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Alliance Data Systems Corporation (NYSE:ADS)

Q4 2013 Earnings Conference Call

February 6, 2014 8:30 am ET

Executives

Ed Heffernan - President and Chief Executive Officer

Charles Horn - Executive Vice President and Chief Financial Officer

Julie Prozeller - IR, FTI Consulting

Analysts

Sanjay Sakhrani - KBW

Darrin Peller - Barclays Capital

Robert Napoli - William Blair

Daniel Perlin - RBC Capital Markets

Georgios Mihalos - Credit Suisse

Operator

Good morning, and welcome to the Alliance Data Fourth Quarter and Full Year 2013 Earnings Conference Call. At this time, all parties have been placed on a listen-only mode. Following today's presentation, the floor will be opened 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 FTI Consulting. 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 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, and Charles Horn, Chief Financial Officer of Alliance Data.

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

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

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

Ed Heffernan

Great. Thanks, Julie, and joining me today is our [indiscernible] and CFO, Charles Horn, and Charles will discuss our operating results for the fourth quarter of 2013 and I'll wrap it up with the final scorecard for 2013 and moving into 2014. And with that, I'll turn it over to Charles?

Charles Horn

Thanks Ed. It was a strong finish to a record year. Revenue increased 17% to $1.14 billion for the fourth quarter, bolstered by 14% organic growth. Importantly, revenue growth was balanced with double-digit growth in all three segments. Our profitability growth was even better. Adjusted EBITDA, net of funding cost, increased 18% to $290 million while core EPS increased a stellar 30% to $2.39 for the fourth quarter of 2013.

A higher than expected diluted share count for the fourth quarter, $66 million versus a guidance of $64.7 million, was offset by a 300 basis points improvement in the effective tax rate. Our guidance for the fourth quarter did not consider either but it was essentially a wash, a $0.05 benefit from the effective tax rate offset by a $0.04 drag by the higher share count. Fortunately, the diluted share count will drop in 2014 as the second tranche of convertible debt matures, while the lower effective tax rate is expected to be sustainable in the 36% to 37% range going forward.

For the year, revenue increased 19% to $4.3 billion, supported by very strong 9% organic growth. Adjusted EBITDA, net of funding costs, increased 16% to $1.25 billion while core EPS increased 20% – core earnings increased 20% to $669 million. Core EPS increased 15% to $10.01, exceeding Company guidance of $9.90. This was achieved despite a $0.43 drag from the higher year-over-year diluted share count.

The Company's effective tax rate dropped 70 basis points to 37.5% for 2013. The improvements for the fourth quarter and the year relates to our ongoing strategy of using international profits to invest in new international growth opportunities. Let's go to next slide and talk about LoyaltyOne.

LoyaltyOne's revenue increased 13% to $245 million while adjusted EBITDA increased to robust 19% to $68 million for the fourth quarter, overcoming a 6% decline in the foreign currency translation rate. On a constant currency basis, revenue increased 20% and adjusted EBITDA 26%. The expansion in adjusted EBITDA margin is a result of favorable operating leverage, higher margins on redemptions and a $3 million reduction in losses associated with international expansion efforts.

Importantly, AIR MILES reward miles issued increased 12% over the fourth quarter of 2012 due to a significant promotional activity in our credit card, gas and grocer sectors as well as the continued ramp-up of new sponsors. The strong second half growth in miles issued offset negative percent growth, producing full year issuance growth of 4% compared to 2012.

For the fourth quarter, AIR MILES redeemed increased 24%, approximately one-half from the ramp of AM cash redemptions, that's your [install] (ph) reward program, and [indiscernible] from better product availability. For the full-year 2013, AIR MILES redeemed were essentially flat with 2012, as we looked to manage the program to achieve a lower burn rate, 74% 2013 compared to 77% 2012. The target burn rate for 2014 is expected to be down again at approximately 71%.

Entering 2014, [indiscernible] breakage rate by 1%. The new breakage rate will be 25.6% representing 26% for the base program and 0% for the [indiscernible] reward program. The 1% change is based on the trending of AIR MILES as the program moves forward to 2016 expiration date for miles greater than five years old. We expect to offset this through lower offering expenses and higher product redemption margins.

During the fourth quarter, LoyaltyOne announced that it was expanding its international footprint by acquiring 60% ownership in Amsterdam based BrandLoyalty, one of the largest and most successful data-driven loyalty marketers outside of the U.S. BrandLoyalty is a growth company driving consistent, double-digit organic revenue growth which is really what attracted us to the company. We expect the overlay of LoyaltyOne's advanced analytics and advisory services will lead to future revenue synergies. This transaction closed on January 2, 2014.

Lastly, dotz, our Brazilian joint venture ended 2013 with 10.6 million collectors, [exceeding] (ph) our 10 million target at the end of 2013 and about double the number of collectors we had at the end of 2012. In addition to member expansion, the dotz program launched in four markets during 2013, bringing the total number of markets to nine. Importantly, [indiscernible], the biggest sponsor in the dotz program recently signed a multiyear renewal.

Let's flip over and look at Epsilon. Epsilon finished the year strong with the revenue up 28% to $375 million for the fourth quarter, driven by 14% organic top line growth. Adjusted EBITDA increased 34% compared to the fourth quarter 2012 as Epsilon achieved excellent operating leverage resulting in a 140 basis points expansion in organic adjusted EBITDA margins.

