Alliance Data Systems Management Discusses Q2 2013 Results - Earnings Call Transcript

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Alliance Data Systems (NYSE:ADS)

Q2 2013 Earnings Call

July 30, 2013 8:30 am ET


Amy Pesante

Edward J. Heffernan - Chief Executive Officer, President, Director and Member of Executive Committee

Charles L. Horn - Chief Financial Officer and Executive Vice President

Bryan J. Kennedy - Executive Vice President and President of Epsilon

Bryan A. Pearson - Executive Vice President and President of Loyalty Services


Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division

Bill Carcache - Nomura Securities Co. Ltd., Research Division

Darrin D. Peller - Barclays Capital, Research Division

Daniel R. Perlin - RBC Capital Markets, LLC, Research Division

David M. Scharf - JMP Securities LLC, Research Division


Good morning, and welcome to the Alliance Data Second Quarter 2013 Earnings Conference Call. [Operator Instructions] And it's now my pleasure to introduce your host, Ms. Amy Pesante of FTI Consulting. Ma'am, the floor is yours.

Amy Pesante

Thank you, Kayla. By now, you should have received a copy of the company's second quarter 2013 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, Executive Vice President and President of Epsilon and Alliance Data Company.

Before we begin, I would like to remind you that some of the comments made on today's call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and the uncertainties described in the company's earnings release and other filings with the SEC. Alliance Data has no obligation to update the information presented on the call.

Also, on today's call, our speakers will reference certain non-GAAP financial measures, which we believe will provide useful information for investors. Reconciliation of those measures to GAAP will be posted on the Investor Relations website at

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

Edward J. Heffernan

Great. Thanks, Amy. And everyone, welcome to our 49th edition of quarterly earnings as a public company. And as mentioned, joining me today is the always engaging Charles Horn, our CFO; and also our always insightful Bryan Kennedy, our President of Epsilon. Charles is going to first discuss our consolidated result, LoyaltyOne, Private Label, Bryan will walk you through Epsilon and then I'll wrap up by discussing our updated guidance and outlook for the balance of '13, as well as our thoughts as we take a look at 2014. Charles?

Charles L. Horn

Thanks, Ed. Alliance Data continued to beat expectations with revenue, again, topping the $1 billion mark, aided by 7% organic growth and adjusted EBITDA increasing double digits to $338 million. Both Private Label and Epsilon contributed to high double-digit increases in both revenue and adjusted EBITDA for the quarter, while LoyaltyOne faced revenue headwinds due to unfavorable FX rates and reduced redemption activity, but still managed to increase adjusted EBITDA by 9% versus last year.

Core EPS beat guidance by $0.16, increasing to $2.41 for the second quarter of 2013, up 13% compared to last year; while net income per diluted share increased to $1.71, up 5% compared to last year. Core EPS for the second quarter of 2013 included a $0.03 benefit from the release of previously reserved tax liability.

Diluted share count increased 4.4 million to 68.2 million versus Q2 2013 due to incremental dilution from convertible notes. Approximately half of the share increase was related to our phantom shares, which are shares we never have to economically settle. And convertible note warrants, which we do have to economically settle, accounted for the remaining half of the increase.

Starting in the third quarter of 2013 and continuing through the second quarter of 2014, we should benefit from a declining share count as our convertible notes mature and the related phantom shares vanish.

Let's move to the individual business segments, starting with Epsilon. With that, I will turn it over to Bryan Kennedy.

Bryan J. Kennedy

All right, great. Thanks, Charles. Epsilon surpassed expectations again this quarter with 41% top line growth, 30% bottom line growth. Organically, we achieved 9% top line and 11% bottom line growth compared to the second quarter of 2012. So I have to say, it's nice to see high single-digit organic revenue growth again.

Breaking down the individual businesses. First, on technology, revenue was up 1% compared to last year, but is showing signs of accelerating revenue growth, especially in database, which is trending towards double-digit growth in the back half of the year. The "slow to grow" trend we saw last year is behind us as key wins in 2013, so far, along with a very strong backlog, support accelerated growth through the rest of the year.

Additionally, there's a lot of optimism around the positive response with the launch of our new email platform, which we believe will help alleviate some softness in the digital product offering. And that rollout is still scheduled for Q3 of this year, with the P&L impact primarily occurring in 2014.

On the data front, revenue was essentially flat with prior year. Notable, our online survey offering continues to exceed expectations as it emerges post restructure in very good form, but it's being mitigated by overall continued softness in the consumer demographic data offerings.

And then finally, on the agency front, agency continued to outperform this quarter, increasing revenue 115% to $179 million. And if you exclude HMI, organic revenue growth is about 25%. So agencies record of converting pipeline items in the key wins has really nicely positioned Epsilon to meet full year growth expectations, as well as negate any potential softness in the back half of 2013. HMI has also been expanding their vertical footprint and adding depth to the current product offering with a variety of innovative new offerings as part of Epsilon.

Overall, pipeline remains very strong across the business, especially in agency and database, and we continue to expand relationships with clients like AT&T, who recently signed a multi-year renewal with us, while onboarding new clients like Dunkin' Donuts, where we are engaged recently to drive technology for their new loyalty program called the DD Perks program.

