Heartland Payment Systems Management Discusses Q2 2013 Results - Earnings Call Transcript

Jul.31.13 | About: Heartland Payment (HPY)

Heartland Payment Systems (NYSE:HPY)

Q2 2013 Earnings Call

July 31, 2013 10:30 am ET

Executives

Maria Rueda - Chief Financial Officer and Principal Accounting Officer

Robert O. Carr - Executive Chairman and Chief Executive Officer

Robert H. B. Baldwin - Vice Chairman

Analysts

Roman Leal - Goldman Sachs Group Inc., Research Division

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

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

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

Tien-Tsin T. Huang - JP Morgan Chase & Co, Research Division

John Campbell - Stephens Inc., Research Division

Michael J. Grondahl - Piper Jaffray Companies, Research Division

Smittipon Srethapramote - Morgan Stanley, Research Division

Andrew W. Jeffrey - SunTrust Robinson Humphrey, Inc., Research Division

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

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

Tulu Yunus - Nomura Securities Co. Ltd., Research Division

Kartik Mehta - Northcoast Research

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

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

Operator

Good day, and welcome to the Heartland Payment Systems Q2 2013 Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Ms. Maria Rueda, Chief Financial Officer. Please go ahead, ma'am.

Maria Rueda

Thank you, Martina, and good morning, everyone. I'd like to welcome you to our second quarter 2013 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 financial results we released early this morning and that accompanies our 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.

Our discussion today may include the use of non-GAAP financial information. The reconciliation of GAAP and non-GAAP disclosures can be found in our earnings press release.

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

Robert O. Carr

Thank you, Maria. Good morning, everyone. I'd like to thank you all for joining us today and for your interest in Heartland.

I am pleased to report the most profitable quarter in Heartland's history. For the quarter, we reported adjusted net income of $23.1 million. Adjusted earnings came in at $0.62 per share, representing a 22% increase over the $0.51 of adjusted earnings reported for the second quarter of last year.

Our success is the product of our growth strategy, which is growing our sales organization and improving its productivity and expanding our product offerings to enlarge our market opportunities, adding complementary capabilities that increase the value of the relationship to both the merchant and Heartland, and we're making tremendous progress on all fronts.

In the quarter, the new business growth accelerated with total new margin installed up 16% and new card margin installed growing even faster. In fact, June was our best month of new margin installed since October 2008, nearly 5 years ago. These strong results were driven by achieving new highs in sales force productivity and growth in our sales organization.

We added another 42 productive relationship managers, which, together with the 48 added in the first quarter, has increased our sales organization by 90 for the first half of the year.

Success usually starts at the top, so we need to recognize the contribution of our recently promoted Chief Sales Officer, Tony Capucille. This promotion is part of the modification of our sales leadership structure by which we reduced the number of nonselling sales managers while increasing our territory managers, the TMs, many of whom were promoted from relationship managers. TMs are the player coaches who are responsible for adding and retaining new relationship managers. Their hiring efforts have also been aided by the addition of a new recruiting director who has brought extensive payments industry experience to the job and been very successful.

With the growth of -- with the goal of growing our territory managers from the current 120 to 140 across the country, we have the resources and organizational structure to add relationship managers, improve our productivity and build out previously unproductive geographies, all of which are key to improving the rate of SME card processing volume and revenue growth.

We're also expanding our capabilities to provide our sales organization with more robust products that enlarge their addressable markets. In the last quarter, for example, we rolled out a couple of exciting new products, including eCommerce in a Box and our new SME Petroleum Solution. eCommerce in a Box productizes a merchant's online shopping solution, enabling our primarily brick-and-mortar SMEs and e-comm merchants to improve the online experience for their customers. The new Petro Solution provides relationship managers with a robust small- to medium-sized petroleum processing platform, opening a large new market that our previous products had trouble cracking.

To further enhance sales productivity, we are adding senior product advisors, or SPAs, in the new product areas modeled on the Ovation SPA program. Because the nuances of selling our broad range of products can be challenging, RMs can call on SPAs to help work through our merchants' technical questions and learn new products. There are many other programs being introduced that have been either developed internally or through partnerships, such as our program with LevelUp, including our new relationship with the gateway for multilane grocery aimed at the higher end of the market.

Success on the card side is being matched, if not exceeded, by success on the non-card side. Favorable revenues more than doubled from a year ago, and the Ovation acquisition is proven to be even better than we had expected.

Heartland School Solutions and its Mosaic K-12 food management system recently beat nearly everyone in the industry to win a contract with the Chicago Board of Education to manage their school nutrition program. Mosaic is our staff-based one-stop shop school nutrition technology platform designed to increase the efficiency of entire food service programs. Chicago services more than 74 million meals per year to 400,000 students at 630 schools and will now be the largest school district in the U.S. to be fully hosted and supported by staff-based technology, the Heartland Mosaic Cloud.

