Heartland Payment Systems, Inc. Q2 2008 Earnings Call Transcript

Heartland Payment Systems, Inc. (HPY)

Q2 2008 Earnings Call Transcript

August 5, 2008 8:30 am ET

Executives

Robert Carr – Chairman and CEO

Robert Baldwin, Jr. – President and CFO

Analysts

David Koning – Robert W. Baird

Anurag Rana – KeyBanc

Heliel Sigman [ph] – Goldman Sachs

James Friedman – Susquehanna

Tim Willi – Avondale Partners

Josh Elving – Piper Jaffray

Thomas McCrohan – Janney Montgomery

Robert Dodd – Morgan Keegan

Reggie Smith – JP Morgan

Brett Huff – Stephens, Inc.

David Parker – Merrill Lynch

Andrew Jeffrey – SunTrust

Robert Napoli – Piper Jaffray

Presentation

Operator

Good morning, my name is Jim and I will be your conference operator today. At this time I would like to welcome everyone to the Heartland Payment Systems second quarter 2008 earnings call. (Operator instructions) Thank you. Mr. Baldwin, you may begin your conference.

Robert Baldwin, Jr.

Good morning and thank you. I would like to welcome everyone to our second quarter 2008 earnings call. Joining me this morning is Robert Carr, Chairman and Chief Executive Officer. Today Bob 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 we opened up for questions.

Before we begin I would like to remind you that some of our discussions may contain statements of a forward-looking nature, which represent our management’s 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 company’s SEC filings. We undertake no obligation to update any forward-looking statements to reflect events or circumstances that may arise after this call.

Now I would like to turn the call over to Robert Carr.

Robert Carr

Thanks, Bob, and good morning everybody. I would like to thank you all for joining us today and for your interest in Heartland and I am really pleased with the report we have for you today given that challenging operating environment. We reported a record second quarter results with net income up 10.3% to $11.5 million and earnings up 15% to $0.30 for fully diluted share.

These results reflect continued strong growth in our processing volume and new merchant generation. Despite one of the weakest economies in memory, we mange to grow faster than the overall industry, while investing across a host of new business initiatives that represent the next leg up in our growth strategy. In addition on May 30, we required the Network Services division of Reliance Data systems broadening our product offerings and adding significant scale to our operations.

We have please with this acquisition, our results for the second quarter include one month of these results as well as the non-recurring costs associated with the transaction. More about Network Services later, for the quarter our organic processing volume was up 14% to $15.2 billion despite same-store sales growth of a negative 0.1%. The first time we have experience negative quarterly same-store sales growth in the history of the company.

Organic net revenue growth was 17.7% in the quarter strong performance in a weak market. For the quarter Network Services settled processing volume was $1.9 billion and an including NWS total volume was up 29% and net revenues were up 29.3%. Operating income for the quarter was up 17% although the operating margin fell from a year ago as anticipated. The plan investment in a number of new business initiatives one-time cost associated with the Network Services acquisition and the influence of amount of Network Services somewhat lower margin all weighed on the consolidated operating margin.

We are no doubt in a challenging environment and the first decrease in same-store sales in the company’s history it’s certainly indicative of headwinds that will probably be with us for the rest of 2008. Many main street merchants are struggling and business failures have increased. Nevertheless, we were able to increase the amount of organic new margin install this quarter by 12.2% over the last year, a solid performance demonstrating the inherent value of our business model and the strength of our sales and services organizations.

Our sales team will continue to drive our continued growth until the economy rebounds and we once again benefit from the secular growth inherent in the electronic payments industry. As was the case last quarter, our success in part due to progress we are making penetrating larger merchants and I am talking about the Heartland legacy business. We are steadily increasing our share of merchants with $0.5 million are more volume. At the same time pricing relative to projected volume on the new margin install this quarter was the highest in the company’s history.

In part due to increasing success of our check and micro payments businesses. Our success in driving volume growth and installing new margin reflects the hard work increasing productivity and growth of our exquisite sales organization. Compared to year ago our relationship manager headcount is up 16% and we are on track to achieving our goal 2000 RMs in the next few years.

In recognition of our outstanding sales organization the American business awards recently honored our Payment Systems out of 1000’s of organizations with the 2008 award for the best sales organization in America.

This is a credit to the members of our dedicated sales forces who have committed themselves to Heartland careers. We have constantly developing new and improved product offerings to make our growing sales team and Heartland even more financially successful. Our payroll business continues to enjoy strong growth as payroll revenue was up 31% this quarter we have made similar progress with our check products although from the smaller starting base. We have also made progress with our Campus Card program. We’ve recently teamed with the identifications systems group a nationwide network of suppliers of identification in card issuing products and services to bring Heartland’s Campus Card Programs to an expanding network of colleges and universities nationwide.

ISG will now offer its clients, Heartlands Campus Solutions OneCard system providing them with a full suite of card services and functionalities. The OneCard system offers Campus all aspects of card technology used, including student faculty and staff identification dining, access control, security, vending, print control, recreation and event management, equipment rental, parking, voting, activity verification, laundry and more. The installed base of our proprietary Give Something Back Network will increase from one college campus a year ago to ten campuses this fall.

