UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended June 30, 2015.

 

or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission File Number: 001-34779

 

HIGHER ONE HOLDINGS, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

Delaware		26-3025501
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

115 Munson Street

New Haven, CT 06511

(Address of Principal Executive Offices)(Zip Code)

(203) 776-7776

(Registrant's Telephone Number, Including Area Code)

N/A

(Former Name, Former Address and Former Fiscal Year, If Changes Since Last Report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” or “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one).

Large accelerated filer				Accelerated filer		x
Non-accelerated filer				Smaller reporting company
(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No x

 

As of August 5, 2015, there were 47,980,711 shares of common stock, par value $0.001 per share, outstanding.

 

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HIGHER ONE HOLDINGS, INC.

INDEX TO REPORT ON FORM 10-Q

FOR THE THREE MONTHS ENDED JUNE 30, 2015

 

		Page
PART I – FINANCIAL INFORMATION		1
Item 1.	Financial Statements (unaudited)	1
	Condensed Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014	1
	Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2015 and 2014	2
	Condensed Consolidated Statement of Changes in Stockholders’ Equity for the Six Months Ended June 30, 2015	3
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2015 and 2014	4
	Notes to Condensed Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4.	Controls and Procedures	30
PART II – OTHER INFORMATION		30
Item 1.	Legal Proceedings	30
Item 1A.	Risk Factors	31
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	37
Item 3.	Defaults Upon Senior Securities	37
Item 4.	Mine Safety Disclosures	37
Item 5.	Other Information	37
Item 6.	Exhibits	38
	Signatures	38

 

 

 

As used herein, the terms “we,” “us,” “our,” “the Company,” or “Higher One,” unless the context otherwise requires, mean Higher One Holdings, Inc. and its subsidiaries. 

 

 

PART I – FINANCIAL INFORMATION 

Item 1.

Financial Statements (unaudited)

 Higher One Holdings, Inc. 

Condensed Consolidated Balance Sheets 

 (In thousands of dollars, except share and per share amounts) 

(unaudited)

 

  

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

 

Higher One Holdings, Inc. 

Condensed Consolidated Statements of Operations 

(In thousands of dollars, except share and per share amounts) 

(unaudited) 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

 

Higher One Holdings, Inc. 

Condensed Consolidated Statement of Changes in Stockholders’ Equity 

 (In thousands of dollars, except share amounts) 

(unaudited)

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

 

Higher One Holdings, Inc. 

Condensed Consolidated Statements of Cash Flows 

 (In thousands of dollars) 

(unaudited)

 

  

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

 

 

Higher One Holdings, Inc. 

Notes to Condensed Consolidated Financial Statements 

(unaudited)

 

 

 

  

 

 

 

 

  

Higher One Holdings, Inc. 

Notes to Condensed Consolidated Financial Statements 

(unaudited)

 

 

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, 2014 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 consist of our Disbursement solutions suite, including our Refund Management® disbursement service, our CASHNet® payment processing suite and our Campus Labs® analytics solutions 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 disbursement service.

 

 

As of June 30, 2015, more than 800 campuses servicing approximately 5.0 million students purchased our Refund Management disbursement service.  In total, there are more than 1,900 campuses servicing approximately 13 million students contracted to use at least one of our services.  As of June 30, 2015, we also serviced approximately 2.0 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 disbursement 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 disbursement 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 Cash Management (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. Several of the views expressed at the sessions were unfavorable to certain of our current business practices.

 

On May 18, 2015, ED published its Notice of Proposed Rulemaking, or NPRM, on program integrity and improvement issues in the Federal Register. When ED published its NPRM the public comment period opened and remained opened until July 2, 2015 and we afforded ourselves of that opportunity to comment. Our comments focused on the provisions of the NPRM relating to cash management and campus debit cards including but not limited to the requirement of a 30-day across-the-board fee moratorium following each disbursement, imposed on top of other proposed fee restrictions, which could make providing accounts offered by third party servicers unviable and the confirmation of ED having the authorization to pay Title IV credit balances directly to students and parents which creates the risk of federalization of the disbursement process, thus discouraging private sector investment and innovation.

 

ED may publish these proposed rules in their current form or in a different form that may be more adverse to our business. Any rules substantially similar to those proposed could have a material adverse effect on our business. Should ED publish final rules in the Federal Register by November 1, 2015, we believe new Title IV Cash Management regulations would likely not go into effect until July 1, 2016. 

