get that stuff done, and we are on it.

And then finally, it wasn't a goal at the beginning of the year, it is I think a new goal we have just put in place, and that is hopefully if things settle down a little bit more in the debt markets, we will be out there looking to raise some incremental liquidity over and above what we've already accomplished. We don't have a use for it at the moment, however, I think it is time we started thinking about what's next. And we have completed the big push, which was spending over $2 billion on buybacks primarily at the depths of the recession plus filling out our data business with the Equifax Data acquisition last year and then the Aspen acquisition this year.

But all that being said, with our leverage still moderate, and very, very strong free cash flow, we think now, of course, is a good time to start thinking about rebuilding the war chest, so that we can be very opportunistic for some things that may be floating around out there, whether it's to return capital to our shareholders or whether it is to further bolster our growth rate through acquisitions, we will wait and see. But we are going to see how the markets go and then we will step in if we think there is a good opportunity.

The bottom line here is despite a lot of the noise from the sovereign risk and from what's going on in DC, does it effect ADS? We are not seeing it at this point. Obviously, if there is some huge downturn from a macro perspective, obviously it is going to hit everyone.

But right now, all 3 engines seem to be cooking along very nicely. We've got Brazil on top of that moving, and with Aspen on board, we are feeling pretty darn good about how things are going. From a guidance perspective, last October, I mentioned we were looking to do $6.70. And we thought that was a pretty decent number coming out of the gate. We then raised it after Q1 to $7 dollars, and we are going to raise it again to $7.20. It just looks like everything is coming together for the year.

But my job specifically is to make sure while the year looks great and everyone can be excited, what does 2012 and 2013 need in order for them to be a success? And so that's where we will be spending a lot of our time, and hopefully the only thing that's left for 2011 will be maybe a final tweak to our guidance when we release Q3.

The critical item as we move into 2012 that we want to get across is balance. As we move into 2012, we are going to have 3 businesses, each of which can generate approximately $1 billion or more of revenues, and at least $0.25 billion of EBITDA. So all 3 of our businesses have the balance and have the critical mass, and on top of it, what makes our model kind of interesting, is all 3 are cycling in a different way. Think of it as having a different philosophy, specifically Epsilon is in what we would call hyper-growth mode right now. We are also supplementing mid-teens organic growth at Epsilon with some moderate tuck-in M&A deals.

So very different from that is Private Label. Which is obviously having a heck of year, and we expect the next couple to be very nice as well. They are just generating huge organic free cash flow. They are just throwing off a ton of free cash right now. And then you contrast that with LoyaltyOne, which has turned the Canadian business back around to a nice growth business. As well as driving all of our organic international expansion; that's their job.

So each of the businesses, each very large, each critical mass, each following a different philosophy for growth. And we think when you put them together it's fairly compelling. So we expect 2012, 2013 to be good years.

All right, let's get to what everyone's waiting for which is guidance. We already talked about on the raising guidance we are bumping it up to $7.20, and I always like to see double digit on everything, on revenues and EBITDA and core EPS and GAAP EPS and everything else, so it's going to be very strong year. There's no one-offs in any of the numbs, so these are also very, very pristine from a reporting perspective which again was one of our goals. Also, Charles referred to the quote-unquote phantom shares, which are those shares which will go away upon expiration of those converts and therefore, they do not have any economic value, but they do saddle our share count until those converts expire. If you were to back those out, since they will go away, you'll find our share count would be very, very much flat year-over-year, and I don't need to tell you if you were to flow that into earnings-per-share, it would increase it quite dramatically. So that's something that's a little gift that is going to come as our converts expire.

And next up on Q3 we will be looking for core EPS of about $1.85 or about 20% growth. Couple of items here. You should expect to see loss rates from a seasonal perspective tend to be lowest in Q3. So we are looking at mid-7% loss rates for the year, year-to-date we're at about 7.6%. Seasonally you'll see Q3 probably go below 7% into the high 6%s. But don't forget, it will pop back in Q4 to probably the low 7s.

Okay, Q4. We should probably also mention someone's going to back into the numbers and say okay, that seems relatively flat to last year. Again, a lot of that is the phantom shares, with the share price run-up, if you take the phantom shares out, you'll find that the actual earnings are up about 8%, which again reflects the fact that -- if you recall in Q4, we are expecting a very nice ramp in the portfolio, we have to put reserves against that. Those will reverse in Q1 as people pay down their holiday balances. It's a little bit of a timing issue.

