Heartland Payment Systems' CEO Discusses Q1 2011 Results - Earnings Call Transcript

May. 5.11 | About: Heartland Payment (HPY)

Heartland Payment Systems (NYSE:HPY)

Q1 2011 Earnings Call

May 04, 2011 8:30 am ET

Executives

Robert Baldwin - President

Maria Rueda - Chief Financial Officer

Robert Carr - Executive Chairman and Chief Executive Officer

Analysts

Robert Dodd - Morgan Keegan & Company, Inc.

Brett Huff - Stephens Inc.

Robert Napoli - Piper Jaffray Companies

Christopher Shutler - William Blair & Company L.L.C.

Thomas McCrohan - Janney Montgomery Scott LLC

David Koning - Robert W. Baird & Co. Incorporated

Tien-Tsin Huang - JP Morgan Chase & Co

John Williams

Grant Keeney - Northcoast Research

Richard Cheever - SunTrust Robinson Humphrey

Meghna Ladha - Susquehanna Financial Group, LLLP

Timothy Willi - Wells Fargo Securities, LLC

Operator

Good day, everyone, and welcome to the Heartland Payment Systems First Quarter 2011 Earnings Conference Call. Today's conference is being recorded. At this time, I am pleased to turn the conference over to President Robert Baldwin. Please go ahead, sir.

Robert Baldwin

Thank you, Jennifer, and good morning, everyone. I'd like to welcome you to our first quarter 2011 earnings call. Joining me this morning is Robert Carr, Chairman and CEO. And also on our call, I'd like to introduce Maria Rueda, our new Chief Financial Officer. Today, Bob will discuss begin our discussion with an overview of the quarter, and then I'll return to go through some of the financials in detail before Bob, Maria and I open the call to take your questions.

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

Now I'd like to turn the call over to Bob Carr.

Robert Carr

Thanks, Bob, and good morning, everyone. I'd like to thank you all for joining us today and for your interest in Heartland. As you saw in our release this morning, in the first quarter, we sustained a momentum of the strategic initiatives that began to take effect in the previous quarter. For the quarter, we reported adjusted net income of $8 million or $0.20 per share, which compares to $1.5 million or $0.04 per share in the first quarter last year. Bob will go through the detailed results in a minute.

The strategic initiatives implemented last year, once again, generated new business growth while improving our operating efficiency, enabling us to achieve the high end of our revenue growth objective and a substantial improvement in our bottom line. Growth was strong in both our Card and non-Card businesses. SME transaction processing volume was up 7% and NWS transactions were up over 9%. Growth in our non-Card business was even better with payroll revenues increasing 15.5% and equipment-related revenues almost 10%.

Small businesses appeared to finally be joining the economic recovery. For the quarter, same-store sales were up 3.2%. Though down a little sequentially from 3.8% in the fourth quarter, it is nevertheless a 470 basis point improvement relative to last year and our fourth quarter -- our fourth consecutive quarter of positive same-store sales performance. And new margin installed registered a second consecutive quarterly increase, up 13.2% in the first quarter or more than double the 6.4% improvement seen last quarter. As a result, volume attrition also improved from the comparable period a year ago.

Better performance across these key business drivers is indicative of operational improvements and, more importantly, strong performance from our reenergized sales organization, as well as a more constructive economic environment. After taking some aggressive actions with our sales organization late last year, we recorded our first quarter of year-over-year new margin installed growth in the fourth quarter. We followed up that performance with even better growth this quarter. Importantly, in the first quarter, we achieved record relationship manager productivity, reaching almost $6,000 of monthly new margins installed per relationship manager.

In addition to the impact of the sales organization comprised of a higher proportion of more productive relationship managers, we believe productivity is also benefiting from the cross-fertilization we have encouraged through an enhanced sharing of best practices across the sales organization. We are institutionalizing this process so that we can move quickly -- more quickly share effective new processes to enhance sales success throughout the entire organization.

At the same time, the disciplined enforcement of our new production requirements continued to reduce the size of our sales team. Relationship manager count was 762 at March 31 compared to 917 at December 31. Fortunately, as of April 30, we believe that the majority of underperforming RM attrition that was anticipated had essentially ended. From this solid foundation of high performers, our goal is to add productive new relationship managers at a deliberate, measured and sustainable pace.

We have fine tuned the hiring process, and that process is ongoing. Division managers who have 80% or more of their relationships managers meeting their production goals are adding new relationship managers. In these divisions, the existing sales force is highly productive, requiring less supervision, thus, freeing up the division managers to spend more time to properly train and develop new results. Consequently, the sales organization will return to focus on growing its numbers of productive RMs. We hope to see an increase in productive relationship managers as of June 30.

On the cost side, processing and servicing costs were down nearly 8% year-over-year, reflecting facility consolidations, reduced merchant losses, efficiency improvements and other cost-containment measures, such as strategic residual buyouts. This combination of top line growth and improved productivity drove the operating margin to 12.9%. This enables us to not only stay on pace with our margin improvement target for the year, but to grow earnings much faster than revenues.

