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ONE > SEC Filings for ONE > Form 10-Q on 8-Aug-2014All Recent SEC Filings

Show all filings for HIGHER ONE HOLDINGS, INC.

Form 10-Q for HIGHER ONE HOLDINGS, INC.


8-Aug-2014

Quarterly Report


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

The information contained in this section should be read in conjunction with our audited consolidated financial statements and related notes as included in our annual report on Form 10-K for the year ended December 31, 2013 and information contained elsewhere in such annual report on Form 10-K and in this quarterly report on Form 10-Q. The discussion contains forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995) involving risks, uncertainties and assumptions that could cause our results to differ materially from expectations. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believes," "anticipates," "plans," "expects," "should" and similar expressions are intended to identify forward-looking statements. Factors that might cause these differences include those described under "Risk Factors" and elsewhere in the annual report on Form 10-K and in this quarterly report on Form 10-Q. The forward-looking statements included in this quarterly report on Form 10-Q are made only as of the date of this report. We do not undertake any obligation to update or supplement any forward-looking statements to reflect subsequent events or circumstances, except as required by law. We cannot assure you that projected results will be achieved or that anticipated events will occur.

Overview General

Based on market share and the number of campuses using our products and services, we believe we are a leading provider of technology-based refund disbursement, payment processing and data analytics services to higher education institutions and their students. We believe that none of our competitors match our ability to provide solutions for higher education institutions' financial services needs, including compliance monitoring. Consequently, we provide the most comprehensive suite of disbursement and payment solutions specifically designed for higher education institutions and their students. We also provide campus communities with convenient, cost-competitive and student-oriented banking services, which include extensive user-friendly features.

Our products and services for our higher education institution clients include our Refund Management service, our Payment Processing suite, and our Educational Services suite. Through our bank partners, we offer the OneAccount, which includes an FDIC-insured checking account, a debit MasterCard® ATM card and other retail banking services, to the students of our higher education institution clients that use our Refund Management service.

As of June 30, 2014, more than 800 campuses serving approximately 5.1 million students purchased our Refund Management service. In total, there are more than 1,900 campuses servicing nearly 13 million students contracted to use at least one of our services. As of June 30, 2014 we also serviced approximately 2.1 million OneAccounts.

Our revenue fluctuates as a result of seasonal factors related to the academic year. A large portion of our revenue is either directly or indirectly dependent on academic financial aid received by students and in turn the number of students enrolled at our higher education institution clients. Higher education institutions typically disburse financial aid refunds to students at the start of each academic term. Distribution of financial aid disbursements through our Refund Management service (1) indirectly generates revenue through deposits of financial aid into OneAccounts, which generates account revenue, and (2) directly generates revenue through our higher education institution clients' use of the Refund Management service, which generates higher education institution revenue.

While revenue fluctuates over the course of our fiscal year, many of our expenses remain relatively constant, resulting in disparities in our net income and adjusted net income from quarter to quarter. Typically, the second quarter accounts for the smallest proportion of our revenues. This is primarily because the majority of financial aid is disbursed outside of this time period and higher education institutions tend to enroll more new students during the first and third fiscal quarters. We expect this trend to continue going forward.

Department of Education

In early 2014, the Department of Education, or ED, formed a negotiated rulemaking committee. Our Chief Operating Officer was selected by ED to serve on the committee as a primary negotiator. The committee convened in February, March, April and May of 2014 to discuss and work toward revising existing regulations to potentially address, among other things, consumer safeguards regarding debit and prepaid cards associated with Title IV credit balance disbursements (including fees associated with such debit and prepaid cards), marketing of financial products (including sending unsolicited cards to students and co-branding of the card and materials) by institutions and their preferred banks or contractors, ATM access and availability, revenue sharing arrangements, and the potential for a government-sponsored debit or prepaid card solution. The negotiated rulemaking committee concluded its efforts in May 2014 and a consensus was not reached on any proposed regulations. As a result, ED will draft proposed regulations to publish in the Federal Register. If the proposed regulations are published by November 1, 2014, the earliest such regulations may take effect is July 1, 2015.