Also, we may be looking to accelerate our quick expansion in Brazil. By adding a new region in addition to the Banco conversion, we're going through that right now, and we would prefer to put some investment dollars in there if it gets things quicker. You saw we put our toe into India, we are still working out whether there is a few million dollars that we want to put in before the end of the year.

And then obviously, with what we would call the uncertainty around a global macro situation, and our general conservative nature, we do keep our reserve levels in our Private Label business fairly robust, and well north of the actual loss rates. We run at least 100, 130 basis points above our loss rate which is a little unusual in a declining loss environment, but frankly, it lets us sleep nicely at night.

And I will leave with and of course, if things continue to go well, there is always the chance of a little bit of extra room there, but we will let you know in Q3 if things continue to rip along the way they are doing for a final tweak in guidance.

Free cash flow, which is our final page, you'll see we raised that again. We were originally around the $7 range of pure free cash and again, that takes into account everything from securitization funding costs, CD cost, corporate debt, CapEx, regulatory capital blah, blah, blah, all that stuff. The net result is we are going to be doing close to $500 million this year, or $0.5 billion of pure free cash for almost $8.50 a share. So this thing from a cash flow perspective is pretty amazing.

We don't have huge CapEx, we don't do huge acquisitions. So as a result, you're looking at a Company as we exit 2011 and going into 2012 and 2013, that's going to be throwing off $0.5 billion of pure free cash, growing double digit organically each year. And so, that's something that will allow us, obviously a lot of flexibility when it comes to either buybacks, tuck-in acquisitions, portfolio acquisitions, international expansion, or other ways of returning capital to shareholders.

So, that being said, I think we will open it up for questions now. But if -- the bottom line is for all of us and our 9,000 associates, it's been a great first half, we're looking forward to a heck of a second half, and again, right now as I look at 2012 and 2013, I am feeling pretty good about 2012 right now. So, let's hope that the macro thing sorts itself out and get that uncertainty out of people's minds, so we can do our job here. Alright, let's open it up for questions.

(Operator Instructions) Jim Kissane, Bank of America Merrill Lynch.

Ed, can you provide a little more color around your confidence in getting to mid-single digit receivables growth by the end of the year? Does that assume some of those signings come on board or any portfolio acquisitions?

Actually it doesn't really assume that there is much there in terms of the signings. In fact, the signings we are hoping for -- if we get a portfolio in, that would be great, but frankly, our business is based on the vintage ramp-ups from starting something from scratch and ramping those up, which really makes the outer years look good.

It's really -- I guess the saying is it's math at this point. We had a couple of things dragging us in the first half of the year. One was a couple of files that were, as Charles call them, defunct. On top of that, what happened was our cardholders actually were paying down their balances quite a bit faster than they had been during the great recession, which makes sense. But again, that's not accelerating.

What is basically happening is people have gone back to payment rates of 2007. That started last August. So, what we expect is the anniversary of those higher payment rates to hit in August, and as a result you don't have that drag for the rest of the year.

That means that if we have sales growth of 9% or 10% which is what we are running at, that will finally stick, in terms of portfolio growth, and so you would expect low single digit in Q3 and then about 5% by year-end.

So it's really the whole -- it's the existing client base, we are not counting on anything new to make that 5% number. It's really a question of payment rate, which goes back to our cardholders tend to be in pretty good shape. But they're paying off at levels pre-recession. You get the kiss obviously on the other side, which is much lower delinquencies and losses, so it's a bit of a trade-off.

And with credit sales up, why are the transaction revenues declining? Is that a function of some of your large renewals? Bigger customers getting better pricing?

Jim, it's a situation where we do have various rebate programs with our key retail clients, which do offset the merchant fees we charge. So as they drive the revenue up, that means we give them a little bit higher rebates, which means that our transaction fees are staying stagnant.

The goal here is since 100% of our new account growth is at stores, some over the catalogs, that is our channel. And so if the card isn't being pushed in the establishment, we're not going to get the accounts, and we're not going to get the growth.

And so providing funds to the merchant to help various promotional programs to push the card, as long as it is to push the card, we feel that, that's a good use of our funds. Our cost per acquisition, compared to a bank card, which is in the hundreds of dollars, is probably $3 or $5.

One last question as you look out to 2012 and you've anniversaried some of the changes in AIR MILES, would you expect redemption growth to normalize?

Yes. We would expect redemption growth to probably be somewhere in the mid-single digits. Which would put your burn rate, we are reserving a 72%, your burn rate would be 70%-ish, a little bit below that. So, a

As long as the miles issued continue to truck along the way they are, you're going to have a nice curve of miles issued growing mid-single digits as well, and off of a much bigger base.

