Heartland Payment Systems, Inc. Q1 2009 Earnings Call Transcript

May. 7.09 | About: Heartland Payment (HPY)

Heartland Payment Systems, Inc. (NYSE:HPY)

Q1 2009 Earnings Call

May 7, 2009 8:30 am ET

Executives

Bob Baldwin – President & CFO

Robert Carr - CEO

Analysts

Anurag Rana - KeyBanc Capital Markets Inc.

David Koning - Robert W. Baird & Co.

[Tim Worgess] – Robert W. Baird

Julio Quinteros - Goldman Sachs

Robert Dodd - Morgan Keegan & Co.

Tien-Tsin Huang - JPMorgan

Thomas McCrohan - Janney Montgomery Scott

Brett Huff - Stephens Inc.

James Friedman - Susquehanna Financial

Franco Turrinelli - William Blair & Co.

Richard Cheever - SunTrust Robinson Humphrey

Robert Napoli - Piper Jaffray

Operator

Good morning ladies and gentlemen, at this time I would like to welcome everyone to the Heartland Payment Systems first quarter 2009 earnings conference call. (Operator Instructions) At this time it is my pleasure to turn the conference over to Mr. Baldwin; please go ahead sir.

Bob Baldwin

Good morning everyone, I would to like to welcome you to our first quarter 2009 earnings call. Joining me this morning is Robert Carr, Chairman, and CEO. Today Robert will begin our discussion with an overview of the quarter then I will return to go through some of the financials in detail before taking your questions.

During the course of this call we will be providing comments on the processing system intrusion we experienced. Our investigation of the processing system intrusion is confidential and ongoing. Consequently, beyond our prepared remarks, we are advising our participants we do not intend to make any additional comments.

Before we begin I would like to remind you that some of our discussions may contain statements of a forward-looking nature which represent our management's belief 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 to reflect events or circumstances that may arise after this call.

Now I would like to turn the call over to Robert Carr, Chairman, and CEO.

Robert Carr

Thanks Bob and good morning everybody. I’d like to thank you all for joining us today and for your interest in Heartland. These are certainly interesting times and we seem to be at the vortex of an economy that has been derailed, the dawning of an age of escalating cyber crime, and possibly some fundamental changes in consumer behavior that could be changing the nature of personal consumption.

I am pleased to report that despite these daunting challenges we sustained our record of consistent quarterly growth while pulling our entire organization together to address numerous outstanding issues that are critical to sustaining our success over the long-term.

In this morning’s press release Heartland reported a GAAP net loss of $2.5 million or $0.06 for the first quarter of 2009. This loss is after a $12.6 million of pre-tax charges or $0.20 per diluted share associated with the processing system intrusion.

Adjusted for these costs net income would have been $5.4 million or $0.14 per diluted share and in a minute Bob is going to go through the numbers in more detail. But let me quickly provide a high-level overview of our key performance metrics before updating you on our plans and strategy.

Bank processing volume in the first quarter was up over 17% to $15.5 billion primarily due to the network services acquisition as well as organic growth and a modest addition from our new American Express processing agreement.

This drove a 26.6% increase in card net revenue and a 23.4% increase in total net revenue in the quarter. Processing volume was up despite an unprecedented 7.6% drop in same store sales, a direct impact of the weak economy.

Negative same store sales comparisons will continue to be a drag on processing volume growth until we see an improvement in the economy. Total new margin installed in the quarter was down from year ago levels due to the weak economy.

For example, new installs in the first three weeks of January before we disclosed the breach, were down 15% from last year’s level. However new install softness was also a function of our emphasis on merchant retention in the quarter. This is an example of the significant business advantage our business model has relative to those of others.

Our model enables us to direct the activities of our W2 relationship and account managers, a privilege unavailable to processors that rely upon independently operated sales organizations with their own priorities.

In the first quarter our first priority for our relationship and account managers was to maintain our over 250,000 merchant relationships and I am pleased to report that their efforts were highly successful with both total and card merchants at March 31 up compared to end of the year levels.

Given the intensity of the competition’s pursuit of our existing merchant relationships in the first quarter we believe the organic growth in our franchise, we grew our small merchants 1.3% sequentially and 7.2% year over year.

We believe this organic growth is a testament to the strength of our value proposition, the loyalty of our merchants, and the hard work of our many Heartland teammates. At the end of the first quarter we had 1,181 relationship managers, up marginally on a sequential basis, and relatively flat from a year ago, while our team of account managers who install new merchants and manage ongoing relationship has grown 25% to 308 over the past 12 months.

I am extremely proud of the performance of our entire sales and servicing organization over the past few very difficult months. They are the engine that drives our model and we work hard as an organization to support their efforts and it is certainly rewarding to see them step up during these trying times.

We just concluded our Heartland Summit where we periodically bring our sales and servicing organizations together in sessions that focus on training development and culture building. In light of the recent challenges faced by this group I was [ratified] by their enthusiasm and optimism. At the Summit we introduced a number of new programs to spur growth.

For instance we have a new program to leverage our prior successes in vertical markets. Our goal is to become the leading transaction processor in a number of other verticals with key characteristics similar to the highly fragmented restaurant industry. And we conducted a number of educational sessions designed to improve the ability of our relationship managers to increase the number of merchants for which we are providing multiple products such as payroll, check, and loyalty products.

Other growth initiatives are also progressing. The American Express One Point product is now complete and we started processing for American Express under the new agreement effective January 1. We will be aggressively rolling out the Discover MAP product shortly as well.