Stepping back, the strategy of selling a full suite of integrated service offerings across our client base continues to pay dividends for Epsilon. The first half of the year, fueled by double-digit increase in customer wins and verbal commitments, has given us the momentum needed to stay on track for high single-digit organic growth by the end of the year. And as we actively ramp up for this year's top line growth, cost containment efforts are also being directed towards actively managing our bottom line growth. This proactive approach, coupled with last year's restructuring efforts, are really setting the stage nicely for steady continued momentum into 2014.

So that's Epsilon. With that, I'll turn it back to Charles for LoyaltyOne.

Charles L. Horn

Thanks, Bryan. Let's flip to the LoyaltyOne slide real quick and what you'll see is similar to the first quarter. LoyaltyOne's revenue declined 4% for quarter due to headwinds from a 9% decrease in miles redeemed and the 1% drag from a softening Canadian dollar. Despite this currency weakness, we expect full year revenue growth to be in the low single-digit range as we anniversary the highest wins comps that we saw in the last half of last year.

Adjusted EBITDA increased 9% compared to the prior year despite unfavorable Canadian exchange rates, which we reduced adjusted EBITDA by approximately $1 million. A combination of operating leverage and the $3 million reduction in losses associated with our international expansion efforts drove a 400 basis point improvement in EBITDA margin for quarter.

As expected, miles issued for the second quarter remained light, due to softness with our credit card sponsors and the timing of promotional spending. We expect to ramp up from these sponsors added during the first half of 2013, coupled with promotional spending by several of our top sponsors, will stimulate issuance growth in the back half of 2013. For the year, we are striving for a 3% to 5% increase in miles issued compared to 2012.

The residual effects from the run on the bank, which occurred last year as consumers responded to the announcement of expiration policy, were felt during the quarter, as miles redeemed dropped 9% versus the prior year. This impact had dissipated by the third quarter of 2012, so we should see a slight increase in miles redeemed during the back half of 2013, which should drive revenue growth.

2013 continues to be a record year for new signings as we added Irving Oil and Eastlink as sponsors during the quarter. Both are key wins as Irving Oil deepens our reach within the high-value, high-frequency spend category and Eastlink grows our presence in the telecoms sector.

Turning to our dotz joint venture in Brazil. Our focus continues to be on market expansion. dotz now has 8 million members, up over 170% last year. It is on track for 10 million collectors by year end. In addition, we are looking to add 4 new markets during the back half of 2013, bringing the total accounts to 9.

Let's flip to the next page and talk about Private Label. Private Label continues to excel with the revenue up 19% and adjusted EBITDA net of funding costs up 13%, driven by 27% increase in average card receivables. The growth was balanced, it's approximately 16% of the AR growth which is organic and by 11% acquired.

Gross yields dropped to 110 basis points during the quarter, primarily due to the onboarding of new programs over the last 12 months. Some of this compression was mitigated by a 30 basis point improvement in principle charge-off rates and a 30 basis point improvement in our portfolio funding costs. The end result is approximately a 50 basis point decline in that spreads versus last year.

Loss rates continues to be at historically low levels and it feels like we have likely bottomed. As such, we should see a more normal seasonal trend on a go-forward basis, basically meaning, the rates should be up in Q1, down in Q2, down in Q3, which should be the low point, and then up again in Q4.

During the quarter, we continued to lock in long-term competitive financing rates by issuing $500 million of new 3-year term asset-backed securities below a 1% coupon. Cost of funding, expressed as a percentage of average card receivables, was approximately 1.8% for the quarter. We will talk more about our funding strategy on the next slide.

Before we do so, we need to talk about the continued success and the onboarding of new programs within our new Private Label operation. 2012 was a record year for Alliance Data in terms of new signings, but we are in a pace in 2013 to potentially exceed it. Just halfway through the year, our new signings should ask about $1 billion in steady-state card receivables as the programs ramp up over the next 3 years.

Let's flip to the next page. As you can see in the debt maturity schedule, we tend to be fairly conservative in our funding approach, giving up some rates for longer-term certainly. Currently, 83% of our funding is fixed with the duration slightly over 36 months. What that means is in a rising rate environment, this approach should be beneficial to us. Or as Ed would say, we should receive a kiss to earnings in a rising rate environment.

Why? Simply, if you look at the slide, we are asset positive in Private Label. The APRs on our cards are variable rate, tied to prime rate plus an adder. In a normal royalty rate environment, prime rate should increase in conjunction with key rates such as fed funds. An increase in prime rate would raise the variable APR in the very next billing cycle.

Conversely, on the funding side, you can see from the chart that we have staggered out maturities until 2020, meaning that we will stair step increase in funding costs. Until the increase is fully burned in, we should see a slight increase in our net interest margin.

I've been asked many times over the last month, what if only long term rates go up and your APRs don't reset? The answer is pretty simple. As the debt matures, we go shorter on the o-curve, minimizing any impact our net interest margin. Essentially, we move closer to a matched book.

Let's turn to the next page and look at our liquidity. Liquidity for Alliance Data remains very strong at about $5 billion as of June 30, 2013. Breaking down our liquidity further, at the corporate level, liquidity remains strong at $1.7 billion, of which approximately $750 million is cash on hand as of June 30, 2013. Our corporate leverage ratio of 2.2x remains well below our maximum leverage covenant of about 3.5x.

