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Heartland Payment Systems (NYSE:HPY)

Q4 2011 Earnings Call

February 09, 2012 8:30 am ET

Executives

Maria Rueda - Chief Financial Officer

Robert O. Carr - Executive Chairman and Chief Executive Officer

Robert H. B. Baldwin - President

Analysts

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

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

Kartik Mehta - Northcoast Research

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

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

Robert J. Dodd - Morgan Keegan & Company, Inc., Research Division

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

Roman Leal - Goldman Sachs Group Inc., Research Division

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

Brett Huff - Stephens Inc., Research Division

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

Operator

Good day, ladies and gentlemen, and welcome to the Heartland Payment Systems Fourth Quarter 2011 Earnings Conference Call. Today's conference call is being recorded. Now for opening remarks and introductions, I will turn the conference over to Maria Rueda, Chief Financial Officer. Ms. Rueda, please go ahead.

Maria Rueda

Thank you, and good morning, everyone. I'd like to welcome you to our fourth quarter 2011 earnings call. Joining me this morning 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 will return to go through some of the financials in detail before opening 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 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 O. Carr

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

As you saw on our financial results for the fourth quarter released this morning, we reported adjusted net income of $14.2 million or $0.35 per share, increases of 73% and 67% respectively compared to the comparable figures in the same quarter of last year. These fourth quarter results are a satisfying conclusion to a year of significant financial and operational progress and improvement.

We are entering the new year from a position of strength and with the wind at our backs. We are using this momentum to capitalize on the great growth opportunities we see for 2012 and beyond in our very large and growing markets.

Certainly, some of the credit for our success goes to an improved economy. I strongly believe our success is primarily the result of the tireless efforts of the many dedicated Heartland team members, who are responsible for the widespread improvement throughout our business.

On the top line, we achieved double-digit net revenue growth in the fourth quarter through increases in new margin installed and same-store sales, as well as a reduction in volume attrition and card processing. Net revenue growth also reflects strong non-card business performance, including a significant contribution from our new K-12 School Solutions business. Operating margins were also up significantly relative to a year ago as our focus on productivity improvements help drive year-over-year declines in processing and servicing costs. And once again, our cash returns were exceptional.

On the new business front, the past 3 months were our best new margin installed quarter of the year. However, because last year's fourth quarter was also our best new margin installed quarter of 2010, the year-over-year comparisons are relatively flat. Relationship manager productivity hit another new record high. But looking at the bigger picture, new margin installed for 2011 was up for the first time in 3 years, and the growth in new business will drive future growth in processing revenues.

The implementation of lower debit interchange rate as a result of the Durbin Amendment, generated a lot of noise in the market, which did more to confuse than help the small and midsize merchants. In contrast to the immediate opportunity created by the last major interchange shake-up, the 2003 Walmart settlement, we think Durbin is creating a longer runway of growth potential for our Fair Deal sales philosophy. As of today, we have passed over $85 million of Durbin Dollars back to our merchants, and we believe that on average, Heartland merchants can expect to save approximately $1,000 annually per location.

As the noise and confusion gives way to the reality of monthly statements, we expect new account acquisition will come down to the savings experienced by the individual merchant, and that's why we really like our chances going forward.

We're getting other benefits from Durbin. It has energized our sales organization, not only existing relationship managers but also new hires. There has been no better recruitment tool for our sales organization than the Durbin Amendment.

Sales professionals are coming to us saying, they want to work for an organization like Heartland that is treating its merchants this way. In the quarter, we added 47 new relationship managers and we remained encouraged by the progress of our new hires as -- have made in building their productivity. We need to keep working on our retention and recruitment strategy, as it's clear that, to increase the level of installs, we need more sales people on the team. Nevertheless, we feel very good about our direction and progress.

Let me just briefly mention some important wins before turning the call back to Maria.

As we announced yesterday, our Campus Solutions division has been awarded a contract by the Tennessee Board of Regents System to manage financial aid disbursement and refund management using Heartland's Acceluraid electronic financial and disbursement product. The Tennessee Board of Regents system has more than 200,000 enrolled students, and over $600 million in annual financial aid refunds. So this award represents a big win for Campus Solutions.

A year ago, we converted our Network Services transaction settlement activity on to our proprietary back-end passport platform. As a direct result, we recently signed a 5-year contract, which adds Visa and MasterCard credit card transaction settlement to our existing authorization services at over 8,000 ConocoPhillips-branded locations.

Wins like the Tennessee Board of Regents and the new capabilities such as in-house petroleum processing settlement are just some of the less obvious successes, that we believe can help us grow our payment processing volumes and better leverage our core processing capabilities.

Finally, yesterday, we signed a new sponsorship agreement with Wells Fargo, further broadening the group of sponsors who facilitate our business with Visa and MasterCard.

