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HPY > SEC Filings for HPY > Form 10-Q on 5-Aug-2013All Recent SEC Filings

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Form 10-Q for HEARTLAND PAYMENT SYSTEMS INC


5-Aug-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 report, 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").


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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 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 June 30, 2013, we provided our bankcard payment processing services to 169,717 active SME merchants located across the United States. This compares to 169,994 active SME bankcard merchants at December 31, 2012, and 173,315 active SME bankcard merchants at June 30, 2012. At June 30, 2013, we provided bankcard payment processing services through Network Services to approximately 704 merchants with approximately 44,146 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 June 30, 2013 was $26.6 billion, a 2.0% increase from the $26.1 billion processed during the three months ended June 30, 2012. Our total bankcard processing volume for the six months ended June 30, 2013 was $50.5 billion, a 2.1% increase from the $49.4 billion processed during the six months ended June 30, 2012. Our SME bankcard processing volume for the three and six months ended June 30, 2013 was $19.3 billion and $36.7 billion, respectively, increases of 4.2% and 4.0%, respectively, over the three and six months ended June 30, 2012 reflecting increases for same store sales growth and new SME merchants installed. Our bankcard processing volume for the three and six months ended June 30, 2013 also includes $7.2 billion and $13.7 billion, respectively, of settled volume for


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Network Services Merchants, compared to $7.3 billion and $13.8 billion, respectively, for the three and six months ended June 30, 2012. Bankcard processing volume for the three and six months ended June 30, 2013 and 2012 was as follows:

                                       Three Months Ended June 30,         Six Months Ended June 30,
                                           2013             2012             2013             2012
                                                               (In millions)
SME merchants                        $       19,343     $    18,572     $      36,673     $    35,271
Network Services Merchants                    7,242           7,288            13,728          13,805
Canada (a)                                        -             194                59             358
Total bankcard processing volume (b) $       26,585     $    26,054     $      50,460     $    49,434

(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 June 30, 2013, we experienced a 12.9% average annualized attrition in our SME bankcard processing volume and for the June 30, 2013 six month period we experienced annualized attrition of 12.8%. During 2012, 2011 and 2010, we experienced average annual attrition in our SME bankcard processing volume of 12.8%, 13.5% and 15.3%, respectively.

In our SME business, we measure same store sales growth 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 June 30, 2013, same store sales grew 1.9% on average, compared to 2.2% in the quarter ended June 30, 2012 and 2.2% on average in 2012. Same store sales growth results from the combination of the increasing use by consumers of bankcards for the purchase of goods and services at the point of sale, and sales growth 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          1.9%   2.2%   2.5%
Third Quarter                  1.8%   2.3%
Fourth Quarter                 1.5%   2.5%
Full Year                      2.2%   2.6%

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 marketing businesses. Our newly installed gross margin for the three months ended June 30, 2013 increased 15.9% and for the 2013 six month period our gross margin increased 13.1% from the gross margin we installed during the three and six months ended June 30, 2012, respectively. 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 829 at December 31, 2012 and June 30, 2013, respectively. In addition, Ovation Payroll, Inc. ("Ovation") employed 29 sales persons as of June 30, 2013 and December 31, 2012 who have augmented our SME 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


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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 and six months ended June 30, 2013 and 2012 were as follows:

                               Three Months Ended June 30,          Six Months Ended June 30,
                                  2013             2012               2013               2012
                                                        (In thousands)
Network Services Merchants:
Settled                            249,918         246,035                 474,703       469,633
Authorized                         581,121         645,875               1,130,373     1,227,186
American Express                     8,195           8,275                  15,778        16,007
Total                              839,234         900,185        1,620,854            1,712,826

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 June 30, 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 June 30, 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 June 30, 2013, we processed payroll for 22,896 customers, including Ovation, an increase of 87.5% from 12,211 payroll customers at June 30, 2012 and an increase of 1.5% from 22,553 payroll customers at December 31, 2012. In the six months ended June 30, 2013 we installed 3,277 new payroll processing customers including Ovation's installation activity, while for the 2012 full year we installed 3,399 new payroll customers. 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, 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, to K to 12 schools throughout the United States. At June 30, 2013 and 2012, our Heartland School Solutions business provided services to over 29,000 public and private schools, respectively. Our Heartland School Solutions business has been built through a series of five acquisitions in 2010 through 2012.

We provide open- and closed- loop payment solutions and higher education loan services to campuses through-out the United States and Canada. At June 30, 2013, our Campus Solutions business served more than 2,000 colleges and universities, compared to approximately 200 at June 30, 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.

Second Quarter of 2013 Financial Results Our financial results for the three months ended June 30, 2013, as compared to the three months ended June 30, 2012, benefited from a higher operating margin, reflecting 13.5% year-over-year growth in net revenue partially offset by increases of 4.4% in processing and servicing costs and 39.0% in general and administrative expenses. For the three months ended June 30, 2013, we recorded net income from continuing operations of $19.7 million, or $0.53 per share, compared to $17.4 million, or $0.43 per share, in the three months ended June 30, 2012. Also for the three months ended June 30, 2013, we recorded net income of $19.7 million, or $0.53 per share, compared to $17.8 million, or $0.44 per share, in the three months ended June 30, 2012. Net income for the three months ended June 30, 2012 includes results of operations from our interest in CPOS, which we sold in a transaction settled on January 31, 2013. The following is a summary of our financial results for the three months ended June 30, 2013:


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         Net revenue, which we define as total revenues less interchange fees
          and dues, assessments and fees, increased $17.8 million or 13.5%, from
          $132.0 million in the three months ended June 30, 2012 to $149.7
          million in the three months ended June 30, 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. ("Nutrikids"), Ovation and
          ECSI, respectively.


