Heartland Payment Systems' Management Presents at the JPMorgan Ultimate Services Conference (Transcript)

Nov.15.12 | About: Heartland Payment (HPY)

Heartland Payment Systems, Inc. (NYSE:HPY)

JPMorgan Ultimate Services Conference

November 14, 2012 01:15 p.m. ET

Executives

Bob Baldwin – Vice Chairman

Maria Rueda – CFO

Analysts

Tien-Tsin Huang – Research Computer Services & IT Consulting

Tien-Tsin Huang – Research Computer Services & IT Consulting

All right. Are we good to go? All right, thanks. Tien-Tsin Huang again from Research Computer Services & IT Consulting. So, we’ve got Heartland Payment Systems up – from Heartland Payments we got Bob Baldwin, who is a Vice Chairman, Maria Rueda, who is the CFO.

We’ve got a full day just so you guys know, a lot of merchant services companies from your direct peers, we’ve had Marc Gardner from NAB, talk about Pan-Ware, we had a VC panel, we just heard from them, talk about chase payment strategy, so obviously there is a lot to talk about. But we’re just going to do a Q&A here in the formal presentation hope that’s okay. But just wanted Bob just give kick it off and just give us a quick update on what we’re seeing in terms of volume trends. We’ve heard some mix things from different players over the last several weeks. Maybe if you can just update us what you’re seeing and then we can dig into the other stuff later.

Bob Baldwin

Sure and thanks for having us Tien-Tsin. Overall for two and half years now we’ve been seeing very erratic patterns in terms of volumes and sales growth. I would say that recent pattern has been no different fortunately, October was actually one of the strong months, which has been through positive three to four areas and then weaker months always positive but sort of 0.5% to 1.5%, and October was one of the slow months, which is good we were better than overall third quarter average for both same store sales and volume attrition. And so a nice start to the quarter but frankly there is nothing in the numbers that gives me any tremendous confidence that we’ve broken in the trend of soft truth results.

And of course, we have a pretty limited affect really but certainly Sandy didn’t help the business, how much it hurt, first couple of days in the mid-Atlantic region was definitely down anecdotally I don’t think I have seen Princeton busier, the downturn in a long time, last couple of weeks, why that is, maybe more people who are still need to eat out or what don’t have the power. But overall it’s probably not good for business and it doesn’t seem like its much negative either.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Yeah, maybe the city folks escaping the Princeton for some life. So, maybe building on that update was helpful. Just thinking about bigger picture, how does – how do we build back up to this sort of double digit volume growth in Heartland Payments also, I mean, is this just more of the function of your smaller merchants on growing spaces some of the national guys, but maybe we would see at Avantive, I’m just curious what you think, how that can build out sort of back to this double digit level?

Bob Baldwin

Well, I think, that the small versus large merchant relationship has moved in recent years towards the larger merchants they had been taking care away from main street, it usually makes sense when you think about, people are still financially stretched you don’t go shopping on main street, you don’t go out to an extra dinner, if you’re feeling financially stressed.

And so we are not expecting that perhaps secular or at least longer terms predominant to change near term. What we do see that if the overall consumer economy got better we can get to a much better same store sales growth in the main street just as a reminder in the ‘06,’08 period, we were getting 7% and 8% same store sales growth.

Question-and-Answer Session

Tien-Tsin Huang – Research Computer Services & IT Consulting

Yeah.

Bob Baldwin

Which was nice, that it did where we perhaps didn’t appreciate as much as we should when it was happening. So we can hope for that, we are certainly not planning for that, in our plans to get our business growing at best levels, it’s really two pieces, one is the SME card business, sort of blocking and tackling, getting higher productivity, adverse sales force is already a record productivity levels, but what we’ve seen of our higher producing sales people is that they’re getting to new heights that we haven’t seen previously.

