Bread Financial Holdings Inc (BFH) 2012 Q2 法說會逐字稿

Good morning and welcome to the Alliance Data second quarter 2012 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) It is now my pleasure to introduce your host, Ms. Julie Prozeller of FTI Consulting. Ma'am, you may begin your conference.

Thank you, operator. By now, you should have received a copy of the Company's second-quarter 2012 earnings release. If you haven't, please call FTI Consulting 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 Bryan Kennedy, President of Epsilon.

Before we begin, I would like to remind you that some of the comments made on today's call and some of the references 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 you full information for investors. Reconciliation of those measures to GAAP will be posted on the Investor Relations website at www.alliancedata.com. With that, I would like to turn the call over to Ed Heffernan. Ed?

Great. Thanks, Julie. All right. We're going to get right at it today. And joining me, as always, is the ever-popular Charles Horn, our CFO, and also, Bryan Kennedy, the head of Epsilon. Charles is going to discuss our consolidated LoyaltyOne and Private Label results, Bryan will walk you through Epsilon's results, and I'll wrap it up by walking you through our updated guidance for 2012. Charles?

Thanks, Ed. To use an Ed-ism, it was a boomer of a quarter. For the second quarter of 2012, revenue increased 17% to $866 million. EPS increased 37% to $1.63 per share. Core EPS increased 22% to $2.13 beating the Company's guidance of $1.85. And lastly, adjusted EBITDA, net of funding costs, increased 33% to $264 million.

As noted above, the 3.8 million share increase in phantom shares dampened core EPS for the second quarter. Excluding phantom shares from the calculation of core EPS for both periods presented, pro forma core EPS was $2.46 for Q2 2012 compared to $1.91 for Q2 2011, a 29% increase year-over-year. We expect the overhang from phantom shares, which is directly correlated with the average ADS share price to continue throughout 2012 and as such have increased our share count guidance for 2012. Ed will talk about this further as part of his update later in the call.

Let's turn the page and look at LoyaltyOne. LoyaltyOne had a solid second quarter, with both revenue and adjusted EBITDA growing by double digits over the second quarter of 2011. Revenue was up 13% compared to the second quarter of 2011 and up 18% when excluding the unfavorable impact of foreign exchange translation. The growth in revenue was driven by robust increases in both redemption and marketing-related revenue. Adjusted EBITDA in the second quarter was up 14% over the same quarter last year. Again, excluding the unfavorable impact of foreign exchange translation and incremental international operating losses, adjusted EBITDA was up 25% in the second quarter.

Adjusted EBITDA margins in the core Canadian operation were very strong and slightly over 29%. Miles issued grew by 8% for the quarter, marking six consecutive quarters of growth. In the second quarter, we saw the continuation of the strong start from our credit card sponsors and our fuel sponsor, Shell. In addition, we experienced gains in our grocery category, as our sponsors increased the presence of vendor promotions in store. Looking forward, our current momentum and our recent new sponsor signings in specialty retail categories have positioned us well to achieve mid single-digit-plus issuance growth for 2012.

Miles redeemed were up 25% for the quarter, which is higher than the traditional growth rates, but in line with our expectations. In late 2011, we announced the implementation of a five-year expiry on all existing and future AIR MILES. We experienced what we believe to be a one-time full [forty] miles redeemed in the first quarter, which moderated substantially in the second quarter. You can see the moderation in the burn rate. The burn rate, which we define as current quarter redemptions over current quarter issuances, dropped to 78% for Q2 compared to over 100% for Q1. We have a target of about 74% burn rate for full 2012. So overall, we expect the redemption activity to further moderate as the year progresses.

And one of the main reasons we expect the redemption activity for the second half to moderate is we plan to phase out certain gift certificates in favor of AIR MILES Cash. AIR MILES Cash, our new instant reward program, launched late in the first quarter of 2012 with four sponsors providing national coverage. To date, we are pleased to reflect acceptance, as over 600,000 collectors have signed up for the program. In the second quarter, we launched our fifth redemption sponsor, RONA, who is in the home improvement category. Issuance in the Cash program continues to meet our expectations. However, to date, it's not a material part of total issuances. We plan to add additional sponsors in categories to the program during 2012 and to increase the number of locations where mile cash redemptions are accepted. During the second quarter, we spent approximately $3 million in marketing costs supporting this rollout.

Now, a quick update on Dotz. Late in the second quarter, Dotz launched in Fortaleza, the fourth region to launch in Brazil. The region is made up of 24 cities with a total metropolitan population of 3.6 million. The launch included 12 sponsors with approximately 232 locations, including 55 Banco de Brasil branches. Nationally, we have seen our total collectors enrolled in the program grow to 2.9 million at the end of the second quarter. That is more than five times the number this time last year. To date, we are excited with the strong results and key metrics, such as number of collectors, points issued, market penetration, cross activation rates, et cetera, and anticipate this positive trend to continue for the balance of 2012. I will now turn it over to Bryan Kennedy to give you an update on Epsilon.

Great, thanks, Charles. Epsilon posted a nice Q2, with revenues up 25% to $235 million, and adjusted EBITDA up 24% to $49 million. On an organic basis, both revenue and adjusted EBITDA were up 8% versus Q2 of 2011, and up a very healthy 13% after one-time costs related to data center relocation and infrastructure investments are excluded. So if you break that down, our database and digital offering continued its growth trend of 7% as in Q1, and we had a number of key wins in this offering this quarter, including an exciting loyalty engagement, with Canadian Tire, which is one of Canada's most shopped general retailers, with over 1700 locations, as well as a solid renewal and expansion with Patagonia, a premium outdoor life-style brand in the retail sector.

