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Heartland Payment Systems (NYSE:HPY)

Q4 2012 Earnings Call

February 07, 2013 8:30 am ET

Executives

Maria Rueda - Chief Financial Officer

Robert O. Carr - Executive Chairman and Chief Executive Officer

Robert H. B. Baldwin - Vice Chairman

Analysts

David J. Koning - Robert W. Baird & Co. Incorporated, Research Division

Timothy W. Willi - Wells Fargo Securities, LLC, Research Division

Roman Leal - Goldman Sachs Group Inc., Research Division

Steven Kwok - Keefe, Bruyette, & Woods, Inc., Research Division

Christopher Shutler - William Blair & Company L.L.C., Research Division

Adam J. Letson - Piper Jaffray Companies, Research Division

Gregory Smith - Sterne Agee & Leach Inc., Research Division

Thomas C. McCrohan - Janney Montgomery Scott LLC, Research Division

Michael J. Grondahl - Piper Jaffray Companies, Research Division

Reginald L. Smith - JP Morgan Chase & Co, Research Division

Christopher C. Brendler - Stifel, Nicolaus & Co., Inc., Research Division

Brett Huff - Stephens Inc., Research Division

Operator

Good day, and welcome to the Heartland Payment Systems Fourth Quarter and Year End 2012 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Ms. Maria Rueda, Chief Financial Officer. Please go ahead.

Maria Rueda

Thank you, Audra. And good morning, everyone. I'd like to welcome you to our Fourth Quarter and Fiscal Year End 2012 Earnings Call. Joining me this morning are Bob Carr, Chairman and Chief Executive Officer; and Bob Baldwin, Vice Chairman.

Before we begin, I want to remind you that some of our discussions may contain statements of a forward-looking nature, which represent management's beliefs and assumptions concerning future events. Forward-looking statements involve risks, uncertainties and assumptions that are based on information currently available to us. Actual results may differ materially from those expressed in the forward-looking statements due to many factors. Information concerning these factors is contained in the report of our financial results we released earlier this morning and in the company's SEC filings. We undertake no obligation to update any forward-looking statements made during this call to reflect events or circumstances that may arise after this call.

Now, I'd like to turn the call over to our Chairman and Chief Executive Officer, Bob Carr.

Robert O. Carr

Thank you, Maria. And good morning, everyone. I'd like to thank you all for joining us today and for your interest in Heartland. The fourth quarter was another strong quarter as we put the finishing touches on the most profitable year in Heartland's 15-year history.

For the quarter, we reported adjusted net income of $17.2 million or $0.44 per share, increases of 22% and 26%, respectively, over the comparable year-ago quarter. And for the full year, we reported adjusted net income of $75 million or $1.87 per share, both up 48% from full year 2011 results. These results reflect outstanding performance across the board.

Total processing volume continues to increase as we grow our new business and improve merchant retention. Our SME card growth strategy focuses on providing our merchants with outstanding service and a full complement of the products and services that simplify and improve the business operations they most highly value.

New margin installed was up 11% for the year to the highest level in 4 years, as we continue to set new relationship manager productivity records. Similar productivity improvements were achieved throughout our operations. As a result, this year, we far exceeded our operating margin improvement objectives with a full-year operating margin of 20.8%, an improvement of 4.6% over the full year 2011 operating margin of 16.2%. This surpassed our 20% intermediate-term operating margin target.

Our success reflects our ability to help merchants improve their business operations from a comprehensive suite of valuable business services. While payment processing remains the focal point of our strategy, our non-card businesses such as Payroll, School Solutions, Campus, Prepaid Card and Equipment Sales, now comprise almost 20% of our total net revenue, up from 16% 1 year ago and are likely to reach as much as 30% over the next 1 or 2 years.

In the fourth quarter, we strengthened our ability to compete across these various markets, with 2 strategic acquisitions. The acquisition of ECSI strengthens Heartland Campus Solutions by adding a number of complementary, cost effective, customized payments processing solutions to our existing portfolio of financial aid disbursement, campus card and payment processing solutions. Heartland is now in the unique position of offering colleges and universities one-stop shopping that will streamline processes and increase operational efficiencies while providing enhanced convenience and value to students.

Adding ECSI's client portfolio has boosted our roster of college and university relationships to over 2000, where the relationships with the finance office provides access to the key decision maker for most of our campus products. The combined organization can better leverage our operational capabilities to achieve scale economics and more efficiently support our growing client base. ECSI also adds experienced leadership, with John Lynch, President and CEO of ECSI, joining our campus management team. Finally, this combination will lift campus' aggregate annual revenue to more than 5% of our total net revenue.

Our Ovation Payroll acquisition is truly transformational in nature from a number of perspectives. Ovation offers payroll tax preparation and administration, Internet payroll reporting direct deposit and serves over 10,000 clients in 48 states. Our consolidated Payroll business will now serve more than 22,000 clients, enabling us to more quickly leverage our proprietary payroll platform and reduce operating costs.

In addition to being an important element in our strategic growth plan, the acquisition immediately brings aboard additional veteran payroll industry leaders. Tony Tortorella, President and CEO of Ovation Payroll, will be leading the combined Payroll services operation, reporting to David Gilbert.

Ovation also represents another opportunity to tweak our innovative sales strategy. With Ovation's dedicated experts, our relationship managers will now have product specialists to assist them in their payroll sales efforts. Product specialists will continue to sell the payroll solution directly while also providing critical product expertise to the SME sales organization.

In addition, Ovation has an established affinity partner network, which consistently generates high-quality sales leads that can be effectively captured with our national sales organization. This is a model, we believe, will strengthen our entire sales organization.

Like Campus, with Ovation, our own payroll services will now represent well above 5% of our aggregate net revenue, and sets the stage for Payroll to become an increasingly important business line for Heartland.

