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EGOV > SEC Filings for EGOV > Form 10-Q on 7-May-2013All Recent SEC Filings

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Form 10-Q for NIC INC


7-May-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTION ABOUT FORWARD-LOOKING STATEMENTS

Statements in this Quarterly Report on Form 10-Q regarding NIC Inc. and its subsidiaries (the "Company", "NIC", "we" or "us") and its business, which are not current or historical facts, are "forward-looking statements" that involve risks and uncertainties. Forward-looking statements include, but are not limited to, statements of plans and objectives, statements of future economic performance or financial projections, statements regarding the planned implementation of new portal contracts, statements of assumptions underlying such statements, and statements of the Company's or management's intentions, hopes, beliefs, expectations, or predictions of the future. For example, statements like we "expect," we "believe," we "plan," we "intend," or we "anticipate" are forward-looking statements. Investors should be aware that our actual operating results and financial performance may differ materially from our expressed expectations because of risks and uncertainties about the future including those risks discussed in this Quarterly Report on Form 10-Q and in our 2012 Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC") on February 28, 2013.

There are a number of important factors that could cause actual results to differ materially from those suggested or indicated by such forward-looking statements. These include, among others, NIC's ability to successfully integrate into its operations recently awarded eGovernment contracts; NIC's ability to implement its new portal contracts in a timely and cost-effective manner; NIC's ability to successfully increase the adoption and use of eGovernment services; the possibility of reductions in fees or revenues as a result of budget deficits, government shutdowns, or changes in government policy; the success of the Company in renewing existing contracts and in signing contracts with new states and federal government agencies; continued favorable government legislation; NIC's ability to develop new services; existing states and agencies adopting those new services; acceptance of eGovernment services by businesses and citizens; competition; the possibility of security breaches through cyber attacks; and general economic conditions and the other factors discussed under "CAUTIONS ABOUT FORWARD LOOKING STATEMENTS" in Part I and "RISK FACTORS" in Part I, Item 1A of NIC's 2012 Annual Report on Form 10-K filed on February 28, 2013 with the SEC. Investors should read all of these discussions of risks carefully.

All forward-looking statements made in this Form 10-Q speak only as of the date of this report. We will not necessarily update the information in this Form 10-Q if any forward-looking statement later turns out to be inaccurate. Investors are cautioned not to put undue reliance on any forward-looking statement.


WHAT WE DO - AN EXECUTIVE SUMMARY

We are a leading provider of eGovernment services that help governments use the Internet to reduce internal costs, increase efficiencies, and provide a higher level of service to businesses and citizens. We accomplish this currently through two channels: our primary outsourced portal businesses and our software & services businesses.

In our primary outsourced portal business, we generally enter into contracts primarily with state and local governments to design, build, and operate Internet-based enterprise-wide portals on their behalf. We typically enter into multi-year contracts and manage operations for each government partner through separate local subsidiaries that operate as decentralized businesses with a high degree of autonomy. Our portals consist of websites and applications that we build, which allow businesses and citizens to access government information through multiple online channels, including mobile, and complete secure transactions, including applying for a permit, retrieving government records, or filing a government-mandated form or report. We help increase our government partners' revenues by expanding the distribution of their information assets and increasing the number of financial transactions conducted with governments. We do this by marketing portal services and soliciting users to complete government-based transactions and to enter into subscriber contracts that permit users to access the portal and the government information contained therein in exchange for transactional and/or subscription user fees. We are typically responsible for funding up-front investment and ongoing operations and maintenance costs of the government portals. Our unique self-funded business model allows us to generate revenues by sharing in the fees collected from eGovernment transactions. Our partners benefit because they reduce their financial and technology risks, increase their operational efficiencies, and gain a centralized, customer-focused presence on the Internet, while businesses and citizens gain a faster, more convenient, and more cost-effective means to interact with governments.