Now let's look at each line of business within Epsilon in a bit more detail. Agency continues growth leader increasing 52% to $196 million in revenue for the quarter. Organic revenue growth was a solid 20% driven by strength in the auto and telecom verticals. Recent signings from the auto vertical should help continue strong agency growth rates in 2014.

Technology revenue increased 12% compared to the fourth quarter of last year. This double-digit top line growth was driven by stellar performance in database, partially offset by continued weakness at e-nail. Database revenue increased 18% as we maintained momentum across the majority of our client base. E-mail revenue declined slightly due to customer attrition. The rollout in new Harmony platform, which is both a full-service and cloud based tax solution, is expected to drive growth opportunities in 2014.

Data revenue increased 30% in the fourth quarter primarily due to growth in our online offerings. Historically, data revenue growth is slower rate than the rest of Epsilon's product offerings and that is expected to continue but they are still an integral part of our bundled solution. Overall, we expect our online offerings to continue to increase as a percentage of the data mix.

In summary, it was a very good year for Epsilon, achieving organic revenue and adjusted EBITDA growth of 12% and 13% respectively. From a growth standpoint, we continue to work on cross-selling opportunities through a set of broad-based internal initiatives and expect agency to continue to be the tip of the sphere driving these efforts. As a result, we feel comfortable with our ability to draw a continued high single-digits organic revenue growth.

From a profitability standpoint, our focus on expense management as we fully integrate HMI, coupled with an improving mix towards higher value-added products will allow adjusted EBITDA margins to expand about 40 basis points in 2014.

Let's now turn and talk about Private Label. Once again private label delivered double-digit revenue growth during the fourth quarter of 2013 with the revenue increasing 13% to $526 million compared to a 14% growth in average card receivables. Adjusted EBITDA net of funding costs increased only 1% for the fourth quarter as it was burdened by 27% increase in provision expense related to seasonal ramp-up and the ending credit card receivables.

As you may recall, we always have a timing issue in the fourth quarter as a portion that's provision billed relates to recently originated card receivables that have not yet become income producing assets. Said another way, we record provision expense in '13 related to these new receivables that won't contribute to earnings until 2014. Private Label's ever-growing marketing capabilities which drive incremental sales for retail partners amplified this trend this past holiday season. We will talk about this more later.

It is also important we talk about the increasing operating expenses which were up 17% for the fourth quarter and 24% for the year. This growth rate which exceeds our revenue growth rate is intentional for the short-term. With a double-digit backlog of new programs to launch, our risk for 2014 is executional risk, meaning that we don't launch when a client expects or perform to the client's level of expectations. These expenses represent a deliberate, upfront personnel investment to ensure that we meet our obligations to existing as well as our new partners.

Funding cost continues to trend down as 2013 progressed. Expressed as a percent of average receivables, our funding rates were 1.6% and 1.8% for the fourth quarter and full-year respectively. For 2014, we expect a funding rate of 1.6%, approximately 20 basis points better than 2013.

Turning to the next slide and looking at the various stats on Private Label, you can see that our differentiated business model helps us drive above market rate, growth rates in credit sales and receivables. For the fourth quarter, credit sales increased 16% resulting in average and ending card receivables growth of 14% and 16% respectively. Our growth in credit sales is particularly impressive given that the overall consumer spend increased only about 4% during this past holiday season and that was largely achieved due to heavy promotional activities by the retailers.

Our retail partners results were really no different with the majority posting results at or below the overall U.S. average increase. However, our card programs were bright spot driving incremental sales for retail partners and creating [industrial] (ph) gains for us. This [industrial] (ph) gain can really be seen as it relates to our core programs and the ones of you who have no idea, that means card programs we've had for more than three years where our credit sales increased 8% compared to the fourth quarter of 2012.

Finally, delinquency and principal charge offs is trended as expected in the fourth quarter. As talked about earlier in the year, we believe that the principal charge-off rate bottomed during the second quarter of 2013 and will more closely follow typical seasonal trends on a go forward basis. Our expectation for 2014 is that the principal charge-off rate will stay in the 4.7% to 4.8% range.

To summarize, our growth strategy is working for Private Label. We're expanding our card holder base, driving [tender share through our 'no more sell more'] (ph) strategy using multiple channels and onboarding record number of new card programs. This three pronged approach promotes short-term growth but also lays the framework for long-term growth.

Before I leave this slide, it's really one more thing I'll focus on and that is the gross yields. The gross yield for the fourth quarter was down about 50 basis points. Most of that if not all of that is attributable to the onboarding of new programs. Again if we go back and look at the core file, programs we've had for more than three years, the gross yield is consistent year-over-year. So I think that's a very important consideration as you evaluate the change in yields.

Turning to – actually I want to address one more thing before I turn to liquidity and that is that I want to talk about confusion recently surrounding Private Label segment, An unusual thing happened this year and the fact that the call reports for our two banks were filed before we held this earnings call. Some people added the two call reports and thought the results represented the entire segment. It's not that simple.

The Private Label segment is comprised of three parts; one, our Utah bank; two, our Delaware bank; and three, our servicing division. The call reports do not include the servicing division while the overall Private label results do. Usually not a big difference but it was 2013 as we changed the process charge by the servicing division to the two banks to better reflect market pricing. The impact was about a [$60 million] (ph) improvement in profitability at the servicing division compared to 2012. So really it was a bit of a necessary drama.