These acquisitions represent strategic actions we've taken to achieve our broader vision that an accelerating convergence of payments and operational systems is creating opportunities for solutions and help merchant simplify and improve their business operations. As both a successful technology integrator and owner of the last mile to the merchant, we believe we have proprietary competitive advantages that place us in a powerful position to capitalize on this market dynamic.

Over the past 6 months, we have been building a senior team that will enable us to separate what is real from what will never get out of the headlines and into the marketplace. We've been engaged with many of the names making these headlines, including LevelUp, Google, Paypal and Dwolla, they all have one thing in common, the lack of an effective channel through which to distribute their products.

We've heard many interesting suggestions on how we could benefit by providing potential partners access to the multitude of merchants who rate Heartland one of the most trusted names in the payment industry. We're going to stick to the philosophy that has built our franchise, and that is to keep the best interests of our merchants in mind.

You only need to look at how the industry reacted to Durbin to understand the real fundamental difference between Heartland and the competition. Heartland is the only processor to give every dollar back, every Durbin dollar back, to every merchant, no questions asked. And that now exceeds over $350 million.

So we're going to continue pursue these opportunities that we believe provide enduring value to our merchants and create value for our shareholders.

And now, Maria, let me turn the call back over to you.

Maria Rueda

Thanks, Bob. For the fourth quarter, we reported GAAP net income of $15 million or $0.38 per share. Adjusted net income for the quarter was $17.2 million or $0.44 per share, up 22% and 26% respectively from $14.2 million or $0.35 per share for the fourth quarter of last year. Fourth quarter net revenue increased 8.4%, driven by growth in SME card volumes and continued strong growth in non-card revenues, led by Heartland School Solutions.

As Bob briefly mentioned, non-card revenue has shown robust growth over the past year, increasing to almost 20% of total fiscal 2012 net revenue and likely to reach as much as 30% of net revenue over the next 1 or 2 years, primarily as a result of rapid non-card business growth and the recent Ovation Payroll and ECSI acquisitions. SME card revenue growth reflects a 5% increase in transaction processing volume as we continue to increase new margin installed, experience positive same-store sales and keep volume attrition in check.

For the year, same-store sales grew 2.2%, which was better than our 1% to 2% guidance for the year. We are expecting 1% to 2% same-store sales growth again this year. Due to lower-than-projected processing volumes and some fluctuation in K-12 revenues, total net revenue for the quarter was a bit short of our expectations.

Productivity and efficiency initiatives continue to limit the increase in expenses. For the quarter, processing and servicing costs were up just 1%, while general and administrative expenses were also contained, up just 6.7% from 1 year ago. As a result, operating income increased to 29.6% from 1 year ago, as the operating margin expanded to 19.3% from 16.1% 1 year ago. For the full year, the operating margin came in at 20.8%, which exceeded our 20% intermediate term objective.

Cash flow was also up, with management's measure of our operating cash flow of $27.1 million or $0.70 per share for the quarter, up almost 15% from the last year. And our free cash generation amounted to $17.6 million, up 8% from last year's fourth quarter.

CapEx in the fourth quarter was $9.5 million, up roughly $2 million from the same quarter 1 year ago. Our substantial cash flow and strong balance sheet are being used to create value and reward our shareholders through dividends, share repurchases and strategic acquisitions.

In the quarter, we utilized $54 million to repurchase nearly 2 million shares at an average cost of $27.63 per share. Also, we drew down $82 million of our revolving credit facility to fund the Ovation and ECSI acquisitions. As it now stands, we have $58 million of borrowing capacity remaining on our existing facilities. As we have previously articulated, we intend to use our free cash flow primarily for dividends and share repurchases going forward.

Also, on January 31, we sold Collective P.O.S., the Canadian company we purchased in 2008. We received $18 million of cash, and recorded a gain of almost $8 million that will appear in our first quarter results.

Let me wrap-up with our guidance for 2013. For the full year of 2013, we expect net revenue growth of 10% to 12% to approximately $600 million to $610 million. Our fiscal 2013 GAAP earnings per share are expected to be between $1.92 and $1.96, net of after-tax stock compensation expense of $0.22 per share for the year.

Implicate in guidance, is a modest reduction in our operating margin for 2012's strong levels. This is the result of a number of factors, including the acquisitions of ECSI and Ovation, which will result a near doubling in our acquired intangibles amortization to $0.15 per share in 2013. Further, the pro forma operating margin of ECSI and in particular, Ovation, where the operating margin is currently single-digit, dilute our operating margins while the sale of CPOS eliminates an operation that was above our corporate average.

And finally, operating margins in fiscal 2013 will also be impacted by the increased investment in the growth initiatives we have been highlighting. On a net basis, we believe the benefits to both long-term revenue and earnings growth resulting from our new businesses and strategic investment spending far outweigh any incremental short-term margin concession and in fact, will hasten our achievement of a 25% operating margin over the medium term.

Now, I'd like to return the call to Bob for some concluding remarks.

Robert O. Carr

Thank you, Maria. 2012 was a year of remarkable progress at Heartland. In addition to our record financial performance, we reached new heights in productivity, deepened our management team and made significant investments that have added new and existing resources and capabilities.

In this rapidly changing payments industry, we are confident that we are building a strong foundation of technology, people and relationships that will be the key ingredients to long-term market success.

Before closing today's call and opening it up to questions, I am pleased to announce that the Board of Directors has increased the quarterly dividend by 17% to $0.07 per share. The new dividend is payable March 15 to holders of record as of March 4. And finally, I'd like to thank all of the great Heartland team members for making these powerful results positive.

Audrey, we are now ready to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go first to Dave Koning at Baird.