Turning to network services, two months into the integration we’re pleased with the opportunity we see, and in fact we have had more pleasant surprises than set backs to date. Obviously, network services leadership positioned the petroleum industry provides a tremendous platform that perfectly complements our existing merchant portfolio. Our initial integration efforts are aimed in capitalizing on our increased scale to gain economies whatever possible such as in telecommunications and back end settlement.

The next phase of our integration will be to migrate NWS onto our proprietary front and back end platforms. The great majority of our traditional Heartland business is already running on our proprietary platforms, which has significantly lowered our cost to process the transaction. As we transition NWS under this common platform we believe we can further leverage our technology infrastructure from the financial perspective in the second quarter, network services was immaterial to our results.

On another reason but smaller acquisition collective POS did about $100 million in Canadian processing volume for the quarter. Not unlike many of our other investments however the real value is our long-term access to a sizable merchant market where we previously did not have a competitor product. Collective also has a tremendous upside as Canada implements a conversion the EMV compliant technology.

We are also well on to the development of Discover and American Express functionality on our platform, well the Network Services acquisition is pushed the timing back a few months. Once this development is complete will benefit from the incremental processing revenues and with very minor additional cost, so you can see that not only as our base business performing well but we are also laying the ground work for the next phase of our growth. Right now it is clear that our opportunities are enormous.

I would like to turn the call back to Bob who will go through some more of the detail and the results before I provide some concluding comments.

Robert Baldwin, Jr.

Thanks Bob. We’re pleased to once again report a record quarter with diluted earnings per share rising 15% driven by strong growth in our processing volume, disciplined pricing and continued increases in the contribution from our payroll and other businesses. Net revenues for the quarter were up 29.3% on a 29% increase in total processing volume. Well revenue did benefit from the one month of Network Services activity the real drivers behind the strength were solid organic card net revenue growth, 31% increase in payroll and 54% increase in equipment revenues.

Same-store sales were down in the quarter, with same-store sales in our restaurant and retail segments trailing the overall average much as we experienced in the first quarter. In the second quarter we also saw particular weakness in the hotel and entertainment categories. Keep in mind that with Network Services our sensitivity to the consumer discretionary spending has been significantly reduced.

Within the quarter June was particularly weak, although business bounced back a bit in July. Network Services is excluded from the same-store sales calculation as their revenues are transaction, not volume driven. I’d also note the in the two since closing that the NWS transaction, their key activity metric the number of transactions has been growing ahead of plan.

Despite negative same-store sales our organic card processing revenue was still up 14.6% in the second quarter of 2008, as a result of the growth and processing volume and disciplined pricing. Pricing relative projected volume on the new market installed this quarter was the highest in the company’s history.

Network Services revenues are primarily a function of the number either authorization or settlement transactions processed regardless of the transaction dollar value. They simply pass through the dues assessments and interchange. Consequently the Network Services financials differ from historic Heartland model were revenues include dues assessments and interchange and are more closely related to the dollar value of transactions processed. Thus the $105 million run rate of the NWS revenues that we discussed at the time of the acquisition is all net revenue putting aside seasonality should therefore amount to around $50 million of net revenue for the second half of 2008.

Due to these differences that may become difficult to compare our future performance with past performance using some of traditional operating metrics. So, we are introducing separate new volume related and transactional related metrics with the historic Heartland business we will continue to provide the process volume statistics that are the driver of net revenue growth and that processing volume from volumes driven trends merchants grew 14% in the quarter. For the larger merchant priced on a per transaction basis we will provide transaction accounts. Transactions base merchants tickets totaled $280 million in the June quarter over 7% better than the Network Services budget for the period.

Total cost of services for the quarter up 17.7%. The rise in cost this quarter is due to the increase in processing and servicing cost and the onetime cost associated with the Network Services acquisition. On a proportional basis both dues assessments and interchange are down from historical percentages this quarter due to the effect NWS reporting net revenues only and this helps slow the growth in overall cost of services.

Processing and servicing was up 40.3% in the quarter. In addition to the natural increase in processing and servicing associated with our organic growth. Processing and servicing rose as a result of the reallocation of some personnel costs as well as the addition of NWS portfolio. We have indicated that the operating margins on Network Services business trail Heartland’s traditional business in part as they continue to process on two separate front ends. Specifically NWS gross margin is currently running in the area of 30% to 35%.

As we consolidate all of our processing onto our proprietary platforms, we expect to improve efficiency and to achieve scale economies. While we are undergoing this migration we’ve already implemented a number of changes such as with our telecom providers that will help drive down cost and improve Network Services and overall margins much sooner.

Overtime the combination of these improvements, some of which may take some years as well as the use of our proprietary front and back end platforms for all but the most unique of applications will continue to drive operating efficiency to our long term goal to 25% operating margin.

Customer acquisition costs were only up 7.8% a year ago consistent with the decline in same-store sales and temporarily elevated attrition level. We saw the same trend in the first quarter when same-store sales had also slowed. Depreciation and amortization was up 48.4% in the quarter largely due to the amortization of the Network Services acquisition intangibles.

General and administrative expenses rose 33.2% this quarter primarily a function of the cost from our new business initiatives. To the point we’ve been absorbing the cost of these growth investments without any significant revenue offset. Beginning in the second half of the year we expect to see investments start to generate revenue without any appreciable increase from current expense levels.