Finally, we have made a few changes that significantly strengthened our management team and better arm us to achieve our strategic objectives. First, Bob Baldwin, who has been instrumental in the significant operational and strategic progress achieved since being elected President, has agreed to take an even greater role in helping improve the execution of our strategy and operational priorities. In order to concentrate his efforts on these broader responsibilities, he has relinquished his CFO title.

Replacing Bob as our new CFO is Maria Rueda, who is on our call with us this morning and who comes to us with a distinguished career as a senior global financial executive. Maria was most recently CFO of ING DIRECT, the largest direct bank and largest thrift in the United States. She will work closely with Bob to transition leadership of both our finance organization and our interactions with the investment community. A strong welcome to Maria.

Please join me also in welcoming Heidi Goff as Heartland's new Chief Marketing Officer. Heidi has extensive payments industry experience, having held executive marketing management positions with TNS, Transaction Network Services, with Global Payments and with MasterCard and was, most recently, President & Managing Director of the Americas at HyperCom, Inc. With Maria and Heidi on the team, I believe Heartland has put in place an outstanding executive group that provides us with even deeper industry knowledge and expertise with which to achieve our strategic priorities, drive growth and position Heartland solidly for the future.

Now let me turn the call back over to Bob.

Robert Baldwin

Thanks, Bob. Heartland reported GAAP net income of $7.8 million or $0.20 per diluted share in the first quarter of 2011. Excluding $300,000 of pretax processing system intrusion costs, adjusted net income was $8 million, which is also $0.20 per diluted share. On a like basis, this is up substantially from $1.5 million or $0.04 per share last year. Earnings for the periods are net of approximately $0.03 and $0.02 per share, respectively, of stock compensation expense.

Small and midsized merchant card processing volume for the quarter was $15.4 billion. Card processing volume growth continued our recent quarterly sequential gains rising from 5.9% in the third quarter, 6.8% in the fourth quarter of last year, now 7.1% in the first quarter of 2011. Processing volume benefited from a 3.2% increase in same store sales in the quarter, although this is down somewhat sequentially from 3.8% in the fourth quarter.

After a slow start in January that was undoubtedly weather related, same-store sales rebounded in February and March. Though we had a modest sequential decrease this quarter, same-store sales growth was still better than our continued expectations of just 1% to 2% growth for the year. We are maintaining our cautious outlook based on both more difficult upcoming quarterly comparisons, as well as some concern whether the current rate of U.S. economic growth will be sustained, especially for small and midsized merchants. Volume attrition in the quarter was also better than a year ago at just 13.4%, which is up only marginally from the recent low of 12.7% last year's fourth quarter.

Our statistical supplement, which is available on the website, provides more detail on vertical industry same store sales performance. But in broad strokes, our best performing industries were utilities, electronics and furniture, QSRs and auto-related retailers. Gasoline prices -- price increases drove SME petroleum same-store growth to high levels and brought our overall average growth up by about 0.3%. Performance to the restaurant vertical continues to restrain same-store sales results.

For the quarter, all of the segments that we follow were in positive territory and all of our geography showed positive same store sales growth. This quarter, we saw a consistent average ticket and a continued shift to a more debit spending. In fact, for our SME merchants, over 71% of our transactions and 52% of our Visa-MasterCard volume now arises from debit transactions.

Network services processed 747 million transactions in the quarter, up 9% from the same quarter of last year. After falling last year while absorbing new pricing in certain contracts, NWS net revenue was up 2.7% in the quarter. This was a major strategic initiative, and we are very pleased to see network services net revenue, once again, contributing to our growth. Including a 15.5% increase in payroll gross revenues and a 9.8% increase in equipment-related revenue, net revenue was up 8.5% for the quarter to $112.7 million. That's the strongest quarterly net revenue growth since the second quarter of 2009.

Total cost of services for the quarter increased 10.9%. The bulk of the increase was concentrated in interchange and dues, assessments and fees, which are costs we do not control and pass-through. Importantly, the largest controllable component of cost of services, which is processing and servicing expense, was actually down 7.8% from a year ago. Customer acquisition costs were also down, falling 12.8% for the quarter, as the amortization of the record 2008 new margin installed started rolling off this quarter.

First quarter G&A expenses were up 10.9%. We want you to recall that G&A expenses in 2010 included $2.1 million for our periodic sales and servicing organization summit. Excluding these summit expenses from the 2010 total, our G&A expenses in 2011 increased by 20.3%. We are making some adjustments in our cost structure, whereby we are achieving some long-term infrastructure saves in processing and servicing costs at the expense of some near term increased G&A. For instance, in equipment and occupancy cost, as part of our move to the cloud-based infrastructure model, we are increasing our computing power and data center capacity, which will lower ongoing processing and servicing costs, but at the cost of increased G&A expense due to additional staff, travel and telecom cost required to build and manage the new structure.

Operating income for the quarter was $14.6 million compared to $2.6 million a year ago. The operating margin expanded to 12.9% of net revenue, which is up substantially year over year. Since the first quarter is our weakest on a seasonal basis, this margin performance is encouraging and is a good start to achieving our margin objectives for the year. Costs associated with the processing system intrusion reduced earnings by only $300,000 in the quarter, whereas a year ago we had a large insurance recovery.