David J. Koning - Robert W. Baird & Co. Incorporated, Research Division

I guess, first of all, just competitive threats obviously being kind of front and center the last several months now, it seems pretty clear that by your attrition numbers, you're really not seeing much of an impact there, but gross margin installed was a little weaker this quarter than it's been over the last few quarters. And maybe you could just comment a little bit on the trends there and maybe on the sales reps, up just slightly this quarter, kind of how you see the sales reps ramping over the year?

Robert O. Carr

Right. We actually slowed down our recruiting processes in the fourth quarter to gain a little bit of traction. We restructured the way we're going to market with some strategies that we think are going to be very helpful over the next couple of years. We felt like it was important to get that structure right. I think we've got it there. And so our margin installed was only up -- was up less than the rest of the quarters but we've already seen that picked up in the first quarter. However, I think a nice model going forward with our sales -- the sales, the senior product advisors, we call them, the SPA arrangement, where we have experts in the field with some of our non-payment products, helping people to get educated on selling the different products. So we expect to have a lot more multi-product sales going forward as a result and think that's going to really pay off for us.

David J. Koning - Robert W. Baird & Co. Incorporated, Research Division

Okay, so we shouldn't be surprised to see you return to 10% plus GMI going forward?

Robert O. Carr

Correct.

David J. Koning - Robert W. Baird & Co. Incorporated, Research Division

And then secondly, just a couple of things, just on the acquisition impacts. I guess, first of all, how much acquisition-related revenue do you expect in 2013? And -- I know it's complicated, but maybe net of the CPOS. I guess, what in-total is kind of your net incremental revenue from all the acquisitions and divestitures and then what is kind of core organic growth in 2013?

Robert O. Carr

Right. Dave, you do have some cross currents with the 2 acquisitions but netting out an unknowable number for what CPOS would have represented for the year. But it's really -- it's going to be 30-plus-million-dollars net, in terms of growth in net revenue. So that really -- somewhere a little under 1/2 of our -- of the guided growth is coming from acquisitions and the remainder is organic.

David J. Koning - Robert W. Baird & Co. Incorporated, Research Division

Okay, good. And then the final question, just the acquisitions obviously diluting the margins a bit, and so it looks like from what you've said, that if margins are flat to down in 2013, that EBIT growth next year will be reasonably similar to net income -- or I'm sorry, to revenue growth. So if revenue and EBIT are both in that 10% to 12% range, how do you get to the EPS? I mean, is it just pretty material buybacks? Or kind of what's happening below the operating line to really drive the big EPS expansion?

Robert O. Carr

Well, EPS is absolutely a driver. If you look, the $50 million -- $54 million, I think, we spent in the fourth quarter, 2 million shares repurchased. So we're going into the year with a good reduction in our shares outstanding. And then, are anticipating completing the $50 million -- we did about, out of the $50 million authorization that the board made in November, we used about $20 million, and we expect to use the remaining $30 million during the course of the year.

David J. Koning - Robert W. Baird & Co. Incorporated, Research Division

Okay. Great. And just final quick one, interest expense for 2013?

Robert O. Carr

$3 million -- around $3 million probably. Of course, it depends on acquisitions and interest rates and only another 1/2 dozen unquantifiable things. But our run-rate basis right now would be about $3 million.

Operator

And we'll go next to Tim Willi at Wells Fargo.

Timothy W. Willi - Wells Fargo Securities, LLC, Research Division

I have 2 questions. First, going back to the margin, Maria, would you expect that EBITDA margins would be up relative to your comments about the acquisition intangibles? I know you don't specifically talk about that. Margin hasn't been a part of the discussion with Heartland. But given the acquisition intangible you called out, would we think about the EBITDA margin being flat to up slightly?

Maria Rueda

Well, we're thinking that it will be up. But we will continue to call out now that we have a significant portion of our intangible related to our purchases, we'll certainly be talking about what that may be.

Timothy W. Willi - Wells Fargo Securities, LLC, Research Division

Okay, that's great. And the second was around sort of the partnerships you guys have, the investment spending that you called out, which I think you've alluded to now for a couple of quarters. I guess, Bob, or Bob or Maria, as you look at the landscape, have you -- are the dollars that you're spending or think you will spend on investments, is that pie getting bigger or do you think you've sort of narrowed it down to the best models and the best horses to place a bet on? Just trying to get a feel for what that creep might look like over time. And just sort of your thoughts about the quality of the opportunities that are out there that are being brought to you?

Robert O. Carr

Right. Well, let me comment first. Bringing in the 3 group presidents, we have to give them resources to build out the areas of the business that we want to focus on. And I'll use e-commerce as an opportunity. We have never had the personnel here at Heartland to focus on e-commerce in an effective way. And Ian Drysdale came over and he has built a fantastic e-commerce team. We are already seeing the benefits of that in terms of new installations and we expect that to be a major part of the business. Grocery is another area that we were never in. We have some expertise now there. That probably isn't going to yield a lot of results in 2013, but we expect that to yield results in 2014 and beyond. So we're investing in some core businesses that our competition has been cleaning our clock on forever. And we're moving into those markets in a significant way. And then on top of that, we're doing some things in mobile that are less -- you can't really point to the revenue. But we want to be there in that space, and we want to be ahead of the game so that our merchants can benefit from things that are working. We're investing in relationships with folks like LevelUp and some other mobile technology providers. We don't know where they're going to wind up, neither does the industry, but we're making the investments. So I think we have a combination of investments of pretty predictable outcomes and some that are not so predictable. We think it would be a really big mistake to not be making these investments because we do want to be one of the top providers and we want to be a full-service provider in payments and also take advantage of all these adjacent technologies that now are becoming part of the payments chain. The idea that we can take a transaction, the value of a transaction, and increase its revenue to us by as much as 50%, by adding couponing and adding loyalty services for our merchants, is extremely attractive. That's the way the industry is headed and I think we're in a very nice position to benefit from those investments later this year and into 2014 and beyond.

