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VNTV > SEC Filings for VNTV > Form 10-K on 20-Feb-2013All Recent SEC Filings

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Form 10-K for VANTIV, INC.


20-Feb-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

This management's discussion and analysis provides a review of the results of operations, financial condition and liquidity and capital resources of Vantiv, Inc. ("Vantiv", "we", "us", or "our company" refer to Vantiv, Inc. and its subsidiaries)and outlines the factors that have affected recent results, as well as those factors that may affect future earnings. Our actual results may differ materially from those anticipated in these forward looking statements as a result of many factors, including those set forth under "Risk Factors," Forward Looking Statements" and elsewhere in this report. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes included in "Item 8 - Financial Statements and Supplementary Data" of this report.

General

We are the third largest merchant acquirer and the largest PIN debit acquirer by transaction volume, according to the Nilson Report, and a leading, integrated payment processor in the United States differentiated by a single, proprietary technology platform. This enables us to efficiently provide a suite of comprehensive services to both merchants and financial institutions of all sizes in the United States. Our technology platform offers our clients a single point of access and service that is easy to connect to and use in order to access a broad range of payment services and solutions. Our integrated business and single platform also enable us to innovate, develop and deploy new services and provide us with significant economies of scale. Our varied and broad distribution provides us with a diverse client base and channel partner relationships.

We believe our single, proprietary technology platform is differentiated from our competitors' multiple platform architectures. Because of our single point of service and ability to collect, manage and analyze data across the payment processing value chain, we can identify and develop new services more efficiently. Once developed, we can more cost-effectively deploy new solutions to our clients through our single platform. Our single scalable platform also enables us to efficiently manage, update and maintain our technology, increase capacity and speed and realize significant operating leverage.

We enable merchants of all sizes to accept and process credit, debit and prepaid payments and provide them supporting services, such as information solutions, interchange management and fraud management, as well as vertical-specific solutions in sectors such as grocery, pharmacy, retail, petroleum and restaurants/quick service restaurants. We also provide mission critical payment services to financial institutions, such as card issuer processing, payment network processing, fraud protection, card production, prepaid program management, ATM driving and network gateway and switching services that utilize our proprietary Jeanie PIN debit payment network.

We provide small and mid-sized clients with the comprehensive solutions that we have developed to address the extensive requirements of our large clients. We then tailor these solutions to the unique needs of our small and mid-sized clients. In addition, we take a consultative approach to providing these services that helps our clients enhance their payments-related services.

We distribute our services through direct and indirect distribution channels using a unified sales approach that enables us to efficiently and effectively target merchants and financial institutions of all sizes. Our direct channel includes a national sales force that targets financial institutions and national merchants, regional and mid-market sales teams that sell solutions to merchants and third-party reseller clients and a telesales operation that targets small and mid-sized merchants. Our indirect channel to merchants includes relationships with a broad range of independent sales organizations ("ISOs"), merchant banks, value-added resellers and trade associations that target merchants, including difficult to reach small and mid-sized merchants. Our indirect channel to financial institutions includes relationships with third-party resellers and core processors.

Executive Overview

In March 2012, we completed the IPO of our Class A common stock. In connection with our IPO, we effected several reorganization transactions. On August 2, 2012, a secondary offering took place in which Advent sold 14,064,500 shares of Vantiv Class A common stock. On December 6, 2012, a secondary offering took place in which Fifth Third Bank sold 13,700,000 shares of Vantiv Class A common stock. We did not receive any proceeds from the secondary offerings. See Note 1
- Basis of Presentation "Initial Public Offering and Reorganization Transactions" section and Note 10 - Controlling and Non-controlling Interests in Vantiv Holding in "Item 8 - Financial Statements and Supplementary Data" for more information.

Revenue for the year ended December 31, 2012, increased 15% to $1,863.2 million from $1,622.4 million in 2011. The revenue growth was due primarily to transaction growth of 19% driven primarily by investments in sales and marketing in connection with the expansion of our distribution, partially offset by a slight decline in revenue per transaction primarily attributable to the addition of a large national processing contract in the second quarter of 2012.


