Blackhawk Network Holdings (HAWK) CEO Talbott Roche on Q3 2016 Results - Earnings Call Transcript

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Blackhawk Network Holdings, Inc. (NASDAQ:HAWK)

Q3 2016 Earnings Conference Call

October 12, 2016 08:30 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 - Executive Chairman

Analysts

Bryan Keane - Deutsche Bank

James Schneider - Goldman Sachs & Co.

Ramsey El-Assal - Jefferies LLC

David Chu - Bank of America Merrill Lynch

Ashwin Shirvaikar - Citi

Paul Condra - Credit Suisse

Wayne Johnson - Raymond James

Operator

Welcome to Blackhawk Network's Third 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'd now like to turn the call over to Mr. Patrick Cronin, Blackhawk's VP of Finance and Investor Relations. Please go ahead.

Patrick Cronin

All right. Thank you, operator, and good morning, everyone. So, yesterday we published our third 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 '16. A copy of the presentation and earnings release can be accessed from our Investor Relations Web site at ir.blackhawknetwork.com.

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

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. 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.

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 2 and the Risk Factors section in our filings with the SEC.

And with that, I'll turn the call over to Talbott Roche.

Talbott Roche

Thank you, Patrick, and good morning, everyone. On Slide 3, I’m going to start with a review of our Q3 financial metrics relative to the guidance provided on the July 20th call. The EMV impact on adjusted operating revenues was in line with expectations. However, adjusted operating revenues fell short of guidance primarily due to revenue shortfall at Cardpool, which had minimal impact on adjusted EBITDA due to its low margin profile.

EBITDA totaled $27 million for the quarter at the high-end of the guidance range provided during our July earnings call. Also during the quarter, we realized operating expense savings, lower interest expense, as well as a favorable tax rate compared to our forecast resulting in adjusted EPS $0.14 versus previous guidance range of $0.05 to $0.11. Also shown on Slide 3, the estimated reduction in income tax payables $13 million in line with expectation.

Now moving on to Slide 4, total Company Q3 adjusted operating revenues were negatively impacted by EMV and the previously mentioned revenue miss on Cardpool due to lower volumes associated with the reduced number of retail kiosk this year versus 2015.

Negotiations with our kiosk partner has been delayed due to a buyout which they concluded in September. While we did implement cost savings efforts across several areas of the Company, adjusted EBITDA, adjusted net income and adjusted diluted EPS declined 7%, 19%, and 18%, respectively versus the third quarter of 2015, primarily the result of the EMV headwind.

On Slide 5, as previously mentioned, the EMV impact on third quarter results was in line with expectations. I will provide additional detail on EMV on the next slide. In Q3, we completed the rollout of Whole Foods and continued the launch of our 5% Visa cash back variable card, utilizing our patented direct spend technology to rebate consumers when they spend at select merchants.

Overall, our Incentive segment grew Q3 adjusted operating revenues 17% and we continue to make progress on becoming the leading global incentive provider, offering a complete suite of employee, consumer and corporate solutions. I will discuss our Grass Roots acquisition completed last week fits into the strategy.

Our employee engagement business also known as Achievers, performed ahead of plan. Existing employee accounts grew 30% and we signed two leading insurance providers that will launch later this year. We continue to grow the incentive card sales through our direct sales team and our newly integrated and improved e-commerce platform. While a few consumer rebate programs pushed to 2017 were later in the year reducing organic growth in the quarter, we expect the Incentive segment to finish '16 with AOR growth in the range of 35% to 40%.

International AOR growth during the quarter was driven by solid performance in Europe. We signed a purchase agreement to the acquisition of Grass Roots in Q3, but did not close until last week, incurring acquisition costs without corresponding revenue. We continue to see strong growth from our emerging markets, specifically Brazil and South Korea. And excluding non-repeating revenues in Q3, 2015, international AOR growth was 23% year-over-year.

Across all our digital, online and mobile distribution channels in the Retail and Incentives segments, transaction dollar volume growth exceeded a 100%. We continue to add new eGift content, including our own Visa eGift product available on our own e-commerce site, as well as our third-party catalog. Year-to-date products delivered digitally represented 8% of global retail gift card TDV versus 4% in 2015.

Now let's move on to Slide 6, for an expanded discussion on EMV. As mentioned earlier, EMV impact on Q3 AOR to EBITDA was in line with forecast. As of last week, 21 of the top 25 accounts representing approximately 85% of the open loop TDV have achieved compliant. Of the four not yet compliant, the largest is in the process of completing its EMV rollout. We expect this large account to be substantially complete by the end of October, which will bring the total TDV coverage for compliant stores to approximately 95%. The remaining three were not expected to achieve compliance before the end of the year or sometime into 2017.

Our updated forecast for Q4 reflects these revised compliance dates and assumes no further delays from the currently communicated schedules. Importantly, our estimates allow for a sales ramp period following compliance. Recently compliant distribution partners are working to create the right conditions for revamp and gift card sales in their stores.

We’ve observed uneven execution by compliant chains as they seek to remove checker restrictions and return cards to shelves. Among our top 25 accounts, approximately a third of stores have some level of restrictions on gift card purchases, such as restricting purchases to cash or debit or limiting credit card purchases to $100 or $200. Once compliant, these stores are eliminating their restrictions, but it may require multiple rounds of training to ensure compliance by all checkers and store clerks.

Separately, about one forth of stores from top accounts removed select higher denom cards from the shelves during their period of non-compliant. Now once compliant cards that were removed or being returned to shelves, typically in a two to four week timeframe. Importantly, all the two accounts that carry variable open loop cards for EMV have returned those cards to shelves.

Of the two accounts, who have not, one with approximately 350 stores have substituted a $20 to $200 variable open loop cards for the $20 to $500. The larger partner that's currently working through EMV compliant is still evaluating whether to keep the $20 to $500 post-EMV or only carry that $20 to $200 variable cards.