 

 

Regulatory Matters

 

 

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 may need to provide restitution to those OneAccounts held at that bank partner. As previously disclosed, 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. Related to this matter, following a recently conducted compliance examination, the San Francisco Regional Office of the FDIC notified us that it is prepared to recommend to the Director of the Division of Depositor and Consumer Protection that administrative enforcement action be taken against us for alleged violations of the Federal Trade Commission Act principally relating to our marketing and enrollment practices related to the OneAccount.  Any such enforcement action could result in orders to pay restitution and civil money penalties. We have responded to the FDIC’s notification and we believe that these allegations are similar and related to the Federal Reserve Board allegations previously disclosed and discussed above.

 

 

During the year ended December 31, 2014, we recorded a liability of $8.75 million related to these matters, which was shown as an allowance for customer restitution on our consolidated statement of operations.  While we believe that it is probable that we will have a loss related to these regulatory matters, in view of the inherent difficulty of predicting the outcomes of regulatory matters, we cannot predict the eventual outcome of these pending matters, the timing of the ultimate resolution of these matters or an exact amount of loss associated with these matters.  The liability, which was recorded at June 30, 2014, and continues to be recorded at June 30, 2015, reflects the minimum amount we expect to pay related to these matters, although there is a reasonable possibility that the liability will increase in future periods. The ultimate amount of restitution or civil money penalties is subject to many uncertainties and therefore impossible to predict. As disclosed in “Note 5 – Credit Facility” of our consolidated financial statements, we amended our Credit Facility in February 2015. The amendment allows, among other things, for the payment of up to $75 million in connection with the resolution of the regulatory matters described above.

 

 

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. While the ultimate amounts of customer restitution or civil money penalties are subject to many uncertainties and therefore are impossible to predict, we believe that our cash flows from operations and liquidity sources available through our Credit Facility, as amended, will allow us to pay such customer restitution and civil money penalties.

 

 

Operating Segments and Reporting Units

 

 

As a result of changes in our operating segments and reporting units in 2015, we now have three operating segments, which are also reporting units. We compared the fair value of our reporting units to the carrying value of our reporting units at the time of the change in our operating segments and determined that there was no impairment of goodwill. However, the excess of fair value over carrying value does vary by reporting unit and the goodwill related to our Disbursements reporting unit could be susceptible to impairment in the future, particularly depending on the conclusion of those matters described above in “Overview – Department of Education” and “Overview – Regulatory Matters.” An adverse conclusion to either or both of those matters could reduce the fair value of our reporting unit below the carrying value of the reporting unit and lead to an impairment charge in a future period. Also refer to “Critical Accounting Policies – Goodwill and Intangible Assets” below for additional information related to certain circumstances that could lead to an impairment of goodwill for the Disbursements reporting unit.

 

 

Results of Operations for the Three Months Ended June 30, 2015 and 2014

 

 

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)
		2015				2014				$ Change				% Change				2015% of Gross Revenue				2014% of Gross Revenue
		(in thousands)
Revenue:
Account revenue		$	24,341			$	26,345			$	(2,004	)			(7.6	%)			53.4	%			57.9	%
Payment transaction revenue			11,118				9,835				1,283				13.0	%			24.4	%			21.6	%
Higher education institution revenue			9,979				9,050				929				10.3	%			21.9	%			19.9	%
Other revenue			151				247				(96	)			(38.9	%)			0.3	%			0.5	%
Gross revenue			45,589				45,477				112				0.2	%			100.0	%			100.0	%
Less: allowance for customer restitution			-				(8,750	)			8,750				(100.0	%)			0.0	%			(19.2	%)
Revenue			45,589				36,727				8,862				24.1	%			100.0	%			80.8	%
Cost of revenue			21,472				21,102				370				1.8	%			47.1	%			46.4	%
Gross profit			24,117				15,625				8,492				54.3	%			52.9	%			34.4	%
Operating expenses:
General and administrative			17,736				16,015				1,721				10.7	%			38.9	%			35.2	%
Product development			2,309				1,770				539				30.5	%			5.1	%			3.9	%
Sales and marketing			4,279				4,705				(426	)			(9.1	%)			9.4	%			10.3	%
Restructuring charge			240				-				240				100.0	%			0.5	%			0.0	%
Total operating expenses			24,564				22,490				2,074				9.2	%			53.9	%			49.5	%
Income (loss) from operations			(447	)			(6,865	)			6,418				(93.5	%)			(1.0	%)			(15.1	%)
Interest income			20				34				(14	)			(41.2	%)			0.0	%			0.1	%
Interest expense			(1,252	)			(792	)			(460	)			58.1	%			(2.7	%)			(1.7	%)
Other income			1,203				1,681				(478	)			(28.4	%)			2.6	%			3.7	%
Net income (loss) before income taxes			(476	)			(5,942	)			5,466				(92.0	%)			(1.0	%)			(13.1	%)
Income tax expense (benefit)			(479	)			(2,171	)			1,692				(77.9	%)			(1.1	%)			(4.8	%)
Net income (loss)		$	3			$	(3,771	)		$	3,774				(100.1	%)			0.0	%			(8.3	%)

