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Blackhawk Network Holdings, Inc. (NASDAQ:HAWK)

Q1 2014 Earnings Conference Call

April 23, 2014 17:00 ET

Executives

Patrick Cronin - Vice President, Finance and Investor Relations

Bill Tauscher - Chairman and Chief Executive Officer

Talbott Roche - President

Jerry Ulrich - Chief Financial and Administrative Officer

Analysts

Ramsey El-Assal - Jefferies

Bryan Keane - Deutsche Bank

David Chu - Merrill Lynch

Mike Grondahl - Piper Jaffray

Gil Luria - Wedbush Securities

Tim Willi - Wells Fargo

Paul Condra - BMO

Operator

Welcome to the Blackhawk Network’s First Quarter 2014 Earnings Conference Call. For those on the audio on redialing, your lines have been placed on listen-only until the question-and-answer session. This call is being recorded. If you have any objections please disconnect at this time.

I would now like to turn the call over to Mr. Patrick Cronin, Blackhawk’s VP of Finance and Investor Relations. Please go ahead.

Patrick Cronin - Vice President, Finance and Investor Relations

Okay, well, thank you, operator, and good afternoon everyone. Before we jump in for your reference, a copy of the earnings release that accompanies this call to be accessed on our IR website at ir.blackhawknetwork.com. With me today to discuss Blackhawk’s first quarter 2014 earnings results is Bill Tauscher, our Chairman and Chief Executive Officer, Talbott Roche, our President and Jerry Ulrich, our Chief Financial and Administrative Officer.

Before I turn the call over to Bill, I’d like to remind you that management will make statements during this call that include forward-looking statements within the meaning of federal securities laws. Forward-looking statements contain information about future operating or financial performance and forward-looking statements are based on our current expectations and assumptions and involve risks and uncertainties that could cause actual results or events to be materially different from those anticipated. However, we undertake no obligation to update or revise any such statements as a result of new information, future events or otherwise. For a list and description of those risks and uncertainties please see our filings with the SEC.

And with that I’d like to turn the call over to Bill Tauscher.

Bill Tauscher - Chairman and Chief Executive Officer

Thank you, Patrick, and good afternoon everyone. The first several months of 2014 including – both represented a very exciting and busy time in Blackhawk. We delivered strong financial results during the first quarter which I’ll touch on in a moment. On March 28 we closed on our new credit facility to provide us growth capital as we completed the separation from Safeway.

During the first week of April Blackhawk’s executive team, the group on this call visited several major investment centers in the U.S. as part of a roadshow related to the Safeway spin-off. The purpose of the roadshow of course was to discuss the benefits of the spin and reinforce with investors, Blackhawk’s growth strategy and investment highlights. I know many listeners on today’s call participated in the roadshow and we hope you founded informative.

On April 14, Safeway completed the spin-off by distributing to Safeway shareholders the remaining 37.8 million shares of Blackhawk that they owned. We are now as of today a fully independent public company trading on NASDAQ under the ticker symbols HAWK and HAWKB with HAWKB representing the Class B shares Safeway distributive.

Turning to the Blackhawk business the first quarter of 2014 produced strong financial results. We delivered adjusted operating revenue growth of 29%, adjusted EBITDA growth of 36%, adjusted net income growth of 31% and adjusted diluted EPS growth of 25%, all in line with the guidance range we had provided on our roadshow webcast on April 1.

We do want to callout our Q1 results including approximately 800,000 of spin-related legal and accounting expenses which obviously had an effect. This incremental cost was not fully factored into our original guidance but we didn’t anticipate the full extent of the (upper) associated with negotiating an amendment to the tax sharing agreement between Blackhawk and Safeway including obtaining opinions to meet the fiduciary requirements of our Independent Board Conflicts Committee. This amendment was filed on Form 8-K on April 11. Now I’ll cover some additional details around our first quarter load value, revenue and earnings.

Load value grew 36% in total or 23% excluding load value from InteliSpend and Retailo which we acquired in late 2013. International load value represented 24% of worldwide load value in the first quarter and hit a high double-digit growth rate. I’ll talk more about international development shortly but it was a good start to 2014 and gives us comfort regarding our previous forecast of international load value growth in the high 50 plus percent range.

First quarter GAAP revenues totaled $233 million, an increase of 26% over the first quarter last year. Commission and fees which are driven primarily by closed-loop gift card sales increased 23% for the quarter. Program management interchange, marketing and other fee revenues or PIMO as we call it increased 46% primarily the result of the strong growth in U.S. open-loop gift cards and the addition of InteliSpend, the incentive and rewards business we acquired late last year. Finally revenues from product sales grew 19% with two-thirds of the growth coming from Cardpool and one-third from our card services business.

Adjusted operating revenues which are total revenues net of the share of commissions and fees paid to our distribution partners grew 29% for the quarter to $115 million. On a GAAP basis net income for the first quarter decreased $3.2 million from a 346,000 profit in Q1, 2013 to a loss of $2.8 million. This was mainly due to a $4.4 million of non-cash acquisition-related amortization expense in the 2014 period. Excluding all non-cash expenses for the quarter our adjusted net income increased from $2 million in Q1, 2013 to $2.6 million in Q1, 2014.