G&A in the quarter also reflects one month of Network Services cost as well as some non-recurring transaction expenses. Operating income for the quarter was $19 million an increase of 17% from $16.3 million in the second quarter of 2007. The operating margin on net revenue for the second quarter was 19.4% down compared to the second quarter of 2007 as a result of the factors just discussed.

As a result of the Network Services acquisition we believe our operating margin will be between 17% and 19% for the full year 2008. Net income for the quarter was up 10.3% and fully diluted earnings per share for the quarter were up 15% to $0.30 per fully diluted share.

Now let’s turn to our cash flow and balance sheet. GAAP operating cash flow for the quarter was $35.7 million compared to $24.9 million a year ago. However, a good portion of the increase is attributable to growth in our due to sponsored bank, liability as we used cash for the Network Services acquisition instead of funding interchange for our merchants.

As we discussed management’s measure of operating cash take net income as adjusted for amortization, depreciation and the other non-cash sources at the top of the operating cash flow statement and then reduces that figure by signing bonuses and buyout paid, using this management measure operating cash from 65% in the second quarter to $17.6 million from $10.7 million last year.

Capital expenditures for the second quarter were $8.9 million, of which $3.1 million was for the construction of our new service center in Jeffersonville, Indiana, and $5.8 million for the other investment to strengthen our technology infrastructure. Taking that same management definition of operating cash and reducing it by non-service center CapEx, our free cash flow amounted to $11.8 million for the year’s second quarter, up from $7.7 million in the second quarter of 2007. We also used $3.4 million of cash to pay dividend the quarter. Our financial position remains strong. At June 30, 2008 we had approximately $40 million in cash and a $164 million in stockholders equity. To finance Network Services acquisition we brought $50 million on our revolver and $25 million on a term note.

Let me ramp up with our guidance for the year, in light the challenging economy we’ve start from the balance of this year, we expect to achieve full-year organic net revenue growth between 60% and 18% including NWS we expect net revenue to be up 35% this year and our 2008 earnings per share guidance is $1.13 to $1.17 per diluted share.

Now back to you Bob.

Robert Carr

Thanks Bob. Let me just quickly conclude, so we can open the call for questions. Heartland is established a much sold foundation that is provided us with the resources that generate record earnings in the near-term, while simultaneously investing heavily a business initiatives to sustain our growth over the long-term, achieving these results despite a weak economy is a clear indication that our business model is right for the times.

I believe our strategic initiatives only strengthen our foundation, undoubtedly the most transformational transaction in our history, the acquisition on Network Services has made us the second largest player in the processing industries second largest vertical market. While providing us with additional scale that will improve leverage across the entire organization, it also provides a nice complement to our traditional consumer discretionary business.

Finally, our Board of Directs has authorized a $0.09 per share second quarter of dividend, maintaining our commitment to continually build shareholder value and with that we’d now like to answer any of the questions. Jim, you can now open the call.

Jim, are you there?

Question-and-Answer Session

Operator

(Operator instructions) and your first question will come from the line of David Koning with Robert W. Baird.

David Koning – Robert W. Baird

Yes, nice growth in this economy.

Robert Baldwin, Jr.

Thanks Dave.

David Koning – Robert W. Baird

Yes. So, first of all just on gross margin instead, I know this is the little weaker quarter than you had recently and I guess a couple of things, should we expect giving kind of tougher comparables on that line going back into Q2 last year, Q3 last year. Should we expect this level of growth to continue and then I guess secondly, I usually look at this is a three year type, I guess running total of that. You basically need three years of 12% gross margins instead of before your revenue would all of a sudden grow that way, is that kind of a fair way to look at it that if a component of growth, but if not like next quarter all of a sudden, you going to be at 12%?

Robert Baldwin, Jr.

That’s exactly right, Dave. It is a very much delayed impact and as to what to expect is a challenging thing. We have in front of our sales teams and sales leadership, some very significant incentive to drive faster growth in that and we would like to achieve faster growth in that. It’s pretty clear that it stop out there with getting merchants to focus on this issue and their processing, when they got other business issues and so it’s, a challenge to get people to pay attention to the sales call.

What we’re doing in response to that is trying to drive some unique sales calls, especially related and surrounding the check services business to get the merchant’s attention, the merchant processing, the card processing is something that merchants sees and also lot of day in and day out, a lot of calls coming in and sales people coming in. We’re standing out in the breadth of our services compared to authorize stores and so what we’re trying to do is go in with some different call that could eventually lead to powerful uptake in new margin install. So, we are not at all satisfied with the 12.2 number, but predicting that we are going to rebound is awful tough given the difficulties in economy.

David Koning – Robert W. Baird

Okay great and secondly you called out some non-recurring expenses in Q2 that that was a little bit of drag on EPS. I’m wondering if you can quantify what those were in Q2 and then kind of the rest of the year, what we may expect in non-recurring expenses?

Robert Baldwin, Jr.

Well, they really shouldn’t see anything that we would characterize as non-recurring, like of this nature in the rest of the year. This is really a lot of stuff that went on around the closing of the deal. A lot of meeting, trips, things like that that we didn’t carve out as merger related specifically, but obviously a transaction of this magnitude get things moving throughout the Company, changes some priorities, necessitate some spend in some areas that you hadn’t anticipated and it’s not a huge number. It’s in the low six figure number, but it was not trivial either.