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

Maria Rueda

Thanks, Bob. Heartland reported GAAP net income of $11.2 million or $0.28 per share in the fourth quarter of 2011. Excluding costs associated with the processing system intrusion and $0.07 per share of stock compensation expense, net income would have been $14.2 million or $0.35 per share, increases of 73% and 67% respectively compared to $8.2 million or $0.21 per share calculated on the same basis in the fourth quarter of fiscal 2010.

We believe our non-GAAP measures of net income and earnings per share provide investors greater transparency into the information used by management for financial and operational decision making. For example, in the quarter, we reevaluated the probability that our future performance would result in the vesting of certain RSUs and so took an additional $0.05 charge in this year's -- this quarter's GAAP results.

Going forward, we expect to continue to employ performance-based share awards to align our employees incentives with shareholders' interests. These awards are likely to result in significant variances in our quarterly stock compensation expense and so our GAAP results. This is why we believe adjusted EPS, which excludes share-related expense, as well as impacts from the 2008 processing systems intrusion, is a better and more consistent measure for investors to use in evaluating our performance.

Small and midsize merchant card processing volume for the quarter was up 7.1% from a year ago, benefiting from a 2.5% increase in same-store sales and a 13.4% rate of volume attrition. For January, we achieved a 4.4% in same-store sales growth.

As Bob mentioned, the fourth quarter was our strongest quarter in 2011 for new installs, so we have good momentum going into 2012. Further, since new margin installed is a leading indicator of processing volume, the first full year increase in new business in 3 years is certainly a great first step to driving faster 2012 processing volume growth. Consistent with this past year, due to a cautious 2012 economic outlook, we are anticipating only modest growth in same-store sales this year. Please consult the statistical supplement on our website for more detailed key performance metrics.

Transactions processed by Network Services were up compared to fourth quarter of last year. However, as a higher proportion of volume was at our more competitively-priced accounts this quarter, net revenue was down. For a year now, we have been processing Network Services settlement activity on our in-house petroleum industry back-end platform, which enables us to offer an end-to-end processing solution, improve our competitive position and create an opportunity to expand both revenue and margins at Network Services.

In addition to card processing, the increase in net revenue reflects continued strong incremental growth in our non-card businesses, with both payroll and equipment-related revenues in the quarter up roughly 6%. Net revenue also benefited from a full quarter's contribution from School-Link, our most recent K-12 School Solutions acquisition.

Fourth quarter card processing revenues also reflect an increase in monthly fees to the majority of our SME merchants. The increase was needed to help us recover at least some of the many new compliance and other regulatory costs we have heretofore been absorbing on behalf of merchants.

You will see that the total cost of services fell 5.6% in the quarter, primarily reflecting the decrease in debit interchange resulting from Durbin. Since interchange is simply a pass-through in our results of operations, the level of interchange has no bearing on our financial performance. More important, within cost of services, processing and servicing expense was reduced 3.3% from a year ago. We are continuing to realize efficiencies from the consolidation of our card processing platforms and the migration of our payroll product onto our new in-house platform, as well as the transition of certain costs from processing and servicing through general and administrative expense.

I would note that after a meaningful reduction and processing and servicing costs on both a relative and absolute basis this year, while we expect some additional efficiency improvements in 2012, many of the major benefits of our consolidation initiatives are in place. In 2012, we also have processing and servicing infrastructure upgrades planned.

The increase in fourth quarter general and administrative expenses was due to a number of items, including changes in the geography of certain costs, primarily IT expenses, that were previously included in cost of services, a substantial increase in share-based incentive compensation due to improved financial performance and accruals for the 2012 Sales and Servicing Summit. In addition, K-12 School Solutions headcount has risen over the past year, particularly with the September 30 acquisition of School-Link, and those additional costs are primarily showing up in general and administrative expense.

Outside of the summit accrual, most of these quarterly costs are essentially ongoing in nature, although we do expect performance-based incentive compensation will be accrued at a higher rate in 2012.

Operating income for the quarter was up 41% year-over-year, and the operating margin expanded to 16.1% of net revenue. There were a couple of non-operating items and results this quarter. We wrote off $1.1 million of assets and investments related to our remote deposit capture product, which was offset by approximately $330,000 of earnout income related to a merchant portfolio that was sold last year.

We are generating significant cash flow. For the quarter, our GAAP operating cash flow was $31.7 million. Since GAAP treatment is not an accurate representation of our operating cash flows, we focus on a management-defined cash flow metric. Our measure takes the traditional sources of operating cash, starting with net income, adds back the noncash items such as stock compensation expense, depreciation and amortization, and then reduces that figure by signing bonuses and buyouts paid, which are true cash outflows.

On this basis, operating cash generation was $23.7 million in the fourth quarter, up 22.2% from $19.4 million last year. This measure of cash generation amounted to $0.58 per share for the fourth quarter and $2.36 per share for the full year 2011.

In the quarter, we used $16.4 million in cash to repurchase shares under the board-approved share repurchase plan that we announced last quarter.

Let me wrap up with our guidance for 2012.