Now let's look at our cash flow. Management's method of calculating operating cash takes net income adds back amortization, depreciation, provision for the processing system intrusion and other noncash items at the top of the operating cash flow statement, resulting in total sources of cash flow from operations of $32.4 million. We then reduced that figure by signing bonuses and buyouts paid. Using this management metric, operating cash was $22.1 million in the first quarter, up 62% from $13.6 million last year. Taking that same management definition of operating cash and reducing it by capital expenditures of $8.1 million, our free cash flow amounted to $14 million, up about 38% compared to last year's first quarter. We also used $1.5 million of cash to pay dividends in the first quarter.

We had $111.5 million outstanding on our borrowing facilities at March 31, and during the quarter, we made our first quarterly amortization payment of $3.75 million on our term loan. Current borrowing availability on our revolving credit is approximately $35 million.

Let me wrap up with guidance for 2011. Given the strong first quarter, for full year 2011, we are raising our guidance and now expect net revenue to increase between 8% and 10% and fully diluted EPS to be between $0.95 and $0.99 per share after deducting $0.15 per share of 123 R stock compensation expense. Company's guidance does not include any of the ongoing costs related to the processing system intrusion.

Back to you, Bob.

Robert Carr

Thanks, Bob. Though typically our seasonally weakest quarter, in the first three months of 2011, we clearly demonstrated the fundamental strength of the Heartland franchise and the impact of our strategic commitment to sustain new business growth, improved productivity and efficiency and generate attractive returns and strong cash flow. The Heartland brand continues to be a powerful force in the marketplace.

On the economic front, the first quarter enjoyed a nice tailwind, especially on February and March. And we remain guardedly optimistic with respect to GDP growth for the rest of the year, and we are building our plans around those expectations. We are working hard to spread the successful practices of our most productive relationship managers throughout the organization and add talented, motivated relationship managers, who can help us achieve the growth we know is available.

With that, we would now like to answer any questions. Please open the call, Jennifer, for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go ahead and take our first question from Tim Willi with Wells Fargo.

Timothy Willi - Wells Fargo Securities, LLC

I had a handful of questions here, if I could. First one was around the network services. You talked about the revenue growth there, which is nice to see after a tough last year. In terms of just the dynamics between volume and pricing that helped to drive that improvement, could you sort of give us a feel for where you're at on the pricing side after, again, having a tough '10 and how the new sales pipeline looks, particularly going into more of the regional and sort of smaller petroleum merchants with that platform?

Robert Baldwin

Sure, Tim, thanks. The major driver of last year's challenge was that we had two major contracts that renewed at a much less attractive profitability. We've annualized those changes and do not have any major contract renewals that are a similar threat to this year, so that's a much easier comp. For this year, as you noted, we're focused primarily not on the large merchant, although we have some interesting a couple of interesting things going along there, but primarily on the mid-market initiatives, and those are going well. It remains very much a focus of ours to keep getting the onboarding process better and making life easier for our bid market and then, ultimately, for our small and midsized installs of petroleum. So that's the opportunity this year that we expect to see playing out and helping us on the revenue side in the back half of the year.

Timothy Willi - Wells Fargo Securities, LLC

And then just a couple of other quick ones. Could you give us a feel for how same store looked in February and March given the drag in January?

Robert Baldwin

Well, they were both in the high 3s, I think. No, actually, one of them was in the 4% range, and I'm blanking on what the number was right now, but it was actually -- for March, it was 4.65%. So it was -- and March was the strongest month of the quarter.

Timothy Willi - Wells Fargo Securities, LLC

And then just lastly, 2 quick ones. Number one, you gave some statistics around your debit volumes. I just couldn't write fast enough to get that breakdown of what percentage of your volume or transactions come from debit.

Robert Baldwin

So this is in the SME category, and if you take combined pin and signature debit and compare that to Visa -MasterCard total activity, plus pin debit, which isn't Visa MasterCard, of course. So it's a little bit of amalgam statistic, but I think this really reflect the SME business as a whole. We end up with 71% of our transactions and 52% of our dollar volume coming from debit transactions.

Timothy Willi - Wells Fargo Securities, LLC

And is the vast majority of that probably signature versus pin?

Robert Baldwin

The a vast majority, somewhere about 93% of it is -- and actually a higher percentage of the transactions because the average ticket in pin is higher than the average ticket in signature. I think largely driven by the -- even though we don't have a lot of supermarkets, people do use pin at the grocery store, and so with those -- and you have a typically higher ticket at a grocery store.

Timothy Willi - Wells Fargo Securities, LLC

And then on the customer acquisition costs, just a last question then I'll hop off. You had said that, that decline, if I heard correctly, was sort of just largely -- sort of the expiration of amortizing strong merchant sign ups from a couple of years ago. Did I hear that correctly?

Robert Baldwin

That is correct. We amortize it over 3 years. It's not straight-line amortization. It's accelerated to be proportional to the revenue we expect from merchants, from the group of merchants that were signed. But still you have -- 2008 was our highest year of installed margin at just over $70 million. And unfortunately, we're at lower levels now. And so the amortization is coming off from those year -- from that year is coming off in 2011, and the amortization we're starting is from a lower base. We are working hard to get the installs up so that, that turns around but it is a benefit we're getting right now.