Subsequent to quarter end, we entered into a new credit facility, which increased corporate liquidity to approximately $2.1 billion. Approximately $770 million will be used to repay the convertible notes coming due August 1, 2013, leaving over $1.3 billion to execute our capital allocation plans.

At the bank level, there's approximately $3.3 billion of available liquidity as of June 30, 2013. During the quarter, one of our Master Trusts issued $500 million of fixed rate, term asset-backed securities. The fixed-rate coupon of 0.91% is the lowest coupon ever achieved for any duration in Alliance Data's 17 years of capital marketing issuance.

Also during the quarter, ADS renewed its $350 million trust for a conduit. We continued to take advantage of this low interest rate environment by extending maturities and adding liquidity as we execute our strategy of building long-term visibility into our earnings.

During the quarter, our 2 banks paid $82.5 million in dividends to the ADS parent, while maintaining strong regulatory ratios. As of June 30, 2013, community banks' regulatory ratios were substantially above minimum well-capitalized levels and are basically the highest in the card industry.

Lastly, we continued to use our share repurchase program to take advantage of market opportunities during the quarter, spending over $150 million. For the first half of 2013, we've spent $208 million of our $400 million authorization.

With that, I will turn it over to Ed for an update on 2013 guidance and the business outlook before we open up the call up for questions. Ed?

Edward J. Heffernan

All right. Thanks, Charles. I want to move to the page titled New Guidance. And I guess, at a very high level, we're raising -- bumping up the -- all of our key metrics from where they were before revenue. We're bumping up a little bit and we're looking at about 17% revenue growth versus prior year.

The thing that I focus on is organic growth. And in this environment of really sluggish GDP growth and hard-to-get organic top line, our goal is to run organic growth about 3x real GDP. Right now, organic growth is actually running above that. We're running at about 8%. We think, on a full year basis, again, it's probably a 2% or less real GDP number. So it's a very strong showing on the organic growth on the top line. So far, so good there.

On core earnings, also we're looking to do about 17% increase, which is up from prior guidance. And the core EPS is going to be up a little bit less than that, about 13% to $9.85. We've bumped it up $0.10 from the prior guidance. And we are inching our way towards the $10 mark as the year unfolds. But for now, we'll keep it at $9.85, up in the low teens.

Economic EPS, obviously, is coming in around $11.28, that's when you exclude the phantoms. So overall, the way things are flowing out, it's pretty nice. I think that we had good core earnings in the low double digits through the first half of the year. We ran into the headwinds of actually higher share count in the first half of the year that dissipates in Q3. And then in Q4, you're going to have this nice earnings increase, but you're also going to have finally a share count that is down versus Q4 of last year. And that, when you combine the 2, essentially is what we call our slingshot as we exit 2013 and move into '14, where that slingshot should continue throughout the year.

Turning next to business outlook. I'm going to talk a little bit about the rest of '13. And then I think, probably as importantly, or more importantly, how we're looking, how we're shaping up for 2014. Obviously, we'll start with LoyaltyOne and AIR MILES.

I would say, if there was a one weak spot that the business is seeing so far this year, it's the key metric of miles issued, which is certainly soft during the first half of this year. We do, however, as we've been saying, expect a very strong bounce in the second half and we can get into what's driving that during Q&A if you want. But it's primarily driven by the spool up of the big new sponsors that have been signed this year. It's been a very strong year for new sponsor signings. They're cranking up.

And then we have definitely gotten some commitments in terms of big promo spending in the back half, especially from our financial institution partners, as they're looking to grow spending on their cards. So I think that this metric should turn very nicely in the second half and -- but that's something that we are clearly, keeping our eye on.

As we talked about, I'd say the high point for LoyaltyOne or AIR MILES so far this year has been, it's been a very strong year for big new sponsors signings. GM, Staples, Irving Oil and EastLink on the telecoms side. We usually do about 2 big signings a year. This year, we're looking at 4, there may be 1 or 2 more out there as well as the year unfolds. So that's very, very good news going forward, in terms of our issuance metric.

Turning to Brazil. It continues to grow and grow quickly. Members are up to 8 million, which is up 170% from 3 million a year ago. We're hoping and expect to get to 10 million folks by the end of the year. Again, how -- the question being asked is how do we compare that to our Canadian business? And a good rule of thumb that Charles and I use would be, we would need about probably 25 million enrolled to roughly equate to the Canadian program, where we have 10 million households enrolled. So that's what we're shooting for, and if we could end of this year at the 10 million, that would be superb.

Full year organic revenue growth will be a couple of points when you include Brazil. And the grow over that Charles talked about from the run on the bank in 2012 is really driving flattish revenues. We'll get a couple of points, as we said, from Brazil that's not in our numbers, obviously. But we're going to put it off to the side here and let you know how things are going. What is a big plus is the organic growth in EBITDA is very nicely running in the high-single digits, which is what we'd like to see as it did last year as well.

So turning to 2014. What's key? What do we need to see? We need to get that issuance turn strongly in the back half. And again, our financial institutions partners had committed to some big promos. We've got the big new sponsor ramps. The watch that's going on right now is the Canadian consumer.

Specifically, the Canadian consumer is running at very high debt levels in terms of debt to income. And the concern is that there's a housing bubble up there. What we are seeing is, in fact, that the debt levels, while high, have not turned into a route in the housing market. And in fact, the housing price increases have been moderating over the past quarter or 2. So we think the Canadian consumer is stretched, but probably not overly so.

