Feb 2, 2010
Executives
Julie Prozeller – IR, Financial Dynamics Ed Heffernan – President & CEO Charles Horn – EVP & CFO Bryan Kennedy – EVP & President, Epsilon
Analysts
James Kissane – Banc of America/ Merrill Lynch Bob Napoli – Piper Jaffray Andrew Jeffrey – SunTrust Robinson Humphrey Dan Leben – Robert W. Baird Reggie Smith – JP Morgan Sanjay Sakhrani – KBW Carter Malloy – Stephens Darrin Peller – Barclays Capital
Operator
Good afternoon and welcome to the Alliance Data fourth quarter and full-year 2009 earnings conference call. At this time, all parties have been placed on a listen only mode.
Following today's presentation the floor will be open for your questions. (Operator instructions) In order to view the company's presentation on their website, please remember to turn off the pop-up blocker on your computer.
It is now my pleasure to introduce your host, Ms. Julie Prozeller of Financial Dynamics.
Ma’am, the floor is yours.
Julie Prozeller
Thank you, operator. By now you should have received the copy of the company’s fourth quarter and full year 2009 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; and Bryan Kennedy, President of Epsilon.
Before we begin, I would like to remind you that some of the comments made on today’s call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and uncertainties described in the company’s earnings release, and other filings with the SEC.
Alliance Data has no obligation to update the information presented on the call. Also on today’s call, our speakers will reference certain non-GAAP financial measures, which we believe will provide useful information for investors.
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?
Ed Heffernan
Thanks, Julie. Based on a lot of comments from investors and analysts we’re going to try our best to cut down the length of these calls as much as I know everyone out there wants to hang on for three or more hours.
We are going to try to make the calls 45 minutes of management presentation and no more than 45 minutes of Q&A and hopefully that will be more than sufficient. We also have revamped as I am sure you've seen both the press release and the deck, we are going to talk about today to really hopefully be as clear as we can be between sort of ongoing core operations, run rates and those infrequently occurring items whether good or bad and calling them out.
So that's part of our game plan going forward and hopefully that makes it easier for everyone. All right.
Let's go ahead and get at it. Joining us today is Charles Horn our recently hired CFO.
He has extensive background in heavy duty accounting policy and tax and controls as well as considerable public company CFO experience, as well as some specific experience in the car business via Pier 1. And I think frankly more importantly to me his last stint was at a large company hit square in the face but a great recession.
So his ability to adapt in towards ahead is experience that you really can't replicate. So it's comforting to have someone else here who’s been service and has a few scars himself.
Also joining us today for his second appearance is Bryan Kennedy, who runs the show at Epsilon. Epsilon had the strongest quarter in its history and Bryan is anxious to chat about that in the upcoming year.
So that being said, Charles, take it away.
Charles Horn
Thanks, Ed. I look forward to meeting many of you over the coming months.
But since I joined in December, I really didn't focus entirely on principally three things. One, trying to learn some of the unique aspects of the company like LoyaltyOne.
Two, trying to wrap up the audit and get any valuation field around our accounting policies, controls and procedures. And then third, I have been trying to get my arms around the new accounting rules which come in to effect January 2010, which will definitely impact our private label credit presentation as well as our regulatory requirements going forward.
Once we get this behind me I hope to be on the road shortly with Ed. Turning to the quarter, I’ll refer you to our fourth quarter slide.
As Ed mentioned, we had spent a great deal of time discussing the format for this release with the goal of providing you not only the actual results, traditional transparency and turn frequently reoccurring items whether good or bad. The normalized line is where we have attempted to remove these items from both periods in order to provide a year-over-year apples to apples comparison.
Any values in the quarter, key takeaways their revenue increase for the first time in over a year on both an actual and normalized basis. The last quarter of top line growth before it was a third quarter of 2008.
Revenue increased 8% for the fourth quarter those aided by $7 million benefit due to a change in treatments of bankrupt accounts. This benefit is isolated to the fourth quarter and is a one-time benefit.
However, the fourth quarter of 2008 included $8 million of servicing revenue related to divesting operations. Accordingly normalized revenues increased the same 8%.
Adjusted EBITDA was $176 million for the quarter up 11% from last year. Our results for the quarter benefited from the bankruptcy change previously discussed as well as a bargain purchase gain of $21 million related to the recent acquisition of private label program and related portfolio.
Excluding these items suggested EBITDA is flat year-over-year if you exclude the frequent items from 2008. This is a tremendous improvement from earlier in 2009 where we were dropping $30 million per quarter from the prior results.
This signals a positive shift in our momentum going into 2010. As I said before, we have excluded the bargain purchase game from the normalization calculation, but it essentially represents the present value of future expected benefits from the assets which we acquired at a very favorable price.
Operating EBITDA was $197 million for the quarter up 8% from last year. Normalizing for the items discussed before, operating EBITDA was roughly flat with last year.
Again, apply year-over-year is an improvement from previous 2009 quarters, and is due to a significant increase in AIR MILES issued during the fourth quarter. A reminder that operating EBITDA is adjusted EBITDA increased for cash received but not recognized through the P&L of our LoyaltyOne business.
For the full year, this excess cash received not recognized added about $50 million to adjusted EBITDA. Cash earnings per diluted share for the quarter was up double-digits a gain on both the actual and annualized basis.
Recorded cash EPS was up 40% while normalized was up 11%. The income tax affected the adjustments of the cash EPS number for the quarter.
The company's effective tax rate of 38% excluding the impact of the bargain purchase gain of $21 million which is nontaxable. Inclusion would have artificially lowered our effective tax rate.
In summary, we return to revenue growth. We stopped the year-over-year fall and adjusted EBITDA and operating EBITDA and we achieved double-digit growth on cash earnings per diluted share.
Importantly, we now anniversary some merger and other costs and it appear to be developing momentum in the business. Let's now look at the businesses.
I will cover loyalty. Bryan Kennedy will cover Epsilon and Ed will take private label.
I refer you to the LoyaltyOne slide at this time. LoyaltyOne is our Canadian business which runs the AIR MILES reward program, and which we just recently begun expansion efforts outside of Canada.
Overall, the fourth quarter of 2009 was strong. Revenues were up 7% to $210 million, and in fact it was the first quarter in 2009 to post year-over-year revenue growth.
Adjusted EBITDA was $54 million up 5% from 2008 on a normalized basis. Operating EBITDA $75 million came in $21 million of ahead of adjusted EBITDA reflecting strong cash flows from increased issuances.
Importantly, miles issued increased 9% in the fourth quarter. This compares to a 4% decrease in Q1, a 2% decrease in Q2 and 3% increase in Q3.
The increase in miles issued immediately benefits cash flow but not adjusted EBITDA. For example, when you fill up at a Shell station or use your Bank of Montreal card, we get paid when the mile is issued.
The portion of the cash proceeds in it's we trust account to cover eventual redemption costs. The remaining cash that nearly usable by the company as it represents two things.
One, servicing fees for running the program, and two, payments by the sponsors for points that ultimately will not be redeemed which is commonly referred to as breakage. Servicing fee and breakage revenue we’ll recognized over the estimated last [ph] the mile which is currently about 3.5 years.
Accordingly we nearly had the benefit of the cash receipts of these two items but they’ll recognize the related income over a number of years. The difference of about $50 million in 2009 adds to adjusted EBITDA to generate operating EBITDA.
The AIR MILES reward program has been around for about 18 years and currently has over two-thirds of all household in Canada active in our program. The current recession negatively impacted our issuances rates for about a year a discretionary spending dropped dramatically.
However, in the third quarter of 2009 Bank of Montreal signed a deal with us to offer double rewards when using the cards. This was a long-term investment by BMO to draw a long-term market share growth.
