Blackhawk Network Holdings (HAWK) Q2 2016 Results - Earnings Call Transcript

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Blackhawk Network Holdings, Inc. (NASDAQ:HAWK)

Q2 2016 Earnings Call

July 20, 2016 8:30 am ET

Executives

Patrick Cronin - Vice President-Finance & Investor Relations

Talbott Roche - Chief Executive Officer, President and Director

Jerry N. Ulrich - Chief Financial & Administrative Officer

William Y. Tauscher - Chairman, Head of International and Corporate Development

Analysts

Ramsey El-Assal - Jefferies LLC

James Schneider - Goldman Sachs & Co.

Sara Rebecca Gubins - Bank of America Merrill Lynch

Bryan C. Keane - Deutsche Bank Securities, Inc.

Ashwin Shirvaikar - Citigroup Global Markets, Inc. (Broker)

Timothy Wayne Willi - Wells Fargo Securities LLC

Paul Condra - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Gil B. Luria - Wedbush Securities, Inc.

Operator

Welcome to the Blackhawk Network's Second Quarter 2016 Earnings Conference Call. For those on the audio-only dial-in, 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 & Investor Relations

Okay. Thank you, operator, and good morning, everyone. Yesterday, we published our second quarter 2016 earnings results along with a supplemental slide presentation, which contains additional detail on Blackhawk's quarterly results, business highlights, and financial guidance for fiscal 2016. A copy of the presentation and earnings release can be accessed from our Investor Relations website at ir.blackhawknetwork.com.

Joining me this morning to discuss Blackhawk's second quarter results are Talbott Roche, our Chief Executive Officer and President; Jerry Ulrich, our Chief Financial and Administrative Officer; and Bill Tauscher, Chairman of the Board and Head of International.

Before we begin, we should spend a minute on forward-looking statements. I'd like to remind everyone that management will make statements during this call that are forward-looking within the meaning of federal securities laws. Forward-looking statements contain information about future operating or financial performance. 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.

Further, such forward-looking statements speak only as of the date of this presentation. 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 the Safe Harbor statement on slide two and the Risk Factors section in our filings with the SEC.

I'll now turn the call over to Talbott Roche.

Talbott Roche - Chief Executive Officer, President and Director

Thank you, Patrick, and good morning, everyone. Our Q2 adjusted operating revenues, or AOR, grew 10%. The EMV impact on U.S. Retail's AOR was slightly better than expected. Overall, total company AOR was in line with our internal forecast and consensus. Our bottom line results exceeded the high end of our guidance range provided during our April earnings call. Both our International and Incentive segment performed well. We also realized expense savings compared to our forecast and interest expense was somewhat lower than forecasted. Adjusted EBITDA, adjusted net income, and adjusted diluted EPS, each declined 14% versus the second quarter of 2015, primarily the result of the EMV headwinds.

On slide 4, in U.S. Retail, we experienced a full-quarter impact of measures taken by certain non-EMV compliant U.S. distribution partners to manage their liability for fraudulent purchases of gift cards with a credit card. The good news is that the EMV impact on U.S. Retail AOR and adjusted EBITDA during the second quarter was slightly favorable to our expectations. I will provide additional detail on the EMV outlook for the remainder of the year in a few minutes.

Also in our U.S. Retail segment, we executed a commercial agreement with NetSpend that outsources our program management role of our U.S. general purpose reloadable, or GPR business. The GPR business represents only 1% of Blackhawk's worldwide revenues, and as a program manager, has required a meaningful investment in regulatory compliance and risk infrastructure.

NetSpend's size and scale allows it to manage the GPR portfolio inside Blackhawk's network in a more cost-effective manner. We will continue to distribute the leading GPR solutions to our network and partner with NetSpend on white label solutions and key retailers while reducing and redirecting resources to the larger core businesses.

In our Incentives segment, adjusted operating revenues grew 70% including the acquisition of Achievers, GiftCards.com, and extrameasures. Achievers exceeded its forecast for the second consecutive quarter, and successfully signed the Meijer chain to its employee recognition platform, representing our first U.S. retail cross-sell customer. Incentives e-commerce integration remains on track and its TDV growth is running ahead of forecast.

International AOR growth of 17% was driven by solid performance in Europe, including strong product sales from newly acquired DIDIX. The AsiaPac region also performed well during the quarter. Across all our digital, online, and mobile distribution channels in the Retail and Incentives segments, transaction dollar volume totaled $237 million, up 117% year-over-year. Year-to-date, products delivered digitally represents 8% of global gift card sales.

Now, turning to slide 5 and the segment results. The 8% year-over-year decline in U.S. Retail transaction dollar volume was driven by three factors. First and single largest factor was the EMV impact on open loop gift TDV, which declined year-over-year. Second, as mentioned during our Q1 call, financial services TDV growth was reduced by the termination of two low-margin programs in our general purpose reloadable business. The T-Mobile private label program was discontinued during the quarter as was the program to link tax refunds to our PayPower GPR cards.

Third, U.S. closed and open gift card transaction dollar volume reflected the shift of Easter into Q1 of 2016, compared to Easter falling in the first week of Q2 in 2015. The lower volumes due to EMV restrictive measures and a year-over-year decline in Cardpool purchase volume in the kiosk procurement channel resulted in decreases in U.S. Retail revenues and EBITDA.

International AOR grew 17% driven by strong performance of DIDIX in Europe and growth in AsiaPac. The FX impact to AOR and adjusted EBITDA during the quarter was negligible.

The Incentives segment showed strong AOR and adjusted EBITDA growth, driven by the addition of Achievers, GiftCards.com B2B business, and extrameasures. Further, the early transition of open loop gift product sold at GiftCards.com to our primary issuing bank brought revenue recognition in line with our existing open loop products, contributing to the favorable results for the quarter.

Corporate and unallocated expense growth of 12% was driven primarily by increased technology, compliance, and acquisition support cost.

Now moving to slide 6. We provided an update on the EMV-related impact to our U.S. gift card business. We continue to dialog regularly with our non-EMV-compliant distribution partners to understand when they will become EMV-compliant. On the balance, our partners are achieving their forecasted compliance dates, which factor in hardware and software upgrades, internal testing, and third-party certification. Of our top 25 accounts, 14 are now compliant versus eight a quarter ago, three are partially compliant, and eight are tracking toward their compliance date versus four prior. Since our last call, two moved up their dates and two have moved back their date.

