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HPY > SEC Filings for HPY > Form 10-Q on 6-May-2013All Recent SEC Filings

Show all filings for HEARTLAND PAYMENT SYSTEMS INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for HEARTLAND PAYMENT SYSTEMS INC


6-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and the accompanying notes to Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q, and the Consolidated Financial Statements, Notes to Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations and the risk factors contained in our Annual Report on Form 10-K for the year ended December 31, 2012 (the "2012 Form 10-K"). Forward Looking Statements
Unless the context requires otherwise, references in this report to "the Company," "we," "us," and "our" refer to Heartland Payment Systems, Inc. and our subsidiaries.
Some of the information in this Quarterly Report on Form 10-Q may contain forward-looking statements that are based on our management's beliefs and assumptions and on information currently available to our management. Forward-looking statements include the information concerning our possible or assumed future results of operations, business strategies, financing plans, competitive position, industry environment, potential growth opportunities, the effects of future regulation and the effects of competition. Forward-looking statements include all statements that are not historical facts and can be identified by the use of forward-looking terminology such as the words "believe," "expect," "anticipate," "intend," "plan," "estimate" or similar expressions.
Forward-looking statements involve risks, uncertainties and assumptions. Actual results may differ materially from those expressed in the forward-looking statements. You should understand that many important factors, in addition to those discussed elsewhere in this report, could cause our results to differ materially from those expressed in the forward-looking statements. Some of these factors are described in Item 1A. Risk Factors of the 2012 Form 10-K and include, without limitation, our competitive environment, the business cycles and credit risks of our merchants, chargeback liability, merchant attrition, problems with our Sponsor banks, our relationships with third-party bankcard payment processors, our inability to pass increased interchange fees along to our merchants, economic conditions, systems failures and government regulation.

Overview
General
Our primary business is to provide bankcard payment processing services to merchants in the United States. This involves facilitating the exchange of information and funds between merchants and cardholders' financial institutions, providing end-to-end electronic payment processing services to merchants, including merchant set-up and training, transaction authorization and electronic draft capture, clearing and settlement, merchant accounting, merchant assistance and support, and risk management. Our card-accepting customers primarily fall into two categories: our core small and mid-sized merchants (referred to as "Small and Midsized Enterprises," or "SME merchants") and Network Services' merchants, predominately petroleum industry merchants of all sizes (referred to as "Network Services Merchants"). We provide additional services such as full-service payroll processing and related tax filing services, marketing solutions including loyalty and gift cards which we provide through Heartland Marketing Solutions, and we sell and rent point-of-sale devices. We also provide school nutrition, point-of-sale solutions, and associated payment solutions, including online prepayment solutions, through Heartland School


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Solutions, open- and closed-loop payment solutions and higher education loan services to colleges and universities through Campus Solutions, and prepaid and stored-value card solutions through Micropayments.

We sold our interest in CPOS in a transaction settled on January 31, 2013. CPOS has historically represented an insignificant component of our financial position and results of operations. However, as further disclosed elsewhere in the notes to the condensed consolidated financial statements, we recognized a gain on the sale of CPOS in the first quarter of 2013. As a result, we presented the net assets of CPOS as held for sale at December 31, 2012 and presented the results of operations for CPOS as a discontinued operation for all periods presented.

At March 31, 2013, we provided our bankcard payment processing services to 170,247 active SME merchants located across the United States. This compares to 169,994 active SME bankcard merchants at December 31, 2012, and 172,153 active SME bankcard merchants at March 31, 2012. At March 31, 2013, we provided bankcard payment processing services through Network Services Merchants to approximately 500 merchants with approximately 46,154 locations. According to The Nilson Report, in 2012, we were the 5th largest card acquirer in the United States ranked by transaction count representing 3.3 billion transactions and the 9th largest acquirer by processed dollar volume, which consists of both credit and debit Visa, MasterCard, American Express, Discover, Diners Club, and JCB transactions.
Our total bankcard processing volume for the three months ended March 31, 2013 was $23.9 billion, a 2.1% increase from the $23.4 billion processed during the three months ended March 31, 2012. Our SME bankcard processing volume for the three months ended March 31, 2013 was $17.3 billion, an increase of 3.8% over the three months ended March 31, 2012 reflecting increases for same store sales growth and new SME merchants installed.
Our bankcard processing volume for the three months ended March 31, 2013 also includes $6.5 billion of settled volume for Network Services Merchants, compared to $6.5 billion for the three months ended March 31, 2012. Bankcard processing volume for the three months ended March 31, 2013 and 2012 was as follows:

                                        Three Months Ended
                                            March 31,
                                         2013         2012
                                          (In millions)
SME merchants                        $    17,330    $ 16,699
Network Services Merchants                 6,486       6,517
Canada (a)                                    59         163
Total bankcard processing volume (b) $    23,875    $ 23,379

(a) Canadian operations were discontinued as a result of the sale of CPOS in January of 2013.
(b) Bankcard processing volume includes volume for credit and signature debit transactions.

Merchant attrition is expected in the card payment processing industry in the ordinary course of business. We experience attrition in merchant bankcard processing volume resulting from several factors, including business closures, transfers of merchants' accounts to our competitors and account closures that we initiate due to heightened credit risks relating to, or contract breaches by, merchants, and (when applicable) same store sales contraction. We measure SME processing volume attrition against all SME merchants that were processing with us in the same month a year earlier. During the three months ended March 31, 2013, we experienced 12.8% average annualized attrition in our SME bankcard processing volume compared to an average attrition of 12.8%, 13.5% and 15.3% for the years ended December 31, 2012, 2011 and 2010, respectively.

In our SME business, we measure same store sales growth, or contraction, as the change in bankcard processing volume for all bankcard merchants that were processing with us in the same month a year earlier. During the three months ended March 31, 2013, same store sales grew 2.2% on average, compared to 3.4% in the quarter ended March 31, 2012 and 2.2% on average in 2012. Same store sales growth or contraction results from the combination of the increasing or decreasing use by consumers of bankcards for the purchase of goods and services at the point of sale, and sales growth or contraction experienced by our retained SME bankcard merchants. Historically, our same store sales experience has tracked overall economic conditions. The following table compares our same store sales growth during 2013, 2012 and 2011:
Same Store Sales Growth 2013 2012 2011

First Quarter           2.2%   3.4%   3.2%
Second Quarter                 2.2%   2.5%
Third Quarter                  1.8%   2.3%
Fourth Quarter                 1.5%   2.5%
Full Year                      2.2%   2.6%


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We measure the overall production of our sales force by the level of new gross margin installed, which reflects the expected annual gross profit from a merchant contract after deducting processing and servicing costs associated with that revenue. We measure installed margin primarily for our SME card processing, payroll processing and loyalty and gift card marketing businesses. Our newly installed gross margin for the three months ended March 31, 2013 increased 10.1% from the gross margin we installed during the three months ended March 31, 2012. We attribute this increase in newly installed gross margin to higher volumes and margins at newly installed merchants and improved individual productivity achieved by our salespersons. We expect to drive increases in year-over-year installed margin in future periods primarily by increasing our Relationship Manager and Territory Manager count. Our combined Relationship Managers and Territory Managers count amounted to 739 and 787 at December 31, 2012 and March 31, 2013, respectively. In addition, Ovation Payroll, Inc. ("Ovation") employed 29 sales persons as of March 31, 2013 and December 31, 2012 who have augmented our sales force.

The bankcard revenue we earn in our SME business is recurring in nature, as we typically enter into three-year service contracts with our card processing SME merchants that, in order to qualify for the agreed-upon pricing, require the merchant to achieve bankcard processing volume minimums. Most of our SME revenue is from payment processing fees, which are a combination of a fee equal to a percentage of the dollar amount of each transaction we process plus a flat fee per transaction. We make mandatory payments of interchange fees to the card issuer through the card networks and dues, assessments and other network fees to Visa, MasterCard and Discover. Our SME gross bankcard processing revenue is largely driven by the Visa and MasterCard volume processed by our merchants. We also realize card processing revenues from processing transactions for our SME merchants accepting American Express and from processing Discover transactions.

