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 September 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 October 23, 2015, there were 47,980,711 shares of common stock, par value $0.001 per share, outstanding.

 

 

HIGHER ONE HOLDINGS, INC.

INDEX TO REPORT ON FORM 10-Q

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2015

 

		Page
PART I – FINANCIAL INFORMATION		1
Item 1.	Financial Statements (unaudited)	1
	Condensed Consolidated Balance Sheets as of September 30, 2015 and December 31, 2014	1
	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2015 and 2014	2
	Condensed Consolidated Statement of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2015	3
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 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	17
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4.	Controls and Procedures	33
PART II – OTHER INFORMATION		33
Item 1.	Legal Proceedings	33
Item 1A.	Risk Factors	33
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	40
Item 3.	Defaults Upon Senior Securities	40
Item 4.	Mine Safety Disclosures	40
Item 5.	Other Information	40
Item 6.	Exhibits	41
	Signatures	42

 

 

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)

 

 

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 September 30, 2015, more than 800 campuses servicing approximately 4.9 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 September 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 2, 2015, we believe new Title IV Cash Management regulations would likely not go into effect until July 1, 2016. 

 

Regulatory Matters

 

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. On September 24, 2015, the Staff of the Board of Governors of the Federal Reserve System provided a revised notification to us with respect to those asserted violations of the Federal Trade Commission Act. 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 and changes to certain of our business practices.

 

In April 2015, the San Francisco Regional Office of the FDIC (the responsible Regional Office for a current bank partner) notified us it was 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.  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. On September 24, 2015, the San Francisco Regional Office of the FDIC provided a revised notification to us regarding those alleged violations of the Federal Trade Commission Act.

 

 

During the year ended December 31, 2014, we recorded a liability of $8.75 million related to these matters. The liability, which continued to be recorded at $8.75 million through June 30, 2015, reflected the minimum amount we expected to pay related to these matters. During the three months ended September 30, 2015, we recorded an additional charge of $21.9 million related to these matters, bringing the total liability to $30.6 million, as a result of an updated assessment of the minimum amount we expect to pay related to these matters. Each of these amounts is shown as an allowance for customer restitution on our condensed consolidated statement of operations in the period in which the charge was incurred and is related to our disbursements segment. The total liability of $30.6 million is recorded within accrued expenses on our condensed consolidated balance sheets. 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 outcomes 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 recorded at September 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, however we believe our exposure related to these matters is approximately $70.0 million in total. As disclosed in “Note 5 – Credit Facility” of our condensed consolidated financial statements, we amended our Credit Facility in February 2015. The amendment allows, among other things, for the payment of up to $75.0 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.

 

Agreement to Sell Campus Labs Assets

 

On October 14, 2015, we entered into an Asset Purchase Agreement with CL NewCo, Inc., or NewCo, an affiliate of Leeds Equity Partners, for the sale of substantially all of the assets of our data analytics business, or Campus Labs.

 

Pursuant to the terms of the Asset Purchase Agreement, NewCo agreed to acquire Campus Labs for a total cash purchase price of approximately $91 million. This purchase price is subject to certain closing adjustments including adjustments for working capital. The working capital adjustments will be determined at the time of closing, but may reduce the purchase price by $5 million to $7 million. The transaction is subject to necessary regulatory approvals and is expected to close by the end of November 2015.

 

We expect to receive proceeds, net of expenses and taxes, of between $55 million and $60 million from the transaction. As a condition of an amendment to our Credit Facility to allow for the sale of the Campus Labs assets, we will be required to repay $30 million of the outstanding amount on the Credit Facility when the sale of Campus Labs is complete. Refer to "Note 5 - Credit Facility" for additional information on the terms of the October amendment to our Credit Facility.

 

 

