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Heartland Payment Systems (NYSE:HPY)

Q2 2011 Earnings Call

July 28, 2011 8:30 am ET

Executives

Robert Baldwin - President

Robert Carr - Executive Chairman and Chief Executive Officer

Maria Rueda - Chief Financial Officer

Analysts

Robert Dodd - Morgan Keegan & Company, Inc.

Brett Huff - Stephens Inc.

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

Roman Leal - Goldman Sachs Group Inc.

Andrew Jeffrey - SunTrust Robinson Humphrey, Inc.

Operator

Good day, and welcome to the Heartland Payment Systems Second Quarter 2011 Earning 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, and good morning, everyone. I'd like to welcome you to the Heartland Payment Systems Second Quarter 2011 Earnings Call. Joining me are Bob Carr, Chairman and CEO; and Bob Baldwin, President. Today, Bob Carr will begin our discussion with an overview of the quarter and then I'll return to go through some of the financials in detail before opening the call where we will all be available 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 our financial results released early 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 subsequent events or circumstances.

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

Robert Carr

Thank you, Maria, and good morning, everyone. I'd like to thank you all for joining us today and for your interest on Heartland. By now, you should have seen our financial results for the second quarter that we released this morning. On an adjusted basis, we reported net income of $12.5 million or $0.31 per diluted share, increases of 38% and 35%, respectively, compared to the second quarter of last year. Results in the quarter were led by a record small merchant processing volume and continued disciplined cost management that drove our operating margin to 17.7%. This is one of the best quarters in recent years, and we are pleased to once again be consistently growing our business, improving efficiencies and generating nice returns for our shareholders without the benefit of any meaningful economic improvements.

For the quarter, we achieved record SME processing volumes of $17.5 billion, a 7.2% year-over-year increase due to the fifth consecutive quarter of same-store sales growth, our best merchant retention levels in 4 years plus solid improvement in our new business initiatives.

New margin installed for the quarter was $12.6 million, up 3.6% from the second quarter of 2010, as we once again achieved an increase in relationship manager productivity which rose to an all-time record of $6,013 in June, more than a 100% improvement in less than one year. This is a very important metric because success breeds success in the sales profession, and we can now accurately say that our sales organization is not only the largest in the payments industry, but that now Heartland has become the home for the elite business-to-business sales professionals in America. Virtually all of our sales people now are earning good incomes.

In the quarter, Network Services grew transaction processing by 6%, which is all organic, while net revenue was up 4.5%. In our non-card businesses, payroll, loyalty and gift and equipment, revenues grew at double-digit rates as we continue to introduce innovative new products that leverage our core technology, unique direct sales force and strong merchant relationships.

Our pipelines for SME petroleum and our SmartLink products are the deepest they have ever been. And we are nearing completion of the conversion of our payroll customer base to our new Heartland-designed and Heartland-developed PlusOne Payroll platform. Finally, we will have a modern platform which offers enhanced features and functionality that are extremely relevant in this new era of heightened compliance.

Also, we have now deployed more than 19,000 end-to-end encryption devices, as small merchants spend money to enhance their security with this best-of-breed solution that is proving itself to be superior to other solutions introduced. And we rolled out a new loyalty product in the second quarter that has caught on remarkably well right out of the box and has driven our year-over-year installed margin growth in this segment to record levels.

We've implemented a disciplined expense management program that drove a significant quarterly decrease in our processing and servicing costs relative to last year, in addition to the clients and customer acquisition depreciation and amortization expenses. In the second quarter, these improvements led to a 17.7% operating margin, our best operating margin in 3 years.

Our improved model for the local servicing of our merchant base, combined with the signed retention experts to each division, has allowed us to reduce merchant attrition to a 4-year low this past month. The best news for us is that this model is working well and is sustainable for the long term. We've made tremendous progress in finding efficiencies to keep a tight lid on our costs, and I want to thank all of our Heartland team members across the country for their focus on the productivity gains that are responsible for this outstanding performance.