  

The following table summarizes our revenue by our different lines of business:

 

		Three Months Ended June 30,
		(unaudited)
		2015				2014				$ Change				% Change				2015% of Gross Revenue				2014% of Gross Revenue
		(in thousands)
Gross Revenue:
Disbursements		$	25,525			$	27,486			$	(1,961	)			-7.1	%			56.0	%			60.4	%
Payments			15,835				14,504				1,331				9.2	%			34.7	%			31.9	%
Data Analytics			4,229				3,487				742				21.3	%			9.3	%			7.7	%
Gross Revenue		$	45,589			$	45,477			$	112				0.2	%			100.0	%			100.0	%

 

 

Revenue 

 

 

Disbursements Revenue 

 

 

The decrease in disbursements revenue during the three months ended June 30, 2015, was primarily due to a decrease in account revenue. The decrease in account revenue is a result of fewer dollars spent by OneAccounts, which had the effect of reducing both interchange revenue and service fee revenue when compared to the same period in the prior year. There was an approximate 7% decrease in the total dollars deposited into OneAccounts compared to the same period in the prior year, which led to a similar decrease in amounts spent from OneAccounts. The amounts deposited and spent from OneAccounts typically move by similar amounts though may vary by several percentage points from one reporting period to the next depending on specific deposit and spending behavior. The decrease in dollars deposited into OneAccounts was the result of fewer financial aid refunds being deposited to OneAccounts and fewer OneAccounts, partially offset by an increase in the amount of non-financial aid deposits made into OneAccounts. We experienced an approximate 7% increase in amounts deposited to OneAccounts from non-financial aid refund sources. Deposits from non-financial aid refund sources constituted approximately 26% of all deposits made to OneAccounts during the three months ended June 30, 2015, an increase from 23% during the comparable prior year period.

 

 

The higher education institution revenue earned from our Refund Management services was $1.0 million during the three months ended June 30, 2015, compared to $0.9 million during the three months ended June 30 2014.

 

 

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 three months ended June 30, 2014, related to the potential requirement to provide restitution to certain OneAccount customers.

 

 

Payments Revenue 

 

 

The increase in payments revenue was due to higher payment transaction revenue, primarily due to an increase in the dollar volume of transactions processed through the SmartPay payment module during the three months ended June 30, 2015. The increase in payment transaction volume was primarily due to increases in volume at higher education institution clients that were processing payments during each of the three months ended June 30, 2015 and 2014. 

  

 

Higher education institution revenue in the payments line of business was $4.7 million during the three months ended June 30, 2015, an increase of approximately $0.1 million from the same period in the prior year.  The increase is primarily the result of new services provided to higher education institution clients over the last twelve months offset by a decrease due to our decision to no longer provide disbursement services to those clients of the Campus Solutions business which did not sign contracts to use Higher One’s Refund Management disbursement services. We ceased providing disbursement services to those clients on the Campus Solutions refund disbursement platform in the fourth quarter of 2014 and therefore earned no revenue related to these services during the three months ended June 30, 2015, compared to approximately $0.2 million during the three months ended June 30, 2014.

 

 

Data Analytics Revenue 

 

 

The increase in data analytics revenue was due primarily to sales of Campus Labs modules to new higher education institution clients over the past twelve months.

 

 

Cost of Revenue 

 

 

During the three months ended June 30, 2015, our gross margin percentage increased, largely as a result of the allowance for customer restitution recorded in the three months ended June 30, 2014, 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 52.9% in the three months ended June 30, 2015. The decrease in our non-GAAP gross margin percentage was primarily due to higher costs to support the disbursements line of business, including the OneAccount.

 

 

While gross revenue associated with our disbursements line of business decreased $2.0 million as described above, our cost of revenue to support that line of business decreased to $13.4 million during the three months ended June 30, 2015, from $13.5 million in the comparable prior year period. The decrease in transaction volumes in OneAccounts led to a decrease in certain costs of revenue; however, those decreases were offset in other areas, primarily due to higher customer service related costs.