The program was very successful and helped to draw issuance growth in the third and fourth quarters of 2009. The 9% increase in the fourth quarter was driven by the BMO promotion.
Supermarkets were increasingly using their miles promotions to boost sales and a slight pickup in nondiscretionary spending due to some improvement in the macro environment in Canada. The non-percentage issuance growth in the fourth quarter is in line with our 8% long-term goal.
Our business model is structured whereby an 8% issuance growth should drive 10% to 11% top line growth and 15% adjusted EBITDA growth. Finally, we signed the best Western and its 4000 hotels as a sponsor as well as kicked-off our Brazilian efforts in the fourth quarter.
We’ll discuss 2010 more later. I now turn it over to Bryan.
Bryan Kennedy
All right. Thank you, Charles.
Very good to be back on the call. I'm looking at the Epsilon Marketing Services slide.
It is great to be back particularly under these circumstances. Essentially for us during a year with a lot of very well documented volatility that our industry the marketing and advertising sector could not fully escape Epsilon had managed to tread water through the first three quarters, and Q4, however, all the pieces came together at the same time and we put up the strongest quarter of the year and in fact as Ed mentioned earlier in Epsilon's history with revenues of $142 million and EBITDA $41 million reaching the double-digit mark on both metrics.
And really throughout the year the portion of our business which combines technology-driven, marketing database and digital services to support transaction based micro targeted marketing and loyalty programs for Fortune 1000 Companies continue to deliver. This business represents about two-thirds of Epsilon and we saw strong growth in all four quarters throughout the year.
Against that growth our Data Services Business lag behind it was a considerable drain on results. Its largest offering the Abacus business suffered as the 1800 clients we served in retail catalog and various other verticals pulled back on their traditional major campaigns as a result of the depressed economy.
Fortunately by Q4 that drain diminished and was replaced with stability and some of that was due to new client confidence. Some of that was due to new business that we signed and also a bit of it was due to the anniversary of some tough comps in 2008.
With continued strong growth in our core and then stability in the data services portion of the Epsilon business we were able to produce a quarter which exceeded our expectations. So our goal is to now carry this momentum forward into 2010 and a combination of significant new signs and expansions represented by clients such as Visa, Capital One and KeyBanc signals that our business is resuming more and sustainable really normalized growth period.
So that's it for Epsilon. For now we will have a bit more to say about 2010 in a few minutes.
Okay, Ed, over to you.
Ed Heffernan
Thanks, Bryan. Let's move on to private label services in credit.
You should have the first slide up there it is a couple of slides. My guess is this will probably take up the most time of the three businesses.
But as we move right along, let's talk a little bit about private label. Reminding folks it represents four functions.
Core processing, which is statementing, remittances, network, etcetera. Very high in customer care via US based call centers.
Marketing and all the loyalty services that we offer and then finally the credit component. The first three are housed within the services segment, while the credit has its own segment.
We put them together for the purposes of this presentation. I am able to say it's been two very long years for this business.
Perhaps the only positive news about that time period is I think it's finally put to bed, the concern that's been hanging around for a decade that private label somehow caters to non calling consumers, so the consumers would abandon the private label card the first sign of trouble. For those of you who follow the card industry the opposite occurred.
The so-called higher utility and higher perceived clientele in the bank card world got hit quite a bit harder than we did. Loss rates for them which traditionally have run a bit below ours all of a sudden shot up well above our rates.
So I guess, for us having tiny balances, no utility outside of the store and a high value loyalty program, in fact proved to be more resilient when the ‘big one hit’. So where are we now?
As noted we took our hits in this business over the last two years and on a run-rate basis even a hit by around $150 million or so just on losses. Toss in IO grow-overs and some of that other stuff and combined that's at least two bucks in earnings which got sucked out of our run-rate over the last two years during the great recession.
And that doesn't even factor in the loss of incremental growth that normally occurs. Let's take a look at the chart.
You can see just the portion from this year. As Charles mentioned earlier, Q1, Q2, Q3, if you put them together we are down a combined $80 million in EBITDA versus prior year, which was in turn down versus 2007.
That's why, quite frankly, we are pretty jazzed about Q4 results. Even when you pull out the nonrecurring type items we actually came in flat.
And again, after quarter after quarter after quarter of minus 25, minus 30 of EBITDA versus per year to have moved all the way to flat to flat as a run-rate is a large achievement on behalf of the company. And I hear that flat is the new up for us.
In 2010 we are going to say up is the new up as we groove ahead. Our contrary debt of growing the file is getting ready to payoff.
Sales and portfolio growth have moved from nothing a year ago to an exit rate of just around 20%. Combine that with one funding rates which are stable and we will continue to be locked down.
Two, loss rates which have also been stable around the midnight percent level for three consecutive quarters despite rising unemployment and three, and this is probably the most interesting one, delinquency rates which have fully anniversary [ph] in Q4. The results should be a heck of a jump off into 2010.
Now let's go to the next slide. Lots of bars going upwards which is a good thing.
Success for our clients in this business is very simple. Are there customers taking advantage of the liquidity and the loyalty programs offered on private label cards to generate sales and less attrition at their stores.
That's it. For us the great recession put this to the test.
Unlike bank cards, we had plenty of room to grow without sacrificing credit quality. We needed to sign new retailers, acquire high quality existing programs and utilize our target marketing and loyalty programs to drive sales at or longer term core clients.
And, yes, this one took awhile. If you go back just a year to 2008, our total credit sales, that's the amount of sales at a store used by our cards were down 3%.
But slowly we started to build. It was plus 1 in Q1, plus 4 in Q2.
Plus 13 in Q3. And we are exiting the year right around a 20% growth rate.
That's obviously super news and about double our traditional run-rate. But then that begged the next question of a lot of folks asked whether we are sacrificing some quality to get such huge growth?
And the answer is no for two reasons. First, the high standards required to open an account with us have never changed.
If, for example, 10 women applied for a card three years ago at one of our retailers, which typically cater to mid to upper income women, perhaps six out of 10 of them would have been approved meaning a 700 plus credit score to get the approval. That never changed.
But in today's climate rather than six getting approved maybe it is only three out of 10. So same quality but lower approval rate.
I would actually argue that its higher quality, since these are the folks who made it through the 22-month recession. Anyhow, we make up the difference of lower approvals by signing new retailers which open up whole new groups of consumers, and so even with a lower approval rate we can still grow.
Second, starting in Q3 our longer term core clients turned the corner for us. It is important to remember that our wallet share, and again, that's a percent of spending at a store which is put on our cards usually runs between 25% and 30%.
During a recession, however, the marginal shopper disappears and the most loyal ones hang in there as long as they can. These loyal ones tend to be our private label card holders.
So when you saw retailers posting plus 1 of plus 3% sales growth that meant for us we were putting up plus 5 to plus 8 at these same clients. Put these two factors together and you can get a sense of how we can grow quickly without sacrificing quality.
All right, let's talk a little bit about credit losses. They continue to remain stable despite rising unemployment this now equates to three straight quarters of stability around the mid-9% level and we are not seeing anything out there that spooks us.
In fact, delinquencies which is a metric driving future losses hit their anniversary in Q4. In other words, delinquency levels in Q4 were flat to where they were a year ago.
Losses will follow. Specifically, Q2 of 2010 should anniversary losses and that drag will be gone as well.
On a side note, how did we go from running 128 basis points worse than unemployment to 60 basis points better? Two things.
First, this recession has been three times longer than the typical ones. So, we have had three times as long to burn off the weaker credit.
And second, as noted above the new accounts coming in the door have to pass the same credit scores as before which is most likely leading to a much more resilient customer. Finishing up private label, it has been a brutal couple of years, not a lot of fun.