For the full year of 2012, we expect net revenue of between $530 million and $540 million, and fully diluted adjusted EPS to be between $1.52 and $1.56 per share before deducting $0.19 per share of after-tax stock compensation expense.

As always, our first quarter will be seasonally our weakest and this will be exacerbated by the summit expenses. The company's guidance does not contemplate any of the potential financial impact of the ongoing processing system intrusion.

Back to you, Bob.

Robert O. Carr

Thank you, Maria. 2011 was a terrific year for Heartland and for its shareholders. The changes we have made throughout the organization have enabled us to generate attractive returns in a period of consumer uncertainty and slow economic growth. Today, we are a more focused and productive organization. We enjoy a strong franchise in large markets that are undergoing tremendous change. This is creating new growth opportunities for companies that are able to adapt and respond. We feel really good about our opportunities for 2012 and beyond, and we thank our shareholders for their support.

Before closing today's call and opening up to questions, I am pleased to announce that the Board of Directors has increased our dividend by 50%. Consequently, a dividend of $0.06 per share has been declared as payable March 15 to holders of record on the 2nd of March.

With that, we are now open for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question today from Tim Willi with Wells Fargo.

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

Just a couple of questions. Number one, on the housekeeping side. Is the K-12 revenue, that is in the processing revenue associated with the Card business, but is the volume also in there, if we want to try to do a calculation around revenue yield versus volume?

Robert O. Carr

Are you talking about the Visa/MasterCard volume, Tim?

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

Yes. You guys gave the SME and the Canadian volumes. So is the revenue from K-12 in your income statement around those processing revenues? Does it tie into that volume number?

Robert O. Carr

Well, a lot of the volume in the K-12 business is ACH processing and that volume is not added into our Visa/MasterCard volume, of course. But the MasterCard transactions and Visa transactions are included in our volume. But are not significant because the dollar amounts are small.

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

Yes. I don't know if I ask you, if you take the processing revenues divided by the volumes, could yield bump up quite a bit sequentially? So it feels like that sort of maybe what occurred as that K-12 revenue is -- I think I got that. Okay. Second thing was, just on the hiring side. Bob, you talked a lot about that in the last half of the year. We're seeing some nice progress in this quarter versus the prior quarter. And I guess, I've just -- embedded in your guidance, is there a way that we should think about how you're budgeting sales growth and merchant growth? I mean, when I mean sales, I mean headcount. Are we talking about 100 people on that, 150. Any thoughts around the merchant growth that sort of drives that underlying guidance?

Robert O. Carr

Well, we're targeting a growth in our sales organization both on productivity and headcounts, and we're not really putting any guidance out there. We do have our forecast, of course, and it calls for continued growth along the lines that we've had in the last half of last year. We hope to do better than that, frankly. But that's what our budgeting is based on.

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

Okay. And the last question I had is, could you just talk about some of the other products and services that you're seeing good uptake on? I know from time to time you talk about the loyalty product getting some pretty encouraging response from your merchant base. I'm just curious about that one or any other types of products that seem to be getting some traction, that are helping out as well.

Robert H. B. Baldwin

Yes, Tim. It's Bob here. Just to throw in, actually, loyalty was -- remains a very bright star. It's grown every quarter for the last 8 quarters and was about 30% above last year's fourth quarter, in this fourth quarter. That remains a very strong one. Of course, K-12 is all new, so that helps. We're seeing some nice uptake on the SmartLink product, which is a very exciting product, particularly focused around petro and c-store opportunities. And generally, also remain encouraged on the payroll side. So good breadth of business from the non-card contributors.

Operator

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

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

I guess my first question is, just to kind of piggyback on what Tim was asking. Just how big was K-12? I think going in, we thought it was like $7 million in the quarter. Is that about what it was in Q4?

Robert H. B. Baldwin

It was actually about $5.5 million for the quarter in direct fee-related income. We also had some fee income -- rather equipment-related income, which adds another close to $1 million.

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

Okay. And then, is that sort of run rate expected to continue in 2012, implying that something like 6% to 9% organic growth once you kind of exclude the benefits that continue from that business into 2012?

Robert H. B. Baldwin

There's no question, we got an annualization benefit from SmartLink, in particular. The other 3 acquisitions were more or less at the beginning of 2011. So those are there for the full year. But we do have -- it's about $5 million a quarter that SmartLink contributed...

Robert O. Carr

You mean School-Link.

Robert H. B. Baldwin

School-Link, sorry. School-Link contributed in the fourth quarter and that's going to continue for the first 3, which is an acquisition thing. I will note however, we're also looking for organic growth in the K-12 School Solutions business as they focus on bringing up the percentage of the students paying -- parents paying through ACH and card rather than the existing check culture [ph].

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

Okay. And then the one other question just with some of the price movements in stuff that you've reinstituted now, do you expect yield on the volumes to go up in 2012 and maybe by how much? I mean, is that -- should yield go up 2% to 5%? Or maybe you could just give us a little bit of color around that.