Robert H. B. Baldwin

Let me just add briefly, right now, and in the first part of this year, you're in that sort of worst part of the cycle, of the investment cycle, where you really can't point to much in the way of incremental revenue, but you've got the spend. Not -- the spending won't, all of a sudden stop, it'll probably grow in the future. But as you look out towards the back part of 2013 and certainly, '14, our plans and intentions would be to have revenue growth that will be absorbing that. So it's really that temporary mismatch between what we're spending now and the benefits that will be achieved later down the road.

Timothy W. Willi - Wells Fargo Securities, LLC, Research Division

So if we think, even though you guys don't give quarterly guidance to sort of conceptually think about the impacts throughout the course of the year, like you just said, Bob, there's probably a little bit more pressure around the margin in the front half and a little bit of, I guess, you could say, the need for lift in the back half relative to the first?

Robert O. Carr

Yes, probably right. And of course, we always have our seasonally weakest first quarter. That's -- and don't forget, last year was a very good first quarter. We had an extra day in the leap year, we had the benign weather that, as we sit here today with the snowpocalypse coming our way or something silly, people are getting crazy again. But the winter is not being nearly as benign. So it's going to be a tougher first quarter for that reason, typically, and I think there's some of that, Tim. We're not going crazy on the spending, it's really just that we aren't getting the revenue benefit that we're expecting later.

Operator

We'll go next to Roman Leal at Goldman Sachs.

Roman Leal - Goldman Sachs Group Inc., Research Division

So first on the acquisitions you closed and the commentary that Maria provided on relative margins relative to kind of the consolidated average, what's the -- how do you want those margins to look maybe 1 and 3 years out? Help us think through the process to gain those closer to the kind of consolidated average? And are some of these models -- I mean, if you look at some of the payroll models that we cover, obviously, well above 20% operating margins, can you get that in your Payroll business?

Robert O. Carr

Absolutely. The -- I don't want to leave you with the wrong impression about Ovation Payroll. They have been historically very, very focused on growth and have been achieving substantial growth. This year, we have challenges in terms of achieving consolidation cost savings. Because they have their platform, we have ours, in an agreement. That was a great experience because their view of the 2 platforms was that we ought to combine on to the Heartland platform, which is a great validation of what we've been building on our own and as you may know, these acquisitions when in essence the -- their management team is taking over, they're saying they like Heartland's platform better. So that was the validation of what we have. As we look towards the end of the year, we can -- we'll be starting to put new merchants, all, on the Heartland platform. We can do that now in part because there are some front-end pieces that interact with those lead generation sources that we talked about that Ovation has and we need to bolt some front-end pieces onto our platform. But then, in the first half of 2014 is when we expect to do the consolidation. We see that driving substantial cost savings. We have a great platform that has -- only the advantage, that right now, there's only about 12,000 merchants on it. When we get the 22,000 plus the growth we're anticipating in the next year, that really drives a lot of cost savings. So Payroll business, absolutely in the -- whether it's in 2014 or maybe 2015, certainly, we'll have a 2-handle on its operating margins, and we're well aware of the operating margins that our larger competitors have and we'll aspire to get to those higher levels. But we think this could be a very much contributor to our getting to 25%. And ECSI in a similar way, they're very close to overall corporate average now and there are some consolidation cost savings and there are also some revenue opportunities we see with cross-selling the different products. That we think that, that business, the Campus business overall can also be a mid-20s kind of operating margin business in the not very distant future.

Roman Leal - Goldman Sachs Group Inc., Research Division

And as a follow-up to the commentary on your partnerships and the potential to increase your revenue per transaction, if you start adding some value-added services there, have you -- first of all, how would that work? Would it be the partner that would charge the merchant for the value-added services? Or would it be Heartland charging the merchant directly? And then secondly, have you actually approached some of your merchants, maybe, in your current pilots and received any feedback or pushback on potentially increasing that revenue per transaction?

Robert O. Carr

Yes. The answer to your last question is, yes, we have, and merchants are happy to pay a little bit more money if we're helping to drive their revenue, which is what we're doing. The CPG companies are happy to deliver coupons that are redeemed. And that's the direction that a lot of us are headed in. This industry is driving new revenue opportunities to the merchants where the cost of getting that revenue are paid for by their vendors. That's been the grocery store magic with the gasoline over the years and that concept is coming to the retail market. And we're leading -- one of the leaders in that effort, I believe.

Roman Leal - Goldman Sachs Group Inc., Research Division

And the last one is just on the acquisition pipeline or strategy going forward. You have Payroll and Campus, and also K-12 all kind of either nicely contributing now. Is the goal to expand in those 3 verticals? Or is there another vertical that perhaps you want to get bigger in?

Robert O. Carr

Yes, we want to not have to invent the whole mobile world ourselves. We need to take advantage of the technology that's out there. And there's a ton of it being developed. We want -- we don't have a pipeline of acquisitions, but we want to build out our capabilities to help our merchants benefit from the change in the POS environment and all the different adjacent environmental technologies around that such as communications. And just all the different services now that are cloud-based, we want to enable those services for our customers. We are looking for acquisitions in those areas. And if we have an opportunity to find other acquisitions that would fit into our Payroll or Campus business or School Solutions business, we would take advantage of those. We're looking for the right opportunities. I think we've done a really good job the last few years of buying properties that were integrated easily into the company. I think that's what we just did with these other 2 acquisitions and we'll be looking for those, more of those. But our plan for 2013 is pretty solid and doesn't include a lot of new acquisitions at all in this existing model. If something comes up, we'll take advantage of it, but it's not in the pipeline.