So, we think there is room on that side for our veterans. And then doing a better job of hiring, in particularly keeping rookies and that’s where we’ve had a few challenges. But I think, that with those we can get our installed margin higher and with maintained or even better attrition and we always focus on better attrition, we think we can get the card net revenue growing in the high single digits near term and target to get to the double digits, that’s given the size the of our portfolio has it’s challenges.

Then the second piece is the quarter of our revenue – of our net revenue is coming from non-card sources and we think that there is a tremendous…

Bob Baldwin

We sort of ignored that in reality with someone was a pain in the ass and was installing 4,000 in my (inaudible). But if they were good person doing 3,000 that might be fine.

What we realized as we dived into 2010 was the sales force had gotten over 1,000 at that point, well over 1,000 and a lot of people were not being very productive and a lot of non-fulltime people and it was really dragging down the whole organization. So, we went and said listen, you need to be producing every month that the $6,000 margin not literally every month but very consistently.

And if you’re not we’re going to let you go and that was a hard standard, I’m not aware of anybody who is doing that in our business at that level. Most people don’t have the direct model that we do. So, we called the sales force and a number of people left and then stabilized as of last summer, a year ago and they’re now working hard at growing it again while maintaining that productivity, I think, that we are not satisfied with what we’ve achieved so far of ramping up rookies.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Right.

Bob Baldwin

And so are right now in the process of tweaking our approaches there to build a more enduring success rate for the rookies that we’re bringing in, we are really happy with the people we’re getting, a very high quality. It’s we need to do a better job of helping them get away there, stream of business and referrals that’s going to maintain them as successful throughout.

On the other hand, we really have never seen our most productive people hit levels that they are right now. And we between the solutions that we have in hand and we are right now really rolling out our payroll solution in a new way to our sales force built on the fact that we developed our own payroll platform last year converted all of our merchants to it and then this year, we’ve been able to finish up the HR side of things, which gives us what we think is a really the most modern and complete platform in the industry. We’ve had that validate to some extent because we had some people actually come and approach us ask if we would sell the platform to them and then we chose not to do.

And so we are excited by the opportunity to really re-launch the payroll product within the sales organization. We’ve seen overtime that we get better attrition out of merchants where there is a second sale, a second product and we’ve had mixed success there convincing a lot of our card sales people to focus on the payroll. But we think we’ve got a lot pieces to get that out to make that happen, which will help to get that sales person, coming out instead of having a sale of $1,500 or $2,000 card margin, they can come out with the sale of $3,000 or $4,000 with card and payroll.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Ignoring permanent price, I mean, it’s the concept of the higher productivity really more about bundling things like payroll and SmartLink on top of your traditional merchants services and if that’s the case, what do you think, everything about our average revenue per merchant as a base number of a 100, how much more could you get if you were to wrap in everything else that you are talking about or thinking about roughly? So, you are not looking at it?

Bob Baldwin

That’s not the way we do look at it frankly, we sort of view the second sale the payroll or SmartLink sale as it’s own sale in some ways, although we would cost subsidize some of the economics. But you can very quickly get to doubling the value of the merchant, I will say that. The different price or different economics, SmartLink that manage network solution really doesn’t have as much margin it in, as a payroll or a card solution. And but, with the three main products to the merchant, which are card and gift/loyalty and payroll, it can have pretty comparable economics, so if you get that rare triple plate, it’s a really attractive economics to the sales person and to the company.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Yeah, okay, okay. Couple more and then I will turn it up. So, we’ve rapid Durbin interchange card, how much sustain power do you think there is in this built in dollars campaign that year-over-year every move from the change?

Bob Baldwin

The fact is that the compelling marketplace has worked very hard to keep it, in their portfolio.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Right.

Bob Baldwin

We’re seeing it in the people who are offering themselves for sale, they’re showing us how these sticks started in October of last year and saying this is going to go out forever.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Yeah.

Bob Baldwin

We’re out in the marketplace trying to compete some of that away. But the reality is that we did not see any signs that’s diminishing in terms of the pure economics and where it is our average margin per deal, it hanging in there at $1,400 level, which is at least $200 a deal higher than we’ve ever been in the company’s history. And that started on October 1 of last year.

