Heartland Payment Systems Management Discusses Q3 2012 Results - Earnings Call Transcript

Nov. 1.12 | About: Heartland Payment (HPY)

Heartland Payment Systems (NYSE:HPY)

Q3 2012 Earnings Call

November 01, 2012 9:00 am ET

Executives

Maria Rueda - Chief Financial Officer

Robert O. Carr - Executive Chairman and Chief Executive Officer

Robert H. B. Baldwin - Vice Chairman

Analysts

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

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

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

Brett Huff - Stephens Inc., Research Division

Kartik Mehta - Northcoast Research

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

Timothy Wojs - Robert W. Baird & Co. Incorporated, Research Division

Michael J. Grondahl - Piper Jaffray Companies, Research Division

Roman Leal - Goldman Sachs Group Inc., Research Division

Operator

Good day, and welcome to the Heartland Payment Systems Third Quarter 2012 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Maria Rueda, Chief Financial Officer. Please go ahead.

Maria Rueda

Thank you, Brandy, and good morning, everyone. I'd like to welcome you to our Third Quarter 2012 Earnings Call. Joining me this morning are Bob Carr, Chairman and Chief Executive Officer and Bob Baldwin, Vice Chairman. Since we just met with many of you earlier this month and with the call-timing change resulting from Sandy, we are going to limit this morning's comments to some brief remarks from Bob Carr and a quick review of a few financial highlights before opening the call for questions.

Before we begin, I want to remind you that some of our discussions may contain statements of a forward-looking nature, which represent management's beliefs and assumptions concerning future events. Forward-looking statements involve risks, uncertainties and assumptions that are based on information currently available to us. Actual results may differ materially from those expressed in the forward-looking statements due to many factors.

Information concerning these factors is contained in the report of 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

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

The third quarter was the most profitable quarter in Heartland's history. We reported adjusted net income of $21.7 million or $0.53 per share, increases of 61% and 60%, respectively, over the comparable figures for the same quarter last year.

Our performance continues to reflect our success in achieving 2 key performance objectives: improving our operating margins and generating strong net revenue growth. Based on these results, we are raising our net revenue guidance, projecting a better than 20% full year operating margin and increasing our full year earnings expectations once again.

Heartland is benefiting from its long-term strategy of focusing on core areas of the business. Recently, we have focused on improving our operating margins, and the results speak for themselves. In the recent past, we focused on consolidating our IT processing platforms, and we've seen the benefits of that consolidation to our financial performance as well.

Most recently, we have expanded our senior management team to take advantage of the multitude of opportunities before us. This has been an exciting time at Heartland because we are rapidly expanding our footprint in the areas that we have deliberately stayed out of heretofore, due to our inability to do everything we would like to do with a much thinner management team.

But the landscape has now changed for the better in exciting ways. Heartland is moving strongly into e-commerce for the SME marketplace, for example. Soon our sales organization will have e-commerce in a box to help small- and medium-sized merchants compete more effectively with Internet clients. We have always processed e-commerce business for our brick-and-mortar merchants, bricks and clicks. But soon, we will offer a full suite of products that allow us to compete with the big guys for this fast-growing sector of the payments world.

Our SmartLink product, combined with the expansion of our petroleum platforms to the mid-tier and SME, petro and c-store space is also very exciting. We now have products that no one else in our industry is offering. SmartLink is a managed telecom service that allows our customers to add many, many services onto a single communications pipe with 3G backup capability. This is a service that is far superior to the competitive DSL and cable modem offerings.

SmartLink is a level 7 service that allows us to prioritize communication requests, so that payment transactions, for example, get higher priority access to bandwidth than someone downloading a movie on their iPad. Restaurants with needs to monitor refrigeration, overnight ovens and cookers, security alarms, video feeds, enterprise application and payments are now learning about SmartLink and embracing the new functionality that leapfrogs other solutions without costing significantly more money. We now have more than 13,000 locations currently installed with SmartLink.

Our investment in a new payroll platform is also paying off. Our new offerings have HR functionality that we were never able to offer with our previously licensed platform. Our sales organization has embraced these new features, and our average payroll installation has improved in margin as the new functionality allows us to move upmarket to larger middle-market employers quite effectively.

With these more sophisticated approaches to the marketplace, we realize that we need more effective resources to support our increasingly productive sales organization. Our salespeople are now almost 3x more productive on average than they were just 30 months ago. That is quite an accomplishment in my view.