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Regulatory Matters

As previously disclosed, the Federal Reserve Bank of Chicago notified us and a former bank partner of potential violations of the Federal Trade Commission Act relating to marketing and disclosure practices related to the OneAccount during the period it was offered by such former bank partner. On May 9, 2014, the Federal Reserve Banks of Chicago (the responsible Reserve Bank for a former bank partner) and Philadelphia (the responsible Reserve Bank for a current bank partner) notified us that the staff of the Board of Governors of the Federal Reserve System intended to recommend that the Board of Governors of the Federal Reserve System, or the Board of Governors, seek an administrative order against us with respect to asserted violations of the Federal Trade Commission Act. The cited violations relate to our activities with both a former and current bank partner and our marketing and disclosure practices related to the process by which students may select the OneAccount option for financial aid refund. We are in discussions with the Staff of the Board of Governors and the Reserve Banks on this matter. The Staff of the Board of Governors has asserted that any administrative order may seek damages, including customer restitution and civil money penalties, totaling as much as $35 million, and changes to certain of our business practices.

Approximately 55% of the OneAccounts are held at our bank partner regulated by the FDIC and we will need to consider voluntarily providing restitution to those OneAccounts held at that bank partner. In the event we do provide restitution to these OneAccounts on the same basis as an order from the Board of Governors, it is reasonably possible that our loss related to this matter will increase accordingly and increase our total exposure by an additional amount of approximately $35 million, or approximately $70 million in total.

During the quarter ended June 30, 2014, we recorded a liability of $8.75 million related to this matter, which is shown as a reduction of revenue on our consolidated statement of operations. While we believe that it is probable that we will have a loss related to this regulatory matter, in view of the inherent difficulty of predicting the outcomes of regulatory matters, we cannot predict the eventual outcome of this pending matter, the timing of the ultimate resolution of this matter or an exact amount of loss associated with this matter. The liability recorded at June 30, 2014 reflects the minimum amount we expect to pay related to this matter, although, there is a reasonable possibility that the liability will increase in future periods. Although the ultimate amount of restitution or civil money penalties are subject to many uncertainties and therefore impossible to predict, it is possible the amounts could reach levels that would cause an event of default under our Credit Facility. As disclosed in "Note 5 - Credit Facility" of our condensed consolidated financial statements, our EBITDA, as defined in the Credit Facility, as of June 30, 2014 for the trailing twelve months was $52.0 million, which exceeds the required minimum EBITDA required in our credit agreement by $2.0 million. In addition, a settlement with regulatory authorities in an amount exceeding $10 million could trigger a material adverse change or cause a default under other covenants in our Credit Facility.

We believe that our cash flows from operations, together with our existing liquidity sources, will be sufficient to fund our operations and anticipated capital expenditures over the next twelve months. However, we may be required to pay material customer restitution and civil money penalties related to certain regulatory proceedings as described above. Although the ultimate amounts of customer restitution or civil money penalties are subject to many uncertainties and therefore are impossible to predict, it is possible the amount we are required to pay could reach levels that would exceed our available cash flows from operations and existing liquidity sources available through our Credit Facility. In that case, we would seek additional forms of financing or other sources of liquidity to supplement our existing liquidity sources. There can be no assurances that such alternative forms of financing or other sources of liquidity would be available to us on favorable terms or at all.

It is possible the charge related to the regulatory proceedings described above could be of such a magnitude that it would cause an event of default under our Credit Facility. In the event of a default, depending on the amount of loss, we believe that we may be able to obtain relief under certain of our current covenants, however there can be no assurance we would receive such an amendment or waiver. If there is any event of default under our Credit Facility, all amounts then outstanding may be immediately due and payable. In such an event, we would need to seek alternative forms of financing or other sources of liquidity in order to repay the amounts outstanding under our Credit Facility, but there can be no assurances that such alternative forms of financing or other sources of liquidity would be available to us on favorable terms or at all.