Our updated forecast assumes no further delays from the currently communicated schedules. Based on the information currently being provided by our partners, we are estimating that stores representing a vast majority of open loop gift TDV will become EMV-compliant by the end of September. Some store compliance will fall into October. Importantly, our estimates do allow for a sales ramp period following compliance and we are currently forecasting the full-year 2016 EMV impact will be $47 million on AOR versus $51 million prior, and $40 million on adjusted EBITDA versus $44 million prior.

While EMV-related headwinds are significant, we continue to believe this issue is limited to 2016. Both our internal consumer research and third-party research conducted by the National Retail Federation indicate the popularity of gift cards remains high for retail consumers.

Moving to slide 7. For the balance of the year and moving into 2017, our number one goal in U.S. Retail is to energize the rebound in TDV at our top distribution partners post EMV. We are coordinating merchandising to restore open loop inventory levels to pre-EMV levels. We are working with our partners to implement marketing programs designed to raise consumer awareness and drive sales growth post EMV. In U.S. Retail, we're also rolling out new category cards and Visa 5% cash back products in each of our top 10 distribution partners. Finally, plans for expansion of Cardpool, our card exchange business, have been pushed to the back half of 2016, benefiting 2017.

In Incentives, Achievers momentum has continued to build and the perspective client pipeline grew 20% over the first quarter. extrameasures performed well during its second quarter and is expected to deliver solid growth from new programs launching in the second half. GiftCards.com's B2B incentive business has been exceeding expectations so far in 2016 and the integration with CardLab establishes us as a leader in the e-commerce channel for prepaid incentive products.

Internationally, during the second-half of 2016, we plan to launch both Achievers employee engagement solutions and Incentives e-commerce in each of the international regions.

Finally, the acquisition opportunities in Incentives remains robust. In International, we are working opportunities to expand digital distribution partner relationships in all regions. DIDIX products and similar high-margin content are being added into distribution in the European, Canadian, and Australian markets. We're also seeing growth in the AsiaPac region, driven by new contents, continued momentum in Japan, and new growth in South Korea.

And finally, across digital channels, we continue to sign up new digital distribution partners, and grow our egift catalog. We're adding more promotional capabilities to our e-commerce platforms and expanding our newly acquired NimbleCommerce capabilities for offers and egift services. These digital channels have become meaningful contributors to our Retail and Incentives business in the U.S. with overall triple-digit growth rates.

And with that, I'll turn it over to Jerry to cover our 2016 guidance and other key financial metrics.

Jerry N. Ulrich - Chief Financial & Administrative Officer

Okay. Thank you, Talbott. First thing I'm going do on slide 8 is discuss the revision we'll be making to certain non-GAAP measures beginning with the third quarter. From there, I'll provide additional detail both on the third quarter guidance and full-year guidance. And then finally, we'll give some of the revenue and expense ratios.

So, on slide 8, beginning in the third quarter of 2016 and in response to the SEC's Compliance and Disclosure Interpretations published on May 17 pertaining to non-GAAP financial measures, the company will revise its presentation of two of those non-GAAP financial measures we've used in the past, adjusted net income and adjusted diluted earnings per share. The reduction in income taxes payable previously include in the determination of adjusted net income will no longer be included, but will be provided separately, including the per share amount of the reductions.

Table 2 of our earnings release displays the current presentation of adjusted net income and adjusted EPS consistent with the previous method, while table 3 presents the revised calculation of adjusted net income and adjusted diluted earnings per share and then separately displays the reduction in income taxes payable based on the new presentation. Also, a revised presentation of all of our historical periods from fiscal 2013 forward are available now on the company's Investor Relations website at ir.blackhawknetwork.com.

All right. So, turning to slide 9, third quarter guidance. As a reminder, the third quarter is seasonally lower from a TDV standpoint. While we expect the dollar impact of EMV in the third quarter will be slightly less than the second quarter, we continue to forecast year-over-year declines in most of our key financial metrics because of the continued impact on U.S. Retail revenues.

A couple of our largest non-EMV-compliant distribution partners are still not scheduled to become compliant, until approximately the end of the third quarter. And our guidance in revenues and earnings ranges reflect this. The guidance is slightly lower than the current consensus, but we believe this is really just an allocation between the third and fourth quarter as you'll see on the annual guidance in a moment.

We did disclose the EMV impact for the second quarter and, on the next slide, for the full year and so, moving to this update full-year guidance on slide 10, the estimates do not assume an immediate rebound in sales, following our distribution partners EMV compliance as we believe it will take some time for the consumer behavior and sales volumes to improve. Second quarter EMV headwinds were slightly better than originally forecasted, as Talbott mentioned; however, we remain cautious in forecasting how quickly sales will rebound after most the partners are compliant late third quarter.

As a result, we're raising full-year guidance to reflect the favorable portion of our second quarter results that is permanent. Specifically, we're adding a slightly better than forecast EMV impact but not adding the early transition of open loop sales on GiftCards.com that transition to our issuing bank, as that latter change was already included in our full-year forecast previously. So, essentially, we're not increasing guidance for the second half of 2016, as compared to our prior guidance mainly due to the uncertainty of EMV impact on U.S. Retail.

Now, both our Incentive and International segments remain on track to deliver results in line with what we expected when we provided full-year guidance in April. And in summary, the estimated EMV impact is slightly less than before, as shown at the bottom of the page, but continues to be a drag on results for 2016.

We are showing the pro-forma figures, if we excluded the estimated EMV impacts, adjusted operating revenues would grow in a 15% to 21% range, excluding the impact of EMV, with adjusted EBITDA, 24% to 33%; and adjusted net income 21% to 34%.

Finally, for your modeling purposes, our full-year growth estimates for adjusted operating revenues are flat to slightly down for U.S. Retail, 45% to 50% growth for the Incentive segment, and growth in the low 20% range for International.

All right. Turning to slide 11, a couple of comments on cash flow and debt. Our free cash flow projection for the year is in the range of $100 million to $110 million. Our CapEx target remains in the mid-$50 million range, which would represent about 5.5% of adjusted operating revenues, excluding the impact of EMV this year, that's down from 6.1% in 2015. We ended the second quarter with a debt to adjusted EBITDA leverage ratio of 2.60%. And as of July 15, our total debt outstanding was $526 million.

