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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

Form 10-Q

 

x

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

for the quarterly period ended June 30, 2011

 

OR

 

o

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: 001-34915

 

NETSPEND HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

20-2306550

(State of organization)

 

(I.R.S. Employer Identification No.)

 

 

 

701 BRAZOS STREET

 

 

SUITE 1300

 

 

AUSTIN, TEXAS

 

78701-2582

(Address of principal executive offices)

 

(Zip Code)

 

(512) 532-8200

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether 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 o

 

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 o

 

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

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x

 

Smaller reporting company o

(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 Act).  Yes o No x

 

The Registrant had 87,386,076 shares of common stock, par value $0.001 per share, outstanding as of August 2, 2011.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

Item

 

Description

 

Page

 

 

 

 

 

 

 

PART I—FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Financial Statements

 

1

 

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

18

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

33

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

34

 

 

 

 

 

 

 

PART II—OTHER INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

35

 

 

 

 

 

Item 1A.

 

Risk Factors

 

35

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

37

 

 

 

 

 

Item 3.

 

Defaults Upon Senior Securities

 

37

 

 

 

 

 

Item 4.

 

Removed and Reserved

 

37

 

 

 

 

 

Item 5.

 

Other Information

 

37

 

 

 

 

 

Item 6.

 

Exhibits

 

38

 



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

Item 1. Unaudited Financial Statements

 

NetSpend Holdings, Inc.

Condensed Consolidated Balance Sheets

As of June 30, 2011 and December 31, 2010

(Unaudited)

 

 

 

June 30,

 

December 31,

 

 

 

2011

 

2010

 

 

 

(in thousands, except share and per share data)

 

Assets

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

$

63,995

 

$

67,501

 

Accounts receivable, net of allowance for doubtful accounts of $231 and $147 as of June 30, 2011 and December 31, 2010, respectively

 

6,558

 

5,441

 

Prepaid card supply

 

1,519

 

1,605

 

Prepaid expenses

 

2,993

 

2,380

 

Other current assets

 

1,857

 

1,007

 

Income tax receivable

 

2,370

 

 

Deferred tax assets

 

3,132

 

3,916

 

Total current assets

 

82,424

 

81,850

 

 

 

 

 

 

 

Property and equipment, net

 

22,028

 

21,007

 

Goodwill

 

128,567

 

128,567

 

Intangible assets

 

23,977

 

25,739

 

Long-term investment

 

2,857

 

2,067

 

Other assets

 

7,431

 

4,673

 

Total assets

 

$

267,284

 

$

263,903

 

 

 

 

 

 

 

Liabilities & Stockholders’ Equity

 

 

 

 

 

Current liabilities

 

 

 

 

 

Accounts payable

 

$

2,217

 

$

2,850

 

Accrued expenses (includes $3,491 and $3,433 of accrued related party expenses as of June 30, 2011 and December 31, 2010, respectively)

 

20,372

 

25,067

 

Income tax payable

 

 

332

 

Cardholders’ reserve

 

3,698

 

4,789

 

Deferred revenue

 

966

 

1,333

 

Long-term debt, current portion

 

694

 

1,354

 

Total current liabilities

 

27,947

 

35,725

 

 

 

 

 

 

 

Long-term debt, net of current portion

 

58,500

 

58,500

 

Deferred tax liabilities

 

7,269

 

9,855

 

Other non-current liabilities

 

4,548

 

3,007

 

Total liabilities

 

98,264

 

107,087

 

 

 

 

 

 

 

Commitments and contingencies (Note 15)

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

Common stock, $0.001 par value; 225,000,000 shares authorized; outstanding: as of June 30, 2011 - 92,080,225 issued less 4,594,445 held in treasury and as of December 31, 2010 - 91,540,381 issued less 3,370,000 held in treasury

 

92

 

92

 

Treasury stock at cost

 

(22,425

)

(11,374

)

Additional paid-in capital

 

158,658

 

151,199

 

Accumulated other comprehensive loss

 

(352

)

(1,142

)

Retained earnings

 

33,047

 

18,041

 

Total stockholders’ equity

 

169,020

 

156,816

 

 

 

 

 

 

 

Total liabilities & stockholders’ equity

 

$

267,284

 

$

263,903

 

 

 See accompanying notes to the unaudited condensed consolidated financial statements.

 

1



Table of Contents

 

NetSpend Holdings, Inc.

Condensed Consolidated Statements of Operations

For the Three and Six Months Ended June 30, 2011 and 2010

(Unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

(in thousands, except per share data)

 

 

 

 

 

 

 

 

 

 

 

Operating Revenues (includes $1,236 and $1,020 of related party revenues for the three months ended June 30, 2011 and 2010, respectively, and $2,879 and $2,258 for the six months ended June 30, 2011 and 2010, respectively)

 

$

74,419

 

$

67,447

 

$

155,169

 

$

136,967

 

 

 

 

 

 

 

 

 

 

 

Operating Expenses

 

 

 

 

 

 

 

 

 

Direct operating costs (includes $11,617 and $8,728 of related party expenses for the three months ended June 30, 2011 and 2010, respectively, and $25,714 and $19,094 for the six months ended June 30, 2011 and 2010, respectively)

 

35,489

 

30,304

 

75,622

 

63,017

 

Salaries, benefits and other personnel costs

 

12,788

 

13,504

 

27,721

 

26,583

 

Advertising, marketing and promotion costs

 

4,147

 

3,528

 

7,732

 

7,369

 

Other general and administrative costs (includes $53 and $71 of related party expenses for the three months ended June 30, 2011 and 2010, respectively, and $94 and $176 for the six months ended June 30, 2011 and 2010, respectively)

 

5,136

 

4,876

 

10,303

 

9,088

 

Depreciation and amortization

 

3,742

 

3,296

 

7,440

 

6,075

 

Settlements and other losses

 

 

300

 

 

4,300

 

Total operating expenses

 

61,302

 

55,808

 

128,818

 

116,432

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

13,117

 

11,639

 

26,351

 

20,535

 

 

 

 

 

 

 

 

 

 

 

Other Income (Expense)

 

 

 

 

 

 

 

 

 

Interest income

 

30

 

40

 

50

 

46

 

Interest expense

 

(502

)

(1,045

)

(1,005

)

(2,057

)

Total other expense

 

(472

)

(1,005

)

(955

)

(2,011

)

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

12,645

 

10,634

 

25,396

 

18,524

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

5,065

 

4,188

 

10,037

 

7,460

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

7,580

 

$

6,446

 

$

15,359

 

$

11,064

 

 

 

 

 

 

 

 

 

 

 

Net income per share of common stock:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.08

 

$

0.08

 

$

0.17

 

$

0.13

 

Diluted

 

$

0.08

 

$

0.07

 

$

0.16

 

$

0.13

 

 

 

 

 

 

 

 

 

 

 

Shares used in the computation of earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

88,412

 

84,370

 

88,298

 

84,843

 

Diluted

 

92,824

 

86,438

 

93,295

 

86,103

 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

2



Table of Contents

 

NetSpend Holdings, Inc.

Condensed Consolidated Statement of Changes in Stockholders’ Equity

For the Six Months Ended June 30, 2011

(Unaudited)

 

 

 

Common Stock

 

Treasury Stock

 

Additional
Paid-in

 

Accumulated
Other
Comprehensive

 

Retained

 

Total
Stockholders’

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Capital

 

Loss

 

Earnings

 

Equity

 

 

 

(in thousands of dollars, except share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at December 31, 2010

 

91,540,381

 

$

92

 

(3,370,000

)

$

(11,374

)

$

151,199

 

$

(1,142

)

$

18,041

 

$

156,816

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase of treasury stock

 

 

 

(1,186,200

)

(10,694

)

 

 

 

(10,694

)

Tax withholding on restricted stock

 

 

 

(38,245

)

(357

)

 

 

 

(357

)

Stock-based compensation

 

 

 

 

 

5,961

 

 

 

5,961

 

Excercise of options for common stock

 

288,229

 

 

 

 

561

 

 

 

561

 

Vesting of restricted stock

 

251,615

 

 

 

 

 

 

 

 

Tax benefit associated with stock options

 

 

 

 

 

1,032

 

 

 

1,032

 

Issuance costs of public offering

 

 

 

 

 

(95

)

 

 

(95

)

Unrealized gain on available-for-sale investment

 

 

 

 

 

 

790

 

 

790

 

Dividend equivalents paid

 

 

 

 

 

 

 

(353

)

(353

)

Net income

 

 

 

 

 

 

 

15,359

 

15,359

 

Balances at June 30, 2011

 

92,080,225

 

$

92

 

(4,594,445

)

$

(22,425

)

$

158,658

 

$

(352

)

$

33,047

 

$

169,020

 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

3



Table of Contents

 

NetSpend Holdings, Inc.