The implementation features a full suite of products, including point-of-sale, back-of-the-house, payments, hardware, support and hosted services, offering attractive economics for Heartland School Solutions. We could not have achieved this significant progress across a variety of programs without the superior leadership of our new senior management team. We now have the depth of management needed to more broadly capitalize on market opportunities and develop strategies that will deliver the greatest return on investments.

Finally, I believe the next few years may be among the most tumultuous in card processing history. This is going to present challenges to our industry. How can we effectively serve merchants who will be confronted with an increasingly complex array of choices from loyalty products to new tablet POS Systems to multiphone-based payment solutions and even EMV? As one of the industry's only fully-integrated low-cost providers, we believe Heartland is ideally positioned to gain the trust and build the confidence of merchants anxious for our guidance with a technology that has the potential to transform the nature of their customer relationships. To accomplish this goal, we want to be the easiest, the most cost-effective, most productive partner with which to work from third-party vendors to the brand and ultimately to the merchants. I think that our model is ideally suited to achieving exactly that outcome, and frankly, it's pretty exciting.

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

Maria Rueda

Thank you, Bob. For the second quarter, we reported adjusted net income of $23.1 million and adjusted earnings per share of $0.62, increases of 12% and 22%, respectively, over comparable year-ago results. For the quarter ended June 30, 2013, GAAP net income from continuing operations, $19.7 million or $0.53 per share, up from $17.4 million or $0.43 per share in the comparable year-ago quarter.

As shown in the reconciliation tables in our press release, adjusted net income and EPS exclude acquisition-related amortization and stock-based compensation expenses from GAAP net income from continuing operations, which is consistent with the manner in which our industry is recording results.

Second quarter net revenue increased 13.5%, with SME card processing revenue growth of 3.6% on SME card transaction processing volume growth of 4.2%. Both same-store sales and volume attrition were consistent with recent trends, and we're still guiding to a 1% to 2% increase in same-store sales this year.

Growth in non-card net revenue continued to outpace card. Non-card net revenue was 26% of total net revenue in the quarter with payroll revenue more than doubling for the second consecutive quarter and Heartland School Solutions revenue up 83%. Non-card revenue is likely to be a significant contributor to our growth over the next couple of years as we expect these businesses to grow faster than the card businesses.

On the cost side, processing and servicing costs were up just 4.4% for the quarter, while cost added by our acquisitions, as well as spending on growth initiatives, drove general and administrative expenses up 39%.

For the quarter, stock compensation was actually down from a year ago, and as in last year's second quarter, we had to increase our share-based compensation expense to reflect a catch-up accrual on performance-based RSUs. However, that save was more than offset by over $1 million of additional acquisition amortization expense in the quarter. As a result, we reported record quarterly operating income of $33.3 million, up 15% over a year ago, as the operating margin expanded to 22.3% in the quarter from 22% a year ago. While we continue to expect to pause an operating margin expansion this year, at the midpoint of the year, margins are running ahead of last year's pace.

For the quarter, management's measure of operating cash flow was a quarterly record $33.8 million, up 15% from a year ago, which equates to $0.90 per share, a 23% increase from last year. And our free cash generation in the quarter amounted to $21.7 million, up around 7% from the second quarter of last year.

In the quarter, we utilized cash of approximately $19 million to repurchase 601,000 shares at an average cost of $31.56 per share. We also used $5 million to reduce our term loan during the quarter. We have $49 million of borrowing capacity remaining on our existing revolving credit facility and $70.6 million remaining on our current share repurchase authorization. Our standing commitment is to use to our free cash flow to reward shareholders primarily in the form of dividends and share repurchases.

We are maintaining our prior guidance for 2013. For the full year of 2013, we expect net revenue of approximately $600 million to $610 million. Adjusted earnings per share are expected to be between $2.29 and $2.33, excluding $0.15 of acquired intangible amortization and $0.22 of share-based compensation expense. Given the level of investment spending we anticipate in the third quarter, our operating margin is unlikely to remain at the high levels achieved in this quarter.

Now I'd like to turn the call back to Bob Carr for some concluding remarks.

Robert O. Carr

Thank you, Maria. We are in a period of tremendous industry innovation, and we believe the most successful of the many new solutions being developed will be those that emerge from an intimate understanding of a merchant's unmet needs.

With the industry's largest sales organization, managing 250,000 direct merchant relationships, we think we are in an enviable position of having real-time proprietary market intelligence that provides us a tremendous competitive advantage. Our focus is on applying our considerable resources to leverage that strategic advantage and profitably grow the business.

Before closing today's call and opening it up to questions, I am pleased to announce that the Board of Directors has declared a quarterly dividend of $0.07 per share, payable September 13 to shareholders of record on August 23.