On behalf of our government partners, we enter into separate agreements with various agencies and divisions of the government to provide specific services and to conduct specific transactions. These agreements preliminarily establish the pricing of the electronic transactions and data access services we provide and the division of revenues between the Company and the government agency. The government oversight authority must approve prices and revenue sharing agreements. We have limited control over the level of fees we are permitted to retain. Any changes made to the amount or percentage of fees retained by us, or to the amounts charged for the services offered, could materially affect the profitability of the respective contract to us. We typically own all the intellectual property in connection with the applications developed under these contracts. After completion of the initial contract term, the government partner typically receives a perpetual, royalty-free license to use the software only in its own portal. However, certain customer management, billing and payment processing software applications that we have developed and standardized centrally and that are utilized by our portal businesses, are being provided to an increasing number of our government partners on a software-as-a-service, or "SaaS," basis, and thus would not be included in any royalty-free license. If our contract was not renewed after a defined term, the government agency would be entitled to take over the portal in place with no future obligation of the Company, except as otherwise provided in the contract and except for the services we provide on a SaaS basis, which would be available to our partners on a fee-for-service basis. We also provide certain payment processing services on a SaaS basis to a few private sector companies and non-NIC portal states, and may continue to market these services to other entities in the future. Historically, however, revenues from these services have not been significant. In some cases, we enter into contracts to provide consulting, application development and portal management services to governments in exchange for an agreed-upon fee.

Any renewal of the outsourced portal contracts beyond the initial term is optional and a government may terminate its contract prior to the expiration date upon specific cause events that are not cured within a specified period. In addition, 15 contracts under which we provide outsourced state portal services can be terminated without cause on a specified period of notice. Collectively, revenues generated from these contracts represented 57% of our total consolidated revenues for the three-month period ended March 31, 2013. In the event that any of these contracts is terminated without cause, the terms of the respective contract may require the government to pay a fee to us in order to continue to use our software in its portal. In addition, the loss of one or more of our larger state portal partners, such as Arkansas, Colorado, Indiana, Montana, New Jersey, Pennsylvania, Tennessee, Texas, or Utah, as a result of the expiration, termination or failure to renew the respective contract, if such partner is not replaced, could significantly reduce our revenues and profitability. See the discussion below regarding the expiration of contracts with the Commonwealth of Virginia and the state of Arizona.

In our software & services businesses, the majority of our revenues are generated from contracts with two federal agencies to provide outsourced services through our NIC Technologies subsidiary. NIC Technologies has a contract with the Federal Motor Carrier Safety Administration ("FMCSA") to develop and manage the FMCSA's Pre-Employment Screening Program ("PSP") for motor carriers nationwide, using the self-funded, transaction-based business model. During the first quarter of 2013, the FMCSA exercised the third of its four one-year renewal options for the PSP contract, extending its term through February 16, 2014. NIC Technologies also designs and develops online campaign expenditure and ethics compliance systems for state and federal government agencies through its contracts with the state of Michigan and the Federal Election Commission ("FEC"). The contract with the state of Michigan expires on June 30, 2013. The contract with the FEC will expire on May 31, 2013 and we do not currently expect to provide services after this date.


Any renewal of these software & services contracts beyond the initial term is optional and a government agency may terminate its contract prior to the expiration date upon specific cause events that are not cured within a specified period. The contract with the FMCSA can be terminated by the other party without cause on a specified period of notice. The loss of the contract with the FMCSA, as a result of the expiration, termination, or failure to renew the contract, if not replaced, could significantly reduce our revenues and profitability. In addition, we have limited control over the level of fees we are permitted to retain under the contract with the FMCSA. Any changes made to the amount or percentage of fees retained by us, or to the amounts charged for the services offered, could materially affect the profitability of this contract to us.

As of March 31, 2013, there were 13 contracts under which the Company provides outsourced portal services or software development and services that have expiration dates within the 12-month period following March 31, 2013. Collectively, revenues generated from these contracts represented 21% of the Company's total consolidated revenues for the three-month period ended March 31, 2013. As described above, if a contract is not renewed after a defined term, the government partner would be entitled to take over the portal in place with no future obligation of the Company, except as otherwise provided in the contract and except for the services the Company provides on a SaaS basis, which would be available to the government agency on a fee-for-service basis.