Mitigating the potential impact from a reduction in TDV from these product changes over the last six months, we have added variable open loop cards in over 4,000 stores in our top accounts who previously did not carry them. Currently only about half of all our distribution store account has the capability at their point-of-sale system to handle variable load. So, there remains opportunity to expand the product offering over time including with our newest 5% cash back variable load products.

Finally our estimates of the full-year 2016 EMV remains intact at $47 million on AOR and $40 million on adjusted EBITDA. We have planned some additional marketing spend for our open loop products around holiday to help increase consumer awareness that products are back in all stores and purchase restrictions have been lifted. This additional spend is not included in this EBITDA impact estimate.

Now on Slide 7, here you see one example of an upcoming holiday promotion. This promotion is good on all Visa open loop cards including variable running at a large distribution partner who recently became compliant and has removed restrictions on gift card sales.

We will also see an example of signage. This signage is an -- shows how some chains are notifying consumers that credit card restrictions have been eliminated. Our merchandising crews will be visiting new compliant stores to ensure the shelves are restocked for holidays with all the cards and where appropriate signage announcing the removal of restrictions is in place.

Slide 8, Grass Roots is a leading incentive provider in the U.K that offers employee rewards, employee engagement, and consumer rebate solutions. It provides Blackhawk with an un-concentrated customer base of strong blue-chip companies. Its current EBITDA margin profile is in line with Blackhawk overall. It will be integrated into Blackhawk's U.K operations with good synergies expected to follow over the next 12 months.

While Grass Roots has lately experienced slower top line growth, this is expected to accelerate by cross selling its products into Blackhawk's retail distribution network as well as introducing Achievers, employee engagement platform into the Grass Roots customer base in the larger U.K market. Net of acquisition and severance costs, Grass Roots is slightly accretive in the fourth quarter of 2016, but nicely accretive to EPS in 2017.

Turning to Slide 9. While we have already covered segment highlights on Slide 5, we have included full segment financial results for your reference. Corporate and unallocated expense growth was limited to 5% during the quarter, primarily due to cost containment measures implemented earlier in the year.

Moving to Slide 10. In U.S Retail, the size of the EMV recovery measures, we plan to launch multiple new closed loop cards, such as the Uber gift cards, Williams Sonama and Delta Airlines into stores. On the open loop side, we will have distribution of our Visa 5% cash back in 15 accounts and as mentioned earlier we will enter holiday with open loop variable card selling in 4,000 new doors. Finally, we plan to launch the marketplace platform for Cardpool and we'll be testing a new kiosk solution. We also plan to finalize expansion plans at our existing kiosk partners post their buyback or buyout.

In Incentives, our focus will be on continuing to deepen relationships with existing accounts and significant -- and signing significant new consumer incentive accounts currently in our pipeline. We are building out Phase 1 of our global reward platform with over 500 brands across 20 countries today. We expect to grow the offering to 50 countries and over 1,000 brands during 2017 to meet the needs of our global accounts and to differentiate our offerings. Finally, we are continuing to evaluate multiple acquisition opportunities in the Incentive segment.

In international, the integration of Grass Roots is already underway. The impact of Brexit is expected to be immaterial in the near-term consistent with our decision to sell our PayPower General Purpose Reloadable product line in the U.S announced last quarter, we also sold the PayPower GPR business in Canada earlier this quarter. Just as in the U.S., we will continue to distribute products in this category throughout our distribution channel. We are forecasting no FX impacts year-over-year in Q4.

Across digital channels, we will continue to roll-out new digital distribution partners, including the launch of a new bank loyalty program that just went out last week. We are expanding NimbleCommerce capabilities with the launch of HAWK Direct. With this platform, we have entered the large first party card distribution market. Further, the launching of HAWK Mall gives us the capability of providing all our physical distribution partners with matching e-commerce capabilities.

And now with completing the business outlook, I will turn it over to Jerry, to cover guidance and other key financial metrics.

Jerry N. Ulrich

Okay. Thank you, Talbott. I'm going to provide, as Talbott said, some additional detail on our financial guidance for the balance of the year and of course we will review our key revenue and expense ratios, as well as free cash flow.

So, turning to Slide 11, in accordance with the SEC's Compliance and Disclosure Interpretations on the use of non-GAAP financial measures that they published in May, we’ve added guidance on key GAAP metrics to our disclosure. So as you can see total GAAP revenues are forecasted to grow 8% to 12% for the full-year, which happened to be the same rate as adjusted operating revenue as shown on the next slide.

Based on year-to-date actual revenues of $1.1 billion, this would mean Q4 growth of $75 million to a $140 million or in a range of 10% to 18% over the fourth quarter of 2015. On a GAAP basis, income and EPS are of course impacted by EMV, but also heavily impacted by our acquisition strategy with the amortization of intangible assets recorded in purchase price allocations, as well as the related acquisition expenses.

Okay, turning to Slide 12, for the non-GAAP financial guidance. We got reduced operating -- adjusted operating revenue since the last call due to the lower Cardpool revenue. Since the Cardpool shortfall won't impact the EBITDA line significantly, we’ve left the adjusted EBITDA and adjusted net income at the same levels as the last quarter. However, the pace of the EMV recovery remain the key factor and how the year comes out, as well as the usual focus on the important holiday season and consumer spending. So while we have maintained the earnings ranges from the last call, at the moment, we would be more comfortable towards the low end of these ranges given Talbott's EMV updates earlier.

Based on recent data, we do feel the economy is steady at the moment and in fact, Deloitte Consulting has recently forecast consumer holiday spend could exceed a $1 trillion and rise 3.6% to 4%, a little bit better than the 2015 increase. Finally, per share data is slightly higher than previous guidance, because of the 1 million share buyback that we completed in July in connection with the convertible debt offering. Our full-year diluted weighted average share count is forecasted at 57.2 million shares.

Turning to Slide 13, we provide the Q4 guidance which of course is simply the full-year less the year-to-date actual results. Now the variability in ranges reflect the larger fourth quarter volumes as well as the EMV recovery and holiday season range of assumptions. We're forecasting diluted weighted average share count to be 57 million even for the quarter.