Okay. Turning to the adjusted free cash flow slide number 12. It shows the cash flow reconciled to adjusted EBITDA and in comparison to the trailing 12-month period of 2015, adjusted EBITDA growth net of a non-cash purchase price accounting adjustment is muted due to the U.S. Retail headwinds.

Cash taxes are favorable year-over-year due to timing of payments and refunds, but that's offset by an increase in working capital due to the timing of some payments related to our issuing bank amendments and also a smaller increase from settlement timing as growth in U.S. Retail TDV was lower in the last 12-month period related to the EMV impacts.

All right. On slide 13, we give our usual revenue ratios and, again, looking at these ratios for the second quarter, prepaid and processing revenues as a percentage of transaction dollar volume increased 60 basis points year-over-year and that was really due to a lower proportion of open loop gift sales in U.S. Retail. And again, the result of EMV, as well as the higher proportion of incentives on the overall business.

Partner distribution expense increased 70 basis points in the second quarter of 2016 compared to the prior year due to the EMV impact on open loop, again, and the mix of U.S. Retail distribution partners. For the full year of 2016, we expect partner distribution expense as a percentage of prepaid processing revenues to increase 50 basis points based on overall mix within Retail, as well as between the Incentives and Retail segments.

The adjusted operating revenue ratio, similar to PPR, improved year-over-year due to the higher proportion of incentive volume, which has a higher revenue yield as compared to our Retail segments. And for the full year, we expect this ratio to come down, primarily due to the increased weighting of U.S. Retail and International retail sales volume in the fourth quarter, again, related to the holiday impact in the fourth quarter.

All right. Turning to slide 14 and expense ratios. Again, the full quarter impact of the lost revenue due to EMVs as well as the acquisition of Achievers, which as mentioned before, is growing into our margin model over the course of the first couple years following the acquisition, caused them to lose some expense leverage in each of the key expense line items during the second quarter. But again, because we gained leverage in the fourth quarter, given the seasonal spike, full year expense ratios are lower than each of the first three quarters of the year.

And without the impact of EMV, we would gain about 200 basis points or we estimate that we've gained about 200 basis points of expense leverage and EBITDA margin in fiscal 2016 as compared to 2015. We have taken some temporary cost containment measures in 2016, so not all of that 200 basis points of leverage would be permanent going forward.

And wrapping up, looking at slide 15, the product margins in product sales include Cardpool, telecom handset sales, ancillary card printing and processing businesses, and product sales at Achievers. For the second quarter of 2016, the year-over-year growth in product sales and margin improvement was driven by the addition of Achievers into this mix.

All right. The appendix includes reconciliations of GAAP to non-GAAP financial measures. You will note that this does not include two of the loss we've been providing previously to break out acquisitions from organic growth. Essentially, as we moved from acquiring completely new areas of business a couple of years ago with InteliSpend and Parago, which formed the foundation for the Incentives business segment to now buying companies more recently that are extensions of either the Incentives foundation businesses or our Retail business, the ability to segregate those results is more difficult.

For example, GiftCards.com has been quickly integrated and we're optimizing e-commerce traffic between our CardLab, GiftCardMall.com, and the GiftCards.com website. So, measuring the impact of GiftCards.com separately on a stand-alone basis is really not practical.

We've also been shifting smaller accounts from InteliSpend to CardLab site and now the GiftCards.com OmniCard.com site for Incentives. Extrameasures also is directly aligned with our Parago business and with the elimination of overlapping costs and quickly working on revenue synergies, it again makes separation of these results difficult.

DIDIX content has been quickly rolled out in our UK distribution channel, but we also have similar content based on our partnership and investment in another category provider. So, we concluded this quarter that the feasibility of this breakout attributing specific results to acquisitions was not feasible.

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

Question-and-Answer Session

Operator

Our first question comes from the line of Ramsey El-Assal from Jefferies. Your line is open.

Ramsey El-Assal - Jefferies LLC

Hi, guys. It looks to me like the guidance, especially the third quarter guidance, is now kind of implying a fairly steep ramp on the revenue, EBITDA, and earnings line in the fourth quarter. I mean, I understand you've got EMV coming back online. Can you walk us through your assumptions, drivers, confidence level around the business kind of accelerating in the fourth quarter to get to your full-year number?

Talbott Roche - Chief Executive Officer, President and Director

Yeah. So, look, the reason that we – the timing in the back half is, as we laid it out, Jerry mentioned in his speaking points that we have some of our larger partners that are non-EMV-compliant today, achieving compliance in late September. So, that's in large part contributing to that steep ramp. We're also allowing for a lot of the steps that need to be taken, and we're in process with many of our chains right now that have recently become compliant to re-merchandise card stock and deploy marketing programs to drive consumer awareness, track it fast to the racks to show consumers that the full selection is there.

We obviously also in the fourth quarter plan a fair amount of marketing activity, and so some of that will drive that steeper ramp and it's been built into our forecast. It is a fourth quarter seasonal business and some of the slopes are exaggerated now coming from non-EMV compliant retail into a state of EMV compliance and full selection of product.

Jerry N. Ulrich - Chief Financial & Administrative Officer

Yeah. I think, just to add to that, again, the seasonality has got a big impact. U.S. Retail really drives profitability in that fourth quarter. We probably didn't pay enough attention to some of the consensus guidance towards the estimates in the third quarter, so there was probably a little bit of a mismatch between third and fourth quarter at consensus. But in any case, we feel confident. There's lots of marketing programs queued up for the holiday period. We also tend to see a bit of an increase in the fourth quarter related to the Incentives business as well. So, we think that the rebound should appear in those fourth quarter results.

Ramsey El-Assal - Jefferies LLC

Okay. Does Whole Foods or Office Depot or any of the new wins – is there any incremental contribution flowing into Q4 that maybe is a fresh insight?

Jerry N. Ulrich - Chief Financial & Administrative Officer

Not really anything different from what we had before. Whole Foods is also going through their EMV compliance, so that roll out has actually been delayed a bit with timing of their compliance. So...

Talbott Roche - Chief Executive Officer, President and Director

Yeah...