But Q4 we feel very strongly finally marked an inflection point highlighted by 20% sales in file growth combined with flat funding rate and stable losses. This was the jump off we have been looking forward to for 2010.
Perhaps it came a little later than we had anticipated but it is here now. During the great recession we lost well over two bucks in earnings as well as the benefits from traditional incremental growth.
It is time to start getting that back. So, back to Charles and he is going to talk a little bit about balance sheets.
Charles Horn
Thanks, Ed. There are really three areas we will focus on today.
First, our corporate liquidity is very strong with cash and cash equivalents of $213 million, and borrowing availability of over $260 million. Our net core debt to LTM operating EBITDA remains at a very modest 2.5x despite spending over 1.5 billion on our stock buyback program over the last two years.
Our current liquidity coupled with 2010 expected free cash flow, gives us the flexibility to pursue M&A opportunities and/or continue with our stock repurchase program in 2010, plus still maintaining reasonable leverage. At the bank subsidiary level we have funding availability of over $1.5 billion which is more than adequate to cover growth on the file and potentially portfolio acquisitions.
New accounting rule to become effective January 1, 2010, will require us to consolidate our off-balance sheet securitization entities going forward. We are currently assessing the impact of the new accounting rules and recently issued transition rules on the capital ratios of our banks.
Second, AIR MILES issuance and redemption activities in our LoyaltyOne business start to picking up in the second half of 2009. This growth should free usable cash in 2010 from the $574 million trust account, which supports the reward obligation.
The related deferred revenue account increased over $150 million from last December, signaling higher revenues in the future. The third thing is, we have spend about $1.5 billion on our stock buyback program over the last two years, reacquiring about 30 million shares or over one third of our stock.
The most recent program expired December 31, 2009, with 275 million left unspent. On January 27, 2010, our board of directors authorized a new plan allowing for the repurchase of stock up to 275 million which is the amount that was remaining under the previous plan.
Overall our balance sheet, liquidity and capital remain very strong. Let's now move into 2010 I'll discuss loyalty again.
Bryan, Epsilon and Ed will wrap up with private label. Turn to the LoyaltyOne trend slide.
And the key takeaways for LoyaltyOne is we expect mild issued to return to restored growth rates of 7 to 8%. We are anticipating the redemption rates will return to historical growth rates of about 10%.
We believe we will be successful in keeping our major customers in 2010 the same way we did in 2009. Our revenues will be up about 10%, largely driven by the increase in redemption previously discussed.
Our cash flow will be strong, driven by the increase in expected issuances. Conversely we expect our adjusted EBITDA to be weak for two reasons.
One, the softness and issuance over the last 12 months and really that's the period ended June 2009. And two, the loss of higher margin miles issued during this economic recession.
Internationally, we expect to spend about $15 million in 2010 to support our rollout in Brazil as well as other test markets. Brian?
Bryan Kennedy
Thanks, Charles. A lot of pluses on this side which as I said before for Epsilon meaning that we expect to carry the momentum we saw in Q4 and to this year, and should deliver strong results for the year.
As such we have set guidance at double digit growth, 10% in revenue, also 10% in EBITDA. Our confidence here is directly attributable to three key drivers that we already see in our operating metrics today.
Let me walk through those. First, the impact of very strong performance in new client wins over the back half of 2009 are going to translate into revenue recognition and that will add growth throughout the year as clients like Visa, RJR and a host of other new clients' ramp up their programs throughout the year.
Secondly, we have very good strong visibility into a stable core of business with existing clients for 2009 that will roll into 2010. That's composed of long- term contracts, a number of key renewals with clients, such as KeyBanc and many significant expansions with clients including Capital One, Astra Zeneca and others.
Finally as I mentioned in Q4 we saw return to stability in our data business. The declining volume from major retailers and catalogers over the course of the year improved steadily to flat by the time we hit the end of the year.
We expect this trend to continue a moving significant volatility and drain that dampened our performance throughout 2009, with those quarters from last year now becoming modest comparables for us to get past in 2010. Then finally, all of these drivers continue to fall in line with the broader market dynamic we designed our business offerings to capitalize on, which is a continued shift of spend away from general media to ROY driven quantifiable marketing channels and program that are driven by data, technology and consumer insight.
We are continuing to see this demand in the marketplace and shift in budgets that accompany it and as such look forward to resuming double digit organic growth in 2010 on Epsilon. Ed?
Ed Heffernan
Thanks, Brian. I want to move to our outlook 2010 private label credit and services.
Again, we combine these, again primarily pluses which again is very different from the last couple of years on credit sales in both portfolio growth; our current run rate is running about twice the rate that we typically run at. Historically, sales and portfolio growth we target anywhere from 9 to 11%, somewhere in there, call it 10%, and we are running about double that right now.
That's a combination from a new client that has signed the recently acquired portfolio, an in-house program, and then also what we are seeing are pretty good numbers from our core client base as all we need are 1 or 2% are plus comps from them and we pick up anywhere between 5 and 8% on our side. So, about double the normal run rate for sales and growth.
Funding rates fortunately I think we got ahead of the game on this one, we got about two thirds of our entire portfolio locked down now either through existing bonds that were issued years ago or through the Charles [ph] program which we did about $1.7 billion last year. We will look to continue to lock down and term out that funding.
In other words, we will give up some of the short term beneath of floating rate money to lock down long-term fixed rate money and you'll probably see a deal or two over the next few months or so. So, we will be looking to do that.
So, we don't get dinged if in fact, rates start moving up, we want to protect that. Next, credit losses.
Finally after a couple of long years we have one more quarter to go which is Q1 before we anniversary, and there is no reason why Q2 shouldn't be flat to last year and then from there things start to turn towards the better. So, I think we are finally through based on delinquency flows that we are going to finally be through the grow [ph] over as we hit the anniversary in Q2, which is good news.
So you're looking at flat funding, flat credit losses and sales and portfolio growth growing at twice our normal pace. Needless to say we are expecting some decent numbers in growth.
Finally, items that we think will offset each other; one on the yield side is probably a negative. Two things, one being on late fees what we are actually seeing is a shift in consumer behavior.
Consumers are, believe it or not, watching very closely when bills are due even if they are revolving their balances as they are trying to make sure they get things in on time, and that has brought our late fee income down a bit. Also, we factored in a potential, a little bit of softness for late in the year depending on what happens with regulations regarding late fees, although, we know nothing at this point.
Offsetting that or more than offsetting that we do not know at this point. It will be a couple of new revenue sources that I'm sure everyone's heard about.
One being on the APR side and one being our go green strategy of getting folks to move online so we don't have to cut down a number of forests to get the new statements out the door. So, we think those will offset in overall private labels should have a heck of a good year.
Let's turn finally to another slide on private label and this is – I know people watch the losses very closely, so we want to make sure everyone understands what's going on here. As we noted earlier the last three quarters of '09 showed stability in our losses around the mid-9% level despite the rising unemployment.
And additionally, fourth quarter witnessed the anniversary of delinquencies and that is for the first time in a very long time delinquencies were flat to prior year, and delinquencies are a good leading indicator of future losses. Both of these trends suggest that our loss rate will soon follow and we fully expect losses anniversary coming in flat to last year by Q2 of this year.
Following that the next leg should be improvement over the prior year as we moved towards the back half of 2010. One important note Q1 of this year is running right on track at a normalized run rate at the mid-9% level.
However, we have made a change in our operations which will create a timing issue whereby Q1 will run about 50 basis points higher than normalized and come in around 10%. We will get this benefit back plus some as the year progresses.
Here's what's going on. A write off of an account occurs every after 180 days of being delinquent.