Results of Operations for the Three Months Ended September 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 September 30,
		(unaudited)
		2015				2014				$ Change				% Change				2015% of Gross Revenue				2014% of Gross Revenue
		(in thousands)
Revenue:
Account revenue		$	26,654			$	31,468			$	(4,814	)			(15.3	%)			47.3	%			52.6	%
Payment transaction revenue			19,055				18,197				858				4.7	%			33.8	%			30.4	%
Higher education institution revenue			10,486				9,929				557				5.6	%			18.6	%			16.6	%
Other revenue			167				181				(14	)			(7.7	%)			0.3	%			0.3	%
Gross revenue			56,362				59,775				(3,413	)			(5.7	%)			100.0	%			100.0	%
Less: allowance for customer restitution			(21,880	)			-				(21,880	)			100.0	%			(38.8	%)			-
Revenue			34,482				59,775				(25,293	)			(42.3	%)			61.2	%			100.0	%
Cost of revenue			27,817				28,182				(365	)			(1.3	%)			49.4	%			47.1	%
Gross profit			6,665				31,593				(24,928	)			(78.9	%)			11.8	%			52.9	%
Operating expenses:
General and administrative			18,098				16,617				1,481				8.9	%			32.1	%			27.8	%
Product development			2,040				1,555				485				31.2	%			3.6	%			2.6	%
Sales and marketing			4,196				4,577				(381	)			(8.3	%)			7.4	%			7.7	%
Restructuring charge			334				-				334				100.0	%			0.6	%			-
Total operating expenses			24,668				22,749				1,919				8.4	%			43.8	%			38.1	%
Income (loss) from operations			(18,003	)			8,844				(26,847	)			(303.6	%)			(31.9	%)			14.8	%
Interest income			23				20				3				15.0	%			0.0	%			-
Interest expense			(1,262	)			(828	)			(434	)			52.4	%			(2.2	%)			(1.4	%)
Other income			77				(198	)			275				(138.9	%)			0.1	%			(0.3	%)
Net income (loss) before income taxes			(19,165	)			7,838				(27,003	)			(344.5	%)			(34.0	%)			13.1	%
Income tax expense (benefit)			(6,510	)			2,922				(9,432	)			(322.8	%)			(11.6	%)			4.9	%
Net income (loss)		$	(12,655	)		$	4,916			$	(17,571	)			(357.4	%)			(22.5	%)			8.2	%

  

 

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

 

		Three Months Ended September 30,
		(unaudited)
		2015				2014				$ Change				% Change				2015% of Gross Revenue				2014% of Gross Revenue
		(in thousands)
Disbursements		$	28,194			$	33,202			$	(5,008	)			(15.1	%)			50.0	%			55.5	%
Payments			23,789				22,889				900				3.9	%			42.2	%			38.3	%
Data Analytics			4,379				3,684				695				18.9	%			7.8	%			6.2	%
Gross Revenue		$	56,362			$	59,775			$	(3,413	)			(-5.7	%)			100.0	%			100.0	%

 

Revenue 

 

Disbursements Revenue 

  

The decrease in disbursements gross revenue during the three months ended September 30, 2015 was primarily due to a decrease in account revenue. The decrease in account revenue is a result of fewer OneAccounts and also fewer dollars spent by OneAccounts compared to the prior year, both of which had the effect of reducing interchange revenue and service fee revenue. There was an approximate 17% 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, but 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 5% increase in amounts deposited to OneAccounts from non-financial aid refund sources. Deposits from non-financial aid refund sources constituted approximately 14% of all deposits made to OneAccounts during the three months ended September 30, 2015, an increase from 11% during the comparable prior year period.

  

The higher education institution revenue earned from our Refund Management services was $1.4 million during the three months ended September 30, 2015, compared to $1.6 million during the three months ended September 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 $21.9 million during the three months ended September 30, 2015, related to the potential requirement to provide restitution to certain OneAccount customers, which has been recorded as a reduction of our revenue.

  

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 September 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 September 30, 2015 and 2014.  A portion of the higher revenue from the SmartPay payment module was offset by lower revenue associated with our tuition payment plan services.

   

Higher education institution revenue in the payments line of business was $4.7 million during each of the three months ended September 30, 2015 and 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 September 30, 2015, our gross margin percentage decreased, largely as a result of the allowance for customer restitution recorded in the three months ended September 30, 2015, described above. Excluding the impact of the allowance for customer restitution, our non-GAAP gross margin percentage would have been 50.6% during the three months ended September 30, 2015, compared to 52.9% in the three months ended September 30, 2014. The decrease in our non-GAAP gross margin percentage was primarily due to lower gross margin percentage in the disbursements line of business, including the OneAccount.

  

While gross revenue associated with our disbursements line of business decreased $5.0 million as described above, our cost of revenue to support that line of business decreased by $0.9 million to $15.2 million during the three months ended September 30, 2015, from $16.1 million in the comparable prior year period. The gross margin percentage for the disbursements line of business, excluding the impact of the allowance for customer restitution, was 46.1% during the three months ended September 30, 2015, compared to 51.6% 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 partially offset in other areas, primarily higher customer service related costs.