David Koning – Robert W. Baird

Low six figure meaning a 100,000…

Robert Baldwin, Jr.

More than 100,000, but we can quantified, sir I don’t think it its anywhere near a half, I don’t think it’s a half a million.

David Koning – Robert W. Baird

And then finally I saw the intangible line, $34 million of intangible assets now mainly from networks services. What’s the quarterly run rate of intangible amortization expense?

Robert Baldwin, Jr.

We are still working that through, Dave. The accounting community is intensely more focused on identifiably intangibles than in the past and we haven’t nailed back down. The run rate is going to be on the quarterly basis, it’s going to be somewhere in the one and three quarters $1 million or $2 million area in all likely hood, but we did have an estimate for June that’s likely due to be adjusted somewhat as we complete this process in the coming, it really, we tried to get it done before now, but it’s going to be in the coming weeks to be nail this down.

David Koning – Robert W. Baird

All right great. Thanks and a great quarter.

Robert Baldwin, Jr.

Thanks.

Operator

Your next question will come from the line of Anurag Rana with KeyBanc.

Anurag Rana – KeyBanc

Hi, good morning guys, congratulation on a good quarter in a tough environment. Have you seen any change in pricing or any comments regarding the competitive landscape both for small deals and large deals?

Robert Carr

What we’re finding Anurag is that our competitors are trying to solve their earnings problems by jacking up rates through all kinds of creative techniques, which has been the norm in our industry, but it seems to have accelerated quite a bit. So, we’ve maintained our margins and we’ve actually improved them just by a hair this last quarter. We are everyday low price guys and we’re also competing with folks who have raised rates and I think this, current times is probably pretty the best in while competitively and it’s helped us to increase our sales to maintain the increasing mode of our sales production. So, I think the pricing adjustments being made by our competitors to increase their revenues is working in our favor in a significant way right now.

Robert Baldwin, Jr.

Is that really funny mix because rarely does a merchant signed up knowingly at a higher rate than where they were the day before. That’s not the way it works, so that’s not the way it worked, so that in the new business mode there are a variety of ways that people can conceal the true magnitude of their pricing and then given the contact that all of us have been which allows as along as you notify the merchant for subsequent price changes, all these increases, people take opportunity to put in a price for merchant and then perhaps jack it up in three months or six months and disclose it, but obviously hope the merchant won’t notice.

So, obviously that is not our approach to the business. Once we have a solid relationship with contract pricing as long as the merchant is doing the volume that was projected we’re going to stick with that pricing. So, that requires good disciplined pricing from the get go and that’s the way our salespeople sell. As you know when we measure their sales in terms of the margin installed, that has a great discipline on the pricing, because it’s never worth it to them to give away the pricing. Their commissions would just go right down the tube. So, we’ve been able to maintain in this environment which will replace pleased.

Anurag Rana – KeyBanc

Thanks, and then lastly could you please remind us when we are going to Discover and AMEX volume come online and how much growth should we expect from this ’09 without even adding a single merchant? Thanks.

Robert Carr

The real impact of Discover and AMEX will what happened in 2009. It exist the trivial amounts in this year really, in 2009. We haven’t quantify that and it’s really quite complex, because the Discover volume once we get it over because of the end of the year conversion freeze, that occurs with all IT systems in our business, the Discover conversion won’t happen until 1Q ’09, but once it happens that will be at a run rate and last year they were at $1.7 billion of volume, that will all be on good pricing for us from that point forward.

AMEX is more complex; we’ll be adding in the fourth quarter and our new merchant run rate is around 1,000 per month and then we’ll start conversions of the existing business to the servicing only model during 2009 if the exact timing of that does not fit in the second half of ’09, maybe the second quarter, but sometime during ’09, so it builds up overtime on the AMEX side, where Discover is really till as we push the button it all comes on as these margin.

Anurag Rana – KeyBanc

Thank you.

Operator

And your next question will come from the line of Liz Grausam, with Goldman Sachs.

Heliel Sigman – Goldman Sachs

Great guys, it’s actually Heliel Sigman [ph] for Liz. Can you just go back and talking a little bit about the pressure that you guys saw on some of the same store sales, if you identify the couple of the major segments, can you just go back and maybe give us a sense on what the same store sales would have been for say restaurants, retails and then what the incremental pressure was in the two other segments that you were talking about hotel and entertainment, which it sounded like you said, we’re tracking weaker.

Robert Carr

What I like to do with it is to compare it to the overall average which was negative 0.1%. Restaurants has been running up just under one percentage point lower than our overall leverage corporate average for the last 24-months, last 12-months, last three months, no relevant deterioration there, but it is lower than, worse done our overall leverage in that period.

Retail has been running more like three percentage points worse than our overall average, and that has continued pretty much unchanged for the 24-months, 12-months and three months, a little bit worse than the three months I would say.

Entertainment was running a couple of percentage points short of it and in the last three months went to about four percentage points worse. Now entertainment is not a really big SIP code, that’s not a driver, but is it interesting in light of what we’re all here in seeing in terms of consumer discretionary spending and then hotel, had been running pretty much inline with the averages in the last 24 and 12 months, with a couple of percentage points worse, so that was the largest fall off.