Andrew Jeffrey, SunTrust.

When I look at Aspen and the revenue contribution it made this quarter, I'm just trying to foot that to your full-year Epsilon revenue growth guidance in the mid-30s. Seems like that's pretty conservative if Epsilon is going to continue to grow double-digit organically, unless there is some seasonality at Epsilon. At Aspen, sorry, can you help me out with that a little bit?

I would say it's more the former, maybe a little bit conservative. From a seasonal standpoint, Epsilon tends to ramp-up in Q3, Q4 so we do expect acceleration in revenue growth in EBITDA growth in the second half. So, it could be a case where we are just staying toward the low end of that growth expectation.

And Ed, you mentioned no lasting effects from the data incident. On the existing account base and also you referenced a big pipeline, record pipeline.

Could you just give us a little sense of how you think about sales cycles? Are customers or potential customers asking more questions, digging a little deeper than they might have in the past? Could there be some bleed-through over to Private Label and may that be affecting the sales cycles in that business too? Just an overall view of that.

I think you start with the fact that within 48 hours of the data incident, when it occurred, we had a bunch of clients calling us saying okay, I have to get things out the door so let's get going here. So we were -- we had a handful of clients who slowed down their permission-based emailing dramatically, for 2 or 3 weeks while they got comfortable with the new Fort Knox we were building.

But everyone is back. It's essentially one of these things, Andrew, where it's a critical channel that our customers need, and they can't wait that long or they are going to lose the opportunity for incremental sales.

So for the most part, I would say except for a handful of clients who slowed things down, but they all came back after a few weeks. So it really hasn't seemed to have had a lasting impression.

In terms of the sales cycle, of course. Has it slowed down the sales cycle? I would say no. Has it put a spotlight on pretty much across every aspect of the business, and from what I've heard from other CEOs, their businesses as well. There is a whole new if you want to call it check the box that is going on right now about security procedures that were already there, except the check the box now has about 20 boxes instead of one.

I don't think it's slowing down the process, but for the first time, security concerns regarding the safety of the data is now a critical piece of the sales process.

So perhaps as everybody in the process becomes more comfortable with that, it gets streamlined or the efficiency of the sales and contract signing process improves a little bit. I guess that's part of your thinking as you look out to 2012?

Yes, I don't think it's really slow down anything. I think it's just more of we have put more resources into getting people comfortable that everything they could possibly want has been built into Fort Knox. So I certainly wouldn't use it as an excuse to say that things have slowed down in terms of signing.

The pipeline at Epsilon in terms of signings this year is up about 20% from where was last year. Those big database builds, that's where the real juice is. So we have not seen it effect the backlog at Epsilon.

I can't sit there and say well, that's the reason we haven't signed all 6 of our new Private Label accounts either, so I would say it's more of this is a new big check the box for all clients, and my guess is it's not just with us.

Darrin Peller, Barclays Capital.

Just want to touch longer-term a bit. The trends in loyalty are fine, I mean they're obviously strong, stable, and your buildings in Brazil and India are on track and going well. Epsilon obviously is going extremely well with some acquisitions supplementing it. So longer-term, it seems like you have good plans there.

On the Private Label side, I just want to understand, it seems like those first 2 segments are growth segments. You touched on this in the past, and I love to hear your -- both your editorials, and updated thoughts. Just touch on actions you expect, portfolio acquisitions or even maybe just separating a business out, spinning it out in longer-turn. What are your thoughts as of now?

I will take the first shot at it, and then Charles can do it. This thing, as you can tell, is -- I don't know how else to say it. It builds Aspen and it builds Canada, so it's a pretty important part of the Company. I think it's having a huge record year this year, primarily because of the huge improvement in credit quality, if we're looking at 150 basis points or so.

That's a big number. Funding costs are down. But to your point Darrin, you are exactly right. That's a gift that is nice to have, and it's something that hopefully will be with us for a longer term at these lower rate levels. But by 2013, we're going to be all the way down to that 6% range, and there's no more juice to squeeze there. Hopefully, we keep at that 6% range which is great.

But, it comes back to we need to have 10% growth in the file year after year after year, and if we can get that, then we can have 8% to 10% organic growth in the business for some time to come. And giving the margins that we generate there and the free cash flow, that to us is a business that's worth keeping. Because I think it's certainly very compelling.