In looking back at the Summit, I am convinced our sales and servicing organizations are better prepared and more highly motivated then ever before to compete in this marketplace armed with a wider array of products that will allow us to resume the growth to which we have all become accustomed.

While the Summit and new products are instrumental to our long-term growth their cost have weighed on current results. The cost of the Summit and new product development along with the noise in our cost of services attributable to the breach combined to reduce the operating margin to 9.3% in the first quarter.

Now let me update everyone on the processing system intrusion as well as our technology initiatives including our end-to-end encryption project.

Our defense of the claims regarding the processing system intrusion remains ongoing. Much of the legal work remains to be done and it is difficult to anticipate when these matters will come to a conclusion. We intend to vigorously defend any claims asserted against us and we believe we have meritorious defenses to these claims asserted to date.

This quarter we have taken a $12.6 million charge in expenses and accruals attributable to the processing system intrusion announced in the first quarter. The smaller part of these intrusion related expenses represents legal and other expenses related to the intrusion and less then $1 million related to fines assessed by Visa against our sponsor banks, which fines our sponsor banks are contesting.

More then 50% of this expense however relates to a fine that MasterCard assessed against our sponsor banks ostensibly because of an alleged failure by Heartland to take appropriate action upon having learned that its computer system may have been breached and upon thereafter having discovered the intrusion.

Heartland believes that it responded appropriately to all information that it learned regarding the possibility of the system breach and that upon discovering the intrusion it took immediate and extraordinary action to address the intrusion.

Moreover Heartland believes that throughout the events of 2008 and 2009 it has fully cooperated with MasterCard’s investigation of first the suspicion and later the fact that an intrusion had occurred. Heartland therefore considers the MasterCard fine to be in direct violation of both the MasterCard rules and applicable law and it intends and is prepared to vigorously contest and it has recommended to its sponsor banks that they vigorously contest, through all means available including litigation if necessary any liability that may be asserted or imposed upon Heartland or its sponsor banks by reason of this fine.

We are very pleased to report that we have recently been recertified PCI DSS compliant after being evaluated by a quality security assessor and have been returned to Visa’s and MasterCard’s lists of PIC compliant service providers and Discover has also accepted Heartland’s compliance report.

We hope that this will end once and for all the host of falsehoods and misleading statements that a few competitors have been using, admittedly with some success to scare merchants into leaving Heartland since we were removed in mid-March.

Those these tactics were largely ineffective given the communications efforts we have been maintaining through our relationship and account managers we are nonetheless pleased that this particular weapon for some of the competition should be silenced. In fact we believe that our systems defenses were robust previously but we are pleased to have this third party confirmation after a very thorough PCI review.

While I continue to support the PCI standard as driving necessary improvements in the security of cardholder data, Heartland is committed to going beyond this standard in order that both merchants and cardholders can have the highest possible confidence in the security of their payment card data.

This is what they expect and deserve and Heartland intends to be a leading voice in persuading the payment card industry to accept this challenge. We are on schedule to introduce our fully encrypted end-to-end terminal solution in the third quarter which we believe will offer merchants the highest level of data security in the marketplace.

We are undertaking this investment primarily because the increasing sophistication of attacks on the payment systems require a more then appropriate response for both our protection and our merchants’ protection.

We are in a cyber crimes arms race, and we need to stay ahead of the bad guys who never rest and do not call committee meetings to update their malicious tools and attack vectors. This is good, not only for the system but we also believe it will be good for our business as security concerns grow among merchants large and small, we are optimistic that our solutions will be well received in the marketplace so there is also the prospect of financial benefit from our encryption solutions.

And last night I just returned from the payments processors information sharing counsel where I am working with other industry leaders to share information among all payments processors regarding attacks made on the system.

While other industries have been sharing such information for some time through various information sharing counsels including the FSI SAC, our industry has not coordinated the sharing of data security information previously. Thirty representatives from 20 payments companies attended this meeting and USB devices were distributed to each of these organizations with documentation and software tools.

These devices contained the malware used to attack our systems, and malware from numerous other cyber crime attacks that had occurred in 2008 and 2009. Software tools were also distributed so that these malware files could be located on scanned computers.

This new PPISC organization had a great start and we believe will make a significant improvement in information sharing about cyber crime attacks among payment processors and merchant acquirers.

I would now like to turn the call back to Bob Baldwin who will go through some of the details and results before I provide some concluding remarks.

Bob Baldwin

Thanks Robert, Heartland reported a GAAP loss of $2.5 million and a diluted loss per share of $0.06 per share for the first quarter of 2009. Excluding expenses directly attributable to the processing system intrusion, net income would have been $5.4 million or $0.14 per diluted share.

There is some noise that is one-time in nature that brought down these numbers, such as the impact of the Heartland Summit on our expenses that we believe masked performance that was fundamentally consistent with our expectations for the quarter.

Overall our results for the quarter were driven by the weak economy and its impact on revenue from our various products combined with expenses that were somewhat over planned primarily attributable to side effects from the breach.

On the revenue side card activity was soft due both to weaker then expected same store sales and the impact on our processing from lower then expected card installs in the quarter. Other business lines were also soft. Payroll results reflect lower customer employment levels or outright closures.

In fact attrition did increase in the payroll business driven by a 51% increase in the number of clients that went out of business in the first quarter of this year compared with last year’s first quarter. And campus and micropayments suffered from delays or reductions in purchases by their business customers.

On the expense side while we have called out specific breach related costs in a separate line item, we incurred numerous legal consulting and other costs that cannot be carved out but nonetheless were significant.