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Income from operations for the year ended December 31, 2012, increased 25% to $304.9 million from $243.2 million in 2011.

Net income for the year ended December 31, 2012, increased 31% to $110.8 million from $84.8 million in 2011. Net income attributable to Vantiv, Inc. for the year ended December 31, 2012, increased 59% to $57.6 million from $36.2 million in 2011.

Recent Acquisitions

On November 30, 2012, we acquired Litle & Co., LLC ("Litle"), an ecommerce payment processor for approximately $361 million in cash. This acquisition will strengthen our capabilities in ecommerce, expand our customer base of online merchants and enable the delivery of Litle's innovative ecommerce solutions to our merchant and financial institution clients. The acquisition of Litle generated tax benefits with a net present value of approximately $66 million which will be recognized over a period of 15 years from the date of the acquisition. The acquisition of Litle did not have a significant impact on our results of operations for the year ended December 31, 2012.

Our Segments, Revenue and Expenses

Segments

We operate as a single integrated business and report our results of operations in two segments, Merchant Services and Financial Institution Services. We evaluate segment performance based upon segment profit, which is defined as net revenue, which represents total revenue less network fees and other costs, less sales and marketing expense attributable to that segment.

Merchant Services

We provide a comprehensive suite of payment processing services, including acquiring and processing transactions, value-added services and merchant services for banks and credit unions. We authorize, clear, settle and provide reporting for electronic payment transactions for our merchant services clients. Our client base includes approximately 400,000 merchant locations, with an emphasis on non-discretionary everyday spend categories where spending has generally been more resilient during economic downturns.

We provide our merchant services to merchants of varying sizes, which provides us with a number of key benefits. Given their size, large merchants generally receive customized payment processing solutions and lower per transaction pricing. These merchants provide us with significant operating scale efficiencies and recurring revenues, due to the large transaction volume that they generate. Small and mid-sized merchants are more difficult to reach on an individual basis, but generally generate higher per transaction fees.

Financial Institution Services

We provide integrated card issuer processing, payment network processing and value-added services to financial institutions. Our services include a comprehensive suite of transaction processing capabilities, including fraud protection, card production, prepaid cards and ATM driving and allow financial institutions to offer electronic payments solutions to their customers on a secure and reliable technology platform at a competitive cost. We provide these services using a consultative approach that helps our financial institution clients enhance their payments-related business.

We serve a diverse set of financial institutions, including regional banks, community banks, credit unions and regional PIN debit networks. We focus on small to mid-sized institutions with less than $15 billion in assets. Smaller financial institutions, including many of our clients, generally do not have the scale or infrastructure typical of large banks and are more likely to outsource payment processing needs. We provide a turnkey solution to such institutions to enable them to offer payment processing solutions.

Revenue

We generate revenue primarily by processing electronic payment transactions. Set forth below is a description of our revenues by segment and factors impacting segment revenues.


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Our Merchant Services segment revenues are primarily derived from processing credit and debit card transactions. Merchant Services revenue is primarily comprised of fees charged to businesses, net of interchange fees, for payment processing services, including authorization, capture, clearing, settlement and information reporting of electronic transactions. The fees charged consist of either a percentage of the dollar volume of the transaction or a fixed fee, or both, and are recognized at the time of the transaction. Merchant Services revenue also includes a number of revenue items that are incurred by us and are reimbursable as the costs are passed through to and paid by our clients. These items primarily consist of Visa, MasterCard and other payment network fees. In addition, for sales through ISOs and certain other referral sources in which we are the primary party to the contract with the merchant, we record the full amount of the fees collected from the merchant as revenue. Associated residual payments made to ISOs are included in sales and marketing expenses. Merchant Services revenue also includes revenue from ancillary services such as fraud management, equipment sales and terminal rent. Revenue in our Merchant Services segment is impacted primarily by transaction volume, average transaction size, the mix of merchant types in our client portfolio, the performance of our merchant clients and the effectiveness of our distribution channels.