All right, on Slide 14, we got our -- some comments about cash flow and debt. Our projection remains in the -- unchanged in the range of $100 million and $110 million for the full-year. Our CapEx target also remains in the mid $50 million range, which would represent about 5.6% of adjusted operating revenues excluding our estimated EMV impact as compared to 6.1% for all of 2015.

We ended Q3 with a debt to adjusted EBITDA leverage ratio of 3.30 against our bank facility covenant of a maximum of 4.0. On pro forma basis, giving effect to the closing of the Grass Roots acquisition last week, the leverage ratio at the end of Q3 would have been slightly lower due to the assumption of the -- or due to the addition of the trailing 12 months Grass Roots EBITDA.

The next item of interest is the capital allocation. Our Board authorized the use of up to $100 million to repurchase our own shares from time to time. This does give us the ability going forward to offset dilution from management equity incentive programs from time to time.

Now finally as we’ve affirmed previously, we continue to evaluate a pipeline of acquisition opportunities, particularly in the Incentives and Content areas. We believe the diversification of our revenue base has in fact paid dividends, particularly at this time when external factors like EMV have significantly impacted our core U.S Retail business. We continue to see acquisitions along with the build out of our digital capabilities and platforms as the best allocation of our free cash flow and available borrowings.

Slide 15 is the statement of our adjusted free cash flow reconciled to adjusted EBITDA. In comparison to the trailing 12 months period of 2015, cash taxes are favorable year-over-year due to the timing of payments and refunds, as was the change in working capital. There was a smaller increase in cash flow from settlement timing for the trailing 12 months as our growth in TV was lower in the 2016 period.

Turning to next slide, revenue ratios, a couple to key revenue ratios for the third quarter, prepaid and processing revenues as a percentage of transaction dollar volume increased 50 basis points year-over-year due to a lower proportion of open loop gift card sales in the U.S. Retail segment. Again, of course the result of EMV, as well as the higher proportion overall of incentives.

The partner distribution expense line increased 170 basis points in the third quarter of 2016 compared to the prior year due to the EMV impact on open loop and the resulting mix of U.S. Retail distribution partners. For the full-year of 2016, we now estimate that partner distribution expense as a percentage of prepaid and processing revenue will increase 40 basis points based on this overall mix between Retail and the Incentive segments.

The adjusted operating revenue ratio to TDV actually declined this quarter versus last year due to the decline in Cardpool revenue for which we have adjusted operating revenue, but don't record transaction dollar volume. So while the year-to-date AOR to TDV ratio is 5.5%, for the full-year we're forecasting approximately 5.3%.

We typically see a lower ratio in the fourth quarter due to the increased weighting of U.S retail and international retail related to holiday volume. For the full-year, the forecast of 5.3% is 30 basis points higher than fiscal 2015, which again is driven by the increased proportion of incentives and Achievers revenue in particular.

Moving on to Slide 17, the full quarter impact of lost revenue due to EMV and the lower margin of Achievers caused us to lose expense ratio in each of the key expense lines during the third quarter. Because we gain expense leverage in the fourth quarter, given the seasonal spike in U.S and international retail revenues, the full-year expense ratios are -- estimates are considerably lower in each of the first three quarters of the year. So the full-year estimate for these expenses combined is 65.6% of adjusted operating revenues compared to 63% EBIT for all of 2015.

As Achievers continues to rapidly grow revenues and expand margins toward our normal range, and as we recover from EMV, we expect to see expense leverage. The decline in Cardpool adjusted operating revenue year-over-year has affected this ratio as well. Note that as shown on the slide if we forecast -- if we adjusted the fiscal '16 forecast for our estimated EMV impact and for Achievers, the total expense ratio would in fact be about 60.2% as compared to 61.3% for 2015 or an improvement of about 110 basis points.

Finally on Slide 16 for the third quarter of 2016, you see the impact of this year-over-year decline in product sales and profit driven by Cardpool as talked about earlier. Okay for your reference, the appendix includes reconciliations of GAAP to non-GAAP financial measures including the new GAAP to non-GAAP guidance reconciliations.

And before we turn it over to the operator for questions, I know that some of our investors suggested that we provide preliminary estimates for our fiscal 2017 growth rates on this call. Now first of all, we always like to see how the holiday season comes in before we finalize and forecasts for the following year.

In addition, based on the fact that one of our largest open loop gift distribution partners has run late on their EMV compliance and the recovery at a store by store level has been uneven as Talbott commented on earlier. It's really not prudent for us to provide a range estimate at this point in time for 2017. But we do remain confident on growth from Incentives and in International segments, and we're excited about the acquisitions completed this year and those in the pipeline.

Based on our current outlook, we will finish 2016 with adjusted operating revenue growth of 35% to 40% over 2015 in both the Incentive segment and in International, which includes Grass Roots. So really it boils down to this variable in the U.S Retail segment at the moment, while we expect to end 2016 down slightly in U.S Retail adjusted operating revenues.

We do not foresee a scenario for 2017 that does not return to growth. The good news is that the revenue base is increasingly diversified and we expect to gain leverage as we complete more of the acquisition integrations and see overall higher growth at the top line in 2017.

We will of course provide all the details of our 2017 outlook with our year-end earnings release in February and we are also going to schedule an Analyst Day shortly after the year-end earnings announcement. We will introduce key management in the Incentives and Digital businesses and we will provide a deeper dive on the opportunities in these high growth areas, as well as the core international and U.S Retail businesses.

With that, I'd like to turn it over to the operator to open-up the line for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from Bryan Keane with Deutsche Bank. Your line is open.

Bryan Keane

Hi, guys. Just wanted to ask on the EMV, the revenue and EBITDA loss in the quarter was similar to last quarter. I'd have thought that with more retailers becoming EMV compliant there would be a little bit of a lessening impact from EMV, but it would tended to be similar, so just wanted to get your thoughts and color on that?