The question is we have been slow out of the gate on getting some of these deals signed. It is up to us to make sure that we do get our 6 that we need each year. If we sign 6 deals a year, it essentially provides about 5 points of growth in the file; the other 5 points come from the existing file. And with 10% file growth -- that's what we've been doing for the last 13 years -- you will have a very, very compelling business.

We do not play with the top 25 files that are out there. We can let GE and Citi and CapOne or whoever else is out there, let them battle back and forth. But in our marketplace, we still feel there is a heck of an opportunity with only about 150 clients -- folks in our sandbox have some type of Private Label program, of which we have 100 plus.

There's another 150 out there who have never had a Private Label program. So, we're looking at a market for us that's only half penetrated. And therefore, we think we are going to give it the old college try to make sure we can make this thing like an 8% organic growth cash flow machine for many years to come.

The only thing I would add, Darrin, is when we look at it, clearly we have the same outlook, we want it to be growth entity. But when your cardholder spending is going up 8%, 9%, 10%, 11%, you know down the road with your payment anniversary may become flat or stagnant year-over-year you're going to get growth coming through at 8%, 9%, 10%, 11%.

The other thing you look at is the backlog in the market and there is a fairly substantial pipeline after potential new deals. Clearly, some of the events going on around HSBC, other potential portfolios, that's going to increase an added pipeline for us as well. So we have good cardholder spending that shows the growth entity, add into it a very strong pipeline that we can add on through new portfolios or new programs, we still very much seeded a growth company.

Are there actually deals out there? Portfolio, call it $100 million, $200 million size deals out there that are to be acquired potentially?

You bet.

I would say if we were going to sign 6 deals, I would say 4 would be our typical ramp it from the beginning at zero, all the way up, and there's probably -- the other 1 or 2 would be in that range that you are talking about. As Charles alluded to, we certainly would like to stick our nose into some of the turmoil that's going on right now and see if we can't get people to leave the dark side and join us.

One follow-up on the actual, maybe for Charles on the economics in the portfolio. The yield was up 27% year-over-year -- or to 27% year-over-year. A, is that sustainable, putting aside seasonality for minute? Then also, I'd love to touch on the allowance level.

I think you and I touched on this in the past but 9.5% is, in our estimate, about 50 basis points higher than what you really needed to do based on calculations on trailing charge-offs and forward-looking metrics. What kind of assumptions are you making economically on that to [make] you to have such a big buffer? It's an extremely conservative allowance level for this environment.

Going back first to the gross yield, I do think the range 27.5% to 28% will be a normalized run rate gross yield, absent any changes coming through, which we don't see any at the moment, so I think that is a normal run rate. On the reserve, you're right; we tend to look at a forward look at our portfolio but also a backward look at our portfolio. We have been looking at it more on a trailing basis that as charge-off rates come down we do take some benefit through the rate.

To your point, there is some flexibility when you determine a reserve base upon the macro environment. Our role rate analysis, our migration models consider unemployment rates, it considers interest rate, it has a number of factors that can influence what the spread is to your actual charge-off rate. Right now with unemployment still high, we dropped that into the migration model to give us a fairly healthy reserve percentage.

So to your point, as the year unwinds and we see improvement in the macro and we see continued trends of downward in our charge-off rate, I would expect the reserve to come down. Generally, I would expect you can have a range anywhere from 80 basis points over the charge-off rate to 130 basis points and that difference is going to be driven more by your macro factors.

Dan Perlin, RBC Capital Markets.

On Epsilon's database revenue you talk about the backlog. I'm just curious how the backlog sets up in the second half of the year. In terms of launches that you are expecting relative to what you were able to launch in the first half.

It's going to be fairly consistent. We have a number of big builds that we had from last year, and I don't think there's going to be any big spike, nor is there going to be any fall off. It's going to be pretty much a consistent series of builds through the remainder of this year and into 2012. That's where you're going to see some of that consistency on the growth. There's no big spike up and there's no big lull that we are looking at.

So deals to get launched are a similar size the first half.

Yes.

And then second-half margins on that business are always better for a number reasons. I'm just wondering, does Aspen impact that ramp in any meaningful way that you need to call out now?

You are correct, true only the back-half margins are higher. I don't think that Aspen will materially impact it, no.

As we think about the provisioning expenses for the third quarter based on lower loss rates but a potential growth in AR, I would expect they are going to be similar to what we saw in the second?

Are you talking in terms of expense?

Absolute dollar provisioning in the third quarter. I think it's $60 million in this quarter; I'm assuming it's going to be similar in the third?

It will be consistent, yes.