The other benefit of Durbin and the Durbin dollar campaign was it really shouldn’t be overlooked the way it is, it’s our concrete demonstration of the way we do business with our customers. And that’s important to us, it’s important to our sales force and it’s important to the merchants.

And to the extent that we are moving toward a world with greater complexity with greater choices that need to be made by the merchants in there processing and in there other interactions with loyalty type or a different merchant deals that they might be offering, having that kind of interaction with the merchant is I think and we think going to be increasingly important. So, yes, the economics is going to stick around longer than we expected to as if a year ago many of our competitors went raised their prices to – merchants that we go after by a $1,000 is now we are going back and get them back. But almost the bigger thing is that value proposition, not just the outside world but also in validating the values that Heartland always stood for.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Understood, so let’s talk about spread and I guess foreign economics here, your spread has been pretty stable here and called 50 bps or so, a lot of disruptors and new entrants and everybody is focused on potentially, using merchant acquiring as a loss leader etcetera. So, how much safety do you see in the spread and how do you see that potentially involving overtime, given what we are seeing in terms of some of these new entrants?

Bob Baldwin

The fact that we are vertically integrated and represent sort of only one profit margin for all the pieces of the processing and servicing pie is really important because in the end when you take interchanging dues, the card brands, we are charging 50 basis points for the distribution. Day-in day-out today just as five years ago or 10 years ago we think that is the lowest price out there.

So, as someone as a disruptor is looking at going into the business, they have a decision to make, do they want to try to go out and grow direct to the merchants and go in thus around the existing infrastructure, or do they want to go through the existing infrastructure. And there will players who do both of those things, sort of wearing and to the extent they are actually doing in a group-on will be going – will be competitors to us. But others have a tremendous interest in gaining access to our distribution.

And if you think in the largest scheme of things, if we are the lowest cost provider, that means we are the – if they are thinking about around somebody we are the last person they should think about going around. They should go around and they should go through the lowest cost player there. In our interactions with both of the players who want to do the wallets and a variety of others who are working in innovations in the technology, there are an awful lot of people who are knocking on the door, we’ve talked about the level up, pilots that we have going, that’s going well, where we’ve now expanded to five cities and are now working hard on working the economic relationship between our two companies on go forward basis and that is still subject to negotiation.

But from everything that we’ve seen when we get merchant with the level up relationship we get and will get and reach the level of profitability that we get currently. And in fact there is pretty good indications that it will be enhanced somewhat so we feel that would be a good thing for us and presumably a level that feels the same way, but we have not yet come to a final deal on that.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Okay.

Bob Baldwin

Right. The other thing I would add is, you know, one of the things that all of the players have to think hard about in these emerging ways of interacting between a merchant and a consumer is that there is going to be a tremendous network effect. And there is one thing that’s true is that networks are really, really hard to create, you know, if you try to have a network of handful of merchants it’s just not going to work.

The utility that we can offer to the many banks that amounts to the deal yesterday will be dependent on their getting in as many merchants as quickly as possible and then getting those merchants to be engaged with the rewards and royalty solutions. Well, that would argue very strongly against building your self model. And in fact, you know, we think we are easier to work through than anybody else. In fact, we had the ISO experience which was very interesting.

Their ISO’s rolled out as pilots in Austin and Salt Lake, they reached out to us, we had our prior team work on it, come up with an understanding of what they were offering us and our merchants to implement the solution, work out all the technical details, call our sales leaders in those two cities, put out the number of installs that ISO’s were willing to subsidize and sort of end the story and then we woke up when they announced the actual goal like we turned out we were 30% of the SME merchants that were installed of the tier 3 and tier 4. We were shocked.

We were not doing anything very different. We certainly didn’t put any big push on, but if you turn things around and you say, well, how does an ISO inserts any of a number of other players who want to get to this marketplace? How do they get to them? If they – in this case they could – ISO could go to, you know, maybe Zion Bank or something in Salt Lake, well who do they call? And how much does that person know or care about acquiring? Maybe they have a joint venture with some third party that they have to call.