Brazil, as we've talked about, we're in the midst of a multi-year landgrab, so to speak, which is essentially pushing as hard as we can to get as many collectors sign up and onboard as quickly as possible. And that is going to be the focus for the next couple of years.

Overall, if I were to sum up LoyaltyOne, clearly, the one area we're watching is miles issued. We want to make sure that, that turns smartly in the second half. Against that, we have probably the big pluses of the big new sponsors. Organic cash flow growth, that's in the high-single digits. We have margin expansion that's up 200 basis points and Brazil seems to be growing nicely. So I think that's about it for the LoyaltyOne.

When we turn to Epsilon, I think Bryan did a nice job covering it, which is good since he runs the division. The division will obviously cycle differently, depending on the various areas within it. And I think the thing that is most comforting at this point is we've seen a 12-point swing in the organic growth number from minus 3% towards the latter part of last year to plus 9% so far this year. So that's very, very encouraging.

He talked about the book of business being exceptionally strong. We've never seen it this strong. So that's good news. I think that, again, looking for what could go wrong as we move into '14 or what we're watching, I think overall, we can say that the pivot that we made to digital agency, starting a couple of years ago with Aspen and then HMI, it's certainly beginning to pay off big time for us. Having a digital agency leading our overall offering is driving our organic growth. And now what we're beginning to see is it's pulling through some very large commitments on the technology side and database sides. So we're going to see some big nums on the database build side as we go into the back half of this year and going into next year. So that's very good to see.

What are we watching? Probably 2 things. One is, as Bryan mentioned, the rollout of our new digital email platform and that's called Harmony. And so far, the initial reviews have been very positive, but we want to make sure we have an extremely strong rollout as we go into '14 and make sure that we're considered best of breed in the marketplace. And then second, obviously, with the huge overall growth at Epsilon, obviously, making sure that we onboard and don't stumble when we bring on the these big new clients is of paramount importance at this point.

Okay, let's turn a little bit now to Private Label. Obviously, Private Label is -- it's certainly continuing on with record signings and we talk in vintages here, which means that when we talk about the 2013 vintage, that means if we were to take those clients that we signed in 2013 and then most of them are starting from scratch, some of them are existing programs. But we look out 3 years and say, "Okay, will this vintage ramp up to about $1 billion of incremental new business for ADS?" And we did $1 billion in the 2012 vintage for the first time since I've been here. And this year, so far, as Charles mentioned, we have signed the $1 billion for 2013.

I will say that there are a number of deals that have been signed that you will see released over the next, I guess, quarter. And I think that it is safe to say that this year, rather than the $ 1 billion vintage, we are probably looking at closer to $2 billion. That's how strong it is out in the marketplace. It is absolutely unreal, the amount of interest that we're having in this data-driven target marketing product that we call Private Label. So very, very strong and hopefully, this is a trend that will continue for quite some time.

What's behind it? Again, it continues to be this huge desire on the part of the retailer to link category or SKU transactional data with an individual consumer. And what's driving a lot of that is the fact that it's very, very hard, obviously, to get the consumer in the door and spend. And what we try to do is we try to make sure that we can offer up an appropriate message or an appropriate offer for each individual consumer.

It's something that has grown in sophistication as we layer in demographic and psychographic information on top of transactional information. And it is, as we said, very compelling when you link it to the ability to communicate through what we call our omni-channel approach, which is everything from direct marketing -- I'm sorry, direct mail to permission-based email, mobile, social, targeted display, whatever it may be.

Okay, funding. As Charles talked about, it's mainly locked down. Credit quality is very stable, call it 5%. We are not seeing anything out there and we have a good view through delinquency flows through the end of this year and the beginning of next year. There is nothing out there that suggests that there's -- that it's going up or is going down. So I think what we're looking at here is you've got funding locked down, you've got credit quality relative -- essentially stable, and so growth is going to be coming from top line.

Overall, full year organic growth, we're looking at about 10%, which is about 2/3 of our total. And if you look at Q2, we talked about roughly 12% organic growth versus a card market that is essentially flat. And we get the question over and over again of why is the organic growth so strong? Why is it growing so quickly? What's very interesting that were seeing is it's less about new accounts flowing in the door when it comes to the organic side because that plays in later. It's more about our growing tender share within our existing client base and new client base.

Essentially, over the last quarter, we have picked up tender share of almost 100 basis points, meaning that traditionally, if 26% of all the dollars that are being spent at the retailer flow onto our card, now it's 27%. It may not sound like a lot, but it's big numbers when it comes to organic growth. You throw in the new ramp ups and that's where you're going to get, 12% organic growth.

And what we're trying to do with the retailer is we found that it's extremely profitable for the retailer to spend a little less time about just driving new accounts in the door and more about activating the inactive or low active accounts. And that's all through these loyalty programs, which is called triggered marketing. And so very simply put, it could be someone who hasn't been shopping all that much at the store. We notice that and we communicate with her and let her know that "Hey, you're only $30 away from the next award here," and we send out that little communication or we send out a coupon or something like that. And what you do is you trigger a reaction and it's extremely, extremely profitable for the retailer.

Basically, it's all about timing, messaging and merchandising, and that's where we are today. So I think overall, we're in very good shape when it comes to Private Label for '13 and for '14. It's a little early for '15, but '14 certainly looks quite strong.