To maintain these productivity improvements and to capitalize on the increasing sophistication of our noncommodity products, we have increased our salaried support staff and focused significant energy in building our territories that dominate their geographies. This approach allows us to get more value from each dollar spent on sales commissions and sales overhead.

In places like Minnesota, Arkansas and New Hampshire, for example, we seem to have found the secret source of building our territories, which are a subset of a division at the same production levels of many of our former divisions. As a result, over the past few months, we have cut back on recruiting new relationship managers and have instead invested in building the careers of our established sales professionals.

We are spreading our best practices that are proven to be successful in our very best territories to other territories and divisions across the country. We are gaining more and more success with our iPad-enabled atlas CRM system that allows our sales organization to complete paperless applications and service their customers faster than ever before.

Because of the increasing complexity of the payments industry and specifically our products, we have moved to a model that allows product specialists to help large numbers of relationship managers sell these new services. As we experience more and more success with these these best practices, we will allow our successful managers to slowly bring on new relationship managers with the intent of significantly increasing the retention rate of these new hires. Going forward, we intend to continue to improve the productivity of our relationship managers and to increase the number of productive feet we have on the street.

As you look through our third quarter numbers, I think you'll agree that our performance remained strong across the board, frankly, exceeding the ambitious goals that we've set for ourselves. Clearly, our industry is in a period of unprecedented change. However, it is exactly that change in which we will, over time, move toward using mobile devices at the point of sale that ensures that the battle for new merchants will continue to be decided by the ability of our sales force to solve merchants' many payment processing problems.

For the sixth time in the last 7 quarters, we grew our installed margin over the prior year. This steady improvement reflects the progress of training and development programs that have helped reduce the number of RMs who did not make a single sale from 142 in June to 114 in September, while simultaneously increasing those putting margin on the board.

Consequently, it is not just the absolute size of our sales organization that matters. But more importantly, the increased productivity throughout and across our sales organization that is sustaining our new business momentum.

One of the ways we can help our sales organization to achieve greater success is to capitalize on emerging new technologies to develop new products that complement our core processing and to provide services that solve other unmet needs of small and midsized merchants. And we have several hundred people in our IT group that are doing just that.

More broadly, we are seeing strong demand for our full-service, multi-product model. Our ability to enable merchants to offer a variety of payment types, demand for market-specific solutions, such as e-commerce and our basic fair deal card-processing pricing strategy continue to generate merchant sales. In recent months, we have been engaged with many of the new solutions like LevelUp and Isis where we believe that we enabled 30% of the tier-3 and tier-4 NFC-accepting locations and with Google as well.

All of these new participants want to grow their platforms by increasing their merchant and consumer penetration. Consequently they see Heartland's award-winning national sales organization and over 250,000 merchant locations as an extremely attractive channel through which they could distribute their products.

In developing new products and partnerships, our long history of merchant advocacy is always foremost in our mind. Nowhere is that more evident than in the selective approach we are taking to the proliferation of the new merchant rewards programs. We see value in these programs, but we also see risk in the programs that do not respect the merchant's ownership of the payments data.

Larger, more sophisticated merchants have already voiced their opinion on the ownership of the data question, and it's been a resounding no to programs that want them to give up control of their data.

Ultimately, we see the entire merchant community adopting this philosophy. It's our ability to see not just the opportunity, but to also be able to evaluate the risk of these emerging technologies that will enable us to make wise choices today that will provide attractive returns over the long term.

Whether it's transaction processing, new products or some of the other emerging technologies, we think merchants will want more of what Heartland has to offer, a brand that has earned their trust and offers integrated state-of-the-art technologies. We have an increasingly valuable asset in our knowledgeable relationship managers and sales managers, one of the only true professional sales organizations capable of guiding merchants through the maze of products to develop a payments platform that helps them achieve their specific business objectives.

At the end of the day, the merchants will make the final decision. And with ownership of the merchant relationship and the last processing mile, we think we are in a strong position to sustain our growth over the long term.

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

Maria Rueda

Thanks, Bob. In the third quarter, we reported GAAP net income of $19.4 million or $0.48 per share and adjusted net income and earnings per share of $21.7 million or $0.53, up 61% and 60%, respectively, from $13.5 million and $0.33 per share for the third quarter last year.

In the quarter, our key performance metrics were all up nicely from last year. We would note that the rate of growth of these metrics is consistent with the generally lower third quarter rate of economic growth, but we do not see any signs that our conservative 1% to 2% expectation of same-store sales growth will prove to be too high.