Further if we adjust for the spin-off related legal and accounting cost I mentioned earlier adjusted net income in Q1, 2014 was $3 million. GAAP diluted loss per share was $0.06 in Q1, 2014 compared to diluted earnings per share of $0.01 in Q1, 2013. Excluding the impact of non-cash items adjusted earnings per share was $0.05 in Q1, 2014 up 25% from $0.04 in the prior year. Of course as we frequently remind our investors our earnings are heavily weighted on the fourth quarter and the percentage change in year-over-year quarterly results early in the year can vary widely.

Next I’d like to highlight some of the underlying business developments for Q1, 2014. I’ll begin with international and then I’ll turn it over to Talbott to cover milestones in the U.S. including an update on digital. For international I’ll start with EMEA. Retailo which we acquired in November last year is continuing to execute on expanded content and distribution partner growth. Its load value grew 67% year-over-year in the first quarter. We currently expected to contribute nearly $20 million in adjusted operating revenues in 2014. Rewe and Edeka the top two grocers in Germany are planning to roll-out expanded programs including full gift card malls and best practices over the course of this year.

Google Play was launched in most of Europe in our program towards the end of last year. It’s already driving significant growth and is among the top 10 content providers that many of our larger European distribution partners including Tesco and Carrefour. Giftcloud, a Vodafone company launched what we believe to be the UK’s largest online digital content distribution program with 11 brands including Currys PC World PizzaExpress, Cineworld, Ernest Jones, and Moshi Monsters. Our UK digital content offering that offers a broad range of gifting categories.

Also of note in the UK one of our largest distribution partners is exploring the use of Fuel Rewards as an enhancement to their loyalty program and plans to apply at the gift cards. In our Americas outside the United States, in Canada we’re expanding distribution of our PayPower product from 500 stores that we ended last year to just under 3,000. On the digital side Rogers the leading wireless telecom carrier in Canada launched with Blackhawk digital services and gift card content in a suretap wallet it is just recently introduced. In the Southern regions of the Americas Google Play launched in Mexico and is about to launch in Brazil. We believe Google Play has the potential to be the top three content provider in both markets.

Finally, turning to the Asia-Pacific region our number two retail distribution partner in Australian Post has committed to move the best practices in 2014. In Japan load value growth exceeded 200% in Q1. We more than doubled our store count and added Google Play. As a reminder, this is one of the regions where we work with a distributor with minimal in county cost but also lower net revenues to load value ratios. We also launched Singapore in late Q1 with our Japanese distribution partner and express to reach other Southeast Asia countries through this same relationship during the reminder of 2014.

In South Korea Google committed to launch later this year because of the size of the Android market in South Korea, we expect this will drive our Korean operation to profitability by 2015. And finally in China we’re still negotiating a revised approach for commencing sales and provide status updates on this large challenging opportunity as it further develops.

Now I’ll turn it over to Talbott who will provide an update on the recent milestones in the U.S. Talbott?

Talbott Roche - President

Thanks, Bill. On the domestic distribution side in Q1 we successfully renewed contract with several leading regional grocers with commitments to expand its license and enhance best practices and in one case expand Fuel loyalty marketing of gift cards. By the end of 2014 we should have moved another 1,000 plus grocery locations to our best practices category and are still working towards one additional top 10 partner later in fuel loyalty rewards on to its gift card purchases. This strong open of gift card growth trends we experienced in 2013 continued into the first quarter of 2014 with load value growth in excess of 40% in U.S. Growth is being driven by several factors; successful marketing promotions in both physical retail and digital channels, the expansion of the availability of variable load cards and the addition of new distribution such as Home Depot.

For prepaid telecom we continue to experience double-digit growth in our top accounts where we have deployed upgraded displays. In addition we recently conducted a telecom product optimization review for a top 20 distribution partners to identify the best opportunities for further expansion in this category. We’re also preparing for the roll-out of new SIM card products during the second and third quarters which will allow consumers to quickly convert handsets they own to a cost savings prepaid plan.

Overall our financial services businesses continue to grow behind improved in-store merchandising and our partnership with T-Mobile. As reviewed on the roadshow we’re in the initial launch phase of a new T-Mobile Mobile Money product which is a private label GPR product and mobile app provided by Blackhawk Network. By the end of Q1 we had launched in 2,900 T-Mobile locations and begun the launch in over 1,500 Blackhawk Network locations.

We expect to see increasing sales in the coming quarters based on additional marketing and incentives to raise consumer awareness of this product. This quarter we released (in sentiments) to our Reloadit product with new features that will allow consumers to load funds to multiple general purchase reloadable cards, scheduled recurring loads of funds and pay multiple bills with the purchase of a single Reloadit Pack.

Turning to our new incentives and rewards business InteliSpend we’re pleased with our progress of integrating this late 2013 acquisition and in particular towards our goal of introducing closed-loop card content to InteliSpend’s product portfolio by the second half of 2014. We believe that combining Blackhawk’s closed-loop content with InteliSpend’s strong Visa MasterCard and Discover Solutions and the proprietary merchant directed cards we will be able to offer the broadest prepaid card solution for the incentives and rewards channel.

Now take a moment to provide an update on our digital business. We continue to execute our strategy of signing and launching new digital distribution and content partners in the U.S. and internationally. Over the past year we’ve signed 20 new digital distribution partnerships which are in various stages of implementation. And over the last year we also expanded our presence in our largest retailers and launched expanded content with a major retail kiosk operator. Finally we signed contract and we launched digital content with various players in the incentives and rewards marketplace and several of the leading mobile wallets.