We try to recover some portion of that write off through our recovery units. About two thirds of our recoveries are worked in this manner.
The remaining third, however, has traditionally been sold off to outside agencies whereby we receive cash immediately and this reduces our gross losses accordingly. It is traditionally been a very good way for us to benchmark our own internal efforts.
We decided this will no longer be the case and we determined that we can do a better job of it if we keep everything in house. So starting January 1st, 100% of this effort has been pulled entirely in house.
It takes about 90 days or so for the internal recoveries to catch up, to the cash that we use to receive from selling the accounts. Thus, from a timing perspective we will be right about 50 BPs in Q1.
Obviously, we wouldn't do it if we didn't expect to more than make up for it as this process gets cranked up and we expect the benefit to start flowing shortly thereafter. The bottom line is look for Q1 right on track at 95 plus about 50 basis points for the new recovery process, timing, so about 10% there.
Q2 we should see an anniversary last year and eliminate the final drag from losses. Then in Q3 and Q4 begin to shape up where not only we will capture the timing issue from Q1 but we get a little bit extra.
For the full year guidance assumes flat loss rate to 2009. At this point we are not assuming improving trends even though many experts are predicting it for the back half.
All we can say is the next leg whenever it should occur should be beneficial to loss rates. And eventually it will happen.
Our normalized loss rate is around a 6% level. We are now in the mid 9%.
So, if you take it 350 basis points improvement on a 5 billion plus 50 [ph] it is worth 180 million of EBITDA or north of two bucks a share. This would be incremental to our normal growth rates.
Anyhow, it is out there and will flow in at some time, we don't know when, only that it will happen sooner or later. Let's move right on to guidance.
And simply stated we are reiterating our previously issued guidance for 2010 of $2.15 billion of revenues. 650 of EBIDTA and six bucks cash EPS.
2010 also includes two items in the numbers. A 20 million charge related to the costs attributable to the new card act and $15 million expense associated with our international coalition development effort including Brazil.
Combined these equate to about a $0.38 hit against 2010's run rate. While we have shown growth versus 2009's reported numbers we have also shown it after pulling out the infrequently occurring items.
Specifically for 2009 it included the charming game. The bankruptcy change in policy, the tax credit from Q3 and the FX translation laws from earlier in the year on US investments, as well as some minor revenue and servicing associated with the vested operations.
Either way you look at it we are looking at some pretty solid growth. When you normalize it for a run rate we are looking at growth rates of 11%, 13% and 29% for revenues, EBITDA and cash EPS respectively.
Next slide free cash flow. Charles talked a little bit about the loyalty adjustment where the profits that we make on each mile is received but we don't recognize it immediately.
You add up all those little profits on all those miles you get to about a $50 million difference added to our adjusted EBITDA and our operating cash flow, our operating EBITDA is about 700 million. Take out the CapEx and interest and taxes and we'll left with free cash flow of about 3.65, a little north of $6.5 a share, roughly 11% cash flow yield where the stock stands today.
Charles?
Charles Horn
I refer you to the 2010 Private Label Services in credit presentation chart. What we are attempting to do here is give you heads up, with the new accounting rule that came into play January 2010 will reshape the presentation for our Private Label Credit and the way you will see it flowing through our P&L.
It is primarily a growth up but it definitely has some impacts. So, if you look at 2009, we would recognize financial charge income when collected, in 2010 it will be on an as billed basis.
Also in 2009 credit losses were netted against revenues. In 2010 credit losses will be a component of operating expense.
The last piece would be securitization and funding cost again in 2009 reduction of revenues. In 2010 it will be a component of interest expense.
It is basically referred to as a commercial presentation since we are not a bank holding company. So you can see the overall impact will be to increase our revenues.
It will increase our reported EBITDA. Now, this change, this impact has not been included or factored into our 2010 guidance and what will attempt to do going forward is to give you a bridge, so every quarter goes by you can compare 2010 to 2009 on an apples-to-apples basis.
We wanted to give this indication. This is coming.
You will see it in the first quarter in 2010 and will make some fairly significant changes to our presentation, Ed,
Ed Heffernan
To sum up, look, for 2009 we had about $160 million of headwinds or about $1.75 a share. And against that we probably had about $0.50 of noise or about a quarter of the headwinds, whether it was a gain or tax credit or whatever else.
It was probably around $0.50 or so in 2009 versus headwinds of about $1.75 and despite that we still held top line relatively flat and grew our cash EPS in the mid-teens. Overall I'd say really not a bad year but frankly not what we expect here at ADS as a growth company.
I will say, however, that we have been waiting for Q4 for a while. We thought it might be coming a bit earlier, but as everything else we needed to be a bit more patient.
But Q4 I think is finally showing the story that we had been talking about. You rip through the divisions, you'll see up notched double-digit top and bottom line growth and it looks as Brian said that that is a sustainable type trend going into next year.
Loyalty is all about the ability to issue miles or points or whatever you want to call them that drives all of our cash. That came roaring back to pre-recession levels in Q4.
And then finally a Private Label, which I mentioned earlier going from quarter after quarter is down 25 million or 30 million in EBITDA versus prior year, and even taking out the one offs it came in nice and clean at flat in Q4 to prior years. So that's a big, big move in Private Label.
You combine that with 20% sales in portfolio growth, flat losses and flat funding. And the much anticipated strong jump off is here now.
2010 is expected to be a return for lack of a better term old school. It is going to be characterized very simply by very strong organic growth and pristine earnings quality.
That's what we are after. Things will pick up speed as the year progresses and if the macro environment continues to improve there will be incremental benefits over and above our run rate.
Frankly, I don't know when it is going to happen, but it will at some point. We talked about losses will eventually normalize.
Abacus will go from stability; actually it's gone from a drain to stability to actually growth. And all of these things are between $2 and $3 incremental to our typical run rate.
So, I guess the theme for today is we are here very simply the turn has arrived and that's where we are going to carry into 2010. It's been a long road and we are looking forward to returning to some nice heavy organic growth across the board.
That's it. Why don't we take Q&A at this point?
Operator
(Operator instructions) Your first question comes from the line of James Kissane.
James Kissane – Banc of America/Merrill Lynch
Thanks. Just want to get you to confirm that the $6 number that using for 2010 does not contemplate any gains.
I know you said pristine, just want to confirm it will be a high quality dollar number.
Ed Heffernan
That's correct.
James Kissane – Banc of America/Merrill Lynch
Okay. And then in terms of loyalty EBITDA you indicated you expected some weakness and I think Charles referred to pressure on some high miles.
Can you kind of elaborate on what's going on there?
Ed Heffernan
Sure. If you looked at the fact when issuance was negative where we are getting hit we are on the two discretionary sponsors which were the card companies and the card companies, those miles that are issued tend to be among our highest margin miles that we have out there and so as a result not only do you have the timing deferral, the timing difference that comes from the revenue being deferred but you also have miles that weren't issued which tend to be high margin.
So you put the two together and you're going to have a timing whack encompassing both of those.
James Kissane – Banc of America/Merrill Lynch
Okay, but presumably a lot of the growth in miles recently would be what you would characterize as high margin miles, is that fair?
Ed Heffernan
You bet.
James Kissane – Banc of America/Merrill Lynch
Since Brian is there. Thank you, Brian.
Do you think Abacus can grow longer term or is this a business that will just model flat going forward?
Bryan Kennedy
Good question, James. Yes, we believe it can grow.
We are not expecting that in terms of our guidance for 2010. We essentially are thinking what we saw in Q4 which was the stability and expecting to see that over the course of the year.