Data, slightly down this quarter, with strength in Abacus offset by ongoing softness in compiled data, driven by a small number of industry verticals that have experienced contraction in 2012. And then lastly, our agency and analytic offering, Aspen, has continued to contribute nicely and we're seeing solid growth in the automotive industry in particular. This quarter, we announced a global expansion, with Jaguar Land Rover, as we've taken a proven data-driven CRM marketing communication program here in the US that operates across a number of channels including direct mail, e-mail, and mobile, and we're rolling that out internationally for Jaguar's global after-sales division, which operates in 177 countries. It's a great example of how Epsilon can amplify the reach of the Aspen business by leveraging our global footprint and it's the first international rollout for our automotive solution and our agency offering.

So looking beyond Q2, I would like to provide some additional color on Epsilon's year, as we've hit the halfway point and we've also reached the anniversary of our acquisition of Aspen. For Epsilon, 2012 has been about focusing on bringing together in an integrated, cohesive way, the broad portfolio of offerings that Epsilon has amassed over the last several years. That means we've been hunkered down on two key initiatives. Number one, we've been aligning our offerings and our organization for growth and scalability, both through platform investments and through tuning our delivery engine. Secondly, we've been focused on achieving margin expansion after a number of years of acquisitions, namely, focusing on EBITDA growth.

Simply put, we've refined our structure from a collection of divisions with complimentary offerings to one that is client-centric in its structure, that enables our sales and our client services leaders to more effectively assemble, sell, and then ultimately deliver solutions from Epsilon's deep marketing stack of offerings. We've done that by organizing our sales and delivery structure around our clients in the industry verticals that they operate in. We believe this shift is very critical in presenting to our clients a unified, consolidated front, enabling Epsilon to elevate the strategic expertise we bring to help Fortune 1000 CMOs navigate the complex data-driven marketing space.

And as we've streamlined our organization and got more client-centric, we're also pruning certain accounts and non-core products, and we have been very selective in our growth opportunities, allowing us to produce healthy EBITDA growth, even as we continue to build our organization and wrap up some of the core investments in platforms and infrastructure that set us up for 2013 and beyond. This streamlined approach should drive margin expansion in the back half of 2012, returning Epsilon over the next 12 months to margin levels consistent with our business prior to the acquisition of Aspen. While we expect the expansion and adjusted EBITDA margins to continue through the back half of the year, we anticipate top line revenue coming in light, particularly in the third quarter.

In addition to what I've already mentioned in terms of our selective focus, our primary driver is contraction in the healthcare sector. The healthcare/pharmaceutical sector, which has been for a number of years a solid growth contributor for Epsilon, flipped the other way on us in 2012, as a large number of drugs came off patent, without a corresponding pipeline of replacement medications rolling out, and those are what tends to drive marketing spend levels. And while weakness in a given vertical is to be expected at times, we would normally cover up these soft spots with one or two large new opportunities coming through our pipeline and this simply didn't happen early enough in the year to give us the coverage we like to see.

In spite of the lumpiness, however, we're confident that the pullback will give way to gradual ramping of growth as we head into the end of the year, and there are three key reasons for that. Number one, our pipeline has produced wins at a pace that exceeds our year-to-date performance at the same point in 2011. And as those clients are onboarded and as revenue is recognized, they will begin to drive incremental growth on our existing revenue base. Number two, the structural changes that I mentioned have better aligned our products and services around our client relationships and that's the key to identifying and producing cross sell and up sell opportunities.

While the current traction of growth opportunities has been promising, we expect this change to improve with our refined structure. And then thirdly, finally, the platform investments in our infrastructure and in our delivery platforms for data and for digital solutions are on track and will, we believe, drive incremental sales performance for our business. So in summary, despite the lull, I feel very good about where Epsilon is headed. Let me hand it back over to you, Charles.

Thanks, Bryan. Private Label continued its strong 2012 performance with revenue of 15% and adjusted EBITDA net of funding costs up 44% compared to the second quarter of 2011. Positive trends continue to be seen in four primary areas. The first would be receivables growth which accelerated, as average credit card receivables increased 13% compared to the second quarter of 2011, while ending credit card receivables increased 16% from June 30, 2011. We expect this growth to continue to accelerate for the remainder of 2012.

Card holder spending remains strong, up 18% from second quarter of 2011. After years of declines, credit card spending is again increasing. The onboarding new programs over the last 12 months contributed approximately 10% of the growth. Portfolio quality continues to improve, as principal charge off rate of 4.9% for Q2 2012 compared to 7.2% for Q2 2011 and 5.3% for Q1 2012. Improvement is on both a year-over-year basis, as well as a sequential basis. Trends are now suggesting 150 basis points to 180 basis points improvement in charge off rates for full 2012 compared to 2011.

Funding costs continue to improve, as older tranches of debt mature and are replaced with new, cheaper, longer-tenure paper. Our cash funding rates for all card-related borrowings, which excludes non-cash items, was 2.7% in Q2 2012, 100 basis points better than last year. Overall, the outlook for 2012 remains positive, solid fundamentals, coupled with a strong pipeline of potential new programs. Similar to 2011, our goal is five new programs for 2012. We remain confident this is an achievable number.