On the other side of the ledger, the relationship manager comp was down a bit this quarter. There is still some lingering loss of unproductive salespeople in the wake of the new productivity standards implemented last year. And while our new hires are the most productive we've ever brought on board, we are still working on our process to increase the pace of additions. We think that our new metrics and our fair deal approach of doing business is attractive to the kind of salespeople who will thrive at Heartland. Admittedly, we are rebuilding our numbers more slowly than we would like, but we know that we are on the right track. Hiring trends have improved recently but I believe there is opportunity to do better, and I am encouraged by the recent vintage of new hires. They've been ramping up their new business production at impressive levels, consistent with our objectives that new hires achieved productive status in the first month after being hired. With their help, June was Heartland's most productive new business month, with a record number of our relationship managers exceeding $6,000 of new margin installed. Our long-term growth strategy will remain focused on maintaining the productivity of our existing sales teams while bringing on and developing new productive sales people.

We are excited about 2 major catalysts that we will introduce to our sales team in the coming months. First is the new mobile sales tool that has been in beta for the last few months. This new iPad-based set of tools will allow us to leapfrog our competition and help our sales people eliminate paper from the enrollment process while they reduce incomplete and inaccurate applications. These tools also will remove the mathematical complexities that frustrated so many of our sales professionals who are not comfortable with doing math on the fly. These tools will simply make our RM's more effective in card sales and will be facilitating multiproduct sales in the very near term.

Second is our Durbin Dollars initiative. We believe that we are poised to gain market share once again as we did 8 years ago when the Walmart litigation was settled, causing debit interchange to be temporarily reduced. Yes, we are the company that is going to send every single dollar that was mandated in the Durbin legislation to the place it was intended to our merchants' bank accounts. Heartland believes this is the right thing to do. But just as importantly, we believe that we can build sustainable organic growth in this way and are excited to once again enter this fray and leverage our fair dealing model to grow our merchant base and our sales organization at the same time. We believe our Durbin dollars campaign will give us lasting momentum in growing our business.

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

Maria Rueda

Thank you, Bob. Heartland reported GAAP net income of $12.3 million or $0.31 per share for the second quarter of 2011. On an adjusted basis, earnings for the quarter were also $0.31 per share, which is a 35% increase from the $0.23 per share reported on a like basis and last year's second quarter. Earnings for the period are approximately for $0.03 and $0.02 per share, respectively, of stock compensation expense.

For the quarter, total SME processing volume was a record $17.5 billion, up 7.2% compared to a year ago. Volume benefited from a 2.5% increase in same-store sales while volume attrition in the quarter continues to track better than a year ago, 13.6% this quarter down from 15.8% in last year's second 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 quick service restaurants, utilities, hotel and electronics and furniture. The restaurant and retail verticals continue to grow but at lower levels than aggregate same-store sales growth.

This quarter, we saw a slight increase in average ticket and a continued year-over-year shift to more debit spending. In fact, for our SME merchants, almost 70% of our transactions and 48% of our Visa/MasterCard volume now arises from debit transactions.

Network Services processed 847 million transactions in the quarter, up 6% from the same quarter of last year, driving a 4.5% increase in NWS net revenue in the quarter. We continue to be pleased with the financial progress being achieved at NWS this year.

In our non-card businesses, loyalty and gift income increased 30.6%, payroll gross revenues increased 13.5% and equipment-related revenue increased 12.5% in the quarter. As a result, the total net revenues increased 6.1% in the quarter to a record $122.2 million. For the quarter, total cost of services were up 8.8% from a year go, in large measure due to a decrease in processing and servicing, customer acquisition and depreciation and amortization costs.

General and administrative costs in the quarter were up 21.9% from the second quarter of 2010. This increase was a combination of higher employee-related costs, occupancy and sales incentives, but nearly $1 million of the increase was for equipment leasing, which reflects the transitioning to the cloud-based IT strategy. We've previously articulated our intention to reinvest a proportion of expected cost of service and savings back into our organization to accelerate growth and further improve operating efficiency.

For the quarter, interest expense was $1.1 million, little changed from a year ago. Operating income for the quarter was $21.7 million and the operating margin on net revenue was 17.7%, our best operating income and margin since 2008.

We are rapidly realizing a significant and sustainable improvement in our leverage as a result of our efficiency and productivity enhancements implemented over the past several years. Getting margins solidly into the mid-teens this quarter is an encouraging sign that our programs are effective. The planned investment spending for the balance this year is likely to limit further near-term margin expansion.