Talbott Roche

Yes, Bryan, this is Talbott. While we did have some retailers become compliant earlier this year and those were working through eliminating the restrictions and putting the cards back, it tended to be smaller in total volume relative to the ones who have become compliant just recently. So, we had quite a few become compliant at the end of this last quarter and so they actually -- one of them which is a larger account too actually delayed about a month. That’s some of the reason for the impact in Q3.

Jerry N. Ulrich

Yes, so essentially we're basically had improvement in those chains that have been EMV compliant for some period, but a couple of the larger ones where late which offset that improvement as compared to last quarter.

Bryan Keane

And so the -- I think there is three now that were kind of delayed past expectations, one the large one that will be compliant by the end of October and then two, running behind expeditions that probably won't be compliant for this year. So, my understanding is there will be sometime early in '17 and as a result to that there is an impact on guidance in '16 that you will be at the low end of the range, I was just hoping you could quantify the exact impact there?

Talbott Roche

Yes, let me just comment on what you said. I think one of the accounts was a chain that had previously planned on being compliant by the end of September. Now they plan to be largely compliant by the end of October. The other that -- the other three that I’ve mentioned was much smaller and were not planned to be compliant before the end of October. So while they will achieve compliance either later this year or in '17 that was as we had originally forecasted. I think the reason that we are guiding towards the lower end of the range in Q4 has to do with the timing of some of the larger partners as well as the variability on a store by store basis. So if you look across chains, what you are seeing is some stores have already returned to previous year's levels of sales and others are still working through getting these restrictions removed as well as getting all the cards back on the shelf. So the good news is we are going into Q4, we are going into a holiday timeframe where there is higher incentive purchase and there is a big focus on this category. We are also as we said have made the decision to invest an additional marketing, so we can drive more consumer awareness to get back into the grocery store to make these purchases. So the higher incidence of purchase that occurs at holiday is actually a good time for us to be going through this, because it forces the checkers to deal with these transactions on a more regular basis, get back to normal course of business not restricting the purchases and the roughly third of the top 25 as we mentioned that did that, it also forces the pegs to get restocked, because consumers are in there looking for these card. Now we are building through all that as we normally do holiday readiness plan this time of the year, it’s just going to be a little heavier lift with EMV and ensuring we get all those cards back on the rack where there were certain skews eliminated.

Jerry N. Ulrich

I think Bryan, to elaborate a little bit, our guidance, as we said, remains unchanged in part because it's hard to quantify this variability impact. What we're seeing as Talbott pointed out is taking a little bit longer to get customers back in the store. We believe that during the restrictions on those chains that actually removed cards as opposed to putting in some purchase level credit card limits or debits/cash limits, the recovery is taking longer which would indicate that the customers may have changed shopping habits, maybe shopping at drug stores versus grocery, but of course the frequency of visited grocery gives us confidence that eventually with the awareness Talbott pointed out the additional spend that we are planning on marketing, we will get the customers back. But of course the delays can be amplified in this quarter, because of the holiday season. So that's why we are kind of putting that cautionary note. It will be a little more variability around this midpoint than we like to have at this stage, we just have to keep working through it as we have been over in the last few months.

Bryan Keane

Okay. Now that's really helpful. And then, just thinking kind of the future ones we normalize or back out for EMV and Cardpool, when you look going forward, what do you think that normalized U.S Retail growth rate should be for AOR?

Jerry N. Ulrich

Well, I took pains to, of course, talk about not providing 2017 guidance specifically. Our reviews on the market overall haven't changed, this continues to be a category that will grow. We had contents, we are looking at new self use product. Talbott mentioned a few of them like launching an Uber card and others of a similar vein. We do have some additional distribution opportunities of course more so internationally and in part growing or maturing those markets. So, we clearly believe that the core gift card business remains a growth opportunity. We talked before about open loop products had become partly, self use type products in addition to get products in the past, we think that will come back as we get EMV solved. The digital area is also growing very rapidly. We believe that it's not fully cannibalistic of course, we talked about that these are incremental opportunities, particularly, as we expand in Incentives, the digital content and the catalog that we are growing is very significant. And as we roll out to more and more countries and are able to serve that broad base internationally, we are going to pick up more global customers in that categories. So, I think just in general, we feel confident about this overall underpinning, but we're just not ready to say what that bounce back level is for 2017 on the U.S Retail segment in particular.

Bryan Keane

Okay, helpful. Thanks guys.

Operator

Our next question comes from Jim Schneider with Goldman Sachs. Your line is open.

James Schneider

Good morning. Thanks for taking my question. I was wondering if you could give us a little more color on the Cardpool business, where you stand with that renegotiation. Talk a little bit about the size of that total business at this point of time and then to what extent you expect once that negotiation is completed, that business would also bounce back in 2017?

Talbott Roche

Sure. The Cardpool business overall is not a significant piece of our U.S Retail business as you know, but we have been in a protracted negotiation with a kiosk partner who was recently went through a change of ownership, but that got concluded towards the end of last month. That negotiation is ongoing and we plan to expand our kiosk footprint both through that partnership as well as some other kiosks that we're testing right now. So that's planned largely to impact 2017. In the meantime we have other avenues of growth for that business. I mentioned the fact that we’re launching a marketplace solution in our online channel, which is a significant piece of that business. The marketplace solution would give us the ability to expand our offering and in terms of the content we provide. This is a business that we are -- its supply constrained, really. So frankly what we are always doing is looking for channels to acquire additional content and then push it out through our Cardpool Web site where we can sell those secondary cards at attractive rates, particularly for consumers who are looking for a deal. So, we feel good about the return of growth in 2017, given we have multi-channels that were both the online and physical kiosk channel that we are pursuing.