  

Our cost of revenue to support the payments line of business increased to approximately $12.1 million during the three months ended September 30, 2015, from $11.7 million in the comparable prior year period.  The gross margin percentage for the payments line of business was 49.1% during the three months ended September 30, 2015, compared to 48.8% 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.”

  

Our cost of revenue to support the data analytics line of business increased to $0.5 million during the three months ended September 30, 2015, compared to $0.4 million during the three months ended September 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 $0.7 million, including amortization related to internal use software, and (ii) our total personnel costs increased by approximately $0.3 million, including a $0.2 million increase in stock-based compensation expenses.

  

Product Development Expense 

  

The increase in product development expense was primarily due to higher personnel costs, most of which related to product development for the data analytics line of business.

  

Sales and Marketing Expense 

  

The decrease in sales and marketing expense was due primarily to amortization expense of approximately $0.3 million recorded during the three months ended September 30, 2014, which related to a marketing software platform which was no longer being utilized at that time.

 

 

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. 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 up to $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 September 30, 2015 we recognized restructuring charges of $0.3 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 September 30, 2015. The average interest rate during the three months ended September 30, 2015 was 4.2%, an increase from 2.4% for the three months ended September 30, 2014. These increases were partially offset by lower amounts outstanding on our Credit Facility; the average amount outstanding on our Credit Facility was $59.0 million during the three months ended September 30, 2015, compared to an average of $94.0 million during the three months ended September 30, 2014.

  

Other Income (Loss)

  

Our other income (loss) during the three months ended September 30, 2014 included a loss of $0.3 million related to the disposition of our interest in FC Winchester Lofts Master Tenant, LLC. 

 

Income Tax Expense 

 

We recorded an income tax benefit during the three months ended September 30, 2015 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 September 30, 2015 and 2014 were 34.0% and 37.3%, respectively. Our effective tax rate is expected to be between 28% and 32% for the 2015 fiscal year. The decrease in our expected effective tax rate from the rate disclosed in our most recent Form 10-Q and the decrease in rate compared to the prior year period are due primarily to the allowance for customer restitution described above, which results in a pretax loss, the tax benefit on which is diminished by permanent differences between book and tax income.

 

 

Results of Operations for the Nine Months Ended September 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:

 

		Nine Months Ended September 30,
		(unaudited)
		2015				2014				$ Change				% Change				2015% of Gross Revenue				2014% of Gross Revenue
		(in thousands)
Revenue:
Account revenue		$	88,523			$	99,475			$	(10,952	)			(11.0	%)			52.9	%			57.9	%
Payment transaction revenue			47,497				42,652				4,845				11.4	%			28.4	%			24.8	%
Higher education institution revenue			30,891				28,958				1,933				6.7	%			18.4	%			16.9	%
Other revenue			558				723				(165	)			(22.8	%)			0.3	%			0.4	%
Gross revenue			167,469				171,808				(4,339	)			(2.5	%)			100.0	%			100.0	%
Less: allowance for customer restitution			(21,880	)			(8,750	)			(13,130	)			150.1	%			(13.1	%)			(5.1	%)
Revenue			145,589				163,058				(17,469	)			(10.7	%)			86.9	%			94.9	%
Cost of revenue			77,479				76,878				601				0.8	%			46.3	%			44.7	%
Gross profit			68,110				86,180				(18,070	)			(21.0	%)			40.7	%			50.2	%
Operating expenses:
General and administrative			54,417				48,343				6,074				12.6	%			32.5	%			28.1	%
Product development			6,120				5,517				603				10.9	%			3.7	%			3.2	%
Sales and marketing			12,638				13,756				(1,118	)			(8.1	%)			7.5	%			8.0	%
Restructuring charge			574				-				574				100.0	%			0.3	%			-
Total operating expenses			73,749				67,616				6,133				9.1	%			44.0	%			39.4	%
Income (loss) from operations			(5,639	)			18,564				(24,203	)			(130.4	%)			(3.4	%)			10.8	%
Interest income			63				73				(10	)			(13.7	%)			0.0	%			0.0	%
Interest expense			(3,894	)			(2,443	)			(1,451	)			59.4	%			(2.3	%)			(1.4	%)
Other income			1,357				1,561				(204	)			(13.1	%)			0.8	%			0.9	%
Net income (loss) before income taxes			(8,113	)			17,755				(25,868	)			(145.7	%)			(4.8	%)			10.3	%
Income tax expense (benefit)			(2,321	)			6,900				(9,221	)			(133.6	%)			(1.4	%)			4.0	%
Net income (loss)		$	(5,792	)		$	10,855			$	(16,647	)			(153.4	%)			(3.5	%)			6.3	%