Where we’re seeing an up ticks, we’re actually seeing related to petroleum prices, the auto side is going pretty well, it’s better than our average and is improving. Fast food and convenient stores have stayed very solid and well better than our overall averages, something like five percentage points better over the 24, 12 and 3 months period and remember that’s where in fast food and convenience you are still seeing higher acceptance of cards than we’ve had in the past and our services and utility businesses are both better than the averages. Well in fact utility took off of that once the spec had something do with energy prices as well.

Heliel Sigman – Goldman Sachs

Okay great and then just on the comment that you made about some of the companies that you guys are working with; some of the merchants facing slightly higher bankruptcy rates or business failure rates; could you just remind us what you’re policy is for setting aside besides your current beliefs?

Robert Carr

A failure in and of itself either costs us nothing or attributable amount because if the merchant for example is a restaurant because there are still a few chargeback. Our losses are related to when there is a chargeback after our merchants have gone out of business and this has been a tough six months for that statistic and so we’ve really do have a reserve, we’ve been growing that but the driver of the way we handle it primarily is just a pass through of our write off when it occurs.

It’s been a tough six months in that regard. We’ve been doing some work on our risk group to try to improve our statistics there, but that the core issue is when you have a merchant particularly one with future delivery of service for example a furniture store, when they got a business you know that you’re going to have charge backs coming at you.

In the quarter our worst loss in years related to a custom aquarium store that had been with us for a number of years and they didn’t change anything, they didn’t change their behavior and those kinds are almost impossible to catch; then all of a sudden one day you get a chargeback and you’re toast; it’s just a question of how many charge backs come back. So it’s been tough but the losses that we’ve been taking really have been running through the current income statement as they occur.

Heliel Sigman – Goldman Sachs

Okay and you feel comfortable with the accurate size of the current reserves.

Robert Carr

Yes I do.

Heliel Sigman – Goldman Sachs

Okay great and then one last thing on just I think a metric that we might have missed in the call here. What was the gross card revenue number for the quarter?

Robert Carr

Gross card revenue was $384.1 million.

Heliel Sigman – Goldman Sachs

Did that include Network Services?

Robert Carr

Yes, and you will see in the Q, we’re still breaking it up; payroll, equipment and card processing because obviously Network Services revenue is almost all either equipment related for card processing related revenues.

Heliel Sigman – Goldman Sachs

Okay, but you had a little bit of apples and oranges there right because Network Services is only net revenue versus the gross revenue for the main business.

Robert Carr

That’s correct.

Heliel Sigman – Goldman Sachs

Got it, okay great, thanks guys.

Robert Carr

Thanks

Operator

And your next question will come from the line of James Friedman with Susquehanna.

James Friedman – Susquehanna

Hi, this is Jamie Friedman, Susquehanna. Bob you were going kind of quick there when you were describing the increase in the amount due to sponsored back $98 million. I was wondering if you could revisit what you had said and kind of walk us through the impact of that if you will.

Robert Carr

Well sure, fine when I said it, but really the focus is when we went public, we told you in about $35 million of cash and that was not needed in our operations and we could have just invested it overnight for the last few years until we found a use for it, but instead we have a better investment on a monthly basis which is that we fund the interchange instead of having our sponsor bank fund the interchange when sponsored bank ask that we pay prime rate so essentially we earned the prime rate on our cash balances when fund the interchange.

During the last nearly three years now since we went public, we’ve made a lot of sizable investments including the Debitek general meters, Collective POS and Network Services acquisitions. We’ve also bought back more stocks than we had an option exercise proceeds so we’ve been taking cash there, we’ve instituted an increase in our dividend about three or four times since then and of course we’ve been investing a lot in the service center. All of those investments have been funded, obviously $75 million of the Network Service, $91 million total purchase price was paid out of new borrowings, but all of the rest of that was funded out of cash from operations plus we’ve been eating into that $35 million and in the second quarter in essence that $35 million was all gone with it’s (inaudible) position and other spending activities.

So, that’s really what it is and so you should see it’s getting a little more complicated now because obviously Network Services, we don’t fund the interchange there, they past it through the daily discount what we would call it and, so we have had receivables in historic part of the business, round numbers interchanges is about three quarters of your revenue and so you would expect that as your revenue. So, therefore you would expect your receivable to be $4 and you’re due to the sponsor banks if fully borrowed at about $3. That relationship will continue, but it will be a little hard to see because we’ll also have receivables associated with Network Services which will bump up our receivables on a quarterly basis. Does that help?

James Friedman – Susquehanna

Yes that helps. We’re trying to make assumptions about that going forward because it’s been somewhat volatile relative to this impact on cash flow. Let me work in a different direction here with Network Services; I’m just trying to reconcile the organic versus acquired growth. Is the $105 million number relative to the historic revenue that you acquired from Network Service and is $50 million the differential between what you were performing on an organic basis and the acquired revenue?

Robert Carr

No, the $105 million we mentioned is the run rate of Network Services. Taking a snapshot essentially of merchants that were with them at the time of the acquisition, they’ve lost some significant customers, a last couple of years. We took them out of it obviously, we’re paying for those merchants even if we were getting a little bit of revs from them our Network Services was, but $105 million run rate, what I was saying was that that worked out too for the last six months of the year, about $15 million of net revenue and that will come from Network Services.

Robert Baldwin, Jr.