Now let's look at our cash flow. For the quarter, we generated GAAP operating cash flow of $22.2 million including a $16.7 million tax refund. Management's measure of operating cash takes net income, adds back amortization, depreciation, the provision for a recovery of the Processing System Intrusion costs and other noncash items at the top of the operating cash flow statement. This measure results in total sources of cash flow for operations of $34.8 million for the quarter. We then reduce that figure by signing bonuses and buyouts paid. Using this management metric, operating cash generated was $23.6 million in the second quarter, up 15.7% from $20.4 million last year. Taking that same management definition of operating cash and reducing it by CapEx, our free cash flow amounted to $17.8 million for the quarter, up 22.8% from the $14.5 million in last year's second quarter.

During the second quarter, we also used cash to pay down $15.2 million of our revolving credit facility, $3.75 million for scheduled term loan amortizations and $1.6 million of cash to pay dividends.

The balance sheet is in great shape. At the end of June, we had outstanding borrowings of $92.5 million under our term loan and no borrowings under our revolver. The current available borrowing capacity on our revolving credit agreement is $50 million.

Let me wrap up with our guidance for 2011. For the year, we are raising our earnings guidance and now expect earnings per share to be between $1 and $1.04 after $0.13 per share of stock compensation. We are still guiding to 8% to 10% net revenue growth primarily due to our continued cautious outlook for same-store sales.

Now back to you, Bob.

Robert Carr

Thanks, Maria. The second quarter was one of Heartland's most profitable quarters and for that, I want to thank the dedicated efforts of our many Heartland team members across the country. Our back-to-basics marketing strategy and value-added complementary non-card products and aggressive pursuit of productivity gains has proven to be a successful formula.

These are transformative times in the payments industry. The coming months will be exciting as we build on our momentum and ramp up our programs to capitalize in one of those rare industry-wide market events. We believe our position as a technology leader in this industry will become increasingly clear as we continue to roll out our enhanced security solutions, our mobile applications and our integrated business solutions over the coming months and years, by staying in front of technology change while continuing to lead with our dynamic sales force and sales model, we think Heartland is in a great position to seize these opportunities to build and sustain organic growth far into the future.

With that, Bob, Maria and I would like to open the call for questions. Kelly, please open the call.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go ahead and take our first question from Tien-Tsin Huang with JPMorgan.

Tien-Tsin Huang - JP Morgan Chase & Co

I just want to ask, I guess, on the relationship manager's side. It sounds like sales productivity is up again, which is great. But did you lose any important producers, Bob? And also I'm curious, are you looking to hire aggressively here to take advantage of the whole Durbin Dollars campaign that you talked about?

Robert Carr

Yes, Tien-Tsin, we have primarily lost nonproductive salespeople. There are a couple of our top people that left but they were about to be terminated anyway, and they knew it and that's why they left. In terms of hiring, we are really on a mission to only bring people on who are going to be successful out of the gate. We are investing a lot of time of our management team in bringing these people on, and this is working. We just need to have more of that happening. So we are not looking to expand our headcount rapidly and hope these people work out. We've learned our lesson. I think the whole industry suffers from a lot of turnover in their sales organizations and we have the different sales model. We think we have a way. We've used best practices from around the country and we have ways of bringing on people successfully. We just have to learn how to do more of it. So I hope that's responsive to your question.

Tien-Tsin Huang - JP Morgan Chase & Co

No, that is. Just as a quick follow-on to that, and then I have one more. Just how sustainable is the cost leverage that we're seeing now if you do start to pick up that headcount target? I understand that a lot of your headcount costs are variable, but clearly there's training costs and other incidental costs as well, so could we see the cost basis change here?

Maria Rueda

I think that will -- it's Maria. I think we will continue to see our cost drive down in our processing and servicing. We are continuing to implement our center consolidations. We hope to complete our transition from the 12 centers to 3 centers by mid-2012. So we will continue to see a good ratio in terms of our costs just like additional hiring.

Tien-Tsin Huang - JP Morgan Chase & Co

All right, good to hear. Just last one, I promise. On the P&L, Maria, just with the impact from Durbin and interchange moving lower here, what's the impact on sort of the optics of the P&L, number one, given the interchange change? And then, Bob Carr, I'm wondering what your thoughts on Visa's proposed network participation fee, which looks like will change the pricing model pretty significantly on the debit side. Any thoughts there?