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    Results of Operations for the Three Months Ended June 30, 2014 and 2013

The following tables summarize key components of our results of operations for
the periods indicated, both in dollars and as a percentage of total revenue:

                                                        Three Months Ended June 30,
                                                                (unaudited)
                                                                                     2014 % of        2013 % of
                                                                                       Gross            Gross
                             2014          2013        $ Change      % Change         Revenue          Revenue
                                      (in thousands)
Revenue:
Account revenue            $  26,345     $  25,944     $     401           1.5 %           57.9 %           64.8 %
Payment transaction
revenue                        9,835         6,086         3,749          61.6 %           21.6 %           15.2 %
Higher education
institution revenue            9,050         7,725         1,325          17.2 %           19.9 %           19.3 %
Other revenue                    247           268           (21 )        (7.8 %)           0.5 %            0.7 %
Gross revenue                 45,477        40,023         5,454          13.6 %          100.0 %          100.0 %
Less: allowance for
customer restitution          (8,750 )           -        (8,750 )       100.0 %          (19.2 %)           0.0 %
Revenue                       36,727        40,023        (3,296 )        (8.2 %)         100.0 %          100.0 %
Cost of revenue               21,102        17,894         3,208          17.9 %           46.4 %           44.7 %
Gross profit                  15,625        22,129        (6,504 )       (29.4 %)          34.4 %           55.3 %
Operating expenses:
General and
administrative                16,015        13,576         2,439          18.0 %           35.2 %           33.9 %
Product development            1,770         2,444          (674 )       (27.6 %)           3.9 %            6.1 %
Sales and marketing            4,705         4,632            73           1.6 %           10.3 %           11.6 %
Merger and acquisition
related                            -        (5,011 )       5,011        (100.0 %)           0.0 %          (12.5 %)
Total operating expenses      22,490        15,641         6,849          43.8 %           49.5 %           39.1 %
Income (loss) from
operations                    (6,865 )       6,488       (13,353 )      (205.8 %)         (15.1 %)          16.2 %
Interest income                   34            20            14          70.0 %            0.1 %            0.0 %
Interest expense                (792 )        (766 )         (26 )         3.4 %           (1.7 %)          (1.9 %)
Other income                   1,681            78         1,603       2,055.1 %            3.7 %            0.2 %
Net income (loss) before
income taxes                  (5,942 )       5,820       (11,762 )      (202.1 %)         (13.1 %)          14.5 %
Income tax expense
(benefit)                     (2,171 )       2,261        (4,432 )      (196.0 %)          (4.8 %)           5.6 %
Net income (loss)          $  (3,771 )   $   3,559     $  (7,330 )      (206.0 %)          (8.3 %)           8.9 %

Three Months Ended June 30, 2014 Compared to the Three Months Ended June 30, 2013

Revenue
Account Revenue
The increase in account revenue was primarily due to an approximate 5% increase in the total dollars deposited into OneAccounts compared to the same period in the prior year. The increase in dollars deposited led to a similar, though slightly smaller, increase in amounts spent from OneAccounts which had the effect of increasing both the interchange revenue and service fee revenue we earn when compared to the same period in the prior year. We believe that the increase in dollars deposited into the OneAccount was partially the result of timing shifts of when financial aid refunds were disbursed by our Refund Management clients as compared to the same period in the prior year. There were certain Refund Management clients that disbursed funds in the second quarter of 2014 which, in the prior year, disbursed such funds in the first quarter. In addition, slightly more than half of the increase in dollars deposited into OneAccounts was due to an increase in the amount of non-financial aid deposits made into OneAccounts. While our service fee revenue decreased as a result of a change we made to our account fee schedule during the second half of 2013, including the removal of a fee assessed to customers that had not repaid an overdraft balance within an allotted time period, the removal of this fee was offset by increases in amounts earned from other fees.

Payment Transaction Revenue
The majority of the increase in payment transaction revenue was due to the higher volume of transactions processed through the SmartPay payment module during the three months ended June 30, 2014, which led to increases in payment transaction revenue. The increase in payment transaction volume was primarily due to the introduction of Visa as a payment method for SmartPay through the end of the second quarter of 2013, which led to increases in payments processed at higher education institutions that were clients as of June 30, 2013. A portion of the increase in payment transaction revenue is also due to the addition of higher education institution clients that began utilizing the SmartPay payment module after June 30, 2013. The Campus Solutions business contributed approximately $2.1 million of payment transaction revenue during the three months ended June 30, 2014, an increase of $1.2 million compared to the three months ended June 30, 2013. The increase in revenue from the Campus Solutions business is primarily due to the inclusion of a full three months of revenue from that business in the current year.