Let's flip the page and now talk a little bit about liquidity. At the corporate level, liquidity increased to $1.6 billion at June 30, 2012, increasing about $300 million during the quarter. Cash has increased to slightly over $600 million, while available borrowing capacity approximates $1 billion. Net corporate debt was approximately $1.8 billion at June 30, 2012, a moderate amount given the leverage ratio defined as corporate debt to adjusted EBITDA, was 2.2x compared to the maximum loan covenant of 3.5x. We expect the leverage ratio will decrease as 2012 progresses and we keep our free cash flow.

At the bank subsidiary level, we have approximately $2.4 billion of available liquidity at June 30, 2012. During the quarter, we renewed two conduits totalling $1.6 billion in commitments at favorable terms. The largest conduit at $1.2 billion renewed for 21 months versus the traditional 12 months. This is the longest conduit tenor ever for ADS. Continuing our dividend trend, our two banks paid ADS parent $57.5 million in dividends during the second quarter. This was accomplished while maintaining strong regulatory capital ratios. Lastly, we acquired approximately 500,000 shares of ADS stock during the quarter, as we took advantage of temporary dips in our share price. I will now turn it over to Ed to walk you through updated guidance and our outlook.

Great. Thanks, Charles. Obviously, the message continues to be quite positive and as such, we're once again going to raise our guidance. First, we've moved our expected top line up to a nice round $3.5 billion, which is up 10% compared to 2011, and versus what we initially had, was up 9% from our previous guidance. So top line looks like it's coming in nicely and second, we also increased our core earnings to $542 million, which is another $6 million higher than the previous guidance, and if you were to go back to our original guidance, it's $40 million higher than that guidance set in October of last year. So overall, core earnings are up a very robust 23% versus last year.

From a reported core EPS basis, however, nothing changes at the moment, since the continuing increase in our share price has added more shares to our share count, making the increased total earnings equal to our previous per share guidance of roughly $8.45 per share. This, of course, is driven by the phantom shares, which disappear at no cost to us when our converts mature in 2013 and 2014. The phantom shares added an additional 400,000 shares to our 2012 diluted share count versus our assumptions last quarter. What we've essentially assumed as we increased our full year average stock price expectation from $125 to $130, which factors in the actual $122 for the first half and then we picked our high point, which was $137 for the back half, which gives us the full year average of $130. If you net all that stuff out, the bottom line is when you exclude the phantoms, our guidance increased by roughly $0.06 versus the prior call.

So let's step back and look at our earnings on an apples-to-apples basis against last year. We lay it out on the next page, but here's the bottom line. In 2011, we reported $7.63 in core EPS. When you exclude the 4.6 million phantom shares from 2011, our true economic earnings were $8.29 per share, showing a delta between the two of $0.66. This year, as our share price has continued to advance, that delta has more than doubled to $1.33.

Said another way, while we're looking to report $8.45 in core EPS, when you exclude almost 9 million in phantom shares, our true economic contribution is $9.78 per share. Lot of numbers moving around. The bottom line is if the phantoms weren't there, we would be looking at $9.78 versus $8.29 last year, which is an 18% increase year-over-year. Next slide walks you through the details, has a bunch of numbers on it. From a guidance perspective, it's easier to just walk through one column at a time.

We started the year expecting to earn about $9.21 when you exclude the phantoms. This has increased quite a bit after Q4 call, Q1 2012, and again today, such that our new guidance of $9.78 is up $0.57 from our starting estimates. Obviously, we've seen some very nice overperformance throughout the year. And certain things also you need to keep in mind when looking at guidance for the back half of 2012. And the following items have a dampening effect on earnings. First of all, a lot of this has to do with where the stock is. If the stock is floating around $137, then the diluted shares will approximate 65.5 million for Q3 and Q4 and essentially drag from the increment, from the new phantom shares.

The $475 million BonTon portfolio, which we're very excited about and we expect to close in Q3 is neutral to 2012 because of this whole fair value accounting, but the good news is obviously the accretion all flows into 2013. So while obviously the win is a huge one and you'll start seeing some nice numbers move up in terms of the overall portfolio growth, sales growth and everything else, the way the fair value accounting works is that essentially we don't see the bennies on the financial side until 2013. Obviously, it's a nice thing to have in our hip pocket as we go into next year.

And lastly, at Private Label, let's not forget that we are driven by the retail sector, which means we usually have a big surge in the Q4, as people are out shopping for the holidays, and that requires a big seasonal reserve build in Q4 to the tune of probably about a $30 million increase from Q3 despite declining reserve rates, because it's due to hypergrowth in the portfolio. It's one of those interesting things where it's been so long since we've seen hypergrowth in the file, we almost forget that at the end of the year, we have to have a big reserve build to cover that temporary spike-up at the end of the year. Essentially, these are all timing issues and the bottom line is they all benefit future results.

So let's flip to the next slide. In the slide titled, In a Nutshell, it sort of gives us a chance to talk a little bit about the big picture, where we see this year, and where we're thinking about next year and beyond. I think we've hit the numbers pretty hard at this point. Suffice to say, top line growth up 10%, core earnings up 23%, and pro forma or true economic core earnings up 18% would suggest that things continue to move along very nicely. For those of you who have been tracking us for years, we always talk about our business' cycle at different times and if we can have two of the three hitting on all eight cylinders, that usually is sufficient to get us a very nice year. And what we're seeing this year is effectively all three businesses are doing quite well.