Growth in non-card revenue was led by approximately $10 million increase in Heartland School Solutions revenues, which included revenues from our LunchByte acquisition that closed late in the second quarter. Heartland School Solutions annualized revenue run rate is still in the $40 million to $45 million range.

Processing and servicing costs were up modestly in the quarter, and general and administrative expenses were up 18.3%. However, very little of the increase in G&A was discretionary. The majority of the increase is attributable to higher stock compensation expense and the G&A from the Heartland School Solutions acquisition. The result was the best operating margin in 5 years, 23.5% for the quarter and 21.3% through the first 9 months of the year.

In the quarter, we also incurred $921,000 of other costs, primarily expenses associated with software development projects, which we have decided not to pursue further.

Management's measure of operating cash flow in the third quarter was $31.2 million or $0.77 per share, up 22% from last year. And our free cash generation amounted to $22.6 million, up 27% from last year's third quarter.

We are using our substantial cash flow to reward our shareholders. In October, we completed the stock repurchase authorization approved by the board in July of this year. That raises the total stock repurchased over the past 12 months to $100 million.

During the quarter, we also paid $2.3 million in cash dividends. We are raising both our net revenue and earnings guidance for 2012. For the full year of 2012, we now expect net revenue of between $544 million and $546 million.

Our fiscal 2012 adjusted earnings per share are expected to be between $1.81 and $1.84, excluding after-tax stock compensation expense of $0.21 per share for the year. After-tax compensation expense for the year is $0.01 less than we had anticipated at the end of the first half of the year.

Now I'd like to return the call to Bob for some concluding remarks.

Robert O. Carr

Thank you, Maria. The results achieved this quarter, as well as over the past several years are indicative of our commitment to build value for our shareholders. We see the tremendous opportunities emerging in our industry to raise the value of the payments platform from a basic utility to a highly sophisticated competitive tool. We believe the key to capitalizing on this opportunity is to understand this evolution from the perspective of the ultimate beneficiary, the merchant. And we are confident that we are about to be rewarded accordingly for the significant goodwill we have accumulated with merchants through the merchant advocacy we have championed for over a decade.

Before closing today's call and opening it up for questions, I am pleased to announce that the Board of Directors has declared a quarterly dividend of $0.06 per share, payable December 14 to holders of record on November 23.

And finally, I would like to thank all of the Heartland team members for making these powerful results possible.

Brandy, we are now ready to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we will go first to Steven Kwok with KBW.

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

Just had a quick question with regards to the operating margin. It seems that it's trending at least year-to-date like around 21%. I was wondering does -- do you think that implies that it's probably conceivable that it could get to your 25% guidance a little -- a bit quicker than what is probably anticipated?

Robert H. B. Baldwin

Steven, it's Bob. I think that we've accomplished a tremendous amount this year. And in terms of 3 quarters, it's around 21%. Seasonally, we expect the fourth quarter to be somewhat down, and that would be consistent with what we gave out in guidance. But over the -- 25% goal is a multiyear goal, and we expect to make progress every year. And the degree of progress has to do with the balance we always maintain between spending money on infrastructure and growth initiatives on the one hand, against our interest in expanding it. So we've given out consistently saying that achieving a number around the 100 basis points a year is the kind of number we'd like to accomplish. Doesn't mean we'll get it every year. And obviously, the higher we are in 2012, that means that we're little bit closer to start with. So I guess, it helps us a little bit. But again, when we get to 25%, really, is more of those opportunities to -- question of how many opportunities we see to spend some money on G&A-type expenses that will improve our growth versus that very strong goal of bringing a healthy amount of profitability to our shareholders.

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

Got it. And then separately with the recent optimization being used up, what's the plan for capital management going forward? Should we expect another share repurchase authorization to be announced?

Robert H. B. Baldwin

There's a lot of thought being given to that. We have a board meeting in a couple of days -- or tomorrow actually. And so the board will consider where we're going to go. But I think that clearly Heartland has demonstrated a lot of interest in returning capital to our shareholders. At the same time, we've probably never been busier in terms of looking at acquisitions. Many are not going to be interesting to us or sufficiently interesting to us, but that's certainly another possible use of capital. And again, that becomes a balance between the best uses of that capital for the company and the shareholders.

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

Understood. The last question I had was with regards to the relationship managers. I know Bob talked a little bit about it being down. But I was wondering, how should we think about it going forward? Do you expect at some point to add on more relationship managers?