Jerry N. Ulrich - Chief Financial & Administrative Officer

...nothing is significant from those two chains that's different than what we assumed before.

Talbott Roche - Chief Executive Officer, President and Director

The Whole Foods roll out did delay a bit because of the EMV work they were doing from what we had originally forecasted, but the schedule now is for them to be complete within the third quarter.

Ramsey El-Assal - Jefferies LLC

Okay. And now that you've had a little bit more of historical experience bringing cards, granted it's still limited, bringing the open loop product back online at retailers who are sort of freshly compliant. I mean, can you comment on that ramp? Is it slower than your expected, do you think there are any revenues that won't come back related to open loop, because they were tied to purchases, kind of gift card purchases or – can you give us a little more color around that process and that trajectory?

Talbott Roche - Chief Executive Officer, President and Director

Yeah. I think as we mentioned, we did have more of our partners become compliant, but it's really only recently, and so we're talking about a few weeks of data in a few accounts. It's a multi-step process for us to achieve the recovery of the volume, and I think I mentioned some of these, but the first step is the merchandizing and returning all the cards to the rack, which is a process we're going through right now.

The second is having marketing in place and deployed with various touch points, both in the store and out of the store to make sure consumers know the complete selection is back, drive the awareness and the traffic back to the rack. The third is, we're also working with our retail partners on ensuring that checkers are trained or retrained to know that all the cards are there and not repress sales of products, which some of them had been doing in a pre-EMV-compliant environment.

So, it's really premature for us to talk about exact time to recovery of that TDV and it also varies fairly significantly by changes because the chains weren't uniform in their reaction to a non-EMV-compliant state. They took varying measures. So, we're really in the process now completely stocking out or restocking those racks in those chains that have become recently compliant. So it's too early for us to talk about complete timelines to recovery.

Ramsey El-Assal - Jefferies LLC

Okay. That's fair. Thanks for your comments. I appreciate it.

Operator

Thank you. Our next question comes from the line of Jim Schneider from Goldman Sachs. Your line is open.

James Schneider - Goldman Sachs & Co.

Good morning. Thanks for taking my question. I was wondering if we could just maybe focus on the 2016 guidance a little bit. If I'm not mistaken, I think relative to the guidance you provided last quarter for adjusted operating revenue, the new guidance is down about 4% at the midpoint on revenue and, obviously, you're talking about EMV being less of an impact than you had forecast previously. So, I'm just trying to understand what's driving that downtick in the AOR revenue guidance, if it's not that?

Jerry N. Ulrich - Chief Financial & Administrative Officer

Yeah, Jim, it's really the Cardpool. So, Talbott had a few comments about some slowdown in the Cardpool revenue base related to one of our acquisition partners. So, generally, in that business, we turn the cards very quickly as we acquire them, so it's paid by the acquisition of cards. And so, one of our partners that contributes a significant portion has done some fine-tuning and slowed the roll-out of some kiosks.

So, I think Talbott mentioned that we're going to get that back on track we believe later in the second half but it won't really impact revenues until we get into 2017. So, we've essentially had to pull back the top line, doesn't really affect the EBITDA line much, because of the low margin nature of that business.

James Schneider - Goldman Sachs & Co.

So, it's entirely due to that effect?

Jerry N. Ulrich - Chief Financial & Administrative Officer

Pretty much. Yeah.

James Schneider - Goldman Sachs & Co.

Okay. And then, I guess, just regarding the International business, can you maybe talk about kind of the dynamics in that business this quarter versus last quarter, because I think, the business was 33% growth in AOR last quarter and that fell to 17% this quarter. Was that anything in terms of more difficult comps going into Q2, and can you maybe talk about the trends in Europe ex-DIDIX and what's going on there?

William Y. Tauscher - Chairman, Head of International and Corporate Development

Yeah. This is Bill Tauscher. Jim, two things. I don't think we'd read anything big into the difference in AOR growth. Some of it has to do – we certainly had growth around the world, and of course, as you heard, the FX was not a big impact, and we are getting some swings in certain parts of the country in FX but offset by others. So, I don't know that it's a comp or – and certainly no material slow down. We're probably as bullish on International's overall growth characteristics as we ever have been.

The second thing I would comment on in Europe if you carve out the DIDIX piece which is a little bit hard, because of course DIDIX is now entering all of our Retail distribution which was part of the plan across Europe, and we introduced DIDIX into the UK where it wasn't before. But there is a bit of change going on to the positive in Europe itself.

Outside of Germany, a number of the grocery chains, if you follow that industry at all, had really been going through some tough times. Literally every CEO of the grocery business across Europe had lost their jobs over the last couple of years because of sales difficulties. That's begun to turn around with repositioning those chains, Tesco and others, and we're beginning to see some positive moves both in terms of content and then moving forward with the programmers the new management teams are settling in. So, what has been a bit of a difficulty for us a year or so ago has now got some good prospects and beginning to pick up.

Jerry N. Ulrich - Chief Financial & Administrative Officer

Yeah. Jim, I might just add that the AsiaPac and we've talked before about Japan is kind of a high volume business that's got some variability. So, year-over-year from an AOR growth standpoint, the revenue growth was a little less coming out of that geography, but from a profit standpoint, not much impact. So, the EBITDA growth, very nice, even though the adjusted revenue growth was 17%.

William Y. Tauscher - Chairman, Head of International and Corporate Development

Yeah. Another part. Japan, of course, converts at a much lower rate than the rest of the world because of our arrangement there, but – and the group there wasn't quite as robust, which overall means the growth that elsewhere was in line and healthy compared to previous quarters and years.

James Schneider - Goldman Sachs & Co.

Great. Thank you very much.

Operator

Thank you. Our next question comes from the line of Sara Gubins from Bank of America. Your line is open.

Sara Rebecca Gubins - Bank of America Merrill Lynch

Hi. Thank you. Good morning. What level of TDV growth is embedded in the guidance for the year?

Jerry N. Ulrich - Chief Financial & Administrative Officer

The overall for the year is somewhere in the neighborhood of about 8% to 10% total TDV.

Sara Rebecca Gubins - Bank of America Merrill Lynch

Okay. And then...

Jerry N. Ulrich - Chief Financial & Administrative Officer

That's obviously, Sara, net of the impact of EMV, so.