Robert O. Carr

Well, our yield is going to go up because that increase we talked about is going to be annualized. So we're going to get a benefit of that. I'm not -- I don't know how to speak to the percentage exactly.

Maria Rueda

I can say, it will be going up and that is a function of the fact that we have the wind at our backs with Durbin, and we have much more energy and morale boost in our RMs as they go out there. So that would give them greater negotiation power with that kind of morale behind them.

Robert H. B. Baldwin

An interesting phenomenon we're getting is that we continue to get higher gross margin in dollars per deal signed than we've ever had in our history. Basically, many of our competitors chose not to pass through the benefits of Durbin. It means that our merchants are in effect seeing very high costs right now, and our sales people as is consistent with our and their philosophy are incented to get the best deal they can because that drives their own personal commission. So the result is, there's a pricing umbrella out there because of Durbin, and we're seeing significantly higher margins per install, which is actually going to result in a higher net revenue spread.

Robert O. Carr

It'll be interesting to see the discussion of the margin expansion in our industry, because I've been hearing about the margin compression that I haven't personally seen for 25 years. But the margin expansion in this industry right now is hard to ignore.

Operator

We'll take our next question from Kartik Mehta with Northcoast Research.

Kartik Mehta - Northcoast Research

Bob, I'm just wondering if you can talk about the Durbin impact on the business so far. I know you've said, you've had very good luck in recruiting salespeople. And I'm wondering, for 2012, maybe what the assumptions are and what type of benefit you're getting from your pricing because of Durbin?

Robert O. Carr

Yes. That's really a great question, Kartik. What's different this time than the Walmart suit is that because the Durbin Amendment seems -- it's going to continue on indefinitely, our competitors have built in a substantial amount of additional margin for the long term into their business models. So in the Walmart suit, it was a finite period of time, where the interchange was reduced and it came back. So now we're dealing with competition that is counting on this margin expansion to continue for the long haul. And we're not looking to expand our margins so much. We have been able to recover -- cover our additional cost that we had to incur as a result of the regulation and all the new rules, so that's good. We haven't lost any margin. But if we can just keep our margins where they are and go forward, we're just in a very strong competitive position. So I think the fact that the salespeople love the story about giving back all the Durbin Dollars, we're going to hit $100 million here pretty soon. We have a contest going on, guess the date that we're going to hit the $100 million. Towards the end of the year, we're going to have a $0.25 billion of Durbin money going back. We think when we hit these milestones that the press is going to help us tell the story. This is new capital going back into the SME marketplace, and it's something that hasn't gotten quite enough attention yet and we're going to try to correct that as we hit these milestones.

Kartik Mehta - Northcoast Research

And then, Bob, on the K-12 business, obviously, you're making progress there. I'm wondering, is that a business where you see an opportunity to acquire some other companies because it's a fragmented business? Or is this a business now where you are going to focus on growing organically and just trying to get greater usage out of the companies that you have acquired?

Robert H. B. Baldwin

Yes. We're going to look. If we see a good opportunity to buy something more, we absolutely will. We'll consider it. But we're going to remain disciplined in our pricing. And with a 20% more or less share in that business, there is a lot of runway to drive incremental growth through better penetration of electronic payments to the existing base of parents. So we think that both are an opportunity. We're not building in any acquisitions into our budgeting or planning. But we are absolutely looking at acquisitions, and if we find something that's attractive, we will do that.

Robert O. Carr

What we like about that, in addition to what Bob is saying, which I endorse completely, is that not all the schools that are under contract with us now are using electronic payments. So we have an opportunity to add new schools, particularly the New York public schools are not using us, not all the schools. And we have a nice chance to pick up many schools there. There's also the expansion of the number of parents, as Bob alluded to, which gives us a nice wind at our back because we can do things with local merchants to attract them, we think, more parents to pay electronically. And then we have the opportunity of using the accounts, the lunch accounts, expand those to take care of student activity fees. So we have, really, we have 4 different growth opportunities within the K-12 market, when you add in the full line of additional acquisitions. So we're very bullish on that marketplace.

Operator

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

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

First question just on, I think, you put out a press release the other day on a city-specific marketing campaign down in Florida. So I'm just curious if you could comment on that, and I'm kind of assuming that you're rolling that out more broadly to other cities. But maybe just talk about that effort a little bit more, if in fact that is the case.

Robert O. Carr

Sure. Frankly, Chris, what we're doing is experimenting there. We wanted to see if, we're doing a media campaign and making investments in getting name recognition would pay off for us, primarily with new merchants but also in our recruiting. So we're throwing some money at this. It may turn out to be the -- a mistake. We don't know yet what kind of uptake we're going to get. But we're just experimenting with the idea. Are there enough merchants out there that a media campaign is going to give us the name recognition that we need to penetrate the market further. So we'll see if this works, and we hope it does, and if it does, we're going to expand it and it could be very, very exciting. And it also could be a big dud. We just frankly don't know yet.