Obviously, the gold star this year will go to the Private Label business, with all the wins they have been getting. But we're very pleased with the way all three businesses are going, but that being said, let's hit what I consider the three sort of big topics. One is, let's have a discussion about, are there any disappointments that we're seeing this year. Two, we always get asked this question of where is all the overperformance coming from? And by the way, how are we using it? I think what you'll find is, as usual, we're taking a very balanced approach of using some to flow through to increase guidance, which we've done every quarter, and we're using a bunch to essentially lock down future growth and visibility.

And then, three, how is 2013 shaping up? Obviously, a lot of folks shy away from talking about something so far away, given the macro uncertainties that are out there. But as you've come to know with us, we feel pretty strongly about our model and I think we already have a pretty good view into 2013 at this point. So let's start off with disappointments. Fortunately, it looks like just about everything's working this year, but there is the one area of weakness that Bryan touched upon, and that's one portion of Epsilon. Now, we still expect Epsilon to post mid-teens revenue and adjusted EBITDA growth for the year. And so you can sit there and say, well, how can that be bad? But it's a bit more of a mix picture.

If you peel things back and look at what we call pure organic growth -- now, from a bottom line perspective, we're right on track with a nice solid 10% EBITDA growth rate, plus finally getting some nice margin lift. And those are two of the critical goals that we had set for Epsilon for the year, which is, let's get double-digit bottom line and let's start seeing the benefits of some margin lift. But the only thing left is therefore a gain at top line and we are hoping would run in the high single digits, but it's coming in at probably half that rate for the full year. I had communicated earlier in the quarter that we were going to be soft on the top line for a number of reasons that Bryan talked about. We actually came in a little bit stronger in Q2, with an 8% organic growth, than we had earlier anticipated, so that's good news.

But obviously, as Bryan said, the pharma sector is unexpectedly weak and accounts for the softness, but quite frankly, we typically have one of these, one or two of these what I call air balls each year and we count on bringing in a whale or two, that is, a large expansion or a new client to cover it off, but alas, it was not the case this year. So job number one at Epsilon for '13 is to get organic top back up, while maintaining this year's adjusted EBITDA growth rate.

All right. Always getting the question of overperformance and what's flowing through, what's not flowing through. It's really two major drivers this year, where the big overperformance is coming from, and they both happen to be in our Private Label group. First, obviously good news is credit quality continues to improve this year versus both last year and versus expectations. Credit quality is now at the best levels we've ever experienced, which completely smashes the age-old correlation between loss rates and unemployment. We'll probably run in the low 5% range this year, bottoming out in Q3, which is our seasonally strongest credit quarter.

And second, and to me the most important, is the return of growth in the portfolio. If you were to look at sort of a larger macro stat, which is consumer revolving debt, it was growing about 7% a year for many years and topped out at $1 trillion, as the great recession hit and continued that dropped almost $200 billion to $800 billion. And essentially what you're seeing is the deleveraging of the consumer. And so the concern was that it would be very, very difficult to have growth return to these files, and you're seeing at some of the larger players out there who are playing the more general bank card space, that that is in fact an area of concern.

However, since the way we grow is by signing new retailers and working to convince them that our program is more of a loyalty tool, what we've seen is a very, very strong snapback, and it's growth rates that I think we've never seen before, or we're heading in that direction. Specifically, we had no growth in the file last year. That turned into high single-digit growth in Q1, mid-teens growth in Q2, and we're currently tracking to 20%-plus growth rate going into the back half. And why we're so excited about this is credit quality, funding costs, things like that, they will bounce up and down, but once you have core growth in the file itself, what you have is an engine that keeps picking up momentum.

So growth is critical to ensuring overperformance this year and it's even more important as we look into '13 and '14. This year, we are plowing back some of the overperformance into locking down more visibility on our future performance. At Epsilon, 2012 is what I call the year of one and done for large infrastructure investments as we pull together the disparate offerings. In other words, anything that needs to be done to the different platforms to bring them together, anything that needs to be done to make them more user friendly, anything that needs to be done to put the bells and whistles on them, they need to be done this year. And because we have such overperformance in Private Label, we feel comfortable doing this.

At Private Label, we are foregoing super cheap short-term funding, in favor of looking to the future, and we're locking down as much as we can, as fast as we can long-term fixed rate money, and that would be fixed rate seven-year money, as opposed to taking the short-term benefit. And lastly, at LoyaltyOne, we've talked a lot about accelerating the Brazilian rollout. And we have in fact accelerated the ramp-up in the new instant reward program in Canada, as well.

Oh, and one other item, our confidence about future growth and profitability continues to translate into additional share buybacks. It was noted in the first quarter that we had sort of backed -- taken our foot off the gas a little bit on the buybacks. But be assured, there is no long-term plan to do that, and in fact, we have a very significant amount of dry powder left. And in Q2, we did drop around $60 million as soon as we saw a nice opening. So as usual, with us, we are very, very bullish about where the future is taking us. So prices at these levels, we certainly find to be attractive. And we'll always be there to jump in, especially as our liquidity continues to pour through.

All right. Let's talk about '13 and, again, I know it seems a bit early to talk about it, but we do have enough indicators as to where things are heading that we can at least give a pretty good view of where we are. And I am reminded of the fact that this is my -- as I was counting up -- my 45th straight earnings call. So it's been a long, long time and we have seen everything from the '01 recession through the great recession and everything else betwixt and between and the one thing we have learned over the last dozen years is the fact that our leading indicators are usually a pretty good signal of where the Company is heading in '13. And right now, everything seems to point towards a very, very healthy '13.