Operator

Our next question will come from Tien-Tsin Huang with JP Morgan.

Tien-Tsin Huang - JP Morgan Chase & Co

Congrats everybody on their new roles. I wanted to ask Bob Carr, just a question about sales force and what the mood is like now, I suppose. I'm just trying to gauge the optimism the sales force might have for signing new merchants, given the economy and all of this regulation that's happening. Well, how does it feel now, Bob?

Robert Carr

I think it feels the best it's been, frankly, since October of 2008 when things went south in terms of the economy. We have a smaller group. Our productivity has more than doubled in the last 12 months of that group. We don't have it seems that folks who aren't successful have more complaints and take up more time, a disproportionate amount of the time of their management teams. So we now -- we have -- we reached the productivity levels that we always thought we could get to, and now we're focused more on slowly, more slowly, than before growing our organization with successful people. We have we've stopped the practice of letting people come into Heartland and be the entrepreneurs that they love to be. They need to follow our model of working with customers and reporting their activities on a regular basis back to management. So we're managing the organization more closely. The people who like that are doing much better, and they're here and are, I think, more excited than ever. And I think it's really the ideal environment for our company, and I think it's going to be the thing that allows us to drive past our record performance of 2008. It's going to take us a little while to get there, but I think we have a model now that can take us to the next level as a company in our sales production. We have some very ambitious goals over the next 2 or 3years and reaching some significant numbers of new installs. We've also done some things to change our competitive position vis-à-vis some of the gateway companies that have come along over the last few years. We frankly got a little bit behind in our competitive position with them. I think we fixed that, and we're excited about being able to bring large numbers of point-of-sale companies into Heartland that have not been available to us in the recent past. So with all those activities, I think our sales organization is probably in the best spirit it's been in the last few years.

Tien-Tsin Huang - JP Morgan Chase & Co

Great, glad to hear that. Just one last follow-up for me, just the higher gas prices. If you can just remind us of how that flows through into your metrics and if it has any influence at all in your ability to add gas merchants as well, because we'll be getting some questions around the impact from gas changes.

Robert Baldwin

In the SME, it does help our net revenue a little bit because we do charge that small number of SME petroleum merchants we have. We do charge them on a basis-point approach. With the vast majority of our petroleum volume though, it's really a transaction driven thing. As you've seen, transactions have held up very nicely. It does feel like people tend to, right now, at least, have gone back to the gas station more frequently. They have $20 to spend right now. They spend it. And then they run out of -- doesn't buy as much gas as they used to, and so they have to go back more frequently. As far as sign-ups go, I'm not aware of any impact plus/minus. The competitive dynamic is going to be the same regardless of gasoline prices, as far as I can think.

Operator

We'll now hear from Tom McCrohan with Janney Capital Markets.

Thomas McCrohan - Janney Montgomery Scott LLC

The data processing initiative, Bob, that you talked about in your prepared remarks, how long is the initiative going to take before we see results in the margin side? And can you possibly frame out the investment in dollars relative to the expected cost savings?

Robert Baldwin

Well, in this quarter, it's sort of balancing itself out in our bottom line, but you really -- it demonstrated in the lower processing and servicing costs that you're seeing and the higher G&A, but the offsets are in different line items of the financials. This is an ongoing process that will -- has various benchmarks during this year, but we do start seeing some more benefit late -- net benefits later in the year as some of the expenses tail off, and we're continuing to realize the benefits. And then really it kicks in heavily in 2012, where we see some very significant benefits in the processing costs.

Thomas McCrohan - Janney Montgomery Scott LLC

And utilities, the same-store sales in utilities was up 11% this quarter. Can you give us an idea what drove that, and how significant that vertical is to dollar volume? What percentage of dollar volume is related to utilities? That's all I have.

Robert Baldwin

It's very small, Tom. And I think I haven't done a lot of analysis of it, but I'm pretty sure it's related to the higher energy prices. But I frankly don't have anything on that. I really haven't looked at it. But utility -- the important thing is utility is a nice growing segment for us, but it's quite small right now.

Operator

We'll now hear from Chris Shutler with William Blair.

Christopher Shutler - William Blair & Company L.L.C.

Can you just give us a little bit of color in terms of the monthly cadence from January through April for the new margin install metric?

Robert Carr

It's growing slowly from one month to the next. Our productivity of our organization's gone up. That's been our focus. It's gone up each month. We expect that to continue, and we are now beginning to add bigger organizations. So we expect that to continue to grow.

Christopher Shutler - William Blair & Company L.L.C.

And then on the, Bob, on the processing and servicing line, it was down sequentially, which isn't the normal pattern. And is it fair to say the biggest delta there between that and the normal pattern was the roll off of the Sage Pay customer acquisition costs?

Robert Baldwin

Well, first of all, it is sequentially often the case that processing and servicing will be lower in the -- I mean, last year, it was not. But I mean, in prior years, because you get less activity in the first quarter, you could expect it to go down. But it really was a combination of -- the driver, I think, more than anything else was the combination of the reduced commissions from the buyout, the buyout activity that we're continuing and very significant reductions in account manager costs that we're still incurring. Some of those still existed in the fourth quarter, so those are the 2 biggest pieces. We are also doing much better on the credit side. We had a very, very tough time last year. And fortunately, that ship seems to have been righted, and we're getting much better experience there.