For example our account managers, who provide local service to our merchants are paid for making in store visits to merchants. In the first quarter these payments were more then $1 million over planned as we encouraged merchant visits in order to provide those merchants with accurate information on the breach.

Further most of the cost of the Summit which fortunately had been scheduled for early this spring was accrued in the first quarter. Over the years we have found this investment and we do this every couple of years, year and a half or so, this investment which can now amount to about $2.5 million most of which had to be accrued in the first quarter to be well worth it since it brings teammates together in Louisville.

In this challenging environment we believe it was absolutely crucial to help the entire Heartland team to build for the future. The effect of the processing system intrusion and weakened economy can be seen in softer transaction activity.

Total processing volume for the quarter was $15.5 billion, up 17.4% but excluding acquisitions organic card processing volume was $13.4 billion, up 2%. Our network services transaction based merchant tickets totaled $641 million in the first quarter. Fourth quarter 2008 activity was $683 million transactions, although the seasonality of the business makes sequential comparisons not so meaningful.

Essentially network service activity was consistent with our expectations and reflective of the lower sensitivity to consumer cycles that the transaction-based petro vertical has and which was part of the motivation for the acquisition.

Total same store sales were down 7.6% in the quarter. Consistent with the recent past retail and hotels were down worse then average and this quarter they were joined in particular by electronics and automotive.

Restaurants remained a relative bright spot, coming in about 2% better then the overall average and quick service restaurants and convenience stores also continue to perform much better then overall same store sales.

Within the quarter March was the worst month for same store sales. We don’t have final numbers yet for April but it looks like April was about the same as March perhaps a touch better. Our revenues are also impacted by the economy. Although net revenues for the quarter were up 23.4% excluding network services, net revenues were up 4.5%.

Payroll which had been growing quite rapidly was up a relatively slow 15.6% while equipment revenues were actually down in the quarter. Total cost of services for the quarter were up only 9.3% from a year ago. The growth of cost of services was held relatively consistent with gross revenue growth despite a 33% increase in processing and servicing costs and a nearly 96% increase in depreciation and amortization, both of which are up primarily due to the impact of the network services deal.

Processing and servicing is one of the categories where costs are up due to the processing system intrusion related expenses which were not separately identified. Interchange the single largest cost of services was up only 4.9% in the quarter even though processing volume rose over 17%. There the network services revenues which incur lower interchange cost for us because of the daily cash settlement is net of interchange fees that drives that difference.

Customer acquisition costs were up around 10% for the quarter continuing to reflect the lower rate of new margin installs and same store sales. General and administrative costs were up 54.9% in the quarter. The increase is due in part to overhead costs added in the network services acquisition and our ongoing new product development investments.

Another big part of the increase is cost related to the Heartland Summit which is planned almost a year in advance but is expensed coincident with the events. In the first quarter we also had additional spending for our end-to-end encryption product development and broader efforts to strengthen our entire IT infrastructure.

What is less easy to quantify are the costs and other inefficiencies in G&A resulting from the breach but which are inseparable from normal operating expenses. We anticipate a small reduction in both those costs and inefficiencies and believe general and administrative expenses should trend modestly lower as 2009 progresses.

In our financial report this quarter we’ve broken out overhead spending specifically related to the processing system intrusion. In the quarter this amounted to $12.6 million pre-tax and on an after-tax represent about $0.20 per share.

As Robert previously discussed most of these costs relate to penalties assessed by Visa and MasterCard against our sponsor banks which we and our sponsor banks are contesting. The remaining portion of these costs are predominantly legal expenses. These costs will continue to be separately reported.

We will continue to closely monitor overall spending but at this time have no explicit plans to make any specific cuts. The focus of our spending is on our growth and productivity initiatives which we’ll sustain at appropriate levels provided these investments continue to meet our return objectives.

Operating income for the quarter was $9.1 million and the operating margin on net revenue for the first quarter was 9.3%. After having absorbed significant inefficiency in the start up costs related to the breach and other non-recurring one-time costs such as the Heartland Summit in the first quarter we should begin to see some cost decreases in subsequent quarters.

With the volume growth anticipated due to typical seasonality and now that our entire sales and servicing organization is returning toward normal operations we expect to get better leverage and see the margin begin to trend back up even allowing for anticipated additional IT spending.

Interest expense for the first quarter was $541,000 up $195,000 from the first quarter of last year as a result of borrowings for the network services acquisition. Now let’s look at our cash flow, GAAP operating cash flow for the quarter was $15.8 million.

More importantly management measure of operating cash take net income and add back amortization, depreciation, the provision for the processing system intrusion, and other noncash items at the top of the operating cash flow statement resulting in total sources of $29.3 million.

We then reduce that figure by signing bonuses and buyouts paid, using this management metric operating cash grew 41% in the first quarter to $17.6 million from $12.5 million last year. Capital expenditures for the quarter were $11.8 million of which $5.9 million was for the construction of our new service in Jeffersonville, Indiana, with most of the balance used to strengthen our technology infrastructure.

Taking that same management definition of operating cash and reducing it by non-service center CapEx our free cash flow amounted to $11.7 million for the quarter up 15.8% from last year’s first quarter. We used $900,000 of cash to pay dividends in the first quarter and $3.2 million for stock repurchases that were made in January.

We remain very conscious of our liquidity especially given perspective costs arising from the processing system intrusion, which could potentially be material. Currently we believe that Heartland’s cash generation capacity combined with our strong balance sheet and access to other sources of liquidity to be adequate to give us capacity to absorb future potentially significant costs.