 

 

Our cost of revenue to support the payments line of business increased to approximately $7.6 million during the three months ended June 30, 2015, from $7.2 million in the comparable prior year period.  The increase in costs was primarily related to the growth of SmartPay transaction volume described above in “Revenue – Payments Revenue.” This increase was partially offset by a net decrease in costs associated with the Campus Solutions contracts that were assigned to us and with the Campus Solutions refund disbursement platform of approximately $0.3 million compared to the three months ended June 30, 2014.

 

 

Our cost of revenue to support the data analytics line of business increased to $0.5 million during the three months ended June 30, 2015, compared to $0.4 million during the three months ended June 30, 2014.  The majority of the data analytics cost of revenue are related to amortization of acquisition-related intangible assets.

 

 

General and Administrative Expense 

 

 

The increase in general and administrative expenses was primarily attributable to the following two factors: (i) increases in depreciation and amortization totaling approximately $0.8 million, including amortization related to internal use software, and (ii) our total personnel costs increased by approximately $0.7 million, including a $0.4 million increase in stock-based compensation expenses.

 

 

Product Development Expense 

 

 

The increase in product development expense was primarily due to an increase of amortization expense, of approximately $0.5 million, related to the acceleration of amortization of a software platform no longer being utilized. In addition, higher personnel costs were offset by a decrease in transition-related product development expenses associated with the Campus Solutions acquisition which we incurred in the prior year period, but not in the current year period.

 

 

Sales and Marketing Expense 

 

 

The decrease in sales and marketing expense was due primarily to decreases in tradeshow costs external marketing costs, including a decrease in costs related to branding efforts that took place during the three months ended June 30, 2014.

 

 

Restructuring Charge

 

 

In April 2015, we entered into an agreement with a third-party service provider to operate our customer care center, in order to provide live-agent, chat and interactive voice response services for our disbursements line of business, including the OneAccount product. In connection with this agreement, we plan to reduce our employee workforce across our customer care department. We began the transition to the third-party service provider in July 2015 and expect to substantially complete the employee reduction by November 2015. However, the timing of this transition and of certain employee reductions may vary.  We estimate we will recognize costs of approximately $1.0 million during fiscal year 2015, consisting of severance and other employee-related benefits. Such costs are expected to be substantially accrued and paid through the end of the first quarter of 2016. For the three months ended June 30, 2015 we recognized restructuring charges of $0.2 million related to the plan described above. We expect to realize cost savings of approximately $4.0 million in 2016 through this arrangement.

 

 

Interest Expense 

 

 

Our interest expense increased compared to the prior period due primarily to additional amortization of deferred financing costs.  As a result of the February 2015 amendment to our credit facility, the interest expense associated with our deferred financing costs increased by $0.4 million to $0.5 million during the three months ended June 30, 2015. The average interest rate during the three months ended June 30, 2015 was 4.2%, an increase from 2.3% for the three months ended June 30, 2014.  However, the average amount outstanding on our Credit Facility was $59.0 million during the three months ended June 30, 2015, compared to an average of $94.0 million during the three months ended June 30, 2014.

 

 

Other Income

 

 

Our other income during the three months ended June 30, 2015 includes a payment of $1.1 million which was due to us as of June 30, 2015, and collected by us in July 2015, related to a settlement and licensing agreement with TouchNet, and its successor company Heartland Payment Systems, which resolved our complaints against TouchNet and their counterclaim against us. During the three months ended June 30, 2014 we recorded other income of $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 

 

 

The change in income tax expense was primarily due to the decrease in the net loss before taxes. The effective tax rates for the three months ended June 30, 2015 and 2014, were 100.7% and 36.5%, respectively. The increase in the effective tax rate is primarily the result of a $0.3 million discrete benefit recognized during the three months ended June 30, 2015, associated with the reduction of a portion of the valuation allowance that had previously been recorded against certain state net operating losses.  As a result of recent tax law changes enacted in the State of Connecticut, it is now more likely than not that an income tax benefit will be derived from the utilization of these net operating losses.  Our effective tax rate is expected to be between 38% and 40% for the 2015 fiscal year.