Robert O. Carr

Yes, we absolutely do. We still have 100 or so relationship managers that are not as productive as we like them to be, and we are focused on reducing that number further. But we also, in our stronger territories and divisions, we are slowly adding people. We're focused on improving the retention of those. We think we have a really good way of doing that, and we're focused on building slowly and having more -- less attrition all the time, more retention, and that's our focus.

Operator

And we will go next to Tom McCrohan with Janney.

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

Two questions. One on the net revenue spread. If we look at your statistical supplement, it looks like the net revenue spread this quarter on the SME business went up on a sequential basis pretty significantly? And I was wondering if you could just discuss or highlight what factors led to that sequential improvement in the net revenue spread?

Robert H. B. Baldwin

We really didn't have -- we had a correction that we sent out on the supplement, Tom. So that had a bad cell formula in there, and so we didn't see an improvement in the net revenue spread, nothing significant.

Robert O. Carr

Good catch, Tom.

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

Okay. And the second question I had was on the dividend. It looks like you've returned the dividend back to on an absolute basis where you were pre-brief. But the payout ratio is still about 20%, assuming you hit the higher end of your guidance this year the point of your payout ratio, the payout of 36% pre-brief. So could you just talk about conceptually how you're thinking about the dividend going forward? Is it the run rate, how do you think about the payout ratio? That's all I have.

Robert H. B. Baldwin

I'd say couple of things. One is that we were actually aren't back up to where we were. We were at $0.09 a quarter, and we're at $0.06 now. I think certainly this year, the board has focused more of our capital allocation toward repurchase than had been true in the past, and the board regularly reconsiders where we are on the dividend. The last time we changed the dividend was in the first quarter of last year and actually each of the last 2 years, that's when it's been changed. So that might be a time when we'll more actively consider it. But the other thing that has to be factored in, that will be thought about, is what happens to tax -- the tax policy with respect to dividends. So overall, I think the better way to look at it is how much capital are we returning to shareholders through dividends and share repurchases? And frankly, it was at a very high level in the last 12 months, indicating our aggressive view on that measure, and more to be told on both the dividends and share repurchases over time.

Operator

And we will go next to Greg Smith with Sterne Agee.

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

The equipment revenue was up pretty significantly at least sequentially, anything unusual going on there?

Maria Rueda

There is nothing -- I think the equipment revenue increase just reflects that we continue to have our installed margin increases, and we expect that to correlate with the growing installed margin.

Robert H. B. Baldwin

Well on the plus side, a big impact from School Solutions. That -- we're changing our equipment profile a little bit here. Historically, we've sort of downplayed that on the card side. We have always viewed that as something of a combination to the merchants. That -- the card business is changing a little bit. We look forward to an EMV environment and all the other stuff. There may be some more revenue from the equipment side there. But there's no question that one important part of the revenue stream of the School Solutions business is the equipment side, and we had a very good quarter for that. And in particular, the addition from LunchByte was very impactful on that, and that is a high-margin type of business that we value highly and see as -- have a good expectation of recurring in the future. Obviously, not at the same schools, but that's very much a part of that business model.

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

Okay. That actually lead to both my next questions. Just first on the K-12, Maria, you said it's at $40 million-plus run rate. But when we just look at the quarterly number, it's $7.5 million. What am I missing there?

Maria Rueda

Well, we told our investors at the Investor Day that if we had completed -- if we had included LunchByte revenue in the third quarter, we would have been close to $10 million at that point. So we are standing by the $10 million range for all of Heartland School Solutions revenue on a quarterly basis.

Robert H. B. Baldwin

And you got 2 pieces Greg, you got the equipment side and then the processing side.

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

Well that's the missing piece, the equipment. Now it makes sense. And back to the -- with EMV coming, with maybe some of the wallet guys wanting to, perhaps and saying, you to get more merchants quickly with NFC. Is there going to be a 3-year period where you have an opportunity to make some good money off equipment going forward?

Robert H. B. Baldwin

Yes. Who knows? This world is changing fast. I'll say that we were really very, very pleased with the Isis rollout. If you think about it from the perspective of Isis, they wanted to get merchants set up to accept their solution. When they look at Heartland, they see the one company that they can come to that has a product group that can talk directly to the field, get solutions out there and then we can talk directly to our field in those 2 locations, and we had what we think was a tremendously effective implementation for both Isis and ourselves on that. And it really drives home the point about that, the power of having a direct sales force that we have working full time for us. How much that's going to play out, what incentives people are going to be offering will be fascinating to see. It's hard to predict right now. But as Bob was alluding to, there's no question that all of these solutions really want to get their solution in front of as many merchants as they can, as quickly as they can, and that makes Heartland and working with Heartland a really attractive option for them.