These resources include our current cash position of approximately $26 million at quarter end, our quarterly operating cash flow, our ability to raise debt, and our ability to leverage the unencumbered asset represented by the service center in Jeffersonville.

In addition we do have insurance coverage that we believe should provide coverage for certain of the intrusion related cost expenses or losses. Of course at this time we cannot assure you that our financial resources will in fact be sufficient to meet the cash burden we may incur as a result of the breach.

We simply do not have the information that will enable us to reasonably estimate the amount of total losses we might incur by reason of such claims, and many of these losses are not currently deemed probable. We recognize however that we may incur losses in connection with the breach and that such losses could be material and could have a material adverse impact on our results of operation and financial conditions.

Let me wrap up with our guidance for the year, we are facing an unprecedented economic environment that is likely to not only limit same store sales but also limit other product growth opportunities as well as new business development activities.

We are also in an environment of additional costs to support our technology plans and to address the processing system intrusion, only a portion of such costs can be separately identified. All of the above factors necessarily add conservatism to our guidance.

Our guidance for 2009 does not include any estimates for potential losses, costs, and expenses arising from the system’s breach, including exposure to credit and debit card companies and banks, exposure to various legal proceedings that are pending or may arise, and related fees and expenses or other potential liabilities costs and expenses.

The cost accrued in this quarter are similarly excluded from this guidance. For 2009 we expect to achieve full year net revenue growth of 12% to 14% for net revenues for the year between $430 million and $438 million, compared to 2008 net revenues of $384 million. This includes acquired net services net revenue as that transaction annualizes which contributes about 5% to that growth.

And our full year guidance is now $0.95 to $1.00 per diluted share. Back to you Robert.

Robert Carr

Thanks Bob, since our last conference call we have made good progress addressing the concerns arising from the breach and stabilizing the organization to focus our energy and resources on our strategy to achieve our long-term goals and objectives and not that that’s been very easy.

But this has been a concerted team effort from all of our many Heartland teammates who continue to engender the spirit of transparency and our fair deal that has won the loyalty of our merchants. Our relationship managers were instrumental in reaching out to our existing merchants to fully and accurately explain what has happened, our actions and reassuring merchants that neither they nor their customers were at risk of any loss as a result of the processing system intrusion.

Just as importantly they were there to stem the tide of misinformation you can count on from some competitors and others to spread whenever they sense an opportunity. There is no doubt this has had a significant negative impact on our performance in this first quarter but we are working hard to return our operations to normal as quickly as we can.

Of course the economy remains a wild card and frankly we’re not counting on much help there. While 2009 will be a challenging year it will not alter our plans to balance current performance, while investing for a sustainable, long-term growth.

We are fortunate to have many dedicated teammates to support our strategy and to achieve our objectives. I want to once again thank our shareholders, customers, and employees and many other friends who have showed incredible confidence and stood by us through thick and thin.

Finally after considering economic conditions and our financial exposure related to the breach, our Board of Directors has declared a reduced second quarter of $0.01 per share payable June 15 to holder of record on the 25th of May.

With that we’d now like to answer any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Anurag Rana - KeyBanc Capital Markets Inc.

Anurag Rana - KeyBanc Capital Markets Inc.

Just wanted to get an idea of the guidance of $0.95 to $1.00, does that include, does that take into account $0.14 for the first quarter.

Bob Baldwin

That takes into account for the first quarter, yes.

Anurag Rana - KeyBanc Capital Markets Inc.

So now just looking at transaction growth rate in April was as March, have you seen any new trends as it relates to either credit or debit.

Bob Baldwin

In terms of overall transaction growth rates and transactions we were up modestly better in April then in March. In March we were up overall 6.2%, in April that was up 7% versus a year ago and breaking that down into debit versus credit, the trends were actually pretty similar. Debit was a little bit better, grew from 11.8% in March to 13% growth in April, whereas credit also improved but perhaps a little bit less, it went from negative 3.9% to negative 3.5% growth.

So overall I’d say modestly better which its hard right now for us to ascertain how much of that’s sort of same store type growth versus new merchants but it is reflective of at least a little bit better environment.

Anurag Rana - KeyBanc Capital Markets Inc.

Looking at your guidance on the top line, with the merchant install going down by about close to 10% how do you still feel confident about that 7% to 9% organic growth rate.

Bob Baldwin

Well I think that what we factored in is both some continued impact from the breach on our plans for our growth but remember its important to recognize that if you’re installing about $15 million of margin a quarter, if you’re going to be up 10% that’s an extra $1.5 million, if you’re going to be down 10% that’s a shortfall of $1.5 million so that we’re installing a lot of new merchants, a lot of new margin.

As we mentioned our absolute merchant counts were up 7% plus year over year and that is the driver of continued growth in that revenue line so it is definitely does have an impact on, by installing less margin in a quarter and frankly in the first quarter that’s the toughest thing because those merchants underperform, or that vintage of merchants underperforms for the remainder of the year.

But nonetheless we feel good about the net revenue performance and as you saw, I just dropped the top end of the range down. I had actually, with our original plan been intending, expecting us to be above the top end of the range in terms of net revenues for the year. So I think we reflected an appropriate amount of impact from the disruption of the first quarter and the economy.

Anurag Rana - KeyBanc Capital Markets Inc.

And the provision for processing system intrusion of about $12.6 million, how much of that should we allocate to money that you’ve allocated for future fines versus the money that you already spent for IT and other compliance related activities.

Bob Baldwin

About two-thirds is in the category of not collected from us at this moment. The other one-third or so is in the form of legal related expenses and one thing that’s clear is the lawyers look to get paid on a more or less current basis.