In contrast to SME card processing revenues, revenues from our Network Services Merchants are largely driven by the number of transactions we process (whether settled, or only authorized), not our processing volume, as the merchants which comprise Network Services' customer base pay on a per transaction basis for processing services. Additionally, we provide authorization, settlement and account servicing services on our front and back end systems for American Express transactions for larger merchants, and merchants signed to American Express by other processors; for those services we receive compensation from American Express on a per transaction basis. The number of transactions we processed for Network Services Merchants and American Express for the three months ended March 31, 2013 and 2012 were as follows:

                               Three Months Ended
                                   March 31,
                                2013          2012
                                 (In thousands)
Network Services Merchants:
Settled                       224,785       223,598
Authorized                    549,252       581,311
American Express                7,583         7,732
Total                         781,620       812,641

Our internally developed front-end authorization systems, HPS Exchange, VAPS and NWS, provide us greater control of the electronic transaction process, allow us to offer our merchants a differentiated product offering, and offer economies of scale that we expect will increase our long-term profitability. During the three months ended March 31, 2013 and 2012, approximately 95% of our SME transactions were processed through HPS Exchange. All of our Network Services transactions were processed through VAPS or NWS.
We provide clearing, settlement and merchant accounting services through our own internally developed back-end processing system, Passport. Passport enables us to customize these services to the needs of our Relationship Managers and merchants. At both March 31, 2013 and 2012, approximately 99% of total SME bankcard merchants were processing on Passport and all Network Services' settled transactions were processed on Passport.
We provide payroll processing services throughout the United States. On December 31, 2012, we acquired Ovation adding over 10,000 customers to our existing payroll business. At March 31, 2013, we processed payroll for 22,468 customers, including Ovation, an increase of 87.2% from 12,005 payroll customers at March 31, 2012. In the three months ended March 31, 2013 and the full year 2012, we installed 1,924 and 3,399 new payroll processing customers, respectively, including Ovation's installation activity for the three months ended March 31, 2013. We operate a comprehensive payroll management system, which we refer to as PlusOne Payroll, that streamlines all aspects of the payroll process to enable time and cost savings. The PlusOne Payroll platform enables us to process payroll on a large scale and provide customizable solutions for businesses of all sizes. The acquisition of Ovation will add scale to our PlusOne Payroll platform, leveraging operating costs once conversion is complete in 2014, and also added management, 29 salespersons to our SME sales force, a new sales approach including an affinity partner network and enhanced product and servicing capabilities.

We provide school nutrition, point-of-sale solutions, and associated payment solutions including online prepayment,


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to K to 12 schools throughout the United States. At March 31, 2013 and 2012 our Heartland School Solutions business provided services to over 29,000 and 19,000 public and private schools, respectively. Our Heartland School Solutions business has been built on a series of five acquisitions in 2010 through 2012.

We provide open- and closed- loop payment solutions and higher education loan services to campuses throughout the United States and Canada. At March 31, 2013, our Campus Solutions business served more than 2,000 colleges and universities, compared to approximately 200 at March 31, 2012. The increase reflects our acquisition of Educational Computer Systems, Inc. ("ECSI") on December 14, 2012, expanding our Campus Solutions business into higher education and post-graduate school/student services.

First Quarter of 2013 Financial Results
Our financial results for the three months ended March 31, 2013, as compared to the three months ended March 31, 2012, benefited from a higher operating margin, reflecting 16.8% year-over-year growth in net revenue partially offset by increases of 6.8% in processing and servicing costs and 45.3% in general and administrative expenses. For the three months ended March 31, 2013, we recorded net income from continuing operations of $15.6 million, or $0.41 per share, compared to $13.5 million, or $0.33 per share, in the three months ended March 31, 2012. Also for the three months ended March 31, 2013, we recorded net income of $19.6 million, or $0.51 per share, compared to $13.8 million, or $0.34 per share, in the three months ended March 31, 2012. Net income includes results of operations from our interest in CPOS, which we sold in a transaction settled on January 31, 2013 and recognized a gain on the sale of $3.8 million, net of tax in the three months ended March 31, 2013. The following is a summary of our financial results for the three months ended March 31, 2013:

         Net revenue, which we define as total revenues less interchange fees
          and dues, assessments and fees, increased $21.1 million, or 16.8%, from
          $125.8 million in the three months ended March 31, 2012 to $146.8
          million in the three months ended March 31, 2013. The increase in net
          revenue was driven by the increased card processing net revenue from
          our SME merchants and increases in revenues for Heartland School
          Solutions, Payroll processing, and Campus Solutions reflecting 2012
          acquisitions of Lunch Byte Systems, Inc. (a.k.a. "Nutrikids"), Ovation
          and ECSI, respectively.