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

On the new margin install, that metric has been up 3 quarters in a row, year-over-year and then it's flat in Q4. Obviously, Q4 last year was your strongest quarter of the year, so. Just want to understand a little bit. Just trying to reconcile that flat performance with Bob's comment earlier, that you're seeing significantly higher margin per install. So does that mean that you've installed fewer or smaller merchants versus a year ago, or am I just looking at that incorrectly?

Robert H. B. Baldwin

No, you're absolutely correct, Chris, that we did have fewer, smaller number of merchants that we signed up. And that's -- we don't really care. I mean, as a company, we put out a margin install number in front of our sales force. That's how they get paid. And we've always said, 2 smaller with -- or one larger with twice the margin were really indifferent between. And so, that's the way it played out. The key thing on the fourth quarter though, is that last year in September, we launched the productivity focus full bore, and there were a lot of people in the sales force in the fourth quarter, who were working very hard to try to get up to the required productivity level. We got a lot of benefit from the installs that they made. But many of them really couldn't make it to the benchmark that we had established of $6,000 a month and ended up leaving the organization. So we think, even though the numbers are substantially identical this quarter versus a year ago, the base of people who created that in this quarter are in place and off and running in 2012, where last year we are facing a different dynamic. So we think there's really a much better foundation for growth going forward than we had last year.

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

Okay, great. And then a couple of housekeeping items. The same-store sales, encouraging that's up 4.4% in January. I was just hoping that we could get the year-ago comp growth rate if possible in January of '11.

Maria Rueda

The comp -- same-store sales in January of 2011 was 25% expansion. So the monthly same-store sales statistics move all over and that is not anything that we can really control, but we do benefit from it when it expands at a higher rate.

Robert H. B. Baldwin

And we really don't know, it's been a sawtooth pattern much more of this in the last 12 months than we've ever seen before. And so February could be a much lower number. So we don't know. But it certainly was a good start for the year.

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

Yes, it makes sense. And then on K-12, it sounds like $5.5 million of net revenue plus a little bit from equipment. Can you give us a rough estimate of what the earnings impact was in the quarter?

Maria Rueda

It was less than $1 million in the quarter, because in the fourth quarter that just reflected we had just closed the School-Link sale on September 30. And the way accounting rules are reflected now, you need to expense all of your M&A-related costs upfront. So there is minimal impact on our fourth quarter of 2011. However, going forward in 2012, we fully anticipate that the margin impact will be very positive from our School Solutions.

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

So less than $1 million net income impact in the quarter?

Maria Rueda

Correct.

Operator

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

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

You guys talked about the same-store sales expectation a little bit in 2012, but do you have a specific number you're targeting that's embedded in the guidance?

Maria Rueda

Our guidance is very conservative in terms of the same-store sales number. It's below 2% because as we've spoken about before, we do not have a lot of control over that particular assumption.

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

Sure. But everything you've seen through January, I guess, we sort of characterize it as encouraging but you're still going to remain cautious with your full year estimates. Was that a good way to think about it?

Robert O. Carr

I think the key word is sawtooth.

Maria Rueda

Yes, yes. It's very...

Robert O. Carr

It's up and down and just really difficult to anticipate what's going to happen next month.

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

I mean, we're looking at good jobless claims numbers here today and it seemed to be some good U.S. economic data. Do you correlate that well? Have you seen a good historical clear correlation just between the economic we can all see every day versus your underlying activity?

Robert H. B. Baldwin

Greg, it's really dangerous to do that. And in our -- going back a longer period, yes, a good economic time is good for the whole card processing industry. I think people have gotten this impression that Heartland is more sensitized to good economy, good consumer than some other card processors. I'm not sure I buy that so much. But generally, better economic activity is going to be reflected in stronger card processing. But that's very directional. And we -- looking at last year, people were very bullish in the spring. We saw things were fine. People got very concerned in August. We saw things looked fine. Not great, not bad. Just bumping along in a positive way. And remember, our merchants, many of our smaller merchants, have still not gotten back to the business activity level that they had in 2007. I mean, the declines from then were very substantial and we've been bouncing along in a positive way now for the better part of 2 years. But if -- the gains have been relatively modest and so thereby, you've still have not gotten back to those high water marks.

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

Excellent. That's very helpful. And then Visa's got this big sort of fee change coming up here in a couple of months. How do you see that impacting your pricing? Is it going to change anything? Cause confusion? Is it an opportunity? How are you guys thinking about that?

Robert H. B. Baldwin

Well, a couple of things. One is, we're just now getting visibility on what that is. Literally this week, we got more information. We are -- at a fundamental level, we will pass through the changes that Visa is putting through. And so, while it may change the dollar amounts in the dues fees and assessments line and our revenue line, it shouldn't impact net revenue at all. As far as the impact of that on behavior, on merchant behavior and all that, it is really impossible to say. And the third thing is, for our SME merchants, it does not look like the dollar magnitude for a typical merchant on a monthly basis is going to be a very meaningful number. And while network-wise, this could have a significant impact for Visa and even within Heartland, in the aggregate, it could have some impacts. The typical small merchant, it's going to be a very small number of dollars per month benefit or increase. And frankly, at this point, we're not in a position to judge which way that's going to go. Very, very surface, we may see, it may be as little as pennies per month difference for the typical small merchant of ours.