Then I'm wondering with Epsilon, how are you guys positioned within mobile payments, either NFC-enabled or otherwise? Are your clients asking for help with this yet? And if they are, what do they need?

It's not just Epsilon; it's really across the business itself. So if you are looking at -- well, let's just take Private Label for example -- what you'll see is the first phase being [double fold] with Mobile Wallet, and we have a number of clients who are testing out the ability to have someone walk in the store let's say and call the 1-800 number, use their phone, and get an application, and get scored immediately, then go up the cash register and have that purchase affected.

So, you move from the actual commerce side of it into SMS, MMS, we of course are very much involved in that. Our clients are asking for the full suite of service, which of course is the ability to get out there and micro-target on an opt-in basis, so we have to make sure we're doing that, on an opt-in basis, a growing portion of Epsilon's client base who use mobile as their primary device.

So yes, we are involved in all aspects of mobile strategy. Obviously it differs -- it differs by demographic, I would love to sit here and tell you that Alliance is a mobile company and everything else, but we are not. To us, it's a very important distribution channel. And we think mobile will be very important for us to drive new application volumes in our Private Label business. It seems to be a big hit, especially with the younger crowd.

In addition, guys who don't like to carry a bunch of plastic in their wallet, the fact you're just going to drop an icon onto your mobile phone, I think will have a nice effect as well.

But as it relates to Epsilon in Canada, absolutely. In Canada it could be a sponsor who wants to get out the word that there is a 2-for-1 AIR MILES promotion going on at one of their establishments. We can facilitate that.

Same thing at Epsilon, whether it's permission-based email, whether it's direct mail, or whether it's a mobile text. It doesn't matter to us. We go into the client with the ability to offer the full suite of services.

So, to finish up and your answer about the whole NFC and everything else, that's not going to matter to us. Our job is to make sure that what we do can be effective regardless of what the front-end technology is.

It may be as simple as a web-enabled phone today, moving into the much more sophisticated and slick NFC type technology going forward, and the tap and go and all that other stuff, that to us is -- makes our job a little bit easier, but we are agnostic when it comes to what the front-end will eventually be.

Just two quick ones if I could. You talked about grocery loyalty programs increasing, as is the large client that pulled back originally and now they're coming back?

Again, it's not huge but we are seeing a little bit of promotional whereas last year it was zero.

But they were huge.

Yes, it's a big sponsor, yes.

Right. Then lastly the non-Canadian operating losses hurting LoyaltyOne's margins, what were those?

Primarily Brazil. We pick up 35% of the operating loss for the Dotz entity.

Yes, I should know that.

Sanjay Sakhrani, KBW.

Ed, you mentioned that you were disappointed with your signings in Private Label, but there are opportunities out there. What's really been the sticking point there? That is question one.

I guess two, congrats on the India opportunity. I was just wondering if you could just talk about what exactly this investment gives you, what's the scope of competition and how soon it could be a contributor to earnings?

On the first one, it's the classic case of you bringing home a report card and you got 5 As and a C. And everyone wants to talk about the C, so that's fair enough.

I think frankly, we have not put our best foot forward in terms of how we are approaching prospects. I think so much time, energy, and effort over the past 3 years has been spent on liquidity and the credit quality issue, and then finally as you know so well, all the regulatory issues that were out there that quite frankly, that's where most of our resources were focused.

We are now turning the ship clearly in the direction of becoming much more active in not only going after traditional folks who don't have a program, but also as we alluded to, we will be very active in the turmoil at some of the larger players and hoping to convince those people to come over. So put it this way, we're making that job number one at Private Label going forward.

On the India piece, boy, your guess is as good as mine. What we are trying to do is plant the flag in what we consider the top potential markets in the world. We think Brazil is obviously critical. We think India, at the rate of growth of their middle class, what that is expected to be, how could you not just dip your toe in the water and see what's going on there.

Our eventual strategy may be perhaps all of Latin America is where we want to focus our attention. Don't know, but we know that Brazil is moving along nicely.

My guess is with India our goal would be to see if we could cobble together a pilot, much like we did in Brazil a 1.5 years ago. And get that pilot up and running, to have proof of concept some time in 2012. And if there is a good reaction in 2012, we would roll it in 2013.

So what you have is the feathering of Canada has turned, now you've got Brazil doing a national rollout, which we hope to be EPS accretive in 2013 and in 2013 if we could have India beginning to roll, that would be great. And there will be a couple more countries we would add, and if we could build a portfolio of coalition programs in the markets we want, it could be a long-term gift that keeps on giving.