Our Financial Institution Services revenues are primarily derived from debit, credit and ATM card transaction processing, ATM driving and support, and PIN debit processing services. Financial Institution Services revenue associated with processing transactions includes per transaction and account related fees, card production fees and fees generated from our Jeanie network. Financial Institution Services revenue is impacted by the number of financial institutions using our services as well as their transaction volume. The number of financial institutions in the United States has declined as a result of prevailing economic conditions, consolidation as well as other market and regulatory pressures. These factors have contributed to industry-wide pricing compression of the fees that financial institutions are willing to pay for payment processing. Since 2009, pricing compression in the Financial Institution Services segment has represented 4% or less of net revenue on an annual basis.

Network Fees and Other Costs

Network fees and other costs consist primarily of charges incurred by us which we pass through to our clients, including Visa, MasterCard and other payment network fees, card production costs, telecommunication charges, postage and other third party processing expenses.

Net Revenue

Net revenue is revenue, less network fees and other costs and reflects revenue generated from the services we provide to our clients. Management uses net revenue to assess our operating performance. We believe that net revenue, when reviewed together with revenue, is meaningful to our investors in order to understand our performance.

Expenses

Set forth below is a brief description of the components of our expenses, aside
from the network fees and other costs discussed above:

         Sales and marketing expense primarily consists of salaries and benefits
          paid to sales personnel, sales management and other sales and marketing
          personnel, advertising and promotional costs and residual payments made
          to ISOs, agent banks and other third party resellers.



         Other operating costs primarily consist of salaries and benefits paid
          to operational and IT personnel, costs associated with operating our
          technology platform and data centers, information technology costs for
          processing transactions, product development costs, software consulting
          fees and maintenance costs.



         General and administrative expenses primarily consist of salaries and
          benefits paid to executive management and administrative employees,
          including finance, human resources, product development, legal and risk
          management, share-based compensation costs, equipment and occupancy
          costs and consulting costs.



         Depreciation and amortization expense consists of our depreciation
          expense related to investments in property, equipment and software as
          well as our amortization of intangible assets, principally customer
          relationships acquired in connection with the acquisition of a majority
          interest in Vantiv Holding in June 2009 and our subsequent
          acquisitions.



         Interest expense-net consists primarily of interest on borrowings under
          our senior secured credit facilities less interest income earned on our
          cash and cash equivalents.


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Income tax expense (benefit) represents federal, state and local taxes based on income in multiple jurisdictions.

         Non-operating expenses consist of charges related to the refinancing of
          our senior secured credit facilities and the early termination of our
          interest rate swaps in connection with our March 2012 debt refinancing;
          a one-time activity fee assessed by MasterCard as a result of our IPO;
          charges related to the refinancing of our senior secured credit
          facilities in 2011; and, during 2010 and 2011, periodic changes in the
          value of the put rights we received in connection with the separation
          from Fifth Third Bank in 2009.

Factors and Trends Impacting Our Business and Results of Operations

We expect a number of factors will impact our business, results of operations and financial condition. In general, our revenue is impacted by the number and dollar volume of card based transactions which in turn are impacted by general economic conditions, consumer spending and the emergence of new technologies and payment types, such as ecommerce, mobile payments, and prepaid cards. In our Merchant Services segment, our net revenues are impacted by the mix of the size of merchants that we provide services to as well as the mix of transaction volume by merchant category. In our Financial Institution Services segment, our net revenues are also impacted by the mix of the size of financial institutions to which we provide services as well as consolidation and market and industry pressures, which have contributed and are expected to continue to contribute to pricing compression of payment processing fees in this segment. We also expect our results of operations to be impacted by the factors affecting the comparability of our results of operations discussed below.

Factors Affecting the Comparability of Our Results of Operations

As a result of a number of factors, our historical results of operations are not comparable from period to period and may not be comparable to our financial results of operations in future periods. Set forth below is a brief discussion of the key factors impacting the comparability of our results of operations.