Maria Rueda

Okay, Tien-Tsin, regarding optics on our P&L, as you know, we just pushed our interchange through so our gross revenues would decrease, but that will have no impact at all on our operating margins since that is a pure pass-through.

Robert Carr

And Tien-Tsin, to respond, I think one of the impacts of Durbin is going to be that our top line revenues that are forced upon us by GAAP of reporting our interchange as revenue, it's going to drop us out of the Fortune 1,000 which is going to upset me a lot because we're going to lose hundreds of millions of dollars in the top line that's passed-through, but that's meaningless, obviously, except to -- it's fun to talk about being a Fortune 1,000 company. But the Visa announcement that -- you're right, I saw it this morning. I think it's good for Heartland. It's a little bit hard to know, the devil's in the details and we don't know all of them, but going to a flat-rate model and a lower variable percentage is going to make the bigger merchant acquirers, I think, more competitive if I'm reading this correctly. It's going to allow us to pass on a lower cost and acquires presumably who are smaller and there's lots of them trying to get into the business. It looks like Visa is trying to have some control over the pricing for the different acquirer types and possibly look at the overall relationship better. We think that's a good thing for Heartland. We think that the card brands like our model of fair dealing a lot because they have fewer merchant complaints as a result of our model. So I'm pretty excited about this new model of Visa and eager to hear more about it.

Operator

And we'll take our next question from Andrew Jeffrey with SunTrust.

Andrew Jeffrey - SunTrust Robinson Humphrey, Inc.

A couple of questions just to start with the revenue outlook. Given the first half of the year, the implication is for a pretty nice acceleration in the second half. Maybe a little color on that would be helpful. Is some of that -- I know third quarter is a strong seasonal quarter. Is there some Durbin tailwind, share gain tailwind, kind of assumed there? Or how do we get back up above the kind of 8% of organic revenue growth rate?

Robert Baldwin

Andrew, the second quarter was a very tough comp in terms of the revenues, net revenues growth. So we have easier comps in the back half of the year. We do have the seasonal increase this year. Obviously, a lot of our expected activity is baked in, in terms of installs. And then the other thing is just looking at some of our various non-card businesses and how they're doing. We see some pretty solid performance on the revenue side on those. So it's not dramatic increase but we see a better opportunity in the back half.

Andrew Jeffrey - SunTrust Robinson Humphrey, Inc.

Okay. And then with regard to the margin, it's nice to see the EBIT margin really move higher. I'm wondering if you can be a little more granular in terms of some of the initiatives on the processing and servicing line because that seems to be where you have the most leverage and just to get a sense of how sort of sustainable those are and then also contrast those with some of the specific investments you're making. Just trying to get a sense of what those investments are and sort of how you look at the ROI on those versus the obvious desirability of taking that EBIT margin steadily higher over time.

Maria Rueda

Well, in terms of our expenses, as we mentioned, we are going to our center consolidation process which we intend to have completed by mid-2012. So those are real savings that we will see going forward. Also, part of that program will be to take part in the advantages of the cloud backup technology so you will see continued operating efficiencies in our businesses. Does that answer...

Andrew Jeffrey - SunTrust Robinson Humphrey, Inc.

Yes.

Robert Baldwin

Well, just to elaborate a little bit more, we've also driven a lot of cost on the condition line through buyouts, buyout activity has remained. It won't be nearly as high this year as last year, but its growth remained on a pace to being $10 million or more this year, and that helps constrain commission costs. And as we mentioned, our new account servicing model is much more cost effective than what we had been working on last year, and so that's a much easier comp. We think we did very well on the servicing side that that will continue. So it really is a lot of that. Now on the growth in G&A, obviously, Andrew, you are always evaluating spending money now on opportunities to grow compared to the benefit to current shareholders of operating margin. We think we've done a pretty good job of growing our operating margin this year. But at the same time, as Bob was mentioning, there's a lot going on in this industry. Heartland is in a fantastic position as the last mile to the merchant but part of seizing that opportunity will be to keep staying in front of the technology, and so we're investing a lot there. And then the other thing is just the implementation of some of the initiatives, we mentioned the lease cost that we had much higher this quarter because of the move to the cloud-based infrastructure that Maria was mentioning. So it's a combination of the investment, specific investment, in those cost saving initiatives as well as staying in front of the curve technologically.