The contract under which the Company's subsidiary, Virginia Interactive, LLC ("VI"), provided outsourced portal services to agencies of the Commonwealth of Virginia, expired on August 31, 2012. As more fully disclosed in a Form 8-K filed by the Company with the SEC on April 18, 2012, VI chose not to agree to terms mandated by the Commonwealth of Virginia for a new contract. Beginning September 1, 2012, VI began providing transition services as required by the contract, and may do so for up to one year following the contract expiration to the extent requested by agencies of the Commonwealth of Virginia. During the second quarter of 2013, VI signed an agreement with a state agency to provide eGovernment services for an additional 18 months. The Company has evaluated the costs which may be incurred in transitioning out of VI's contract with the Commonwealth of Virginia, including employee retention bonuses, operating lease termination costs, and fixed asset impairment, which are not expected to have a material impact on the Company's consolidated results of operations, cash flows, or financial condition. For the three-month period ended March 31, 2013, revenues from the Virginia portal contract accounted for approximately 2% of the Company's total consolidated revenues.

The contract under which the Company's subsidiary, NICUSA, Inc. ("NICUSA"), provides outsourced portal services to agencies of the state of Arizona expires on June 26, 2013. NICUSA chose not to respond to a request for proposal issued by the state of Arizona for a new contract. Beginning June 27, 2013, NICUSA expects to begin providing transition services as required by the contract, and may do so for a period of time following the contract expiration to the extent requested by agencies of the state of Arizona. The Company has evaluated the costs which may be incurred in transitioning out of NICUSA's contract with the state of Arizona, including employee retention bonuses, operating lease termination costs, and fixed asset impairment, which are not expected to have a material impact on the Company's consolidated results of operations, cash flows, or financial condition. For the three-month period ended March 31, 2013, revenues from the Arizona portal contract accounted for approximately 1% of the Company's total consolidated revenues.

REVENUE RECOGNITION

We classify our revenues and cost of revenues into two categories: (1) portal and (2) software & services. The portal category includes revenues and cost of revenues primarily from our subsidiaries operating state and local government portals on an enterprise-wide outsourced basis. The software & services category primarily includes revenues and cost of revenues from our subsidiaries that provide software development and services, other than enterprise-wide outsourced portal services, to state and local governments as well as federal agencies. We currently earn revenues from three main sources: transaction-based fees, time and materials-based fees for application development, and fixed fees for portal management services. Each of these revenue types and the corresponding business models are further described below.

Our outsourced portal businesses

We categorize our portal revenues according to the underlying source of revenue. A brief description of each category follows:

? DMV transaction-based: these are transaction fees for providing electronic access to motor vehicle driver history records, referred to as DMV records, from our state portals to data resellers, insurance companies, and other pre-authorized customers on behalf of our state partners, and are generally recurring.

? Non-DMV transaction-based: these are transaction fees from sources other than electronic access to DMV records, for transactions conducted by business users and consumer users through our portals, and are generally recurring. For a representative listing of non-DMV services we currently offer through our portals, refer to Part I, Item 1 in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on February 28, 2013.

? Portal software development: these are revenues from the performance of application development projects and other time and materials services for our government partners. While we actively market these services, they do not have the same degree of predictability as our transaction-based or portal management revenues. As a result, these revenues are excluded from our recurring portal revenue percentage.


? Portal management: these are revenues from the performance of fixed fee portal management services for our government partners in the states of Arizona, Indiana, and Delaware and are generally recurring.

Our software & services businesses

NIC Technologies currently derives a significant portion of its revenues from its contract with the FMCSA to develop and manage the PSP for motor carriers nationwide, using a self-funded, transaction-based business model. NIC Technologies recognizes revenues from this contract (primarily transaction-based information access fees) when the services are provided. NIC Technologies also derives a portion of its revenues from fixed fee and time and materials application development and outsourced maintenance contracts with the FEC and the state of Michigan and recognizes revenues as services are provided.

CRITICAL ACCOUNTING POLICIES

There have been no material changes in our critical accounting policies from the information provided under "Critical Accounting Policies" in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," included in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on February 28, 2013.