Jerry N. Ulrich

Yes, Jim just to add to that, this is a business that is -- we said relatively small contributor to EBITDA. The margins, in particular, this year because we have kind missed the forecast in the second half are less than the percent of our overall EBITDA number and we're going to have negative growth this year of probably 20% on this business. So, it's a business that as Talbott said, we're looking to bring back in 2017 with resolution of some of the acquisition channel challenges that we faced. But not having a huge impact from an earnings standpoint and frankly we talked about it previously why we're moving to more of a marketplace concept here, because the margin structure really doesn't fit with the rest of for business.

James Schneider

Helpful. Thanks. And then, maybe on the discretionary spending obviously you have kind of curtailed and reined in some of that corporate expense. Can you maybe talk about how much in terms of absolute dollars that spending is kind of reduced relative to your original plan in 2016? And then, as we look into 2017, if the EMV recovery plays out as you expect and things are kind of call green lights as you go forward, how much of that spending is going to come back next year?

Jerry N. Ulrich

I would say that we have talked about this before that some of that reduce spend was "temporary in nature" and we took some measures to scale backward for example some incentive plans and so forth. So, ballpark you’re really talking about $5 million to $7 million of spend that normalized year would come back.

James Schneider

And then finally, can you maybe -- I think you mentioned in the prepared remarks a little bit about some of the limitations that your partners have put on the value of the -- at the high-end of the open loop variable gift cards and you also talked about some mitigation measures. As you look forward, do you think that the mitigation measures of putting more those variable open loop spend prepaid cards in the other partners will fully offset the reduction in the high value with the other partners?

Talbott Roche

Well, I mean, we certainly feel like it will go a long way to doing that. We don’t know exactly, because there hasn’t been a final decision by one of the partners I’ve mentioned. Again, remembering only two partners have made any substitution and they are not eliminating variable, they are just making a decision to go to 0 to $200 versus 0 to $500, and one hasn’t made their final decision. So, we think adding 4,000 doors that previously didn’t have variable will be nicely additive. In terms of totally offsetting that it's unclear at this point because we are just seeing them ramp the sales of variable in those new channels. We are excited about those channels because they are very high traffic, some big box retailers that are in our network that previously couldn't support variable and our top performers for us as a distribution partner. I think the other bigger point here is we have more Greenfield to potentially drive more variable sales into channels that today can't support loading the variable card and adding the fee as its required on open loop and as they make those POS changes we have opportunity to continue to add. So …

Jerry N. Ulrich

And we have talked before also that our overall average load, our transaction dollar volume average on an open loop card is around a 100 bucks and on those higher denom cards in a couple of our more important chains, the average load on the $20 to $500 would be $225 or so. So, even if they brought it to a $20 to $200, we don’t believe the overall impact on TDV is severe. So, you could imagine that a $20 to $500 card is universal. I mean it is used extensively on a unit basis, because it's got again the variability, but when you look at the overall averages a $20 to $200 card wouldn’t make a substantial difference in that total dollar volume. There will be some impact, but we don’t believe it's as severe as some people would worry with replacing that $20 to $500.

James Schneider

Great. Thank you.

Operator

Our next question comes from Ramsey El-Assal with Jefferies. Your line is open.

Ramsey El-Assal

Hi, guys. I was wondering on -- also on EMV sort of following up on the last question that if the liability issues goes back to the bank after EMV compliance is achieved at the retailer, what is the drivers of their hesitancy to kind of just put things back the way they were to begin with? It doesn't seem like they are on the hook anymore, so what is the sort of specific pushback you’re getting at those retailers who sort of are EMV compliant, but now don't want to relax these risk controls?

Talbott Roche

You know actually we are getting that kind of pushback in terms of relaxing controls. I think when we talk about variability at the account level or at the store level rather, it's really just training these checkers to relax these credit card purchases. The management of those chains wants those restrictions lifted and they want to go back to normal. They want to support an easy consumer experience. It's just hard to execute that across all of them. And I think in terms of the other thing that we hear consistently is that the chains really understand this is the destination category, particularly at holiday. There they want to carry all cards that are available in their competitive channels. So, while some have looked at economics on a $20 to $500 and said well, I have some expense when that purchase is made, the overarching feeling is and that’s interchange expense, but the overarching feeling is it's important to have that offering in their suite. And as Jerry mentioned earlier, most of those are being loaded well below the top limit of $500. So having that offering in their suite is more important to have complete selection versus not having that offering like any other category where you want to have a full selection in some units or some products will be more profitable than others.

Ramsey El-Assal

Okay, understood. On the buyback, Jerry your commentary, after you mentioned it was that maybe the purpose of it was more to sort of offset dilution from stock-based comp, how should we think about your execution of this here going forward? I understand it's opportunistic, but is it something that really is intended to be a shift in your balance sheet deployment strategy or is it really just to soak up kind of ongoing dilution from share-based comp?

Jerry N. Ulrich

Well, I think I mentioned the latter, so that's really the focus at the moment, but it is an allocation of capital decision. We have talked -- continue to talk about a pipeline of acquisition opportunities and so forth and we believe that diversifying certainly into the B2B and incentive space has paid a lot of dividends here. But as you move across the space, maybe the acquisitions become smaller, the opportunities aren't as large and so you still have decisions to make as you go through the course of the year on what you deploy on a small acquisition, which may take just as much work as a bigger acquisition, so you may make a decision on capital allocation. But if you really analyze and one other things we will do again at this Analyst Day is talk about how we view ROIC, some of the returns that we have seen historically from our acquisitions, obviously the overall core business and kind of our capital cost hurdle that we look at. But if you run the math on share buyback, it's hard to see that they outperformed on a perspective basis, what you would expect with an acquisition or even investment in these digital platforms that we’ve talked about over the last several years. So that’s a natural order of your capital allocation, but as you said this does give us flexibility to be opportunistic as we go forward.

Ramsey El-Assal

Okay. Quickly and lastly from me and I will just hop back in the queue, an update on Whole Foods, I’m assuming EMV as sort of in their POS upgrade to change the schedule in terms of that rollout. Should we expect that to be a 2017 impact?