Turning to liquidity, Company liquidity was very robust $3.8 billion at December 31, more than sufficient to execute our capital allocation plans for 2014. Breaking it down, corporate liquidity which reflects available drawn capacity and usable cash was $1.3 billion at year-end. Outstanding corporate debt at December 31 was $2.8 billion, essentially flat compared to 2012 but supported by a much stronger leverage ratio, meaning our EBITDA to debt ratio fell from 2.3 to 2.0 times.

Bank liquidity was $2.5 billion at year-end, outstanding borrowings at December 31 aggregated $7.4 billion and were comprised 40% of term asset-backed securities, 20% conduit, 35% CDs and 5% money market demand accounts. So it's very diversified funding. The average duration of the borrowings approximated 27 months with 74% turning at fixed rate.

For 2013, we used $231 million of our $400 million board authorization to buy 1.4 million shares. We were more active in the first half of 2013 than the second half of 2013 for an obvious reason, accretion. As the year progressed and our share price increased, our capital allocation prioritization shifted to M&A opportunities capable of providing superior accretion. We were successful and found BrandLoyalty. Entering 2014, we have a new $400 million authorization which will continue to be a key part of our strategy. The only question is whether it will be number one or two in terms of prioritization. Obviously the recent pullback in our stock price has opened up a very nice buying opportunity.

With that, I will turn it over to Ed.

Ed Heffernan

Great. Thanks Charles. I'm moving on to the 2013 wrap-up page and I'm glad Charles addressed some of the confusion around that call report stuff. We've been to that dance before and it's important that you look at all the pieces and obviously you seem them to get combined today in the financials. So sorry for the confusion, obviously things are in very good shape but you can always call the Company if you start hearing about a piece here or a piece there and Charles can put the puzzle together.

So that being said, on '13 wrap up, again what I focus on and what the Company focuses on primarily is organic growth. As we're seeing obviously the market results coming in across various companies, once again it looks like the top line from an organic growth perspective seems to be the one item that is struggling. And so here once again it looks like we had a bang up here as it comes to organic growth as compared to the follow-up in GDP growth rates over the past two years and likely going forward it becomes increasingly hard to grow above the nominal GDP growth rate.

From our perspective however, we would suggest that we can comfortably grow in the high single-digits which would put us at least 3x on nominal GDP, 4x on real GDP and we did so in '13 as well as in '12 and in '14 it looks like it's going to be a similar repeat. For us to be very clear, organic means that we take out or the pro forma any acquisitions, be it of a company or of a portfolio and we look at true organic growth rate.

So that was very strong for '13. Our model essentially is combining strong organic growth with modest M&A and that should drive mid-teens, adjusted cash flow growth and core EPS growth. While doing so, because the Company does have a lot of free cash flow, we've been able to maintain very modest net debt levels of around 2% – sorry, 2.0 or less and a result of this quite a bit of dry powder as we go into '14 and '15. Also I think we've done a number of things that I'll talk about in terms of shoring up visibility for '14 and beyond.

Before we hit that I think it is important that we go back and say what worked for us in '13 what didn't work for us in '13 and be very frank about you know the minuses as well as the plusses, and if you looked at LoyaltyOne, I would say three out of four was certainly positive. I would say the miles issued increasing 4% in '13 after being down 4% in the first half comes exact double-digit in the second half, very nice job for the folks at our AIR MILES program.

Again I know there was some scepticism early on in the year that we could make such a strong swing but it turns out that these folks did a wonderful job getting us there. Second, very strong year for new sponsors with Staples, Old Navy, Irving, Eastlink and Good morning, and again for a program that's been around for 20 plus years, adding big new sponsors certainly suggest that the future looks bright.

On the negative side, quite frankly the Canadian consumer is stretched and we're seeing it in the card spending nums and we're seeing it in the overall consumer spending numbers up there. Again, this is more related to the housing situation in the sense of the fact that Canadian households are allocating an increasing portion of their disposable income to servicing housing cost, which have continued to go up. They did not experience the type of hit that we had here in the States and as a result that's choking off some other spending that would otherwise flow into our program.

So again, we want to watch that. I don't think it's anything that's at crisis level but it's something that certainly we need to be cognisant of. Also the Canadian dollar has shown some weakness and continues to show some weakness and we need to watch that as we go into '14 as well.

Turning back to the positive side, the expansion of the program in Brazil came in better than expected. We now have 11 million folks wind up in the program, we launched another two relatively small markets in Q4 that was in the release yesterday, and with the renewal with Banco we're up for the races and we're going to continue to grow that thing more and more each year. Our goal is to get somewhere up to about 25 million collectors I think is a reasonable number.

At Epsilon, very strong organic growth, double-digit organic growth on top of hunting a 39% total revenue growth, and if you look at overall, we saw some margin expansion of 100 bps. Our strongest areas were strength in the auto vertical, financial services vertical, CPG and the retail verticals. Those were all very, very strong for us this year.

Again on the negative side, if you were to look at all the pieces of Epsilon what was disappointing, there's no question that our e-mail business was disappointing this year and hopefully with the launch of our new platform called Harmony, we will see that turn during the latter half of '14. So stay tuned on that one, that is probably job number one at Epsilon this year. On the good news side, the other piece is agency database and the other digital pieces were very, very strong and continue to benefit from the secular trends in the marketplace.