 

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

 

		Nine Months Ended September 30,
		(unaudited)
		2015				2014				$ Change				% Change				2015% of Gross Revenue				2014% of Gross Revenue
		(in thousands)
Disbursements		$	92,930			$	103,833			$	(10,903	)			(10.5	%)			55.5	%			60.4	%
Payments			61,921				57,455				4,466				7.8	%			37.0	%			33.4	%
Data Analytics			12,618				10,520				2,098				19.9	%			7.5	%			6.1	%
Gross Revenue		$	167,469			$	171,808			$	(4,339	)			(-2.5	%)			100.0	%			100.0	%

  

 

Revenue 

 

Disbursements Revenue 

 

The decrease in disbursements revenue during the nine months ended September 30, 2015 was primarily due to a decrease in account revenue. The decrease in account revenue is a result of fewer OneAccounts and 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 11% decrease in 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, but 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 17% of all deposits made to OneAccounts during the nine months ended September 30, 2015, an increase from 14% during the comparable prior year period.

 

The higher education institution revenue earned from our Refund Management services was $4.0 million during the nine months ended September 30, 2015, compared to $3.9 million during the nine months ended September 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 $21.9 million and $8.75 million during the nine months ended September 30, 2015 and 2014, respectively, 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 nine months ended September 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 nine months ended September 30, 2015 and 2014. 

 

Higher education institution revenue in the payments line of business was $14.4 million during each of the nine months ended September 30, 2015 and 2014.  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 nine months ended September 30, 2015, compared to approximately $0.6 million during the nine months ended September 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.

   

Cost of Revenue 

  

During the nine months ended September 30, 2015, our gross margin percentage decreased, largely as a result of the allowance for customer restitution recorded in the nine months ended September 30, 2015, described above. Excluding the impact of the allowance for customer restitution, our non-GAAP gross margin percentage would have been 53.7% during the nine months ended September 30, 2015, compared to 55.3% in the nine months ended September 30, 2014. The decrease in our non-GAAP gross margin percentage was primarily due to a decrease in gross margin percentage in the disbursements line of business, including the OneAccount.

 

 

While gross revenue associated with our disbursements line of business decreased $10.9 million as described above, our cost of revenue to support that line of business decreased only $0.8 million during the nine months ended September 30, 2015. The gross margin percentage for the disbursements line of business, excluding the impact of the allowance for customer restitution, was 51.3% during the nine months ended September 30, 2015, compared to 55.6% in the comparable prior year period. While the decrease in transaction volumes in OneAccounts led to a decrease in certain costs of revenue, those decreases were partially offset in other areas, primarily higher customer service related costs.

   

Our cost of revenue to support the payments line of business increased to approximately $30.7 million during the nine months ended September 30, 2015, from $29.5 million in the comparable prior year period.  The gross margin percentage for the payments line of business was 50.3% during the nine months ended September 30, 2015, compared to 48.6% 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 nine months ended September 30, 2014.

  

Our cost of revenue to support the data analytics line of business increased to $1.4 million during the nine months ended September 30, 2015, compared to $1.2 million during the nine months ended September 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 $2.7 million, including a $1.2 million increase in stock-based compensation expenses, and (ii) increases in depreciation and amortization totaling approximately $2.5 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 only in the prior 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 nine months ended September 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 up to $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 nine months ended September 30, 2015, we recognized restructuring charges of $0.6 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 $1.3 million to $1.7 million during the nine months ended September 30, 2015. The average interest rate during the nine months ended September 30, 2015 was 3.8%, an increase from 2.4% for the nine months ended September 30, 2014. These increases were partially offset by lower amounts outstanding on our Credit Facility; the average amount outstanding on our Credit Facility was $64.4 million during the nine months ended September 30, 2015, compared to an average of $94.5 million during the nine months ended September 30, 2014.