Consolidated. At the consolidated level, we're looking at high single-digit organic top line growth, greater than 3x for GDP. Again, we talked about roughly 12-ish percent for Private Label, 9-ish percent for Epsilon. If you adjust for FX, it's probably relatively flat for LoyaltyOne. And overall, that should give you about 8% organic growth for the year.

I think as we move ahead into 2014, we talk about what exactly are we worrying about right now at the Private Label. Obviously, the credit sales looks strong. Portfolio growth is strong, funding is fixed, losses are flat. I think Private Label is in good shape for next year. Epsilon, what we're looking for is a bit of a cycling where the big, big database builds start ramping up heavily in Q3 of next year, which will drive a lot of the organic growth as we go into '14, which is kind of nice. It takes the pressure off of the digital agency piece a little bit. But overall, Epsilon should be in very good shape for '14.

In Canada, obviously, we are looking for a turn on the miles issued. Our focus is making sure that key metric turns for 2014, and it's a little bit of a wait and see at this point until we actually bring in the numbers in Q3 and Q4 of this year.

In Brazil, as we talked about, we're going as hard as we can to ramp up. We've gone from no collectors to less than 2 million to 6 million last year, hopefully, 10 million this year. We own 37% of this entity. It's obviously very appealing to us. We're looking at double-digit free cash flow for next year. And then sort of the nice kiss that we get is our share count is going to drop off quite dramatically going from 66 million shares to closer to 59 million. So if you just do simple math, which is if earnings in general grow 10% and your share count is going down by 10%, that suggests that you're going to have pretty nice earnings per share growth of 20% plus.

So we feel pretty good about the rest of this year. We feel pretty good about next year. Our goal is to be 7% to 8% organic for next year, double-digit core earnings for next year and as we said, with the lower share count, you're going to have a slingshot on earnings per share.

That's it. Why don't we open it up for questions?

Question-and-Answer Session


[Operator Instructions] Your first question comes from the line of Sanjay Sakhrani with KBW.

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division

In the press release that international expansion is something that you're looking at, could you just talk about what exactly you're looking for within Loyalty and Epsilon, especially within loyalty, because you guys just talk about the fact that you might take -- not take up the ownership in Brazil?

Edward J. Heffernan

Sure. On the international side, I think that the LoyaltyOne group up there is well positioned from a management and organizational perspective that they can handle a little bit more. And so we are casting our net for other Loyalty-like programs outside of Canada and Brazil. And there are a handful of attractive ones as we look out in places such as Europe or the Far East. So if we could establish a Loyalty program elsewhere, then we'd certainly like to do that. Probably the best way to get in is through M&A. And again, not saying it's going to happen, but that's something we're looking at. Here in the States, we think the pricing on some of these deals are just nuts. So we're going to stay away from that for now. We're not going get in the middle of these pricing wars that are going on. But there are opportunities out there. I think Epsilon will probably focus entirely on organic growth for the next year. It has more than it can handle in terms of new wins and verbal agreements, so they're going to stick pretty close to their knitting over the next year. And as far as Brazil goes, again, we don't want to upset the apple cart down there. So as far as we're concerned, it's basically go as hard as they can to drive this landgrab that's going on.

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division

So just -- and in terms of Brazil, not taking up the ownership, does that change your view of the growth potential there and the ability for Banco do Brasil to renew?

Edward J. Heffernan

No, what we need is -- it's a question of what is Banco going to do. Hopefully, we will have that completely resolved as the end of the year approaches. I don't think we're all that concerned about whether they're going to renew or not. It's a question of, are we looking at an extension or renewal? We don't really know right now, Sanjay. But our focus is entirely on getting that core base customers from 8 million to 10 million to 15 million to 20 million, and not distract management within some type of other financial transaction right now. So when the time is right, we'll be stepping in. And we'll see if we can't get something done there that's attractive to both sides, but right now, all eyes are on the landgrab.

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division

Okay, great. And one final question for Bryan. I guess the big announcement in the marketing world was the merger of Publicis and Omnicom. I was just wondering if there were any implications as far as that Epsilon is considered.

Bryan A. Pearson

Yes. Sure, Sanjay. I mean, I don't see any immediate or even long-term significant implications for us. I think, from my perspective, the fact that a merger that size happened just validates the thesis that we've been pursuing for the past several years, which is there's a sea change in the world of advertising and data and technology and analytics is really what's driving the future of this industry. I think we've been way out ahead of that with our strategy and with operation pivot, and are well down the path with our own integration of all those kinds of capabilities. So it'll be interesting to see where that one goes, but other than maybe some disruption that creates some opportunities for us from a growth perspective, I don't see any major impact on us.


Your next question comes from the line of Bill Carcache with Nomura.

Bill Carcache - Nomura Securities Co. Ltd., Research Division

I wanted to kind of go back to some of your comments on tender share and you threw out 26% as an example. Is that kind of a reasonable level to think about traditionally that now, it's up 100 basis points to 27%. I guess I was hoping you can kind of give a little bit of additional perspective around that? How long does it typically take to get there? I guess, maybe what's the high? How high could it go overall? Maybe just some commentary around that. And maybe how also it differs by vertical, furniture, electronics, apparel, home products, et cetera.