Andrew Jeffrey - SunTrust Robinson Humphrey, Inc.

Okay. But I assume at some point we could think about Heartland is having a 20% plus EBIT margin, that's still a corporate goal?

Robert Carr

Absolutely, it's a goal.

Operator

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

David Koning - Robert W. Baird & Co. Incorporated

I guess one question on the sales force productivity. With reps down about, I guess, 50% year-over-year now and I guess the gross margin up 4%, it seems like the existing reps must be, I guess, I don't know how to phrase it exactly, but I mean it seems like they must be 40%, 50%, 60% more productive on an individual basis. So in other words, gross margin per rep must be going up an extreme amount given how many reps have gone. Is that a fair way to characterize it?

Robert Carr

Yes, Dave, that's a very insightful question. In fact, the production of our average sales rep is up over 100% over a year ago. And although we had a big headcount a year ago, many, many of -- I don't understand this, someday, maybe I'll get it. A lot of people sign up and work in the sales organization on a commission model and they work part-time. And we just decided that we wanted people who are really committed to making a good living working here. And it's just changed the whole atmosphere around the company because you got people who are out. They know the business. They're selling everyday and they know the business. They don't have the same kinds of questions that part-timers have, so it's a little bit misleading. A lot of our people were doing very well a year ago and they're still doing well today. But the average productivity is double, more than double. But that's a result primarily of people who weren't doing much or were doing nothing that have left the company.

David Koning - Robert W. Baird & Co. Incorporated

Okay, great. And then I guess the second thing is just with the margins ramping so much this year, it looks like something around 500 basis points potentially. The pace -- obviously, the pace can't go at that level forever, but is the ramp back to 20 plus? Is it something like 100 basis points a year? Is there any way you're kind of managing that pace?

Maria Rueda

We are looking to keep our margins in the high teens as we previously talked about in our earnings call and our goal is to be in the 20% range.

Robert Baldwin

Specific opportunity on how fast that goes really will depend -- there's 2 things, dynamics there, Dave. One is I'd say 100 basis points a year. Below that is going to take you a long time to get there. So we're not going to lock ourselves into any particular number. It will depend on the opportunity. The other thing frankly is also dependent on how our revenues grow. The incremental margin on a dollar of revenue is very, very high. So we're going to be -- we mentioned, our margin --we're not looking for further improvement this year because even though seasonally our best margin is usually the third quarter, we got lots of spending to do related to the Durbin and things like that. So that's not looking for much improvement this year, but we are definitely looking for some help in terms of account -- taking accounts away from other guys, driving installed margin up which in turn will drive our revenues with that high incremental margin on the revenue. So I'd say certainly we're thinking of 100 at the low end. And what the high end could be will depend in some part on investment opportunities and some extent on how fast those revenues grow.

Robert Carr

And, Dave, there's another point I want to make which I think is more subtle and it's something that even some of our board members have taken a while to figure out, but we definitely take out the Processing System Intrusion cost as a separate item, et cetera, et cetera, but after the breach, we made heavy, heavy investments, obviously, to upgrade our technology platforms. And at the same time, we were working on converting over the alliance data system's mainframe technology over to our client/server model. And those investments took millions and millions of dollars. We couldn't charge those off to Processing System Intrusion, and now we're getting the benefits of that now. So our operating margins went down markedly from 2008 after the breach, and they're coming back up partly because of that onetime investment that we had to make that wasn't exactly visible to everyone because of the way that we report things. So that's another factor I think that's material. We're recovering back to where we were. And we think getting to 20% is in the near horizon and our objective is ultimately to get to 25% before too long.

Operator

And we'll go to our next question from Tom McCrohan with Janney Capital.

Thomas McCrohan - Janney Montgomery Scott LLC

Just when can we expect to see the benefits from the new Durbin Dollar initiative showing up in new margin installed metrics?

Robert Carr

We're working on it as we speak and probably mostly in the fourth quarter, but we're hoping to get some traction yet this quarter.

Robert Baldwin

But I think it's fair to say that the typical merchant is not going to see their first statement with the savings until November 5 or something so that's when you have something really tangible to put in front of a merchant to be able to say, "Hey, we're processing for such and such restaurant down the street. They saved so much money. Now here is the number. How much did you save?" And that's going to be a powerful discussion that the salesperson's going to be able to have with a perspective merchant.