  

Other Income

  

Our other income during the nine months ended September 30, 2015 includes a payment of $1.1 million 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 nine months ended September 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. We also recorded other loss of $0.3 million during the nine months ended September 30, 2014 as a result of the disposition of our interest in FC Winchester Lofts Master Tenant, LLC.

 

Income Tax Expense 

 

The change in income tax expense (benefit) was primarily due to the decrease in net income before taxes. The effective tax rates for the nine months ended September 30, 2015 and 2014, were 28.6% and 38.9%, respectively. Our effective tax rate is expected to be between 28% and 32% for the 2015 fiscal year. The decrease in our expected effective tax rate from the rate disclosed in our most recent Form 10-Q and the decrease in rate compared to the prior year period are due primarily to the result of the allowance for customer restitution described above, which results in a pretax loss, the tax benefit on which is diminished by permanent differences between book and tax income.

 

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 September 30, 2015, we had $27.8 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 September 30, 2015, we had a working capital deficit of $18.4 million.

  

Senior Secured Revolving Credit Facility

  

In October 2012, we entered into a five-year senior secured revolving credit facility, or the Credit Facility.  We amended the Credit Facility in February, June and October 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 September 30, 2015 in the accompanying condensed consolidated balance sheet. 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. As of September 30, 2015, we had $59.0 million in borrowings outstanding, at a weighted average interest rate of 4.2%, under the Credit Facility. In connection with the October 2015 amendment, we are required to pay down the outstanding balance of the Credit Facility by $30.0 million upon the sale of the Campus Labs business. We expect to record an expense of approximately $1.9 million during the three months ended December 31, 2015 to write-off deferred financing costs in connection with the October 2015 amendment.

 

 

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 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 September 30, 2015. As of September 30, 2015, our trailing twelve month consolidated EBITDA was $53.7 million. Our leverage ratio was 1.10 to 1.00 as of September 30, 2015.

  

Cash Flows

  

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

 

		Nine Months Ended September 30,
		2015				2014				$ Change
		(unaudited)
		(in thousands)
Net cash provided by (used in):
Operating activities		$	32,935			$	20,903			$	12,032
Investing activities			(6,170	)			43				(6,213	)
Financing activities			(39,002	)			5,231				(44,233	)
Change in cash and cash equivalents		$	(12,237	)		$	26,177			$	(38,414	)
Cash and cash equivalents, end of period		$	27,785			$	32,445			$	(4,660	)

 

The increase in net cash provided by operating activities was primarily the result of changes in working capital balances during the nine months ended September 30, 2015, compared to the prior year.  The consumer class action litigation settlement of $15.0 million was paid in cash during the nine months ended September 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 provided by (used in) investing activities primarily relates to cash provided by investing activities during the nine months ended September 30, 2014, as a result of (1) $3.6 million related to the disposition of an equity method investment and (2) $3.5 million associated with state historic tax credits generated by the construction of our headquarters. In addition, our purchases of fixed assets and internal use software development costs decreased by a total of $0.9 million during the nine months ended September 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								Nine Months Ended
		September 30,								September 30,
		2015				2014				2015				2014
		(unaudited)
		(in thousands)
Adjusted EBITDA		$	11,211			$	14,959			$	39,478			$	44,820
Adjusted net income		$	4,191			$	6,969			$	16,220			$	21,674
Number of students enrolled at OneDisburse client higher education institutions at end of period			4,918				5,018				4,918				5,018
Number of OneAccounts at end of period			2,038				2,190				2,038				2,190

 

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 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								Nine Months Ended
		September 30,								September 30,
		2015				2014				2015				2014
		(unaudited)
Net income (loss)		$	(12,655	)		$	4,916			$	(5,792	)		$	10,855
Interest income			(23	)			(20	)			(63	)			(73	)
Interest expense			1,262				828				3,894				2,443
Income tax expense			(6,510	)			2,922				(2,321	)			6,900
Depreciation and amortization			5,563				5,235				16,429				14,123
EBITDA			(12,363	)			13,881				12,147				34,248
Restructuring charge			334				-				574				-
Stock-based compensation expense			1,360				1,078				4,877				3,426
Allowance for customer restitution			21,880				-				21,880				8,750
Campus Solutions settlement received			-				-				-				(1,604	)
Adjusted EBITDA		$	11,211			$	14,959			$	39,478			$	44,820

 

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

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2015				2014				2015				2014
		(unaudited)
		(in thousands)
Disbursements		$	3,084			$	7,142			$	18,759			$	28,317