Okay, I lied, I have one housekeeping question. Just Charles, for Aspen, do we have an expense number there?

In terms of you mean like integration expense, transaction expense?

No, the actual expenses from Aspen.

No. We had one month's worth of performance, we had very nominal integration costs associated therewith. So what I would assume is about 0.083 of the run rate that we gave you in our release back a long time ago when we announced Aspen. So I'm not sure what you're talking about Sanjay. You can call me afterwards and I'll see if I can understand --

David Scharf, JMP Securities.

Just a couple of quick things. One, I don't want to belabor the point, Ed. Just drilling down once again into portfolio growth.

I am wondering, historically, if there's any kind of relationship or lag period that you can draw between credit sales and portfolio growth, perhaps 1 or 2 quarters later, because 12% credit sales, when you exclude those couple that were running off, that's a material acceleration. We haven't seen that kind of spending growth in your customer base in quite some time.

Even if you are unable to bring on board a couple new files or acquire one, does the 12% -- should that give us an awful lot of confidence you should be able to be at 5% growth by the end of the year even without some additional business?

Yes, it's again -- as you correctly suspect, it's pretty straightforward stuff. This ain't brain surgery. It's all payment rates, if you have high payment rates, versus people stretching out their payments during the slower periods, that's going to be a headwind, as we mentioned. That anniversary is in August. And we are already seeing it begin to -- the gap to narrow.

So simply stated, you do 10% credit sales growth, 5% to 6% portfolio growth, and if you went back 10 years, you would find that relationship is very solid. So that's exactly what we're saying is we just need people to hit that anniversary level, and you do 10% sales growth, 5% sticks to portfolio growth, and it's as simple as that.

Just a mundane housekeeping item. Just to help us keep some of these numbers on an apples-to-apples basis. Can you give us a sense for what diluted share count is actually implied in the Q3 and Q4 guidance? And more appropriately, when we get rid of these phantom shares, what is the actual diluted number we are looking at? Help us put these core earnings figures on, on a consistent basis.

For Q2, we are at $58.1 million, for Q3, Q4, I would assume it would be in the low $59 million. And that's again based upon maintaining current price levels. And that's on the weighted average outstanding diluted shares.

And Charles, if the stock were where it is today and let's assume these converts, converted or went away today. What is the actual true diluted number when we get rid of these phantom shares?

You would lose about 10%.

It would take off about $5.5 million.

From the low $59 million level?

That is correct.

So you get back and then slightly below where we were last year at this time. The accounting behind these phantom shares, I got to tell you I'm not a huge fan of it but it's one of those things where as they go away you're going to have a 10% kiss via a lower share count.

Bill Carcache, Macquarie.

Ed, I was hoping you could address a question that's come up a few times in some conversations I've had with investors that they've expressed some concern over the sustainability of the high returns that you generate in the Private Label segment, particularly in the post card act world where Private Label looks pretty attractive.

So the idea that the returns you generate will attract competition that will ultimately drive returns lower. Can you just speak to that and maybe just highlight some of the competitive advantages that you enjoy in Private Label that would be difficult for competitors to replicate?

It goes back to whether you buy into what this Company does, which is transactional base marketing. It's important to note that when you look at Private Label of course, especially over the past few years, everyone focuses on credit, credit exposure and the whole 9 yards. But the fact of the matter is there are 4 businesses that if you were to look in the marketplace, are 4 separate verticals that are all rolled into one in Private Label.

You have the credit component, very similar to a Citi or a CapOne or someone like that, but where they stop, we continue on and do all the network and processing similar to a First Data and a Total Systems.

Then where they stop, we continue on and do all the high-end customer care where we have all of our associates here in the States, as opposed to outsourcing overseas. That's a different vertical from the first 2, and finally everything rolls together in our whole marketing and database channel similar to what we do at Epsilon and up in Canada, where we're doing highly focused, highly targeted customer communication, customer acquisitions, promotions, et cetera, et cetera.

I think that overall what you're looking at is the returns that you are seeing in our Private Label, for someone to be competitive against our product offering, you would need to bring together 4 different business segments and frankly, right now there is no one out there who does that. If they do, they could probably get the same type of return.

But you're talking about bringing 4 businesses together and right now pretty much everyone likes to stick into their own vertical. So we just, we don't see it. It's also a killer sometimes on the sales process, because it's all or nothing with us. You sign up for the full deal or you can go piecemeal it out somewhere else, but once we hook someone it's pretty much for life.

There are no further questions, are there any closing remarks?

No, we are closed.

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