Edward J. Heffernan

Sure, you bet. Yes, I mean, it's one of these trends that, frankly, it's really beginning to pick up. We have programs where we have tender share in the high 40s. So 45%, almost 50% are half of all the money spent that the retailer has put on our card. And obviously, we have a number of programs that are below that and others that are ramping back up. But I think a tender share of around roughly 30% is something that's extremely comfortable. We are at about 27% today and we can grow these programs to about 40% as we work on them throughout the year. What we are seeing, which is very different from past years, is what we talked about in terms of the focus on getting the less active or virtually inactive accounts back into the game. And in the past, we didn't have all the tools that we have today. So a lot of this stuff is focusing around retention. And right, there's 2 ways to grow. You can just chunk in a bunch of new accounts to the front end, but you're going to have folks going inactive in the back end and hopefully, net-net, you're up. What we're seeing is, yes, we're bringing in the accounts on the front end, but we're doing a much under job of keeping our shopper interested on the back end, so that she is more willing to come in, let's say just one extra time per year or make one additional online purchase. And a lot of that is focused around the data and the ability to identify all these micro-segments. We will then do all this trigger marketing as I talked about. You're only 30 bucks away from the next reward. You bought these pants. How about you try this top and we'll give you something off? So it's one of those things that if we can drive tender share, you're talking probably 8 points of organic growth just coming from driving your tender share up a little bit. So that's where we're going. Obviously, the big, big drivers of our tender share growth would be in our more traditional areas, such as soft goods. But also, furniture and jewelry are also very big in terms of very strong tender share.

Bill Carcache - Nomura Securities Co. Ltd., Research Division

That's really helpful. Switching gears, you guys had -- I think you said 12% of the increase in your credit sales came from higher core cardholder spending. Can you relate for us how much of the strength in your credit card sales volume growth is really kind of tied to wealth effects that kind of -- I hadn't really heard you guys talk about wealth affects as being much -- or I guess, specifically being a driver, but I wondered if you could comment to what extent you see that specifically in your customer base.

Edward J. Heffernan

Yes. I mean, it's a good question. I think it's more of an incremental benefit, Bill. I think we talked about -- of our revenue, 2/3 of our revenue or 12% was coming from this organic growth that we talked about, the other 1/3 from the acquired side. And on the organic growth side, what we're seeing is that our shopper, she is not going nuts in terms of huge increases and spending. We're seeing our average card balance probably going up 5% or 6% for the year, which is not a huge number when you're talking about a $450 balance. So what we're seeing from the consumer side is a continuation of the last couple of years of elevated payment rates, meaning that she is shopping, but she is paying off a big chunk every month and a very moderate increase in balance size, probably going from $450 to probably $480, $490. So we're seeing a lot of discipline out there. What we are seeing also is that we are beginning to see the start of those folks who had challenges during the great recession. It has taken now almost 4 years for them to get back in the game in terms of being really attractive to us from a credit perspective. And so that also is the new trend that's beginning to cycle in.

Bill Carcache - Nomura Securities Co. Ltd., Research Division

That's great. And finally, if I may, one for Charles. Charles, can you try to square the commentary you guys had in the release about there being a moderate provision build this quarter? But from looking at the monthly credit data that you guys put out, it looks like there's -- there were $80 million -- about $80 million of charge-offs during the quarter and you had a $58 million provision, so that it would seem to imply a release, but you guys said there was a build. Can you help me understand what I'm missing there?

Charles L. Horn

It's on a year-over-year basis, Bill. If you look at our reserves Q2 last year, it was $432 million. This year, at the end of Q2, $448 million. So it's [indiscernible] for the reserve build.


Your next question is from the line of Darrin Peller with Barclays.

Darrin D. Peller - Barclays Capital, Research Division

Let me just start off on the Private Label side. The portfolio yields, it seems like overall, this business is obviously performing extremely well. But even with that said, it's probably underperforming in some regard, given that the portfolio yields continued to be negatively impacted by some of these new portfolios you're onboarding. So I think Charles, I think you mentioned this -- you've mentioned in the past that it could improve over time. When do you expect the portfolios to actually generate yields that are more in line with ADS' core portfolio? And what are the key factors that would drive that?

Charles L. Horn

I think you'll see a little bit of lift to come through in Q3 and Q4 of this year. As we talked about in Q1, of our earlier call, we're looking for probably 27.4% gross yield for the year, which is down slightly year-over-year, it was 27.7% last year. So I think you'll see a little bit of lift in Q3, Q4, for the year round, 27.4%, so a slight compression year-over-year, but that's due to the onboarding that Ed talked about. So what I'd be looking for, Darren, is a little bit lift in Q3. For the year coming and basically what we signaled in Q1, around that 27.4% level.

Darrin D. Peller - Barclays Capital, Research Division

And that's just basically the -- as you have the opportunity to really provide your services and your expertise around the portfolios that you're acquiring?

Charles L. Horn

That's part of it. Also just obviously, with Bon-Ton onboarding in Q3 of last year, some of the effect will start going off in Q3 of this year. So some of it's just timing as well.

Darrin D. Peller - Barclays Capital, Research Division

Okay, that's helpful. And just another question, a follow-up on the private label side. Opportunities for additional portfolios beyond maybe sales, for instance, which I know really doesn't probably come on until even -- or at the earliest, 2014. What else is out there? And then, I think Ed, you mentioned in your prepared remarks around the vintage, you're seeing now so much strength that a new vintage of $2 billion is more likely than $1 billion? Is that right? Did I hear that correctly?