         During the three months ended March 31, 2013, our SME processing volume
          increased 3.8% to $17.3 billion from $16.7 billion during the three
          months ended March 31, 2012. We earn percentage-based revenues on our
          SME processing volume. The year-over-year increase reflects same store
          sales growth and improvements in the level of new SME merchants
          installed.


         Our processing and servicing expenses increased $3.8 million, or 6.8%,
          from $55.6 million in the three months ended March 31, 2012, to $59.4
          million in the three months ended March 31, 2013. The increase in
          processing and servicing expenses was due to increased costs associated
          with processing and servicing higher SME bankcard processing volume,
          increased residual commission expense and increased cost of sales and
          servicing related to higher Heartland School Solutions, Campus
          Solutions, Payroll processing, and equipment-related revenues.


         Our general and administrative expenses increased $14.3 million, or
          45.3%, from $31.5 million in the three months ended March 31, 2012 to
          $45.8 million in the three months ended March 31, 2013. General and
          administrative expenses increased primarily due to a $10.4 million
          increase in personnel costs, including a $0.9 million increase for
          share-based compensation. The increase in personnel costs is primarily
          attributable to the 2012 acquisitions of Nutrikids, ECSI and Ovation,
          as well as other headcount increases. The remaining increase in general
          and administrative expenses also resulted from our acquisitions, as
          well as to support increased investments in our growth initiatives.
          Partially offsetting these increases was a decrease in costs associated
          with our periodic sales and servicing organization summit. General and
          administrative expenses as a percentage of net revenue for the three
          months ended March 31, 2013 was 31.2%, an increase from 25.1% for the
          three months ended March 31, 2012.


         Primarily as a result of the 16.8% growth achieved in net revenue, our

income from operations, which we also refer to as operating income, increased $4.0 million to $26.8 million for the three months ended March 31, 2013, from $22.8 million for the three months ended March 31, 2012. Our Operating Margin, which we measure as operating income divided by net revenue, was 18.2% for the three months ended March 31, 2013, compared to 18.1% for the three months ended March 31, 2012.

See "- Results of Operations - Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012" for a more detailed discussion of our first quarter financial results.


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Critical Accounting Estimates

The discussion and analysis of our financial condition and results of operations are based on our Condensed Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. These condensed consolidated financial statements are unaudited. In our opinion, the unaudited condensed consolidated financial statements include all normal recurring adjustments necessary for a fair presentation of our financial position at March 31, 2013, our results of operations, our changes in stockholders' equity and our cash flows for the three months ended March 31, 2013 and 2012. Results of operations reported for interim periods are not necessarily indicative of the results to be expected for the year ended December 31, 2013. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses. Actual results could differ from those estimates. Our significant accounting policies are more fully described in Note 2 to our Condensed Consolidated Financial Statements included elsewhere in this report and in our 2012 Form 10-K.

Our critical accounting estimates and judgments have not changed materially from those reported in Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2012.

Results of Operations
Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012
The following table shows certain income statement data as a percentage of net
revenue for the periods indicated (in thousands of dollars):
                            Three Months                Three Months
                                Ended                       Ended                          Change
                              March 31,     % of Net      March 31,     % of Net      Amount        %
                                2013         Revenue        2012         Revenue
Net revenue:
 Total revenues             $  501,239                  $  467,576                  $  33,663      7.2  %
Less: Interchange              307,072                     297,948                      9,124      3.1  %
Less: Dues, assessments and
fees                            47,332                      43,868                      3,464      7.9  %
     Total net revenue         146,835       100.0  %      125,760       100.0  %      21,075     16.8  %

