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Heartland Payment Systems Inc. Reports Operating Results (10-Q)

August 07, 2009 | About:

Heartland Payment Systems Inc. (HPY) filed Quarterly Report for the period ended 2009-06-30.

Heartland Payment Systems Inc. provides bank card-based payment processing services to small- and medium- sized merchants in the United States. Heartland facilitates the exchange of information and funds between merchants and cardholders\' financial institutions providing end-to- end electronic payment processing services to merchants including merchant setup and training transaction authorization and electronic draft capture clearing and settlement merchant accounting merchant assistance and support and risk management. Heartland Payment Systems Inc. has a market cap of $413.9 million; its shares were traded at around $11.05 with a P/E ratio of 11 and P/S ratio of 0.3. The dividend yield of Heartland Payment Systems Inc. stocks is 0.4%.

Highlight of Business Operations:

At June 30, 2009, we provided our bank card payment processing services to approximately 172,850 active SME merchants located across the United States. This represents a 2.4% increase over the 168,850 active SME merchants at December 31, 2008 and a 4.9% increase over the 164,750 active SME merchants at June 30, 2008. At June 30, 2009, we provided bank card payment processing services to approximately 78 large national merchants with approximately 54,153 locations. Our total bank card processing volume for the three months ended June 30, 2009 was $17.8 billion, a 3.8% increase from the $17.1 billion processed during the three months ended June 30, 2008. Our total bank card processing volume for the six months ended June 30, 2009 was $33.3 billion, a 9.7% increase from the $30.4 billion processed during the six months ended June 30, 2008. Bank card processing volume for the three and six months ended June 30, 2009 includes $2.6 billion and $4.6 billion, respectively, for large national merchants acquired with Network Services, compared to $1.9 billion for both the three and six months ended June 30, 2008. Additionally, we provided bank card processing services to approximately 6,000 merchants in Canada.

For the three and six months ended June 30, 2009, we expensed a total of $19.4 million and $32.0 million, respectively, or about $0.32 and $0.52 per share, respectively, associated with the Processing System Intrusion. Over the six months ended June 30, 2009, the majority of these charges, or $22.1 million, related to fines imposed by certain card brands in April 2009 against us and our sponsor banks and a settlement offer we made in an attempt to resolve certain of the claims asserted against our sponsor banks (who have asserted rights to indemnification from us pursuant to our agreements with them) relating to the Processing System Intrusion. Notwithstanding our belief that we and our sponsor banks have strong defenses against the claims that are the subject of the settlement offer, we decided to make the settlement offer in an attempt to avoid the costs and uncertainty of litigation. We are prepared to vigorously defend ourselves against all the claims relating to the Processing System Intrusion that have been asserted against us and our sponsor banks to date. In particular, we are prepared to vigorously contest (and we have recommended to our sponsor banks that they vigorously contest) through all available means, including litigation if necessary, any liability that may be asserted or assessments that may be imposed against us or our sponsor banks by certain card brands.

System Intrusion. Poor economic conditions unfavorably impacted both new merchant installs and processing volume at existing merchants. For the three months ended June 30, 2009, we recorded a net loss of $2.6 million, or $0.07 per share, compared to net income of $11.5 million, or $0.30 per share, in the three months ended June 30, 2008. During the three months ended June 30, 2009, we recorded pretax charges of $19.4 million, or about $0.32 per share, for costs we incurred for investigations, remedial actions, legal fees, crisis management services and a settlement offer. The following is a summary of our financial results for the three months ended June 30, 2009:

The amount of the up-front signing bonus paid for new SME bank card, payroll and check processing accounts is based on the estimated gross margin for the first year of the merchant contract. Estimated gross margin is calculated by deducting interchange fees, dues, assessments and fees and costs incurred in underwriting, processing, servicing and managing the risk of the account from gross processing revenue. The gross signing bonuses paid during the six months ended June 30, 2009 and 2008 were $17.9 million and $23.1 million, respectively, and for the full year ended December 31, 2008 were $43.8 million. The signing bonus paid, amount capitalized, and related amortization are adjusted at the end of the first year to reflect the actual gross margin generated by the merchant contract during that year. The net signing bonus adjustments made during the six months ended June 30, 2009 and 2008 were negative $(0.2) million and positive $0.9 million, respectively. Positive signing bonus adjustments occur when the actual gross margin generated by the merchant contract during the first year exceeds the estimated gross margin for that year, resulting in the underpayment of the up-front signing bonus and would be paid to the relevant salesperson. Negative signing bonus adjustments could result from prior overpayments of up-front signing bonuses, and would be recovered from the relevant salesperson. The amount of signing bonuses paid which remained subject to adjustment at June 30, 2009 was $38.6 million.