Transition, Acquisition and Integration Costs

Subsequent to our separation from Fifth Third Bank in June 2009, our expenses included certain transition costs, including costs incurred for our human resources, finance, marketing and legal functions and severance costs, consulting fees related to non-recurring transition projects and expenses related to various strategic and separation initiatives. In connection with our acquisitions, we incurred acquisition and integration costs, consisting primarily of consulting fees for advisory and integration services. These costs are included in other operating costs and general and administrative expenses. For the years ended December 31, 2012, 2011 and 2010, transition, acquisition and integration costs were $11.0 million, $37.3 million and $49.0 million, respectively.

Share-Based Compensation

Prior to our IPO, certain employees and directors of Vantiv Holding participated in the Vantiv Holding Management Phantom Equity Plan. In connection with the IPO, outstanding awards under the Vantiv Holding Management Phantom Equity Plan were converted into unrestricted and restricted stock, issued under our 2012 Equity Incentive Plan. On the IPO date, we also granted restricted stock units to members of our board of directors and certain employees and intend to grant additional share-based awards in the future. During the years ended December 31, 2012, 2011 and 2010 we incurred share-based compensation expense of $33.4 million, $3.0 million and $2.8 million, respectively, which is included in general and administrative expense. See Note 14 - Share-Based Compensation Plans in "Item 8 - Financial Statements and Supplementary Data."

Non-operating Expenses

For the year ended December 31, 2012, we recorded $92.7 million within non-operating expenses, which consisted of $86.7 million related to the refinancing of our senior secured credit facilities and the early termination of our interest rate swaps in March 2012 and a $6.0 million one-time activity fee assessed by MasterCard as a result of our IPO. During the year ended December 31, 2011, we recorded $14.5 million within non-operating expenses of which $13.7 million related primarily to the refinancing of our senior secured credit facilities in May 2011. These expenses were $4.3 million for the year ended December 31, 2010, and consisted of losses related to the put rights we received in connection with the separation from Fifth Third Bank.


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Non-Controlling Interest

As a result of the non-controlling ownership interests in Vantiv Holding held by Fifth Third Bank subsequent to our IPO and by Fifth Third Bank and JPDN Enterprises, LLC ("JPDN") prior to our IPO, our results of operations include net income attributable to non-controlling interests. Net income attributable to non-controlling interests for the years ended December 31, 2012, 2011 and 2010 was $53.1 million, $48.6 million and $32.9 million, respectively. Future sales or redemptions of ownership interests in Vantiv Holding by Fifth Third Bank will continue to reduce the amount recorded as non-controlling interest and increase net earnings attributable to our stockholders.

Cash Net Income

We use cash net income for financial and operational decision making as a means to evaluate period-to-period comparisons of our results of operations. We believe cash net income provides useful information about operating results, enhances the overall understanding of past financial performance and future prospects and allows for greater transparency with respect to key metrics used by management in its financial and operational decision making.

Cash net income includes adjustments to exclude amortization of intangible assets acquired through business combinations and customer portfolio and related asset acquisitions; share-based compensation expense; transition costs associated with our separation from Fifth Third Bank; integration costs incurred in connection with acquisitions; non-operating expenses; conversion of non-controlling interests into shares of Class A common stock and tax benefits due to the amortization of intangible assets and other tax attributes resulting from or acquired with our acquisitions, including Litle, and to the tax basis step up associated with our separation from Fifth Third Bank and the purchase or exchange of Class B units of Vantiv Holding, net of payment obligations under tax receivable agreements ("TRAs") established at the time of our initial public offering. For purposes of providing better comparability, we also made adjustments to interest and depreciation expense in 2011. Cash net income is a non-GAAP financial measure and should be considered together with GAAP operating results.