On Private Label, it was a boomer, no question about it. Average card receivables up $1.3 billion or 22%, and what's interesting as I mentioned before is if you look at consumer revolving debt, right, that hasn't budged for years and prior to that it was growing 7% a year before it tanked from a $1 trillion to $850 billion and then it's been essentially flat since then for many years. The industry maybe growing zero, maybe growing 1% or 2% if folks are lucky, pumping up 22% growth in that environment means something's working and we think our full-service approach is something that is unique to the marketplace and does continue to work.

Credit sales growth 22% versus nominal GDP, growth of 3%, again something seems to be working here and I would say we highlight of not only the year but of the holiday season which is so important to our retailers and Charles already mentioned is the fact that if you look at holiday spend in U.S. you know that's what number you choose, but it's about up 4%. Our retailers were up somewhere around 2.5% to 3%, so a little bit underneath that.

If you were to look at those retailers who've been with us for many years, so these are relatively mature Private Label clients, our growth rate against their 2.5% to 3% was actually 8% to 9%. So we grew three times the spend growth rate of those retailers, and if there was any doubt in prior years whether this mousetrap works, the answer I think was shown during the holiday season.

So it was the bright spot for many, many retailers in the sense that yes it does work that when you accept data and you weren't to understand the data and hence the customer, you then use that to do very, very focused targeted marketing offers through multichannel distribution that you know what you can drive that person online one extra time to make that purchase, you can drive that person into the store to make one more purchase.

And the ability to do so was never more evident than in this holiday season and I think that is behind the fact that we have had a huge number of new signings starting in '13 going into – I mean starting in '12 and then in '13 and the backlog quite frankly is even bigger in '14. So there is no question that this product that we're offering to the marketplace has hit the sweet spot of where the retailer wants to be.

On credit quality, Charles mentioned things look stable, we've flown around that 5% level where we were at in '12 we're at in '13 and we're going o be at 5% or under in '14. So no excitement at all when it comes to the – credit quality's picture looks very solid and we think that will continue through '14 and beyond.

Also probably the biggest thing in terms of looking forward was the fact that if you understand our business seeing an announcement of a new client is obviously great news but it doesn't do a thing for our bottom line in the first year. In fact it takes up to three years before that client moves up to the point where it's generating very nice revenue and earnings for us.

So in a sense every time you see an announcement you can think of that as a big investment for years three, four and five and the good news for us was the fact that as we talked about, this product seems to be selling like hot cakes and right now we're at the point where we did sign a $2 billion vintage, that means it will spool up to $2 billion in portfolio size during the 2013 year. To put it in perspective, that's 15 signings versus a typical four to five in any given year. So it's been quite a year in Private Label and we look forward to more of the same.

Let's go to '14 and talk about guidance. We've had a lot of questions over the last month or so about well, looks like '13 was a great run, '12 was a great run, '11 was a great run, '10 was a great run, can the train keep running into '14 and beyond? Having done this for an awful lot of years, I can certainly say at this point the answer is, yes. We are expecting another very strong year in 2014. We do have visibility very nicely through most of the year and we are right now investing heavily into building for '15, '16 and '17.

We have updated the guidance to reflect two things. First as Charles mentioned, we wanted to roll in the BrandLoyalty acquisition. That will add about $500 million because we take in 100% of the revenue even though we can only recognize 60% of the earnings. So pop in about $500 million in revs for BrandLoyalty over in Europe and that would add about $0.25 to core EPS putting us up about 19% or so for the year.

The softer Canadian dollar is going to hit us for about a nickel. So the net $500 million to top line and about $0.20 to core EPS, puts overall growth rate and earnings per share at about $12.20 which is about 22% growth rate versus this year, which isn't so bad. So again, very strong year, more of the same, probably not a lot of drama, just very nice solid growth going forward, mid-teens top line growth rate, high single-digit organic top line growth and over 20% core EPS growth rate.

Let's talk specifically about how the quarters are going to roll out because it's going to be different this year than the past couple of years and essentially you have a couple of big drivers. So Q1 will still come across and have very strong mid-teens top line growth. So right out of the gate, you should see strong top line growth. But our earnings will be held back and dampened down to the mid-single digit growth to reflect one big thing and that is the unique opportunity that we're seeing in Private Label.

What we're looking at right now is we're going to grow operating expenses in our Private Label group as much as 25% versus prior year which is a huge amount. We're doing that for one simple reason and that is we are building for '15, '16 and '17, and to put it in perspective, we normally bring on four to five new clients per year, in 2012 we brought on seven, in 2013 we brought on 15, and in 2014 we are going to bring up over 20 new clients on our platform. That requires ramping up expenses well ahead of the revenues.

We talked about revenues come down flow-through in the later years, not right up-front, and so we're going to go ahead and sit there and say, all right, this is the right thing to do and what does that mean, it means we added 800 people to the card group during '13, we're going to add over 1,000 to the card group in '14, most of them are already onboard and getting ready for the 20 plus new clients that we're bringing on.

So essentially the infrastructure, the people are all in place to ramp up these 20 plus new clients. That bodes extremely well for '15, '16 and '17 when the revenue pours in the door. At the same time however, it will dampen Q1 but it won't dampen the year. Business is absolutely booming. We believe we can continue to grow earnings 20% this year while at the same time really getting some nice visibility into '15, '16 and '17 for our card business, and also with our extension and expansion in Brazil and in Europe, we think we can set the table for having a very strong international footprint in future years as well. So it's a little bit of I think we can deliver some real nice nums for 2014 with high single-digit organic top line and 20% plus EPS while at the same time absorbing some huge investments for the big growth spurt that's coming down the road.