Talbott Roche

Yes. So, I think we mentioned in last call that we were amid that rollout and had some delays, because they were going EMV compliant. They subsequently completed that, we’ve completed our rollout and the products are in the store and selling. So we are heading into the Q4 holiday with them intact, so they should be functioning -- fully functioning contributing in the Q4 timeframe and that of course their much bigger contribution will be having a full-year of them in our base next year. There are also a chain that has taken a variable 0 to $500 Visa product as well as some other large variable brands on the closed loop side.

Ramsey El-Assal

Got it. Okay. Thank you so much.

Operator

Our next question comes from David Chu with Bank of America. Your line is open.

David Chu

Hi. Good morning. Thank you. So, how much visibility do you feel Europe partners have in this EMV conversion process? I ask because October is only a few weeks away, so should we assume the larger partner conversion by the end of October is a done deal?

Talbott Roche

Well, we're talking away silly to our partners as we mentioned before on a weekly basis and we have seen and get regular reports on which stores are becoming compliant and we are seeing the progress they are making in terms of hundreds of stores per week. So we feel confident that they will hit that.

Jerry N. Ulrich

Right. And this is an IT project, so as you can imagine detailed project plans and once they launch and validated the various environments that they have been upgrading and then testing, they do have pretty good visibility. I think there may be a few hundred left at the end of October as Talbot mentioned that kind of carry over specific environments with specific types of POS, but they've got a very good line of sight based on specific project plans.

David Chu

Okay.

Jerry N. Ulrich

Our frustration is just -- we always think simplistically that they have certified EMV, the next day all the cards are back in the shelf, every checker that is across couple of thousand stores, understands the new policies and so forth, but that's part of our challenges. It hasn't happened quite that quickly. You got to remerchandise the racks, which really involves a reset. We typically go through retail resets in the stores twice a year, once in the spring, once in the fall preparing for holiday where you put new product on and reshuffle the plan-o-grams, the pegs and so forth. So some of them are working that open loop restocking into that cycle. We’d rather see it immediate next day, but it doesn't quite happen that way.

David Chu

Okay. And then, you mentioned uneven execution post-EMV. I mean, what makes this process a variable? So is it really the actions of the checker at point-of-sale, is it consumer behavior, and what …?

Talbott Roche

Yes. So, what -- one of the reasons its variable is that different chains enacted different -- took different actions during their non-compliant period, right. So I mentioned that a third of them put some restriction at point-of-sale in terms of the form of tender you could use or how many gift cards or, how many dollars you spend on gift card. And that was obviously an attempt to make sure they control for any fraudulent transactions and minimize charge backs related to that. Having become compliant, it is absolutely in our interest to remove those restriction, take that friction out of the point-of-sale experience, but when you have 200,000 checkers to train who work often on a 24/7 cycle, you're not going to get them all trained adequately in the first round. So it takes multiple rounds. So there is just that human issue of getting people trained to remove those restriction. So the next type of consumer comes in, they know oh, I don't have to restrict as I don't have to limit it to a $100. For instance, I don’t have to send in the customer service for a high denom card, because its already back on the rack. So there is just that human element. That’s what we mean by variability. We can look into a chain and we can say oh, look 60% of stores are now performing at/or above their prior year levels, but 40% of the stores haven't got it all squared up. So then we go and we do audits and we see what’s going on, we tell that the chain and they’re actually doing their own audits and then we go into another round of training or they do another kind of training, that we get -- I'm trying to bring to light some of the issues. The other thing that could happen frankly and we have seen this in a quarter of our top 25 accounts that actually remove certain denoms from the rack. They have either kept those cards at store level or at some cases maybe they have misplaced some of those cards. So we then have to reorder and get cards into the store either through a DSD system or through a bulk of warehouse delivery system and then get those cards back on the pegs. So that happens not always at perfect, we believe the same rate within a store. So that's what we mean by some of the variability of the execution.

Jerry N. Ulrich

And then we saw the signage towards the example we showed, hey good news you can now buy these cards again using your credit card. So consumers have to become aware and we’ve built up awareness of the program over a decade or more and to the extent that we had a product gap here that's part of the challenge as well.

Talbott Roche

One of the things that I'll just address to remind people, look it is a destination category that does two things for the retailer. It drives a lot of profit and growth for them, but it also drives traffic, because people go to get the gift card, they pick up other things while they are there. Grocery is inherently the most high frequent channel you can buy these products in. It's higher frequency of shop by the mainstream customer who spend more on gifting, so this is families that have kids and their spending more and gifting they’re shopping in these retail outlets one to two times per week versus drug and dollar stores and even big box where maybe the frequency is not as high. So there is a natural reason for people to return to grocery as soon as they see they have access to a complete selection and the restrictions have been lifted. So we feel very good about grocery continuing to be the most productive. In a post compliant world we think that the transactions will return, the consumers will return to this channel. There is another benefit they get by buying at grocery. Many of the grocers have loyalty programs, be it fuel loyalty programs, it's prevalent throughout the grocery channel and they also benefit when their credit card companies offer two or three points when they buy grocery and fuel. Those loyalty programs are typically not seen in drugs and -- they don't exist in dollar stores and not in mass merch as much. So there is other reason to make their purchases. Its convenience and value in grocery.

David Chu

Great. That’s very helpful. Just last one for me, what type of underlying growth for the holiday season is embedded in your guidance? And maybe we can talk about stores that haven't seen the EMV impact?

Jerry N. Ulrich

Well, I think we pointed out this retail forecast, I mean we typically have referenced both the National Retail Federation, NRF as well as other reports tracking retail sales, bit of a mix bag these days you see a lot of variability on physical retail results versus online and online obviously growing faster for us just as it is for the retail world overall. So, we’re pretty optimistic about continuing the growth in the digital category as we talk about. And then on physical gift cards, you got that convenience factor around the holiday, particularly the last minute shoppers, we’ve always said that the last week before the holiday we did some incredible volumes and we are obviously watching it on a daily basis at that point. So, it's hard this season to kind of separate out the pure growth, seasonal growth versus pull back from EMV or hangover from EMV, but the guidance incorporates some assumptions for a normalized growth year-over-year.