Condensed Consolidated Statements of Cash Flows

For the Six Months Ended June 30, 2011 and 2010

(Unaudited)

 

 

 

June 30,

 

June 30,

 

 

 

2011

 

2010

 

 

 

(in thousands of dollars)

 

 

 

 

 

 

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

15,359

 

$

11,064

 

Adjustments to reconcile net income to net cash provided by operating activities

 

 

 

 

 

Depreciation and amortization

 

7,440

 

6,075

 

Amortization of debt issuance costs

 

163

 

265

 

Stock-based compensation

 

5,961

 

3,010

 

Tax benefit associated with stock options

 

(1,032

)

(44

)

Provision for cardholder losses

 

7,014

 

3,399

 

Deferred income taxes

 

(1,802

)

(2,918

)

Increase in cash surrender value of life insurance policies

 

(105

)

 

Changes in operating assets and liabilities

 

 

 

 

 

Accounts receivable

 

(1,117

)

(488

)

Prepaid card supply

 

86

 

360

 

Prepaid expenses

 

(613

)

(344

)

Other current assets

 

(850

)

128

 

Other long-term assets

 

(1,985

)

(16

)

Accounts payable and accrued expenses

 

(5,328

)

2,224

 

Income tax payable

 

(1,670

)

3,588

 

Cardholders’ reserve

 

(8,105

)

(3,157

)

Other liabilities

 

1,174

 

(569

)

Net cash provided by operating activities

 

14,590

 

22,577

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Purchases of property and equipment

 

(4,750

)

(4,269

)

Long-term investment

 

 

(3,210

)

Other

 

(831

)

 

Net cash used in investing activities

 

(5,581

)

(7,479

)

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Dividend equivalents paid

 

(353

)

(176

)

Proceeds from the exercise of stock options

 

561

 

181

 

Tax benefit associated with stock options

 

1,032

 

44

 

Issuance costs of public offering

 

(95

)

 

Principal payments on debt

 

(2,609

)

(15,247

)

Treasury stock purchase

 

(10,694

)

(5,670

)

Tax withholding on restricted stock

 

(357

)

 

Net cash used in financing activities

 

(12,515

)

(20,868

)

 

 

 

 

 

 

Net change in cash and cash equivalents

 

(3,506

)

(5,770

)

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

67,501

 

21,154

 

Cash and cash equivalents at end of period

 

$

63,995

 

$

15,384

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid for interest

 

$

1,296

 

$

1,873

 

Cash paid for income taxes

 

13,470

 

7,235

 

 

 

 

 

 

 

Non-cash investing activities:

 

 

 

 

 

Capital lease entered into for the license of software

 

$

1,949

 

$

 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

4



Table of Contents

 

NetSpend Holdings, Inc.
Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 1: Organization and Business

 

Nature of Operations — NetSpend Holdings, Inc. (‘‘NetSpend’’ or the ‘‘Company’’) was formed as a Delaware corporation on February 18, 2004 in connection with the recapitalization of one of the Company’s current subsidiaries, NetSpend Corporation, which was founded in 1999. The Company operates in one reportable business segment to provide general purpose reloadable (‘‘GPR’’) prepaid debit and payroll cards and alternative financial service solutions to underbanked and other consumers in the United States. The Company’s products provide underbanked consumers with access to FDIC-insured depository accounts with a menu of pricing and features specifically tailored to their needs. The Company has an extensive distribution and reload network comprised of financial service centers and other retail locations throughout the United States.

 

The Company is an agent of FDIC-insured depository institutions that serve as the issuers of the Company’s card products. The Company has agreements with Meta Payment Systems (“MetaBank”), a division of Meta Financial Group, Inter National Bank, U.S. Bank, Sun Trust Bank and The Bancorp Bank (collectively, the ‘‘issuing banks’’) whereby the issuing banks issue MasterCard International (‘‘MasterCard’’) or Visa USA, Inc. (‘‘Visa’’) branded cards to customers. The Company’s products may be used to purchase goods and services wherever MasterCard and Visa are accepted or to withdraw cash via automatic teller machines (‘‘ATMs’’).

 

The Company’s common stock trades on the Nasdaq stock market under the symbol “NTSP.”

 

Basis of Presentation — The accompanying unaudited condensed consolidated financial statements of NetSpend and its subsidiaries do not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America (‘‘U.S. GAAP’’). The Company’s significant accounting policies are disclosed in the notes to the audited consolidated financial statements included in the Company’s Annual Report (the “Annual Report”) on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 2, 2011. The condensed consolidated financial statements contained in this Quarterly Report on Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Audited Consolidated Financial Statements for the year ended December 31, 2010 included in the Company’s Annual Report.   Interim results are not necessarily indicative of results for a full year.

 

In the opinion of management, the accompanying condensed consolidated financial statements reflect all adjustments of a normal, recurring nature considered necessary to be fairly stated. The condensed consolidated financial statements and accompanying footnotes reflect certain reclassifications that have been made to prior period information to conform to the current year presentation. These reclassifications had no effect on previously reported net income.

 

Use of Estimates —  The preparation of the Company’s financial statements requires management to make various estimates and it is reasonably possible that the circumstances under which these estimates were made could change in the relatively near term. Such a change could result in a material revision to management’s estimates, which could result in a material change to the Company’s financial statements. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2010 included in the Company’s Annual Report. The Annual Report provides additional disclosures regarding the nature of the estimates made by management in preparing the Company’s financial statements.

 

5



Table of Contents

 

NetSpend Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 

Significant Concentrations — Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. A significant portion of the Company’s cash is deposited in cash and money market funds at large depository institutions. The Company has not experienced any losses on its deposits to date. Accounts receivable as of June 30, 2011 and December 31, 2010 are primarily receivables due from cardholders for service fees and for interchange revenues due from card associations related to merchant point of sale transactions.

 

Cardholder funds and deposits related to the Company’s products are held at FDIC insured issuing banks for the benefit of the cardholders. Although the Company currently has agreements with five issuing banks, MetaBank holds a large majority of cardholder funds. In September 2010, the Company amended its agreement with Inter National Bank and agreed to transition the cards issued by Inter National Bank to another bank on or prior to July 2011, at which time Inter National Bank would cease serving as one of the Company’s issuing banks. In May 2011, the Company further amended its agreement with Inter National Bank to extend this transition date to September 30, 2011.  The failure of any of the Company’s issuing banks could have a material adverse effect on the Company’s business.

 

Interchange revenue, which is recorded net of sponsorship, licensing and processing fees charged by the card associations and network organizations for the services they provide in processing purchase transactions routed through their networks, represented approximately 22.2% and 21.0% of the Company’s revenues during the three months ended June 30, 2011 and 2010, respectively, and 23.4% and 21.5% during the six months ended June 30, 2011 and 2010, respectively.  The amounts of these fees are currently fixed by the card associations and network organizations in their sole discretion.  The enactment of the Dodd Frank Wall Street Reform and Consumer Protection Act in May 2010 and the issuance of final regulations under this Act in June 2011 has imposed limits on the interchange fees that can be paid to certain card issuers, effective October 2011.  The Company believes its programs are largely exempt from these restrictions.  See “Item 1A. — Risk Factors—Risks Relating to Our Business— Limitations on the amount of interchange fees that may be charged to merchants that accept our cards could decrease our revenues and negatively impact our business and financial performance” contained in this Quarterly Report on Form 10-Q.