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Higher Education Institution Revenue
The increase in higher education institution revenue was primarily due to an increase related to our Campus Labs business and also from revenue associated with the Campus Solutions business. The revenue associated with Campus Labs increased to $3.5 million during the three months ended June 30, 2014, compared to $2.5 million during the same period in the prior year. The increase in Campus Labs revenue was due to a combination of fair value adjustments to deferred revenue, which reduced revenue during the three months ended June 30, 2013, and year-over-year increases in higher education institution client billings. We also had an increase in revenue associated with subscription revenue for our payment processing products due to a combination of new client sales, as well as additional sales to existing schools.

Allowance for Customer Restitution
As further described in "Note 6 - Commitments and Contingencies" to our condensed consolidated financial statements and the "Regulatory Matters" section within "Management's Discussion and Analysis of Financial Condition and Results of Operations - Overview," we recorded a liability of $8.75 million during the quarter ended June 30, 2014, related to the potential requirement to provide restitution to certain OneAccount customers.

Cost of Revenue
During the three months ended June 30, 2014, our gross margin percentage decreased, largely as a result of the allowance for customer restitution described above. Excluding the impact of the allowance for customer restitution, our non-GAAP gross margin percentage would have been 53.6% during the three months ended June 30, 2014, compared to 55.3% in the comparable prior year period. The decrease in our non-GAAP gross margin percentage was primarily due to higher costs to support the ongoing Refund Management and OneAccount services, including an increase in the amount of cards sent to students at our Refund Management clients and also higher data processing costs.

The increase in our cost of revenue was primarily related to costs to support the growth in our SmartPay transaction volume, the inclusion of a full three months of expenses associated with the Campus Solutions business, and the increase in Refund Management and OneAccount costs described above.

General and Administrative Expense
The increase in general and administrative expenses was primarily attributable to the following three factors: (i) our personnel costs increased compared to the three months ended June 30, 2013, (ii) higher professional fees related to additional compliance and regulatory related activities, and, to a lesser extent, (iii) increases in depreciation and amortization.

Product Development Expense
The decrease in product development expense was due to a decrease in certain transition related product development expenses associated with the Campus Solutions acquisition compared to the prior year period. The decrease was also due to an increase, in 2014, of internal costs which are capitalized rather than expensed. These costs are related to internal use software development projects that have advanced beyond the preliminary project stage and have met the criteria for capitalization under U.S. GAAP.

Sales and Marketing Expense
The increase in sales and marketing expense was primarily due to an increase in amortization expense of acquired intangible assets from the Campus Solutions business. Excluding the increase in amortization, sales and marketing expense decreased compared to the three months ended June 30, 2013, including a decrease in tradeshow costs.

Merger and Acquisition Related
Our merger and acquisition related expenses during the three months ended June 30, 2013 included professional fees associated with the acquisition of the Campus Solutions business in May 2013 of approximately $0.3 million, and a fair value adjustment to the contingent consideration component of the purchase price of the Campus Labs acquisition from August 2012 which resulted in a net reduction in operating expenses. During the three months ended June 30, 2013, we recorded an adjustment of $5.3 million as a result of a change in the fair value of the contingent consideration liability. There were no such costs during the three months ended June 30, 2014.


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Interest Expense
Our interest expense increased compared to the prior period due to a small increase in the average amount outstanding on our Credit Facility. The average amount outstanding on our Credit Facility was $94.0 million during the three months ended June 30, 2014, compared to an average of $93.2 million during the three months ended June 30, 2013. The average interest rate during each of the three months ended June 30, 2014 and 2013 was 2.3%.

Other Income
Our other income increased during the three months ended June 30, 2014 by $1.6 million as a result of an agreement related to the resolution of certain escrow balances that were part of the acquisition of the Campus Solutions business.

Income Tax Expense
We recorded an income tax benefit during the three months ended June 30, 2014 as a result of our net loss before income taxes. The change in income tax expense (benefit) was primarily due to the decrease in net income before taxes. The effective tax rates for the three months ended June 30, 2014 and 2013 were 36.5% and 38.8%, respectively. Our effective tax rate is expected to be between 39% and 41% for the 2014 fiscal year. The increase in our expected effective rate from the rate disclosed in our most recent Form 10-Q and the increase in rate compared to the prior year period is primarily the result of the allowance for customer restitution described above, which results in lower pre-tax income and a larger relative impact related to permanent differences between book and tax income.