 

 

Results of Operations for the Six Months Ended June 30, 2015 and 2014

 

 

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)
		2015				2014				$ Change				% Change				2015% of Gross Revenue				2014% of Gross Revenue
		(in thousands)
Revenue:
Account revenue		$	61,869			$	68,007			$	(6,138	)			-9.0	%			55.7	%			60.7	%
Payment transaction revenue			28,442				24,455				3,987				16.3	%			25.6	%			21.8	%
Higher education institution revenue			20,405				19,029				1,376				7.2	%			18.4	%			17.0	%
Other revenue			391				542				(151	)			(27.9	%)			0.4	%			0.5	%
Gross revenue			111,107				112,033				(926	)			(0.8	%)			100.0	%			100.0	%
Less: allowance for customer restitution			-				(8,750	)			8,750				(100.0	%)			0.0	%			-7.8	%
Revenue			111,107				103,283				7,824				7.6	%			100.0	%			92.2	%
Cost of revenue			49,662				48,696				966				2.0	%			44.7	%			43.5	%
Gross profit			61,445				54,587				6,858				12.6	%			55.3	%			48.7	%
Operating expenses:
General and administrative			36,319				31,726				4,593				14.5	%			32.7	%			28.3	%
Product development			4,080				3,962				118				3.0	%			3.7	%			3.5	%
Sales and marketing			8,442				9,179				(737	)			-8.0	%)			7.6	%			8.2	%
Restructuring charge			240				-				240				100.0	%			0.2	%			0.0	%
Total operating expenses			49,081				44,867				4,214				9.4	%			44.2	%			40.0	%
Income (loss) from operations			12,364				9,720				2,644				27.2	%			11.1	%			8.7	%
Interest income			40				53				(13	)			-24.5	%			0.0	%			0.0	%
Interest expense			(2,632	)			(1,615	)			(1,017	)			63.0	%			-2.4	%			-1.4	%
Other income			1,280				1,759				(479	)			-27.2	%			1.2	%			1.6	%
Net income (loss) before income taxes			11,052				9,917				1,135				11.4	%			9.9	%			8.9	%
Income tax expense (benefit)			4,189				3,978				211				5.3	%			3.8	%			3.6	%
Net income (loss)		$	6,863			$	5,939			$	924				15.6	%			6.2	%			5.3	%

 

 

The following table summarizes our revenue by our different lines of business: 

 

 

		Six Months Ended June 30,
		(unaudited)
		2015				2014				$ Change				% Change				2015% of Gross Revenue				2014% of Gross Revenue
		(in thousands)
Gross Revenue:
Disbursements		$	64,736			$	70,631			$	(5,895	)			(8.3	%)			58.3	%			63.0	%
Payments			38,132				34,566				3,566				10.3	%			34.3	%			30.9	%
Data Analytics			8,239				6,836				1,403				20.5	%			7.4	%			6.1	%
Gross Revenue		$	111,107			$	112,033			$	(926	)			(0.8	%)			100.0	%			100.0	%

 

 

Revenue 

 

 

Disbursements Revenue 

 

 

The decrease in disbursements revenue during the six months ended June 30, 2015, was primarily due to a decrease in account revenue. The decrease in account revenue is a result of fewer dollars spent by OneAccounts, which had the effect of reducing both interchange revenue and service fee revenue when compared to the same period in the prior year. There was an approximate 7% decrease in the total dollars deposited into OneAccounts compared to the same period in the prior year, which led to a similar decrease in amounts spent from OneAccounts. The amounts deposited and spent from OneAccounts typically move by similar amounts though may vary by several percentage points from one reporting period to the next depending on specific deposit and spending behavior. The decrease in dollars deposited into OneAccounts was the result of fewer financial aid refunds being deposited to OneAccounts and fewer OneAccounts, partially offset by an increase in the amount of non-financial aid deposits made into OneAccounts. We experienced an approximate 7% increase in amounts deposited to OneAccounts from non-financial aid refund sources. Deposits from non-financial aid refund sources constituted approximately 18% of all deposits made to OneAccounts during the six months ended June 30, 2015, an increase from 15% during the comparable prior year period.

 

 

The higher education institution revenue earned from our Refund Management services was $2.5 million during the six months ended June 30, 2015, compared to $2.4 million during the six months ended June 30 2014.

 

 

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 six months ended June 30, 2014, related to the potential requirement to provide restitution to certain OneAccount customers. 

 

 

Payments Revenue 

 

 

The increase in payments revenue was due to higher payment transaction revenue, primarily due to an increase in the dollar volume of transactions processed through the SmartPay payment module during the six months ended June 30, 2015. The increase in payment transaction volume was primarily due to increases in volume at higher education institution clients that were processing payments during each of the six months ended June 30, 2015 and2014. 