 

During each of the three and six months ended June 30, 2011 and 2010, the Company derived more than one-third of its revenues from GPR cards sold through one of its third-party distributors, ACE Cash Express, Inc. (‘‘ACE’’). The Company’s current distribution agreement with ACE is effective through March 2016.

 

Note 2: Immaterial Error Correction

 

During the quarter ended March 31, 2011, management identified an error related to the accounting for excess tax benefits associated with the exercise of certain incentive stock options in conjunction with the Company’s initial public offering during the three months ended December 31, 2010. The Company reduced retained earnings and increased additional paid-in capital by approximately $1.0 million to correct this immaterial error on the Condensed Consolidated Balance Sheet as of December 31, 2010 contained in this Quarterly Report on Form 10-Q. The Company will revise its Statements of Operations, Changes in Stockholders’ Equity and Cash Flows for the year ended December 31, 2010, and the Statement of Operations for the three months ended December 31, 2010, to reflect this correction in future filings that contain such financial statements, including the Company’s Annual Report on Form 10-K for the year ending December 31, 2011. The adjustments will increase previously reported income tax expense and decrease the previously reported net income for 2010 and for the fourth quarter of 2010 by approximately $1.0 million. Management does not consider these adjustments to be material to the

 

6



Table of Contents

 

NetSpend Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 

Company’s prior period financial statements.  These adjustments do not impact the Condensed Consolidated Statements of Operations or the Condensed Consolidated Statements of Cash Flows contained in this Form 10-Q.

 

Note 3: Other Financial Data

 

Compensating Balances and Restricted Cash — The Company has established compensating balances at its issuing banks to offset overdrawn cardholder accounts. Some of these compensating balance accounts are included in the Company’s Condensed Consolidated Balance Sheets as cash and cash equivalents because there are no legal or contractual restrictions over the deposits in these accounts.  As of both June 30, 2011 and December 31, 2010 these compensating balances totaled $0.3 million.

 

Restricted cash is cash with statutory or contractual restrictions that prevent it from being used in the Company’s operations. Restricted cash is classified in other current assets on the Company’s Condensed Consolidated Balance Sheets. The Company had restricted cash of $0.4 million and $0.8 million as of June 30, 2011 and December 31, 2010, respectively.

 

Cardholders’ Reserve — The Company is exposed to losses due to cardholder fraud, default and other forms of cardholder activity, as well as losses due to non-performance of third parties. The Company establishes a reserve for the losses it estimates will arise from processing customer transactions, debit card overdrafts, chargebacks for unauthorized card use and merchant-related chargebacks due to non-delivery of goods or services. These reserves are established based upon historical loss and recovery rates and cardholder activity for which specific losses can be identified. The cardholders’ reserve was approximately $3.7 million and $4.8 million as of June 30, 2011 and December 31, 2010, respectively. The provision for cardholder losses is included in direct operating costs in the Condensed Consolidated Statements of Operations.

 

Establishing the reserve for cardholder losses is an inherently uncertain process and the actual losses experienced by the Company may vary from the current estimate. Any such variation could be material and adverse. The Company regularly updates its reserve estimate as new facts become known and events occur that may impact the settlement or recovery of losses.

 

Note 4: Recent Accounting Pronouncements

 

In June 2011, the Financial Accounting Standards Board (“FASB”) issued amendments to the guidelines on presenting comprehensive income. The amendments require that all nonowner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  The amendments are effective for the first reporting period beginning after December 15, 2011, and are to be applied retrospectively.  The adoption of these amendments is not expected to have a material impact on the Company’s consolidated financial statements.

 

Note 5:  Investments

 

In 2010, the Company purchased 150,000 shares of the common stock of Meta Financial Group (“MFG”), the holding company of MetaBank, one of the Company’s issuing banks, for $3.2 million. The investment in MFG is an available-for-sale security and is included in the Condensed Consolidated Balance Sheets as a long-term investment. As of June 30, 2011, the fair value of the Company’s investment in MFG was $2.9 million.

 

7



Table of Contents

 

NetSpend Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 

Note 6: Property and Equipment

 

Property and equipment consisted of the following as of June 30, 2011 and December 31, 2010:

 

 

 

June 30,

 

December 31,

 

 

 

2011

 

2010

 

 

 

(in thousands of dollars)

 

 

 

 

 

 

 

Computer and office equipment

 

$

16,536

 

$

13,983

 

Computer software

 

28,555

 

26,568

 

Furniture and fixtures

 

1,419

 

1,368

 

Leasehold improvements

 

1,631

 

1,625

 

Construction in progress

 

4,261

 

2,579

 

 

 

52,402

 

46,123

 

Less: accumulated depreciation

 

(30,374

)

(25,116

)

 

 

$

22,028

 

$

21,007

 

 

Property and equipment are assessed for impairment whenever events or circumstances indicate the carrying value of an asset group may not be fully recoverable by comparing the carrying value of the asset group to the total future undiscounted cash flows associated with it. Impairment is recorded for long-lived assets equal to the excess of the carrying amount of the asset group over its estimated fair value. During the six months ended June 30, 2011, there were no events or circumstances indicating that the Company’s long-lived assets were impaired.

 

During the three months ended June 30, 2011, the Company modified a capital lease arrangement with a software provider, extending it for one year. The capital lease arrangement resulted in the purchase of $1.9 million of computer software, which is included in property and equipment on the Company’s Condensed Consolidated Balance Sheets.

 

Depreciation expense for the three months ended June 30, 2011 and 2010 was approximately $2.9 million and $2.5 million, respectively.  Depreciation expense for the six months ended June 30, 2011 and 2010 was approximately $5.7 million and $4.5 million, respectively.

 

8



Table of Contents

 

NetSpend Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 

Note 7: Intangible Assets

 

Intangible assets consisted of the following as of June 30, 2011 and December 31, 2010:

 

 

 

June 30,

 

December 31,

 

 

 

2011

 

2010

 

 

 

(in thousands of dollars)

 

Distributor and partner relationships

 

$

26,426

 

$

26,426

 

Trademarks and tradenames

 

10,615

 

10,615

 

Developed technology

 

7,261

 

7,261

 

Other

 

172

 

172

 

 

 

44,474

 

44,474

 

Less: Accumulated amortization

 

(20,497

)

(18,735

)

 

 

$

23,977

 

$

25,739

 

 

Amortization expense for the three months ended June 30, 2011 and 2010 was $0.9 million and $0.8 million, respectively.  Amortization expense for the six months ended June 30, 2011 and 2010 was $1.8 million and $1.6 million, respectively.

 

Note 8: Accrued Expenses

 

Accrued expenses as of June 30, 2011 and December 31, 2010 consisted of the following:

 

 

 

June 30,

 

December 31,

 

 

 

2011

 

2010

 

 

 

(in thousands of dollars)

 

Commissions payable to distributors

 

$

5,797

 

$

4,986

 

Accrued wages and related personnel expenses

 

3,531

 

8,541

 

Marketing and professional fees

 

3,464

 

2,740

 

Processor and association fees

 

2,445

 

2,228

 

Call center expenses

 

1,013

 

2,974

 

Other accrued expenses

 

4,122

 

3,598

 

 

 

$

20,372

 

$

25,067

 

 

Note 9: Debt

 

As of June 30, 2011, the Company’s outstanding debt included $0.7 million of short-term borrowings associated with a capital lease entered into for software licenses and $58.5 million of long-term borrowings under the Company’s revolving credit facility with Sun Trust Bank as administrative agent.  During the three months ended June 30, 2011, the Company modified a $1.9 capital lease arrangement with a software provider, extending it for one year.  Payment of $1.9 million for the capital lease was made in June 2011.  Outstanding balances under the Company’s revolving credit facility are scheduled to mature in September 2015. During the six months ended June 30, 2011, the outstanding borrowings under this facility bore interest at a weighted average rate of 2.8%.

