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NTSP > SEC Filings for NTSP > Form 10-Q on 3-May-2013All Recent SEC Filings

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Form 10-Q for NETSPEND HOLDINGS, INC.


3-May-2013

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q and the documents incorporated into this Quarterly Report on Form 10-Q by reference contain forward-looking statements that are based on our current expectations, assumptions, estimates and projections about our company and our industry. The forward-looking statements are subject to various risks and uncertainties. Generally, these forward-looking statements can be identified by the use of forward-looking terminology such as "anticipate," "believe," "estimate," "expect," "intend," "will," "project," "seek," "should," "may," "could," "would," "plans," "predicts," "potential" and similar expressions, as well as other words or expressions referencing future events, conditions or circumstances. Those statements include, among other things, the discussions of our business strategy and expectations concerning our market position, future operations, financial position, revenue, costs, prospects, margins, profitability, liquidity and capital resources, as well as management's plans and objectives. We caution you that reliance on any forward-looking statement involves risks and uncertainties and that, although we believe that the assumptions on which our forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and, as a result, the forward-looking statements based on those assumptions could be materially incorrect. These factors include but are not limited to:

our dependence on a limited number of distributors of our products;

increasing competition in the prepaid debit card industry;

exposure to cardholder fraud and other losses;

our reliance on our relationships with our issuing banks;

regulatory, legislative and judicial developments;

          changes in card association or network organization rules;



          our ability to protect against unauthorized disclosure of cardholder
data;

our ability to promote our brand;

our reliance on outsourced customer service providers; and

our ability to protect our intellectual property rights and defend against claims of patent infringement.

These and other factors are more fully discussed in our Annual Report on Form 10-K for the year ended December 31, 2012. In light of these and other uncertainties, you should not conclude that we will necessarily achieve any plans, objectives or projected financial results referred to in any of the forward-looking statements. Except as required by law, we do not intend to update any of these forward-looking statements to reflect future events or circumstances.


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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and related notes to audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012. In this Quarterly Report, unless otherwise specified, "NetSpend," "we," "us," and "our" refer to NetSpend Holdings, Inc. and its consolidated subsidiaries.

Overview

NetSpend is a leading program manager for FDIC-insured depository institutions that issue general-purpose reloadable prepaid debit cards, or GPR cards, and provide related alternative financial services to underbanked consumers in the United States. The programs managed by the Company empower underbanked consumers by providing them with innovative and affordable financial products and services tailored to meet their particular financial services needs and preferences in a manner that traditional banking institutions have historically not met. In addition, the products and services we manage provide our distributors an opportunity to enhance their customer relationships and generate incremental, ongoing revenue streams.

Cardholders may use their GPR cards to make purchase transactions at any merchant that participates in the MasterCard, Visa or PULSE networks and to withdraw funds from participating ATMs. MetaBank holds the majority of the cardholder funds. We own approximately 3.6% of the outstanding equity interests in Meta Financial Group, Inc. ("MFG"), MetaBank's holding company.

Our principal operating company, predecessor and current subsidiary, NetSpend Corporation ("NetSpend"), was incorporated in Texas in 1999. In May 2004, Oak Investment Partners acquired a controlling equity interest in NetSpend through a recapitalization transaction pursuant to which we, as a newly-formed holding company incorporated in Delaware acquired all of the capital stock of NetSpend. In 2008, we acquired Skylight Financial, Inc. ("Skylight"), a payroll card provider, in a stock-for-stock merger. Entities affiliated with one of our significant shareholders, the JLL Funds, were previously the majority owners of Skylight.

We have built an extensive and diverse distribution and reload network in the United States to support the marketing and ongoing use of the GPR cards we manage. We market cards through multiple distribution channels, including alternative financial service providers, traditional retailers, direct-to-consumer and online marketing programs and to corporate employers as an alternative method of wage payment for their employees.

We have developed and operate a proprietary technology platform. Our in-house platform is end-to-end in that it encompasses the critical functions required for us to acquire cardholders, process transactions, maintain account-level data, communicate with cardholders, manage risk, ensure regulatory compliance and connect to our Issuing Banks and distributors. These integrated capabilities allow us to customize our products and services for different markets, distribution channels and customer segments. Further, by processing transactions on our own platform, we gain unique and extensive insight into the attitudes, characteristics and purchasing behavior of the holders of the cards we manage.