And finally, I would like to thank all of the great Heartland team members for making these powerful results possible. And Martina, we are now open -- ready to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Roman Leal with Goldman Sachs.

Roman Leal - Goldman Sachs Group Inc., Research Division

First, a couple of questions on the core client [ph] business, specifically looking at the attrition and pricing trends. When we look at attrition on a year-over-year basis, obviously, that was up somewhat as same-store sales declined. I'm just curious, how much of the attrition increase on a year-over-year basis was attributed to that same-store sales decline versus merchant attrition? If you can parse that out, that will be helpful. And then on pricing, the decline as well, a little bit less than we were expecting. Just wondering if there's seasonality in there that we should be thinking about as we go through the second half of the year.

Robert O. Carr

Yes. Thanks, Roman. On attrition, you have a little lower same-store sales growth that offsets the volume of merchants who left you. So we view those as being entirely consistent. In essence, all of the reduction in the very modest increase in attrition was attributable to the same-store sales numbers. And I'm not aware of any particular pricing seasonality except we do have in -- any fixed merchant fees tend to be more noticeable in our net revenue yield in a lower-volume quarter. So the second quarter being a higher-volume quarter, those will have a little less of an impact.

Roman Leal - Goldman Sachs Group Inc., Research Division

Okay, that's helpful. And just to be clear, with same-store sales, you're holding the guidance unchanged. You mentioned that June quarter was the strongest in new margin installed. Was there any color in terms of same-store sales? Was it better over the quarter? Or is it kind of still kind of tracking along with expectations?

Maria Rueda

As I said, Roman, we are not going to revise our guidance. We didn't see any surprises. We were 2.2% same-store sales in the first quarter of 2013. We are at 1.9% for the second quarter 2013. So we think that is in line with our expectations going forward.

Roman Leal - Goldman Sachs Group Inc., Research Division

Okay. One last one on payroll. It's -- maybe we did it incorrectly, just kind of trying to use the last quarter's results as the baseline. It seems like maybe there were some W-2 related revenues there that didn't recur. What should we think about on a quarterly run-rate basis for the payroll business in '13?

Maria Rueda

Well, the payroll business is, by design, seasonal and has the strongest net revenue in the first quarter because the first quarter is the quarter in which a lot of W-2 revenue is earned. So we didn't see anything other than our expectation in the first quarter. But the first quarter would understandably, due to that W-2 revenue, be stronger than future quarters.

Roman Leal - Goldman Sachs Group Inc., Research Division

Okay. But quarters 3 and 4 should look more like the second quarter?

Maria Rueda

Yes, that's correct.

Operator

We'll take our next question from Dave Koning with Baird.

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

I guess first of all, just the competitive environment. Last year, there was all the worry about Square, and it seems to have dissipated quite a bit over the last couple of quarters. Now I'm just wondering, are you at a point now where you're taking away more Square volumes then you're losing to Square, do you feel like?

Robert O. Carr

That's hard to really know, David. We have taken some business away from Square. They've taken some away from us. They're not really a very big factor in our day-to-day activity. So we have no statistics that could answer that accurately.

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

Okay, okay, great. And then just a second thing on margins, it sounds like just given the investment profile, Q3, it sounds like not quite the same margin expansion. But what I'm wondering about is Q2, if it wasn't for the summit expenses, margins would have been up 100 basis points year-over-year. So I guess I'm wondering, what's happening sequentially from Q2 to Q3 that you feel like doesn't allow for margins to stay quite as high because you'll get a benefit sequentially from summit not being in the Q3 numbers, it seems like?

Maria Rueda

In terms of our margin, our margin expectations, we are investing significantly in our future and that we fully expect to impact our margins on -- in the third quarter.

Robert O. Carr

Also, our summit this year is in October. And actually, the bulk of our expense for the summit is coming in the third quarter, whereas in different years -- least year, it was in March, right? So comparing the quarter-over-quarter activity for the -- our cost of the summit is not -- it needs to be factored that in. And in fact, we're going -- it's about $0.05, I think, of costs that we're taking in the third quarter. Now that's an aggregate. Okay, an aggregate. But the bulk of it is coming in the third quarter because we're so close to -- our summit is October 11. So that is a factor, and it's going to depress third quarter a little bit over the fourth quarter this year.

Robert H. B. Baldwin

And you do have, Dave, just as Maria said, just there are other expense that we're running along as we see opportunities to build out solutions. It's really going to be driven by G&A. And so we know that there's a historic pattern with the third quarter because of the strong volumes. Usually, that's an improving operating margin quarter. That's with the G&A expense that we expect will be a headwind there.

Operator

We'll take our next question from Greg Smith with Sterne Agee.

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

I just wanted to be sure, the new margin installed, that includes sales across all products. So it's payroll, merchant and the School Solutions, is that correct?