Expenses:
Processing and servicing        59,397        40.5  %       55,628        44.2  %       3,769      6.8  %
Customer acquisition costs      10,733         7.3  %       11,436         9.1  %        (703 )   (6.1 )%
Depreciation and
amortization                     4,090         2.8  %        4,352         3.5  %        (262 )   (6.0 )%
General and administrative      45,840        31.2  %       31,549        25.1  %      14,291     45.3  %
Total expenses                 120,060        81.8  %      102,965        81.9  %      17,095     16.6  %
Income from operations          26,775        18.2  %       22,795        18.1  %       3,980     17.5  %
Other income (expense):
Interest income                     34           -  %          104         0.1  %         (70 )  (67.3 )%
Interest expense                (1,234 )      (0.8 )%         (850 )      (0.7 )%        (384 )  (45.2 )%
Provision for processing
system intrusion costs            (206 )      (0.1 )%         (157 )      (0.1 )%         (49 )  (31.2 )%
Other, net                         116         0.1  %            -           -  %         116    100.0  %
Total other (expense)
income                          (1,290 )      (0.9 )%         (903 )      (0.7 )%        (387 )  (42.9 )%
Income from continuing
operations before income
taxes                           25,485        17.4  %       21,892        17.4  %       3,593     16.4  %
Provision for income taxes       9,840         6.7  %        8,366         6.7  %       1,474     17.6  %
Net income from continuing
operations                      15,645        10.7  %       13,526        10.8  %       2,119     15.7  %
Income from discontinued
operations,
     net of income tax           3,970         2.7  %          326         0.3  %       3,644
Net income                      19,615        13.4  %       13,852        11.0  %       5,763     41.6  %
Less: Net income
attributable to
     noncontrolling
interests (a)                       56           -  %           98         0.1  %         (42 )  (42.9 )%
Net income attributable to
Heartland                   $   19,559        13.3  %   $   13,754        10.9  %   $   5,805     42.2  %

(a) Attributable to income from discontinued operations.


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Total Revenues. Total revenues increased by 7.2% from $467.6 million in the three months ended March 31, 2012 to $501.2 million in the three months ended March 31, 2013, primarily as a result of a $25.8 million, or 5.7% increase in gross processing revenues.

The breakout of our total revenues for the three months ended March 31, 2013 and 2012 was as follows (in thousands of dollars):

                                  Three Months Ended          Change from
                                      March 31,               Prior Year
                                  2013          2012       Amount        %
Processing revenues, gross (a) $  478,774    $ 452,942    $ 25,832      5.7 %
Payroll processing revenues        12,809        6,279       6,530    104.0 %
Equipment-related revenues          9,656        8,355       1,301     15.6 %
  Total revenues               $  501,239    $ 467,576    $ 33,663      7.2 %

(a) Includes Visa, MasterCard, American Express and Discover bankcard processing revenues, American Express fees, check processing fees, customer service fees, gift card, loyalty, Heartland School Solutions, loan servicing and other miscellaneous revenue.

Processing revenues, gross. Further breakout of our gross processing revenues for the three months ended March 31, 2013 and 2012 was as follows (in thousands of dollars):

                                        Three Months Ended           Change from
                                            March 31,                 Prior Year
                                        2013          2012        Amount         %
Merchant card processing revenue:
  SME card processing                $  423,421    $ 409,226    $ 14,195        3.5  %
  Network Services card processing       32,954       33,193        (239 )     (0.7 )%
                                        456,375      442,419      13,956        3.2  %
Heartland School Solutions revenue       10,085        5,613       4,472       79.7  %
Campus Solutions revenue                  9,393            -       9,393      100.0  %
Prepaid card revenue                      2,921        4,415      (1,494 )    (33.8 )%
Other miscellaneous revenue                   -          495        (495 )   (100.0 )%
  Total Processing Revenues, Gross   $  478,774    $ 452,942    $ 25,832        5.7  %

The $25.8 million increase in gross processing revenues from $452.9 million in the three months ended March 31, 2012 to $478.8 million in the three months ended March 31, 2013 was primarily due to higher SME card processing, Heartland School Solutions, and Campus Solutions revenues.

Our gross SME merchant card processing revenues for the three months ended March 31, 2013 increased $14.2 million, or 3.5%, primarily due to the increase in SME bankcard processing volume. For the three months ended March 31, 2013, our SME bankcard processing volume increased 3.8% to $17.3 billion, compared to $16.7 . . .

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