Thomas McCrohan - Janney Montgomery Scott LLC

Great. And then just on the sales force growth, what is the objective as far as number of new sales people per month that you're targeting?

Robert Carr

Our objective is to have 50% of our new hires get to a $6,000 install level their first or second month. And to have our rookies, which we define as 6 months, to be having 75% win -- 75% of their month, to the $6,000 and above. We have not established goals, companywide. We have a division-by-division set of goals and we are having -- we're struggling to meet them, but we've struggled before in other areas and figured things out and we're very confident we're going to figure this out. But we're not going to give you a number that we expect to hit by the end of the year because we don't know how this is going to go. We are hiring nicely right now, but it's very difficult to know how fast we're going to ramp up. And I think we do expect to get some gain in the number of interested parties working for Heartland as a result of the way we're treating our merchants in the Durbin Dollars program.

Thomas McCrohan - Janney Montgomery Scott LLC

Bob, is the productivity increase in sales a function of you selecting differently when people come into Heartland? Or is it the practices after you hire people and how you're managing them that's driving the productivity improvement?

Robert Carr

Yes, that's a great question. It's both of those things. We now have very strict requirements that we have imposed on our division and territory managers in terms of what a new hire has to do. We just don't hire somebody because they tell a good story or they have a good history. They have to -- the new hires have to go through a specific process for which we pay them, and they have to be successful at that process. And what's great is we don't have a whole lot of people around here that aren't making a decent living now and that's really, really important to the culture and to the attitude and to the productivity. And we have a lot less headcount here. And I think that's one of the reasons for some of our operating margin gains, too. There's a lot less expense taking care of people who aren't really making a decent living and have more complaints because they have more time on their hands to complain about various and different things. So and then when they do, when our new hire does come on board, manager is spending -- I talked to a person yesterday, one of our division managers who just spent 3 days with the brand-new hire, 3 full days talking to prospective merchants in their cities. So we're paying a lot more attention to the people we do bring on and we're requiring a lot more of them.

Operator

We'll take our next question from Chris Shutler with William Blair.

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

I was just hoping, on the Durbin Dollars campaign, first of all, that you could give us a little bit more color on just how you're going to be marketing that, any kind of media you expect to use and how much incremental cost that may entail?

Robert Carr

We're going to use our existing advertising budget to take care of this. This is mostly trench warfare, and we're preparing for each one of our merchants. We're going to give them an estimate of the annual dollar savings. It's going to average about $1,200 a year, about $100 a month. And as Bob said, beginning in October, we will be producing and telling each merchant each month how many dollars that we passed back to them as a result of the Durbin amendment, and we will be asking their neighbors who are not yet Heartland customers how much they saved because of Durbin Dollars. And I know it's really ingenious to keep some of this money, and we're idiots for giving it all back. I know that's how we're described by some of our competitors. But I think our motto is much more sustainable. We don't have to worry about our margins being "competed away". We're going to continue to build this company in a way that our sales people can be proud and go out every single day. So it makes our people feel a little bit taller that we're out there doing what was intended. The law was not intended to increase the acquirers' margins. I don't think that was what Durbin had on his mind.

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

And then on our relationship manager count, I tried to pull up the supplement but I don't think it's out there yet, maybe just give us the number of RMs at the end of the quarter?

Robert Baldwin

It was 731.

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

731, okay. And if we were to look at the number of new RMs that we're added in the quarter versus attrition, can you give us any sense of that breakout or...

Robert Carr

I don't have that number handy.

Robert Baldwin

There's fewer, a fewer added that it looks like [indiscernible]

Robert Carr

But wasn't our number down 30?

Robert Baldwin

Down about 30. And I think on the quarter, we hired I'm guessing maybe 60 people or so, so that would suggest that we added 60 and took away -- [ph] and had 90 left.

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

And then just one last cleanup question. On K-12, Bob Baldwin, maybe you can just talk for a second about how big that was in the quarter and then talk about the seasonality that we should think about in our models as we look out to the back half.