Operator

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

Robert J. Dodd - Morgan Keegan & Company, Inc., Research Division

On the pricing, kind of getting back to the first question. I mean, obviously, adjusting for the K-12, stepping back, I mean. It looks like net spread up, just north of 850 basis points. With 600 of that was the K-12 contributions with School-Link. That leaves 250 kind of basis points in net spread price increase year-over-year. Can you give us any color on how much of that was these extra fees, annual fees, i.e. those one-time kind of in Q4, versus how much of that was the new customer signings, where you are putting them on at somewhat higher price?

Maria Rueda

We have been very hesitant to pass through any of the increases in the regulatory and compliance costs. And we've seen other processors do that. But we have really held back until actually this last fourth quarter. So we are seeing -- we did pass through increases in some of our monthly charges reluctantly, but we have done that and you see the benefit of that in the fourth quarter.

Robert J. Dodd - Morgan Keegan & Company, Inc., Research Division

Got it. On the, second question, on the relationship management productivity side. I mean, obviously, this year average managers, and it's just my simple math, it might not round the same. As you have done about 34% gross margin installed up for the year, average about 5%. The productivity up almost 60% per average manager. When we look out into '12 or even beyond that, how much of your future growth do you think you can get from increasing productivity per RM, versus is it going to have to be driven by growth in the relationship manager base going forward?

Robert O. Carr

The comments that Bob made earlier that our merchants -- that we're signing are giving us more margin than ever before in our history, I think, is a really good indicator of where we're headed. With our new approach to -- that we instituted 16 months ago, we've been -- we've had to really raise the bar. We created a whole category of reps called All-Stars that install at $10,000 a month. And we have more All-Stars today than we had winners, some people who did $6,000 a month in June of 2010. So we've had to create a new category called distinguished All-Stars that are at $15,000 a month. So the short answer to your question is, that we do expect productivity to go up because there's a certain percentage of our sales people who are very competitive. They want to be the top dog. And we, of course, want to encourage that. So we think that that's going to continue to raise the average margin per rep but the biggest opportunity for us is to fill in some of the areas of the country that we don't have a full sales organization. And there's lots of areas where we don't and our recruiting is focused there. So we think we can sort of hit our numbers just by the increased productivity this year. But we really are hoping and working hard to expand the headcount and to maintain that higher productivity level at the same time.

Operator

We'll take our next question from Tien-Tsin Huang with JPMorgan.

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

I just wanted to ask Bob Carr the type of merchant in the new margin install, it sounds like it's changing. I heard that you're winning larger merchant. But any other trend in there, type of merchant by end market? I'm just curious.

Robert O. Carr

I think the biggest part, Tien-Tsin, is that the salespeople who have left us were more focused on the smaller merchant, and were not very good at establishing the value that Heartland brings and in telling our story. I think the people that are with us now, that have the higher productivity, can explain what Durbin Dollars really mean, and they're attracting larger merchants and they're spending their time going after larger merchants. So I think just the general answer is that we're selling more gift and royalty marketing products to our base and we're going after a little bit bigger merchant. And that seems to be the direction we're headed. And the smaller merchants out there, all these merchants going to Square and so on. Frankly, we haven't figured out how to capture that market yet. And when we do, we're going to have a much more robust forecast going forward. We just have to figure out how to go after these smaller merchants and be able to make a reasonable amount of money with them, without gouging them. And it's hard to figure that one out right now with all the changes in the marketplace.

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

Sure. Sure. I wonder just, do you share the view at the top there with First Data and others, that Durbin will get competed away in 12 to 18 months?

Robert O. Carr

We hope so and we hope that we're competing it away from them.

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

All right. Right. Okay. So just quickly, I mean, the RC trip [ph] in the quarter, what was that amount again? And what metrics trigger it? And I suppose I'll ask also how broad based is that award across the firm? Is it just with senior management? Or does it -- go deeper than that?

Maria Rueda

Well, the details are -- in accounting, you need to determine if achieving your goals is more likely than not. And based on the circumstances that we are seeing, we made a determination in the fourth quarter and we recognized a bit of a catch-up in that regard. And that's what we disclosed. The stock-based compensation awards are not exclusive to just senior management.

Operator

We'll take our next question from Roman Leal with Goldman Sachs.

Roman Leal - Goldman Sachs Group Inc., Research Division

I guess first, a clarification question on Durbin. Your commentary that given you -- what your competitors are doing, are not passing down the entire benefits. And just sort of giving your salespeople an opportunity to get the best deal possible. Can you help us kind of walk through what that means in light of the broader dollar Durbin's campaign? Are they passing down every dollar to the merchant? Or are they basically keeping some of this?