But we have a number of strategies that we've been pursuing and we are hopeful that those are going to start to produce some incremental growth on top of that sort of flat, which is going to be low single digits growth, and part of that is pursuing other verticals, part of it planning to new revenue streams off of the data we already own. And then of course, you're going to get some resumption of spend among the existing clients and we saw that towards the end of the year.
In fact in December our prospecting volume was actually up over 2008. So that's what we think we will see this year.
James Kissane – Banc of America/Merrill Lynch
Great. Thank you very much.
Operator
Your next question comes from the line of Bob Napoli.
Bob Napoli – Piper Jaffray
Thank you. Couple of questions.
First of all, on Epsilon, Bryan, the 10% revenue growth and EBITDA growth, there was no expectations of margin expansion. Shouldn't this be a business that has some operating leverage?
Bryan Kennedy
Typically you would see some operating leverage, yes, is a good point. We are not modeling that into our expectations this year.
We manage our costs very carefully obviously throughout 2009 and so we have got a poor investment back into the business. We also have always a mix of product from our data business to our technology business and we have, as we discussed earlier, a lot of wins that we experienced in 2009 that will roll into 2010.
Those are nice high margin pieces of business for us. But they don't necessarily give us the leveraged pop that growth in digital or growth in our data offering would typically present.
So we see higher growth in data than what we have modeled and you're going to see leverage from that.
Bob Napoli – Piper Jaffray
Okay. And now, I think with less buy backs and getting back to being a growth company for ADS, there and Epsilon or elsewhere ac acquisition are their holes in the product line that you think there are opportunities to fill through M&A?
Bryan Kennedy
Yes, we have been at the drawing board for most of the year throughout 2009 mapping out where those gaps might be and that's outlined a focus for us going forward. One of the areas that I will touch on is starting to develop more of a consumer facing model which will allow us to essentially increase the value of some of the data assets that we own.
So, we'll talk more about that over the course of this year but we are in a mode of exploring ways that we can add to the core.
Bryan Pearson
And I would say, Bob, if you were looking at some of the other divisions, obviously at LoyaltyOne the big push is going to be on the international coalitions. That's a little bit less of M&A and maybe a little more perhaps of partnerships and maybe not capital intensive, but again sort of different from what we have been doing the past couple of years, Brazil being a good example.
And then finally in Private Label, again, given what we feel is a pretty (inaudible) good market out there for buyers. We will be looking to continue what we have been doing in the past 12 months or 15 months which is take advantage of the environments and if some high quality assets come up we would certainly step in there as well.
Bob Napoli – Piper Jaffray
Thanks. Just, I mean, my math says that four times $1.21 of normalized earnings gets me to $4.84 and I'm just hoping you might be able to talk about the normalized run rate in the fourth quarter and earnings guidance of $6?
Bryan Kennedy
Sure. I think first up obviously you're going to be seeing Epsilon with double-digit growth rate going into next year.
I think the bigger story will be obviously on Private Label. Again the $1.21, you're basically looking at something that is maybe 100 basis points of losses that hadn't anniversaried yet.
So, well, as we move into next year in the losses anniversary and you've got 20% plus growth in the files, you're going to begin to see that type of acceleration and then the losses should start trickling downwards. So I would like for Epsilon's contribution, Loyalty will contribute albeit less than normal and look for sort of oversized contributions from the Private Label group.
Bob Napoli – Piper Jaffray
Any feel for first quarter, you usually give us one quarter ahead guidance? And that's my last question.
Bryan Kennedy
At this point until we are comfortable we have all the 166, 167 stuff in shape. We will try to get something out before first quarter is over but, Charles, you may want to speak to it.
We are still going through numbers, and it's a big conversion for us.
Charles Horn
That's absolutely correct. We got to go through and look at the initial adoption which will record as of 1-1.
And then of course, we'll do that from a GAAP standpoint but then we also have to consider from a regulatory standpoint as well. So it is the inner play between what we need to do, the regulatory environment to get to the initial starting point and then how we actually flesh out the first quarter.
That's the process we are in. We are hoping to make progress.
We hope to spend some time on it the next couple of weeks and knock it out, but right now it is premature.
Bob Napoli –Piper Jaffray
Okay. I'll let somebody else follow-up on 166, 167 and capital ratios and things like that.
But thank you for your time.
Operator
Your next question comes from the Andrew Jeffrey with SunTrust.
Andrew Jeffrey – SunTrust
Hi, guys. Thanks for taking my question.
Ed, is it reasonable to think about Brazil as being kind of a 2011 contributor ultimately from a revenue standpoint or is it further out in that or how should we look at Brazil progressing?. What doesn’t make some benchmarks; we could look for that would demonstrate you've got some traction to make a progress there?
Ed Heffernan
It is a fair question. It is actually going to be fairly straight forward.
We are right now knee deep in the pilot and that is right now matching the numbers that we were hoping for, but essentially, we need to give it a full year before we can get together with the sponsors. So, October of this year we will get together with the biggest sponsors which, of course, would be Banco do Brasil, the number two petroleum player (inaudible) and large retailer grocer down there and if they are happy with the way things are going I think that would bode extremely well to really ramp up and roll this puppy out.
So we are going to need a full year. We will know by October whether there is fire in the belly in the sponsors.
Whether we feel comfortable and I think at that point that is the one. I would say that's our one big decision point and it is either full blown roll or we call it a day.
Right now quite frankly things seem to be on track, so, I'm hopeful the sponsors are excited and we can get going. But other than that one data point, unless you hear us say something is going off the rails, you won't hear anything probably until October.
Andrew Jeffrey – SunTrust
Okay. And do I remember correctly that after the third quarter you thought you might spend 20 million in Brazil this year and now the number is 15?
Ed Heffernan
Well, that was – it's not just Brazil. That covers really all international efforts.
So Brazil will be something less than the 15 to get us to October. But we have budgeted some monies.
We are looking at two or three other countries that we might plant our flag over there and see how that goes, but I think 15. Right now we are looking at about 15.
That is a good number.
Andrew Jeffrey – SunTrust
Okay. And then broadly in AIR MILES can you talk about pricing.
I know you in the past you said firm plus, the economy has changed, the sponsorship has changed a little bit. Where do you stand in terms of price here if 2010 looks kind of more like the fourth quarter did than the preceding three quarters for example?
Ed Heffernan
Again, I think the pricing has held up quite well. What we found is that again one of the real interesting things that took place as we moved into Q4 was that one of our largest category supermarkets which obviously spend a lot of money with us but also on more traditional type of promotional coupons and stuff like that have decidedly moved away from those types of verticals and into promotions with the packaged goods industry and are offering two for one miles and everything else.
So, the grocer segment was quite strong in Q4 and then the snapback from BMO in the card business, which is, again, high quality type miles, I think if you were to look at the mix now, the firm-to-firm plus still holds. So we are not seeing pressure on that end.
In fact, I would argue that on the cost side because of this environment, it is certainly giving us a few opportunities there as well.
Andrew Jeffrey – SunTrust
Okay. Thanks a lot.
Operator Your next question comes from the line of Dan Leben with Robert W. Baird.
Dan Leben – Robert W. Baird
Great. Thanks.
Just first on the Loyalty business. FX that should have been a tailwind in the quarter, maybe as much as 10 to 15%.
If that's the case, the revenue number was down while issuance and redemptions are up. Help us understand what the factors were there, whether it was the higher margin miles or whatnot?
Charles Horn
In terms of the FX in Q4, I think our EBITDA probably benefited by about 5 million or so. And again, last year you need to factor that against an FX translation gain from US-held investments of double that or 10 million.
So from that perspective if you factored in the FX from an EBITDA perspective, you're probably coming in closer to flat. Certainly not down.
And then on the top line basis, again you're probably talking about if you took out FX you were probably slightly under last year. And I think that's nothing more than the redemptions that we were pushing through last year versus this year.