 

 

Higher education institution revenue in the payments line of business was $9.6 million during the six months ended June 30, 2015, a decrease of approximately $0.1 million from the same period in the prior year.  The decrease is the result of our decision to no longer provide disbursement services to those clients of the Campus Solutions business which did not sign contracts to use Higher One’s Refund Management disbursement services. We ceased providing disbursement services to those clients on the Campus Solutions refund disbursement platform in the fourth quarter of 2014 and therefore earned no revenue related to these services during the six months ended June 30, 2015, compared to approximately $0.5 million during the six months ended June 30, 2014. Offsetting that decrease is revenue associated with new services provided to higher education institution clients over the last twelve months

 

 

Data Analytics Revenue 

 

 

The increase in data analytics revenue was due primarily to sales of Campus Labs modules to new and previously existing higher education institution clients over the past twelve months. Slightly more than half of the revenue increase is due to revenue earned at higher education institutions which were not Data Analytics clients during the same period in the prior year.

  

 

Cost of Revenue 

 

 

During the six months ended June 30, 2015, our gross margin percentage increased, largely as a result of the allowance for customer restitution recorded in the six months ended June 30, 2014, described above. Excluding the impact of the allowance for customer restitution, our non-GAAP gross margin percentage would have been 56.5% during the six months ended June 30, 2014, compared to 55.3% in the six months ended June 30, 2015. The decrease in our non-GAAP gross margin percentage was primarily due to higher costs to support the disbursements line of business, including the OneAccount.

  

 

While gross revenue associated with our disbursements line of business decreased $5.9 million as described above, our cost of revenue to support that line of business was $30.1 million during each of the six months ended June 30, 2015 and 2014. While the decrease in transaction volumes in OneAccounts led to a decrease in certain costs of revenue, those decreases were offset in other areas, primarily due to higher customer service related costs.

  

 

Our cost of revenue to support the payments line of business increased to approximately $18.6 million during the six months ended June 30, 2015, from $17.8 million in the comparable prior year period.  The increase in costs was primarily related to the growth of SmartPay transaction volume described above in “Revenue – Payments Revenue.” This increase in costs was partially offset by a decrease in costs associated with supporting the Campus Solutions refund disbursement platform, which were $1.2 million during the six months ended June 30, 2014.

  

 

Our cost of revenue to support the data analytics line of business increased to $0.9 million during the six months ended June 30, 2015, compared to $0.8 million during the six months ended June 30, 2014.  The majority of the data analytics costs are related to amortization of acquisition-related intangible assets.

 

 

General and Administrative Expense 

 

 

The increase in general and administrative expenses was primarily attributable to the following two factors: (i) our total personnel costs increased by approximately $2.4 million, including a $1.0 million increase in stock-based compensation expenses, and (ii) increases in depreciation and amortization totaling approximately $1.7 million, including amortization related to internal use software.

 

 

Product Development Expense 

 

 

The increase in product development expense was primarily due to an increase of amortization expense, of approximately $0.5 million, related to the acceleration of amortization of a software platform no longer being utilized. In addition, higher personnel costs were offset by a decrease in transition-related product development expenses associated with the Campus Solutions acquisition which we incurred in the prior year period, but not in the current year period. 

 

 

Sales and Marketing Expense 

 

 

The decrease in sales and marketing expense was due primarily to decreases in tradeshow costs and external advertising and marketing costs, including a decrease in costs related to branding efforts that took place during the six months ended June 30, 2014.

 

 

Restructuring Charge

 

 

In April 2015, we entered into an agreement with a third-party service provider to operate our customer care center, in order to provide live-agent, chat and interactive voice response services for our disbursements line of business, including the OneAccount product. In connection with this agreement, we plan to reduce our employee workforce across our customer care department. We began the transition to the third-party service provider in July 2015 and expect to substantially complete the employee reduction by November 2015. However, the timing of this transition and of certain employee reductions may vary.  We estimate we will recognize costs of approximately $1.0 million during fiscal year 2015, consisting of severance and other employee-related benefits. Such costs are expected to be substantially accrued and paid through the end of the first quarter of 2016. For the six months ended June 30, 2015 we recognized restructuring charges of $0.2 million related to the plan described above. We expect to realize cost savings of approximately $4.0 million in 2016 through this arrangement.