 

9



Table of Contents

 

NetSpend Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 

Note 10: Fair Value of Assets and Liabilities

 

Fair value is defined in U.S. GAAP as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between arms-length market participants at the measurement date. When determining the fair value for applicable assets and liabilities, the Company considers the principal or most advantageous market in which it would transact and considers assumptions market participants would typically use when pricing the asset or liability, such as inherent risk, applicable transfer restrictions and the perceived risk of nonperformance.

 

The Company’s financial instruments include cash, cash equivalents, accounts receivable, accounts payable and accrued expenses, long-term investments and current and non-current borrowings. As of June 30, 2011 and December 31, 2010, the fair values of cash, cash equivalents, accounts receivable, and accounts payable and accrued expenses approximated their carrying values because of the short-term nature of these instruments. As of June 30, 2011 and December 31, 2010 the Company’s long-term investment in MFG (see “Note 5”) was recorded at its fair value based on a quoted price in an active market.

 

As of June 30, 2011 and December 31, 2010, the fair value of the Company’s outstanding borrowings under its revolving credit agreement approximated their carrying value based on prevailing market rates for borrowings with similar ratings and maturities.

 

Note 11: Stockholders’ Equity

 

Treasury stock is accounted for under the cost method and is included as a component of stockholders’ equity.  During the six months ended June 30, 2010, the Company repurchased 1,500,000 shares of its common stock for $5.7 million.  In June 2011, the Company’s board of directors approved a $25 million share repurchase program.  The share repurchases are being made in the open market, through block trades, through 10b5-1 plans, in privately negotiated transactions or otherwise.  During the three months ended June 30, 3011, the Company repurchased 1,186,200 shares of common stock for $10.7 million pursuant to this program.  See “Item 2. Unregistered Sales of Equity Securities and Use of Proceeds — Issuer’s Purchases of Equity Securities” contained in this Quarterly Report on Form 10-Q.

 

Certain of the stock options issued to the Company’s Chief Executive Officer (“CEO”) prior to the Company’s initial public offering contain rights to dividend equivalents.  The dividend equivalents relate to dividends paid by the Company in 2008 and are paid when the underlying options vest.  The Company paid $0.4 million and $0.2 million in dividend equivalents during the six months ended June 30, 2011 and 2010, respectively.

 

Note 12: Share Based Payment

 

During the six months ended June 30, 2011, the Company granted 1,624,129 options with a fair value of $11.6 million to officers and employees and issued 15,269 shares of restricted stock with a fair value of $0.2 million to members of its Board of Directors under the Amended and Restated NetSpend Holdings, Inc. 2004 Equity Incentive Plan (the “Equity Incentive Plan”).  The options generally vest in four equal annual installments on each of the four anniversaries of the grant date.  The restricted stock vests upon the first anniversary of the grant date.  Compensation expense associated with these equity awards is recognized on a straight-line basis over the requisite service period, net of estimated forfeitures.

 

10



Table of Contents

 

NetSpend Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 

The following table summarizes the assumptions used to value options issued during the six months ended June 30, 2011:

 

Expected volatility

 

49.4% - 50.2%

 

Expected dividend yield

 

 

Expected term

 

6.0 - 7.0 years

 

Risk free rate

 

3.1% - 3.4%

 

Weighted average fair value of options at grant date

 

$7.12

 

 

Note 13:  Comprehensive Income

 

The Company’s comprehensive income is included as a component of stockholders’ equity and is composed of net income and unrealized gains and losses on investments designated as available-for-sale. As of June 30, 2011, the Company had an unrealized loss of $0.3 million, net of tax, related to the difference between the fair value of the Company’s long-term investment in MFG (see “Note 5”) of $2.9 million on June 30, 2011 and its $3.2 million purchase price.

 

The following table presents the calculation of comprehensive income:

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2011

 

2010

 

 

 

(in thousands of dollars)

 

Net income

 

$

15,359

 

$

11,064

 

Unrealized holding gain on investment, net of tax

 

790

 

823

 

Comprehensive income

 

$

16,149

 

$

11,887

 

 

Note 14: Earnings Per Share

 

Basic earnings per common share is calculated by dividing net income  available to common stockholders by the number of weighted average common shares issued and outstanding for the period.  The Company calculates basic and diluted earnings per share using the treasury stock method, the if-converted method and the two-class method, as applicable.

 

Upon completion of the Company’s initial public offering (“IPO”) in October 2010, all of the Company’s class A common stock was reclassified as common stock. In addition, promptly following the IPO, all of the Company’s class B common stock was transferred to members of Skylight Holdings I, LLC, which had the effect of converting all of the Company’s outstanding class B common stock into shares of common stock on a one-for-one basis.  Only one class of common stock existed during the six months ended June 30, 2011.

 

Certain of the CEO’s stock options contain rights to dividend equivalents.  These options are considered participating securities to the extent vested.  In calculating basic earnings per share using the two-class method, earnings available to participating securities are excluded from net income available to common shareholders.

 

Diluted earnings per common share is calculated by dividing net income available to common stockholders by the weighted average number of common shares issued and outstanding for the period, plus amounts representing the dilutive effect of stock options, warrants and restricted stock, as applicable. The Company calculates dilutive potential common shares using the treasury stock method, which

 

11



Table of Contents

 

NetSpend Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 

assumes that the Company will use the proceeds from the exercise of stock options and warrants to repurchase shares of common stock to hold in its treasury stock reserves.

 

During the three months ended June 30, 2011 and 2010, the potential dilutive effect of 2.0 million and 2.1 million stock options, respectively, were excluded from the computation of diluted weighted average shares outstanding because they were anti-dilutive.  During the six months ended June 30, 2011, the potential dilutive effect of 1.7 million stock options was excluded from the computation of diluted weighted average shares outstanding because they were anti-dilutive.  During the six months ended June 30, 2010, the potential dilutive effect of 5.7 million stock options and restricted stock awards were excluded from the computation of diluted weighted average shares outstanding because they were anti-dilutive.  These excluded options and awards could potentially dilute earnings per share in the future.

 

The following is a reconciliation of the numerator (net income) and the denominator (weighted average number of common shares) used in the calculation of basic and diluted earnings per share for the three and six months ended June 30, 2011 and 2010:

 

 

 

Three Months Ended June 30,

 

 

 

2011

 

2010

 

 

 

Class A

 

Class B

 

Class A

 

Class B

 

 

 

(in thousands, except per share data)

 

Basic earnings per share:

 

 

 

 

 

 

 

 

 

Net income

 

$

7,580

 

$

 

$

5,648

 

$

798

 

Less: Earnings distributed to participating securities

 

 

 

 

 

Less: Undistributed earnings allocated to participating securities

 

(124

)

 

(56

)

(8

)

Undistributed earnings available to common stockholders

 

$

7,456

 

$

 

$

5,592

 

$

790

 

Weighted-average shares outstanding used in basic calculation

 

88,412

 

 

73,921

 

10,449

 

Basic earnings per share

 

$

0.08

 

$

 

$

0.08

 

$

0.08

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

Undistributed earnings available to common stockholders

 

$

7,456

 

$

 

$

5,592

 

$

790

 

Add: Earnings distributed to participating securities

 

 

 

 

 

Add: Undistributed earnings allocated to participating securities

 

124

 

 

64

 

 

Add: Reallocation of undistributed earnings as a result of conversion of class B to common stock

 

 

 

790

 

 

Net income

 

$

7,580

 

$

 

$

6,446

 

$

790

 

 

 

 

 

 

 

 

 

 

 

Weighted-average shares outstanding used in in basic calculation

 

88,412

 

 

73,921

 

10,449

 

Weighted average effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Conversion of class B to common stock outstanding

 

 

 

10,449

 

 

Options

 

4,222

 

 

1,430

 

 

Warrants

 

 

 

545

 

 

Restricted stock

 

190

 

 

93

 

34

 

Weighted-average shares outstanding used in diluted calculation

 

92,824

 

 

86,438

 

10,483

 

Diluted earnings per share

 

$

0.08

 

$

 

$

0.07

 

$

0.08

 

 

12



Table of Contents

 

NetSpend Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 

 

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

 

 

Class A

 

Class B

 

Class A

 

Class B

 

 

 