Redemptions really are just now beginning to crank up, and we would expect as we go into 2010 the redemption level to continue to pick up versus this prior year.
Dan Leben – Robert W. Baird
Okay. And then for Bryan, could you talk a little bit about your exposure in the different verticals.
What you saw both in the fourth quarter and then what you are hearing from clients as they are planning their budgets and looking at their marketing expenditures in 2010?
Bryan Kennedy
Sure. I’ll just go down a couple of the key ones starting with pharmaceutical, I think throughout the year 2009 pharmaceutical was a really solid vertical for us with not really any substantial change in the spending pattern versus what they had budgeted.
We are seeing basically the same behavior from that vertical going into 2010. If you look at financial services, that was a vertical with kind of a mixed story in 2009.
Most of our big programs and big clients they’re held pretty firm but you had some slight cutback in terms of sort of peripheral ancillary, the projects and budgets, and we started to see towards at the tail end of the year and we anticipate in 2010 is that that incremental spending is coming back. We also had a number of very substantial renewals and expansions in that vertical in ’09.
So even though you didn't have a tremendous amount of spending, you had a lot of very big decisions that will flow to our benefit in 2010. And then the other big one worth calling out is the retail vertical.
Obviously that’s the vertical that struggled the most in 2009 with a lot of volume cutbacks and that is what’s really dampened our Abacus business. As I mentioned a minute ago, we started to see volumes pick up towards the very end of the year, actually grow and what we are hearing from most of our retail and catalog clients now that the holiday season is past is that they have set their budgets and they are looking to do more of a healthy normal year.
Not what we have seen a couple of years ago in terms of very strong performance but there's some optimism there. So that's why we are expecting that business to be flat to slightly up this year.
Dan Leben – Robert W. Baird
Okay. And then the last one for me for, Bryan, at the risk of trying to raise your bar without listening to the question.
With all the very significant contract wins and renewals you have in place there, why shouldn't we think about Epsilon in 2010 as being something pretty meaningfully north of a 10% grower?
Bryan Kennedy
Okay, let’s see. Thank you.
Certainly we would like to produce something along those lines. We essentially have a year in front of us that's going to be digesting a lot of those wins from 2009.
We have discussed on this call in the past the fact that when we bring on a large new client engagement, we don't have the ability to recognize any of that revenue until that’s is up and running in production. So the impact of those wins will be staged over the course of the year, and of course we have sensitivity in terms of timing as to exactly when each of those comes on board.
So that's really why you're probably not seeing something in terms of a bigger bump in the year 2010. But we are quite happy to have that roll in on a steady base and then start into 2011.
Dan Leben – Robert W. Baird
So I guess the way to think about it would be single digit growth rates in the first half ramping up above 10% giving yourself a solid jump off into 2011?
Bryan Kennedy
That's a good way of putting it.
Dan Leben – Robert W. Baird
Okay, great. Thanks guys.
Charles Horn
I wanted to come back to a question that was asked earlier about run rates and I think I put pen to paper a little bit here. If we did with everything pulled out of the numbers about $1.21 this quarter, and you looked at the run rates or jump-off going into next year, I think it is important to mention also that for the first time I think in a long time or ever since I have been in the card business, fourth quarter is no longer our largest quarter.
It has been shifting slowly over the years. It used to be our biggest one because a lot of our money came from merchant sales and everything else, merchant discounts.
That's no longer the case. The merchant discounts, there is rebates in there and everything else has eroded over the years and been replaced more by financed income.
And so by far the shift has pushed Q1 to be definitely our largest quarter, and this year specifically will certainly be quite a bit larger than Q4. Also Q4 has in it somewhere between 5 to $8 million of additional operating expenses because at that time of the year, the holiday where we staff up and overstaff our call centers to make sure they get the high quality that they pay us for.
So between those two items I think people think Q4 is always the hot quarter for private label. It's not.
Q1 is definitely the big quarter and then Q2 is usually our lightest. Q3 is probably our second best.
And then Q4 is probably our second worst. So, from that perspective even if you took a run rate of $1.21 and with losses essentially anniversarying for 2010 and the file growing 20% that type of growth rate would give you an incremental.
Let's call it 20 million of EBITDA a quarter from where we are running today. And that's the big chunk of the growth.
Additionally if you just took Epsilon's growth that will give you 5, 6, 7 million a quarter from where we are today, and just those two combined are worth close to $0.30 a quarter. You add that to the $1.20 or whatever, and that's where you get your $1.50 and run it out and that's your $6 for the year.
So sorry to take so long to put all the numbers together, but I think people have been thinking that Q4 has always been a monster quarter for private label, and that has shifted due to the payroll costs that come in Q4 and the lower discounts and we get it back in Q1. So hopefully that provides a much cleaner picture of the run rate for next year.
Why don't we take our next question? Operator Your next question comes from the line of Reggie Smith [ph] with JP Morgan.
Reggie Smith – JP Morgan
Hi guys. Thanks for taking my question.
I guess I wanted to go back to LoyaltyOne for a second. Your guidance for next year, what currency rate are you guys assuming for next year?
And I guess the next question to that is, I looked at where the Canadian dollar is today, it looks like you're going to get about a full point lift from currency alone. I'm just wondering the 10% revenue growth that you guys are talking about next year in Loyalty, the differences, is that really just the pricing component that you’ve been talking about earlier tonight or is it just some conservatism kind of baked in there?
Charles Horn
Well, I don't think we will ever say it is conservatism baked in, Reggie, [ph] but I think that who knows where the dollar will go, but certainly we would expect it to be a tailwind for us. I don't think we would use 95, 96.
I don't think we would use 90 or 91. Probably somewhere in the middle would make sense from an FX perspective, so yes we would expect to have some on the FX side, I think probably what we are watching very closely is the fact that we want to make sure that the Canadian consumer is very comfortable with where their economy is going, and if they are comfortable then our redemption activity will surely pick up.
We had modeled in a roughly 10% redemption rate. That's a little bit lower than our historical rate.
And if in fact the consumer pops back there to full-bore then you're going to have a little bit higher redemption rates than we have modeled.
Reggie Smith – JP Morgan
Got you. And then I guess moving to the credit segment, how should we think about – can you hear me?
Charles Horn
Yes.
Reggie Smith – JP Morgan
How should we think about, I guess the net margin of what you kind of brought in with the Shamin Shah’s [ph] portfolio? So, I was trying to figure out what the quarterly accretion is from that, I guess net of whatever profit sharing agreement you guys worked out with Shamin Shah?
[ph] What’s the accretion looking like on that portfolio?
Ed Heffernan
I’d say it’s just a hair below 10. I think that's a good number.
Reggie Smith – JP Morgan
So could take the 500 million and assume roughly 10% is the net yield much, that's net of all costs, charge-offs, everything?
Ed Heffernan
A little bit less than that.
Charles Horn
Right. If you want your after operating costs, it will be a little bit less than the 10%, right.
It will be more like was it 8 times 50 or something like that, 8% for EBITDA.
Reggie Smith – JP Morgan
Okay.
Charles Horn
That should get you about 40 million, right?
Reggie Smith – JP Morgan
Got you. Okay.
And then I guess you touched on it in the release, the venue retail. Can you talk a little bit more about what that was exactly?
How big were those guys and what services did you provide and what's happening with that portfolio?
Charles Horn
Sure. I have to be a little careful here as they say on advice from counsel because it is an interesting situation.
It is, in the past obviously we have tried a number of different things in different parts of our business. Some have worked well; some have worked not so well.
This one was without a doubt an unmitigated disaster. It was a brand new vertical for us, pretty much a new business, which is why it qualified for disc ops treatment.