Operator

Your next question comes from the line of [Tim Worgess] – Robert W. Baird

[Tim Worgess] – Robert W. Baird

Just wanted to talk about the seasonality in the EPS line, I know there’s some non recurring expenses related to the Summit and stuff in Q1, but typically you’ve seen kind of 7% to 9% sequential increase from Q1 to Q2 in terms of EPS, should that be a little bit higher this year just given some of the roll off or how should we think about that. I know you don’t give quarterly guidance but just trying to get a sense for the EPS trend through the year.

Bob Baldwin

Other things being equal, yes, where we took an extra hit, comparing this year to last year we took an extra hit because of the Summit and harder to discern the number, the noise that was introduced in our other expenses perhaps could come down a little bit in the second quarter, the account manager expenses and things like that.

So it could be a little bit more then our typical pattern this year, that’s correct.

[Tim Worgess] – Robert W. Baird

And then just on the gross margin install, I know the comps get a little bit easier year over year, should this really be a bottom or you do expect some sequential improvement in that.

Bob Baldwin

Yes we do. We do think this is as a bottom, it was a tough quarter. The beginning of this quarter, the second quarter was also tough. We were still off Visa’s list which as we’ve mentioned, competitors were saying all kinds of outlandish things about us. Unfortunately some still will, but to a lesser extent and also one of the impacts of the Summit is you take the vast majority of our productive capacity and you take it out of the marketplace for four or five days and that’s not a trivial impact.

So its obviously a sacrifice we think is well worth making but it definitely April, but yes, we are absolutely looking as we have gotten back on the PCI list, as we’ve armed our sales force with a lot of new tools and products that will get back to getting sequential growth, or year or year growth in the install margin.

Robert Carr

I’d just like to add that we have had many competitors who have been very supportive and professional and we certainly don’t want to tar everyone with the same brush. We have had some competitors saying, telling merchants falsely that you’ll be fined $10,000 a day if you stay with Heartland. We think we’re through the worst of that and its very difficult to manage commission sales people who are very understanding of that, but we have had tremendous support from a large majority of competitors in the field. I don’t want to tar them all with the same brush because they certainly behaved differently in the marketplace.

[Tim Worgess] – Robert W. Baird

And then just housekeeping, CapEx, do you have an updated range of what that should be for the year.

Bob Baldwin

I think that, not right now. I’ll try to get back to you separately.

Operator

Your next question comes from the line of Julio Quinteros - Goldman Sachs

Julio Quinteros - Goldman Sachs

I just had a question starting with the 2009 guidance, the $0.95 to $1.00 includes the $0.14 and the revenue guidance has not changed that much, what kind of incremental costs are you seeing and which lines of the G&A, because going into the year you were probably knowing that you had those product developments as well as the other costs, so where was the surprise in terms of the EPS guidance change.

Bob Baldwin

There are two elements there, one is that even though we haven’t changed the revenue guidance that much, it is definitely down because of the impact of the lower installs and assuming tougher, if you remember in the first quarter we were assuming 5% to 7% same store sales decline. I think that we’re feeling notwithstanding commentary right now, we’re feeling a little more conservative. It was a tough quarter in same store sales and March was the worst month of the quarter.

So we got more conservative on that so, we did definitely bring down our revenue expectations for the year, net revenue expectations, and in terms of expenses its really a lot of this, we think the noise will come down but its still going to be there. It’s a whole host of things just in preparation for this call, the amount of time we’ve spent with outside advisors on preparing the text and things just went up compared to prior years.

All of our SEC filings, there’s just a lot of stuff. You can’t call it out, as it is very hard, if you have a bill from a separate law firm, that’s only working on the breach, that’s an easy thing. But there are a lot of people we work with that it gets comingled so we just, those are the main expenses that we’re looking to see.

But the combination is, the good news is when we have a lot of growth we have a lot of leverage in our model, the more challenging thing is when you get that tougher economic environment, when you have that tougher install environment, that leverage doesn’t work as well to your advantage.

Julio Quinteros - Goldman Sachs

When you said G&A should be probably modestly lower compared to the first quarter, was that as a percentage of net revenue, could you just give us like maybe an understanding of what it will be as a percentage of revenue or year over year guidance how it will trend compared to the first quarter.

Bob Baldwin

Well it should trend relatively flat in dollar terms for the out quarters so then as a percentage of revenue since the first quarter is seasonally lower then any other quarter, that should be an impact. One thing that I just wanted to mention in passing and it is something you have to take into account in this business, last year we had an extra day in the first quarter because of leap year.

That’s literally 1% increase in your revenues with very few incremental costs associated with it. You don’t have to pay most of your people for that extra day. So it really was a nice plus last year. It was a comp challenge this year.

Julio Quinteros - Goldman Sachs

On the Summit, you said this quarter you accrued $2.5 million I think in terms of costs, what will be the cost, will it be all done in the second quarter or is it going to be throughout the year.

Bob Baldwin

No we accrued about three-quarters of that $2.5 million, you need to accrue it in the period in which the expense is going to be incurred, so it had to be in this year, that’s where we’re going to get the benefit from the Summit and it occurred in April so that’s excluding some lagging bills and things like that, it should all be paid by April.

Operator

Your next question comes from the line of Robert Dodd - Morgan Keegan & Co.

Robert Dodd - Morgan Keegan & Co.

You mentioned some detail about March transactions and then April, could you give us some visibility, you said March was the worst month of the quarter, was it 100 basis points worse then the quarter average or a couple of hundred and then what you’re seeing roughly in the April month.