Robert O. Carr

It's not correct. It's the product of our sales organization that deals with SME accounts. And it's a year-over-year comparable to previous years. It does not include School Solutions, does not include major accounts, does not include the sales from the Ovation Payroll team at this point.

Robert H. B. Baldwin

It does include Ovation.

Robert O. Carr

Okay. Because it's sold to SME merchant. But it does not include K-12, Campus, MicroPayment sales and major accounts sales. Those are all kept separately because they are sold by a separate sales organization. Any product that we will sell through our SME sales force, being Ovation and the RMs, will be what we count in new margin installed.

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

Okay, great. And then just given the strengths there, where -- just thinking about the core merchant acquiring business within SME, where are the new merchants coming from? Any category or geographical location? Any trends you're seeing there that you can give us some color on?

Robert O. Carr

Well, we have some new geographies that we've been able to recruit some new leaders in, and so we're getting some new production out of areas that have been fallow for us in the past. And the good news is that we think we've learned how to find folks like that and to bring them into the organization. So it's more from that than anything else, I believe, in terms of our increasing productivity in our sales organization.

Robert H. B. Baldwin

Also a little bit on the Petro side. That was a nice start to the SME Petroleum Solution. As an example of -- we're adding people and adding things that those people can sell, driving both productivity gains, as well as absolute production gains that we're obviously looking to continue to grow in the future.

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

Okay, great. And then just one last question. Just help us think a little bit about 2014 kind of puts and takes we may have from things that are sort of within your control. I know you're going to have the payroll platform consolidation. Is there anything else we should be thinking about as a significant headwind or tailwind in 2014?

Robert O. Carr

Well, we're not really -- haven't given guidance in the past on the out-year and aren't going to start now. And we -- obviously, the Ovation platform consolidation is something we look forward to. There's a lot of stuff going on, some of which we hope is good. It depends on how it plays out, which will impact the cost structure. If we have more success in some variants, then we're going to spend more money on things like that. If they don't work out, then maybe we'll cut back. So it's really hard to project it at this point in the year.

Operator

We'll take our next question from Tim Willi with Wells Fargo.

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

I had 3 questions here. First, just a housekeeping item. Could you identify what acquired revenue was in the quarter, so just sort of back into an organic growth rate or maybe ballpark if you can hand it out?

Maria Rueda

We didn't hand it out. But Tim, the ballpark is about 60% of our net revenue growth in the quarter was non-organic, about 40% organic.

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

Okay, great. And then on K-12 and the win with Chicago that you referenced. First is, I'm not an expert on that marketplace at this time, but is that the -- it sounds like the kind of win that could actually, as we think about that ramping up, it would seem like that could actually reduce the growth rates of that business a little bit given the size of that school district. Is that a good way to think about it? Or is that sort of getting overly excited about how big that win is for you in that division?

Robert O. Carr

No, it's a pretty good win, Tim. It's one of the 3 biggest school systems in America. It sort of got some complexities. It's great in terms of the Mosaic platform that we think is a market-leading solution and taking things where it needs to go. It's not as great in terms of the payments because -- which is a core focus of ours in the business because the reality in the Chicago environment is an awful lot of the kids are on the free and reduced program. But still, it grows the payments pie, and there's a big implementation, with a multiyear, multiple millions of dollars of aggregate revenues.

Robert H. B. Baldwin

I think that even bigger than that is the fact that we're introducing this cloud-based SaaS platform, and that's new to the new technology in Chicago. Now it's got the leading technology, and we believe a lot of the school districts, especially the bigger ones, are going to want to go with this platform because of all the benefits that it provides.

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

So this sort of serves as a sort of beta reference client and obviously a very large one at that, and I'm assuming other people are going to watch pretty closely?

Robert H. B. Baldwin

Exactly. And we have some smaller ones coming right along with it.

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

Great. And the last question I had, and this is something that has popped up this morning. But evidently regarding debit interchange, I guess the judges has ruled in favor of the, I guess, National Association of Convenience Stores and their suit that the Fed had misinterpreted the mandates going back a couple of years at setting debit interchange. I guess I'm curious, even if you haven't had a chance to look at it or study it, given your focus on the small businesses, et cetera, do you -- would you view this as a credible issue or just some legal maneuvering that might not really turn into anything big, if you're willing to offer a thought?

Robert O. Carr

Well, while we all give our opinions, it's so early. We just heard of this just before the call. The Durbin issue has helped Heartland in the past and to the extent that this changes debit interchange by lowering the cost in the future. I think it's going to help us even more in the future. We're, I think, up to over $600 million of Durban money that we've given back, and we'll continue to do that. That's our model, and everything is predicated on continuing that model.