It was the first time that we essentially went out there and signed up with a vendor that provides a 100% through the mail of high-end items that have a deferral program attached to it, and then after the deferral period is up and installments type plan. And again that really isn't atypical.
In fact it's very un-atypical of what we do. But we wanted to test – that sort of I think of it as a financing almost arrangement, and I guess there is a reason why we never did it before, and we saw that come to fruition as the summer progressed, and we started to see that there was – even though we sent out lists that I think should have attracted pretty decent credit, it was certainly adverse selection for sure, and that combined with the recession being so deep and severe, we got our heads handed to us quite frankly.
It was a mistake. It was a bad mistake, it was a vertical, we should never been in, and it is the vertical we are never going back in again.
It’s just simple as that.
Reggie Smith – JP Morgan
Got you. And if I could sneak one more question in.
I guess the impact of that, pulling that out will that help the reported charge-off rate at all or was it so small that it’s kind of insignificant? And then I guess lastly, would the dental – I guess you guys announced a dental program about a year ago and a veterinarian program.
I mean would those be similar in risk profile to the venue business or are they different?
Ed Heffernan
No. They are all good questions.
I think the loss rate – the loss is already pulled out and they’re netted in that venue number. So it’s – the loss rates you see all through the year, you're going to be looking at apples to apples when you compare it to next year.
That's already out. And in terms of the other verticals I can assure you that we are keeping extremely close tabs on the performance of those files.
They are very small files. And right now there is nothing that would suggest there are issues there at all.
At this point I would view those as something that would in fact fall into and fall under the private label group's core business. Because they do have certainly Loyalty components to them and then just not the financing program per se.
So that would not be something that we would consider as if it goes bad as something that's a disc ops. It would definitely be treated as part of the core, and needless to say we’ve triple checked those things as they stand now, and basically the files are so small; there is nothing really there at the moment.
Reggie Smith – JP Morgan
Got you. Thank you.
Operator
Your next question comes from the line of Sanjay Sakhrani with KBW.
Sanjay Sakhrani – KBW
Hi, thank you. I wanted to follow-up on this FAS 166, 167.
So, just so I'm clear, are you guys comfortable still with the capital levels at the bank? Maybe you could give us some insight as to what levels those could be.
And then maybe if you can't give us the ratios pro forma, could we just get the reserve coverage on owned receivables as of the fourth quarter? And I'm assuming that's what we would use as an adjustment factor as far as the reserve build would be.
Charles Horn
On the first part candidly we are still trying to determine the adjustments from the accounting rule, and then flush it through what the impact will be to our various capital ratios, then they just came out recently with the transition rules for these ratios, and we’re looking at that. We’re looking at various accounting firms, guidance on these transition rules.
And so based upon how we initially recorded impacts as ratio. At this point we have not fully flushed it through to evaluate the impact.
We do know on most of the ratios we have a transition period, one ratio we do not have a transition period, and that’s one we are focused on at this time.
Sanjay Sakhrani – KBW
Do you have the ratios?
Charles Horn
Yes. I think at year end Tier 1 was north of 15.
Total risk base was slightly north of 16, and I think the leverage ratio was like 32% or something like that. Under the new guidelines, I believe, the numbers were well capitalized Tier 1 or you would know as well as I would 6%, and were capitalized for risk base since 10% and were capitalized for leverage ratio is 5%.
So I think when all the transition is said and done, we are certainly going to be well capitalized, and then it’s question of are there adjustments or discussions that we need to have with the regulators, if in fact we want to proceed and continue the sort of growth plan that we have. And how does this year and a quarter transition plan impact us?
We just don’t know right now. But those are the ratios and then the minimums that you have that have been established and we certainly would expect to be considered well capitalized and it is more a question now of are the regulators comfortable with our plan going forward?
Sanjay Sakhrani – KBW
As far as like the reserve in the fourth quarter, I mean, is there any clarity? Can you give us a sense of time what the coverage was, because that’s on a GAAP basis that’s what the reserves are going to be in January 1, right?
Charles Horn
I am not following your question?
Sanjay Sakhrani – KBW
Come January 1, you guys have to establish reserves for all the off bound fee receivables?
Charles Horn
That’s correct.
Sanjay Sakhrani – KBW
Unlike what the – have you guys calculated the amount of the reserve built from January 1 or could you give us a sense of kind what that coverage ratio was as of the fourth quarter, so we could use that as a proxy to calculate what the reserve build would be?
Charles Horn
Now that’s the issue we have. We have not finalized that yet.
That’s how we are in (inaudible) process. Initially when we spent up the reserves, you have three things going on.
You will be setting up reserve for the principal, build FTI, and you will be setting up reserve for open to buy for the credit line you’re bringing onto the books. Now offsetting that you have to go through and take build FTI from the previous year, net it and that will be your net impact going through equity.
That’s going to be the biggest thing, the biggest impact and that’s what we are working on now. But we have not finalized it that we have been working on new loan loss module, trying to get that up and going, but have not finalized it to make that beginning point to evaluate what’s the impact on our ratios will be?
Charles Horn
I would say there’s a bunch of other stuff that need to be set up. But, if you look at our run rate on losses then the guidance were given for Q1 and Q2, it is obviously going have to be fairly close to those numbers.
Sanjay Sakhrani – KBW
Okay. All right, and then add one other question.
You mentioned some offsets to the potential changes that may come later in this year related to the card act. Is there a specific time that those APR increases and the going green initiative kind of kick in the place or are those kinds of wait-and-see and you would implement as needed?
Ed Heffernan
Yes. One of the reasons we went out and did our 36 million piece mailing was to give us the flexibility obviously to pull the trigger on certain levers should we deem it appropriate.
We have gone ahead on the APRs and that will get us anywhere from a point or two of additional coverage compared to if you look right at the bank cards (inaudible) right up 400 or 600 basis points on there. We did probably 1% or 2% on that.
So that’s right out of the gate, and we should start seeing that begin to filter in, in the March timeframe. And then additionally as much as we have enjoyed the press on it, we have, are beginning to test a $1 charge for people receiving a paper statement.
The goal, of course, is to get people to do it online. That obviously saves paper, Go Green, and it saves us a whole bunch of operating expenses, and just to give you a sense, with all the new disclosure rules and regs that are out there, our statements typically are one pages – the one-pager, 6 inches by 11 inches and that’s that.
We are now going to 6 by 14, two pages. So that’s an awful lot of new paper print.
Obviously we have to figure out the postage issue and everything else. So we would prefer people Go Green and do it online and save the tree.
If they don’t, then chances are we are going to go ahead and pull the trigger on this other item at some point during the year. But right now we are just in the testing phase.
And we think those two items combined should mitigate any of the weakness that we could see from potential late fee degradation.
Sanjay Sakhrani – KBW
So just to be clear, at the beginning of 2010, you guys should have an impact of repricing on the yield in order of magnitude of 1 to 2 percentage points, and then come like February 22, do you guys feel like – is there another impact to the down side from the card act or is there not for your book?
Charles Horn
No, the APR change based on the time lag that was required, you won’t see flow through until March. Okay.
So that’s the first time you’ll see it flow through. We had to give a certain period of time before we could actually make that change and then have it hit the billing cycle.
So that would be in March. And then the dollar statement fee would certainly be later on in the year after we are done – going through some testing and going through and see how many people convert to green.
So that’s the timing of it. The additional cost from the card act, look, I think we have talked about the big ones which is the massive amount of new paper and statements and (inaudible) disclosure and all that other stuff will also have to have some more folks available for if people decide to, you know, choose a different way of paying.
They need to be able to reach someone on the customer service side. So there’s a bunch of other costs in there that we think between these two levers we should be in a pretty decent shape.