Robert Baldwin

K-12 is not that big in the quarter. It's a little over $1 million or something like that in terms of revenue, but I think the key thing to focus on is that's really the purchased business. We've been doing some great things to start converting and step those merchants up to those schools up for electronic payments, that's the focus of that business is, not the POS fees that those companies had but layering on top of those POS fees the income from turning those schools into accepting payments not by checks that the kids bring in but by electronic payments. That really will not take place in a meaningful way until you start the new year just because of the timing of things. So the benefit that we're looking for from the K-12 initiative will start kicking in, in the second half of the year. But the penetration will still be very low payments and those that we expect to ramp up progressively for a number of years.

Operator

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

Brett Huff - Stephens Inc.

Just a quick question on the margins, I just want to make sure that I was hearing the discussion right. So it sounds like 3Q and 4Q, we expect similar margins to what we saw in 2Q. Is that -- first of all, is that the right way to think about it?

Maria Rueda

Yes, that is the range. Yes.

Brett Huff - Stephens Inc.

And then, Bob, I think you mentioned and, again, I want to make sure I heard this right, you thought you could increase margins about 100 basis points from an annual margin this year for EBIT to annual margin next year for EBIT? I'm not trying to put words in your mouth. I just want to make sure I heard what you said.

Robert Baldwin

No, I was saying that if you go much less than 100 basis points, we said we really want to get near term to 20%. If you go at 50 basis points a year, you aren't going to get there very fast, but I think it'll take a long time. So we haven't done our budgets for next year. We don't have specific numbers out there for next year, but I would expect that we would focus very much on at least 100 basis points of operating margin improvement so that we can get reasonably near term way back to what we think is a reasonable margin for a business like ours which is in the 20% area.

Brett Huff - Stephens Inc.

Okay. And then can you just give us a little more commentary on same-store sales. I know there's info on the supplement where you give us some ideas on kind of what the good performers were. Can you just give us your commentary on why it moderated this quarter versus last quarter in terms of growth? Any difficult comps or any other items? And then also July month-to-date if you have any thoughts on that.

Maria Rueda

Well, the first quarter we had 3.2% same-store sales growth and that was a very strong expansion. The 2.5% that we see in the second quarter, not as high as the first quarter but we continue to see uncertainty in the retail markets that we are in expansion mode is positive for us because as you know, our same-store sales KPI just moved into positive territory a year ago in the second quarter of 2010. So as we see our small merchants start to benefit slowly from the slowly improving economy, we hope that we will continue to see positive expansion in that metric. However, we are still maintaining our guidance in terms of same-store sales growth between 1% and 2% for the year.

Robert Baldwin

It's very jumpy. April and May were terrible. I mean they're still growing but much lower rate. So this year, we had January, April and May, which were very modest, partly positive, and then February, March and June, which were much stronger. I don't know how you make a particular trend out of that. Obviously, some of the macro impact and I think the jump up in the price of gasoline in the April, May period definitely impacted things. June was the strongest month in the year and we don't have -- you can't tell our same-store sales growth during the month. We don't get that granular on it, so we don't have that data. We won't have it for another week or so.

Brett Huff - Stephens Inc.

Okay. And then lastly, again on the Durbin, the more qualitative question. When you're having discussions with merchants now, I'd assume you're bringing it up right now and I'm curious just what their reaction is, their level of interest, et cetera. How does that the conversation go right now with reps?

Robert Carr

It's pretty positive. You're right, we are talking about it now. There have been lots of speeches given around the country about it. Merchants are eager to save money, and our average merchants saving $100 a month is significant to them. So we're getting a lot of good traction with it.

Operator

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

Robert Dodd - Morgan Keegan & Company, Inc.

A question on kind of resource allocation. I know you are being a lot more systematic about managing the margin and managing investments spend in terms of taking a proportion, as Maria said, of your savings in some areas and reinvesting for growth. How are you going about it? Could you give us any color on how you're going about allocating that? Because you have, for a lack of better term, almost too many growth opportunities, too many initiatives. And how is the allocation going there, and is there a risk of almost dis-incenting the sales people in some of the new initiatives to a lack of, frankly, financial resources as you managed the margin?