Operator

We'll go next to Steven Kwok at KBW.

Steven Kwok - Keefe, Bruyette, & Woods, Inc., Research Division

I just had a quick follow up on the networks services business. It seems like there was little bit of a decline quarter-over-quarter with regards to revenues and the -- for the processing volumes and transactions. I was wondering if you could just provide a quick update on that. If that is a seasonal move? And how should we expect things to go going forward?

Robert O. Carr

It was -- I think that you're really talking about -- I mean, on a linked-quarter basis, it was down. And that's not unexpected in the business. Summer is the peak driving season and things like that. And year-over-year, the business is -- the net revenue is down but has been tracking for the year as well. So nothing particular out of line with the Network Services net revenue. We are very focused this year on turning that around. It's been a challenging area. But it's one that we've had some major investments in technology, to have a better solution. And that's being realized, actually, a substantial rollout of new technology that really completes our product sets for those mid-market merchants that we're really targeting. So we're pretty excited about turning this trend around. And then the last thing I'd mention is you will be impacted still by fluctuations in gas prices and generally, the fourth quarter, the gas prices were lower.

Steven Kwok - Keefe, Bruyette, & Woods, Inc., Research Division

I was just wondering if around the Heartland Summit, are you guys planning to have one in 2013?

Robert H. B. Baldwin

We are. We have one scheduled for middle of October.

Robert H. B. Baldwin

We're on an 18-month cycle there. It's where our heads are at. So there is a likelihood, I'm not guaranteeing it, but the 2014, we probably -- we may well not have a summit in 2014. Makes a lot of sense, because if we -- on the 18 months, we'd be doing it in the first quarter of 2015, when -- and you'd have some pre -- some expenses prior to the summit, but that's keeping that 18-month schedule.

Steven Kwok - Keefe, Bruyette, & Woods, Inc., Research Division

And in terms of from expense-wise, is around like $2 million?

Robert H. B. Baldwin

In aggregate, those run north of $3 million.

Operator

We'll move next to Chris Shutler at William Blair.

Christopher Shutler - William Blair & Company L.L.C., Research Division

I might have missed this, but the EPS accretion from the 2 acquisitions that you're embedding in the guidance for '13?

Maria Rueda

That's in the $0.13 to $0.15 range.

Christopher Shutler - William Blair & Company L.L.C., Research Division

And a couple of questions on ECSI. First, I guess, I'm wondering if the decision-maker at the college for some of their loan management products, is it the same decision-maker that decides on a campus card sales? Is it typically the bursar or CFO?

Robert H. B. Baldwin

There are multiple decision-makers on that product. But it gets us -- certainly, the bursar or the business officer is involved in that decision. So the answer is partially, yes.

Christopher Shutler - William Blair & Company L.L.C., Research Division

Okay, okay, fair enough. And then, I guess, secondly on ECSI, I think, not 100% sure about this, but I think they had a refund product themselves for the students, just curious, is that...

Robert O. Carr

Yes, as a matter fact ...

Adam J. Letson - Piper Jaffray Companies, Research Division

Had that gotten much traction at all? Or what's going to change now that Heartland's the owner?

Robert O. Carr

Yes, actually, they had a very strong tuition payment plan, which is what we were looking for, and we developed a relationship with John Lynch with that product and he liked our refund product better. So that's how the conversation got started between our 2 companies. And we have a stronger platform for the tuition -- the reimbursement card product. But they had such a strong tuition payment plans, and of course, the loan payment processing. They were just a really great match, also, with our sales organization. So, I think, together, we have a really competitive product to the other ones that are out there and we're winning some nice accounts as a result of that.

Adam J. Letson - Piper Jaffray Companies, Research Division

Just a couple more quick ones. The sold CPOS, I think you said it's about an $8 million gain that's going to appear in Q1, I just want to confirm that, that is included in your guidance?

Robert H. B. Baldwin

That is not. We've left that out of the guidance because there's no -- and let me address CPOS more broadly. That was a really attractive acquisition, we felt, back in 2008. The intention was to take -- they were essentially a sales-only iSO that was relying on others for underwriting, risk-taking, sponsorship, processing. And our intention when we bought 70% was to help them move up the food chain as it were in the acquiring world, provide, get them sponsorship, provide processing, take on the underwriting function. Two things happened in later 2008 into 2009. First, we bought Network Services, which changed the profile of what we could and wanted to invest in from a technology standpoint. And the second thing of course, was the unfortunate breach. The combination really set our plans back dramatically in terms of what we could do to work with this Collective P.O.S. team. And so then we got to the point where 1-year-plus ago, we had either to really invest a lot in terms of platform and probably acquisitions if we wanted to really grow that business. They're growing nicely, but it was still very, very small relative to our overall net revenue. So I think we've been pretty consistent in articulating what we've decided internally that we want our business lines to either be or have a near-term prospect of becoming at least 5% of our net revenue. And on their own, they had no reasonable prospects for doing it and the cost of getting them there in terms of getting -- making acquisitions in the market that there aren't a lot of plus the platform investments when we have other -- lots of other exciting alternatives, the decision was made, "Okay, it's going to be very tough to devote those kind of resources into Collective P.O.S.," then we've turned to the other side, "Okay, let's sell it." And obviously, the gain indicates that we had invested in a really good operation. Elavon was a natural buyer. They've been the processor for a lot of what CPOS was producing. I think they named CPOS their ISO of the year last year. And so really was a transaction that in many ways we regret giving up the profitability and the growth. But it was the result of a good disciplined process and we wish them the best while we focus on other bigger opportunities for Heartland.