Turning to 2014 outlook, again more of what you heard us talk about forever, which is the marketing dollars continue to flow into the data-driven marketing and loyalty programs. I don't think that's news to anyone. We've been saying pretty much the same thing for about a dozen years and all we're seeing now is it looks like it's picking up which is obviously good news for us. You know the fact that our assets consist of data, consists of platforms, loyalty programs, analytics, digital distribution, we're kind of sitting right in the middle where a lot of these trends are converging and I think we're sitting in a good spot.

One thing I do want to say, because people ask sometimes about how we are different or how we compete with some of the other models that are out in the marketplace, my belief is that this is a huge and growing market and as a result there are going to be more than one model that will be successful. You could have a model that is pure software-as-a-service, you could have a model where it gets expertise in one piece of the puzzle which could be whether it's e-mail or data or something like that, or you could have the Alliance model where we are effectively an end-to-end solution, one-stop shopping all wrapped in a very, very solid 12,000 person services model.

I think all three will have a very good shot at being successful. I think if you're in one of those three, you need to be the biggest and the best and our job is to be the biggest and the best in this area that we've chosen. So again, I don't see it necessarily competing with other models. I think there are a number of large companies out there who want one-stop shopping with a lot of service attached to it and those are the folks we're going after.

Again to finish up, ADS is going to look to drive organic growth at two to three times that of the market and real GDP. Turning to 2014 outlook specifically, at LoyaltyOne AIR MILES, relatively flat revenue growth with low single digit adjusted EBITDA growth. Again, we're looking at some dampening by very soft Canadian dollar versus where it was in 2013. We think the economy in Canada from what we're seeing is a little bit weak vis-a-vis the U.S. and the consumer is stretched. And then finally, one of our verticals, pharmacy, there's a big unknown right now but there is recent legislation essentially questioning whether we can issue reward miles AIR MILES on the pharmacy sector, so stay tuned on that one. Again at the end of the day, we should have some decent issuance growth throughout 2014.

BrandLoyalty, the acquisition adds about $500 million and that should be up double-digit organically from where they were in 2013. Brazil, we're looking to add at least another 2 million members by the end of 2014 which would put membership up 20%. From a revenue perspective, I think the overall entity will do U.S. about 140 million, which is up about 50% versus where they ended this year. Again none of this is captured in our financials, so it's a very nice sort of off-balance sheet asset that's growing in value very quickly, and again we're very, very bullish on where this thing is heading.

At Epsilon, high single-digit organic revenue growth to continue. We look for a little bit of a kiss in terms of margin. Very strong 2013 signings and that can provide for good '14 visibility. And one of the things here is, for whatever reason it's kind of strange but it's really, really tough to get our clients that we signed to let us issue press releases when we're building or launching a big new loyalty platform. It's interesting to read about all the new programs that are out there in the newspapers and stayed on TV and actually go to some of these places but we are definitely not having much traction in getting our clients to let us sort of sing the praises of these new loyalty wins.

To give you a sense again about the trends that we're seeing out there, much like in Private Label, this stuff works and we had 23 wins in 2013 versus a normal rate of about 15. So normally it's pretty busy, '13 it was very, very busy. So you start in the numbers as database, went from a very soft back in Q3 of 2012 and we called it then the air pocket, and then it's finishing up high single-digit organic top line growth and based on the builds that we're looking at bodes very well for '14.

Finally, Private Label, very robust pipeline. We talked about historically we sign four to five clients, will bring on a few hundred million of growth in the portfolio when it matures after three years of seasoning. And then last year, or I'm sorry in '13 we signed $1 billion vintage, last year we signed on a $2 billion vintage, and based on the pipeline right now we are looking at signing another $2 billion vintage this year. So it is incredibly robust at this point in time.

The focus of the retailers is entirely on the ability of our closely-knit network to link the consumer with her purchases down to the category or SKU level. And again you saw it during the holiday sales lift where our card members were running at 4x, where the retailer was running at. So pretty exciting stuff and again double-digit organic revenue growth. As Charles mentioned, yields are holding up very, very nicely and the growth is there. There's just going to be an awful lot of upfront expense to get this puppy up and going as we move into the next few years but it's all good.

Principal loss rates, very similar to '13. The way the delinquencies are flowing and what we're seeing on the recovery side, I would just that first quarter is going to be slightly over 5% and the remainder of the year we feel pretty comfortable will be below 5%. So I think coming in at 5% over the last couple of years and 5% this year is pretty close and I think maybe we can do a little better than that.

Okay summing up, great '13, more of the same for '14, first making big investments in both the card business as well as in the international expansion in both Europe through BrandLoyalty and in Brazil. I think that's about it. At this point, why don't we turn it over to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Sanjay Sakhrani from KBW.

Sanjay Sakhrani - KBW

So a couple of questions. First just on Private Label, I appreciate the color around the yield, Charles, just as we move out to this year, you expect yields to remain relatively flattish relative to last year, is question one, and then secondly, what kind of receivables growth are you guys assuming in 2014?