Robert O. Carr

One other dynamic here is that there are some people who think that the EMV and NFC technologies are going to be leapfrogged with cloud-based authentication, and that's making all of us think about our approach here. With petroleum not really being required until 2017, there's a long period of time here before -- for explosions [ph] to get developed for pay at the pump. And merchants -- a lot of merchants are just dragging their feet waiting to see how strong these wallet applications are really going to turn out to be. Because of the large percentage of transactions R&D processed with wallets on smartphones, the EMV, the need for EMV equipment has reduced significantly. And why spend the money, if the transaction flow is going away from that type of hardware to the smartphone? So it's really, as Bob said, it's up in the air. Lots of -- we're going learn a lot of information over the next 3, 6, 12 months. We're not banking on selling a heck of a lot of equipment, I'll tell you that, in our model. If we do, that's great, but we're not counting on it.

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

And then just one last one. With LevelUp, how are those sort of pilot exercises progressing? Is that going to expand to other cities? And I just want to be clear on the economics, I think the assumption is you'll get the processing maybe at a lower rate, but then you share in some of their -- some of LevelUp's essentially revenues. Therefore, it ends up being more money that you could typically make at one of your merchants, is that all accurate?

Robert O. Carr

Not really. LevelUp, our relationship with LevelUp is quite good. We have many of the same business philosophies. What we like most about LevelUp is it's a pay-for-performance model. It's good for the merchants. It's a good value for our customers. So we're willing to bring them into our customers, and we're working on multiple different ways of working together, trying to find out the best fit. But so far so good, and we are expanding into a couple of other markets. But it's too early to tell where this is going. We're investing some serious time and effort into it. Our salespeople are excited about it and as we are. But it's too early to declare any kind of a victory at all. The processing part of it is sort of a second level. We want it, obviously. But the main thing we're interested in is, do our merchants like this over the long haul? Is this a sustainable product that our merchants are going to use, not just this month and this year but over the long haul? So that's we think it's a pretty good opportunity to be seeing on how permanent it's going to be.

Operator

And we'll go next to Brett Huff with Stephens Inc.

Brett Huff - Stephens Inc., Research Division

My question -- first question is around Durbin and just getting an update on that. Bob, I think you mentioned in the press release, you mentioned the numbers that you guys had hit already. But I'm curious about whether or not you feel you're still sort of in the slow share-taking mode as a result of that sort of share-deal pitch or kind of where we stand on that and what kind of revenue opportunity or upside we can see in the near or medium term from that?

Robert O. Carr

I think you described it well. We're not gaining as much market share as fast as we would like to with Durbin, but we're true to our business model. I think it has helped us a lot in terms of strengthening our organization. We really believe in this model, especially our sales organization. We haven't capitalized on it as much as we want to but we're working hard to figure it out. It's just so complex. Very smart businesspeople have a hard time understanding what's real and what's not real vis-à-vis the competition. We have a very large customer that saved almost $100,000 a year with our Durbin approach, but it's hard for them to see. We have to literally spend hours with them going through how others charge for it. So it's a challenge but we're in the right place. We don't have to worry about our margins getting eaten away by the competition, but all of our competition does need to worry about that and they should as we get better and better in the marketplace with our approach to developing territories and divisions.

Maria Rueda

And then also say that we did hit some milestones in October. We've now given back more than $250 million to our merchants from the Durbin Dollar campaign, and we continue to be very proud of that, and our salespeople are also.

Brett Huff - Stephens Inc., Research Division

That's a big number. And in terms of our RMs, I just want to make sure I heard what you said right. Did you say they were down sequentially? Or just that they were slower in hiring than you thought? I just want to make sure I heard that number correctly.

Robert O. Carr

Yes. We actually terminated more unproductive salespeople than we hired last quarter. We don't have a whole lot of unproductive reps left, but we are focused on getting them up to a productive level. We just find that in our sales organization that the lowest common denominator seems to hold us back, if Sally isn't producing, why do I have to produce? And with a commission sales organization, there's a lot of that mindset. And we've learned in many of our divisions that if you don't tolerate that mindset, everybody wins. So we wanted to just get that rolled out throughout the rest of the country. Our focus has been on that. But in our areas -- in many areas that are doing very well, they are hiring and bringing people on, but much more slowly. We have a very organized approach now of bringing a person on, and basically a territory can only bring one person on every 2 months because it requires 2 months of success before that area can hire another person. So we feel really good about the direction we're going, but it has not resulted in an increase in headcount the last quarter.