Adam J. Letson - Piper Jaffray Companies, Research Division

And then last questions on the Ovation deal. Just curious to get the kind of earlier reaction amongst your RMs in terms of just what they think of the deal. And then what kind of early educational efforts or efforts are you undertaking to ensure that, that revenue ramps as you expect over the next, let's call it, 12 to 18 months?

Robert O. Carr

Well we closed it at the last minute of December 31. So we didn't have a lot of chance to do a lot of work until after the holidays. The answer is that most of our RMs are pretty thrilled about the acquisition because they're going to have expertise available for them that they've never had available before in terms of calling on bigger payroll prospects and just learning the different systems. Also, Ovation brings us this affinity network. We've never really been able to break into the CPA firms and the insurance companies and so on, and the Ovation folks are experts at doing that. That's their model. And so not every -- we have a -- a couple of our sales people would prefer to not have a new player in the marketplace. But that's definitely just a few. In terms of our rolling it out, we are in the middle of doing that right now, we just announced our new FPA program that I mentioned earlier, that's just, really, was released this week, and we're implementing it now. So we have high expectations for it. But it's too early in the game to really say that we have any results yet.

Operator

[Operator Instructions] And we'll go next to Greg Smith at Sterne Agee.

Gregory Smith - Sterne Agee & Leach Inc., Research Division

First question, just what are your thoughts on surcharging? What we may ultimately see within your merchant base?

Robert H. B. Baldwin

Good question. We're going to -- we're sort of caught in between, frankly, the settlement. And the merchants, where the platforms are not ready for surcharging, we're working hard to make them ready. We're getting very modest incoming commentary from merchants who want to do it. And the strictures -- the restrictions on it are, I think, going to make it a very modest uptake in most of our everyday kind of merchants, restaurants and retailers, et cetera. You probably will see it in environments where the customer is more captive to using a card. One that comes to mind immediately, it'll be fascinating to watch what the airlines do. We don't process for airlines. So right now, modest demand, lot of confusion out there, but we're working hard to prepare ourselves so that we can take care of a merchant who want to undertake surcharging.

Robert O. Carr

I'll just add, that in 2003, if you recall, merchants were given this opportunity. They were screaming, they didn't want to have to take all kinds of cards. So merchants were given the right to accept debit or credit and not the other, if they so choose. We didn't have one single merchant select that as far as I know. And at this point, I'm not aware of more than just like under 5 merchants that even brought up the topic of doing surcharges. Like Bob, I think there are niches, such as government, units are going to now able to take cards with a surcharge. We don't expect a lot of volume to come from that. There will be some. There's actually a move on for surcharging debit, which is different from the settlement, but there's more of a move to do that on the back end and there's some products that are in the market in that area that we're looking at trying to match that functionality. So it's to be seen but my view is that we're not going to have much of an impact on the surcharging and credit with our current base.

Gregory Smith - Sterne Agee & Leach Inc., Research Division

And then just thinking about your EPS guidance for this year, over the past 1.5 year, your guidance has actually proven to be very conservative. So I guess the first -- the question is just, where could your guidance for this year be conservative? And where does the risk lie in potentially missing it, that would be helpful.

Robert H. B. Baldwin

Well, we're trying to be reasonable in our expectations and cover for unexpected spending requirements and things like that. I think that we feel good about the revenue side of things. And so the risk could be on some either, if you had an unexpected deterioration in the margins, is always the risk in the business. That's a very competitive business, and has been for years, and will remain. And so there's always a risk there. But we're not, if you look at recent trends, the margin deterioration had been very modest to virtually nonexistent. And so we're not expecting that, but you do want to be prepared in case something turns for the negative and to try to condition our guidance accordingly.

Maria Rueda

And I would just add that I think we run a very well organized ship here. But sometimes there are macroeconomic factors that come into play, for instance, in the fourth quarter, I think a lot of institutions were feeling the aftermath of Hurricane Sandy. And also, there was also a lot of uncertainties regarding the looming fiscal cliff, and that's the sort of thing that's very difficult to incorporate into any sort of forward-looking guidance.

Gregory Smith - Sterne Agee & Leach Inc., Research Division

And you have all the normal risks, including merchant losses and those kinds of things?

Robert O. Carr

And the final thing I would throw out is, there is some chance, we're not -- we don't see it right now, but it-- we'll work out a lot of really interesting initiatives. And we do have plans for rolling those out. If you saw -- if we saw an opportunity to roll something out much more aggressively, to push an initiative much more aggressively, you get into that situation which always exists in our business, which is you have to spend the money upfront in order to drive the revenue in the future. I don't see -- I mean, we're planning on some aggressive rollouts this year, so it's not like we're not incorporating those into our planning, but if something came up where we saw a substantial opportunity to take market share to really drive the traction of a particular new solution or product, that might argue for increasing spending in the near term in order to make that succeed over the -- in the near -- soon, but not quite as quickly.

Operator

And we'll moves next to Tom McCrohan at Janney.

Thomas C. McCrohan - Janney Montgomery Scott LLC, Research Division

How much of your dollar volume is generated in the, say, tri-state area or the area that was adversely impacted by Hurricane Sandy?

Robert O. Carr

Probably -- it's under 10%. I've said, what you have defined as -- because if you look -- I think New York is under 5% of our total volume and-- because one of our 4 biggest states, the other 3 being California, the largest, Texas and Florida. So New Jersey would be smaller than that. So probably -- and much of New York was not that heavily impacted. So overall, frankly, we didn't see a substantial impact in terms of our sales and revenues from Sandy. October same-store sales were the strongest of the quarter. And so it's hard to see an impact there.