Aside distribution we’re also continuing to add new content into our digital network. Today we have 230 individually branded eGift activating through our network. And we complement them with 100s of physical cards to meet consumer’s desire for both physical and digital products across the digital network. We’re working closely with our content partners and multiple third-party processors to certify new transactions to meet the full range of prepaid functionality being requested by our new digital distribution partners.

In our own proprietary GoWallet mobile and online application, we have now registered over 1.2 million users. And while we are pleased with this figure, our strategy remains to use GoWallet as a reference app to showcase the capabilities of our digital platform to larger third party digital distribution partners.

Finally in Q1, load value for our online and digital channels continued to grow at a triple digit pace and for the quarter represented over 2% of U.S. load value.

Now I will turn it over to Jerry.

Jerry Ulrich - Chief Financial and Administrative Officer

Alright. Thank you, Talbott. I am going to provide a little additional color here on our first quarter financials and then share some specific comments on the second and third quarters as we look forward to the rest of the year. And so first let me touch on our first quarter results. Load value totaled $2.2 billion, up 36% or 23% excluding the two acquisitions made in late 2013. In the U.S. load value growth was 24% or 15% if you exclude the results from InteliSpend. Gift cards and retail in the U.S. grew in the low teens in the Q1 with online and digital card sales growing at over 200%.

A couple of other drivers on the revenue lines, commissions and fees revenue increased by $34 million or 23% year-over-year, which was generally in line with the worldwide load value growth from closed loop products that primarily drive this line of revenue. As a percentage of total load value, commissions and fees was 8.1% in the first quarter, down about 90 basis points from the first quarter of last year. This was expected and the vast majority of this ratio decline was due to a higher rate of load value growth from the network branded open loop products, both retail gift cards, the financial services products and InteliSpend incentives and rewards products. All of which have a higher portion of their revenues under the PIMO line of revenue, that is the program management, interchange, marketing and other fee revenues lines.

Alright, so turning to PIMO, they increased 46% in the first quarter and if exclude the marketing revenues which are generally pass through and spend on the sales and marketing line, they increased 48% year-over-year. This increase was driven by strong sales of the Visa, MasterCard and American Express open loop gift cards as well as the addition of program interchange and card expiration fees on InteliSpend’s programs.

As Bill mentioned, product sales increased 19% with two-thirds of the increase coming from the Cardpool sales. So while Cardpool had double digit revenue growth, this rate was below our full year expectations due to a slower than anticipated roll out of some of our newer cards acquisition channels.

Okay, on the expense side, distribution partner commission expense increased $23 million or 24% year-over-year, which was in line with the growth in commissions and fee revenue. As a percentage of commissions and fees for the first quarter this line was 66.6% about 20 basis points higher than the first quarter last year and that was due to a higher mix of international load value, offset by the contribution from InteliSpend, which has lower partner commission expenses as a ratio of commissions and fees.

Turning to processing and services, this expense line increased $9 million or 30% in the first quarter and $5 million of that increase related to the two acquisitions InteliSpend and Retailo. It did represent a 20 basis points increase against adjusted operating revenues in 2014 versus 2013 mainly due to InteliSpend’s revenue recognition deferrals that we have mentioned earlier as compared to the normal spend levels for processing and services. Now excluding the acquisitions, year-over-year processing and services showed about 60 basis points of leverage against what we would call pro forma adjusted operating revenues, which is a measure that excludes the pass through marketing revenues as well as product sales from the revenue line.

Looking at sales and marketing expenses, they increased $10 million or 37% with $4.5 million of the increase coming from our two acquisitions. The remaining increase is from higher distribution partner program development expense and non-cash mark-to-market and warrant amortization expense. Sales and marketing excluding non-cash items as well as netting the pass through marketing revenue was essentially flat year-over-year as a percentage of pro forma adjusted operating revenues.

And then finally, general and administrative expenses grew $2.8 million or 24% in the first quarter. And they did include as Bill mentioned $775,000 of spin related expenses. Excluding these expenses, G&A grew 17% year-over-year. By looking at the income tax expense line, the effective tax rate on an adjusted pretax income basis for Q1 was 39.4% which was roughly equivalent to last year’s 39.3%. Capital expenditures for the quarter were 8.5%, an increase of 40% from the first quarter of last year with InteliSpend accounting for 1.1% of the year-over-year increase as they were completing the migration to a new processing platform.

So now I will turn to our guidance comments. So just as a reminder, many of you know this and have heard this both at our annual investor conference on February 20 and then reiterated on April 1 on our road show webcast. But we discussed both our preliminary first quarter results and we provided additional commentary on Q2. But from where things stand today, we will reiterate our full year 2014 financial guidance that we shared previously.

As a reminder, adjusted operating revenues will be in a range of $670 million to $690 million representing growth of 24% to 28%, adjusted EBITDA $137 million to $142 million or growth of 20% to 24% and adjusted net income in the range of $64 million to $67 million or growth between 11% and 16% with diluted adjusted earnings per share in the range of $1.19 to $1.24.

Now the lower growth, we have pointed out previously, the lower growth in adjusted EBITDA as compared to the adjusted operating revenue line reflects reduced near-term revenue contribution from InteliSpend because of deferred accounting of certain revenue elements. The expenses – amortization expenses from expanded retail displays that we have installed last year. Some increased program development expenses as well as the initial launch cost of the T-Mobile mobile money card this year.