RESULTS OF OPERATIONS

The following discussion summarizes the significant factors affecting operating
results for the three-month periods ended March 31, 2013 and 2012. This
discussion and analysis should be read in conjunction with our unaudited interim
consolidated financial statements and the related notes included in this Form
10-Q.

                                                                     Three months ended
                                                                          March 31,
Key Financial Metrics                                             2013                2012
Revenue growth - outsourced portals                                     27 %                13 %
Same state revenue growth - outsourced portals                          16 %                10 %
Recurring portal revenue as a % of total portal revenues                96 %                92 %
Gross profit % - outsourced portals                                     44 %                37 %
Revenue growth - software & services                                     5 %                27 %
Gross profit % - software & services                                    65 %                68 %
Selling & administrative expenses as a % of total revenues              16 %                16 %
Operating income margin % (operating income as a % of total
revenues)                                                               26 %                20 %

PORTAL REVENUES. In the analysis below, we have categorized our portal revenues according to the underlying source of revenue (in thousands), with the corresponding percentage increase or decrease from the prior year period.

                                    Three months ended March 31,
Portal Revenue Analysis          2013           % Change         2012
DMV transaction-based         $    22,762              31 %    $ 17,419
Non-DMV transaction-based          30,170              35 %      22,312
Portal software development         2,545             (30 %)      3,631
Portal management                   2,565               9 %       2,350
Total                         $    58,042              27 %    $ 45,712

Portal revenues in the current quarter increased 27%, or approximately $12.3 million, over the prior year quarter. Of this increase, (i) 16%, or approximately $7.3 million, was attributable to an increase in same state portal revenues (portals in operation and generating revenues for two full periods); and (ii) 11%, or approximately $5.0 million, was attributable to increases from our newer portals, including Pennsylvania, which began to generate revenues in January 2013; Oregon, which began to generate revenues in June 2012; and Maryland, which began generating revenues in May 2012.

Same state portal revenues in the current quarter increased 16% over the prior year quarter primarily due to increased revenues from our Texas, New Jersey, Mississippi, Montana, and Colorado portals, among others. Our same state revenue growth in the current quarter was higher than the 10% revenue growth we achieved in the prior year quarter due mainly to higher same state non-DMV transaction-based revenues and, to a lesser extent, same state DMV transaction-based revenues, which were partially offset by lower portal software development revenues. Same state non-DMV transaction-based revenues increased 35% in the current quarter due to strong performance from several key services, including tax filings, motor vehicle registrations and the motor vehicle inspection service for the Texas Department of Public Safety ("DPS") as part of the DPS Direct suite of services that we are implementing for the DPS. Same state non-DMV transaction-based revenue growth was 21% in the prior year quarter. Same state DMV revenue growth was 2% in the current quarter compared to flat growth in the prior year quarter. Our same state portal software development revenues decreased 30% in the current quarter, which was primarily due to the expiration of certain Master Work Order projects in Texas on August 31, 2012.


COST OF PORTAL REVENUES. In the analysis below, we have categorized our cost of portal revenues between fixed and variable costs (in thousands), with the corresponding percentage increase or decrease from the prior year period. Fixed costs include costs such as employee compensation (including stock-based compensation), subcontractor labor costs, telecommunication, and all other costs associated with the provision of dedicated client service such as dedicated facilities. Variable costs consist of costs that vary with our level of portal revenues and primarily include bank fees required to process credit/debit card and automated clearinghouse transactions and, to a lesser extent, costs associated with revenue share arrangements with our state partners.

                                       Three months ended March 31,
Cost of Portal Revenue Analysis      2013            % Change      2012
Fixed costs                       $    20,860             12 %   $ 18,649
Variable costs                         11,902             18 %     10,102
Total                             $    32,762             14 %   $ 28,751

Cost of portal revenues for the current quarter increased 14%, or approximately $4.0 million, over the prior year quarter. Substantially all of the increase, or approximately $3.9 million, was attributable to an increase in same state cost of portal revenues; and approximately $0.1 million was attributable to our newer portals in Pennsylvania, Oregon, and Maryland. The prior year quarter included start-up costs of approximately $1.8 million in our Oregon and Maryland portals, which had not yet begun generating revenues.