So, $105 million as the budget for 2008 and in the first half of the year there was a major client that was deconverting and that’s taken out of our going forward run rate. So, the run rate is actually a little bit less than in ’05, that was the budget for ’08. The $15 million for the second half is a bit high.

James Friedman – Susquehanna

Okay that’s helpful and then the last one, so 0.6% and the negative 0.1%, does your guidance still contemplate flat same store sales for the year?

Robert Carr

Yes.

James Friedman – Susquehanna

Okay. Thank you.

Robert Carr

Thanks.

Operator

Your next question will come from the line of Tim Willi with Avondale Partners.

Tim Willi – Avondale Partners

Thank you and good morning. I just have two questions; first Bob, if I missed this, I apologize Bob, but could give any kind of commentary around net new merchants added during the quarter for the legacy business or total merchant account excluding Network Services?

Robert Baldwin, Jr.

Tim, we’re getting away from the merchant account stuff because it was always a shortening for new margin installed. That was why I started giving out the new merchants, because when we are going public, I didn’t think that it would clear enough what this new margin installed number was, merchant account was going to be a proxy for that.

It became a decreasingly good proxy as we’ve gone for larger and more profitable deals. Our growth in margins was consistently outstripping our merchant account. We’ve also ended up with some statistics that people could run that were misleading to investors and to merchant contrition. So, we’re just getting out of the business of reporting merchant accounts.

We had about 75,000 locations in the Network Services deal; obviously one big deal there will add a lot of locations, on the other hand we’ll be doing Network Service business distributing, that capability through our legacy hardware sales force. So, which side would you attribute the deal to, so really just getting out of the merchant count number for all of those reasons?

Tim Willi – Avondale Partners

Okay, that’s fair and then my second question revolves around on the network services side. A couple of weeks ago I guess it may not have impacted this quarter but Visa, MasterCard made changes around the security and the fees etc in the petroleum industry around pay at the pump etc because of automatic shut offs and at things like things there might have been impeding transaction growth or volume for petroleum merchants.

Again I realize that the price of gas can come and go impact that to a degree, but was there any of that impact that you are aware of in Network Services, when you purchased it, that could be reversed to any degree what their changes and stands around those issues at Visa and MasterCard. They might actually have this in terms of budgets more transactions or volumes than you had expected because of those changes at DNMA?

Robert Carr

Actually because all of the contracts pass through the increases and decreases and interchange from Network Services has no impact on us directly. It does give us an opportunity because of our modern platforms to implement these real time clearing systems quicker than our competition, also gives our customers a reason to move to our more modern platforms quicker. So, we think there is going to be benefit to us for those reasons but in terms of the number of transactions or the revenues to the company those are not affected.

Tim Willi – Avondale Partners

Okay, thank you.

Operator

Your next question will come from the line of Josh Elving with Piper Jaffray.

Josh Elving – Piper Jaffray

Hi, good morning. Most of my questions have been answered. I guess I just had one quick question on the capital structure and your use of cash going forward now that you have a little bit of debt on your books; what is the right level of debt or what do you plan to do with cash flow on a go forward basis, are you going to likely continue to increase the dividend or pay down that debt; any thoughts on that?

Robert Carr

Well, it’s something I guess is part of the dividend, obviously the board determines that and their evaluation is that increasing dividend is a good discipline on the company, so overtime I would expect that to be case, but clearly we have a healthy amount of debt, we don’t need it for any current operations and so the operations are generating free cash and so we would expect to start to pay that down pretty quickly and the question really is do we find any other acquisitions that hat’s the only thing I can think of that would result in any significant, even leaving the debt to same at the same levels or possible growing.

In today’s environment you need to be very careful to the have the banks remain positive about lending to you and we’re deeply sensitive to that and of course the irony is the best way to keep the positive about lending to you is not far of very much and so we are going to be sensitive to that. If we see the transaction come along we feel very good about how the competitive landscape played up in the NWS deal and so we are going to keep our eyes opened, we’ve got a lot on our plate and we are cooling the world for the transactions either.

Josh Elving – Piper Jaffray

Okay, great. That’s really all I had; thank you, very much.

Robert Carr

Thanks.

Operator

Your next question will come from the line of Thomas McCrohan with Janney Montgomery.

Thomas McCrohan – Janney Montgomery

Hi, good morning, Bob and Bob. On the equipment sales side that looks like it was pretty strongest quarter? Was there anything worth pulling that and trends are driving that?

Robert Baldwin, Jr.

That’s mainly, easy comparisons to last year because we had acquired General Meters back in October and it’s because we’ve increased our college campuses by 900% going from 1 to 10, but that is the major driver there.

Thomas McCrohan – Janney Montgomery

Thanks and any kind of….

Robert Carr

Yes, also with these the check business all of which involves the sale of the scanner is which is not at a particular item.

Thomas McCrohan – Janney Montgomery

Great, now a follow up question on the Campus Card business. So, if you can just talk about that market, the noise has been kind of increasing as far as your appetite to kind of enter that space as far as what you find attractive about it, just any type of growth trends, the colleges already have systems in place or not you’re replacing other providers, just kind of a little primer on that would be really helpful.

Robert Carr

I’m not sure we have time to do much of a primary there, but basically it’s a prepaid card that we’ve put a lot of functionality on and are very excited about and one of the pluses of the Network Services acquisition is that we have now we have a lot of convenience store and petroleum clients that are eager to work with us and taking these lower cost prepaid cards and we think there is going to be a lot of traction coming in the area.