Sara Rebecca Gubins - Bank of America Merrill Lynch

Yes. Okay. And from an organic perspective, could you help us break that out as to what's organic?

Jerry N. Ulrich - Chief Financial & Administrative Officer

Well I think that's part of what I talked about earlier was having that breakout. For example, GiftCards.com versus our existing properties, CardLab and GiftCardMall.com, it's become a lot more difficult to provide that breakout because we're redirecting traffic based on effectiveness of marketing and ad spend, and so forth, so.

Talbott Roche - Chief Executive Officer, President and Director

Yeah, we're literally consolidating or going through a process of integrating multiple platforms, so that obviously we don't want to be investing in multiple platforms, where we can channel all of that volume into one. And so, it's muddy the waters considerably and made it impractical for us to be able to break out exactly what is attributable to, for instance, a GiftCards.com versus a CardLab versus an OmniCard or Incentive CardLab or GiftCardMall.com. So, in an effort to capture operating synergies which make a lot of sense for the business, as it drives more traffic to our consolidated site, that's an example where it's become really difficult for us to divest.

William Y. Tauscher - Chairman, Head of International and Corporate Development

Yeah, if you think about it, we have a very disciplined approach to our acquisitions. And now, what we're doing is we're acquiring bolt-ons and when we started, we were acquiring a new business in the Incentive business to put in our Retail business. We acquired a series of platforms that we labor sort of best-in-class. Now, we're acquiring bolt-ons and the right thing to do of course is to bolt them on and not have multiple platforms, as Talbott said, and end up with single organizations, expanding the cluster base and reaps considerable synergy. So, you'll see going forward, we'll continue with this exact same thing and it's just – it's not just a statement that we don't want to do it, it's virtually impossible to do it.

Sara Rebecca Gubins - Bank of America Merrill Lynch

Got it. Thanks. Your last comment was a nice segue to a question about M&A plan. So, it sounds like you plan to continue with bolt-on M&A. Could you give us some color on what you're seeing in areas in particular that you're focused on?

William Y. Tauscher - Chairman, Head of International and Corporate Development

Well, I think I alluded to it. Several years ago, when we concluded that the incentive marketplace was right opportunity for M&A, it's a fragmented marketplace, it's a large marketplace. We very carefully acquired several of the leading foundation players in that market, and there is a robust opportunity list of people in the market privately-owned companies, companies that represent an opportunity for us to acquire favorably as we have others in the past, and as I said earlier, bolt them on to this foundation that we've built.

So, as long as we can continue doing that at favorable acquisition prices and harvest the synergies we've seen, we will push that forward at least until we get closer to diminishing returns. So, we don't see anything like that. We're excited about the robust pipeline we have and think we can generate very accretive acquisitions going forward as we have in the past.

Sara Rebecca Gubins - Bank of America Merrill Lynch

Thanks. And then just last question. Could you give us an update on the pipeline of new distribution partner stores and how many chains you think you'll add this year in the U.S. and internationally?

Talbott Roche - Chief Executive Officer, President and Director

Yeah. We're continuing our new distribution growth. There will be a few chains here in the U.S., but I also want to emphasize, we're focusing a lot of our business development in the area of digital partners. So, we call them DDP, digital distribution partners, in addition to physical. We've mentioned the rollout of Office Depot last year, so that's been added; this year, Whole Foods. There's going to be, we believe, at this point two others that we can't talk discretely about right now, but launching later this year in a physical distribution in the U.S.

But there'll be multiple digital distribution partners as well. And some of our newer digital distribution partners we're also expanding fairly significantly with the addition of new content now up over 450 egift in our catalog, and in some cases, adding physical card product in addition to digital. So, we expect to continue growing.

And then, Bill, I'll let you comment on the International.

William Y. Tauscher - Chairman, Head of International and Corporate Development

Yeah. If you look at International, we hold a fairly mature position in Australia, and Canada, and the UK. There is still a fair amount of greenfield compared to the U.S., but I would talk about them as mature, but we really are at the beginning part in our growth countries. So, we've just signed some significant distribution of bringing on board and Korea is an example, and Korea is continuing to grow dramatically. We have signed and are rolling out the two giant convenient store chains in Indonesia, some 26,000 store points across Indonesia. We added a bunch of retail in the German marketplace, which is a bit behind in terms of maturity in the UK, et cetera, so. And I can keep going, but the point here is that we do have a bunch of our new lesser developed, less mature countries where there is real adds in distribution partners.

Sara Rebecca Gubins - Bank of America Merrill Lynch

Great. Thanks very much.

Operator

Thank you. Our next question comes from the line of Bryan Keane from Deutsche Bank. Your line is open.

Bryan C. Keane - Deutsche Bank Securities, Inc.

Yeah. Hi, guys. Just on the EMV update. The two clients that moved down their timeline, are they still within the end of September, or they pushed out to the end of the year, or end of 2017? Just trying to get a sense of how far this can go out. Can we still see a few of your top 25 non-compliant by end of this year?

Talbott Roche - Chief Executive Officer, President and Director

Yeah. Based on the information we've received and as I said, we're talking to these partners very regularly every week. We believe the vast majority of stores will be compliant before the end of September. We don't know of anybody that's starting their work later than this fall, and we've allowed for the idea that there could be some – a chain may start in the early part of the fall and beyond this end of September, but that would be only partial some of the stores not being yet compliant in earlier part of October.

So, really, overall on balance just as we saw in the Q2 timeframe, while stores move around a little bit, they in balance came in. We have the number of stores compliant for Q2 that we had forecasted we would. They shifted a little bit between banners, but overall, we ended up where we thought we would and that's what we're forecasting largely for Q3 as well.

Bryan C. Keane - Deutsche Bank Securities, Inc.

Okay and as you guys start to think about 2017 on the EMV impact, how much of the revenue and EBITDA loss can you get back in 2017?

Jerry N. Ulrich - Chief Financial & Administrative Officer

I think as we talked before, Brian, last quarter, it's still a little early to predict exactly the "bounce back," meaning are we going to be – have compounded growth in the 8% to 12% long-term growth target for U.S. Retail, is that going to be two years of compounded growth in 2017 as compared to 2015, that's the part that I think we need to see the rebound in the fourth quarter quickly happens to all the customers, absolutely come back, et cetera. Again, we don't see any reason why, today, that it shouldn't come back. But can you really build in mathematically that compounded two-year growth rate into 2017. We definitely believe it'll be above that long term growth rate in 2017 by some percentage. We just haven't picked the number quite yet.