Brett Huff - Stephens Inc., Research Division

And then last question, is -- any update on some of the things you talked about on flat rate pricing and some of those innovations in the market? Have you all -- I know it's only been 3 weeks, but any more thought on that? Or should we stay tuned on that particular idea?

Robert O. Carr

Lots of thought, lots of work, but nothing to announce.

Operator

And we will go next to Kartik Mehta with Northcoast Research.

Kartik Mehta - Northcoast Research

One of the questions, obviously, in the marketplace right now is what Square and PayPal and Groupon and those guys are doing. And then as you report numbers, it seems as though you're reporting better and better margins out of your customers. Would that imply that the competition you're seeing out there isn't as great from some of these new players in the market? Is that one way to look at it? Or would you look at it differently?

Robert O. Carr

No, I think the press release value is significant. But the models -- they don't even make sense, the things that you can have -- open up your platform to every criminal on the planet and not have losses that are just stunning. We can't figure that one out and we can't figure out a whole lot of things about how you make money processing babysitters. I mean, they're great, we all need babysitters, nothing against babysitters. But how many dollars can you make when you're charging 2.7% where your cost is at least half of that and you're doing $10 a week? You just can't make any money doing that. So we're just dying to see how people make money with these other models. That marketplace is a very small percent of what we do. Our merchants are a lot more sophisticated than some of these folks think they are in terms of the pricing and the approaches to holding money and that type of thing. It just doesn't work in the real world where there's real merchants taking real payments every single day. So we're interested in seeing how these things work out, too, because there's a lot of smart people out there, and we just want to understand how their model works because t's counterintuitive to our experience in many cases.

Robert H. B. Baldwin

And the only thing I'd add, Kartik, is that it's really critical to keep separate -- distinguish in your mind between those who are self-consciously competing with us, that would include Square and Groupon; and those who are not, you mentioned PayPal in there. PayPal, to the extent they succeed and we're engaged with them right now. We're engaged with Groupon -- with, sorry, with Google. We're engaged with Isis. These are all people who are looking for us to help them. And we see absolutely no signs that -- not only do we not see any signs that that will hurt our margins. But in fact, as witnessed, the Isis experience in Salt Lake and Austin, these are -- we represent a great asset to them, we think, and can be paid accordingly. So lots of ferment, lots of interesting things going on. Some of it will be competitive and add to an already competitive world, but lots of this supplements or complements to our business.

Maria Rueda

And one last point that I'd like to add is in terms of the customer service that our merchants expect from us and we have always succeeded in providing, with a Square customer service issue, you would have to send an e-mail, whereas we have always provided premier customer service to our merchants, and they know they can count on us for real-time help.

Kartik Mehta - Northcoast Research

And then Bob, you talked about the School Solutions business now being close to a $40 million to $45 million run rate business. Is this business to a point now where you're going to take time to integrate this? Or is this still a business where you can acquire companies because it is so fragmented that this is an opportunity to continue to acquire and grow it?

Robert O. Carr

We think we can do some additional acquisitions, but we've bought most of the bigger companies out there. We do have a 30% market share. We have absolutely integrated the payments already, but we're working on growing the number of parents and working on growing the number of payment opportunities at each of the schools. So we think there's a tremendous opportunity to increase that business just with our existing 30%, and we will continue to do our best organically, as well as with acquisitions, to grow that.

Operator

And we will go next to Chris Brendler with Stifel, Nicolaus.

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

Couple of questions. Just in relationship manager side, it seemed to me that if there's anything that's being disrupted by the new players, it may be the sales channel, and in my understanding is that if you go direct as a merchant, you're not having to pay the sales person, so there's some potential arbitrage there. As you look at your business, and my understanding is that the ISO channel is under some pressure here, I'd expect you guys to be expanding your sales force and finding people who are frustrated and having a hard time making it work under an ISO model and joining Heartland with their unique approach and all the growth opportunities that you guys have would be a great time to be hiring people? What's the disconnect there that I'm missing?