David Chu

Okay. Thank you very much.

Operator

Our next question comes from Ashwin Shirvaikar with Citi. Your line is open. Your line is open Ashwin.

Ashwin Shirvaikar

Hi, Talbott. Hi, Jerry. Can you hear me?

Jerry N. Ulrich

Yes.

Talbott Roche

Yes, we can hear you now.

Ashwin Shirvaikar

Okay, so I’ve been thinking about all of the things you’ve said with regards to merchandising push to educate consumers so they can go back to their card purchase behavior, the type of education you are doing for checkers. Are there examples where some of these initiatives, let's say, let's call it, four, six, eight weeks old where you are seeing some results? You mentioned that there are obviously stores where sales have returned to pre-EMV levels. What differentiates those from the ones where it hasn’t, is it just a matter of time, is the question I’m trying to get to?

Talbott Roche

Right. I think one way of trying to summarize it is even for the stores that haven't we see progress week over week. So it's a general march towards a return in the sales and even from stores, let's say where they don’t have perfect checker training yet or they haven't implemented, they haven't got all the cards back, we are seeing them make progress. So if they were 50% of their prior year sales, they move to 75%, and then they continue to increase.

Jerry N. Ulrich

35% of the sales last year, yes.

Talbott Roche

I’m sorry, of sales year prior, hopefully that was clear. And then we do have stores that have returned and exceeded prior year. So it's like a scattergram and at the end of the day when we audit and/or try to match literally thousands of stores of exactly what's happened in each of store location, we triangulate in on a couple of things and it tends to be the restrictions have not been fully lifted, they have certain checkers who are still imposing those and/or for some reason they’ve not become -- they have not gotten all their cards back onto the racks. And you think that would be a simple thing, but when you consider the fact it's literally thousands of stores, it's not as simple as it seems. Now that means progress has been made every week, because we are working closely with those retail operators, their divisions, and their district managers to ensure this is happening. People want to be in a compliant and fully stocked condition going into holiday and so that's why we're saying earlier, it's a good time to be going through this, because people are motivated to make sure they have a competitive offering and they have what the consumer is looking for. So there is a progress happening even for those stores that aren't today back to their previous year's levels. So that's what Jerry was saying, we want to get through this holiday season, so we have a better view on, while we are confident returning to growth in '17, we want to have a better view on what that looks like across the entire spectrum of stores.

Ashwin Shirvaikar

Got it. Okay. Now that's quite useful. I'm going to go out on a limb here and ask a non-EMV question.

Talbott Roche

Ashwin, thank you.

Ashwin Shirvaikar

So, I guess, Jerry you mentioned operating leverage you can get from all these acquisitions in the Incentives and International as you integrate them through the course of the next year or so, can you quantify that statement? I mean, what should we expect in terms of incremental margins on those segments?

Jerry N. Ulrich

I think we're going to stick with what we have been talking about and that's about a 100 basis point expansion in EBITDA margins and it's a little tricky trying to normalize this year. But again, we believe that we'll make solid progress as normalized, what turns into normalized growth returns in U.S Retail complimented by this much more rapid growth in the other two segments, we will get that leverage. So we are confident about that expansion.

Ashwin Shirvaikar

Okay. And the balance sheet question in terms of given some of this uncertainty, I was a little bit surprised with regards to the Grass Roots acquisition and the timing, I know it helps the leverage ratio modestly, but just in terms of just laying on debt on the balance sheet, why not pay down debt is sort of -- and I know you laid out your priorities, but I just wanted to ask with regards to why those set of priorities?

Jerry N. Ulrich

Well, I think there is a couple of characteristics about the business. First, it's a very broadly based consumer type business, meaning millions of customers with hundreds of millions of visits the stores per year, so it's a very diversified business overall. It's further diversified now over the last couple of years with a B2B segment, which is growing rapidly. And so the profitability should as I just described, continue to improve. So we are generating over a $100 million a year in cash flows, we feel comfortable both with the margin structure and that cash flow characteristics and the diversity of the business that we can't move forward at this kind of leverage ratios. And you know I think we have been with our lead banks on the credit side for quite some period of time. They understand the business very thoroughly, so we also look at comparables in the payment space and so this leverage ratio of 4.01 on our current credit facility is we think quite reasonable. Grass Roots, in particular, it was a large enough acquisition -- not huge, but large enough, it took a while. So this is the one that we studied for a while and timing wise this is when it kind of came together naturally over the course of the due diligence process. We are working on it almost a year before we completed this deal.

Talbott Roche

You know I was going to add to that, I mean, look at it as a piece of our strategy to be the global leader in Incentives and branded solutions. And I think this is a -- an important step towards us achieving that goal. There is a lot of things that come with us achieving that as we talked about the incentive market space very fragmented, so we'd have a unique and differentiated position by truly being a global provider that can better service global entities which we see as some of the richest opportunities to grow this business. It was a deal we have been working on for 13 months, so it wasn't something that we opportunistically did at the last minute, but really had contemplated for quite some time and wanted to work through to ensure we have the right deal. So I hope that also kind of adds to what Jerry already …

Jerry N. Ulrich

And importantly we did pay down bank debt as you know, so we issued longer-term debt with a convert and do in 20, 22, this summer. So I think that was an improvement from our capital structure and gives us a little more flexibility in the near-term.

William Y. Tauscher

This is also a Company that is broad-based in its customer base. It's a profitable Company. It's not a project. It's a Company that has a broad base of products as well. There is lots of nice synergies that will harvest over the coming years, Talbott spoke about and because of all those earnings it actually -- over time will improve any kind of debt ratio, so we’re paying down absolute debt is one thing, you know having something that’s not only expanding strategically as Talbott has talked about, but expanding us financially in a pretty strong way just seem to be logical for us.