(in thousands, except per share data)

 

Basic earnings per share:

 

 

 

 

 

 

 

 

 

Net income

 

$

15,359

 

$

 

$

9,709

 

$

1,355

 

Less: Earnings distributed to participating securities

 

(353

)

 

(155

)

(21

)

Less: Undistributed earnings allocated to participating securities

 

(262

)

 

(100

)

(14

)

Undistributed earnings available to common stockholders

 

$

14,744

 

$

 

$

9,454

 

$

1,320

 

Weighted-average shares outstanding used in basic calculation

 

88,298

 

 

74,449

 

10,394

 

Basic earnings per share

 

$

0.17

 

$

 

$

0.13

 

$

0.13

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

Undistributed earnings available to common stockholders

 

$

14,744

 

$

 

$

9,454

 

$

1,320

 

Add: Earnings distributed to participating securities

 

353

 

 

176

 

 

Add: Undistributed earnings allocated to participating securities

 

262

 

 

114

 

 

Add: Reallocation of undistributed earnings as a result of conversion of class B to common stock

 

 

 

1,320

 

 

Add: Reallocation of undistributed earnings to class B shares

 

 

 

 

8

 

Net income

 

$

15,359

 

$

 

$

11,064

 

$

1,328

 

 

 

 

 

 

 

 

 

 

 

Weighted-average shares outstanding used in in basic calculation

 

88,298

 

 

74,449

 

10,394

 

Weighted average effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Conversion of class B to common stock outstanding

 

 

 

10,394

 

 

Options

 

4,721

 

 

788

 

 

Warrants

 

 

 

435

 

 

Restricted stock

 

276

 

 

37

 

16

 

Weighted-average shares outstanding used in diluted calculation

 

93,295

 

 

86,103

 

10,410

 

Diluted earnings per share

 

$

0.16

 

$

 

$

0.13

 

$

0.13

 

 

Note 15: Commitments and Contingencies

 

Operating Leases

 

The Company has commitments under operating lease agreements, principally a commitment for office space which extends through May 31, 2017. During the three months ended June 30, 2011, the Company executed leases for office space in Austin, Texas and Leawood, Kansas.  During the six months ended June 30, 2011, the Company also executed a lease for office space in Atlanta, Georgia.

 

As of June 30, 2011, future minimum operation lease commitments under non-cancelable leases were as follows:

 

 

 

(in thousands of 
dollars)

 

 

 

 

 

Remainder of 2011

 

$

717

 

2012

 

821

 

2013

 

1,027

 

2014

 

983

 

2015

 

1,036

 

Thereafter

 

1,508

 

Total minimum payments

 

$

6,092

 

 

Rent expense was $0.4 million for each of the three months ended June 30, 2011 and 2010. Rent expense was $0.7 million for each of the six months ended June 30, 2011 and 2010.

 

13



Table of Contents

 

NetSpend Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 

Service Agreements

 

The Company has agreements with various members of the Company’s distribution network and third-party vendors to provide card issuance services, card processing services, internet data center services, advertising and other consulting services. The Company generally makes payments under these agreements on a monthly basis.  The remaining term of these agreements ranges from one to four years.

 

As of June 30, 2011, future minimum commitments under non-cancelable service agreements were as follows:

 

 

 

(in thousands of
dollars)

 

 

 

 

 

Remainder of 2011

 

$

5,097

 

2012

 

14,554

 

2013

 

8,896

 

2014

 

4,480

 

2015

 

1,038

 

Thereafter

 

 

Total minimum payments

 

$

34,065

 

 

Guarantees

 

A significant portion of the Company’s business is conducted through retailers that provide load and reload services to cardholders at their locations. Members of the Company’s distribution and reload network collect cardholders’ funds and remit them by electronic transfer directly to the issuing banks for deposit in the cardholder accounts. The Company does not take possession of cardholders’ funds at any time during the settlement process. The Company’s issuing banks typically receive cardholders’ funds no earlier than three business days after they are collected by the retailer. If any retailer fails to remit cardholders’ funds to the Company’s issuing banks, the Company typically reimburses the issuing banks for the shortfall created thereby. The Company manages the risk associated with this process through a formalized set of credit standards, volume limits and deposit requirements for certain retailers and by typically maintaining the right to offset any settlement shortfall against the commissions payable to the relevant retailer. To date, the Company has not experienced any significant losses associated with settlement failures and the Company had not recorded a settlement guarantee liability as of June 30, 2011 or December 31, 2010. As of June 30, 2011 and December 31, 2010, the Company’s estimated gross settlement exposure was $9.4 million and $13.9 million, respectively.

 

Cardholders can incur charges in excess of the funds available in their card accounts and are liable for the resulting overdrawn account balance. Although the Company generally declines authorization attempts for amounts that exceed the available balance in a cardholder’s account, the application of card association and network organization rules and regulations, the timing of the settlement of transactions and the assessment of subscription, maintenance or other fees, among other things, can result in overdrawn card accounts. The Company also provides, as a courtesy and at its discretion, certain cardholders with a “cushion” which allows them to overdraw their card accounts. In addition, eligible cardholders may enroll in the issuing banks’ overdraft protection programs and fund transactions that exceed the available balance in their accounts. The Company generally provides the funds used as part of this overdraft program (MetaBank will advance the first $1.0 million on behalf of its cardholders) and is responsible to the issuing banks for any losses associated with any overdrawn account balances. As of June 30, 2011 and December 31, 2010, the Company’s reserves related to the risk that it may not recover

 

14



Table of Contents

 

NetSpend Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 

cardholders’ overdrawn account balances were $3.7 million and $4.8 million, respectively. As of June 30, 2011 and December 31, 2010, cardholders’ overdrawn account balances totaled $8.5 million and $6.9 million, respectively.

 

Alexsam Litigation

 

On October 24, 2007, Alexsam, Inc. filed suit against the Company in the District Court of Travis County, Texas, 419th Judicial District, asserting breach of a license agreement entered into between the Company and Alexsam in 2004 and seeking monetary damages, attorneys’ fees, costs and interest.  The license agreement was entered into by the parties following Alexsam’s assertion and subsequent dismissal without prejudice of a claim of patent infringement filed by Alexsam against the Company in 2003. The Company has asserted counterclaims against Alexsam for breach of contract. In April 2010, the Company filed a motion for summary judgment, and following a hearing, the court denied the motion without substantive comment. In October 2010, Alexsam filed an amended petition, which added a claim by Alexsam that NetSpend fraudulently induced Alexsam to give up its prior patent infringement claims against NetSpend and enter into the license agreement.  In November 2010, the Company removed the case to the United States District Court for the Western District of Texas.  On January 7, 2011, the federal court remanded the case back to the Travis County District Court for the 419th Judicial District for further proceedings.  In February 2011, the Company filed a motion for partial summary judgment on Alexsam’s fraudulent inducement claim.  Following a hearing, the court denied the motion.  Trial was previously scheduled to begin in October 2011, but this date has been moved to April 2012.  The Company plans to vigorously contest Alexsam’s claims, including Alexsam’s newly asserted claims, and to vigorously pursue its own claims.

 

Katz Settlement

 

In 2008, the Company received a letter from Ronald A. Katz Technology Licensing, L.P. (“RAKTL”), which contained an offer for the Company to acquire a license under the RAKTL portfolio of patents. In March 2010, the Company recorded a $4.0 million contingent loss as a result of substantive discussions and negotiations it held with RAKTL in early 2010. In July 2010, the Company and RAKTL reached an agreement on the matter. In accordance with the agreement, the Company paid RAKTL a total of $3.5 million in exchange for a release from potential infringement liability related to the Company’s possible use of RAKTL patents. As part of the agreement, the Company also acquired a non-exclusive license related to certain pending RAKTL patents. The initial $4.0 million contingent loss was reversed and a $3.5 million loss was recorded in settlements and other losses on the Condensed Consolidated Statement of Operations.