Turning to the adjusted net income line that growth rate a bit lower than the EBITDA growth rate reflects an increase in interest expense, higher effective tax rate and a slightly higher rate of growth in depreciation expense. So regarding the lower near-term revenue for InteliSpend, we are working on a contract change with our issuing bank for certain of the InteliSpend Visa and MasterCard based programs that we believe would change the timing of the revenue recognition and allow us to recognize revenue more (instant) with when we provide the actual services to our InteliSpend corporate customers, as well as when the recipients of the incentives and rewards utilize the products as opposed to the deferred accounting methods currently required. In addition, we are working to mitigate the impact of higher state tax rates that we discussed at Investor Conference on February 20. And now expect our adjusted effective tax rate as applied to adjusted pretax income to be in the range of 39% rather than the 40 plus percent we indicated earlier.

I will me make a few comments about the second quarter specifically. So as Bill mentioned earlier, we are off to a great start in Q1 and while we are very pleased with our Q1 results, we do like to remind investors that the first three quarters of the year represent a small portion of our annual earnings and given the low earnings base in each of these quarters one-time items can impact, cause large fluctuations in a percentage change in year-over-year results. During our road show presentation three weeks ago, we mentioned several one-time headwinds that would affect the second quarter year-over-year comparisons. The largest is a $3.5 million amount of breakage revenue that we recorded in the second quarter of 2013 from Visa gift cards in our Asia-Pacific region that won’t repeat in the second quarter this year. So this is a timing issue around breakage of revenue or breakage revenue rather on those particular products.

We have also estimated $1.5 million of interest expense in Q2 of this year related to the new credit facility, which we deployed at the end of March essentially financing the acquisitions that we completed at the end of last year. We didn’t have any interest expense to speak of last year, so that’s a net headwind in the second quarter and I am providing this specific amount, so the analysts can update their models. In addition, net marketing expenses in the second quarter are in fact projected to increase by a couple of million dollars year-over-year, mainly related to growth in spending for our open loop gifts and online and digital products and channel efforts. Finally, the costs related to the launch of the T-Mobile mobile money product will hit the second and third quarter particularly. Combined these items will cause our second quarter 2014 adjusted net income line to decline by approximately $5 million to $6 million compared to the second quarter of last year.

Now again none of the items I mentioned are new and were all considered in the annual guidance that we previously provided. I did want to provide the specific guidance comments on the second quarter as the team’s several analysts have not fully reflected these items in their quarterly models. We have similar comments except for the breakage revenue that would apply to the third quarter so we would expect a more modest decline in third quarter adjusted net income versus last year.

Now having provided this detail, there are a couple of items worth mentioning that could affect results favorably and either the second or third quarter. First of all, an appellate court has ruled in our favor related to our appeal of a judgment in 2011 intellectual property litigation case. We had recorded a $3.5 million accrual in 2011 related this patent infringement matter and if our appeal stands, we would realize the benefit of approximately $3.5 million reversal of that accrual this year. However, the counterparty in this case has challenged the appellate court ruling, so this item remains uncertain at this juncture. The second item has to do with the InteliSpend deferred revenue accounting issue that I mentioned previously. So we are successful in modifying the contractual terms with our issuing bank. This would favorably affect the timing of revenue recognition over the course of the rest of this year. So as I said earlier, these items while individually small can swing the year-over-year quarterly growth results significantly.

So with that, I would like to turn it back to the operator to open up the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Ramsey El-Assal with Jefferies. Please proceed.

Ramsey El-Assal - Jefferies

Hi, guys. I had a question about the telecom business. How fully penetrated, would you say your existing – sort of your existing distribution footprint is with the telecom products. Is there a lot of I assume there is a lot of runway in the U.S. but in terms of the available sort of market, how much runway is there ahead of us?

Bill Tauscher

Talbott, why don’t you?

Talbott Roche

Sure. Well, we may have a telecom offering in most of our deployed retail outlets. It has not been optimized in the majority of locations. And what I mean by that is we have started with a fairly basic offering that did not originally incorporate prepaid handsets or even a complete offering of airtime cards in unlimited plans. And we have found that through the deployment of larger destination displays notably in three of our top four accounts we have been able to generate fairly significant increases in sales. So we see a lot of headroom in this space but it takes time to deploy these new bigger eye catching displays into the locations.

Ramsey El-Assal - Jefferies

As a certain follow-up the – does your – give the right demographic of customer and the kind of grocery channel where you are dominant to kind of drive growth with the prepaid telecom product, I am thinking of a more sort of under-banked, underserved financially consumer, is that a fair assessment of the users of these products and do you think you have the right sort of demographic mix in your distribution to kind of drive growth in the category?

Talbott Roche

I think that’s a fair question and I do think while we see a more mainstream customer in grocery as opposed to an underserved customer that we might see in more of our convenience locations where prepaid telecom does very well on a per store basis. We are seeing prepaid telecom coming more mainstream with the induction that more smartphones and better hardware and these value plans now appealing more broadly to the consumer base. So the grocers again that have deployed the destination displays have seen double digit increases in their telecom offerings. And so we think that this will continue to grow with the mainstream customer base. It is also doing well in convenience where we serve more underserved customers.

Ramsey El-Assal - Jefferies

Okay.

Bill Tauscher

I would just add to that, what’s really changing is not people embracing the old prepaid which was sort of buying minutes and clamshell throwaway phones and alike. What’s changing here is that the value proposition for a reasonably priced high end Android phone and then buying service on a monthly basis without a contract is very compelling. And of course that value proposition dominates the way Europe consumes its wireless telephony. We have been driven to a model in the U.S. that is different than that. With the higher priced phones being subsidized and contracts being prevalent. What’s really happening is the world – the U.S. is stooping away from that model making by the Talbott’s point correct that we are going more mainstream.