Christopher Shutler - William Blair & Company L.L.C.

And just a couple more. The residual buyouts, is there anyway you could give us a -- tighten that range a little bit? I know that in the past it's been $6 million to $8 million per year, and last year was obviously materially higher than that. Can you give us a range of a few million dollars where you think it's going to be this year?

Robert Baldwin

Probably -- it's hard to say. We're fine tuning what we will and will not do on buyouts, but I think it's safe to say it's going to be at $10 million this year and maybe somewhat more. It's not going to be -- as of right now, we do not expect it to be anywhere near last year's number.

Christopher Shutler - William Blair & Company L.L.C.

Okay, that's helpful, and then last one for me. The division managers that have at least 80% of their RMs that are at an acceptable productivity level, what percentage of division managers are now kind of at that level and are hiring, and maybe remind us again the threshold? I think it's 6,000 per month but I just want to make sure.

Robert Carr

Yes, the threshold is 6,000 a month per rep for them to be considered performing. We -- quite a few of our divisions are in the process of recruiting folks. And I don't have a precise number, but let's say it's somewhere in the 50% range.

Operator

We'll take a question from Dave Koning with Baird.

David Koning - Robert W. Baird & Co. Incorporated

Nice job. The one thing I wanted to pursue was the pricing or the yield, I guess, on volume was one of the strongest quarters that I think ever that I can find, both in the U.S. and then, I guess, even more so in Canada. And I'm just wondering if that's a function of mix whether maybe some of your petroleum SME clients just have naturally better yield and that's where the growth is, or maybe you could just walk through that and -- I guess in Canada what's been interesting is, it steps up. I think the yield's up like 30% relative to what it was just a couple of years ago, and just wondering kind of what's happening there.

Robert Carr

Well, Dave, you're fine-tuned analytics has us looking at each other, and I guess we need to get back to you on the Canadian analysis. I think that in terms of pricing improvement, I mean, I think that the first quarter is typically our strongest. We do have annual fees that we're charging and are -- that's actually a slightly lower percentage of our business than it used to be, but it's always been our strongest pricing quarter. Also, what you get is with lower activity, relatively low, the first quarter is the lowest activity quarter, any monthly fees, anything like that will have more of a relative impact. So on the domestic side, we really didn't see. We thought pricing came in pretty much right where we expected, and nothing extraordinary there. Again, I'll have to get back to you on Canada because we're not aware of any dramatic changes there, and so have to figure out what you're seeing.

David Koning - Robert W. Baird & Co. Incorporated

That sounds good. And then just a couple of small ones. The February and March -- you talked about February and March same-store sales. I think in the prepared comments, you said April maybe decelerated a bit but was still better than the 1% to 2% original target for the year. Was that right?

Robert Baldwin

Actually, I didn't say anything about April. I don't have any numbers from April. And I would say that based on the dollar volume processed, the numbers feel pretty consistent with February March same store sales. We're just saying that there remains enough uncertainties that when we look at the world, we're not going to assume that things are going to stay exactly the way they were in the first quarter, that they may be a little bit softer in the out quarters. So that's why we're using -- still using that sort of 1% to 2% same-store sales growth expectation in making our plans. And we are not forecasters of the economy. We -- a lot smarter people than we are who are out trying to figure that out and generally don't do a very good job. So we think that given the uncertainties in the world, we want to be cautious, and so are continuing with our assumptions on that metric for the rest of the year.

David Koning - Robert W. Baird & Co. Incorporated

Yes, that sounds good. And then the summit this year, would you expect the same $2 million or so in one of the quarters of the year, and maybe...

Robert Baldwin

We're not doing one this year. The mindset on the summit, Dave, is to do it every about year and a half. Two years ago, we did it in the spring. Then we decided to accelerate last year's and do last year's in the spring, and we're just holding off until the spring of 2012 for the summit. We will have some costs in the third and fourth quarter associated with the preparation, but those costs will be recurring in 2012 and probably not miles away from that cost that you saw there.

Operator

We'll take a question from Brett Huff with Stephens.

Brett Huff - Stephens Inc.

Congratulations on a nice quarter. Just 2 follow ups. One, on the data processing project that you're working on, obviously, it looks -- I think it will start paying dividends here at the end of the year. But in terms of how the project management is going this quarter relative to what you expected, I mean, is it kind of -- are things progressing as you expected, better, worse, level of difficulty versus what you thought the project would be?

Robert Carr

Well, that's a question that can be a very tough question there, Brett, because these kind of projects have a funny way of not playing out the way people expect them to. Fortunately, I can say that as of right now, as of 2 days ago update, everything is spot on schedule. I'm not going to guarantee that's going to stay that way. These things have a way of varying from schedule, and it's truly a rare day when they go faster than schedule. So the risk is to the downside. Right -- as of right now, it's going along very nicely. Our partners on this are working hard and as are our people.