     Results of Operations for the Six Months Ended June 30, 2014 and 2013

The following tables summarize key components of our results of operations for
the periods indicated, both in dollars and as a percentage of total revenue:

                                                         Six Months Ended June 30,
                                                                (unaudited)
                                                                                     2014 % of        2013 % of
                                                                                       Gross            Gross
                             2014          2013        $ Change      % Change         Revenue          Revenue
                                      (in thousands)
Revenue:
Account revenue            $  68,007     $  69,307     $  (1,300 )        (1.9 %)          60.7 %           71.2 %
Payment transaction
revenue                       24,455        12,787        11,668          91.2 %           21.8 %           13.1 %
Higher education
institution revenue           19,029        14,866         4,163          28.0 %           17.0 %           15.3 %
Other revenue                    542           443            99          22.3 %            0.5 %            0.5 %
Gross revenue                112,033        97,403        14,630          15.0 %          100.0 %          100.0 %
Less: allowance for
customer restitution          (8,750 )           -        (8,750 )       100.0 %           (7.8 %)           0.0 %
Revenue                      103,283        97,403         5,880           6.0 %          100.0 %          100.0 %
Cost of revenue               48,696        40,194         8,502          21.2 %           43.5 %           41.3 %
Gross profit                  54,587        57,209        (2,622 )        (4.6 %)          48.7 %           58.7 %
Operating expenses:
General and
administrative                31,726        26,665         5,061          19.0 %           28.3 %           27.4 %
Product development            3,962         4,339          (377 )        (8.7 %)           3.5 %            4.5 %
Sales and marketing            9,179         7,839         1,340          17.1 %            8.2 %            8.0 %
Merger and acquisition
related                            -        (4,465 )       4,465        (100.0 %)           0.0 %           (4.6 %)
Total operating expenses      44,867        34,378        10,489          30.5 %           40.0 %           35.3 %
Income from operations         9,720        22,831       (13,111 )       (57.4 %)           8.7 %           23.4 %
Interest income                   53            39            14          35.9 %            0.0 %            0.0 %
Interest expense              (1,615 )      (1,395 )        (220 )        15.8 %           (1.4 %)          (1.4 %)
Other income                   1,759           155         1,604       1,034.8 %            1.6 %            0.2 %
Net income before income
taxes                          9,917        21,630       (11,713 )       (54.2 %)           8.9 %           22.2 %
Income tax expense             3,978         8,269        (4,291 )       (51.9 %)           3.6 %            8.5 %
Net income                 $   5,939     $  13,361     $  (7,422 )       (55.5 %)           5.3 %           13.7 %


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Six Months Ended June 30, 2014 Compared to the Six Months Ended June 30, 2013

Revenue
Account Revenue
The decrease in account revenue was primarily due to an approximate 1% decrease in the total dollars deposited into OneAccounts compared to the same period in the prior year. The decrease in dollars deposited led to a similar decrease in amounts spent from OneAccounts which had the effect of decreasing both the interchange revenue and service fee revenue we earn when compared to the same period in the prior year. The decrease in dollars deposited into the OneAccount was the result of fewer financial aid refunds being deposited to the OneAccount, partially offset by an increase in the amount of non-financial aid deposits made into OneAccounts. In addition, our service fee revenue decreased as a result of a change we made to our account fee schedule during the second half of 2013, including the removal of a fee assessed to customers that had not repaid an overdraft balance within an allotted time period. The removal of this fee was partially offset by increases in amounts earned from other fees.

Payment Transaction Revenue
Just over half of the increase in payment transaction revenue was due to revenue associated with the Campus Solutions business, which was acquired in May 2013. The remaining increase in payment transaction revenue was due to the higher volume of transactions processed through the SmartPay payment module during the six months ended June 30, 2014, which led to increases in payment transaction revenue. The Campus Solutions business contributed approximately $6.7 million of payment transaction revenue during the six months ended June 30, 2014, an increase of $5.8 million compared to the six months ended June 30, 2013. The increase in payment transaction volume was primarily due to the introduction of Visa as a payment method for SmartPay through the end of the second quarter of . . .

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