Charles Horn

Couple of things there from a growth yield standpoint, combined has probably been about 40 basis points in '14 compared to '13. If you break that down, the core programs will be stable to maybe even slightly up. The onboarding of the 20 plus programs that Ed talked about will be what drives the little bit of decline in overall yields. In terms of growth, we're looking at least 15% growth in average receivables year-over-year. I think with the potential that we're seeing in the top line, that could be a very conservative number.

Sanjay Sakhrani - KBW

And then, as we look out into the future, when can we expect some operating leverage in Private Label, I'm understanding that you guys [aren't] (ph) investing this year, is it next year or is it later than that?

Ed Heffernan

It's by Q3 of '14.

Charles Horn

So essentially what you're seeing, Sanjay, is we're getting ready for the new volume, we're getting a new call center in Q1. When you put in [indiscernible] call center, you staff up immediately, so growth is going to b coming Q3, Q4 and going into next year. So by Q3 you should see some leverage.

Sanjay Sakhrani - KBW

Okay, great. And then just on the Loyalty division, when you guys discuss taking on the breakage rate, I guess what's really driving that, is it engagement, is it the economy, because I've heard like American Express talk about in a weaker economy people like to redeem more of their points. Is that what's happening there or is it just maturation or what?

Charles Horn

Clearly maturation is part of it I think. From my standpoint it's just another data point. Historically, we've always had an actuarial analysis that helps us determine what the rate should be. Now we have the benefit of with the expiry policy in place we can track the maturation of our miles driven five years old. So really what you have is just the ability now and have another data point that can influence where you want it to go.

Beyond that in some cases it could be a case like American Express who decided to let it move a little bit just as part of running the program. So again with all the moving pieces of loyalty program, you've got the ability to make money on the marketing upfront, on the servicing of the program, on the product redemption as well as breakage. You can make your money in different ways and maybe in case where you want to run the program slightly differently where that can influence that break rate going forward as well.

So my end of the line statement would be, one, you've got another data point here, and then two, based on the way you want to run the program can influence that to some degree.

Ed Heffernan

Yes, I would say that if you looked at where we put the stake in the ground years ago where we wanted this thing to be, we're pretty close and right now as we are getting closer to 2016 when some of these actually start expiring we want to be even more precise and so we have the outside folks run all these models and if we tweak breakage of point here or a point there, as Charles mentioned, there are other levers that we pull and we can maintain the margin going forward. So I think we're in good shape.

Sanjay Sakhrani - KBW

One final question again on operating leverage but this time in Epsilon, obviously you guys are getting some operating leverage in Epsilon but I assume there's still investments being made, so Harmony probably is one area, I mean as we look out to next year, should we expect that you might get more traction in terms of operating leverage because I'm sure there's room for more operating leverage there, right?

Ed Heffernan

Absolutely. We've given guidance of 40 basis points in '14, could be more in '15.

Sanjay Sakhrani - KBW

Okay, thank you.

Operator

Our next question comes from the line of Darrin Peller from Barclays.

Darrin Peller - Barclays Capital

Nice quarter. Just want to start off following quickly on the Private Label side, I mean here with the number of signings that you're expecting this year, first of all if you could maybe deconstruct it a little bit, I think you said about 19 or 20 for the year versus mid-teens last year, I mean how many of those should we be expecting to be portfolio acquisitions versus organic, real business wins? And then just a bigger picture question, if you can help size this opportunity, I mean you've talked in the past about the number of private label retailers out there that potentially meet your profile, but we're going through 14, 15 to 20 now, and it's a great run rate, just want to know how long it could last?

Ed Heffernan

So are we and I think that right now times are good. I think that the interest and especially once the numbers get out there about the holiday season and how effective the program has been, that will crank it up even more. And I think that from an overall perspective we're probably not going to move up of our sort of original number. If you were to look at a couple of new verticals like T&E that we've been into with you know the Virgin deal and Caesar's, that opens the market up a little bit but if you were to really slice it and dice it down to what's attractive to us, we think it's probably about a $30 billion receivable market that looks doable and you know if we can keep cranking along at a couple of billion a year in vintages, I think obviously that's a real long runway if we're looking at wherever we wound up this year, 10-ish or something like that. So we got about a third done and about two thirds to go of what we think is the real market.

In terms of how long it's going to last, I don't know. I thought that frankly '12 was the high watermark and then '13 doubled '12 and as we're looking at '14 it looks like another 2 billion vintages is there. And so it's already beginning to lineup for the following year. So we're kind of running out of slots quite frankly. So that's what Charles said is, our biggest issue now is executional risk which is why we spooled up 1,000 people for the beginning of this year for programs that aren't even going to be coming on till later on. So we're real careful about that.

From the 20 that we're talking about, I would say probably three quarters, now probably 80% of those will be starting programs from scratch and there may be a few portfolios in there but by far the vast majority of them will be organic growth.

Darrin Peller - Barclays Capital

That's great. And the one that are not, does that includes Coldwater Creek I guess and perhaps PayPal or PayPal is sort of new?

Ed Heffernan

PayPal was a start-up. They had no program but we started it up from scratch when they came over to us, and Coldwater would be, that's an acquired file, yes.

Darrin Peller - Barclays Capital

Got it. All right, that's helpful. Just a quick follow-up, with the AIR MILES issued number 12%, we felt that that was a pretty impressive number and just curious to know what we should expect. I know you gave some guidance but in terms of long-term run rate with the Canadian consumer being able to more stretched, I mean just give us some idea as to how that's actually being achieved and really what we should expect over the course of the year in terms of trajectory on AIR MILES issued?