Ramsey El-Assal - Jefferies

Interesting. On the T-Mobile initial launch, so you have been out in the market, I know it’s probably early days, but do you have any preliminary read on uptake or performance there?

Talbott Roche

What we did at a beta in the back the fourth quarter of last year in a limited number of stores and achieved much higher sell through rate on a per location basis and the primary reason for that was its in assistant sales environment. And by having interaction with the T-Mobile sales representative it’s a more effective selling environment. So we were able to achieve sales rate much higher – multiple higher than what we see in our unassisted sales environment like groceries. Now that being said when we rolled to a broader number of stores, so we went from essentially less than 100 stores to now as I cited earlier over 2,500 locations and 2,900 in T-Mobile’s network, it takes us time to work back to a per store number more equivalent with we saw on the beta. Because you don’t get the uniform performance sales rep to sales rep until the contests have been deploying the incentive programs that we are putting into market. But it is multiples on a per store basis of what we see in an unassisted sales environment.

Bill Tauscher

If you look at prepaid GPR like programs, there has really only been two super successful programs, both driven on the backup, sales assisted marketing. And the reason for that again is what Talbott said, there is a huge differential on a per store basis between GPR sold when there is a sales assist – check cashier in the case of net spend who offers the card up instead of cash are partially instead of cash. And so our hope is and what we saw in the test stores is that we can replicate something like that with the T-Mobile experience.

Ramsey El-Assal - Jefferies

Okay. Last one from me, in terms of productivity, you mentioned last quarter and also at Analyst Day that you saw some decline in fuel messaging relative to the 2012 levels and that you expect that to be a sort of a more normalized comp this year. Has that decline in fuel messaging sort of stabilized, are you seeing an incremental – any incremental sort of de-emphasis regarding fuel messaging or is it sort of back to a more sort of steady state.

Talbott Roche

I would say that it’s to a steady state. And really what it was, was not revoking or eliminating those programs, but certain retailers deciding to post pricing messages alongside their loyalty, their fuel loyalty program. And they have entered more regular cables of their fuel marketing messaging now and so we would say it’s more regular.

Ramsey El-Assal - Jefferies

Great, that’s all from me. Thank you very much.

Operator

Your next question comes from the line of Bryan Keane with Deutsche Bank. Please proceed.

Bryan Keane - Deutsche Bank

Hi, guys. It’s Bryan. Just wanted to ask about load value I think it was 13% organic in the fourth quarter and obviously it pops on to 23% so maybe you can just give us an idea. I know there is seasonality involved here but just give us an idea of what drove some of that organic increase?

Bill Tauscher

Well, it was really a couple of things. First one is the one you mentioned we do tend to see us a little lesser organic growth value in the U.S. and particularly in the fourth quarter because the fuel programs are overwhelmed a bit by the whole gift giving. Having said that, the primary reason for it this year if you exclude the acquisitions and just look at organic is really the international numbers. International is simply becoming a bigger piece. If you go back even a year or so ago it was in the low-teens. We ended last year a little under-20%. This quarter it was 24% and of course, it’s growing organically much faster in load value than the U.S. is.

Jerry Ulrich

It will have a nice pickup in the U.S. too Bryan.

Bryan Keane - Deutsche Bank

Yes, yes, I saw that.

Bill Tauscher

And then frankly the question that was asked earlier we are now beginning to cycle a consistent fuel messaging, so the comps now are on sort of consumer trends of messaging and not only did we see a pickup and Jerry gave you some numbers in the first quarter. The first period of the second quarter we have seen a further pickup and really has reinforced our belief that as we comp to more stable fuel messaging levels, the natural increase of gift card growth in third party distribution comes forth in the U.S.

Bryan Keane - Deutsche Bank

Yes and just along those same line it looks like you came in for total load value at 36%, the guidance was for 38%, so I guess that says there will be further acceleration I guess what accounts for that. And then again the seasonality piece in the fourth quarter I assume this isn’t going to be a significant slowdown like it was in the fourth quarter last year in order to hit those goals?

Bill Tauscher

For these, if you look go through the year you have a couple of factors, again we have mentioned both of them. In the first quarter we still had pretty dramatic fuel messaging in 2013. It really began to turn down in the second quarter of 2014 and in fact if you sort of look at the relative numbers of load value growth last year you could see that quarter-by-quarter. So we will start comping and as I already mentioned the Q4 results for load value in the U.S. were quite a bit ahead of what they were for Q1. So that has reinforced our theory and our belief that as we move through the year and get into the constant messaging compared to last year, we think the numbers we provided for guidance are reasonable as a result of that. And then the second thing of course is that it’s just a formula as you continue to – as we continue to grow international organically at an accelerated pace to the U.S. not a new phenomenon one that’s been happening for a while, it hasn’t ever increasing weak factor.

Jerry Ulrich

I think the other factor on top of that is the T-Mobile ramp that we do expect. So we have mentioned that T-Mobile based on the financial services aspect of the business as you get more active accounts, you have more reloads in the financial services space the average transaction value is higher. So part of our big load value growth will also be the ramping of that financial services product this year.

Bryan Keane - Deutsche Bank

So will Q4 have a seasonal slowdown impact this year as well or it won’t happen this year?