Robert H. B. Baldwin

Well, you got to look, Roman, at the distinction between the existing portfolio and the new installs. Existing portfolio, we are just passing through the reduction period, the end. Then you get out in the marketplace. The salesperson out in the marketplace and looking at what they can do to attract a new merchant. And they are facing an environment where in effect that merchant, if you look, if you analyze their statements, which is typically part of the sales process. That merchant, if it's one of our -- was one of our typical merchants, just had a price increase from their acquirer of $1,000 annually, because that acquirer -- competing acquirer did not pass through the reduction. Well, in that environment, the salesperson is going to price the deal at the best price that they can do, that is going to attract the merchant to them. And what we're finding is that, that price point is much higher, really higher than we've ever had in our history as a company. They are just getting a merchant at -- their -- in a sense, the margin is a little bit higher than it would otherwise have been because of that large price umbrella that's been created. As we discussed a few minutes ago, over time, that incremental margin per deal is probably likely to come down as other people are realizing that they're facing share losses due to their pricing approach.

Robert O. Carr

And I think one other comment is we have that Merchant Bill of Rights out there and we don't say, you can't do price increases. We just say, you should tell the truth about price increases and about interchange and so on. So, and our position is very clear and it's easy to see. We're giving 100% of every Durbin Dollar savings to 100% of our merchants. I don't think there's any other processor out there that can say that honestly. And our salespeople are out telling that story very well.

Maria Rueda

And one thing to add to that, Roman, is we actually culled out for our existing merchants what their dollar savings were on each individual statement when this happened. So it was very transparent to our merchants, our existing merchants, the savings they were getting. So of course, that causes very positive communication to the merchant next door who might not be using Heartland yet.

Roman Leal - Goldman Sachs Group Inc., Research Division

Right, right. That actually makes a lot of sense. So on the average annual savings of $1,000, I mean, is that an all-in number? Because it seems like that number will be more meaningful to a smaller merchant versus kind of the large merchants you've been signing. Help us kind of think of that.

Robert O. Carr

But that's an average. So the smaller merchants, there might be $100 and the bigger merchants, it might be $30,000. We do have merchants that are saving over $50,000 a year because of Durbin. So that's an average.

Robert H. B. Baldwin

And that's speaking to the SME merchants, not to mention the larger merchants from Network Services and some of our other activities, who are saving an awful lot more.

Robert O. Carr

Right.

Roman Leal - Goldman Sachs Group Inc., Research Division

Right, right. Makes sense. Okay. And then the commentary, same-store sales into the quarter seems very favorable and you definitely ended the quarter on a high note. So the commentary that the first Q seasonality will be more pronounced this year, I guess, it's more of an expense issue versus a revenue issue?

Robert H. B. Baldwin

Well, it's both, Roman. Because you got to remember the first quarter has just had 2 of our 4 worst months seasonally, January, February. It is a shorter quarter, although it's less short this year because we get the leap day. And that's 3% of a quarter's activity. And the incremental margins on an incremental day of activity are quite high. So it is a revenue thing, because in the quarter your expenses, most of which for us, are people. You pay people the same in the first quarter as you do in the second or third quarter. So it really is -- our expenses are relatively high relative to revenue in the first quarter. And then we exacerbate it with the summit cost this quarter.

Robert O. Carr

And then we have our summit, which is a major expense, millions and millions of dollars. We have 1,100 people plus many of our employees, plus many of our guests coming to Louisville on March 11, 12 and 13 for our 3-day summit that we have every 18 months. And that's a very major expense. Most of it's booked in the first quarter and that brings down our operating margin for the first quarter.

Operator

We'll take our next question from Tom McCrohan with Janney.

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

Bob, what is the behavior that Visa is trying to influence with this new pricing rules that you received this weekend? Are they trying to influence you, the merchant acquirer or your behavior or the behavior of the end merchant? Maybe you can just kind of talk conceptually about what they're trying to drive here and accomplish.

Robert H. B. Baldwin

I think, Tom, you're better off asking Visa directly. They move to a fixed and variable number. I think the biggest impact is likely to be at the larger merchants with whom they'll have a direct deal. And maybe that will influence behavior, maybe it won't. It's very hard to say what they're trying to accomplish. They also mentioned sort of better matching their costs. So maybe that's just it. I'd direct you to them.

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

Okay, that's fair. And do you have any thoughts surrounding Chip & Pin, EMV and the push by both card networks and what the implications could be to you folks over the next couple of years?

Robert O. Carr

Yes. We're frankly excited about it. We think that it's a transformative event. We think Visa's on the right track with what they have done in terms of mandating it. And we have planned to be a leader in rolling it out.

Operator

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

Brett Huff - Stephens Inc., Research Division

Question first on the expenses and then the EBIT goal you guys have set out for yourself. Obviously, you saw a lot of the COGS and the acquisition costs go down. How much more leverage in those line items do you see going forward in '12 and maybe even beyond? And can you maybe answer in the context of is the 20% EBIT goal still the right one or any updates to that?