Specifically, Private Label, we continue to see a very, very strong outlook for 2013. We talked about the fact that the portfolio is continuing to accelerate. We haven't even dropped on the BonTon deal yet. There are a number of other potential significant deals in the pipeline that, if a couple of those pop, it's going to be a very, very strong '13 and into '14. And it's, again, what I like best is it's what I call old school growth. It's not coming from credit quality, it's not coming from funding. It's coming from bringing on new business, new retailers, and consumer spending.

Now, do we expect any big pops in terms of credit quality getting worse or deteriorating, given the macro environment? All our indicators say no. There may be a slight drift upward in credit losses, but I mean very, very slight. Nothing that would knock off the importance of the portfolio growth. It just doesn't really matter. So we see mid-teens portfolio growth will drive strong increases in revenue and earnings in that business. As we look north to Canada, we continue to see solid miles being issued, which, again, is how we make money. As Charles talked, about a very moderate burn rate and solid results.

At Epsilon, the quote, unquote, air ball from 2012 will be gone and the return to solid organic top and continued double-digit bottom line growth. How are we comfortable there? Well, what we didn't really talk about was the fact that what we're seeing in terms of new contracts signed in the pipeline, as we head into the back half and going into '13, has snapped back very strongly and we're beginning to see a number of deals getting signed. That gives us good comfort for next year.

And finally, on the convertible notes, one of the two notes mature and we'll pay it off with cash and a chunk of those phantom shares will go with it. I, of course, will mourn terribly having to discuss them every single quarter. Free cash flow is expected to be up double-digit again over our 2012 expected $600 million-plus number. And overall, we look into '13 and at this point, I can say we're looking at a very strong '13. I think we're taking the measures that we need to take to flow through both overperformance into higher guidance, but at the same time, plowing a bunch of it back into ensuring that '13, '14, '15 will also be years that will not disappoint. And that's been our mantra for quite sometime.

So that's pretty much it. Why don't we step back now and take some questions for a little bit. I know everyone's on a bunch of calls, but we'll try to wrap it up in the next 20 minutes or so and let everyone get back to business. Operator?

(Operator Instructions) Jim Kissane, Credit Suisse.

Thanks. Ed, I think you just touched on it. But just want to confirm with all this phantom stuff that your intention is to settle all of the converts, the ones in '13 and '14 with cash?

Yes.

Great. And then Bryan, since you're on the call and there's a lull here in the third, maybe fourth quarter, how much of it's related to the sales force reorganization? Typically you have slippage when you reorganize and restructure sales. Is that part of it? Then maybe just following onto that, what portion of Epsilon is from the pharma industry?

Sure, Jim. I would not say that the lull has anything to do at all with the restructuring of the sales force. The restructuring of the sales force is really about go-forward basis, making sure that we capture all the growth opportunities that are out there. And if you think about, as our business grows and gets substantially bigger than it was a few years back, a higher percentage of our growth going forward comes from existing clients and making sure that we have a really methodical approach to how we pursue those clients from a sales perspective, we believe, really, is critical to driving incremental growth. The lull at this point is not really related to that.

Pharma, you know, pharma is around 10% of our Business, and the math is pretty simple on something like that, that's been growing at a very healthy clip, double digit, even higher than that at times. It kind of pulls back and drops to a decline. That pullback is definitely a major driver here in the performance that we're expecting to see in the back half. So, hopefully that answers your question.

And that will persist into '13 and some of the new business that you're adding will offset that? Is that the way to think about it?

Yes, I mean, first of all, from a pharma perspective, we see things as stabilized for now. As we move through this phase, we would expect to see growth returning to that vertical, which would be key. And then as Ed indicated earlier, our pipeline is shaping up nicely, number of very solid signings that we have in the works, and our year-to-date wins, as I mentioned earlier, exceed where we were at this point last year.

So, as you might recall, it takes a while for Epsilon to actually get to a point of revenue recognition on new wins. As we build out new platforms then roll them out, that's when we begin to see the lift from that and that's why we're comfortable with the outlook rolling into 2013.

Yes, I think also, Jim, I mean, the one thing we do want to stress is, look, every year in every business, you've got pluses and minuses and surprises here and there. And, it just has been the case over the last seven, eight years at Epsilon that anything that comes up a little bit short, for whatever reason, we've had a nice whale or two come in on the sales side that has covered that off. We just haven't had it this year. It doesn't mean we're not going to have it next year, and that could accelerate things. It's just, this year we had an air ball and we didn't cover it off.

Got it. And then the last question for Charles, can you maybe walk through the math on the BonTon deal? When would you expect it to be accretive to earnings? Is that right away in the first quarter of '13, or does the fair value accounting kind of hit the first half of next year as well?

I would answer that in two ways. One, we expect to close the portfolio or convert it probably late in July. Based upon what we've seen of the portfolio, it turns about every six months. So, to get the full income production, it would be early, or if not the beginning of January. So, what will happen with the portfolio is we'll be a little bit of a drag in Q3, turn positive in Q4, so it nets out to be basically zero benefits in 2012, with full benefit rolling into 2013.

Great. Thank you.

Sanjay Sakhrani, KBW.

Thank you. Good morning. So I got one question on each of the segments, so bear with me. Sorry. Could you -- on Private Label, could you talk about how surcharging may affect you guys? I would think it may benefit, if retailers actually choose to do it. But I was just hoping you could talk about that. And just on the fee income practices that the CFPB has been looking into with Capital One and Discover, I was wondering how it affects you guys.