Robert O. Carr

We don't find a lot of people who sell for ISOs to share the philosophy of doing business that we do, and we tend to stay away from hiring those folks. In some cases, we do. But most of our competitive sales people either work for a bank where they're handed leads from people coming in opening up checking accounts or they work for ISOs that make their money in ways that we don't allow our salespeople to sell.

Robert H. B. Baldwin

And so I think that in terms of the hiring, what we were describing, Chris, is that we really, really are focused on that productivity metric, and we are hiring people but we're -- as we continue to learn about how best to make that happen, how to help someone get to productive level and stay at a productive level, we are gearing up the amount of in-field training that they're going to receive. And in order to do that, we're gearing down the rate at which we're letting people hire new candidates. And so we think that's going to be a more effective solution. But in the short run, when you gear that rate of growth -- adds down while actually being more disciplined than ever in terms of having unproductive people exit the sales force, that's what you get. We think that this solution is the best way to go to build over the long haul. But it obviously resulted in that setback in terms of the numbers. And again, there is -- it's a very interesting discussion about what's the best way to distribute to a different kind of a merchant. And there's no question that mass-market kind of approach to a micro-merchant is the only way that economically works. We see absolutely no signs that the kinds of merchants that we go to -- and remember, our average merchant is much larger than your typical ISOs merchant. We see no signs that the kinds of solutions that they're looking for and the kind of relationship they're looking for is going to be satisfied by a direct distribution. And so feel very good about our position, not only now but as we look at the introduction of all of these exciting new solutions. That's not going to be -- parsing them, understanding them, making decisions among them is all going to be challenges that a merchant is going to be facing, and we think we're in an ideal position to help them make those choices.

Operator

And we'll go next to Tim Wojs with Robert W. Baird.

Timothy Wojs - Robert W. Baird & Co. Incorporated, Research Division

Just, I might have missed this before, but could you just talk about the pace of same-store sales through the quarter and then maybe what trends in October might look like?

Maria Rueda

Certainly. Our same-store sales expansion for the quarter was 1.8%. Within the quarter, it was 1.8%. Now within the quarter, we continue to see our sawtooth pattern. We had a 1-month when we were only at a 0.4% expansion. Now the good news there is, it wasn't a contraction, but still we have rates that range from 3% for a month to 0.4%. So that really does affect your average quarterly same-store sales statistic, which is the statistic that we report to you.

Robert H. B. Baldwin

And the worst month was July so -- and September was sort of okay. So we're really consistent with what you're seeing in the broader environment, where things are okay but not great in the main street market.

Timothy Wojs - Robert W. Baird & Co. Incorporated, Research Division

Okay, that's helpful. And then just on gross margin install, it decelerated a little bit this quarter and accomplished fairly similar. And so I'm curious, as we go into 2013 and comps actually get tougher, can you guys still grow gross margin in-sell at double-digit rate?

Maria Rueda

That is going to be our goal, to continue that positive trend.

Robert O. Carr

Yes, we think we'll be able to do that.

Timothy Wojs - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then just on the Q4 -- or the Q3 share count, what was the end of the quarter share count? And then were all the purchases made in Q3? Or did you guys exhaust the authorization during October?

Robert H. B. Baldwin

We exhausted it all in October. And so at the quarter end, the -- I'm not sure. Maria, do you have that?

Maria Rueda

Yes, I can get that. We were at 38.7 million shares at the end of September.

Robert H. B. Baldwin

And we obviously were active in our repurchase in October because we brought the $50 million program authorized in July to a conclusion before the end of October.

Operator

And we'll go next to Mike Grondahl with Piper Jaffray.

Michael J. Grondahl - Piper Jaffray Companies, Research Division

A year ago, you guys kind of implemented a monthly merchant fee. Do you have any plans to increase that or implement another fee at the end of this year or in 2013?

Robert O. Carr

We do not.

Operator

And we'll go next to Roman Leal with Goldman Sachs.

Roman Leal - Goldman Sachs Group Inc., Research Division

Most of my questions on the quarter had been answered. So I'll just focus on maybe 2 follow-ups, 2 quick follow-ups on the new entrants theme here. Obviously, we've seen a lot of partnerships across the industry with some of new entrants and you talked about some of the partnerships you're forming. Is there, and I know it's early stages, some of them, I understood, are still in pilot. But is there a base case here? Can we say that on a base case, you expect your processing volume to be unchanged? And then is there any upside from these relationships? Or are there some situations where you can see your processing volume -- I'm sorry, your processing economics actually go down in return from maybe creating some more sticky relations with your clients?