We have a series of seminars starting in a month and you might to check those out and maybe come to one of the web-nears or even come to one of our seminars that are opened to the public.

Thomas McCrohan – Janney Montgomery

Is there anything going on in the environment that is causing you to increase your attention on that space today or is just kind of natural progression of where you’re going?

Robert Baldwin, Jr.

I say you know basically the industry is dominated by legacy folks that are selling software, hosted software to university and schools. It’s a model that is difficult to operate. There all kinds of Reg E problems, there is PCI problems. Our model is a recurring revenue model, it’s more attractive and we just think we have a better mousetrap.

Robert Carr

But the issue is getting out there, getting our name known and clearly we’re building, but we have a long ways to go. So, it’s a long race this one but I think there is a great opportunity. We’re going to have to move along, Tom and also a follow on questions, if are really going to keep it to your top question because we have a number of people still waiting.

Operator

Your next question will come from the line of Robert Dodd with Morgan Keegan.

Robert Dodd – Morgan Keegan

Hi, guys. Looking at the gross margin in still, can you tell us what effect if any your expectation the same store comps has on that? When you install new customer do you annualize the current volume or do you factor in the same-store comp and then how does that relate to what the same-store comp was the last year on the gross margin the year before to get the growth rate?

Robert Carr

We always take three months of statements and annualize those, we’ve always assume that the attrition would offset the same-store sales growth in those numbers and we claw back of course of the merchant leaves. So, we have not change that process and don’t plan on changing it.

Robert Dodd – Morgan Keegan

If I could have quick follow-up what was your relationship measure count. You said was up 16% below this specific number?

Robert Baldwin, Jr.

I’m sorry it was 1190.

Robert Dodd – Morgan Keegan

Thank you.

Operator

Your next question comes from the line of Reggie Smith with JP Morgan.

Reggie Smith – JP Morgan

Hi, guys nice quarter. Question on NWS, I mean can you guys I guess describe who the existing customer is today, is it primarily larger gas station retailers or is your client base made up independent retailers and then I guess the follow up question to that would be, is the pricing can ventilate any difference between those two customer types?

Robert Carr

The business has mostly large customers first of all, it is big company you’ve heard the names of most of that. It also resells authorizations through other card back end services. So, many of our competitors in our general business are receiving services from front end services from the networks of platform. Substantially all of the merchants are price on a per transaction basis not on a dollar volume basis or present dollar volume that why we’re going to be talking about the number of ticket on the NWS and in the other large merchants that we get that aren’t priced on earnings per transaction basis.

Reggie Smith – JP Morgan

Is the strategy to move to directly acquiring some of the accounts that you might be providing reseller services to today, and if that is a strategy is there an opportunity to price your business differently?

Robert Carr

Its going to be a transaction price, well even if you provide the settlement services, Heartland does I think it safe to say that we are more of a believer in providing settlement services than in the historic Network Services business, it providing a single solution, but we will continue to work with a number of third parties as well. Our industry has a long history of competitors also working with each other.

Robert Baldwin, Jr.

And there are a couple of distributors that may want to sell their portfolio to us, but it won’t be a significant amount.

Reggie Smith – J. P. Morgan

And did you guys talk about how quickly you think you can begin selling NWS through your existing channels?

Robert Baldwin, Jr.

Well the irony is we are now already, because we had an arrangement with received as theses where NWS as was the front end. We are going to be trying to clean up that process as there is a lot of complexity that go into it so the timing hasn’t nailed down at this point, but its within six to nine months we expect our salespeople will be out with a more direct product.

Reggie Smith – J. P. Morgan

And I think I missed the actual transaction count for NWS in the quarter, did you guys give that?

Robert Baldwin, Jr.

It was $289, just in June.

Reggie Smith – J. P. Morgan

And that was better than your internal projections?

Robert Baldwin, Jr.

Than was budget, yes correct. Year ago comps really aren’t relevant.

Reggie Smith – J. P. Morgan

Okay.

Robert Baldwin, Jr.

Well, obviously as we forward we’ll be able to give those to you as we annualize.

Reggie Smith – J. P. Morgan

Okay. Alright, thank you.

Operator

Your next question comes from the line of Brett Huff, with Stephens Incorporated.

Brett Huff – Stephens, Inc.

Good morning, and congrats on a nice quarter.

Robert Carr

Thanks.

Brett Huff – Stephens, Inc.

Two quick questions, you mention that the Telco cost savings are going to be one of the quicker hits that you guys saw on ADS. Did any of that actually occurred in this quarter, or conversely how much more do we think can occur in the third or fourth?

Robert Baldwin, Jr.

Not they occurred in June, you can’t flip level switch on that stuff, but we will start having a benefits relative to their expected cost what they would have paid starting in the third quarter, and we’re also going back to the telecom provider that we were using and saying by the way we have a lot more calls coming over our network than we used to, so can we get a better deal. So, you will start seeing benefit on both if you will on the Heartland side as well as on the Network Services side starting this quarter, but really gets much bigger impact in 2009.

Brett Huff – Stephens, Inc.

And the second question was, last call I believe you talked about the opportunities to start picking up sales folks given the churn of the industry right now that were more experienced etc. Are you seeing any changes in trends in that? Or just any color on that particular process?