Yes, I'll take a shot at the surcharging. Obviously, it doesn't -- it's not really relevant to Private Label itself. These are all negotiated contracts with the merchants themselves. So, it's completely moot when it relates to Private Label.

Now, that being said, if merchants do decide to surcharge for general purpose bank cards, obviously we would like to think that there is an added incentive for folks to use Private Label. And so I would say on the margin, from an incremental basis, it's probably a little bit of kiss, but again, it's too early to tell at this point. It's certainly not a negative. I would say it's probably a slightly positive.

On the second issue, Sanjay, remember we talked about this several months ago as it related to Discover. And I think we have to break it down first as to what the issue is. And what the issue is, is the Consumer Financial Protection Bureau is looking at deceptive marketing. They are not really questioning the validity of the product.

So if you look at us specifically, it's really not an issue for us. And I'll tell you why in four ways. One, it's not a big number for us. If you look at our total other revenue for Private Label, it's right around $90 million, of which any type of credit monitoring, payment protection, is just a piece of that, so it's not material to us overall.

The second thing is, and this is the most important piece, we do not do outbound marketing either internally or through a third party. So, we're not out soliciting the product. So, what happens is, if we have a consumer, current customer call in to one of our customer service reps, we'll bring it up and then we'll walk them through a pre-prepared script that's been agreed to with our Private Label customer. So, again, no outbound marketing, only inbound, it's a very strict script.

Third piece is we record every authorization we have to make sure it's fully documented. And the last piece is we make it very easy for the consumer that if he or she feels that they didn't give appropriate approval to cancel it and get out very quickly. So with us, not a big number for us. We do not do outbound marketing, so we're not subject to deceptive marketing or deceptive trade practices. And then the third piece of it is, we make it very easy for consumer, if they did approve, but changed their mind, to get out of the program.

Okay, great. And then maybe just one on loyalty. I was just wondering, the conversions of accounts from Banco de Brasil to Dotz, where are we right now and how fast can that fully ramp? And I guess what I was trying to think about is for next year, do you guys actually recognize any breakage?

Why don't you talk about breakage.

On the breakage, Sanjay, we'll probably look first to do that in 2014.

Okay.

In terms of Banco, there's a couple of stats there. One obviously is Banco is the dominant player down there and they have relationships, depending on how you define it, somewhere between 30 million and 40 million different households, of which, a little less than 10 million have some type of call it credit card product. Those are the ones we're going after. And so what we will do obviously is as we flow into each new region, we will do a very strong push to align those card holders who are in the region who are Banco customers, with the benefits of joining the coalition. But we have to have the other members of the coalition on board.

So, as we're rolling through these different areas of Brazil, there is an installed base at Banco that once we team up with the petroleum player and the pharmacy player and the grocer, et cetera, et cetera, we'll hopefully drag along the Bancos to convert over to us. So, it will be part of the rollout and in each region that goes in, a big chunk of those converts will be the already-installed Banco customers. Eventually, we'll move beyond the 9 million or 10 million card holders, and hopefully move much more aggressively into just the overall general relationships that Banco has, which is between 30 million and 40 million households.

So right now, you're around 2?

2 what?

Is that right?

We've got about 3 million collectors at this point.

Okay, wonderful. Then just one for Bryan, I'm sorry if you touched on this before, but how much reverse inquiry are you getting on mobile payments and everything that comes with that? Thanks.

I'm not sure I fully understand the question, Sanjay. Can you elaborate?

Yes, are the financial firms and other partners of Epsilon kind of looking to Epsilon to provide some assistance in terms of marketing in a mobile payments environment?

Yes, yes, they are. It gets into a fair level of complexity to describe, but I think obviously all of those financial players are looking at mobile payments, mobile wallet, and there are conversations that take place on a regular basis about the right way to provision messaging into that environment, from a marketing perspective. So, our data comes into play in that conversation pretty frequently in terms of how that data can be helpful to personalize any sort of marketing message that may take place in a mobile environment like that.

And then, of course, the mobile device is a pretty natural channel extension to customer databases that we're managing for clients. So, the connectivity and the integration back into the information about those consumers tends to play into those discussions, as well. So, I would say there's an awful lot of talk out there right now among some of our clients and in the industry. There's less action, but we're certainly actively engaged with a lot of our clients in terms of thinking through their strategies.

Thank you.

Darrin Peller, Barclays.

Ed, I think for you the first question, overall, all three of your businesses have obviously performed extremely well, in particular as you said earlier, Private Label has been outstanding, and now contributes to more like 60% of the Company's earnings versus 40% I think in the past. Ed, can you give us a sense as to the mix of business you're looking at for the Company over the next few years, especially if another nice BonTon-like portfolio may come available? We could maybe be more specifically around, should Brazil be a line item on its own to help that out? Is there any kind of deals in Epsilon or like Epsilon businesses that you can do to maybe change the mix bag? What is your goal in terms of business profile?

Yes, I mean, obviously the goal overall is to grow organic cash flow at a very nice, healthy double-digit clip. I think a lot of this will cycle at different times. There is no question that this year and next year, with probably it trailing off a bit as we go into '14, will probably be the years of huge overperformance in Private Label.

What we're seeing -- and, you know, you got to go with the trends, right? And what we're seeing in the pipeline right now is that there are a number of retailers who are very interested in this as a loyalty product. There is also, as I've talked about in prior calls, a number of disaffected clients of some of the other players, in terms of how they were treated through the great recession. And we're going to make hay on that.