If you are trying to figure out who the two best ISO’s are in Austin and Salt Lake, I am sure there maybe you know ways to do it, but it’s not easy. So, when we are working on that, we really represent the easiest call. And I think the result at 30% that’s far beyond and we know that we are near that kind of share in those two cities. We love to have that everywhere, but I think it’s an example of, you know, if you are an easy player to work through, if you are cost effective, then economic argument whether someone is making more money another way or not, you know, is still going to be better for them to do it through us than around us.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Got it. Got it. Let’s take some questions, it’s good why are we doing that? Just going back to the your earlier comments, what percentage of your merchants are I guess probably you want to define it micro merchant and maybe if you could just give us a comparison of, you know, the pricing that you would get from a square up anywhere or call whatever you said and you are 275, what that would look like versus Heartland Payments?

Bob Baldwin

Well, first we really don’t try to sell to the micro merchants.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Right.

Bob Baldwin

It’s sort of economically insane to have a sales person go after somebody who is doing three or five or ten thousand dollars a year on the lowest gradation that we track is a 50,000 merchant. And those merchants represent less than 1% of our volume, but it is a higher profitability merchant so that right now we are going into where we are right now, I would say our average small merchant is priced higher, somewhere under 50,000, it’s priced higher than the 270, 275 area that has been the resting place of a lot of the farm solutions, but it’s more or like 3%.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Okay. Okay, take a question from audience if not, I can continue.

Bob Baldwin

Yes, not a problem.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Can you talk about your cost position and why you have the lowest cost relative to competition?

Bob Baldwin

Well, there is a couple of things behind that. As I mentioned, we are vertically integrated so we are doing everything ourselves. The biggest aspect of that is the processing. We are is effectively the sixth largest processor of transactions in the US and have driven sale in our platforms to appoint that at this point we look forward, we calculate the incremental cost of processing the transaction and a fraction of a penny. And when we say the incremental cost, that’s for doubling our number of transactions so it’s not next one, it’s next two billion.

So that’s a very powerful position, but the second piece is really that we have an incentive structure out for our sales people that resulted in what we calculate the sale on what we call the margin which is after our costs are considered to processing and servicing. And it’s a shared economics model. And that shared economics model has resulted in us getting somewhere just a little north of 50 basis points over the last 15 years.

There are, you know, the two other ways to distribute processing for to SMEs or through independent sales organizations, we are now ISO, I mean, through other ISO’s who frequently end up their sort of tend to be super ISO’s and then sub ISO’s and maybe a sub sub ISO and then a merchant level sales person and influences levels of complexity and cost burden to that distribution channel.

The other approach is that is through banks and there are some other some banks including Chase that are quite large in the business, and they are perhaps I will choose the fact they feel that the customer relationship is a bigger thing that they have or whatever other reason, they don’t tend to be as price competitive as you know, they will tend to be not price competitive so it’s really just been the way I think that the standard commentary among the community has been – Heartland has been ruining the business for, you know, forever and you know, they were saying that 10 years ago and 5 years ago ruining in the sense of the economics, we are getting the same economics we’ve got 5 and 10 years ago, so we are perfectly happy to sit with that course.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Anyone else? Maybe we can raise just bringing in to the conversation like just, you know, I guess you have been surprising on the margin side, expense side, you know, et cetera so what’s the, you just talked about contribution margins being very high, but what’s the, you know, what’s the plan to build up to that target margin that you’ve laid out? Is there a lot more work to do on the expense front?

Bob Baldwin

Well, we think at this point we really hit all the low hanging fruit, but we are going to continue to focus on all of our expenses. We think that the expectation of a 100 points a year to get to a 25% of a margin goal is achievable with the structure that we had in place. And we will continue to build, we are going to continue to build the productivity of our Ims, we are going to continue to develop internally good solutions for our merchants to give us a foray into even more of the total adjustable merchant base that we see up there.