Brett Huff - Stephens Inc.

And then just a second follow-up. Looking at the margin installed, can you guys give any color on -- do you have a sense of -- is that pickup -- it's clearly both a result of better productivity, but my guess is it's probably partially also due to the economy. Any thoughts or color on the acceleration drivers between those 2 or if there's other drivers of that?

Robert Carr

Yes, I would say the driver is mostly our focus on increasing productivity and closer management and support of our people. Of course, it's better to have some wind at your back in the economy, but I think the biggest driver is our initiatives of productivity.

Robert Baldwin

And the only thing I'd add is that I don't -- based on everything I'm seeing, are we seeing a lot of our merchants adding new locations, for example, which would be from the economy. And I don't -- that is not the economy we're seeing. Things are bumping along, but our retailer -- you've got to keep in mind, our SME retailers, even if they're up 3% from a year ago, well, a year ago was down 4% from the prior year, and that prior year was down 8% or 9% or 10% from the year before that. So they're still at levels that are -- that those who have survived are managing their business and can survive at that level, but that doesn't mean that they're aggressively growing. There's not a lot of signs of credit extension, especially in the kind of segment where people are getting loans to build or start a new restaurant or retail operations. So I think it's a lot of our internal work rather than the economy.

Operator

We'll take a question from Robert Dodd with Morgan Keegan.

Robert Dodd - Morgan Keegan & Company, Inc.

Just 2 questions. One, a little bit more analytical on same store sales, which you might not want to go into. But given the timing of Easter, you might not have data at this level, I mean, we would have expected March, I think, to be a little weaker than April, other than fuel. I mean, is there any other color you can give on what your expectations were about the Easter shift on the merchant base, or did you just basically ignore that because it's too complicated?

Robert Carr

Robert, I think your introduction to that question was absolutely spot on. It's too analytic for us. Easter is not a huge event for us. If you move Mother's Day to a different month, that would be something that we would notice. If you move Valentine's Day, that would be something we'd notice. Easter is much more ambiguous for us at -- some people go out, some people don't. So for restaurants and various hospitality, it's not that big a deal. And so I don't take any particular meaning from the relatively stronger March on that score.

Robert Dodd - Morgan Keegan & Company, Inc.

Okay, got it. Second question, on the sales, in terms of those that are starting to hire again. I mean, if we look in the past, the general trend seems to have been for you guys to hire former business service sales type people, and obviously that's had a mixed track record over the last few years in terms of new hires turning into productive sales reps. I mean, is there any change, or do you anticipate a change in where you're looking for sales people? What type of sales people you're looking to hire to have a better flow-through on hires to productivity?

Robert Carr

I would say we haven't changed the sources of our recruiting so much as we required when somebody comes on board, we pay an awful lot of attention to what they do even from -- even before they start with us. I'm not going to get into a lot of details about it because we think it's a pretty powerful approach. It's more about our -- we want to have fewer people coming through the system, and we want a very high percentage of success as we bring these new people into the company. So it's about process, the idea that somebody can come in here and do whatever they want to and be a maverick is just no longer acceptable at Heartland. And that's been a turnoff to a lot of people that have left, and it was the right thing for them to leave. We have a reputation as a company. We have a method of doing business that is extremely well received in the marketplace. We have a brand that we're very proud of that we can build on, but we need an organization of people who believe in that and are willing to act on it and be a little bit more company people. And in turn for that, they're getting a heck of a lot more support from us. So I think that's a much bigger factor than our sources of recruiting.

Robert Dodd - Morgan Keegan & Company, Inc.

All right. So I mean, if I turn that into a number, would you expect first-year attrition to drop materially from the historic 60%?

Robert Baldwin

Absolutely. And I think it's -- the other thing -- the other side of that is we're also saying to the managers, you're going to be responsible for helping those people you're hiring achieve success, where there was a certain mindset of throw the bodies up against the wall and see what sticks in the prior approaches. And not to seem cavalier about it, but there was a certain element of that. Now people will be evaluated very carefully upon the success or lack thereof of their recruits.

Robert Carr

And also, our industry has the attitude that, "Well, just hire this person. And if they bring in one or 2 accounts a month, that's fine. Because that's one or 2 accounts that we wouldn't have had otherwise." And frankly, that was our attitude about it for the first 15 years in business. But we've come to believe that if a person's not committed 100%, they're not making a career out of this position that the -- it's just not a sustainable model to build the kind of a company that we want to build going forward. We think we have the sales model out there to compete with all these ISOs who are not committed, their people are not committed to their company or to any particular set of principles. We think we're in a special position in this marketplace, and we need a team of people that believes in it, acts on it. And we think it's going to work.

Operator

And we'll now hear from Meghna Ladha with Susquehanna.

Meghna Ladha - Susquehanna Financial Group, LLLP

Bob, you indicated that debit transactions have been increasing more than credit. Can you give us the volume or growth numbers or transactions comparing debit to credit?

Robert Baldwin

Sure. In the first quarter, debit dollar volume grew by 8.5%. Debit transactions grew by 7.9%, so a slightly higher average ticket. Credit grew by, on average, 3.8% volume and 2.5% transactions. And in all categories, it was sort of month over month improvement in the rate of growth.