Bob Baldwin

Well importantly, March was the worst in terms of same store sales growth, not in terms of transactions. There’s some reasons why those will differ. In terms of transactions, I’ll just give you the numbers that we have starting in January, overall Visa, MasterCard, in January were, plus 9.4%, February plus 5%, March plus 6.2%, and April 7.0%.

For debit that goes 15%, 10.3%, 11.8%, and 13% and for credit its negative 0.2%, negative 4.6%, negative 3.9%, and negative 3.5%. Just remember that statistic includes any new merchants that we have, its not the same as same store sales which again is only the merchants that were with us a year ago and are with us this year so its fundamentally different statistics that we’re giving there.

Robert Dodd - Morgan Keegan & Co.

And I know that you’re not going to want to talk about this question but I’m going to ask it anyway, you mentioned sort of the capital insurance etc., could you give us any more color on are you having discussions for example to line up another revolving facility or something like that just in case you need to, you come up more then $12.5 million to pay fines or give us any color on how much, what kind of scope you’ve got in insurance, not to pick on TJ Maxx but I think they had about $20 million, I think that covered about 10% of their total fines. Can you give us any additional color on that.

Bob Baldwin

Not a heck of a lot but let me give you a sense for how we’re approaching this issue. We have ongoing process with the brands on determining the extent of liability they want to impose on us and then an interaction that we expect to develop on what is a number that we are perhaps willing to absorb.

That’s a complicated interaction. We also have a number of lawsuits out there. Therefore its my job as the CFO to layer in a set of financial resources that cover as many contingencies in the outcome of those various challenges and be prepared to absorb whatever level is eventually it comes to.

Its really hard to ascertain, get any specificity right now. For example there’s nothing that says that any amounts that the issuers look for reimbursement necessarily is paid at one point in time. It could be paid over time and so really its not at this point, not possible for us as we’ve indicated, we cannot estimate the potential liabilities therefore I can’t estimate how many resources I need.

We believe that our insurance coverage is a healthy amount and should be available to cover costs here. But we are also getting ourselves geared up to be able to access additional sources of financings should those be necessary.

Robert Carr

I’d like to point out that TJ Maxx situation which you brought up, being a retailer that had to upgrade their point of sale systems in many, many stores, throws a lot of variables in there that don’t apply to our situation. We have spent the money to do numerous upgrades and add additional security into our system and those investments have been made to date.

Robert Dodd - Morgan Keegan & Co.

On the end to end encryption product you’ve talked about, what’s the kind of feedback you’re getting from Visa and MasterCard because obviously those guys, I don’t want to pick on them either, but kind of the bottleneck here that they are not encrypted at their end, so what’s the feedback you’re getting from them about the viability of actually going full encryption through them rather then just between the merchant and your back end obviously.

Robert Carr

Well actually we’ve been getting good cooperation with the card brands. There’s five steps to a true end-to-end encryption and we have, we believe that with our merchants’ cooperation we have control of four of those five steps as a full service merchant processor. The card brands do take a file encrypted transactions, we would like them to take track encrypted transactions and pan encrypted transactions, and we are in discussions with three of the four brands on that and are encouraged.

We’ve also talked to the executives of the PCI SSC and I think everyone in the industry is looking for, PCI is an important and valuable set of tools that we endorse and support. I think everyone however is interested in finding ways to have even better security and we’re not confronting any opposition whatsoever to improving the industry’s security.

Operator

Your next question comes from the line of Tien-Tsin Huang - JPMorgan

Tien-Tsin Huang - JPMorgan

Quick question, I think you said new margin install was down 15% before you reported the breach, is that correct.

Bob Baldwin

The first release of January we were running at a down 15% from the same period a year ago, that’s correct.

Tien-Tsin Huang - JPMorgan

Did you disclose what the trend was in that for the balance of the quarter.

Bob Baldwin

We didn’t go through it but I can run through it quickly, it really was not, it was really better for most of the remainder of the quarter. For example, in March we were down about 6% throughout March versus the same period of last year. So it was modestly better during the course of the quarter.

Robert Carr

But the quarter overall is 9.7%.

Bob Baldwin

Down almost, just under 10% for the quarter, that’s correct.

Tien-Tsin Huang - JPMorgan

And it sounds like you are, you definitely called out the economy and I guess the conclusion I can draw is that the economy is driving a lot of the decline in new margin install from fourth quarter to first quarter.

Bob Baldwin

Yes, that’s what we believe. That’s why, clearly we haven’t had any impact from the breach in that first three week of January period and what we and I think the competition are running into is merchants have other things on their minds and—

Robert Carr

And they’re closing locations and not opening a lot of new ones and so there’s not a lot of new merchant formation. And our people have been pretty busy out there trying to keep our 250,000 merchant locations on board with us and answering questions and helping educate them about their own security levels with PCI DSS standards.

So we’ve been doing the right thing I think but that’s meant not having as many resources out knocking on doors.

Tien-Tsin Huang - JPMorgan

Wow, that’s interesting. Can I get the organic processing volume growth, I think the last few quarters you have called out specifically what you got from the NWS acquisition, I didn’t see it in the release this morning.

Bob Baldwin

The organic processing volume growth was 2% resulting in 4.5% organic net revenue growth.

Tien-Tsin Huang - JPMorgan

Did you comment at all about staff turnover and retention, I mean have you seen any poaching from ISO’s or any color you can provide there would be helpful.

Robert Carr

Sure, massive efforts continue on an ongoing basis to recruit our people. We have had no noticeable loss of any of our key people whatsoever. In fact I think our group is more energized and cohesive then ever before. I think we all feel like we have to work for here to secure our position in the industry.