And now we think we have the right talent in place to do that. We’ve recently added some group presidents. We brought Mr. David Gilbert from the National Restaurant Association to join us and that just tells us about that just simplifies our continued commitment to the hospitality phase, we are very excited about David joining us. We have also brought Mr. Ian Drysdale, he was at WorldPay previously and Ian is going to help us as we grow in the aggressive space and also E-commerce that Bob talked about. So, we feel a lot of opportunity at Heartland. We have a real strong presence and we are focused on our margins and we articulate our goals and we work together as a strong team to achieve those goals.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Good. One of the things that came up in the venture panel this morning was non-traditional payments players who have – who touch a lot of merchants, Groupon was mentioned specifically including payment services as essentially a loss later just kicking in and I guess I don’t really know how to ask the question but how do you sort of deal with that from a strategic perspective and you know, how do you counter that risk factor?

Bob Baldwin

Well, it’s an interesting question. This is not a business where you sort of wake up one day and say, hey, we are in the business. So, I think I turn that around and say, what’s exactly is the strategic or what is the strategic bones that have been put in place to make that not just something to throw out there but something that’s effective. How are they going to compensate their sales force for that sale versus the reward sale? How are they going to train their sales force?

I think it will be a rude awakening when a sales person walks in to a merchant and says, I am, you know, I am going to do your call processing at a cost and the merchant says, well I’ve heard that 100 times always already, what’s the next comment? What do they have in terms of training and background and experience or support within the company for gong through and saying well, this is how I am going to demonstrate that this is a lower cost solution to you because literally that is the standard operating line, opening line for many many merchant level sales people is I have got the best deal available. So, simply saying that is going to be entirely inadequate. You know, you always got to be cautious about a company that’s sort of on a lot of cash looking for a business model but you know, that’s sort of what they seem to be in right now and I think that is going to be tremendously harder for them to even give it away than they think it’s going to be.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Has the industry had to sell against that sort of competitive threat in the past that you can think of?

Bob Baldwin

I am not aware of the industry having to sell against that in the past. It’s, you know, I am still waiting to hear my first complaint about moving a deal to Groupon, you know, we will say it certainly is I would say it’s interesting when a company where there are questions about what their fundamental profitability is and then say, and we are going to give away this other service and make more money doing it.

So, I think that there is going to be a credibility issue, internally there is going to be a lack of confidence so there will be sales people going out and trying to deal in very competitively that the merchant levels, merchant sales, the sales of call processing is probably the most frequently seen sales call for most merchants.

This is not something, oh, someone came in this month, isn’t it nice? It’s like you know, not again kind of response. So I think they are going to find this a very tough market. We have seen in the past, you know, a lot of effort was done around giving away free equipment in the business and that’s been sort of starting in I don’t know ‘06, ‘05, ‘07 period when it became a very popular way of selling and you know, it had a certain level of success for strictly the players but as always as with any strategy really, you know, we certainly had more success with it, certain, you know, we are able to generate good business with it.

Others just gave away for most and so I think that especially when you look at the merchant groups that we are focused on, they recognize that that this is truly the white blood of their business and having someone who is just sort of we are just going to get into the business now as their service provider is not something they will attempt to take advantage of even if they do commit themselves on the prices advantage.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Now, in the retail world there are a lot of fears about the death of lot of retailers, RadioShack and Best Buy in getting killed by Amazon, what’s your view on the future of retail and what can you do to help your merchants feel that?

Bob Baldwin

Well, retail per se is a smaller percentage of our business, I mean, it’s smaller than some others, say for example Christmas is not a big deal for Heartland. Our strongest volumes is during the summer when hospitality industry is at cross way. I think it’s pretty clear that you know, if you are selling commodity type products that it’s a very competitive world with a consumer who is increasingly comfortable with the process of buying online and we are very engaged with our merchants, our retail merchants on enabling their offerings online where we have both the like a mortgage business.