Jerry Ulrich

I think if you look to at the typical pattern it may slowdown a bit versus the previous three quarters. But we also have some ramping items I described the T-Mobile one we would expect as Bill said we are accelerating in some new international territories, while we are just initially launching and then adding content like Google Play. So it’s possible that particularly those two channels would buck as typical trend.

Bryan Keane - Deutsche Bank

Okay, just last question from me on distribution I know we are talking about 2014 prospects big OfficeMax, Office Depot hold through its COSCO, so just any update there on those prospects? Thanks so much.

Bill Tauscher

Talbott do you want to…

Talbott Roche

Yes, we can’t comment definitively on OfficeMax, Office Depot. We are looking very good for piloting and with our (hold through) in ruling that out. And we can’t – we also I mean at this point with COSCO I think that we will be pursuing things overseas and outside the U.S. And but we can’t comment a bit in a way on that.

Bryan Keane - Deutsche Bank

Okay, thanks.

Operator

Your next question comes from the line of Sara Gubins, Merrill Lynch. Please proceed.

David Chu - Merrill Lynch

Hi, this is David Chu for Sara Gubins. So average load value per transaction was up significantly year-over-year, I mean, is this mainly being driven by the mix shift toward open new gifts?

Bill Tauscher

That’s a big factor. That’s correct.

David Chu - Merrill Lynch

So we should see the similar patterns throughout the year?

Bill Tauscher

Yes. I think we would be reasonably consistent throughout the year, because it is gift products and it’s been growing strongly. You will also see an uptick because of the T-Mobile factor financial services average transaction value higher as we go through the course of the year. Now offsetting that would be as international grows more rapidly, as digital media products might have a slightly lower average transaction value.

David Chu - Merrill Lynch

Got it. And my understanding is that you generate revenue for T-Mobile as T-Mobile as value is added to plans, so I know what you are thinking about load value, but what type of revenue generation are you thinking for 2014?

Jerry Ulrich

Yes. We haven’t commented long time at this point on the specific revenue contribution from T-Mobile. It obviously is a program where they would share the bulk of the economics. Our revenue really kicks in as the active cards become longer than life. So you have repeat usage over a longer period of time typical of all GPR type programs.

Bill Tauscher

If you look at the GPR business, it’s quite different than the gift business of course, even the open-loop gift business, because you not only have much larger portion of the revenue that comes out of our T-Mobile line when our commission and fee line. And of course we share that revenue with our partners including T-Mobile, but then you have your extended life of the card on the program that continues to generate various kinds of revenue items.

David Chu - Merrill Lynch

Okay, great. And just last question, so can you provide some color on the pipeline of new distribution partner stores for 2014?

Bill Tauscher

Well, it’s very different outside the U.S. than it is in the U.S. So the one thing that is the fact we haven’t run out any distribution opportunities in the U.S. If you sort of look at the overall market, there is probably 15% of retailers that would matter that don’t have gift card programs today. And there is over half the marketers that aren’t in our program. So if you exclude any switching which we haven’t had – which we have had very little of, there is a reasonable base of new store opportunities. Talbott mentioned Whole Foods, the whole emergence of high end grocery stores which are growing like mad in this country, almost without an exception or without gift card programs.

David Chu - Merrill Lynch

Have you expressed interest?

Bill Tauscher

Well, we are rolling out a program with Whole Foods. So they are past interest.

David Chu - Merrill Lynch

Okay, got it, got it. Okay, thank you very much.

Operator

Your next question comes from the line of Mike Grondahl with Piper Jaffray. Please proceed.

Mike Grondahl - Piper Jaffray

Yes. Could you talk a little bit about the load value in the U.S. for gift cards being in the low-teens, did that sort of meet your internal projections and where do you see sort of see that trending?

Jerry Ulrich

Yes, Mike. I think on the roadshow, we did comment that we are comfortable that the U.S. gift card business is going to be growing in low double-digits. And we think that combined with the other growth initiatives both international from financial services things obviously the acquisitions and in particular opening up the B2C channel with incentives and rewards will cause us to grow overall in the 20% plus range that we have talked about. So I think that is a growth rate that we believe is sustainable at this point from what we see. And so we are comfortable with that growth rate.

Bill Tauscher

If you look at the structural makeup of that growth rate, I think it’s important just to say there is two pieces to it, one of course is the continued fact that gift cards get to be a larger percentage every year of overall gifting. So if your retail markets growing 2% to 3% the gift card itself overall not just the third-party distribution that we enjoy but total gift cards have grown generally two plus times faster than that because of that move. And then the second thing that is just a fact, the gift card business is much bigger than our third-party distribution business and in fact still today there are more gift cards sold direct from retailers that issue them that are sold in our third-party distribution. But every year that percentage of third-party distribution versus the total or compared to gift cards sold direct by retailers our percent goes up, of course 12 years ago it was zero, we originated all of it.

And so what you got now is a still a lot of run room left for that shift and all our conversation and all our models that we build about best practices is essentially driving the consumer into an awareness that gift cards on a much more convenient basis can be brought in our third-party distribution and save them time and that’s proving to be a fact then the course as we do a better job and our distribution partners do a better job with best practices we grow that awareness faster. As far as new distribution we still have as we said already new distribution left but of course if you go outside the U.S. we have a completely different factor because we have so much new distribution left countries, content etcetera in addition to just new distribution partners we’ve also got a much less mature program than we have in the U.S.