So no I think that’s one of our great success stories out of this whole situation.

Bob Baldwin

And it is important, we’re essentially flat with a year ago in terms of our number of RMs. When you’re not installing as much margin in the Heartland model that means the sales force is not getting paid as much and that’s hard and so its always been a hard model.

In a tough economy when the merchants are sitting on their hands, its that much harder and so we feel great about the quality of new people that we’re getting but we’re still seeing a lot of people who have trouble making it work for them and their families and that’s just going to be a reality as we go through this tough period.

Tien-Tsin Huang - JPMorgan

On merchant attrition, you define it, you have kind of a peculiar definition for it, but I’m trying to understand what as far as attrition what have you lost in this quarter compared to the prior year period and how that kind of relates to the fourth quarter, if you can do that calculation.

Bob Baldwin

Well the volume attrition for the quarter was our worst in our history resulting from modestly higher merchant count attrition then in the fourth quarter and worse same store sales growth which acts to offset, usually same store sales growth helps to offset attrition.

The added complexity is the smaller merchant that [inaudible] faster then bigger ones but have less of an impact on volume. So I’d say that both measures of merchant count attrition was modestly worse then fourth quarter and because of weaker same store sales volume attrition was also worse then its ever been.

Robert Carr

And merchant closures in our payroll business which we monitor very closely was 51% over last year. The number of merchants going out business on a percentage basis was 51% higher this year then last year in the payroll business and we have no reason to believe that same thing is not true for the processing business.

Tien-Tsin Huang - JPMorgan

So could you ballpark the attrition rate, is it 17%, 18%, or something lower then that.

Bob Baldwin

Its running in the low 20’s right now in terms of volume attrition.

Tien-Tsin Huang - JPMorgan

And that’s inclusive of I guess the 7% or 8% same store drag.

Bob Baldwin

That’s correct.

Tien-Tsin Huang - JPMorgan

And that used to be in the low teens with same store—

Bob Baldwin

When same store sales growth was 6%, 7%, 8%, it was running in the 10% to 12% area, so its definitely an impact.

Robert Carr

We don’t think that’s unique to us by the way.

Bob Baldwin

It’s a tough environment.

Operator

Your next question comes from the line of Thomas McCrohan - Janney Montgomery Scott

Thomas McCrohan - Janney Montgomery Scott

Regarding the breach, given the virtual impossibility to prevent 100% a data breach down the road, no matter what technological changes you make, in your view who really should be bearing the brunt of the costs for future data breaches.

Bob Baldwin

That’s a question.

Robert Carr

Bob’s looking at me and—do you have another question.

Bob Baldwin

Why did you waste your question on that one Tom? That gets philosophical and all that. There are many participants in this system. You’re absolutely right, its, there are some good questions about that. What we want to do is to encrypt our data from the moment it is swiped and leave it encrypted until it leaves our possession. That we think will be a very good argument that even if our walls were to be breached which is the issue with any wall, the bad guys keep getting better, that it renders the data sufficiently valueless that they go somewhere else.

And we’ve focused on this as a solution because we can control most elements of it. We are looking to the brands to allow us to push it right through to them but even if we can’t we can encrypt it all the way right to that last moment of sending. We think that that will be a lot of ways for us to avoid future liability.

Thomas McCrohan - Janney Montgomery Scott

Can you just give us the total quarterly revenue for equipment, payroll, and network services.

Bob Baldwin

Yes, its going to be, payroll revenue was $4.4 million, equipment was $5.5 million and so card related was $362.3.

Thomas McCrohan - Janney Montgomery Scott

How much was network services.

Bob Baldwin

Network services revenues were, I don’t have that available right here I think so let me get back to you on that.

Operator

Your next question comes from the line of Brett Huff - Stephens Inc.

Brett Huff - Stephens Inc.

Quick question, I did want to dig in a little bit on, you had called out the American Express program that you’ve been working on this quarter, can you give us more color on how that result compared to your expectations given all that’s going on both with the economy and the intrusion and how you continue to think about that for 2009 and 2010 and maybe sort of similar color on Discover as that begins to roll out.

Robert Carr

I’ll make some comments about the hardest part which was the development of the IT infrastructure to be compatible with our back end system passport, the team didn’t miss a beat. We have been able to roll out American Express and Discover settlement with all this going on in the background. They’ve done a great job pass through the various milestones very successfully.

In terms of our expectations, compared to our original expectations were down but so is the general business environment down quite a bit. But I think we are pretty comfortable and our merchants love the idea that they get a single deposit, they have one place to call, they have one statement fee, its really a great product set for the merchants.

Brett Huff - Stephens Inc.

And the timing on Discover, is that, my understanding was that was going to be a little bit later in the year, is that still true.

Bob Baldwin

We’re rolling out aggressively on the Discover MAP program in two weeks. And by the way going back to Tom’s question about $20.2 million of the card processing $362.2 million was from network services.

Operator

Your next question comes from the line of James Friedman - Susquehanna Financial

James Friedman - Susquehanna Financial

The first question is regarding the same store sales are you still maintaining the negative 5% to 7% sales growth for the full year.

Bob Baldwin

No we bumped that up some, we’re sort of in the more in the 6%, 7%, 8% area.

James Friedman - Susquehanna Financial

And then now that the PCI DSS recertification is behind us, what are we going to [endure] in the next six months regarding the breach related issue, any updates that we can expect in the next few months.