Ashwin Shirvaikar

Okay, got it. Thank you, guys.

Operator

Our next question comes from Paul Condra with Credit Suisse. Your line is open.

Paul Condra

Hey, good morning everybody. Thanks. Just on the holiday sales, when do you historically tend to see the real ramp? Does that -- as early as October or is it more November, December kind of thing?

Jerry N. Ulrich

That’s typically November, December. Obviously we have talked that last month of the last four weeks represent a relatively high percentage of U.S Retail TDV and to some extent International Retail as well. So, it's not dissimilar to a lot of our retailers have taken to running promos around Black Friday. Sometimes they try to get a jump on the next guy and do it the week before, we will definitely start seeing the ramp as we exit this month gradually through the month of November and then it really steepens during December.

Talbott Roche

That's right. And that's true of Digital as well, maybe even more exaggerated.

Paul Condra

Okay, great. Thanks. And then, I wanted to ask about the international and global business. I think you had said Jerry 35% to 40% growth in both of those for the year, did I hear that right?

Jerry N. Ulrich

Right.

Paul Condra

So for international you had been around low 20%, is the difference there mostly just from Grass Roots? Is that where most of that business is going?

Jerry N. Ulrich

Yes, that’s right.

Paul Condra

Okay. And then in global it's a little bit of a step down and you mentioned just some customer program push out, does that kind of explain the reason why that’s lowered?

Jerry N. Ulrich

Yes.

Paul Condra

Okay. And then, I understand the sensitivities on the retail prepaid business in 2017 giving an outlook, but the international and global businesses, it's pretty high-growth, you got a lot of acquisitions there. Is there any way you can kind of frame out or give us some way to think about what kind of growth we could see there in 2017. I don't know qualitatively or just something, some way to wrap our heads around it?

Jerry N. Ulrich

Well, we talked about it as we entered this year normalized growth long-term of around 8% to 10% or so in the U.S Retail business. I think you have to still think about that framework, but maybe modify downward slightly. So mid to high single-digits would be our longer term continued belief for U.S Retail.

William Y. Tauscher

But if your question was about our leverage business -- or Incentive business and our international business, we tried …

Paul Condra

Right.

William Y. Tauscher

… some idea by thinking about how 2016 would -- and I don't think there is anything in those businesses either in the organic growth that we have talked about or our continued pursuit of acquisitions that add to that growth that is changed. If anything, we feel stronger about those businesses than we did last month a year ago, two years ago.

Paul Condra

Okay. I mean, if we -- if growth -- I mean, if we think about them growing 30% to 40% in 2017, is that this way too high or I mean …?

Talbott Roche

I think we’ve talked about long-term growth rates in incentives being 15% to 20% and international 20%.

Paul Condra

Thank you. That's very helpful. Okay. Great, guys. Thanks a lot. That's all I had.

Jerry N. Ulrich

Yep.

Operator

Our final question comes from Wayne Johnson with Raymond James. Your line is open.

Wayne Johnson

Hi, good morning. Quick question on best practices. And I apologize. I got disconnected here, if you've already answered this, so I’ve just dialed back in. But did you guys give an update on where you stand with that? Any kind of progress on that front, with all the, I would think, renewed interaction with your supermarket distribution partners over EMV, would create lots of opportunities to bring up best practices during those conversations? So, any color you could shed on that, I would appreciate.

Talbott Roche

Yes, that’s a great question, Wayne. We obviously do continue to focus on best practices and while we had planned it earlier in the year to move about 500 of our stores over to best practices from basic and we’re accomplishing that. I would say in addition to that we’ve also been successful as we shared with you in securing more placement of variable products and some retailers in the back half. And so that we go in addition to those 500 that we had originally planned and have now executed into best practices coming into holiday the 500. So, and of course it will be a little bit easier to once we get out of the EMV scramble here to go back to that next year. So we are excited about having a year where EMV is largely behind us, people are in a compliant state and we can focus on expanding our footprint with more pegs and doing more marketing and getting back to regular cycles of merchandising and all of those things next year, but hopefully that answers your question for this year.

Wayne Johnson

Yes, it does. That’s helpful. And just a quick follow-up, have you seen any competitive change from any of your larger or smaller competitors in the prepaid gift card space?

Talbott Roche

No. I think we see kind of business as usual. I think we did not -- some of the drug chain service by our competitor and some of the big box chains service by our competitors had gotten EMV compliant by the original October date, so I think some of those issues were not as significant for those players.

Jerry N. Ulrich

And they may in fact have benefited a little from our slip in and open loop sales.

Talbott Roche

Yes, while its not -- its hard, obviously we don’t have data, but how hard is it if you’ve -- you can't find a variable card in your local grocery store to walk down the street and go find it in the drug chain. That could possibly have happened. I think the good news as I shared earlier on the call, we feel confident in the inherent appeal of grocery just because of frequency shop is higher, it tends to be a loyalty program that add value on top of just the gift card purchase itself. And so as we enacts these marketing promotions we want to remind consumers to purchase their gift cards at grocery. And it's a broader selection, it tends to be a broader selection when you're in grocery versus drug.

Jerry N. Ulrich

And on the digital side, we think, Talbott mentioned some of the developments there and in fact where we feel like we’re gaining momentum in that space overall. So, while we know that for example, a large competitor in the payment space purchased a digital provider late last year and there is another independent smaller guy out there that’s focused completely on digital, our growing catalog and the diversity of our product offerings and solutions across digital, we think gives us again the best position overall in that marketplace and we are having good results as we talked about and continuing to gain momentum.

Wayne Johnson

Great. Thank you very much.

Operator

And that concludes the Q&A session. I will now turn the call back over to Patrick Cronin for closing remarks.

Patrick Cronin

All right. Well, thanks everyone for joining us today. Enjoy the rest of your week and we will be in touch soon. Thank you.

Operator

Thank you, ladies and gentlemen. That does conclude today’s conference. You may all disconnect. Everyone have a great day.

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