For the three and six months ended June 30, 2009, we expensed a total of $19.4 million and $32.0 million, respectively, or about $0.32 and $0.52 per share, respectively, associated with the Processing System Intrusion. Over the six months ended June 30, 2009, the majority of these charges, or $22.1 million, related to fines imposed by certain card brands in April 2009 against us and our sponsor banks and a settlement offer we made in an attempt to resolve certain of the claims asserted against our sponsor banks (who have asserted rights to indemnification from us pursuant to our agreements with them) relating to the Processing System Intrusion (see “—Processing System Intrusion” for further discussion). The accrual of these fines and the settlement offer resulted in a $14.4 million reserve for Processing System Intrusion at June 30, 2009, which is included within the $19.4 million expensed for the three months ended June 30, 2009. To date we have not received any response to our settlement offer and you should not assume that we will resolve the claims that are the subject of the settlement offer for the amount of the settlement offer. We understand that the portion of this reserve related to the settlement offer is required by SFAS No. 5 based solely on the fact we tendered an offer of settlement in the amount we have accrued. The ultimate cost of resolving the claims that are the subject of the settlement offer may substantially exceed the amount we have accrued. Moreover, even if the claims that are the subject of the settlement offer were resolved for the amount we have accrued, that would still leave unresolved most of the claims that have been asserted against us or our sponsor banks relating to the Processing System Intrusion. We feel we have strong defenses to all the claims that have been asserted against us and our sponsor banks relating to the Processing System Intrusion, including those claims that are not the subject of the settlement offer. However, it is possible we will end up resolving the claims that are not the subject of the settlement offer, either through settlements or pursuant to litigation, for amounts that are significantly greater than the amount we have reserved to date in respect of those claims. We may also be required to reserve significant additional amounts in the future, either in respect of the claims that are the subject of the settlement offer or in respect of the other claims that have been asserted against us and our sponsor banks relating to the Processing System Intrusion (or in respect of both categories of claims).

Disputes between a cardholder and a merchant periodically arise as a result of, among other things, the cardholder’s dissatisfaction with merchandise quality or merchant services. Such disputes may not be resolved in the merchant’s favor. In these cases, the transaction is “charged back” to the merchant, which means the purchase price is refunded to the customer by the card-issuing bank and charged to the merchant. If the merchant is unable to fund the refund, we must do so. We also bear the risk of reject losses arising from the fact that we collect our fees from our merchants on the first day after the monthly billing period. If the merchant has gone out of business during such period, we may be unable to collect such fees. We maintain cash deposits or require the pledge of a letter of credit from certain merchants, generally those with higher average transaction size where the card is not present when the charge is made or the product or service is delivered after the charge is made, in order to offset potential contingent liabilities such as chargebacks and reject losses that would arise if the merchant went out of business. At June 30, 2009 and December 31, 2008, we held merchant deposits totaling $32.7 million and $15.8 million, respectively. Most chargeback and reject losses are charged to processing and servicing as they are incurred. However, we also maintain a loss reserve against losses including major fraud losses, which are both less predictable and involve larger amounts. The loss reserve was established using historical loss rates, applied to recent processing volume. At June 30, 2009 and December 31, 2008, our loss reserve totaled $1,157,000 and $1,097,000 respectively. Aggregate bank card merchant losses, including losses charged to operations and the loss reserve, were $3.0 million and $2.6 million for the six months ended June 30, 2009 and 2008, respectively, and were $5.1 million for the year ended December 31, 2008.

Read the The complete ReportHPY is in the portfolios of Richard Pzena of Pzena Investment Management LLC.

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