Robert H. B. Baldwin

I'll just add. This is not -- nothing technical about this. This is sort of a major surprise. Clearly, we would expect it to be appealed, and I don't have an opinion about whether that appeal will succeed. One thing for sure is it will take time. But if it stands, what I've read about the ruling clearly says that the Fed is being instructed to come up with the lower cost factors, which would reduce interchange on a -- further on about 2/3 of the transactions. As always, with government -- these kind of government things, you get unintended consequences, and if interchange went down further for regulated banks, you don't know what their activity is going to be as far as promoting debit versus promoting credit, all kinds of things. So it's really hard to handicap. Our approach will be, as we've said many times, we will pass it through to the merchants and try to benefit from that pro-merchant stance that we've always taken.

Operator

We'll go next to Tien-Tsin Huang with JPMorgan.

Tien-Tsin T. Huang - JP Morgan Chase & Co, Research Division

Just I guess on the -- I just wanted to dig further on the sales headcount. Any sort of revelations or surprises in retention or productivity at the new hires? Obviously, the new margin installed was good. How much of it was tied to the headcount changes?

Robert O. Carr

We have what we call a rookie salesperson. He's been with us less than 6 months, and our rookie production was at its all-time high. We have figured, Tien-Tsin, figured out ways of having more rookies be more productive right out of the gates. We spent a lot more time with them in the field than we've done in the past. And we have -- we limit the ability of the division to bring on new people until their rookies are being successful. So it's helped a lot, and we think we have discovered some keys to future success in adding to our rookie base.

Tien-Tsin T. Huang - JP Morgan Chase & Co, Research Division

Anything we should expect in terms of second half changes in headcount?

Robert O. Carr

We think we're on a path to continue to grow the sales organization productively and feel pretty confident that we're going to be able to do that. Yes, we feel good about that result, and our -- have always set high goals for our sales leadership and are very pleased with the results.

Tien-Tsin T. Huang - JP Morgan Chase & Co, Research Division

Put you on the spot a little bit, I guess, given that, should we expect the margin installed then to accelerate as we go into the back half of the year from the 16% level in 2Q?

Robert O. Carr

Well, in 2012, we flatlined our -- essentially, our new margin installed in the sort of $15 million -- $14 million, $15 million area. To the extent that we can keep adding successfully to the net headcount, and let's not lose sight of the fact that productivity was also at an all-time high in the sales organization, yes, that will feel pretty good. But we purposely set out -- we've set out what our minimum expectation is for the full year, which was the net gain of 100. We almost hit that already, and we're not going to -- please don't hang us on our success by expecting it to happen. We aspire to have this kind of level continuing, but we're certainly not in the position to predict it.

Tien-Tsin T. Huang - JP Morgan Chase & Co, Research Division

Understood. Last one, I promise. 25% growth in equipment sales was called out, I think, in the release. What drove that? Is it EMV related? Is it just tied to some of the new margin installed that you saw? I'm just curious if there's anything unusual.

Robert O. Carr

Nothing particular unusual, I would say. It's definitely not EMV because EMV is -- at this point, you're really not ready with the terminal solution. In fact, just this week, we got Visa and MasterCard agreeing on a solution that was just going to tie in to the -- that was going to tie in to the -- to what one would set up for a terminal. So you really couldn't do it right now.

Robert H. B. Baldwin

Bob, I think it was probably the year-over-year growth because of the acquisition of NUTRIKIDS preparing for schools opening in the fall.

Robert O. Carr

NUTRIKIDS would be -- that's right, would be definitely a part of that modest increase in SME cards. And actually, other areas are sort of -- it's basically in the School Solutions area, so that's the driver.

Operator

We'll take our next question from Brett Huff with Stephens Inc.

John Campbell - Stephens Inc., Research Division

It's John Campbell in for Brett Huff. Sorry for the mixup earlier. So the payroll platform consolidation, is that still on track for midyear '14? And then if you guys could maybe just size up that cost reduction opportunity?

Robert O. Carr

I don't think we're really ready to nail it down. It's absolutely intended to happen in 2014. We don't have a laid-out schedule yet, and so can't quantify the extent of the savings that we're going to achieve in 2014. Obviously, the later in the year that you end up doing that, the less you saved. And we haven't gotten that granular, as I've mentioned before. Right now, the focus is on adding functionality to our PlusOne program, the platform that Heartland has, so that the Ovation sales force can start putting merchants on there in the fourth quarter. That's tracking on that plan, and that's an important step. Once that's done, that's when we'll start turning our focus after the W-2 season to the actual conversion off of the Ovation platform.

John Campbell - Stephens Inc., Research Division

Okay, great. And then just in the supplemental data you guys provided, I mean, it looks like the payouts of accrued buyout liabilities came up a bit in 2Q. Maybe if you guys can maybe just talk about what the driver of that was and then just kind of how that trends over the next few quarters?

Robert O. Carr

Well, the buyout liability is a function of the installed margins. And buyouts were a little bit light the last couple of months, but more impactful is the increased margin installed.