Mike Grondahl - Piper Jaffray

Okay. And then maybe just a follow-up from a high level how should we think about margins maybe EBITDA margins related to U.S. load versus international load value?

Jerry Ulrich

Yes, Mike we don’t break it down per se, but in general international has been less profitable as we’ve been investing in growth of new countries and building new content and so forth. In fact in Europe for example as a region we’ve just turned the corner to profitability. The Americas of course, Canada is much more like the U.S. so those margins would be comparable, we service much of the Americas from the U.S. from an infrastructure standpoint. Asia-Pac is still not nearly at the profit level of the U.S. I think we still have development time and growth in that EBITDA, the margins if you will and some leverage as we continue to expand international volume and grow into that infrastructure.

Mike Grondahl - Piper Jaffray

Okay. Thank you.

Operator

Your next question comes from the line of Gil Luria with Wedbush Securities. Please proceed.

Gil Luria - Wedbush Securities

Yes, Gil Luria, close enough. First of all would you mind telling us what the first quarter revenue was from InteliSpend and Retailo?

Jerry Ulrich

Well Gil we can’t broke out what the load value was excluding the acquisitions and we’re not going to take it down to the revenue level.

Gil Luria - Wedbush Securities

And then in terms of your net cash went from almost from $550 million at the end of the fourth quarter to a value more rather than $500 million, what’s that attributed to and what’s that now that you’ve raised the additional bet?

Jerry Ulrich

Well I think it’s a seasonal business and we sell a whole lot of gift cards around the holiday time. So there is very typically a large buildup of cash at the end of every calendar year, so we take (pains) to explain that, Safeway has explained it for many years. So the first quarter of course you pretty much make those settlement payments related to the gift cards that you sold in the last couple of weeks of the December time period. So that accounts for the big cash change in the first quarter. You really look at on a trailing 12-month basis last year we generated free cash flow of about 45 plus million and we’d expect it to grow again this year.

We did take down the financing $175 million of term debt in absence that covers the acquisition that we made in late 2013. We initially borrowed the money for those acquisitions from Safeway. We repaid Safeway before our fiscal year end out of the operating cash flows that I described at year end. And then (indiscernible) from Safeway paid them off when we took down a credit facility. So that debt relates primarily to the acquisitions.

Gil Luria - Wedbush Securities

Got it. So the reduction in cash was the same as it was last year in terms of the seasonality?

Jerry Ulrich

Yes I mean typically there is some variance depending on the day of the week that the holiday falls and therefore how much you collected versus how much you paid out of the settlement, receivables and payables but this is a typical pattern each year.

Gil Luria - Wedbush Securities

Sure. And then in terms of your expectations for free cash flow for the year so that would be relatively comparable to adjusted net income?

Jerry Ulrich

Yes. One of the things that we didn’t mention but we did talk about certainly on the roadshow is that we will expect presuming that the Safeway and Albertsons merger completes later this year which a very high likelihood we will end up with a stepped up basis in our assets though that stepped up basis would be deductible as a tax deduction over a 15 year period. We’ve estimated the impact of about $30 million in cash tax savings on an annual basis that would not run through the P&L but in fact it would be demonstrated in kind of pro forma cash earnings if you will per share. So it’s a significant item on an annual basis not really reflected in our earnings and free cash flow numbers. We will move later this year as this field gets done to providing kind of a cash EPS figure and then a pro forma cash EPS figure including this tax deduction or tax benefit. And that will be more typical of companies in the payments business reporting on a cash EPS basis.

Bill Tauscher

And so to be clear that $30 million or so will add directly to your comment about what our free cash flow is because that free cash flow that Jerry quoted for last year and our expectations for this year are without that.

Gil Luria - Wedbush Securities

Got it. And then last question you talked about the fact that with a normal cadence of fuel promotions you expect continued growth but in your 10-K there is a disclosure that the business at Giant Eagle actually practically didn’t grow at all last year and that’s the business where I think you had the fuel promotions among the longest. What explains that lack of growth there and why would we not expect that to happen at the Kroger business once it matures and the Safeway business once that matures?

Talbott Roche

I think that there can be reasons for decline in the business and are unrelated to loyalty marketing and we can’t comment on the individual performance of each of the chains and narrow competitive issues that they’re facing in their markets that might affect traffic. But I think what we’re trying to comment on here is that so cadence of the promotional activity around and the messaging of the loyalty marketing program we don’t see abrupt changes in for the remainder of 2015 or 2014 rather.

Jerry Ulrich

I think Gil you did point out that Giant Eagle has flattened in terms of growth is disclosed in the 10-K. But they definitely had the longest running program, Talbott mentioned though that that’s not the only driver of the gift card business at any given retail chain. The other programs that have fuel loyalty are quite a bit less mature. We do think that there is room for growth and not only in the existing guys that have been doing fuel for a couple of years now but also in a couple of other chains. So (indiscernible) fact is dialing in today from the East Coast working on a regional chain that is looking to enhance their fuel program and we are continuing to say that we believe one or other top 10 provider or distribution partners will move to a full fuel program from a pilot program in the past year. So we think there is still room for the next several years to increase consumer awareness and drive behavior with these loyalty programs.

Bill Tauscher

I would say one thing it’s easy to look up. If you look up the Giant Eagle store count and Kroger store count and you look up the percentages disclosed that they are in our business, what you will discover is Giant Eagle is a huge outlier. So even if what you said under a worst case circumstance came true and Cougar began to mature at some point at giant eagle levels. That level would cause Cougar’s business to drive growth for us for a long, long time.