 

15



Table of Contents

 

NetSpend Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 

Note 16: Employee Benefit Plans

 

The Company has established a defined contribution retirement plan under Section 401(k) of the Internal Revenue Code. This plan covers substantially all employees who meet minimum age and service requirements and allows participants to defer a portion of their annual compensation, not to exceed a federally specified maximum ($16,500 for 2011, plus $5,500 for employees age 50 or older), on a pre-tax basis. The Company contributes to the program by matching funds based on a percentage of the employee’s contribution.  The Company matches 100% of the first 3% of wages contributed by an employee and 50% of the next 2% of wages contributed by that employee.  The Company is also permitted to make a profit-sharing contribution as determined annually at the discretion of the board of directors. For each of the three months ended June 30, 2011 and 2010, the Company’s match under the 401(k) Plan was approximately $0.2 million.  For the six months ended June 30, 2011 and 2010, the Company’s match under the 401(k) Plan was approximately $0.5 million and $0.4 million, respectively.  No profit-sharing contributions were made during the three or six months ended June 30, 2011 and 2010.

 

The Company has a deferred compensation plan (the “Deferral Plan”) for the benefit of those employees who qualify for inclusion. Participating employees may defer a certain percentage of their base salary and annual bonus.  These percentages are determined on an annual basis by the Company’s compensation committee.  For the current Deferral Plan year, participating employees may defer up to 80% of their salary and 100% of their annual bonus. Amounts deferred by a participant are credited with earnings and investment gains and losses by assuming that the deferral was invested in one or more investment options selected by the participants from a family of mutual funds chosen by the Company. In addition, the Company may, but is not required to, make contributions into the Deferral Plan on behalf of the participating employees. The amount of any Company contributions is discretionary and subject to change. The Company did not make any contributions to the Deferral Plan during the three and six months ended June 30, 2011 and 2010. Each employee’s deferrals, together with any earnings thereon, are accrued as part of the unsecured, long-term liabilities of the Company. The deferred compensation liability was $1.5 million and less than $0.1 million at June 30, 2011 and December 31, 2010, respectively.

 

To offset this liability, the Company has purchased life insurance policies on some of the plan participants. The Company is the owner and beneficiary of the policies and the cash values are intended to produce cash to help fund the Company’s obligations under the Deferral Plan. The Company intends to hold the life insurance policies until the death of the plan participants. The net cash surrender value of these life insurance policies was $1.5 million and $0.6 million at June 30, 2011 and December 31, 2010, respectively. The values of the life insurance policies and the related Company obligation are included on the accompanying Condensed Consolidated Balance Sheets in other assets and other non-current liabilities, respectively.

 

Note 17: Related Party Transactions

 

ACE

 

JLL Partners Fund IV, LP and JLL Partners Fund V, LP (collectively “the JLL Funds”) own approximately 97% of ACE Cash Express, Inc. (“ACE”), the Company’s largest distributor. The JLL Funds beneficially owned more than five percent of the Company’s outstanding common stock as of June 30, 2011. The Company incurred expenses from transactions with ACE of $9.3 million and $6.9 million for the three months ended June 30, 2011 and 2010, respectively, and $20.7 million and $15.6 million for the six months ended June 30, 2011 and 2010, respectively. Although revenues generated from

 

16



Table of Contents

 

NetSpend Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 

cardholders acquired at ACE locations represent more than one-third of the Company’s revenues in the three and six months ended June 30, 2011 and June 30, 2010, the portion of those revenues earned from transactions directly with ACE were $1.1 million and $1.0 million for the three months ended June 30, 2011 and 2010, respectively, and $2.5 million and $2.3 million for the six months ended June 30, 2011 and 2010, respectively. As of both June 30, 2011 and December 31, 2010, $2.8 million was payable to ACE.

 

Sutherland

 

Oak Investment Partners X, LP and Oak X Affiliates Fund, LP (collectively “Oak”) own in excess of 10% of Sutherland Global Services, Inc. (“Sutherland”), one of the Company’s external customer service providers. Oak beneficially owned more than five percent of the Company’s outstanding common stock as of June 30, 2011. The Company incurred expenses from transactions with Sutherland of $2.1 million and $1.8 million during the three months ended June 30, 2011 and 2010, respectively, and $4.7 million and $3.5 million during the six months ended June 30, 2011 and 2010, respectively. At June 30, 2011 and December 31, 2010, $0.7 million and $0.6 million, respectively, was payable to Sutherland.

 

Vesta

 

Oak owns in excess of 10% of Vesta Corporation (“Vesta”), one of the Company’s partners within its reload network. The Company incurred expenses from transactions with Vesta of $0.2 million during the three months ended June 30, 2011 and $0.4 million during the six months ended June 30, 2011.  Additionally, the Company earned revenues from transactions with Vesta of $0.2 million during the three months ended June 30, 2011 and $0.4 million during the six months ended June 30, 2011.  The Company incurred no expenses and earned no revenues from transactions with Vesta during the three and six months ended June 30, 2010.

 

Birardi

 

The Company incurred expenses of less than $0.1 million during each of the three months ended June 30, 2011 and 2010, and less than $0.1 million and $0.2 million during the six months ended June 30, 2011 and 2010, respectively, for charges related to the use by the Company’s CEO of an airplane owned by Birardi Investments, LLC (“Birardi”).  Birardi is an airplane leasing company that is partially owned by the CEO.

 

Henry CJ1 LLC

 

The Company incurred expenses of less than $0.1 million during the three and six months ended June 30, 2011 for charges related to the use by the Company’s CEO of an airplane owned by Henry CJ1, LLC (“Henry CJ1”).  Henry CJ1 is an airplane leasing company that is owned by the CEO.  The Company incurred no such expenses during the three and six months ended June 30, 2010.

 

Note 18: Subsequent Events

 

In July 2011, the Company repurchased 709,246 shares of common stock for $6.8 million pursuant to the Company’s share repurchase program (see “Note 11”).

 

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

 

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

 

·                  increasing competition in the prepaid debit card industry;

 

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

 

·                  exposure to cardholder and other losses;

 

·                  our reliance on our relationships with our issuing banks;

 

·                  regulatory, legislative and judicial developments in our operations area;

 

·                  changes in regulations impacting interchange fees;

 

·                  changes in card association or network organization rules;

 

·                  our ability to protect against unauthorized disclosure of cardholder data;

 

·                  fluctuations in customer retention rates;

 

·                  general economic conditions;

 

·                  our ability to promote our brand;

 

·                  our reliance on outsourced customer service providers; and

 

·                  our ability to protect our intellectual property rights.

 

These and other factors are more fully discussed in “Risk Factors” and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2010. In light of these and other uncertainties, you should not conclude that we will necessarily achieve any plans, objectives or projected financial results referred to in any of the forward-looking statements. Except as required by law, we do not intend to update any of these forward-looking statements to reflect future events or circumstances.

 

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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and related notes to audited consolidated financial statements  included in our Annual Report on Form 10-K for the year ended December 31, 2010. In this Quarterly Report, unless otherwise specified, “NetSpend,” “we,” “us,” and “our” refer to NetSpend Holdings, Inc. and its consolidated subsidiaries.

 

Overview

 

NetSpend is a leading provider of general-purpose reloadable prepaid debit cards, or GPR cards, and related alternative financial services to underbanked consumers in the United States. We empower underbanked consumers by providing innovative and affordable financial products and services tailored to meet their particular financial services needs and preferences in a manner that traditional banking institutions have historically not met. In addition, our products and services provide our retail distributors an opportunity to enhance their customer relationships and generate incremental, ongoing revenue streams.

 

We have built an extensive and diverse distribution and reload network in the United States to support the marketing and ongoing use of our GPR cards. We market our cards through multiple channels, including retail distributors, direct-to-consumer and online marketing programs and to corporate employers as an alternative method of wage payment for their employees. Beginning in 2008, we decided to focus primarily on our GPR cards, and we ceased marketing gift cards entirely as of August 21, 2010.

 

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

 

We have agreements with FDIC-insured depository institutions that serve as the issuers of our GPR cards. Our cardholders may use their GPR cards to make purchase transactions at any merchant that participates in the MasterCard, Visa or PULSE networks and to withdraw funds from participating ATMs. MetaBank holds the majority of our cardholder funds. In January 2010, we acquired approximately 4.9% of the outstanding equity interests in Meta Financial Group, Inc. (“MFG”), MetaBank’s holding company.