And essentially the BonTons and the Pier 1s and names like that, my guess is you are going to see a number of those continue to move over to us, which would suggest exceptionally strong performance in Private Label this year, next year, and into '14. So therefore, that doesn't really address your mix issue.

And so, what we need to do is we need to look at the other two businesses. And I do expect Epsilon and Canada to do what they need to do to hit their numbers, and that by itself will not be enough to, if you talk about shifting where things are coming from. What will do it, however, would be if Epsilon and LoyaltyOne, their Canadian business continues to do what they need to do, plus if Brazil finally kicks in and spools up the way we think it will in a couple of years, that's going to be a very, very big program.

And then as we head into 2013, there's no question that Epsilon, as we talked about, took this year to be one and done and get their thing ready to rock and roll for next year. You will most likely see a restart of some of these bolt-on type acquisitions. And between Epsilon, Canada, Brazil, and some bolt-on acquisitions, what you'll see, that combined with as Private Label begins to moderate going into '14, you'll see a shift back to the more traditional, you know, 50% or less, so more of a 50/50.

But, we're certainly not stepping away from the trend in Private Label. It is a great place to be right now and it gives us the free cash flow to build up the other businesses, as well. So, it's going to gradually go back the other way. And I think probably as early as '14, you'll probably see something more in the 50/50 level.

Okay, that's helpful, Ed. By '14, we can expect probably the Brazil opportunity to maybe become its own line item, would you say?

Yes.

I mean just in size and scale, relative to what's in Canada right now. Charles, on the -- go ahead. I'm sorry.

Yes, I mean, if you look at Brazil, it was nothing last year. We're going to be between 4 million and 5 million by the end of this year in terms of collectors. If we double that the following year, you're actually beginning to talk about big numbers, given that Canada itself has a total of 15 million collectors and throws off $250 million of EBITDA. So, this thing is spooling up very quickly and your point is dead-on.

All right. Thanks. Just one follow-up to that, it's amazing how much opportunity there seems to be forming around the Private Label from a portfolio standpoint. I imagine a lot of that, like you said, was sort of mistreatment during '08, '09, or other time frames and merchants looking for a change.

I'm surprised there aren't others, other credit card issuers, or other banks that recognize how amazingly profitable Private Label has become, if you manage it the right way. Can you just give us a little color as to what you're seeing from a competitive landscape in terms of going after these kinds of portfolios, like maybe with what you saw with BonTon and what you're seeing with maybe things coming out of either GE, or HSBC, or others?

I would prefer not to. (laughter) But I would say a lot of it has to do with what others are offering. It has always been the case of us versus the big banks.

Yes.

And the big banks are after what they do for a living, which is let's have big balances and make our money on finance charges and everything else. We'll outsource for the most part the processing networking, the customer care. The retailer can keep that in the marketing and database functions. They can go to another vendor for that.

What we've always done is 100% of our clients must choose all four of those functions if they want to be part of our offering, and so what we have found and what is accelerating, and it's hitting Bryan's area over in Epsilon, as well for clients who want the same stuff, but don't need the credit component to it. What we're seeing in Private Label is more and more retailers are looking at it as a loyalty tool. And when you can get down to SKU-level information, what you now have is extremely rich data that you can segment and then market to, and at the same time, Private Label is a perfect platform for exploiting the various distribution pipes that are out there, whether it's direct mail, permission-based e-mail, targeted display, social, or mobile.

All of those are natural extensions once you have the SKU-level data all segmented and spooled up, ready to go. I think a number of the higher-end type retailers which are our target base recognize that. That's why we're seeing a lot of renewed interest in the Private Label space, and I don't think, to answer your question finally, why others are not in it, is because of the fact that I don't think others view the Private Label product itself holistically as a loyalty tool. They view it as a finance tool and I think that's to our benefit.

Okay. All right. I'll go back in the queue. I appreciate the time. Thanks, guys. Good quarter.

David Scharf, JMP Securities.

Hi, good afternoon. Just a couple follow-ups. Ed, when you refer to, I think you said significant deals in the pipeline related to Private Label, are these pre-existing programs in-house that may be acquired, or are you talking about significant retailers that don't have any program that would be sort of a greenfield build of balances?

Both. And as you've known for having followed us for many, many years, the vast bulk of our new signings have typically been retailers who start a program from scratch. And what we've seen, obviously, this year and there's no question based on what we're seeing in the pipeline of going into next year, to supplement that, there are a number of significant size files which for us are anywhere between 300 million to 500 type million, that seem very attracted to our model. So, again, it's building on the fact that you go where the trends are and you go where the business is. What we're seeing is it's a combo of both, although David, there aren't a lot of in-house programs left. So, these would mainly be take-aways from some of the large banks.

Okay. Just two quick ones on the other segments. On the loyalty side, so now it's 25% redemption growth in the first half with the miles expiration having been put in. Since that drives revenue recognition, can you give a little bit of a sense for how we should view redemption growth in the back half of the year?

It's one to your point, David. We do expect the redemption growth to moderate and actually drop some obviously in Q3 and Q4, so that will put a little bit of a pressure on top line growth, but it could actually somewhat stimulate profitability. Generally when we have lower redemptions, we can generate some better surplus of gross margins. So, your premise is correct. You'll probably see a little bit of slowing in revenue growth, Q3, Q4, but I don't anticipate it will affect our EBITDA flow-through.