Bryan C. Keane - Deutsche Bank Securities, Inc.

Okay. And then just finally, Jerry, on the adjusted free cash flow range, looks like it dropped down a little bit to $100 million to $110 million; I think previously it was $110 million to $125 million. What caused that downshift in free cash flow guidance?

Jerry N. Ulrich - Chief Financial & Administrative Officer

I think, it's really a – you know saw in the trailing 12 months and the second quarter we have some shift in working capital. It's a little bit hard to exactly predict the working capital movement at the end of each quarter. So, I think, it was just dialing that in a little bit compared to previous quarter.

Bryan C. Keane - Deutsche Bank Securities, Inc.

And that shift in working capital, does that reverse at some point in 2017, because it seems to be a drag on cash flow today.

Talbott Roche - Chief Executive Officer, President and Director

Yeah. It would turn around, because as I mentioned, a good chunk of it was related to timing of some receivable payments that we would expect in the second half of this year. So again, I think just for conservatism, we dialed back the previous forecast by $10 million or $15 million.

Bryan C. Keane - Deutsche Bank Securities, Inc.

Okay. All right. Thanks.

Operator

Thank you. Our next question comes from the line of Ashwin Shirvaikar from Citi, your line is open.

Ashwin Shirvaikar - Citigroup Global Markets, Inc. (Broker)

Hi thanks. I just want to ask on the GAAP and non-GAAP change. Can you remind us if the tax related – the add back, does that have cash flow impact as well?

Jerry N. Ulrich - Chief Financial & Administrative Officer

Well essentially, our view was that, two things, with respect to the spin-off from Safeway which was the largest – or is the largest component of the reduction in tax liabilities, that was representative of an ongoing economic stream. It obviously does improve cash flows. But it also has measurable value in the stock price. With respect to the NOLs, of course, when you do purchase accounting, you set up a deferred tax asset. The purchase price – the full purchase price is not reduced for the expected value of those NOL benefits. And so, again, when you're measuring return on investment, it seems like a reasonable measure to include.

I think the distinction is that the SEC guidance pointed out that certain tax items, maybe more of a liquidity measure, i.e., cash flow item versus a true operating measurement, the measurement of results, we believe we're somewhere in between that, but it's important to include these cash tax benefits, I think as most of the analysts do. And so, we'll continue to disclose them, and you guys will treat them, probably, we assume, consistent with how you've done in the past. Obviously, NOLs will get used over some shorter period of time. The spin-off from Safeway was a 15-year amortization beginning in 2014.

William Y. Tauscher - Chairman, Head of International and Corporate Development

But make no mistake, it's cash.

Ashwin Shirvaikar - Citigroup Global Markets, Inc. (Broker)

Yeah. And that's what – that was my point, because both of those things have economic value.

Jerry N. Ulrich - Chief Financial & Administrative Officer

That's very true.

Ashwin Shirvaikar - Citigroup Global Markets, Inc. (Broker)

So, I'd assume that the higher numbers gets used, but we'll see. The seniors unsecured debt tranche, any color on expectations of size or terms?

Jerry N. Ulrich - Chief Financial & Administrative Officer

No, not at this time.

Ashwin Shirvaikar - Citigroup Global Markets, Inc. (Broker)

And the reasons for that are basically M&A?

Jerry N. Ulrich - Chief Financial & Administrative Officer

No. I think it's really, when you look at the structure, it would just be to add a senior layer of debt. We talked about this at the beginning of the year. We've had a bank facility exclusively since we've spun off from Safeway. So, it's really just looking at a longer-term capital structure.

Ashwin Shirvaikar - Citigroup Global Markets, Inc. (Broker)

Got it. And then the Cardpool decline, I apologize, I got disconnected briefly when you started talking about it, I did not get the reason for that. Would you mind reviewing the dynamics around that?

Talbott Roche - Chief Executive Officer, President and Director

Yeah. We have a partner that we work with that allowed us to acquire cards through kiosks and we're in dialog with that partner about, first, they retracted some of their kiosks out of market, redeploying those into productive locations. And then a large expansion that could have positively – or will positively impact 2017. But some of that work has been delayed for the back half of 2016, and so that's causing a shortfall in revenue. What we also mentioned and we want to remind people, it's very low margin, it's our lowest margin revenue for the business. So, the relative impact at EBITDA line is – it's not significant.

Ashwin Shirvaikar - Citigroup Global Markets, Inc. (Broker)

Okay. And the reasons for the delay, however, I – what are the reasons for the delay though?

Talbott Roche - Chief Executive Officer, President and Director

Oh, it's an ongoing negotiation with this partner.

Ashwin Shirvaikar - Citigroup Global Markets, Inc. (Broker)

Okay. Understood. The last question I had was with regards to as the EMV-related revenue sort of comes back, you have a choice with regards to the cost that you've taken out and you did mention that not all of the leverage will stick. I guess my question is why not stay at that more efficient state?

Jerry N. Ulrich - Chief Financial & Administrative Officer

Well I think, we certainly will continue to work on leverage. So, really the statement is more, as I head into 2017 what's my base level. If we achieve, excluding the EMV impact, 200 basis points of improvement, what I'm suggesting is maybe half of that is the improvement for 2016 to use as a base of expenses for 2017. Now, does that mean we can't gain leverage in 2017 because if our target's 100 basis points and we up-level the base by 100 basis points well, we're even. I think we would still shoot for some leverage in 2017 as we continue through the integration process, full integration of all the acquisitions within the U.S. Retail part of the business. We continue to look at the efficiencies and organization as the growth is slower over time.

So, I think – we don't want to discount the opportunity, and I think you're right in pointing out that some of those cost reductions would certainly be permanent and carry forward. The temporary ones we're talking about are, for example, reduced incentive compensation plan and some pull back on hiring. Obviously, the hiring is always discretionary and should be in line with what the growth is.

Ashwin Shirvaikar - Citigroup Global Markets, Inc. (Broker)

Got it. Understood. Thank you, guys.

Operator

Thank you. Our next question comes from line of Tim Willi from Wells Fargo. Your line is open.