Operator

We'll take our next question from Mike Grondahl with Piper.

Michael J. Grondahl - Piper Jaffray Companies, Research Division

Yes. Could you guys talk a little bit about the payroll business and the K-12 business and how that's performing against your expectations and then some milestones we should watch for there?

Maria Rueda

Mike, well, in terms of those businesses, the businesses are performing according to our expectations. And as we said in our release earlier, in the K-12 business, we continue to call out successes such as Chicago and moving to the SaaS technology base for the schools that we do have in our stables right now. The payroll business is moving according to plan. We are happy with what we've seen to date. We continue to maintain our high expectations for that business.

Michael J. Grondahl - Piper Jaffray Companies, Research Division

Okay. And then maybe just a follow-up. In terms of some of the margin, fresh or whatnot, in the third quarter, could you be a little more specific where those investment dollars are going to so we can think about that a little bit?

Maria Rueda

We don't have any specific areas that we would address at this point. We continue to look for opportunities to invest that will build out the business solutions that we have -- able to offer to our merchant base. And we will continue to do that.

Robert H. B. Baldwin

In the end, during a year, when you're trying to roll out solutions, the various infrastructure costs, heavily people, but also taking -- we're doing a lot of development. When you take that live, you get the amortization that begins on it. So that's a cost. You get people involved. You just have marketing dollars. And it's really -- as we pointed out, it's really going to be coming heavily in the G&A area that costs are just going to be running a little bit stronger in the third quarter.

Operator

We'll take our next question from Smitti Srethapramote with Morgan Stanley.

Smittipon Srethapramote - Morgan Stanley, Research Division

Yes. Just briefly non your cross-selling initiatives on the card with your merchants. Can you give us some color on which products eCommerce in a Box, the networking products, which products are getting better or worse traction than you had anticipated? And any updates on any further offerings that you may plan to target those merchants with?

Robert O. Carr

We're targeting e-commerce right now and small Petro right now. I would say that Payroll is a little bit better than we expected, and our product called SmartLink, we've had challenges at getting a way to install these small merchants because it's difficult to understand the topology that's in an existing small merchant location. And oftentimes, we get incomplete or inaccurate information from the business owner and makes it very difficult to install a complex telecommunication system. So we're challenged by that. But we think we can overcome it. We have to have a more standardized product, we think, there. But otherwise, I think our multi-products are working well. We've upgraded our marketing solutions loyalty program and are gaining some traction with that as well. So I think we're working really hard on that area, and our sales people are doing a very good job of doing multi-product sales better than ever. And we expect that to continue to improve.

Operator

[Operator Instructions] And we'll go next to Andrew Jeffrey with SunTrust.

Andrew W. Jeffrey - SunTrust Robinson Humphrey, Inc., Research Division

Bob Baldwin, you mentioned last year that new margin installed was flat. You're obviously running at a pretty good pace of growth this year. Could you just help us understand how that translates into SME net processing or processing volume growth assuming relatively stable yield? Is there -- are we seeing a relative lag in processing volume growth this year owing to flat new margin installed? And then would this year's growth translate into acceleration all else being equal next year? How exactly does that hit the volume and ultimately the P&L?

Robert H. B. Baldwin

Yes. Andrew, thanks. Good question. It's -- there's always a frustrating lag in this. We installed a good amount of margin. 15% growth is a good thing, but it's not that many millions of dollars of incremental margin or the higher net revenue associated with that compared to our overall portfolio. So as we discuss the analogy often is that of a tanker. We're raising the RPMs in the engines. That is going to result in a faster growth. And the more we can increase the growth in installed margin, the more that will play out to faster net revenue growth. So it's something that we'll keep building as long as we keep growing the installed margin compared to that baseline that we were at the last year.

Andrew W. Jeffrey - SunTrust Robinson Humphrey, Inc., Research Division

Okay. So if organic revenue growth this quarter was somewhere between 5% and 6%, again, as we look out to next year, all else being equal, staying in the low-single digit 1% to 2% same-store sales, that would just mathematically pick up if you continue to drive strong NMI growth? Am I thinking about that correctly?

Robert H. B. Baldwin

Given that condition of if we continue to grow the net margin -- the margin installed growth, yes, that is true.

Andrew W. Jeffrey - SunTrust Robinson Humphrey, Inc., Research Division

Okay. And then I know you don't want to give 2014 guidance, and I don't want to hold your feet to the fire, although one of the things you've said in the past is ultimately you'd like to -- the goal is to get to a 25% EBIT margin. Recognizing that '13 is kind of a moderation year or a flatlined year in light of some of the incremental investments you're making and so forth, just directionally, qualitatively, should we think about '14 being a return to trajectory improvement? And without necessarily asking you to quantify what that would look like.