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We are pursuing a bank diversification strategy and we are distributing our card issuing activities across three issuing banks, in addition to the banks that issue our payroll cards. We are focused on balancing our diversification strategy with the protection of existing cardholder and direct deposit relationships and other operational considerations. In furtherance of this strategy we entered into an agreement with The Bancorp Bank ("Bancorp") in January 2011 pursuant to which Bancorp serves as an Issuing Bank for some of our new and existing card programs, including the cards we distribute through traditional retailers. We have also signed an agreement with BofI Federal Bank ("BofI") pursuant to which we will manage GPR and payroll cards issued by it. BofI began issuing GPR cards in January 2013 and payroll cards in February 2013. We are continuing our discussions with other prospective issuing banks.

In May 2011, we amended our agreement with Inter National Bank ("INB") to extend the date by which we agreed to transition the GPR cards issued by INB to another bank from July 2011 to September 2011. We have transitioned the distributors of cards issued by INB to other Issuing Banks and we transitioned INB's cardholder portfolio to Bancorp in February 2013. We and INB are engaged in an active dispute regarding the contractual obligations of the parties in connection with the transition of INB's portfolio.

During the first quarter of 2013, SunTrust Bank ("SunTrust"), U.S. Bank ("USB") and BofI acted as issuers of our payroll cards. In February 2013, we transferred the USB portfolio to BofI. Our contract with SunTrust has been extended to September 2015. We are actively seeking to sign agreements with additional banks to act as issuers of payroll cards. As a result of these efforts, we signed an agreement with Regions Bank pursuant to which we will act as the program manager for the payroll cards to be issued by it.

Recent Developments

On February 19, 2013, we entered into a merger agreement with Total System Services, Inc. ("TSYS") pursuant to which each share of our common stock (other than any dissenting shares, treasury shares, or shares held by us, TSYS or any of their subsidiaries) will be converted into $16 in cash, subject to the terms and conditions of the merger agreement. For additional information, see Note 17. "TSYS Merger" within the Condensed Consolidated Financial Statements appearing in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Key Business Metrics

As a leading manager of providers of GPR card programs and related alternative financial services to underbanked consumers, we evaluate a number of business metrics to monitor our performance and manage our business. We believe the following metrics are the primary indicators of our performance.

Number of Active Cards - represents the total number of GPR cards that have had a PIN or signature-based purchase transaction, a point-of-sale load transaction or an ATM withdrawal within three months of the date of determination. The programs we manage had approximately 3,158,000 and 2,350,000 active cards as of March 31, 2013 and 2012, respectively.


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Number of Active Cards with Direct Deposit - represents the number of active cards that have had a direct deposit load within the three months of the date of determination. We managed 1,708,000 and 1,025,000 direct deposit active cards as of March 31, 2013 and 2012, respectively. Our strategy is to focus on increasing the number of cards that receive direct deposits because cardholders who use direct deposit generate more revenue for us than those who do not. Additionally, consumers who receive direct deposits tend to remain in our programs longer than non-direct deposit cardholders.

Percentage of Active Cards with Direct Deposit - represents the percentage of active GPR cards that have had a direct deposit load within three months of the date of determination. The percentage of active cards that were direct deposit active cards as of March 31, 2013 and 2012 was approximately 54% and 44%, respectively.

Gross Dollar Volume ("GDV") - represents the total dollar volume of debit transactions and cash withdrawals made using the GPR cards we manage. Our gross dollar volume, also known in the industry as purchase volume, was $5.4 billion and $3.8 billion for the three months ended March 31, 2013 and 2012, respectively. Approximately 86.8% and 82.2% of the gross dollar volume for the three months ended March 31, 2013 and 2012, respectively, was made using active cards with direct deposit.

Non-GAAP Financial Metrics

Adjusted EBITDA - We use a non-GAAP financial metric that we label "Adjusted EBITDA" to evaluate our financial performance. We compute Adjusted EBITDA by adjusting net income or net loss to remove the effect of income and expenses related to interest, taxes, depreciation and amortization ("EBITDA") and then adjusting for stock-based compensation and non-recurring gains and losses. We believe that Adjusted EBITDA is an important metric for the following reasons:

It provides a meaningful comparison of our operating results over several periods because it removes the impact of income and expense items that are not a direct result of our core operations, such as goodwill and intangible impairments, legal settlements and one-time settlement gains, losses on the early extinguishment of long-term debt and other infrequent losses;

We use it as a tool to assist in our planning for the effect of strategic operating decisions and for the prediction of future operating results; and

We use it to evaluate our capacity to incur and service debt, fund capital expenditures and expand our business.