Meghna Ladha - Susquehanna Financial Group, LLLP

You know you indicated that 71% of your pin and -- of your volumes -- no, sorry, 52% of your dollar volume is now debit. What was that last quarter?

Robert Baldwin

I think -- no, I don't know. I don't have it for last quarter. I calculated it. I think around 68% or 69% of our transactions, at some point, in the second half of last year. I know I calculated it, but I don't have that in front of me.

Meghna Ladha - Susquehanna Financial Group, LLLP

And what is the contribution from AmEx and Discover?

Robert Baldwin

AmEx and Discover, in terms of the SME net revenue, bear with me a second, AmEx was about, though this is the full commission or full residual business, was about $325 million, up from $217 million in the year-ago quarter, and Discover was $441 million versus $376 million.

Meghna Ladha - Susquehanna Financial Group, LLLP

And lastly with operating margin. Bob, can you just remind me again the operating margin progression through the year? I think it peaks in the third quarter, am I right?

Robert Baldwin

Seasonally, our third quarter is, I think, invariably our best quarter of the year and the first quarter is our worst. So it's really first, third, second, fourth as the -- let me rephrase that. From best to worst, it would be third, second, fourth, first, yes. So best to worst operating margin typically is third quarter, then the second quarter, then the fourth quarter, then the first quarter.

Operator

Our next question comes from John Williams with Goldman Sachs.

John Williams

Really quickly, just curious to get a sense of what you're seeing from the larger competitors out there in the space, the Paymentechs and First Datas of the world, and whether you're seeing them being aggressive or not particularly aggressive on pricing. Just generally get a sense of what they're up to in the space these days.

Robert Carr

John, it's really hard to generalize about what -- I mean, for example, First Data by -- except in the large merchant categories, we don't run into them. We ran to their -- ran into their ISOs. So we run into Wells Merchant Services or PNC Merchant Services.

Robert Baldwin

I think it's fair to say that the banks certainly are raising the visibility of merchant services as part of their overall efforts in the New York area right now. You have pretty active marketing campaigns by both PNC and Chase. And yesterday, I actually I heard an ad from Citi that mentioned merchant services, and that's a first for me I think ever. So I think that they're working ISOs that are distributing for First Data or for Global or others. Everybody's working hard, and it's a very tough competitive marketplace. But generalizing about whether it's tougher or less tough than it was, I think it's very hard, very localized competition. What's happening in Des Moines is not the same thing as what's happening in Jacksonville. And I think that what we see is that we're achieving some pretty good success and look to continue.

John Williams

I guess, Bob, the other side of that question is something you and I have talked about a bunch in the past is, the impact of teaser rates. I know that's a tough thing to compete with for anyone who's trying to be as straightforward as you guys generally are with your pricing. Are teaser rates still as much of an issue as they have been over, say, the last 18 months out there in the market?

Robert Baldwin

Absolutely. The obvious case in departments of our competitors are running overtime trying to hide rate increases, et cetera, et cetera. So yes, that is the model. It is the Heartland model of transparent pricing. And it seems like the majority of our competitors put out rates that are teaser rates only, they don't -- they're not too good at telling the merchants that. And so when their price increases come, we have a very good of taking those merchants away. And that's a lot of our approach to the market right now.

Robert Carr

Well, I have been asked a number of times about, are people doing extra stuff relative to Durbin and things. And I think that I don't see that. And frankly, the status of Durbin, which I am shocked that we've gotten 50 minutes into this call without having used the word, I think that the uncertain status of that would make any such strategy even more risky. I don't -- we don't see any sign that it's gotten worse. It's just continued.

John Williams

I'm not going to ask you about Durbin, because it's probably a dead horse at this point. But I guess when you think about the role of the merchant acquirer over the next few years and where you see merchant acquiring in the context of NFC and mobile payments, it seems to be -- it really depends on who you talk to, but where do you view your role, and how involved will you be on things like the mobile advertising side potentially? And how willing are you going to be to share that data with others?

Robert Carr

Let me take the first part of that. I think the role of the acquirer is becoming fairly clear, more clear than -- because of all the things going on with alternative payments, mobile payments, PayPal, iTunes. The acquirer is the company that consolidates the deposits for these merchants. All these jillions of deposits that different companies want to control and ACH into the merchant's bank account, it's just impossible for merchants to deal, to manage their deposits, to confirm that they really got paid for what they think they should get paid. So I think the back ends of acquirers are becoming much, much more valuable and much more complex. We're expecting to add another half a dozen payment types over the next 4 or 5 years. And without an acquirer to consolidate the Visa, MasterCard, American Express or Discovery, historically, now pin debit, now all the prepaid programs that are out there, Open Table, I mean, it's all the different approaches that are in the marketplace based on mobile phones and iPads, et cetera, I think that's going to be a big, big dynamic for the acquiring industry. It's completely separate from the front end. The front end is being -- becoming a commodity with the gateways doing the customized reporting in a very powerful way. But I think the industry is sorting itself out into a commodity front-end switches. Gateway is where the true feature functionality is built in, and then the back end acquiring that, basically, is a reporting and cash management tool for the merchant. That's my view of it.