 

Our operating company, predecessor, and current subsidiary, NetSpend Corporation, was incorporated in Texas in 1999. In May 2004, Oak Investment Partners acquired a controlling equity interest in NetSpend Corporation through a recapitalization transaction pursuant to which we, as a newly-formed holding company incorporated in Delaware, acquired all of the capital stock of NetSpend Corporation. In 2008, we acquired Skylight Financial, Inc., or Skylight, a payroll card provider, in a stock-for-stock merger.

 

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Recent Developments

 

MetaBank Announcement

 

On July 18, 2011, MetaBank publicly disclosed that it stipulated and consented to a Cease and Desist Order (the “Order”) issued by the Office of Thrift Supervision, now the Office of the Comptroller of the Currency (“OCC”). Under the Order, MetaBank remains subject to the Supervisory Directives issued by the OTS (the “OTS Directives”) in October 2010 (as previously disclosed in our Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 filed with the Securities and Exchange Commission on November 10, 2010). Under the OTS Directives, MetaBank is required to obtain prior written approval of the OCC to, among other things, enter into any new third party relationship agreements concerning any credit or deposit product (including prepaid access), or materially amend any such existing agreement.

 

Based on further communications between MetaBank and OTS, we understand that the OTS Directives will require MetaBank to obtain OCC approval prior to MetaBank executing third party agency agreements with new distributor relationships established by existing program managers such as NetSpend. This means that we remain unable, without MetaBank obtaining the prior written approval of OCC, to enter into new agreements with distributors that are also required to enter into third party agency agreements with MetaBank, which would include any retail distributors that have the capability to distribute cards issued by MetaBank and accept funds to be loaded onto those cards. Our programs that do not involve retail distributors that accept funds to be loaded onto cards, such as our direct-to-consumer and online marketing programs and our non-standard auto insurance marketing relationships, do not require third party agency agreements with our issuing banks. Similarly, as a general matter extensions or renewals of our existing distributor agreements do not require execution of new or amended third party agency agreements with our issuing banks, including MetaBank. Therefore, MetaBank expects to be able to continue to service its existing third party relationship agreements, which would include our card program management agreement and its existing third party agency agreements with our distributors, consistent with their terms and the OTS Directives. We are also actively pursuing our own money transmitter licenses in the jurisdictions where we do not currently have them in order to reduce our dependence on the ability of our issuing banks to enter into agency relationships with proposed new distributors.

 

Issuing Bank Diversification

 

We are pursuing a bank diversification strategy pursuant to which we intend to diversify our cards among at least three issuing banks. We are focused on doing so in a manner that balances our diversification strategy with the protection of existing cardholder and direct deposit relationships and other operational considerations. In furtherance of this strategy, in January 2011, we entered into an agreement with The Bancorp Bank pursuant to which The Bancorp Bank will serve as a new issuing bank for our new and existing card programs. The Bancorp Bank began issuing our cards in a pilot program in April 2011 and we are working diligently with The Bancorp Bank on a more extensive rollout. We are also continuing our discussions with other prospective issuing banks.

 

In May 2011, we amended our agreement with Inter National Bank to extend the date by which we agreed to transition our cards issued by Inter National Bank to another bank from July 2011 to September 2011.

 

For a discussion of the risks associated with moving these banking services to another provider, see “Risk Factors—Risks Relating to Our Business—The loss of, or change to, our relationships with MetaBank or our other issuing banks could adversely affect our business, results of operations and financial position” included in our Annual Report on Form 10-K for the year ended December 31, 2010.

 

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Interchange Regulations

 

In July 2010, the U.S. Congress adopted legislation which requires the amount of interchange fees charged to merchants in connection with transactions utilizing traditional debit cards and certain prepaid cards issued by financial institutions that, together with their affiliates, have assets of $10 billion or more to be reasonable and proportionate to the costs of the underlying transactions. The new legislation also generally gave the Federal Reserve Board (the “FRB”) the power to regulate the amount of such interchange fees and required the FRB to promulgate regulations establishing standards for determining when interchange fees are reasonable and proportionate to the costs of the underlying transactions. The FRB published final regulations in June 2011. For a discussion of the impact these final regulations are expected to have on our business, see “Item 1A. — Risk Factors—Risks Relating to Our Business—Limitations on the amount of interchange fees that may be charged to merchants that accept our cards could decrease our revenues and negatively impact our business and financial performance” contained in this Quarterly Report on Form 10-Q.

 

Share Repurchase Program

 

On June 13, 2011, we announced a $25 million share repurchase program.  The share repurchases are being made on the open market, through block trades, through 10b5-1 plans, in privately negotiated transactions or otherwise. The repurchase program commenced June 15, 2011 and is authorized to continue for a period of up to 12 months. The amount of shares purchased and the timing of the purchases are based on working capital requirements, general business conditions and other factors, including alternative investment opportunities. We intend to hold the repurchased shares in treasury for general corporate uses. As of June 30, 2011, we had purchased 1,186,200 shares at an average price of $8.99 per share pursuant to this program.  See “Item 2. Unregistered Sales of Equity Securities and Use of Proceeds — Issuer’s Purchases of Equity Securities” contained in this Quarterly Report on Form 10-Q.

 

Florida Attorney General Subpoena

 

In June 2011, we, along with a number of other participants in the prepaid debit card industry, received a subpoena from the Florida Attorney General’s office requesting information regarding our marketing materials, the fees we charge to cardholders and the disclosures we provide to them.  We completed our initial documentary response to this request in June 2011.  We believe that our programs comply in all material respects with applicable law and we are cooperating with this review.

 

Anti-Money Laundering Regulations

 

On July 26, 2011, the Financial Crimes Enforcement Network of the U.S. Department of the Treasury, or FinCEN, issued a final rule regarding the applicability of the Bank Secrecy Act’s anti-money laundering provisions to “prepaid access” products and services. This rulemaking clarifies the anti-money laundering obligations for entities, such as us and our distributors, engaged in the provision and sale of prepaid access cards, such as our GPR cards. For a discussion of the impact this final rule is expected to have on our business, see “Item 1A. — Risk Factors—Risks Relating to Our Business—Our card programs are subject to strict regulation under federal law regarding anti-money laundering and anti-terrorist financing. Failure to comply with such laws, or abuse of our card programs for purposes of money laundering or terrorist financing, could have a material adverse impact on our business.” contained in this Quarterly Report on Form 10-Q.

 

Key Business Metrics

 

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

 

Number of Active Cards with Direct Deposit — represents the number of our active cards that have had a direct deposit load within the previous 90 days.  We had 771,000 and 615,000 direct deposit active cards as of June 30, 2011 and 2010, respectively.

 

Percentage of Active Cards with Direct Deposit — represents the percentage of our active GPR cards that have had a direct deposit load within the previous 90 days. The percentage of our active cards that were direct deposit active cards as of June 30, 2011 and 2010 was 36.7% and 30.8%, respectively.

 

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Gross Dollar Volume (“GDV”) — represents the total dollar volume of debit transactions and cash withdrawals made using our GPR cards. Our gross dollar volume was $2.6 billion and $2.3 billion for the three months ended June 30, 2011 and 2010, respectively, and $5.8 billion and $4.9 billion for the six months ended June 30, 2011 and 2010, respectively. Approximately 77.2% and 70.3% of the gross dollar volume for the three months ended June 30, 2011 and 2010, respectively, was made using active cards with direct deposit. Approximately 76.1% and 69.0% of the gross dollar volume for the six months ended June 30, 2011 and 2010, respectively, was made using active cards with direct deposit.

 

Number of Active Cards — represents the total number of our GPR cards that have had a PIN-, or signature-based purchase transaction, a load transaction at a retailer location or an ATM withdrawal within the previous 90 days. We had approximately 2.1 million and 2.0 million active cards as of June 30, 2011 and 2010, respectively.