Adjusted Net Income - In addition to Adjusted EBITDA, we use a second non-GAAP financial metric that we label "Adjusted Net Income" to evaluate our financial performance. We compute Adjusted Net Income by adjusting net income or net loss to remove tax-effected amortization expense, stock-based compensation and other non-recurring gains and losses. We believe that Adjusted Net Income is an important metric that is useful to our board of directors, management and investors for the following reasons:

Assets being depreciated will often have to be replaced in the future and Adjusted EBITDA does not reflect any expenditure for these items;


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Adjusted EBITDA does not reflect the interest expense or the payments necessary to service interest payments on our debt;

Adjusted Net Income provides a meaningful comparison of our operating results over several periods because it removes the impact of income and expense items that are not a direct result of our core operations, such as goodwill and intangible impairments, legal settlements and one-time settlement gains, losses on the early extinguishment of long-term debt and other infrequent losses;

Adjusted Net Income per share on a diluted basis functions as a threshold target for our company-wide employee bonus compensation; and

We believe Adjusted Net Income measurements are used by investors as a supplemental measure to evaluate the overall operating performance of companies in our industry.

By providing these non-GAAP financial measures, together with the reconciliations below, we believe we are enhancing investors' understanding of our business and our results of operations, as well as assisting investors in evaluating how well we are executing strategic initiatives. Our Adjusted EBITDA and Adjusted Net Income are not necessarily comparable to what other companies define as Adjusted EBITDA and Adjusted Net Income. In addition, Adjusted EBITDA and Adjusted Net Income are not measures defined by U.S. GAAP and should not be considered as substitutes for or alternatives to net income, operating income, cash flows from operating activities or other financial information as determined by U.S. GAAP. Our presentation of Adjusted EBITDA and Adjusted Net Income should not be construed as an implication that our future results will be unaffected by unusual or non-recurring items.

The following is a reconciliation of our net income (loss) for the three months ended March 31, 2013 and 2012 to Adjusted EBITDA.

                                        Three Months Ended
                                             March 31,
                                         2013            2012
                                     (in thousands of dollars)

Net income (loss)                  $         11,290    $  (5,788 )

Interest income                                 (31 )        (36 )
Interest expense                                722          720
Income tax expense (benefit)                  6,351       (3,860 )
Depreciation and amortization                 3,778        3,781
EBITDA                                       22,110       (5,183 )

Stock-based compensation expense              3,051        2,990
Other losses and expenses                     2,704       25,315
Adjusted EBITDA                    $         27,865    $  23,122


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Other losses and expenses of $2.7 million in the three months ended March 31, 2013 primarily related to accruals associated with the anticipated transaction with TSYS. Other losses and expenses of $25.3 million in the three months ended March 31, 2012 primarily related to accruals for legal contingencies.

The following is a reconciliation of our net income (loss), the most comparable GAAP measure, for the three months ended March 31, 2013 and 2012 to Adjusted Net Income.

                                               Three Months Ended
                                                   March 31,
                                             2013                 2012
                                        (in thousands of dollars, except
                                        percentages and per share data)

Net income (loss)                    $             11,290    $       (5,788 )

Stock-based compensation expense                    3,051             2,990
Amortization of intangibles                           590               881
Other losses and expenses                           2,704            25,315
Total pre-tax adjustments                           6,345            29,186

Tax rate                                             36.0 %            40.0 %
Tax adjustment                                      2,284            11,674

Adjusted net income                  $             15,351    $       11,724

Adjusted net income per share: (1)
Basic                                $               0.22    $         0.15
Diluted                              $               0.19    $         0.13



(1) Diluted share counts used in the computation of adjusted net income per share for the three months ends March 31, 2012 are approximately 87.3 million shares compared to approximately 76.5 million shares used in the computation of GAAP diluted earnings per share. The GAAP diluted shares outstanding excludes the potential dilutive impact of 12.3 million options, 0.9 million shares of restricted stock and 0.7 million shares of series A convertible preferred stock which are considered to be anti-dilutive.