Robert Carr

Yes we are seeing changes there. We are getting more seasoned and experienced set of veterans, we’ve tightened up our hiring procedures however, so that the absolute numbers of hires has not increased, but we believe we have a better quality. The best quality candidates we’ve ever had in recent times.

Brett Huff – Stephens, Inc.

Okay. That’s all I needed. Thanks for your time.

Operator

Your next question will come from the line of David Parker, with Merrill Lynch.

David Parker – Merrill Lynch

Thank you, good morning. I just had one industry question, the recently passed Housing and Foreclosure Act, included the provision that requires third-party providers to file annual reports on merchant transactions to the IRS. Just wanted to hear your thoughts on that and just what the cost and efforts required to become complying with that by 2010?

Robert Carr

David, we’re just getting into that, it is something that doesn’t hit until 2010. It’s not going to be a huge deal for us. We’ve seen some commentary about people have to collect the ID numbers, the taxpayer ID numbers. If they’re not collecting taxpayer ID numbers I’d stunned, we certainly do. There is going to be a certain amount of effort to associate, so we out a statement to the IRS, obviously we’re unhappy with any kind of additional reporting burden and unfortunately we think this is going to be used inappropriately by the IRS to assume a certain percentage if you are a borrower, if you’re getting X amount card receipts that means you must have Y amount of cash receipts so therefore you should be paying tax, which actually really slippery slope that they’re getting onto, but we comply without excess burden.

David Parker – Merrill Lynch

Okay, great. Thank you

Operator

Your next question comes from line of Andrew Jeffrey, with SunTrust.

Andrew Jeffrey – SunTrust

Hi, good morning guys. I saw a bit of a widening in the spread between organic volume growth and revenue growth. Is that just mix, is that things like payroll and equipment sales in college campus cards and so forth and is that, kind of the trend we should assume prospectively?

Robert Baldwin, Jr.

When you say you’re widening of the …

Andrew Jeffrey – SunTrust

Revenue growth, net revenue growth grew faster than volume, whereas historically they’ve been more closely…

Robert Baldwin, Jr.

Right, yes. That’s really what you’re seeing is we are getting a little more impact from some of the more non-card recurring revenue businesses like check.

Andrew Jeffrey – SunTrust

Okay and its sounds like that’s, fairly sustainable, would you expect the GAAP to widen at all or is it just about the level you’d anticipate going…

Robert Baldwin, Jr.

You got a big portfolio here, so it’s all going to be glacial, if you more glacial then it doesn't on a time. With that said is will continue I would expect, we are definitely spending, our sale force is definitely spending time selling other product besides card and that will not an impact.

Andrew Jeffrey – SunTrust

Okay, and then with regard to the NWS, portfolio merchant attrition, how comfortable are you with the profile of the current book of business and with your attrition expectation over the next several quarters.

Robert Carr

We feel pretty good that we are going to be able to retain the business

Robert Baldwin, Jr.

There are no major contracts coming up for at least a couple of years. There are a number of contracts that roll over but major once are for a couple of year. We feel good about that and attrition just happens a very different way in this business than in the legacy Heartland business.

Andrew Jeffrey – SunTrust Robinson Humphrey

Okay thanks a lot.

Operator

Your next question as a follow-up question from the line of James Friedman with Susquehanna.

James Freidman – Susquehanna

Hi, this is Magna actually from Susquehanna. Bob I just wanted to make sure that I heard these correctly, you no longer going to provide any merchant data going forward.

Robert Baldwin, Jr.

We will as we give you an indication of the payroll business that remains a pretty decent measure how the business is developing, but otherwise in the card business is just too many Apples and Oranges turned together at this point

James Freidman – Susquehanna

Okay. So can you tell us, what was the payroll customer at the end of the quarter?

Robert Baldwin, Jr.

What is?

James Freidman – Susquehanna

The number of payroll customers that we had at the end of the quarter?

Robert Baldwin, Jr.

Payroll customers that the end of the quarter was 770,250

James Freidman – Susquehanna

And I just also wanted to make sure that heard these numbers correctly, the relationship manager headcount was 1190 for the quarter?

Robert Baldwin, Jr.

1190 that’s correct.

James Freidman – Susquehanna

Okay thank you.

Robert Baldwin, Jr.

Thank you.

Operator

Your next question will come from the line of Bob Napoli with Piper Jaffray.

Robert Napoli – Piper Jaffray

Thank you, good morning. Just hopping you might be to give an update on your progress with Canada especially in light of I guess better pricing out of Visa up there just wondering if you can give any update.

Robert Carr

Well the pricing isn’t better out of Visa, the pricing has added a lot of complexity to the interchange level and that is creating a certain amount of format in the business. We have seen some players aggressively using that added complexity to rise their prices. Collective POS has not taken that approach and is really trying to use that as the way to go into new, more business. Its really a very small company, we are please with helpings are coming along they’re doing well verse their budget, but either a great quarter or terrible quarter has a hard time of making much of dent on our results either what..

Robert Napoli – Piper Jaffray

Thank you.

Operator

And at this time there are no further questions. Mr. Carr, do you have concluding remarks.

Robert Carr

Thank you all for joining us today and look forward to chatting with you next quarter.

Operator

This will conclude today’s conference call. You may now disconnect and have a great day.

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