Bob Baldwin

Well there’s a whole process going on whereby the brands come to us with their view on the costs that have occurred on the issuing side and the portion of that that we should bear. And we expect to have a dialogue on that in the coming months and eventually that will be resolved. Its very hard to predict the timing on it. If you look at the TJX situation they announced their intrusion in January of 2007 and they came to a settlement with Visa in November of 2007 and with MasterCard in April of 2008.

There are lots of reasons based on what’s happening now to expect that timeframe to be compressed but there’s a lot of interaction that needs to go on.

Operator

Your next question comes from the line of Franco Turrinelli - William Blair & Co.

Franco Turrinelli - William Blair & Co.

First question, just to make sure I understand the fine from MasterCard is separate from any of those cost discussions with MasterCard, is that correct.

Bob Baldwin

Well yes and no, its not really, it is a fine from MasterCard not a purported issuer compensation or reimbursement so in that sense its separate. We absolutely reject the validity of it and you can be sure that it is going to be part of our overall interaction with MasterCard on the cost to be borne in the breach.

Franco Turrinelli - William Blair & Co.

I was trying to quickly do the math in my head, so going back to the attrition and adjusting it for the impact of same store sales just it looks like attrition in fact if anything its probably slightly down once I adjust it for same store sales relative to a year ago or two years ago. And I guess part of my question related to this is how much time to you think the sales force has been spending on working with the existing merchants relative to spending time looking at new merchants and how should we think of that proportion of time changing over next 12 months or so.

Robert Carr

The day that we announced the breach we had a company wide call and the directive was our job is to go out and see every one of our customers that we can go see. So from January 20 pretty much for the rest of the quarter I think a high, high percentage of time was out talking to existing customers and educating them about their own security as well as our breach. And then when we were delisted from the Visa list on March 14, that created a new flurry of activity playing defense and that was pretty significant right up until we were put back on the list last Friday.

So we think being put back on the list allows us now to play more offensive then defense and we’re expecting to get back into our growth mode here. We think we’re already there frankly in are pretty positive about that.

Bob Baldwin

Let me just caution you on this, as the mass of merchant count versus same store sales is beyond my meager understanding so I think its risky to get into straightforward analogies because they don’t work so well. Different merchant size attrition really makes a huge difference in this and there’s lot of empirical evidence that the smaller merchants attrite much more quickly then the larger ones and that really messes it up. So its really hard to say who’s suffering the most in the current environment because this is such a unique environment.

Operator

Your next question comes from the line of Richard Cheever - SunTrust Robinson Humphrey

Richard Cheever - SunTrust Robinson Humphrey

Hopefully I didn’t miss this number, but I was hoping you could give a NWS transaction count.

Bob Baldwin

We did mention it, it is a total of 641 million transactions of which settled was 105 million.

Richard Cheever - SunTrust Robinson Humphrey

And just so I can clarify this, you talked a little bit about the Summit and you said you do it periodically, what’s the frequency of that. Is that a once every couple of years things or is that an annual deal to maintain morale or—

Bob Baldwin

Its not an annual deal, it’s too expensive and too resource consuming to do it annually. We did the last one in July of 2007 and now we did one, our thinking is around once every 18 months or so but that will really depend on factors that it is a very expensive proposition but it is very powerful both in terms of training and education but also culture building for the company.

Richard Cheever - SunTrust Robinson Humphrey

Did I get the number right, you said it was about $2.5 million that you accrued in the first quarter.

Bob Baldwin

The aggregate cost comes to about $2.5 million. By the way we ask a number of our sales people to contribute to their participation. We essentially, those who are performing at the higher levels, we pay for them. If they are performing at lower levels, we invite them but expect them to bear some of the cost and many of them do because they recognize the value of it.

But the company cost is round numbers $2.5 million of which about three quarters had been accrued in the first quarter.

Operator

Your next question comes from the line of Robert Napoli - Piper Jaffray

Robert Napoli - Piper Jaffray

I was wondering on the end-to-end encryption eventually could this be viewed as a differentiator in the marketplace, is this something that you see as eventually helping you compete as we get this data breach stuff behind us and would it impact pricing.

Robert Carr

The answer is yes, we do think it’s a competitive advantage. We’re doing TRS and encryption which is a hardware encryption right at the point of data entry through the mag stripe into the system. We think that will be a point of differentiation and many, many merchants want to be out of having card numbers going through their POS systems and there’s a lot of interest in it in the marketplace.

Robert Napoli - Piper Jaffray

What about the pricing, eventually would it impact—

Robert Carr

The merchants will bear the cost of the technology. Its not as expensive as one might think and we think that the cost of the compliance issues that are reduced will more then offset the cost of upgrading the system. But it does require a hardware upgrade.

Bob Baldwin

And I would say just to add that we’re not looking at this as a way to, out in the small and mid sized merchant community, it will be a differentiator, it will I think allow us to be discussing the multiple advantage of working with Heartland including our three year contract where we don’t change pricing and full disclosure and other attributes. We’re not looking at this, we’re not expecting a small to mid sized merchant to pay more for this except for the incremental cost of the hardware necessary to adopt the system.

As you get to the larger merchants that’s a more complicated discussion but we think that there are larger merchants who are absolutely eager to undertake a solution like this. In the larger merchant community is a very price sensitive sale. The hope however is that if you can get the Chief Risk Officer of the enterprise thinking about this as a solution then maybe the purchasing manager doesn’t try to squeeze you for the last 01 out of the deal.

And so it may be an opportunity to protect a better margin. You’re not going to get a big uplift in those larger merchants because of the competitiveness of that marketplace.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Robert Carr

Thank you very much, thank you again for joining us this morning and have a great day.

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