Robert H. B. Baldwin

We don't see any sign right now. First of all, a lot, a lot, a lot of this is on the comp, also known as people who put out press releases long before they have something that's actually being offered in the marketplace. And so a lot is unclear. But we see absolutely no signs that we will have to deteriorate our portion of the economics. We talked about how for a long time Heartland's had about 50 basis points of net revenue that we kept. We think that, that's -- as someone is looking for distribution, as they look at competitors who are charging typically more than that, they're going to find us to be the most economically attractive distribution force. And so we'll be able to keep our margins while helping them get access to the merchants, and we hope as we work with these solutions, provide -- end up with a stickier relationship with that merchant. That's all to be seen in the future. It's exciting stuff, but all of these innovations just take time. And right now, there's very little impact on the real businesses being done by real merchants in America.

Robert O. Carr

Also I think the opportunity to move downstream, we're moving upstream from the level-4 merchant, the tier-4 merchants has been our sweet spot for years. Tier 3, we moved into. We're moving into tier 2 and a little bit into tier 1. But now, with this new approach, we're going to be able to go right after the best Square merchants, the tier 5, 6 and 7 merchants through aggregators. Nobody is better positioned than Heartland to go after aggregators with their feet on the street. So we think the market is expanding, and we think we're in a better position to take market share in those new areas than other people are with our model. And for our merchant, that the average merchant doing $400,000 of Visa and MasterCard is typically a $1 million business. Those businesses just -- they have to have customer service and they have -- they don't want to pay a flat rate 2.75%, which is an outrageously high rate for somebody of that size. So we think that we're going to expand our marketplaces. I mean, folks like PayPal and Google, they need us to be the last mile to the merchant, and we're out there and our phone is ringing pretty heavy right now from want-to-be partners, and we're certainly want to be available to them to offer more merchants -- more services to our merchants. So I think it's additive to our business in the long haul. We're not going to be able to compete directly for a -- until further into 2013 than we'd like. But once we get there, I think we're going to be the guys to compete against, not some of the players out there who have a lot of capital right now that are burning it real fast.

Roman Leal - Goldman Sachs Group Inc., Research Division

That's good color. And at this point, are you prepared to give us maybe either percentage of revenue contribution or even SME volume that comes from micro-merchant level versus small versus mid-market?

Robert H. B. Baldwin

Well, what do you mean by micro-merchant, first of all? Although we would call a micro, our micro-merchant is larger. It's the smallest category. We look at it typically as $1 to $50,000 -- under $50,000 of volume that's substantially larger than this new group of merchants that have been created by some of these innovations. I think that the answer is it's really a very small percentage of our current business, any way you want to cut it, and we'll see where we are going to take that over the future. But it's really not an impactful portion. The impactful portion is that $0.5 million, $0.25 million, $0.5 million, $1 million merchant that we've been working with for years.

Robert O. Carr

But we do know this much, that less than 1% of our net revenue comes from merchants that do under $10,000 of volume.

Roman Leal - Goldman Sachs Group Inc., Research Division

Interesting. Okay. And one last philosophical question here. I think you guys mentioned in your Investor Day that you are at least willing to consider introducing a flat-fee model in some segment of the market. And I'm just curious, you're already at the cost plus. Most of the industry, if not the entire industry, except for you guys, are not there at the SME level. They're still on the bundle basis. What's the philosophy versus sticking to cost plus?

Robert O. Carr

That's a really good question. And I think it's in Investor Day, what I said was that we are going to offer a flat rate as an alternative. We're going to stick with our cost plus, but there's just some people that want simplicity in their life and they want to pay a flat rate. They don't want to have to look at the statement with 300 different rates on there. Our statement is fairly complex. And so the merchant that just wants to go to bed at night they're paying so much per month or so much for knowing they're paying so much per month or so much per dollar, a flat rate, we're going to meet their need and offer them that as well. And I think Square, that was one of the things that Square did right in coming up with a flat-rate price that holds a very strong margin for them. We think we'll be able to get margins out of our flat rate pricing than we can out of our cost plus, but we're not giving up cost plus, not at all.

Operator

And that concludes today's question-and-answer session. Ms. Rueda, at this time, I would like to turn the conference back over to you for any additional or closing remarks.

Maria Rueda

Thank you very much, Brandy. I'd like to thank all of you for joining us this morning, and have a great day.

Operator

And this concludes today's conference. We thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!