Gil Luria - Wedbush Securities

Got it. Thank you very much.

Operator

Your next question comes from the line of Tim Willi with Wells Fargo. Please proceed.

Tim Willi - Wells Fargo

Thank you. Good afternoon. I have two questions. The first one going back to Google Play any thoughts for data around whether or not that is cannibalizing any other content with the partners that you go there out. I know it’s early but just sort of curious anything around cannibalization of our content and sort of what portion of Google Play you think is truly net new opportunity?

Talbott Roche

I can (Technical Difficulty).

Bill Tauscher

I am sorry about the echo. I would add to Talbott’s comment. It’s behaving differently in different countries and we think it’s a combination of share of Android, because remember you can’t get iTunes on an Andriod phone and you can’t get Google Play on an iTunes phone. So its part of its share of market and part of it is the gaming factor. We are finding a correlation with companies who have big gaming populations and usage and finding Google Play to be stronger in terms of its initial marketplace reaction. But I think it’s too early for us to completely measure that there is obviously some additional factors going on in the Google Play like market where you have some other folks who have different models instead of charged by the drink, charged by the monthly service. And so there are number of factors going on there. And I think right now we are so early in the Google Play thing it will take us a couple of quarters maybe even a year to get our complete handle on whether it’s newness or is the measurement just an Android share measurement or is it game playing etcetera. But it is behaving very differently in different countries.

Tim Willi - Wells Fargo

Great, thank you. Again just a quick follow-up and I will hop off. In terms of M&A and digital just your thoughts around it seems like what you think digital scaling and we are positioning, are there things that you think you will have an opportunity to acquire or build over the next couple of years to really make sure you are well positioned to have that it was certainly you have realized where you are at now you got the basis covered?

Talbott Roche

(Technical Difficulty) evaluate opportunities for digital, but we don’t feel that our growth to digital is dependent on acquisitions. The nice things as we have very robust offering of content, which I think is critical for securing the distribution and delivering the sales through this new channel as it emerges. But we will continue to look I think again I just would have said we will do like if a requirement for success or growth in this space.

Bill Tauscher

I would add to that, two things. We have not had a habit of acquiring sort of digital technology or technology that would add to our digital efforts for lots of different reasons. Generally, frankly it’s been cheaper for us to build it than acquire it. We do spend probably the largest piece of any other things we do in our capital technology budget in the digital space. I think we feel pretty good about our offering today and the contracts we are signing and the rollouts that we are beginning to experience and the growth in the business while small, the huge growth we are getting in that business seems to indicate that, but conversely I don’t think we are going to stop looking at every possible thing and trying to keep up rest of that market nor are we going to stop spending money to continue to enhance our offering. We are going to stay focused in our knitting in terms of the space we are in and try to capitalize on this move that moves to digital. If you think about something that’s now 2% than growing triple-digits, right now, it looks like it’s incremental and it could become a very nice part of our story over the next year or two as it just stays at the same sort of pace. So, I think we are getting more excited about the space even though it has come slower than most all of us predicted. And we are excited about the position we have, but it doesn’t mean we won’t keep looking and it doesn’t mean we won’t keep investing, we will do both of those things, but we don’t view it as a requirement strategy that people feel.

Tim Willi - Wells Fargo

Great. That’s all I have. Thanks very much.

Operator

Your next question comes from the line of Paul Condra with BMO. Please proceed.

Paul Condra - BMO

Hi, guys. Thanks for taking my call. I just wanted to ask new one about PayPower card, I wanted to know if this was the first season that you are kind of doing the tax programs to give any updates on how that’s performing and how it impacted the business?

Bill Tauscher

On that Paul, this is the second year teamed up with a company called (TaxPact). We had a smaller program in 2012, but the figures this year are similar to last year. It’s a program that does provide a nice (indiscernible) to the PayPower product, although you don’t convert as many people through active account users long-term as you would obviously with our retail product. So, we think it’s a good program, but it’s one that we use obviously on an annual basis, but haven’t expected or planned to expand it further as we go forward.

Paul Condra - BMO

Okay. Yes, I was curious if maybe that skewed the average load value up a bit, but that doesn’t seem to have an impact?

Bill Tauscher

Well, in the first quarter relative, but compared to last year was a similar proportion of the total.

Paul Condra - BMO

Okay, great. And then may be if you can just give us an update on the Coinstar rollout?

Talbott Roche

Yes, that’s progressing. And just to be clear today we have already actually deployed Egypt into all of the Coinstar machines. So, I should say that part is complete.

Paul Condra - BMO

Coin sorting machines?

Talbott Roche

The coin sorting machines, correct. And we are grasping with the deployment of hundreds of coin – I am sorry, card exchange kiosks and that’s an ongoing effort throughout and we expect this would continue throughout 2014. So, that sounds just ongoing as new locations are established. And we are of course I’d like to move as quickly as possible, because we are seeing great results. Consumers seem to be responding very positively to the experience. And so on a per kiosk basis, we are very happy with the figures we are seeing, but we will have to partner with – work with our partner on the actual point of schedule.

Paul Condra - BMO

Okay, great. Thanks.

Operator

And no further questions in the queue at this time.

Bill Tauscher - Chairman and Chief Executive Officer

Okay, we want to thank everybody for participating today. And we look forward to the next call at the end of the second quarter.

Operator

Thank you for your time and that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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