Robert O. Carr

Well, given that the trajectory is coming off of 2 fabulous years of improvement in our operating margin, no, we're not going to commit to that. I think that it's fair to say that we have set out a 25% operating margin objective. We have said that it's going to be in a reasonable amount of time. We've said that this year is a pause on that. That means that in order to get to that 25% number in a reasonable amount of time, we need to improve it again next year.

Robert H. B. Baldwin

And the only other thing I'd say is that the degree to which that succeeds, as we've talked about, all of our businesses have high incremental margins, the focus of all this activity, all of these investment is enhancing our growth -- our success at growing the various businesses that we have. The greater success we have at achieving that growth, the easier it is to bring dollars to the operating margin line.

Operator

We'll go next to Steven Kwok with KBW.

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

Most of my questions have been answered. But I just wanted to drill down a little bit within the payroll processing revenues segment. What's the organic...

[Audio Gap]

Robert H. B. Baldwin

Well, the Form 1098 form that people get for their kids at colleges, and that's a first quarter phenomenon, much like the W-2 income in the payroll business. In terms of the organic growth, there's 2 forms of organic growth. We're seeing organic growth at Ovation. So if you look at where they are this year versus a year ago, they're getting organic growth. But obviously, as it's reported to Heartland, it's all inorganic growth. And at this point in the year, we're seeing sort of 10%-ish payroll company growth right now. So we're -- that's all organic, and we do feel good about how the legacy Heartland sales force is spending more time on payroll installs and achieving success there. And also the SPAs that we have brought on under 10 have been hired so far. Some very positive early signs on how that program will work for the payroll solution in the legacy Heartland sales force.

Operator

And we'll go next to Chris Shutler with William Blair.

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

One of the keys to the story, really, at least in my opinion, is showing you can sustainably grow the SME sales force on a productive fashion. So in that vein, can you give us any detail around retention for the new sales people hired over the last couple of quarters?

Robert H. B. Baldwin

The retention is -- of new hires is the best it's been in the last 5 years.

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

Okay. And then can I ask one more? On acquisitions, what areas do you think you're most -- that are most attractive to you guys right now? And then anything -- how come -- what's the highest level you'd be comfortable going from the size of acquisition at this point?

Robert H. B. Baldwin

We're interested in good accretive acquisitions that will expand our product set. And there's a lot of interesting things out there right now. And we would -- for the right type of acquisition, we would stretch a little bit to be able to do that.

Robert O. Carr

Yes, I think that we are philosophically inclined more toward singles than doubles. But if the right opportunity that was larger came along, we'd be open to it. As Bob said, there's a lot of interesting stuff going on, and we're in a pretty good position from a financial standpoint to take advantage if something good comes along.

Operator

We'll take our next question from Tulu Yunus with Nomura.

Tulu Yunus - Nomura Securities Co. Ltd., Research Division

I guess, Bob, what -- in your attrition number, generally speaking, how much comes from bankruptcies versus switches? Just on average over time sort of what's the split.

Robert H. B. Baldwin

It's around 50-50. 50% go out of business, change ownership, whatever other reasons that we have to have a new install. And then the other 50% is -- left us for whatever reason.

Robert O. Carr

Most of the businesses, they call it business [indiscernible], don't declare bankruptcy, though, just from a technical answer.

Robert H. B. Baldwin

The clue, you could see a closed sign on the door.

Robert O. Carr

If a merchant sells their business and we gain the new account, we count that as attrition and a new sale, which is probably different from the industry way of doing it. But we do that because of our sales organization model.

Operator

We'll go next to Kartik Mehta with Northcoast Research.

Kartik Mehta - Northcoast Research

Bob, at the beginning of the -- in your prepared remarks, I think you said something like that you expect the next few years to be the most tumultuous for the credit processing industry. And I'm wondering if that is because the competition or technology or something else. And how -- is that good or bad for Heartland as you see the future?

Robert O. Carr

So I think the change is just fabulous for Heartland because being a core processor that's vertically integrated and having our own employee-based sales organization, we're pretty unique animal out there. And so for those third parties who are really middle man between the core processor and the merchant who are offering a single product or multiple products that are not integrated together, I think we're just in a really strong position there. And the change is coming in no doubt with tablet technology and smartphone technology. The world is changing rapidly, and we're seeing it pick up steam. The younger generation is driving us to these technologies. And we have our mobile product. We haven't given it a lot of attention, but we have lots of acceptance over the mobile product. And we're developing other mobile products in our MicroPayments business. In our Campus business, we've developed mobile technology. We've done press releases on them. But I really think that over the next 3 to 5 years, there's going to be a tremendous turnover of point-of-sale in a much more sophisticated point-of-sale world than we have today. I think the big iron point-of-sale systems are not going to be around so much over the next 3 to 5 years. There's going to be a change that's driven primarily by merchants wanting to give better services to their customers and being in partnerships with vendors of products who want to incent customers who buy their product. And we're right in the middle of all that and very excited about the developments that are happening right now.