Edward J. Heffernan

You did.

Darrin D. Peller - Barclays Capital, Research Division

All right, so that's -- I mean, that's a pretty significant number obviously for a 1-year addition over time, even over -- with 6 months left of the year. What else is out there? Is that -- how much of that organic? How much of that is actually acquired?

Edward J. Heffernan

There's probably at least one more announcement coming out of a fairly significant file or portfolio that we would expect to acquire. The rest of it, quite frankly, is coming from -- starting from scratch. And what we're seeing is, again, Darrin, it's one of those things right now where we're right in the sweet spot of every retailer and it's now expanding into the T&E market like with Caesars. But all these retailers out there are so focused on, "Hey, tell me about the customer, tell me what works, the trigger marketing, how can I get that her to repurchase just one more time this year," and that essentially will make their year. And so what we're finding is the offerings that we have just seem to be extremely attractive today. You sprinkle on top some of the Epsilon dust in terms of, for example, also providing a whole bunch of potential prospecting names for the retailer on a go-forward basis. That's also something that is turning out to be very attractive from an offering perspective. And you factor in the fact that we can reach the consumer through direct mail, permission-based email, mobile, social, targeted display. All those abilities that we have in-house today, I think, are really driving the signings. I mean, it's, look we've been doing the same thing for -- it seems like forever. And the last couple of years, there just seems to be a massive shift towards this data-driven targeted marketing. And so that's why think you're looking at -- it's going to be a biggie this year.

Darrin D. Peller - Barclays Capital, Research Division

All right, that's amazing. Just last question for Bryan and then I'll turn back to the queue. And Epsilon obviously performed well, a little better than our expectations in the quarter. A lot of it seems to be driven, as I think you said, off the agency business. Is it possible for you to give us a little bit of a breakdown or at least some color on the size of each one of those segments, agency versus data versus technology? And then what's driving the 20-plus percent? It sounds like it's organic growth. You back out HMI, I think, in the agency side of the business.

Bryan J. Kennedy

Yes. Sure, Darren. I mean, for sure, the agency -- digital agency, as Ed said, is the driver right now for our growth. And I think if you were to break it down between existing clients versus new clients across the board, not just in agency, but I would say we're seeing a little bit higher contribution from new clients coming onboard as we go into the back half of this year and into next year. Then we are -- from existing, which is, for me, a very good sign for this business because typically, we rely on existing clients to drive growth and then new adds a little bit on top of that. So when you see that number flip, it typically signals a pretty good longer-term trend ahead because we're continuing to drive growth of existing clients as well. And I think if you think about our agency offering, just to distinguish it from much of the broader advertising market, it is very data-centered, very technology-enabled agency services that we tend to deliver. And just like Ed was saying in the Private Label, we're seeing the same thing among our client base that there's high demand there. So that's a bit of what's driving that growth of our 3 largest verticals, which should be automotive, financial services and insurance/telecom are all growing strong double digits. That's with good agency offerings and increasingly, as we get in the back half, you're going to see a ramp up on the technology side.

Edward J. Heffernan

Yes. And I think also, just to say, as you recall, last year, health care got dinged a little bit on our calls in terms of going backward. So it's only appropriate to say that, that has not only stabilized, but has turned positive this year as well, so that's good news.


[Operator Instructions] Your next question is from the line of Dan Perlin with RBC.

Daniel R. Perlin - RBC Capital Markets, LLC, Research Division

Can you guys maybe talk a little bit about what's going on with EMEA and CIBC and then TD? In Canada, it seems like there's some questions around what's going on, that kind of coalition marketing program as a competitor? And is that -- do you think that's opportunistic for you guys or has it been disruptive?

Edward J. Heffernan

That's a fairly loaded question, Dan. I would say, at the highest level, the easiest way to think of it is it's typically not our customer. It tends to be the business traveler. So it's, again, recall it's an airline program where ours is after the mass consumer. And so it's -- they're very different programs, they never really overlapped in the past. I don't really expect them to overlap in the future. I would be remiss if I didn't say that, "Look, there is a fair amount of disruption in that program that's going to happen as you have the 2 largest sponsors cycling in and cycling out," meaning the banks. And as a result, could that be an opportunity for other financial institutions to, let's say, take advantage of that displacement in the marketplace? And that's a long-winded way of saying that our folks in our financial institution category are probably viewing it as an opportunity to perhaps pick up some incremental growth if they do heavy promotions in the back half. And that's one of the reasons why we think miles issued is going to flip pretty nicely in this back half.

Daniel R. Perlin - RBC Capital Markets, LLC, Research Division

Great. Can you also just remind us -- I mean, it's been a while since we've talked about rising rates. And I know Charles, you talked about the fixed funding and how that kind of falls through. I'm really more interested in your commentary around kind of price elasticity for the consumers that revolves in your portfolio. What would you expect them to tolerate? And then can you just remind us to the extent that there are any caps on the cards rates? I think they're running at close to 25% today, and I'm pretty sure they're all variable up to that. You talked about the way that they get pushed forward. But I'm just wondering, are there any caps that we got to be mindful of at some point in the future?