Robert H. B. Baldwin

A technology comment, 200 of our merchants in New Jersey now have our mobile product, which is the Square competitor, where you have a card swipe on your cell phone. And when Sandy took out the power and a lot of our merchants were able to go to their mobile devices to continue to process transactions even though we couldn't get to them physically. So that's something that wasn't available during Katrina, for example. So not all merchants were out of business because their credit card machine was not workable. I just think that's an interesting thing.

Thomas C. McCrohan - Janney Montgomery Scott LLC, Research Division

Yes, that is interesting. And just a follow-up on same-store sales, your guidance is reasonable, I would say, strong relative to your comments in the past about saw tooth patterns in same-store sales growth in 4 of the 11 sub-merchant categories that you break down for same-store sales, was it -- were in negative territory for the fourth quarter? So I'm wondering if that was Sandy-related or if you're seeing trends in January, that are giving you confidence that same-store sales in the aggregate basis are going to be in line with what you reported in the fourth quarter or better?

Robert H. B. Baldwin

I -- we don't try to speculate on where that's going. We do not feel it's hard. We do not feel that the environment is getting worse. We don't have our same-store sales results for January at this point, but our overall volumes in January, where the growth rate for both debit and credit was -- or for combined rather, was higher, well higher than the growth rate in the fourth quarter. Interestingly, more credit growth in January than debit growth, which has not been typical. But so January was a pretty decent start. And we don't see, much as we didn't see last year, the strong part strength in the -- the strength in the early part of the year, we didn't anticipate that, it came back to things. We don't anticipate any further weakening from the current kind of levels.

Operator

We'll go next to my Mike Grondahl with Piper Jaffrey.

Michael J. Grondahl - Piper Jaffray Companies, Research Division

First question, could you just repeat what you said about the amortization expense in 2013?

Maria Rueda

We are going to have -- because we've just only [indiscernible] very strong strategic acquisitions in December of 2012, we will have amortization expense, additional amortization expense, related to those purchases. And that will probably be in the 10% to 15% range.

Robert O. Carr

Well, $0.15.

Maria Rueda

Yes, it will $0.15.

Robert H. B. Baldwin

That's up about double from the intangible amortization expense we had in 2012.

Michael J. Grondahl - Piper Jaffray Companies, Research Division

Okay, that's what I thought I'd heard double. And then secondly, I think in the earlier prepared remarks, there was a reference made to some outside entities approaching Heartland basically trying to leverage Heartland's sales force or access to small retailers, can you give us an 1 or 2 examples of what some of those entities are, and what they want to offer and use you for?

Robert H. B. Baldwin

Well, this has been true for Heartland for a long, long time. Because we have a large, single-branded employee-only sales organization. We don't have control of our people, but we certainly can direct them and put requirements out there. So virtually anyone that wants to sell a product to a merchant comes to us. We literally got people coming to us every month, wanting us to distribute their product. And we have to obviously select products that our sales people can sell and earn a good reasonable amount of commissions from and that the company can still make a viable profit margin. So virtually anyone that wants to have a face-to-face relationship with a merchant comes to us. So we are working with just about -- just about everybody you can think of in the payments world out there that isn't our direct competitor, will like us to distribute their product. And we named 4 companies in their prepared marks and we'll leave it there. But there are others that we don't want to name them, because we don't want to give the wrong expression. But we talk to just about everybody, and we're in the unique position, and I think the enviable position to be able to pick and choose what it is that we want to distribute. And it's hard to find the right product because many of these companies, as brilliant as their boards and their management teams are, they don't realize that it costs them serious money to go visit merchants and sign them up. And their business models don't really allow for enough sales expense to make a financial arrangement that makes sense for us and our sales team. I'm not sure if that answers your question but...

Operator

And we'll move next to Reggie Smith at JPMorgan.

Reginald L. Smith - JP Morgan Chase & Co, Research Division

I guess I have a few questions. I guess when you guys gave your long-term outlook at your Analyst Day last fall, you kind of talked about 12% to 15% net revenue growth, and you said that would include acquisitions. I guess, thinking about your 2013 guidance, and the mix of inorganic and kind of organic growth, is that a fair approximation for what you think the growth mix will look like in coming years? Or is there something going on, this year in particular, that may be depressing organic growth?

Robert H. B. Baldwin

Reggie, we are very focused on improving our organic growth. And that's what we're spending these resources on, trying to get into new verticals, spending what we can do in payroll. As an example, we think the footprint in the School Solutions is great as well as K-12. So I would say that we are looking for an improved -- an improving rate of organic growth and a heavier percentage of our growth going forward to be from that.

Reginald L. Smith - JP Morgan Chase & Co, Research Division

And I guess that kind of leads into my next question with the kind of K-12 opportunity. I know you guys talked about having 30% kind of market share amongst the schools, but it sounded like your, I guess, wallet share relative to total spend was pretty low. Can you kind of give us a sense of what your penetration is within the K-12 segment to kind of help us understand what the opportunity really is there?

Robert O. Carr

Right, good question, actually. It's low. The competition is checks and cash. The companies that we acquired were primarily focused on the Point-of-Sale business. And they didn't really push payments the way that we are. So we have 2 major opportunities. One, is to grow the number of parents who want to use the site to make the payments and also to view what their children are eating in school or at least what they're buying. And the other opportunity is to expand the payments opportunity within each school to take payments for uniforms, for club memberships, for tickets, all the student activities. So we have 2 growth opportunities, they're both extremely significant. And so we think there's a tremendous opportunity to grow that with the 30% market share of schools that we have.

Reginald L. Smith - JP Morgan Chase & Co, Research Division

And if I could sneak one last quick last in, I guess on SME volume, and as I think about kind of revenues there, so obviously, excluding the education opportunity and some of the other things you guys are doing, I mean is that -- is it fair to think about that business as kind of a mid-single digit grower? Or do you think the SME, specifically, can kind of reaccelerate over time? And that will be my last question.