Robert Baldwin

And I think -- the only thing I'd add to that is the taking a glancing blow at your second part of your question, which is, information is, of course, the Holy Grail. We like the Holy Grail as well, but the unfortunate reality is that we're not in a position of knowing what that person does when they go outside of our store, unless they happen to go into another of our stores. And so while we can do some things and are building aggressively around gift and loyalty to try to be more engaged with our merchants and their existing and potential customers, on a more broad-brush basis, that's not an area that we're particularly focused on. And I think it's going to be a fascinating byplay going forward, the tension between marketing appetite for more information and privacy concerns, and we'll see how that plays out. But that's really not going to be an area that we're going to be instrumental in.

Operator

[Operator Instructions] We'll now hear from Richard Cheever with SunTrust.

Richard Cheever - SunTrust Robinson Humphrey

I wanted to ask about the sort of the headcount or the relationship manager outlook for the rest of the year. I think you had said that you expected to exit the year around 1,000, if memory serves. I mean, do you think you're going to have a steady ramp or you're going to accelerate through out the course of the year?

Robert Carr

I think it's going to be more of a steady ramp, and I'm not sure that we're going to get to 1,000. We're more focused on getting our installed margin to a certain number, and that's our focus. So I'm not sure the 1,000 the number is -- give or take 15%, something like that. So we're not focused on the number of heads. We're focused upon the installed margin and the productivity of the people. We want everyone of our salespeople to be making 6 figures of revenue after their 18 months, and we're not there yet. We're getting there, but that's more of our focus.

Richard Cheever - SunTrust Robinson Humphrey

I assume the productivity number that you gave us is a blended one. Can you kind of parse out the veteran versus the new hire productivity and what...

Robert Carr

Well, that's one of the exciting things is, our new hires now are doing just as well as our veterans. We figured out how to bring somebody on and have them productive right out of the gate, and that's very exciting to us. So we have a number of our veterans who are in a new category that we established called ambassadors. And about 8% of our sales force is in that category, and those are veterans who really don't want to work so hard as to hit the productivity goals and they get a pass. They also don't -- they're not able to get some of the benefits that our producers are getting. But they stay with the company. They service their merchants. They're good ambassadors for us out in the community. So I hope that's responsive to your question.

Operator

And we'll now hear from Grant Keeney with Northcoast Research.

Grant Keeney - Northcoast Research

Bob, you mentioned on last quarter's call possibly passing through new cost to merchants that stemmed from new government regulations. Just looking for more color on whether that came to fruition in Q1, and if so, just what type of dollar amount we're talking about for the fee.

Robert Carr

We haven't finalized that yet. We're still in the process of making a determination. We've been waiting on some answers from Durbin, frankly. And we don't know where that's going exactly -- I don't think it's as clear as some of you might think it is in terms of the direction there. So we'd like to get some clarity on that, before we pull the trigger on anything.

Operator

And now we'll take a question from Bob Napoli with Piper Jaffray.

Robert Napoli - Piper Jaffray Companies

Just a big picture on your sales force. I mean, you guys made a gutsy call. I mean, you really totally changed direction third quarter, I think, of last year, where you had gone with a strategy for a long time. You talked about ramping up your sales force substantially, and then you just turned. I mean, what drove the dramatic change in strategy?

Robert Carr

Great question. And maybe 3 years from now, we can look back and see if that was the best thing we ever did or the dumbest thing we ever did. But it seems -- it was our conclusion that the model that we had was not sustainable. It was not going to get us where we needed to be, because managing folks who feel like they have no responsibility back to the company to hit a production number just wasn't tolerable. And the headcount was extraordinarily high, and we weren't getting the results with that approach. And we had really worked hard and tried every way for over the years. And we're known as having the best sales organization in the industry, and we do. But we just didn't feel like we'd get to the next level of production with the approaches that we were taking. So we stopped the recruiting approach that was in force, changed the management team, adopted a -- for years, we just said, "You're the professional salespeople, you go out there and do the job." But we have such a strong base of customers and relationships now, it's important how people go out and represent themselves in the community. And the way we were doing it before, letting people sort of be all they can be however they wanted to be that, it just wasn't a model that was going to take us to where we want to go. So we'll see in due time how well that worked. I think it's going to be a brilliant game changer for us, and you'll start seeing that over the next 18, 30 months.

Operator

That does conclude our question and answer session for today. At this time, I would like to return the call to Maria Rueda, CFO. Please go ahead.

Maria Rueda

Well, thank you, everyone, for your warm welcome this morning. I am very enthusiastic about joining the Heartland team, and I'm enjoying our first earnings call together.

Over the next few months, I plan to get to know you through both in person meetings, such as the conference appearances which we are scheduled to appear, or if not in person, certainly over the phone. My goal as CFO is to maintain the high level of integrity, credibility and transparency that Bob Carr and Bob Baldwin so strongly believe in. And I plan to be accessible to help your understanding of Heartland's strategy, operations and performance.

With that, I would like to thank you for your participation and conclude the call. And have a great day.

Operator

That does conclude today's teleconference. We do thank you all for your participation.

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