         During the three months ended June 30, 2013, our SME processing volume
          increased 4.2% to $19.3 billion from $18.6 billion during the three
          months ended June 30, 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 $2.4 million, or 4.4%,
          from $55.9 million in the three months ended June 30, 2012, to $58.4
          million in the three months ended June 30, 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 $12.2 million, or
          39.0%, from $31.3 million in the three months ended June 30, 2012 to
          $43.5 million in the three months ended June 30, 2013. General and
          administrative expenses in the three months ended June 30, 2013
          included $1.2 million for our periodic sales and servicing organization
          summit to be held in October 2013. Excluding these summit expenses, our
          general and administrative expenses in 2013 increased $11.0 million, or
          35.0%, primarily due to a $8.9 million increase in personnel costs. The
          increase in personnel costs primarily reflects the 2012 acquisitions of
          Nutrikids, ECSI and Ovation, as well as other headcount increases. The
          remaining increase in general and administrative expenses resulted from
          our acquisitions, as well as to support increased investments in
          various growth initiatives. General and administrative expenses as a
          percentage of net revenue for the three months ended June 30, 2013 was
          29.1%, up from 23.7% for the three months ended June 30, 2012.


         Primarily as a result of the 13.5% growth achieved in net revenue, our

income from operations, which we also refer to as operating income, increased $4.3 million, or 15.0%, to $33.3 million for the three months ended June 30, 2013, from $29.0 million for the three months ended June 30, 2012. Our Operating Margin, which we measure as operating income divided by net revenue, was 22.3% for the three months ended June 30, 2013, compared to 22.0% for the three months ended June 30, 2012.

See "- Results of Operations - Three Months Ended June 30, 2013 Compared to Three Months Ended June 30, 2012" for a more detailed discussion of our second quarter financial results.

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 June 30, 2013, our results of operations, our changes in stockholders' equity and our cash flows for the three months ended June 30, 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 2012 Form 10-K.


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Results of Operations
Three Months Ended June 30, 2013 Compared to Three Months Ended June 30, 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
                            June 30,      % of Net      June 30,      % of Net           Change
                              2013         Revenue        2012         Revenue      Amount        %
Net revenue:
 Total revenues           $  546,624                  $  515,218                  $  31,406      6.1  %
Less: Interchange            345,233                     330,742                     14,491      4.4  %
Less: Dues, assessments
and fees                      51,649                      52,505                       (856 )   (1.6 )%
     Total net revenue       149,742       100.0  %      131,971       100.0  %      17,771     13.5  %

Expenses:
Processing and servicing      58,376        39.0  %       55,938        42.4  %       2,438      4.4  %
Customer acquisition
costs                          9,983         6.7  %       11,263         8.5  %      (1,280 )  (11.4 )%
Depreciation and
amortization                   4,522         3.0  %        4,472         3.4  %          50      1.1  %
General and
administrative                43,531        29.1  %       31,309        23.7  %      12,222     39.0  %
Total expenses               116,412        77.7  %      102,982        78.0  %      13,430     13.0  %
Income from operations        33,330        22.3  %       28,989        22.0  %       4,341     15.0  %
Other income (expense):
Interest income                   32           -  %           34           -  %          (2 )   (5.9 )%
Interest expense              (1,269 )      (0.8 )%         (756 )      (0.6 )%        (513 )  (67.9 )%
Provision for processing
system intrusion costs           (33 )         -  %          (81 )      (0.1 )%          48     59.3  %
Other, net                       (37 )         -  %           (4 )         -  %         (33 ) (825.0 )%
Total other expense           (1,307 )      (0.9 )%         (807 )      (0.6 )%        (500 )  (62.0 )%
Income from continuing
operations before income
taxes                         32,023        21.4  %       28,182        21.4  %       3,841     13.6  %
Provision for income
taxes                         12,342         8.2  %       10,782         8.2  %       1,560     14.5  %
Net income from
continuing operations         19,681        13.1  %       17,400        13.2  %       2,281     13.1  %
Income from discontinued
operations,
     net of income tax             -           -  %          562         0.4  %        (562 ) (100.0 )%
Net income                    19,681        13.1  %       17,962        13.6  %       1,719      9.6  %
Less: Net income
attributable to
     noncontrolling
interests (a)                      -           -  %          161         0.1  %        (161 ) (100.0 )%
Net income attributable
to Heartland              $   19,681        13.1  %   $   17,801        13.5  %   $   1,880     10.6  %

(a) Attributable to income from discontinued operations.

Total Revenues. Total revenues increased by 6.1% from $515.2 million in the three months ended June 30, 2012 to $546.6 million in the three months ended June 30, 2013, primarily as a result of a $23.9 million, or 4.8% increase in gross processing revenues.

The breakout of our total revenues for the three months ended June 30, 2013 and 2012 was as follows (in thousands of dollars):

                                  Three Months Ended          Change from
                                       June 30,               Prior Year
                                  2013          2012       Amount        %
Processing revenues, gross (a) $  525,335    $ 501,432    $ 23,903      4.8 %
Payroll processing revenues        10,261        4,947       5,314    107.4 %
Equipment-related revenues         11,028        8,839       2,189     24.8 %
Total revenues                 $  546,624    $ 515,218    $ 31,406      6.1 %

(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.


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Processing revenues, gross. Further breakout of our gross processing revenues for the three months ended June 30, 2013 and 2012 was as follows (in thousands of dollars):

                                           Three Months Ended           Change from
                                                June 30,                 Prior Year
                                           2013          2012        Amount         %
Merchant card processing revenue:
  SME card processing                   $  472,111    $ 452,908    $ 19,203        4.2  %
  Network Services card processing          35,673       38,402      (2,729 )     (7.1 )%
                                           507,784      491,310      16,474        3.4  %
. . .
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