But also their online presence and that would be an increased focus of 2013 for our sales people, but I don’t know how to advice someone who, you know, I would advice someone who is trying to sell against those models to figure out a way even through local service or other non-commoditized aspects because, you know, if you are trying to compete with Amazon in that commodity business, that’s a very tough thing to do. It could be, I mean, you know, and I guess the best analogy I draw is that you think about a hardware that does just fine in the local community, again even with Home Depot and Lowe’s around, but they do it by a very strong not only by getting reasonably effective cost but also through any service component. And when you look at a local merchant who is selling things that service component and or quality or other points of differentiation have to be really emphasized.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Part of your strategy though you are rolling out the E-commerce platform completely shopping card and things like that, you want to push that to some really smaller merchants as well. So there is a little bit of a bridging effect that you are trying to promote. Does that affects them as well?

Bob Baldwin

Absolutely. I mean, I think it’s a different, you know, it’s helping them offer a modality, a solution that after that they are just going to lose the business.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Right. So, at the same time are you also I think you talked about tablets and providing little bit more ERP like services to smaller merchants as well, how real is that, you know, maybe pushing something more feature rich and going to get some micros and doing more of that work?

Bob Baldwin

It’s certainly a year out.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Okay.

Bob Baldwin

So, it’s exactly it’s really from this year out. We are working hard on it. It’s very clear that the functionality offered through and cost advantages of a tablet and powered by the Cloud are going to be transformative to shopping at the retail and when you tie in with those who are going up to the wallets and the changed interaction between the consumer and the merchant, it’s a very powerful mix and we are looking and very much interested in partnering with players who come up with solutions that hit particular parts of the business. In other areas we will build our own. We are not dedicated, oh, we have to do it all ourselves.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Right.

Bob Baldwin

I think the level of, you know, developing partnership is a good example of that and there are many other discussions that are going on, but in the higher in restaurant areas that’s a specific area of strength and depth of understanding for Heartland and so we think we can add some real value with our own solution there.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Good, I have one more question, just one, somebody has to get a chance. So, I guess just a question on surcharging coming to US, you know, obviously with your smaller merchant focus you might see a little bit more of that assuming litigation goes through as advertised here. So, what’s the latest thinking of the house if you want to impact the surcharging?

Bob Baldwin

Well, not entirely clear how much surcharging is going to go on in the, you know, physical present world. I have read some things the educated people do that on airlines and virtual things and you know, we all know how much surcharge you think about buying a ticket online and you know, surcharge on surcharge throwing an extra one on for card probably, you know, they will wake up and do in their sleep but for retail merchants the rules around it are going to be fairly restrictive including signage. There is a work we have to do to enable that because the card brands are going to require to be separately disclosed.

And again that’s harder at physically – at the physical merchant. That’s going to be the sort of so that the story with the official story is going to be – I think it is going to be relatively lineage amount, how much sort of I am going to do it anyway and not follow the rules of surcharging numbers is a little harder to evaluate, you know, what’s going to happen if smaller merchants start just charging a buck or two for the processing. Now so I guess the rules if there is someone from Visa comes along, they will get through us at the merchant, how strictly they will enforce that I don’t know, but it’s certainly our risk and one that we are not particularly in favor of because it just – it creates uncertainty by the consumer as to the true cost of what they are buying and that’s a reverse of opportunity commerce that we want to encourage.

Tien-Tsin Huang – Research Computer Services & IT Consulting

So, will there be any – you think any P&L impact either from a volume side or using point already from expenses to get some – get many colors?

Bob Baldwin

They are willing to having to be some expenses associated with it. We had viewed as just sort of an add to our compliance burden which already is rather staggering.

Tien-Tsin Huang – Research Computer Services & IT Consulting

Okay.

Bob Baldwin

So I think it would be meaningful in anyway but you have to go through it, you have to make the change on this type of terminal and certify that and then go to the next terminal type and certify that and to the next and certify that. So there is a process to be handled and you hate to do it, but we have to do. I don’t see any revenue.

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