Charles L. Horn

No caps in place. I'll answer that one first. So we do have programs, we have some at a 23% rate, some up to 25%. I think frankly, revolving rates will not be affected adversely if it moves 1%, 2%, 3%, 4%, I really don't. If you look in the Private Label industry now, there are programs out there over 30% APRs. And so I don't think you would see any appreciable change in the consumer behavior. I think many people at the income levels were going after about $65,000 a year, work more toward a payment and that's what the most important part of it. So frankly, and I think we've talked about this before, Dan, I don't think small changes and rates will affect the revolving behavior. And the way we are structured, we are true variable rate. So if prime rate moves, we do get that flexing through in the next billing cycle. Again, we do not have any caps on our programs, the way we're structured.


Your next question is from the line of David Scharf with JMP Securities.

David M. Scharf - JMP Securities LLC, Research Division

I wanted to follow up on the last question. Just to clarify, all of -- are all of your programs variable, Charles?

Charles L. Horn

I believe so, yes.

David M. Scharf - JMP Securities LLC, Research Division

Okay, got it. And shifting to provisioning, I know you had mentioned in the year-over-year basis. Just based on the growth of the portfolio, obviously, your overall provisioning is up. It looked like at about 6.2% provisioning rate on ending balances. At June 30, it came down quite a bit. I haven't run the numbers. But I mean, effectively, was there any -- well, put another way, it looks like it's 50 basis points down from March 31. I mean, is this a planned step down in the provisioning rate as you kind of assessed the forward charge-off outlook? I'm trying to get a sense for just how low a level and what spread over loss rates we want to provision at.

Charles L. Horn

So 2 points there. The first one is our rate in Q1 always drifts up, because you get a lot of transactors that basically go into the -- to our stores, buy in the fourth quarter and then pay off in Q1. So you always see the rate drift up in Q1 and drop in Q2. So you're right. They went from 6.7% at the end of Q1 to 6.2% at the end of Q2. Probably, target in end of year, around 6%, 6.1%. And basically, what that means is we'll be drawing into it based upon the growth profile I had talked about, not necessarily releasing reserves. But we'll somewhat key base spread differential. We've talked about it could be 120, 130 basis points over the trailing charge-off rate. When we do the provisioning, we're always looking forward 12 months, 15 months. We're not looking necessarily backwards on us. So in that situation, you get a little flex into a quarter. So what I always try to get people to do is target end of the year and look at an end-of-year spread. So let's say, roughly, for the year, we're at 4.8% charge-off, right, then you'll see us reserve at around 6% at the end of the year.

David M. Scharf - JMP Securities LLC, Research Division

Got it, that's helpful. Actually, one other clarification. The comment about the 2013 vintage, ultimately comprising potentially $2 billion of receivables. I mean, over what timeframe are you thinking about when you've put that $2 billion figure out?

Edward J. Heffernan

Yes. It's -- all our vintages, a good assumption is 3 years. So since the majority of this advantage will be programs starting from scratch, it takes about 3 years before we'll hit that $2 billion dollar mark. And you look back to 2012, 3 years to hit that $1 billion mark, so you'll see it coming in chunks. The net result is you're going to be in a very strong growth mode for the next 2, 3 years for sure.

David M. Scharf - JMP Securities LLC, Research Division

Got it. And lastly, you commented in the context of sort of consumer health and behavior that payment rates are kind of still at elevated levels. There seems to be more discipline, less willingness of households to relever as much. Are there any trends you can discern in that though? I mean, are the payment rates pretty much holding steady? Is there anything about recent vintages that maybe tell you that may go up a little in the next couple of years or...

Edward J. Heffernan

Yes. It's a good question. I think what we're seeing across roughly 30 million active households on an annual basis is that you had payment rates right during The Great Recession trend way down as people were stretching to probably 14%, 15% well below where we usually run, which is probably 18%, 19%. And then post recession, as you really cleanse the pipes, so to speak, in terms of folks who are somewhat on the margin, you move towards more of a prime or super prime file and you saw payment rates jump up to like 21%, something like that, which is quite a bit higher than our historical average. What we've seen is that has stabilized. So the last 2 years has been very flat in terms of any movement in payment rates. The net result seems to be that, right now, we are in an environment where the consumer is a bit more comfortable paying off more than she did historically, but at the same time, is still out there shopping, which is good. And I would say, overall, if for example, you had 10 new folks apply for the card on any given day at one of our retailers, you might have had 7 get approved, pre-recession, during the recession, and maybe more like 2 or 3. And right now, we're probably back up to 5 or so. So I still don't think we're all the way back to the level that we could be at because those the folks who had difficulty during The Great Recession, it has taken 4 years for them to finally get back into the flow. So I think going forward, there's no reason for us to believe that payment behavior will be any different from what it is right now, which is fairly conservative, but spend is still strong.

David M. Scharf - JMP Securities LLC, Research Division

Got it, got it. And then lastly, in that context, can you give us a sense at these levels of payment rates, 20%, 21%? How many basis points of your gross yield, your roughly 27% gross yield, is now derived from late fees on an annualized basis?

Charles L. Horn

I think we're still fairly consistent on the collected yield, about 2/3, slightly over 2/3 from APR, slightly under 1/3 from late fee.

Edward J. Heffernan

Okay, I think that's it. So thanks, everyone, and we'll let you get back to work. Bye.


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

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