Robert Carr

Yes, I think, fortunately, Robert, we don't really have a lack of financial resources to do what we want to do. We don't have enough management time to devote to everything the way that we would like to do because we have so many other things in process. Our objective at Heartland has been, has always been and continues to be, to build our core base of merchant customers and the recurring revenue from those customers, whether it be in the form of payment processing, payroll processing, gift marketing, SmartLink fees or whatever. And we believe -- so our focus is on building the products that are going to help us go out and get more core revenue business. And that's sort of the filter that we run everything through in terms of prioritizing our development resources. We wish we could spend 10x as much money as we are on developing resources in this environment because there are so many really great opportunities to develop revenue-generating products, especially with all the tools, the platform that we have, all the great talent we have in this organization. As I said, we're limited by the amount of time that our great IT people and product managers have to get things done, not by financial constraints.

Operator

And we'll take our next question from Julio Quinteros with Goldman Sachs.

Roman Leal - Goldman Sachs Group Inc.

This is actually Roman Leal standing for Julio. Two quick follow-ups. One, if we go back to the Walmart case study, I guess just to ask you to think back and give us what was the average kind of fee reduction you were able to pass-on then? And what was the timing like from kind of when you saw a peak in interest or merchants and how did that translate into e-business [ph]?

Robert Baldwin

Well, the reduction that occurred was by about 1/3 in terms of the signature debit rates. This was only signature debit and it was effective in August of 2003. So we actually didn't get notice of it till June something like 21 with the settlement. So in terms of timing of implementation, it was quite a challenge. But we got it put through and were able to be out there in the marketplace in September with the specifically identified savings from debit. Your debit rebate was and it was laid out down at the bottom of the statement. It was an immediate impact. I can't remember exactly what the numbers were in the fourth quarter of 2003. I do know that in 2004, our overall installed margin grew by 50% versus 2003's numbers, so it was powerful. I think it's -- not to get carried away with that, though, it's fair to say that Heartland was the only major provider of acquirers to SMEs that passed it through. And so we really stood out. This time, there are -- obviously, there going to be people taking different strategies, some are going to pass it through, some are going to try to keep it at all and some will then be in between. The reality is that everybody will be claiming their passing it through in front of the merchants. The sales people will be saying, "oh, sure it's being passed through." And so it becomes much more a nuanced discussion. Card processing costs are quite complex and there are a multiple ways you can obfuscate what you're charging someone. So it's going to be, I think, a little bit tougher work to highlight the benefits to the merchant than it was in 2003, but it's going to be -- nonetheless, the facts will be the facts. If a merchant has not gotten the benefit, we will be able to parse that. And as Bob mentioned, the other thing that was powerful then and will be powerful now is that the Heartland sales people will be the ones who are empowered, who know that they're treating their merchants right and an empowered salesperson is an effective salesperson.

Robert Carr

And one thing I like to add to that, I agree with everything Bob just said, is that this time around, some of the competitors, the financial engineers and their company have gotten very creative and redefined the word interchange. We talk about interchange plus, and that is what the industry is talking about. And now many of the companies have their sales people out saying "we're an interchange plus just like Heartland", but they don't realize that interchange is being marked up 30%. So a merchant looks to the column on their merchant statement and built into what was called interchange is actually a markup of interchange. We think that's duplicitous and if not dishonest, but that's what we're dealing with. It's by some of the more well-known competitors in the industry, and we're looking forward to going out and continuing with our quest to add merchants as a result of that and exposing that type of behavior.

Roman Leal - Goldman Sachs Group Inc.

So that's actually a good segue for my next question. I know something similar was already asked, but how do you think those dynamic changes with the new kind of introduction of the Visa pricing structure? Do you think it changes at all?

Robert Carr

It's hard to know without more details. The initial cut looks like it's positive from the way I see things and maybe the way I want to see things. But we really need some more details on it before we can be very definitive on that.

Robert Baldwin

It's really hard for us to -- the details are critical. It's hard to come up with a scenario where this hurts us. There is no question that the mindset at the brand is that when they raise the fees, the acquiring side, that those will be passed through to the merchants. And that's the fact. We are unequivocal. Yes, we will pass-through savings that are appropriate to the merchants, but we also, when our costs go up from the brands, we pass that through without apology. And so that dynamic will be there for us and for everybody else. We think being larger may help us in the evolution of the business but the devil is very much in the details here.

Operator

And at this time there are no further questions in queue. And I would like to turn the call back over to Ms. Rueda for any additional or closing remarks.

Maria Rueda

Thank you very much. I'd like to thank everyone for their time and participation this morning and offer you all to have a great day. Thank you.

Operator

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

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