Other losses and expenses of $2.7 million in the three months ended March 31, 2013 primarily related to accruals associated with the anticipated transaction with TSYS. Other losses and expenses of $25.3 million in the three months ended March 31, 2012 primarily related to accruals for legal contingencies.

Operating Revenues

Our operating revenues primarily consist of a portion of the service fees and interchange revenues received by our Issuing Banks in connection with the programs we manage.

Cardholders are charged fees in connection with our programs, as follows:


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Transactions - Cardholders are typically charged a fee for each PIN and signature-based purchase transaction made using their GPR cards, unless the cardholder is on a monthly or annual service plan, in which case the cardholder is instead charged a monthly or annual subscription fee, as applicable. Cardholders are also charged fees for ATM withdrawals and other transactions conducted at ATMs.

Customer Service and Maintenance - Cardholders are typically charged fees for balance inquiries made through our call centers. Cardholders are also charged a monthly maintenance fee after a specified period of inactivity.

Additional Products and Services - Cardholders are charged fees associated with additional products and services offered in connection with certain of our cards, including the use of overdraft features, a variety of bill payment options, custom card designs and card-to-card transfers of funds initiated through our call centers.

Other - Cardholders are charged fees in connection with the acquisition and reloading of our GPR cards at distributors and we receive a portion of these amounts in some cases.

Revenue resulting from the service fees charged to our cardholders described above is recognized when the fees are charged because the earnings process is substantially complete, except for revenue resulting from the initial activation of our cards and annual subscription fees. Revenue resulting from the initial activation of our cards is recognized ratably, net of commissions paid to our distributors, over the average account life. Revenue resulting from annual subscription fees is recognized ratably over the annual period to which the fees relate.

Our revenues also include fees charged in connection with program management and processing services we provide for private-label programs. Revenue resulting from these fees is recognized when we have fulfilled our obligations under the underlying service agreements.

We earn revenues from a portion of the interchange fees paid by merchants when cardholders make purchase transactions using their cards. Subject to applicable law, interchange fees are fixed by the card associations and network organizations (the "Networks"). Interchange revenues are recognized net of sponsorship, licensing and processing fees charged by the Networks for services they provide in processing transactions routed through them. Interchange revenue is recognized during the period that the related purchase transactions occur. Also included in interchange revenue are fees earned from branding agreements with the Networks.

Our quarterly operating revenues fluctuate as a result of certain seasonal factors. The most significant increases in the number of our active cards and our GDV typically occur in the first three months of each year as a result of consumers acquiring new cards and loading them with their tax refunds. This seasonal variance became more pronounced in 2013 due to our agreement with Intuit, Inc. ("Intuit") pursuant to which we provide the only GPR card that can be ordered through the use of its TurboTax software. We began marketing cards under this program in early 2013.

Operating Expenses

We classify our operating expenses into the following categories:

Direct Operating Costs - Direct operating costs consist primarily of the commissions we pay to members of our distribution and reload network for their services, ATM processing fees, card supply


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costs, costs for fraud and other losses related to the card programs we manage, customer verification costs, customer service costs and fees paid to our Issuing Banks. These costs are driven by transaction volumes and the number of active cards.

Salaries, Benefits and Other Personnel Costs - Salaries, benefits and other personnel costs consist of the compensation costs associated with our employees, including base salaries, benefits, bonus compensation and stock-based compensation. This excludes any personnel costs associated with customer service personnel. Costs associated with these employees are included in direct operating costs.

Advertising, Marketing and Promotion Costs - Advertising, marketing and promotion costs primarily consist of the costs of our efforts to market the products we manage to potential cardholders including direct mailings, internet and television advertising, promotional events run in conjunction with our distributors, conferences, trade shows and the creation of marketing collateral and other materials.

Other General and Administrative Costs - Other general and administrative costs primarily consist of costs for legal, accounting, information technology, travel, facility and other corporate expenses.

Depreciation and Amortization - Depreciation and amortization consists of depreciation of our long-lived assets and amortization of finite-lived intangibles.

Other losses and expenses - Other losses and expenses consist of legal contingencies, accruals associated with the anticipated transaction with TSYS and other infrequent losses.

Other Income (Expense)

Other income (expense) primarily consists of interest income and interest expense. Interest income represents interest we receive on our cash and cash equivalents. Interest expense is associated with our long-term debt and capital leases.

Income Tax Expense (Benefit)

Income tax expense (benefit) primarily consists of corporate income taxes on our profits (losses).


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