Maria Rueda

Thank you for that question. Basically the 20% goal, we hope we get there as quickly as possible, and we have not communicated any change at this point. In terms of our processing and servicing costs, we will continue to focus on making those as efficient, as small as possible. However, we do not anticipate the decreases that we have been able to reflect in this year.

Robert H. B. Baldwin

And then just to add, the other piece of it is the customer acquisition costs, which have really come down. We're still at a place where we just finished in 2011 amortizing off the last of the strongest year we had, which was 2008 results. The question on customer acquisition cost is, the more successful we are at driving new customer acquisition, the more that will not be a contributor to operating leverage. That will be a great fit. We're driving more installs, remains always the focus of the company. And if we can drive, get ourselves going back toward that high water mark of $70 million and ultimately past it, that will start increasing our customer acquisition costs, but will also importantly drive revenue to greater growth, which is a key focus.

Robert O. Carr

And 2 other points I'd like to make is, our operating large margin in the first quarter is going to be terrible. So let's not be surprised by that because of this huge expense we have for the summit. And the margin expansion that's occurring in the industry is going to make it much more likely for us to be able to hit that 20% goal that we do have, and to increase it beyond that in the coming years in my view.

Brett Huff - Stephens Inc., Research Division

That's helpful. And then second question, you mentioned attrition. I think it's kind of held steady at mid-13 through most of this year. Does that number conceivably go down given that your pitch -- given that you're sending out the savings of XYZ to each individual merchant. Do you think that keeps folks around? Does that drive that attrition down, which obviously would be a high incremental margin saved?

Robert O. Carr

I have a 3-word answer. We hope so.

Operator

We'll go now to a follow-up from Tien-Tsin Huang with JPMorgan.

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

I forgot. I wanted to ask, thanks for letting me ask the follow-up, on EMV. Bob Carr, just with that looking like it's coming over the next 2 to 5 years, what would the impact be in your mind to Heartland?

Robert O. Carr

I think it's going to help us, move our strength to a bigger merchants. And I think it's going to help us to upgrade the point of sale equipment in our merchants, and it will help drive growth. We're combining all the number of new things besides just being a conventional card processing company. We're developing some point of sale solutions, our SmartLink product is this broadband product. It's going to -- we're going to be able to take in to merchants. So if we can go into a merchant and offer them 3 or 4 solutions that are all combined together, that are all well-integrated, which is the path that we're on and we're well down that path, EMV is just one more reason to make the changeover to Heartland and to upgrade the point of sale equipment to a modern equipment. The NFC thing is much more up in the air, I think, than EMV. EMV, we know what has to be done there. There are people all over the globe who are doing it. The NFC take-up, once we can get some visibility on Google versus ISIS versus what's all going on there, we'll be able to figure out the best solution for our merchants. But the EMV, I think, is a pretty well understood project for us. And we're working on -- working with some global partners to help us move EMV into our technology without us having to reinvent the wheel.

Robert H. B. Baldwin

And we're also encouraged in that regard by MasterCard coming out just in the last week with a more, a proactive statement that was useful to the -- further defining things, which is, A, consistent with what Visa said and actually in some ways seeming to give strong incentives to the merchant to make the switch. So that's an encouraging thing to make sure we can get the unanimity among the networks, so that we can present our customers with confidence with that the solution is not, oh, you're going to have to do this again in a few years kind of thing, which is important.

Operator

And we'll take our final question today from Chris Brendler with Stifel.

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

Just a couple of Durbin clarification questions. I guess, I'm a little bit confused, I mean, we've -- I think you tried to address this a couple of times in the call. But given the competitive opportunities that Durbin presents to your sales force, I would have thought we would see an acceleration in installed margin this quarter. Is it just the fact that it's only been out there for 3 months and you see things picking up? Or are there other factors in play here? Just help me think about the competitive dynamics. And also if you could comment on -- it sounds like from your perspective that you are seeing a significant opportunity were some of your competitors are trying to keep some of the savings for themselves. Could you just characterize the competitive environment with the Durbin and the interchange pass-through? Is it better, worse or about as expected from your opinion?

Robert O. Carr

I think, from -- my view is that merchants don't understand it yet. And our competitors this time were much more prepared. And many of them are out talking about how they're passing through the Durbin, but they're really not or they're passing part of it back and keeping part of it. So first of all, Durbin went into effect October 1. Merchants didn't see anything until they got their statement for October, which is in the middle of November. Now you start Black Friday and then Christmas, the holiday rush. So I think merchants just haven't been paying attention. And we think that that's our opportunity. We would have liked to have had a bigger impact in the fourth quarter, but we do expect it to help us quite a bit in 2012 and beyond.

Operator

That concludes our question-and-answer session. I'll turn it back to Maria Rueda for closing remarks.

Maria Rueda

Thank you very much, Debbie. Well, thank you, and thank you, everyone, for joining us today and I hope you have a great day.

Operator

Ladies and gentlemen, thank you for your participation. This does conclude today's conference.

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