Robert H. B. Baldwin

SME card is right now driven by the volumes and we're very focused on growing that. Our productivity of our sales people in the cards installed in new merchants has never been higher, we need more salespeople and we're working very focused on that. Overall, SME will include Payroll, of course, as well. And give them loyalty solutions, those are growing faster and have greater growth. Getting back to it, overall SME is a tanker. It's going along at a certain speed. Getting it to speed up is hard. It's slower to happen, but we're very focused on moving that up towards the double-digit growth. But that's going to take a while.

Operator

We'll go next to Chris Brendler at Stifel, Nicolaus.

Christopher C. Brendler - Stifel, Nicolaus & Co., Inc., Research Division

I have a question on SME, if you could. Bob, I think you alluded to some changes, I think, in your strategy when it comes to the sales force and I was wondering if you could give us a little more detail on what you're planning on doing to reenergize the sales force growth effort. I think, when we go back to 1 year ago when Durbin was the hot topic, it sounded like you are planning on adding a lot of sales people this year to take advantage of that opportunity. That doesn't seem to have materialized, I'm just wondering if there's something structurally you're planning on doing to help energize that sales force growth? And is there anything you see that -- obviously, productivity is a key focus right now, but can you balance productivity with also helping grow that sales force? And I have a follow-up as well?

Robert O. Carr

I think we can grow the sales organization productivity. Our major focus is on multi-product sales with our specialist program. And we are -- we as I said, slowed down recruiting at the end of the last year deliberately. And I think -- and we have a really good momentum and a nice pipeline right now that we expect to yield results in getting that growth now.

Christopher C. Brendler - Stifel, Nicolaus & Co., Inc., Research Division

A follow-up, just can't help asking one question on Square. I know you focus on generating -- you're focused on a larger merchant, and I, in talking to some of the merchants and the ISOs out there, I get a wide range of answers. Some people say they're not seeing an impact, some people say that every small merchant they've talk to, Square is now part of the conversation. Any increase in the number of conversations you're having and educating your sales force on how to sell against Square and some of these cheaper alternatives? I think obviously, a real merchant account from Heartland is going to be a better solution for most larger merchants. But at the smaller end, are you hearing that complaint from your sales force or is that still just at the fringes at this point?

Robert O. Carr

There's a couple of merchant categories where the Square deal is attractive financially, where they actually lose money. Well it'll be interesting to see how long they continue to do that. But the marketplace for Square is a different marketplace than ours and we don't -- the answer is we don't hear a lot about Square from our core merchants.

Robert H. B. Baldwin

Anything with a low average ticket is at a very difficult price, the money...

Robert O. Carr

Well Square is losing big dollars on small ticket merchants and we'll see how long they're willing to do that.

Operator

And we'll take our final question today from Brett Huff at Stephens Inc.

Brett Huff - Stephens Inc., Research Division

One quick question. I'm trying to assess out the impact from the acquisitions, both the acquisitions and disposals on rev and profit. So I just want to make sure. I'm going to reiterate kind of what I heard and if you could correct me, that would be great. I think you said, Maria, that the net revenue impact would be a positive 30 from both the buy and the sell, is that right?

Maria Rueda

That's correct.

Brett Huff - Stephens Inc., Research Division

And then CPOS last year, was about $10 million, so we should we assume about $10 million for that as a negative, and about $40 million positive for the new deals?

Maria Rueda

That's reasonable to assume.

Brett Huff - Stephens Inc., Research Division

Okay. And then I think, you or Bob, I'm not sure who said it, that the new businesses coming on were single-digit EBIT margins, is that -- did I hear that right?

Maria Rueda

Well, yes, in our commentary, we did talk about the Payroll being in the single-digits at this point, because we haven't had the opportunity yet to obtain the integration synergies that we anticipate over the long-term. But the ECSI margins are accretive, they're not single digit.

Brett Huff - Stephens Inc., Research Division

And then, I guess you kind of answered my last question, which is we're not getting any real cost synergies this year and Bob, I think you said that maybe first half of '14 is when we're expecting that because there's -- can you just explain why we can't get them, is it the platform can't be moved or something?

Robert H. B. Baldwin

Yes, because the platforms -- well, our platform is not ready for all of their originations until late in this year, then you get into the January effect for next year but you never -- you don't mess around with the platform conversions while you're doing W-2s, so as a practical matter, we can't convert their portfolio until the first half of next year, of '14, and that's going to be a significant cost savings. But right now, we have to run 2 parallel platforms. And so we'll achieve some other -- obviously, some other synergies, but you have to have the different servicing centers to handle the 2 needs, the redundancies you just need to maintain until you can consolidate the platforms.

Brett Huff - Stephens Inc., Research Division

Okay, and then just one last question. On the processing and servicing cost, that was better than we expected. Structurally, how do we -- how should we think about that going forward into next year? I mean, it was meaningfully lower than we had modeled? How does that look relative to the run rate in the fourth quarter when you think about '13 on a percentage basis, I guess?

Maria Rueda

Well we've extemporaneously indicated that we have been undergoing long-term program to streamline our processing and servicing costs. And we really think that we achieved the low hanging fruit at this point. But we will continue, we've got the right bandwidth here, we've got very talented people. We're going to continue to refine those costs and keep our focus on those costs. So I would say don't anticipate any bellwether changes. However, we will continue to keep those costs as efficient as possible.

Operator

And that does conclude today's question-and-answer session. At this time, I'll turn it back over to management for any closing remarks.

Maria Rueda

Thank you very much, Audrey. I'd like to thank all of you for joining us this morning. And all of you, have a great day.

Operator

And that does conclude today's conference. Again, thank you for your participation.

Maria Rueda

Thank you.

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