The table below provides a reconciliation of cash net income to GAAP net income for the years ended December 31, 2012 and 2011:

                                                     Year Ended December 31,
                                                       2012            2011
                                                         (in thousands)
Net income                                        $    110,758      $  84,810
Transition, acquisition and integration costs (1)       11,007         37,342
Share-based compensation                                33,444          2,974
Intangible amortization (2)                            117,435        123,327
Depreciation and amortization adjustment (3)                 -         (1,734 )
Interest expense adjustment (4)                              -          5,897
Non-operating expenses (5)                              92,672         14,499
Income tax expense adjustment (6)                     (111,832 )      (82,969 )
Tax adjustments (7)                                      6,525              -
Cash net income                                   $    260,009      $ 184,146

(1) Represents acquisition and integration costs incurred in connection with our acquisitions and costs associated with our separation from Fifth Third Bank.

(2) Represents amortization of intangible assets acquired through business combinations and customer portfolio and related asset acquisitions.

(3) Represents adjustment to depreciation and amortization associated with our property and equipment, assuming that our property and equipment at December 31, 2011 was in place on January 1, 2011.

(4) Represents adjustment to interest expense to reflect what our interest expense would have been at December 31, 2011 if our level of debt and applicable terms was outstanding on January 1, 2011.

(5) Expenses primarily associated with the refinancing of our debt in March 2012 and May 2011 and the termination of our interest rate swaps in March 2012.

(6) Represents adjustment to income tax expense assuming conversion of non-controlling interests into shares of Class A common stock, including the tax effect of the adjustments described above.

(7) Adjustment relates to tax benefits due to the amortization of intangible assets and other tax attributes resulting from or acquired with our acquisitions, including Litle, and to the tax basis step up associated with our separation from Fifth


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Third Bank and the purchase or exchange of Class B units of Vantiv Holding, net of payment obligations under TRAs established at the time of our initial public offering. No adjustment is made during 2011 as such adjustment would not be comparable due to our existing corporate structure and TRAs having been put in place in connection with the IPO during the current year.

Results of Operations

The following tables set forth our statements of income in dollars and as a
percentage of net revenue for the periods presented.
                                      Year Ended
                                     December 31,
                                  2012           2011        $ Change     % Change
                                             (dollars in thousands)
Revenue                       $ 1,863,239    $ 1,622,421    $ 240,818        15 %
Network fees and other costs      840,597        756,735       83,862        11
Net revenue                     1,022,642        865,686      156,956        18
Sales and marketing               280,644        236,917       43,727        18
Other operating costs             158,374        143,420       14,954        10
General and administrative        118,231         86,870       31,361        36
Depreciation and amortization     160,538        155,326        5,212         3
Income from operations        $   304,855    $   243,153    $  61,702        25 %
Non-financial data:
Transactions (in millions)         15,362         12,935                     19 %

                                  Year Ended
As a Percentage of Net Revenue   December 31,
                                2012      2011
Net revenue                    100.0 %   100.0 %
Sales and marketing             27.4      27.4
Other operating costs           15.5      16.6
General and administrative      11.6      10.0
Depreciation and amortization   15.7      17.9
Income from operations          29.8 %    28.1 %

Fiscal Year Ended December 31, 2012 Compared to Fiscal Year Ended December 31, 2011

Revenue

Revenue increased 15% to $1,863.2 million for the year ended December 31, 2012 from $1,622.4 million for the year ended December 31, 2011. The increase was due primarily to transaction growth of 19% driven primarily by investments in sales and marketing in connection with the expansion of our distribution. Revenue growth lagged transaction growth primarily due to the addition of a large national processing contract in the second quarter of 2012.

Network Fees and Other Costs

Network fees and other costs increased 11% to $840.6 million for the year ended December 31, 2012 from $756.7 million for the year ended December 31, 2011. The increase was due primarily to transaction growth of 19%, partially offset by debit routing benefits and the elimination of third party processing fees as we transitioned clients to our single processing platform. The increase in network fees and other costs lagged transaction growth due to the addition of a large national processing contract during the second quarter for which there are no substantial associated network fees and other costs.

Net Revenue

Net revenue increased 18% to $1,022.6 million for the year ended December 31, 2012 from $865.7 million for the year ended December 31, 2011. The increase in net revenue was due primarily to transaction growth of 19%.


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