 

 

Interest Expense 

 

 

Our interest expense increased compared to the prior period due primarily to additional amortization of deferred financing costs.  As a result of the February 2015 amendment to our credit facility, the interest expense associated with our deferred financing costs increased by $0.9 million to $1.2 million during the six months ended June 30, 2015. The average interest rate during the six months ended June 30, 2015 was 3.6%, an increase from 2.3% for the six months ended June 30, 2014.  However, the average amount outstanding on our Credit Facility was $67.1 million during the six months ended June 30, 2015, compared to an average of $94.8 million during the six months ended June 30, 2014.

 

 

Other Income

 

 

Our other income during the six months ended June 30, 2015 includes a payment of $1.1 million which was due to us as of June 30, 2015, and collected by us in July 2015, related to a settlement and licensing agreement with TouchNet, and its successor company Heartland Payment Systems, which resolved our complaints against TouchNet and their counterclaim against us. During the six months ended June 30, 2014, we recorded other income of $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 

 

 

The change in income tax expense was primarily due to the increase in net income before taxes. The effective tax rates for the six months ended June 30, 2015 and 2014, were 37.9% and 40.1%, respectively. The decrease in the effective tax rate is primarily the result of a $0.3 million discrete benefit recognized in the six months ended June 30, 2015, associated with the reduction of a portion of the valuation allowance that had previously been recorded against certain state net operating losses. As a result of recent tax law changes enacted in the State of Connecticut, it is now more likely than not that an income tax benefit will be derived from the utilization of these net operating losses. Our effective tax rate is expected to be between 38% and 40% for the 2015 fiscal year.

 

 

Liquidity and Capital Resources

 

 

Sources of Liquidity

 

 

Our primary sources of liquidity are cash flows from operations and borrowings under our Credit Facility, as defined below.  As of June 30, 2015, we had $16.8 million in cash and cash equivalents, $0.3 million in available-for-sale investments and approximately $81.0 million in borrowing capacity available under our Credit Facility, $35.0 million of which is restricted as described below. Our primary liquidity requirements are for working capital, capital expenditures, product development expenses and general corporate needs. As of June 30, 2015, we had a working capital deficit of $8.5 million.

 

 

Senior Secured Revolving Credit Facility

 

 

In October 2012, we entered into a five-year senior secured revolving credit facility in an amount of $200.0 million, or the Credit Facility.  We amended the Credit Facility in February and June 2015, which modified certain of the financial covenants and other terms of the agreement, including the amount available for borrowing, as described in “Note 5 – Credit Facility” of our notes to consolidated financial statements.  In connection with the February 2015 Amendment, we paid down the outstanding balance of the Credit Facility by $35 million, expensed approximately $0.4 million of previously deferred financing costs and incurred new financing costs of approximately $4.5 million in February 2015, which are included in deferred costs as of June 30, 2015 in the accompanying condensed consolidated balance sheet. As of June 30, 2015, we had $59.0 million in borrowings outstanding, at a weighted average interest rate of 2.4%, under the Credit Facility.  The Credit Facility permits the issuance of letters of credit of up to $20.0 million and swing line loans of up to $10.0 million to fund working capital needs.  Loans drawn under the Credit Facility are payable in a single maturity on October 16, 2017.

 

 

Each of HOH, HOMI, Real Estate Inc. and Real Estate LLC, or together with HOI, the Loan Obligors, is a guarantor of HOI’s obligations under the Credit Facility.  Loans drawn under the Credit Facility are secured by a perfected first priority security interest in all of the capital stock of HOI and its domestic subsidiaries, and substantially all of each Loan Obligor’s tangible and intangible assets, including intellectual property. We pay a commitment fee of 0.5% on the daily average undrawn portion of revolving commitments under the Credit Facility, which accrues and is payable quarterly in arrears.

 

 

The Credit Facility contains certain affirmative covenants including covenants to furnish the lenders with financial statements and other financial information and to provide the lenders notice of material events and information regarding collateral.  The Credit Facility also contains certain negative covenants that, among other things, restrict our ability, subject to certain exceptions, to incur additional indebtedness, grant liens on our assets, undergo fundamental changes, make investments, sell assets, make restricted payments, change the nature of our business and engage in transactions with our affiliates.  The maturity of the Credit Facility Acceleration could be accelerated upon a change of control or if we experience a material adverse change in our operations, condition or prospects. In addition, the Credit Facility contains certain financial covenants in addition to the covenants described above, including a requirement to maintain a fixed charge coverage ratio of at least 1.25 to 1.00. We were in compliance with each of the applicable affirmative, negative and financial covenants of the Credit Facility as of June 30, 2015. As of June 30, 2015, our trailing twelve month consolidated EBITDA was $57.7 million. Our leverage ratio was 1.02 to 1.00 as of June 30, 2015.