The increase in same state cost of portal revenues in the current quarter was partially attributable to higher employee compensation and benefit costs across various portals and certain costs related to, in part, the motor vehicle inspection service as part of the DPS Direct suite of services we are implementing in Texas. In addition, the increase in the current quarter was partially attributable to an increase in variable fees to process credit/debit card transactions, due mainly to higher transaction volumes from our portals in New Jersey, Texas and Colorado, among others. A significant percentage of our non-DMV transaction-based revenues are generated from online applications whereby users pay for information or transactions via credit/debit cards. We typically earn a percentage of the credit/debit card transaction amount, but also must pay an associated interchange fee to the bank that processes the credit/debit card transaction. We earn a lower gross profit percentage on these transactions as compared to our other non-DMV applications. However, we plan to continue to implement these services as they contribute favorably to our operating income growth.

Our portal gross profit percentage was 44% for the current quarter, up from 37% in the prior year quarter, due mainly to higher revenues from our newer portals in Pennsylvania, Oregon and Maryland in the current quarter and higher start-up costs from our Oregon portal in the prior year quarter, as discussed above. We currently expect to expand our operations in newer portal states, particularly Pennsylvania, and increase capital expenditures and staffing levels over the remainder of 2013, which will increase costs and lower our portal gross profit percentage. We carefully monitor our portal gross profit percentage to strike the balance between generating a solid return for our stockholders and delivering value to our government partners through reinvestment in our portal operations (which we believe also benefits our stockholders).

SOFTWARE & SERVICES REVENUES. In the analysis below, we have categorized our software & services revenues by business (in thousands), with the corresponding percentage increase or decrease from the prior year period.

                                            Three months ended March 31,
Software & Services Revenue Analysis      2013            % Change     2012
NIC Technologies                       $     2,726             4 %    $ 2,615
Other                                          456            10 %        416
Total                                  $     3,182             5 %    $ 3,031

Software & services revenues in the current quarter increased 5%, or approximately $0.2 million, over the prior year quarter. The increase was primarily due to higher revenues from our contract with the FMCSA ($0.3 million) as a result of increased adoption of the PSP, and was partially offset by lower revenues from our contract with the FEC ($0.1 million).

COST OF SOFTWARE & SERVICES REVENUES. Cost of software & services revenues in the current quarter increased 15%, or $0.1 million, over the prior year quarter. Our software & services gross profit percentage was 65% in the current quarter, down from 68% in the prior year quarter. The decrease was primarily due to lower revenues from our contract with the FEC in the current quarter.


SELLING & ADMINISTRATIVE. Selling & administrative expenses in the current quarter increased 21%, or approximately $1.7 million, over the prior year quarter. In the current quarter, we incurred approximately $1.8 million of legal fees and other third-party costs related to the previously disclosed SEC matter. These expenses were reduced by approximately $1.4 million of reimbursement by the Company's directors' and officers' liability insurance carrier that we expect to collect subsequent to March 31, 2013, resulting in a net expense of approximately $0.4 million related to the SEC matter. In the prior year quarter, we incurred approximately $0.8 million in legal fees and other third-party costs related to the SEC matter. These expenses were reduced by approximately $0.7 million of reimbursement from our directors' and officers' liability insurance carrier, resulting in a net expense of approximately $0.1 million related to the SEC matter.

We expect to continue to incur obligations to advance legal fees and other expenses to our Chief Financial Officer in connection with the previously disclosed civil action by the SEC against him. We are not a party to the civil action, but are obligated to provide indemnification in certain circumstances (including advancing certain defense costs) to our Chief Financial Officer in accordance with our certificate of incorporation and bylaws and our indemnification agreement with him. In addition, we expect to continue to incur costs responding to subpoenas and other discovery requests relating to the civil action. Our directors' and officers' liability insurance carrier has agreed to reimburse us for certain reasonable costs of defense advanced by us to our Chief Financial Officer in the SEC civil action. Because we are not directly involved . . .

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