Timothy Wayne Willi - Wells Fargo Securities LLC

Thank you and good morning. I have three questions. I apologize if anything here is redundant, I had to hop off for a sec. But number one, just on capital and cash flow. In your slide, you still said dividends and you articulated what the priorities are. If I remember correctly you used to say explicitly no share buyback either, and I'm just sort of curious if there's any stance on buyback around limiting dilution or just how you think about the share price and your free cash flow right now and where priorities may have shifted.

Jerry N. Ulrich - Chief Financial & Administrative Officer

Yeah. I think, we have said that explicitly in the past, but we've also been asked if we'd consider it, so I think we just removed it as a definitive statement at this juncture.

Timothy Wayne Willi - Wells Fargo Securities LLC

Okay. Great. And then turning to the business, two things. First, in terms of the new content, I think you referenced a little bit around digital and growing that catalog of content over 400 offerings, I think. But just in general, as store value and gift has evolved over the last couple of years, could you just talk about the pipeline of perspective new content partners that you're seeing and to the extent that there would be anything noteworthy to talk about or to the extent you think that's still a driver of sort of the core U.S. Retail business would be new content versus new distribution?

Talbott Roche - Chief Executive Officer, President and Director

Yeah. Sure, Tim. Yes, we're always and each year looking for additions to our content and our catalog of content, if you will, and there are new brands. We do two resets a year. We do a big reset in the spring where we introduce new brands. We do another one in the fall in advance of holiday, where we integrate new content on to our physical racks, as well as into our digital catalogs, in both B2B and B2C. This year we think, we'll add about 50 new brands and they would include household names like an Airbnb or Hotels.com, Round Table Pizza, Whataburger, lots of popular prepaid products that will be added to both physical and digital catalogs. We also mentioned, I think, earlier in our talking points that we're launching some pretty exciting new open loop content, Visa 5% cash back.

So, the innovation and the launch of new products continues, EMV headwinds aside. There is no reason for us not to make sure we have the best brands available to both our consumers and our corporate buyers through all of our catalogs. So, yeah, that activity continues and it does contribute new growth. Particularly, as we enter new spending categories, another area that we've been focused on is transit products as well as lottery, and we're piloting some things coming up here not too soon – or relatively soon that will get us into new categories of spend, so.

William Y. Tauscher - Chairman, Head of International and Corporate Development

And, Tim, of course, just to make sure it wasn't lost, we have continued our focus on both DIDIX-like products where we have much higher margins and we essentially have a collection of retail outlets represented by a card. And then, secondly, regional and local where we're doing something similar. So, in both those cases, we don't necessarily have the big impact that the large card might have individually, but because the margins are so much better, it has a resulting profit impact and our focus on that is unchanged around the world.

Timothy Wayne Willi - Wells Fargo Securities LLC

Great. Thank you. And my last question was you had referenced I think a couple times in your comments about expanding. I don't know if it was specifically Achievers or just sort of the overall Incentive platform. I think you said digital as well as International, I guess, if you could clarify and then just sort of talk about that opportunity and how that may or may not impact margins around expenses to launch and ramp up or if you think this is actually pretty sort of profitable endeavor from the start.

William Y. Tauscher - Chairman, Head of International and Corporate Development

Yeah. We have – we're basically going to – let's start with Achievers, the answer is yes, we're bringing Achievers – Achievers, by definition, just so we're clear, is in Canada and United States, that's where it's business was built. So, we're bringing it outside the U.S., first to Europe and then over to AsiaPac and Australia, and we're also expanding it but, really from the U.S. into Mexico. And we see that sort of as the first round.

We've developed a model that we don't think has a big high cost touch to get it launched. And the reason for it is that our target initially is all of our retail partners, where we have such a close and strategic relationship, and they have lots of employees. And as Talbott mentioned in her comments, we've gotten our first one to, if you will, close here in the U.S., a significant partner actually, as it relates to Achievers for sure.

And so, we've got sort of a customer base that we have, if you will, half (54:41) leads into and relationships all established and we'll leverage all of those to keep our cost launch down from something that could be much major if we were just going into it alone.

And the second comment you had, we think we've got an excellent opportunity to launch these e-commerce sites. Obviously, e-commerce sites don't cost a whole lot to bring up since we're leveraging the U.S. platforms, they just have to be localized. So, there's not a rebuild that we'll leverage right off the U.S. platforms and the localization cost in today's technology is not huge. And we think, just like in the U.S., what we're doing in the digital platforms for e-commerce is a very open field, if you will. People are constantly looking in small, medium businesses as ways to get gift cards for incentives. And the solution we have with the personalization and the turnaround times, all of which we've mimicked where we're launching it we think has the same kind of opportunity for rapid growth that was achieved by the businesses we bought without really a whole lot of start-up costs.

Timothy Wayne Willi - Wells Fargo Securities LLC

Perfect. Thank you so much. That's all I had.

Operator

Thank you. Our next question comes from the line of Paul Condra from Credit Suisse. Your line is open.

Paul Condra - Credit Suisse Securities (USA) LLC (Broker)

Thank you. Good morning, and nice to see things moving in the right direction. Just had a quick one on the guidance as well. It looks like you had a pretty good outperformers on EBITDA and EPS, but it doesn't really flow through to the guidance for the year. So, is that all related to the Cardpool impact or just can you give any other detail on what's happening there?

Jerry N. Ulrich - Chief Financial & Administrative Officer

It's really a little bit on the Cardpool because, as we said, that's not a high margin business. We also mentioned that we were a little ahead in the second quarter on the Incentives business as we got – it's actually a combination of Incentive and Retail, but it's – GiftCards.com transitioned their portfolio to our issuing bank, which had a favorable impact on revenues. That was planned for the third quarter. We actually got that done in the second quarter. So, it pulled forward some revenues and margin into the second quarter. So, between $3 million and $4 million pulled into the second quarter, which was really planned for the second half.

Paul Condra - Credit Suisse Securities (USA) LLC (Broker)

All right. Thanks. And then does that – you also had a really good margin improvement in International and Achievers, and I just wondered if you could touch on what are the biggest drivers there, is it related to some of this?