 

 

Cash Flows

 

 

The following table presents information regarding our cash flows and cash and cash equivalents for the six months ended June 30, 2015 and 2014:

 

 

		Six Months Ended June 30,
		2015				2014				$ Change
		(unaudited)
		(in thousands)
Net cash provided by (used in):
Operating activities		$	19,660			$	8,223			$	11,437
Investing activities			(3,910	)			(1,595	)			(2,315	)
Financing activities			(39,012	)			5,163				(44,175	)
Change in cash and cash equivalents		$	(23,262	)		$	11,791			$	(35,053	)
Cash and cash equivalents, end of period		$	16,760			$	18,059			$	(1,299	)

 

  

The increase in net cash provided by operating activities was primarily the result of changes in working capital balances during the six months ended June 30, 2015, compared to the prior year.  The consumer class action litigation settlement of $15.0 million was paid in cash during the six months ended June 30, 2014. This payment is a significant component of the overall change in working capital balances and increase in cash provided by operating activities compared to the prior year. Also, our income receivable balance has decreased from the prior year due to an acceleration in the settlement of the revenue proceeds associated with the Campus Solutions business compared to the prior year.

 

 

The change in cash used in investing activities primarily relates to the receipt of $3.5 million associated with state historic tax credits generated by the construction of our headquarters during the six months ended June 30, 2014. In addition, our purchases of fixed assets decreased by $1.0 million during the six months ended June 30, 2015, compared to the prior year period.

 

 

The change in cash provided by (used in) financing activities primarily relates to the cash used to repay debt in connection with the February 2015 amendment to our credit facility described above which totaled $39.5 million.  In the prior year, we had net borrowings of $5.0 million on 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. As described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview” we may be required to pay material customer restitution and civil money penalties related to certain regulatory proceedings. Please refer to the “Regulatory Matters” section within “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview” for the impact that such regulatory matters may have on our liquidity.

 

 

Non-GAAP Supplemental Financial and Operating Information

 

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2015				2014				2015				2014
		(unaudited)
		(in thousands)
Adjusted EBITDA		$	8,011			$	7,184			$	28,267			$	29,860
Adjusted net income		$	2,178			$	2,485			$	12,029			$	14,705
Number of students enrolled at Refund Management disbursement service clients at end of period			5,026				5,119				5,026				5,119
Number of OneAccounts at end of period			2,007				2,088				2,007				2,088

 

 

We define adjusted EBITDA as net income before interest, income taxes and depreciation and amortization, or EBITDA, further adjusted to remove the effects of stock-based compensation expense, the receipt of a settlement amount from Sallie Mae, Inc. related to our Campus Solutions acquisition, the allowance for customer restitution recorded and a restructuring charge. Neither EBITDA nor adjusted EBITDA should be considered an alternative to net income, operating income or any other measure of financial performance calculated and presented in accordance with GAAP. Our EBITDA and adjusted EBITDA may not be comparable to similarly titled measures of other organizations because other organizations may not calculate EBITDA and adjusted EBITDA in the same manner as we do.  In addition, adjusted EBITDA may not be identical to the corresponding measure used in our various agreements, in particular our Credit Facility.

 

 

The following table presents a reconciliation of net income, the most comparable GAAP measure, to EBITDA and adjusted EBITDA for each of the periods indicated:

 

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2015				2014				2015				2014
		(unaudited)
Net income (loss)		$	3			$	(3,771	)		$	6,863			$	5,939
Interest income			(20	)			(34	)			(40	)			(53	)
Interest expense			1,252				792				2,632				1,615
Income tax expense			(479	)			(2,171	)			4,189				3,978
Depreciation and amortization			5,696				4,432				10,866				8,887
EBITDA			6,452				(752	)			24,510				20,366
Restructuring charge			240				-				240				-
Stock-based compensation expense			1,319				790				3,517				2,348
Allowance for customer restitution			-				8,750				-				8,750
Campus Solutions settlement received			-				(1,604	)			-				(1,604	)
Adjusted EBITDA		$	8,011			$	7,184			$	28,267			$	29,860

 

 

The following table presents adjusted EBITDA for each of our three lines of business for each of the periods indicated:

 

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2015				2014