And so, come the end of Feb we don’t really see much else hidden.
Sanjay Sakhrani – KBW
Okay. Well, thank you very much.
Ed Heffernan
And I think we have time for one more question or two more questions at the most. Let me do that, two more?
Operator
Your next question comes from the line of Carter Malloy with Stephens.
Carter Malloy – Stephens
Hi, guys. Thanks for taking the questions.
Most have been asked but on the last question on the doubt for statement and in your testing, are you seeing – or what type of conversion are you seeing and/or are you seeing fallout from domestic card holders at all?
Ed Heffernan
That’s a great question. It is too early.
I think the newspapers got ahead of us a little bit. So we just really started the process and at the end of Q1 we will be happy to give you some data points on the conversion ratio.
So, obviously from an Ops cost perspective it would be ideal.
Carter Malloy – Stephens
And then also just on your in-store compliance with the regulations, ZMM [ph] specifically on the consumer’s ability to pay, is there any potential business impact there both in terms of costs and also maybe on approval rates?
Ed Heffernan
Yes. This gets to Sanjay’s question earlier of some of the other costs that are in there.
Of course, nothing will rise to the level of going from one to two pages per statement when you are doing 15 million statements a month that gets pretty heavy. But, in terms of the in-store, for sure, we were watching that very closely because as you know all of our accounts are either through the store or piggy backed over the catalog and, the concern about income needs to be taken into account, we thought we had a decent work around in place.
The regs came out and it looks like there is a fairly elegant solution. In other words, in addition to going out to the bureaus to score new applicants, we can also utilize the bureaus to estimate, using their databases, which estimate income and make that part of the decision process as well.
So from a business perspective, we fully expect to keep things flowing the way they have been flowing, but from a cost perspective if you want to think of us going out to the credit bureaus and having to pull five pieces of information, now we need to go to another source of the data to pull this income estimation item, and that’s going to cost us some money for every applicant. So, yes, it will be an additional cost from an operations perspective.
However, we don’t expect the sourcing of our new accounts or the decision making to be any different.
Carter Malloy – Stephens
Okay. And on that modeled income data you are talking about, just any per score right rather than 4506 T data which is fairly lot more expensive?
Ed Heffernan
I certainly hope its pennies because I would have heard if it was different than that, I have never heard of a 4506T data. So –
Carter Malloy – Stephens
Sorry, the IRS income verification data.
Ed Heffernan
What is it?
Carter Malloy – Stephens
The IRS income verification data.
Ed Heffernan
Okay. I don’t know what that 4506 meaning squared thing is.
Carter Malloy – Stephens
All right, thanks.
Ed Heffernan
Yep. One more?
Operator
Your final question comes from the line of Darrin Peller with Barclays Capital.
Darrin Peller – Barclays Capital
Thanks, guys. Just a quick question on the – first of all on the credit portfolio.
The delinquency rate, last quarter, during third quarter, I should say was – correct me if I am wrong. It was 6.6%.
Charles Horn
It was 6.1 at the end of the quarter.
Darrin Peller – Barclays Capita
For the third quarter?
Charles Horn
6.1 for Q3 and 5.9 for Q4.
Darrin Peller – Barclays Capital
Okay. So regardless of that there was a sequential improvement, I guess, of 20 basis points, and that’s obviously the lowest by roughly 40, 50 basis points from earlier in the year, yet your charge-offs, you are calling for 9.5, roughly flat charge-offs through the year with unemployment actually flat, but even putting aside macro trends why would that be the case with delinquencies trending lower pretty much dramatically through the year?
Charles Horn
It’s a fair question, Darrin. I think the way I am going to answer is, you can call it a little wimpy, but the fact of the matter is until we see something that says everything’s coming down, we will leave it up to you guys to figure out when that extra – whatever we figured it is, 250, whatever it is $2, something like that, starts to flow in –look at the end of the day we all know it is going to come in at some point.
Right now, I would say that the delinquencies certainly are heading in the right direction. They are certainly looking better.
In fact, they are down just slightly year-over-year actually in the last month which is good news. So that would explain the bulk of our write-offs, however what is not factored in until we know how it works is the fact that our recoveries and personal bankruptcies don’t – aren’t really captured right in the delinquency rate.
And personal bankruptcies have gone up fairly dramatically. And they probably represent 20%, 25% of our net write-offs.
And so, I would say, if you start seeing personal bankruptcies begin to level I would say you’re right on the money at that point.
Darrin Peller – Barclays Capital
All right. Just moving over to the portfolio yield in that business now, the yield itself looked like it was sequentially down if you back out the noise from the $21 million and the $7 million bankruptcy benefit, to me it looked like you were down a couple of 100 basis points sequentially into the fourth quarter.
How much of that would you say is actually just a timing? I know the fourth quarter is a seasonally low yield.
Would you say it’s kind of timing around the seasonality versus maybe what you were saying in terms of consumer behavior on late fees, and do you know, I guess, what would you expect that to return to in the first quarter? And then, just to add to that the APR increase you talked about, even if it was only 1 percentage point, a 100 basis points and started in March, is that – correct me if I am wrong, but wouldn’t that end up being something to the tune of $0.40 of EPS for the year, 100 basis points on your $5 billion book, and is that $0.40 in your guidance?
Ed Heffernan
That’s got a lot going there. I don’t know quite where to start.
Certainly as a percent of the portfolio Q4, you’re correct. It is always going to be lower because of the fact that especially because it is a private label card you can have your balances go up $400 million or something like that.
So, and we haven’t even billed for it. And that’s why in Q4 your yield will drop off, I would say, probably two thirds to three quarters of that drop-off is just seasonal in nature and there’s probably 60 or 70 basis points that is probably trimmed because consumers are paying a bit more on time than they used to.
But certainly the bulk of it is definitely just seasonal in nature. So we would expect a good chunk of that to snap back as the portfolio starts cycling back down towards normalized levels, towards the end of Q1 and that, of course, is where all the billing takes place on these high balances, which is why we are very excited about Q1 here.
Second, in terms of – what was the other part of the question? The 1%, if you did 1% on 5 billion, and you did it for nine months of the year, that’s 37 million and let’s say your revolving rate is 80% or something like that.
That’s 30 million. Call it $0.30, Darrin.
Is that in your guidance? These things are all in our guidance, and I think going back to the person who asked me about how do you get the 6 bucks, you know, you’re beginning to see the pieces that will flow together, but right now what we are saying is these types of levers that we are pulling or may pull are going to be used to offset potential softness on the late fee side, potential some softness from new rates that are out there and additional costs from the card act.
So to the extent all that doesn’t play out that certainly would be good news just for us. But we are not waiting around
Darrin Peller – Barclays Capital
Any news on timing around the late fee rulings from the Fed or others?
Ed Heffernan
If there is, they have not made it down to Texas.
Darrin Peller – Barclays Capital
Last question for you on the loyalty business, you might have touched on this at full-year pricing discussion earlier, but the revenue per mile to me looked a bit lower in the quarter. I think someone alluded to it earlier why was your with Air Miles issued up and there were gains, why was the actual revenue kind of card to cards basis not higher?
Can you help me understand what’s happening in the business and we should expect from our revenue per mile trend?
Charles Horn
I am looking around here and everyone is going, not a clue. So, I think we will have to a pass on that one, and there is nothing that popped up in the trend per se that we saw.
So we will take a pass on that one.
Darrin Peller – Barclays Capital
All right. Thanks, guys.
Ed Heffernan
Okay. All right, thank you, everyone.
And we are about 5 minutes over, but best we could; we’ll get it better going forward. Thank you.
Operator
That concludes today’s conference call. You may now disconnect.