Ed Heffernan

As we continue to learn every year, trying to look at it on a quarter by quarter basis can be very painful to derive a trend from that. So on an annual basis, what do we do, 4% miles issued, I think that's a good target going forward.

Darrin Peller - Barclays Capital

All right. And then just quickly on Loyalty task, obviously with [profitable result] (ph) now in renewals, that was one of the big questions you had around whether or not you perceived taking majority, so what are your updated thoughts on that? I mean is that something we're closer to doing now?

Ed Heffernan

It's certainly something that [indiscernible] at some point, we'd love to take another look at it. That's all we can say on it.

Darrin Peller - Barclays Capital

All right, guys. If I could just squeeze one last quick one on Epsilon and I'll turn it back to the queue, Epsilon obviously performed 14% organic growth from 16% the quarter before, you guys are calling for I think high single digit growth rates now, if anything agency continues to grow really well and you know almost [indiscernible] a call option to improve, so what would drive the deceleration I guess you can say albeit still good rate?

Ed Heffernan

I think we were little – we are going in '14 being cognizant of the fact that the digital agency piece went through the roof especially in the auto sector, and so the question is, is that repeatable in '14 or not, and so until we see that we can achieve that type of growth again, we've moderated our expectations on the agency side.

Darrin Peller - Barclays Capital

Okay, that's helpful. Thanks guys, good quarter.

Operator

Your next question comes from the line of Bob Napoli with William Blair.

Robert Napoli - William Blair

Question on the security, as your thoughts around security and the hackers are getting, continue to get more sophisticated every year and there have been suggestions that the Private Label, the retailer Private Label portfolios they might have more risk than the general purpose credit card market. I was just wondering what you're doing on the security side, what investments you're making there, if you've seen, if you've had any issues or have seen any issues, I mean obviously I think most of those would be announced for your retailers?

Ed Heffernan

Yes, I mean actually the Private Label card itself is probably much less attractive to a hacker than a general purpose credit card, right, because you are talking about a card with a $800 credit line that can only be used to buy a specific line of clothing or something like that. So it doesn't lend itself to the type of hacking activity that you'll find in the general purpose card environment with credit lines of around 5,000 and can be used anywhere. So I don't think that concerns us.

However, obviously you know we do have co-brand products, but I would say overall our focus on the security is not only on as I call it bubble wrapping the whole company but we have an awful lot of data, right, over in our Epsilon side that is equally valuable to outside folks. And so I would say our security efforts are two-fold, it's both focused on specifically the card business and securing those cards as well as the overall data within the entire ADS organization.

We spend some incredible amount of money every year and it is a bit of an arm-stretch, right, it's the more you build up, the more defences you put up, the more sophisticated the offense is. What we have figured out and we do talk with obviously a number of other large companies out there and share information about who's doing what and where, is that it continues to be less about firewalls and getting inside and more about this whole spear-fishing stuff, seems to be the area where folks are getting in. So a lot of that has to do with educating the employee base and we spend a lot of time on that as well.

Robert Napoli - William Blair

Thank you. A follow-up on the eBay relationship, I need more color you could give on how – I mean are you now issuing or taking some credit risk under the Bill Me Later program and how are you working with them on their Wallet and then update on that because it seems like it could be a very big program long-term, and I'm still little confused on how that's working and what other services you're providing?

Charles Horn

I think, Bob, the Bill Me Later program is going exactly as we expected. I think it's going to be a good program, [indiscernible] for us. We do take some credit risk, we keep a small undivided interest in the portfolio, again it's fairly small, that we will take credit risk on the profitability that's primarily driven by the upfront merchant fee. In terms of traditional marketing support, we don't have that same level yet but that could be an opportunity for us down the road to expand our relationship with eBay.

Robert Napoli - William Blair

Thanks and just last question, the Harmony, how is that rollout going and you've mentioned some customer losses, has that rollout stand the losses and the e-mail space and are you getting traction with clients with it yet?

Ed Heffernan

It's a little too early to tell. We think the future functionality of the platform has been very attractive to our prospects that we've shown it to. Quite frankly right now it's a question of getting it rolled out and people converted on it before we can actually say, yes, this is market competitive. I would say we're two quarters away from making that call.

Robert Napoli - William Blair

Okay. Thank you very much.

Operator

Your next question comes from the line of Dan Perlin from RBC Capital Markets.

Daniel Perlin - RBC Capital Markets

Just a couple of quick ones. So I heard you guys talk about margins on redemptions being higher, I was trying to understand what was driving that and why that would be sustainable?

Charles Horn

Again, we have unilateral control of the programs to specify what products we offer, how we price it and then what products we give. So it's actually quite easy to control, it could be a case where you just give a little bit cheaper products so you know what are your cost to your mile or it could be a case where you just make more miles to be used with an equivalent cost of the products to get more margin. So it's a very flexible way of dynamically running the program that we have unilateral control over.

Daniel Perlin - RBC Capital Markets

Okay, so it's just your mix that you guys have been playing with it in terms of the conversion ratios for that. Okay, the other thing is, I wanted to explore this recent legislation impacting the ability to have rewards programs for prescription drugs at the pharmacy, I know pharmacy is a very big vertical for you guys, can you maybe put a finer point on what that is and then if there's the guideline that we need to be aware of to monitor that?