Robert H. B. Baldwin

The only thing I'd add is that, that direct contact to the customer is just key. Being able to talk to the customer, find out what they want and what they don't want, what their problems are, it's sort of a slightly odd thing in our industry that many, many sales SMEs are made through indirect distribution channels. And that's just not a very easy way to navigate what will undoubtedly be complex opportunities. There's a lot of exciting innovation, a lot of people who are coming up with new ideas. Funding has arguably never been easier for our payments-related company. And so -- and there will be a lot of people who have an idea that crashes and burns, but there will also be some really great successes. And our goal will be to be part of those great successes.

Operator

And we'll go next to Tom McCrohan with Janney.

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

I missed the early part of the prepared remarks, so apologies in advance if I'm asking questions that you've already addressed. Can you tell at this point the average size of the merchant that you're kind of adding that's kind of baked into the new margin install? Then in terms of pricing, are you -- well, are you having to give up anything on pricing to win new business or you're still priced well below what the merchant that you're winning is currently paying. If you can just talk about trends there. And what verticals in particular are you winning new merchant activity in?

Robert H. B. Baldwin

The average merchant that we're installing is rolling about 5% a year. And that, in our business, a larger merchant rightly expects to get a slightly better deal. So the dollars of margin is good, but the basis point is -- can be lower. And there's going to be -- as we grow the average merchant in our portfolio, that's just the way the math works out. So it's perfectly fine with us. It's just -- so we aren't seeing any compression in terms of the same-sized merchants. It's just that when you go after a slightly larger merchant, that marginal merchant will have a marginally lower price in terms of basis points. In terms of industry, we'll add -- like Petro is a new thing. eCommerce, very excited about the opportunities there. So we keep adding new things, but an awful lot of our sales are still hospitality. And we don't have any particular things that we try to incent the sales force to go after at the expense of another thing. Each sales person makes his or her own decision about what kinds of merchants to go after based really on their comfort level. So there will be people who decide, "I'm going to go after the petro world." Others who say, "I'm not comfortable with that technology, with that installation," and so they'll shy away, and that's fine. Our job is to give them a suite of products, a suite of -- make their life easier to understand those new things, and that will result in better sales of those products.

Operator

We'll take our final question from Chris Brendler with Stifel.

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

I just want to follow up on the buyout liability that increased this past quarter. My understanding was that when it spiked up like that, it indicated that you had let go of some sales people. But I thought your previous answer suggested that was part of your growth trajectory. So if you can just help me understand that. And also, the payments of buyout liability was down 20% -- I'm sorry, buyout liability. The payments of these bonuses was down 25% -- 20% year-over-year, which doesn't really seem to fill my understanding of what that line item is relative to your growth in installed margin. And finally, at the installed margin for the quarter, we had estimated that Ovation added about 400 basis points last quarter. Does that sound about right that organic growth was in the low double digits for volume x the Ovation acquisition?

Robert H. B. Baldwin

Okay. We'll have to keep track of those. The first question was related to the accrued buyout liability balance sheet account, which is down marginally. It's really -- when you take the current portion plus the long-term portion, it's only down a couple of million dollars. And that's really the results. If you then go to the cash flow statement and you see the payouts of accrued buyout liability for the year had been $10.5 million. That's higher than the $6.7 million. Buyouts occur for a host of reasons and a host of circumstances. Sometimes, we will buy out a terminated person who was vested. Sometimes, we will not. It depends on why are they -- if they're leaving us to go to a competitor, we're not so inclined to buy them out because we don't want that merchant to be taken along by the sales person. On the other hand, if the person is retiring, we might buy them out, especially if their attrition is low. In the quarter, we [indiscernible] calculated now includes Ovation sales, which don't have a signing bonus associated with them. So that's part of it. Another part is that we have taken our very top level of our sales management and taken them off of the override model, so we stop paying them signing bonuses. And we've taken them to a salary and bonus compensation scheme that really is designed to give us a better lever in terms of the bonus to motivate the right behavior in hiring and training of people. So that was a significant change that we had that also reduced the amount of signing bonuses. So that's all of those -- the buyouts and the signing bonus things. Your other question?

Robert O. Carr

The other question was how much of the growth in our installed margin was Ovation? Is it about 400 basis points? I think that direction, that's about right.

Robert H. B. Baldwin

That sounds about right.

Robert O. Carr

Right.

Operator

And at this time, we'll turn the conference back over to Ms. Maria Rueda for any additional or closing remarks.

Maria Rueda

Thank you very much, Martina, and thanks, everyone, for joining us, and have a great day.

Operator

That does conclude today's conference. We appreciate your participation. You may now disconnect.

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