Okay. Perfect. Then lastly on Epsilon, we over the years have listened to a lot of calls where there's a discussion of significant pipeline and kind of a two steps forward, one step back on the margins, kind of have to ramp up for new assignments. It sounds like things are a little different this time. Can you expand a little bit about perhaps what some of the non-core products are that maybe you've rationalized, eliminated, and how we ought to think about normalized margins in that segment going forward?

Yes, sure, David. I mean, I think first of all, just in terms of your comment about the pipeline and growth, you think about the number of businesses that Epsilon has brought on board over the past several years, and the sort of sales structure and client services structure.

Part of the margin focus and the margin expansion is around really getting that structure streamlined so that we have one organization that sells and services into our key client relationships. And that means being pretty focused on head count and accountability and making sure that we've got the right folks lined up to serve clients in the right kinds of capacity. And to the extent that we do that well, which we have done over the course of this year, that's where you begin to see that margin expansion take place.

I think we spent the last several quarters talking about the fact that, as Aspen has come into Epsilon's overall P&L, you see a little bit of dilution. Now that we're starting to see that bounce back to the historic trends for Epsilon overall, pretty good evidence of the kind of lift that we're getting and that we believe we'll continue to get over the back half of this year and into next year.

And then around your question on non-core products and being selective, I would say two things. One is, we've been very careful not to go out and buy business. You can go out and buy new business at any point in time if you're willing to sacrifice margins and that to us is not a winning strategy. Might get some gain in the short-term, but you end up with a problem in the long-term, so we've been very careful to avoid that.

And then from an offering perspective, as we kind of look across our different businesses and what we find common in our agency offering and our database and our digital offering in terms of overlap, those provide us with some opportunities to begin to streamline and cut back any of the overlaps that are redundant, unnecessary, or in some cases that actually don't contribute from a margin perspective.

So, without getting into much more detail, that's pretty much what we're focused on from a products perspective. If you think about how that impacts us from a margin perspective, in 2011, we were at 23%, 2012, getting that to 23.5%, and then getting an additional 50 basis points of lift going forward keeps us nicely in the mid-20s on a go-forward basis, which is what we're after.

So, that's helpful. And just following up quickly, when we think about the mix of services at Epsilon, obviously the agency business at Aspen is the lowest margin contributor as it leads to operating leverage. When we talk about the pipeline and how booming it is right now versus this time a year ago, is there anything in the mix that would weigh down margins a bit? Is it more weighted towards agency? Or is it more weighted towards traditional data and processing, database?

No, I don't think there's anything there that would shift the mix. It's a good blend across all. Frankly, every pitch that we go into now is a fully integrated pitch, where we're bringing together our strategy and analytics, our agency capabilities, data, digital and database, and then the ability to then execute messages across channels from a distribution perspective.

So, we like that mix. We think it's critical to keep it healthy. In fact, it goes back to our whole rationale for picking up Aspen in the first place, is we believe the buying decisions really are going to be centered across a span of offerings. And if you get too heavily concentrated in one area, you're going to find yourself on the wrong side of deals. So, we've got good, healthy representation across the board in the pipeline today.

Thanks so much.

We'll take one more.

Carter Malloy, Stephens.

Hey, guys. It's actually Ben on for Carter. Thanks for squeezing me in. Couple of quick questions on Epsilon. First, Bryan, can you give us some more detail on the drag in the Data business?

Yes, we've had a couple of verticals, financial, insurance, telco in particular this year in our Compiled Cata business that have not performed in the way that they historically have. And that's been a growth drag on the Compiled Data business. So, this is our non-cooperative, non-Abacus data products. And that's been offset on the positive by continued growth and strength in Abacus, which continues to perform very well for us as traditionally not a high-growth business, but solid mid-single-digits growth, which contributes really nicely from a bottom line perspective.

And the other thing I would say about data in general is that's also an area of our Business where we've added on a number of new businesses over the past several years. And in the data realm, if you think about bringing together effectively new raw ingredients, it takes some time to put those raw ingredients together, build new models, get those models embedded into client relationships.

And so, as we've gone through that process, you get a little bit of bumpiness and that's a little bit of what we've experienced over the past year, as well. So, good news from my perspective is that decline in our Compiled business is coming down as we go into the back half of this year, and we're rolling out a number of new product offerings with these raw ingredients, if you will, more fully compiled in a way that we think will drive a return to growth in that Compiled business.

Okay, great. And sorry if you've already answered it, but do can you give us a sense of how big pharma is, and maybe your time line, your internal time line of when you expect pharma to come back or pick up?

Sure. Yes, pharma is right around 10% of our business. I mentioned earlier, I think that that has traditionally been a nice grower for us, double-digit, mid-teens, even north of that at different times, shifting to a decline right around a double-digit decline for us this year. That has stabilized, to answer your question, for us as we go into the end of the year. So, we would expect to see a gradual resumption of growth. And on pharma, that's an unusual scenario for us. It's not typical that we see something that systemic that's an industry-related impact versus something that's revolving around a specific client or our Business in particular. So, as the industry goes to some degree, that will, I think, dictate how our growth plays out, but we see it pretty stable at this point.

Great. Thanks, guys.

You bet. We're going to wrap up now. We appreciate everyone hanging in there. I know you got a bunch of other stuff to do, but obviously we're pretty jazzed up and, again, we'll talk to you next quarter. And sorry we couldn't get to everyone today. So have a great day. Bye.

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