Ed Heffernan

It's primarily in the provinces in the Western Canada and I guess the concern is that when someone picks up a prescription getting rewarded for that prescription for reason I guess some people are having some challenges with is that the right thing to do or not. To me frankly the idea of rewarding someone to keep making sure that they're taking their required medication is probably a good thing. But then again no one asked for my opinion. Bottom line of all of it is that it's a few provinces in Western Canada, it's probably a total of a couple hundred million miles out of over 5 billion. So it's under 5% of our issuance for sure, but it's something that we need to watch because if it rolls through, we need to make sure that we have some mitigant in terms of other issuance avenues to make up for that. So it's not a killer from that perspective, it's a few points for sure but it's under 5%, and it's kind of a wait and see this year and we'll keep you posted on it.

Charles Horn

Just to be clear, it's a big vertical for Epsilon but this is not [indiscernible] Epsilon at all. It's a purely isolated Canadian market.

Daniel Perlin - RBC Capital Markets

Okay. I wanted to ask, Ed, you mentioned an $800 credit line like average credit line, is that what you guys are at now? If it is, that's a pretty big bump-up from what I remember being in, and then if that's the case, how much of that is driving your [indiscernible]?

Ed Heffernan

Actually our 800 line has been fairly consistent. We've been around 750 to 800. You may be thinking our balances, balances are more right in the 4-ish, 400, 450 range.

Daniel Perlin - RBC Capital Markets

I was thinking line, so I was [indiscernible].

Ed Heffernan

It's not there something to scale that fast.

Charles Horn

Okay, co-brand lines were a little bit higher, Dan, but Private Label lines we've not really moved very much.

Ed Heffernan

You get open to buy there usually about 300, 400 and you get – the balances take up about 50%, 60% of [line] (ph).

Daniel Perlin - RBC Capital Markets

Got it. And then just one quick last one, I want to follow-up on what Sanjay was asking, so the 40 basis points decline in gross yields, that's a mix issue that you guys are seeing right now, it's not an issue with the profitability of 5the new programs long-term and so the message is that it's coming down but that's not necessarily say drumbeat coming down, you have to say I need to break on the programs, is that correct?

Ed Heffernan

Yes, as Charles mentioned, the core portfolio [indiscernible] incentives with us for three years and more, right. They've seasoned and so their yields are flat to last year. So they are solid. But any time that you slap on 2 billion of new business that's ramping up, right, you're going to have a pool-up time and that's what's going on.

Daniel Perlin - RBC Capital Markets

Okay, understood. Thank you.

Charles Horn

We'll take one last question.

Operator

The next question comes from the line of George Mihalos from Credit Suisse.

Georgios Mihalos - Credit Suisse

Congrats on the quarter. Just wanted to circle back on the Epsilon margins just to make sure I understand you're talking about that 40 basis points improvement in '14 versus '13 yet the ad agency business continues to grow at very strong healthy clicks, so am I thinking a bit wrong that the agency business should be diluted from the overall margin for Epsilon or is something else happening to help drive the margins higher next year?

Charles Horn

No, you're absolutely right, George. Over the last two years, if you look at '12 and '13, where we bought two agencies, it definitely had that impact. Now what happens over time is as percentage of the mix gets stabilized, it will start to drop a little bit as we cross-sell, up-sell into the higher value-added products. That's part of it. Now obviously as we can integrate multiply HMI, that gives you a little bit of benefit coming through on the leverage as well.

Ed Heffernan

Yes, but let's also be crystal clear here, this event was offered as a service, right. I mean this is not, here's a bunch of software, here's the platform, go have a ball. What we are focused on is a premium level service offering and you know we've been over 5,000 at Epsilon providing that level of service. So you are not going to get the type of leverage that you know you see with some of these other, here just have the product and walk away. We're specifically going after the very deep long-term commitment with a promise of premium level service and you're going to get some leverage, as Charles said, 50 basis point is probably a good number, but that's it.

Georgios Mihalos - Credit Suisse

Okay. And then just last question, you spoke a little bit about the potential for BrandLoyalty revenue synergies, I assume that's bringing that model to the U.S., can you provide any details on that, it sounds like it's not in your numbers for '14 but when might we start seeing that start to come through?

Ed Heffernan

It's a fair question. It actually goes both ways. So if you think of BrandLoyalty specialty are these shorter-term 12 to 20 week type loyalty programs, what we don't offer would be the longer-term large loyalty reward platforms that either Epsilon or the coalition program folks in Canada offer. So that would be something that we would be adding to their portfolio of products and at the same time let's keep on about it, we have not been able to penetrate the U.S. marketplace in the grocer segment, we just can't seem to solve the puzzle. We're doing pretty well in a lot of the other verticals but we can't solve the grocer. And perhaps these folks at BrandLoyalty have the secret sauce where maybe the grocers are focusing more on there's a lot of interest in the shorter-term, move the needle, right out of the gate type program that fits with their DNA better than these huge big loyalty builds that we've been focused on in the U.S. So if that's the secret sauce, we'll be thrilled to death, but it should – you're going to see it out of both sides.

Georgios Mihalos - Credit Suisse

Okay, great. Thanks guys.

Charles Horn

Thank you everyone.

Ed Heffernan

Okay, I think that's it. So I want to thank everyone for their – to put up with us and talk to everyone next quarter. Bye-bye.

Operator

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

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