Jerry N. Ulrich - Chief Financial & Administrative Officer

Yeah. On the International side, we mentioned the contribution from DIDIX, that's a positive; Bill talked about that type of content being developed around the world. It's a good economics first and it's been a nice additive to the Europe business. So, that helped the International profitability as well.

Talbott Roche - Chief Executive Officer, President and Director

Yeah. I don't think, on the Achievers, we commented on the specific margin around Achievers, but we continue to make progress. As you know that's a bit of a drag on overall company margins, but we continue to make progress in achieving our synergies, as well as growing that business slightly ahead of expectation. So, we have been happy with the results there. That is a business that, because we bought it early stages, has become a contributor this year, will be more so and more in line with our overall business as we exit 2017 as our forecast.

William Y. Tauscher - Chairman, Head of International and Corporate Development

Yeah. I don't think, we see anything with Achievers that says that as it matures and we load the wagon, it won't meet our EBITDA margin metrics, there is a lot of added value in that business for sure. And of course, the nice thing about International is that, again, we have a structure that we've now turned most of our International operations profitable and the balance of them will come true in 2017. So, we're beginning to get profit margin leverage just on the way the fundamentals of International work as opposed to where it was a couple of years, and that should help us with margin expansion as well in the coming years.

Paul Condra - Credit Suisse Securities (USA) LLC (Broker)

Thanks. And, yeah, Talbott, I was actually referring to the Incentives business, not Achievers, you're correct, but I think you – I think you answered my question.

Talbott Roche - Chief Executive Officer, President and Director

Okay.

Paul Condra - Credit Suisse Securities (USA) LLC (Broker)

And then just lastly, so on the cash tax benefits, can you may be just unpack that $61 million number? Isn't there something in there related to deferred stock comp as well?

Jerry N. Ulrich - Chief Financial & Administrative Officer

Yeah, we did add – Patrick, we added...

Patrick Cronin - Vice President-Finance & Investor Relations

(59:27) Paul. The $60 million breaks out to $28 million through the Safeway spin, you have $18 million for NOLs, and you have about $14 million for the stock comp piece.

Paul Condra - Credit Suisse Securities (USA) LLC (Broker)

Stock. Okay. Thanks. And then can you tell us what you're expecting for 2017?

Jerry N. Ulrich - Chief Financial & Administrative Officer

It's going to be similar. The NOL might be a little less. Hold on one second, Paul. Obviously, the Safeway spin will be the same number. The NOLs drop by – currently, we estimate about $5 million, and then the stock comp is somewhat variable. So, hard to predict exactly where that will end up.

Paul Condra - Credit Suisse Securities (USA) LLC (Broker)

Okay. Okay. Got it. And then just lastly, the Visa 5% back, I mean, who supplies the 5% cash back, how the economics on that work?

Talbott Roche - Chief Executive Officer, President and Director

Yeah. We have, we think, fairly creatively worked with our merchant partners who are providing additional value to consumers when they redeem that card inside their location. So, that is the way the economics work on that. That's funded by our merchant partners, retail partners.

Paul Condra - Credit Suisse Securities (USA) LLC (Broker)

All right. Great. Okay. Okay. Thanks a lot.

Operator

Thank you. Our next question comes from the line of Gil Luria from Wedbush. Your line is open.

Gil B. Luria - Wedbush Securities, Inc.

Yes. Thank you. So, wanted to ask about the acquisitions. You haven't really lapped any acquisitions since last quarter and you've added a few. So, is it safe to assume that, even if you can't pin down a specific number, it's higher than it was last quarter?

William Y. Tauscher - Chairman, Head of International and Corporate Development

I'm sorry. Repeat the question. I think you got it.

Jerry N. Ulrich - Chief Financial & Administrative Officer

Yeah. Gil was asking the fact that we had Achievers and DIDIX, we haven't lapped those quite yet, actually just at the end of the second quarter, but we added GiftCards.com and extrameasures, as well as Nimble. So, the impact compared to the first quarter might be slightly higher, but we have some variability by quarter for those individual acquisitions. So, you'd have to estimate your own number. But again, as we said, the integration is happening a little faster on some of the recent ones. And so, difficult to kind of pull out which piece is which.

Gil B. Luria - Wedbush Securities, Inc.

Got it. But then if that's true, then the acquisitions represent more than all of your AOR growth in the quarter. Doesn't that make that material enough that you'd have to disclose at least some number in your Q?

William Y. Tauscher - Chairman, Head of International and Corporate Development

The reason that's a true statement is EMV, which obviously distorts the normal numbers and we've reported and pointed out all of the EMV statistics, it's effect with and without EMV. And as we said, so breaking out acquisitions, I mean, at the end of the day, our acquired businesses are Incentive business.

Jerry N. Ulrich - Chief Financial & Administrative Officer

Yeah. I think, Gil, with respect to the Q, we of course disclose anything that is material, we meet all the disclosure requirements for those individual acquisitions.

Gil B. Luria - Wedbush Securities, Inc.

Then your digital gift cards, you disclosed 8% of TDV going on digital. What percent of revenue does digital represent?

Talbott Roche - Chief Executive Officer, President and Director

Yeah. We don't disclose that. Let me also, Gil, just make sure that we're real clear in how we're communicating about digital. So, we think of digital as a channel, and inside digital partners will distribute egift as well as physical cards, so that 8% refers to that. We're seeing a growing percentage of that business being egift. And as we said in the past, the economics around digital is pretty similar to the economics in our physical retail channels. So, we have some lower cost in digital, we have some acreage (1:03:44) cost, but it all kind of nets out to about the same.

Gil B. Luria - Wedbush Securities, Inc.

And then last one. Over what time do you expect to utilize your NOLs?

Jerry N. Ulrich - Chief Financial & Administrative Officer

I think, they're generally used up based on the current acquisitions within the next five years.

Gil B. Luria - Wedbush Securities, Inc.

Got it. Thank you very much.

Jerry N. Ulrich - Chief Financial & Administrative Officer

Okay.

Operator

Thank you. That concludes our today's question-and-answer session. I would like to turn the call back over to management for closing remarks.

Patrick Cronin - Vice President-Finance & Investor Relations

All right. We want to thank everybody for joining us today and look forward to talking again a quarter from now. Thank you.

Operator

Ladies and gentlemen, thank you again for your participation in today's conference. This now concludes the program, and you may all disconnect at this time. Everyone, have a great day.

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