 

Operating Revenues

 

Our operating revenues primarily consist of compensation for the services we provide to our issuing banks and result from cardholder service fees and interchange revenues.

 

Cardholders are charged fees in connection with our products and services as follows:

 

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

 

·                  Customer Service and Maintenance — Cardholders are typically charged fees for balance inquiries made through the Company’s customer service centers. Cardholders are also charged a monthly maintenance fee after a specified period of inactivity.

 

·                  Additional Products and Services — Cardholders are charged fees associated with additional products and services offered in connection with certain of our GPR cards, including overdraft protection through our issuing banks, a variety of bill payment options, custom card designs and card-to-card transfers of funds through our customer service.

 

·                  Other — Cardholders are charged fees in connection with the acquisition of our GPR cards at retailers.

 

Our operating revenues also include fees charged to retail distributors in connection with the reload of our GPR cards at their locations and interest earned, if any, on cardholder funds maintained at MetaBank, although under our current arrangement with MetaBank we would only be entitled to receive interest on cardholder funds if market interest rates rose significantly above current levels.

 

We earn revenues from a portion of the interchange fees remitted by merchants when cardholders make purchases using our prepaid debit cards. Interchange revenues are fixed by the card associations and network organizations. Interchange revenues are recognized net of sponsorship, licensing and processing fees charged by the card associations and network organizations for services they provide in processing transactions routed through their networks.

 

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Our quarterly operating revenues fluctuate as a result of certain seasonal factors affecting our GDV and the number of our active cards. For example, the most significant increases in the number of our active cards and our GDV typically occur in the first fiscal quarter as a result of consumers acquiring new cards and loading federal tax refunds onto their cards during tax season.

 

Operating Expenses

 

We classify our operating expenses into the following categories:

 

Direct Operating Costs — Direct operating costs consist primarily of the commissions we pay to members of our distribution and reload network for their services, ATM processing fees, card supply costs, cardholder and other losses related to our card programs, customer verification costs, customer service costs and fees paid to our issuing banks. These costs are driven by transaction volumes and the number of active cards.

 

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

 

Advertising, Marketing and Promotion Costs — Advertising, marketing, and promotion costs primarily consist of the costs of marketing programs including direct-to-consumer and internet advertising to potential cardholders, promotional events run in conjunction with our distributors, conferences, trade shows and marketing materials.

 

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

 

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

 

Other Income (Expense)

 

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

 

Income Tax Expense

 

Income tax expense primarily consists of corporate income taxes related to profits resulting from our ongoing operations.

 

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Condensed Consolidated Statements of Operations Data (unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

(in thousands of dollars)

 

 

 

 

 

 

 

 

 

 

 

Operating Revenues

 

$

74,419

 

$

67,447

 

$

155,169

 

$

136,967

 

 

 

 

 

 

 

 

 

 

 

Operating Expenses

 

 

 

 

 

 

 

 

 

Direct operating costs

 

35,489

 

30,304

 

75,622

 

63,017

 

Salaries, benefits and other personnel expenses

 

12,788

 

13,504

 

27,721

 

26,583

 

Advertising, marketing and promotion costs

 

4,147

 

3,528

 

7,732

 

7,369

 

Other general and administrative costs

 

5,136

 

4,876

 

10,303

 

9,088

 

Depreciation and amortization

 

3,742

 

3,296

 

7,440

 

6,075

 

Settlements and other losses

 

 

300

 

 

4,300

 

Total operating expenses

 

61,302

 

55,808

 

128,818

 

116,432

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

13,117

 

11,639

 

26,351

 

20,535

 

 

 

 

 

 

 

 

 

 

 

Other Income (Expense)

 

 

 

 

 

 

 

 

 

Interest income

 

30

 

40

 

50

 

46

 

Interest expense

 

(502

)

(1,045

)

(1,005

)

(2,057

)

Total other expense

 

(472

)

(1,005

)

(955

)

(2,011

)

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

12,645

 

10,634

 

25,396

 

18,524

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

5,065

 

4,188

 

10,037

 

7,460

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

7,580

 

$

6,446

 

$

15,359

 

$

11,064

 

 

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Consolidated Statements of Operations Data as a Percentage of Total Revenues (unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Operating Revenues

 

100.0

%

100.0

%

100.0

%

100.0

%

 

 

 

 

 

 

 

 

 

 

Operating Expenses

 

 

 

 

 

 

 

 

 

Direct operating costs

 

47.7

 

44.9

 

48.7

 

46.1

 

Salaries, benefits and other personnel expenses

 

17.2

 

20.0

 

17.9

 

19.4

 

Advertising, marketing and promotion costs

 

5.5

 

5.2

 

5.0

 

5.4

 

Other general and administrative costs

 

6.9

 

7.2

 

6.6

 

6.6

 

Depreciation and amortization

 

5.0

 

4.9

 

4.8

 

4.4

 

Settlements and other losses

 

 

0.5

 

 

3.1

 

Total operating expenses

 

82.3

 

82.7

 

83.0

 

85.0

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

17.7

 

17.3

 

17.0

 

15.0

 

 

 

 

 

 

 

 

 

 

 

Other Income (Expense)

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

 

 

Interest expense

 

(0.7

)

(1.5

)

(0.6

)

(1.5

)

Total other expense

 

(0.7

)

(1.5

)

(0.6

)

(1.5

)

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

17.0

 

15.8

 

16.4

 

13.5

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

6.8

 

6.2

 

6.5

 

5.4

 

 

 

 

 

 

 

 

 

 

 

Net income

 

10.2

%

9.6

%

9.9

%

8.1

%

 

Comparison of Three Months Ended June 30, 2011 and 2010 (unaudited)

 

Operating Revenues

 

Operating Revenues — Our operating revenues totaled $74.4 million in the three months ended June 30, 2011, an increase of $7.0 million, or 10.3%, from the comparable period in 2010. Service fees represented approximately 77.8% of our revenue for the three months ended June 30, 2011 with the balance of our revenue consisting of interchange fees. Service fee revenue increased $4.6 million, or 8.6%, from $53.3 million in the three months ended June 30, 2010 to $57.9 million in the comparable period in 2011. The increase in service fee revenue was substantially driven by the expansion of product features across our direct deposit customer base and, to a lesser extent, a 5% increase in the number of active cards outstanding.

 

Interchange revenue represented approximately 22.2% of our operating revenues for the three months ended June 30, 2011. Interchange revenue increased $2.4 million, or 17.0%, from $14.1 million in the three months ended June 30, 2010 to $16.5 million in the comparable period in 2011. This increase was primarily the result of a 13.0% increase in our gross dollar volume, combined with more favorable rates on some of our interchange revenue contracts negotiated during the later part of 2010.

 

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Our total operating revenues of $74.4 million in the three months ended June 30, 2011 were comprised of $74.0 million related to our GPR cards and $0.4 million related to our gift cards. Our GPR card related revenues increased by $8.4 million, or 12.8%, from the comparable period in 2010. Our gift card related revenues decreased by $1.5 million, or 79.0%, from the comparable period in 2010 as we ceased marketing gift cards in August 2010.

 

Operating Expenses

 

The following table presents the breakdown of our operating expenses among direct operating costs, personnel costs, advertising and marketing costs, other general and administrative costs, depreciation and amortization and other components of operating expenses:

 

 

 

Three Months Ended June 30,

 

 

 

 

 

2011

 

2010

 

 

 

 

 

Amount

 

Percentage
of Total
Operating
Revenues

 

Amount

 

Percentage
of Total
Operating
Revenues

 

Change

 

 

 

(in thousands of dollars)

 

 

 

 

 

 

 

 

 

 

 

 

 

Direct operating costs

 

$

35,489

 

47.7

%

$

30,304

 

44.9

%

$

5,185

 

Salaries, benefits, and other personnel costs

 

12,788

 

17.2

 

13,504

 

20.0

 

(716

)

Advertising, marketing, and promotion costs

 

4,147

 

5.5

 

3,528

 

5.2

 

619

 

Other general and administrative costs

 

5,136

 

6.9

 

4,876

 

7.2

 

260

 

Depreciation and amortization

 

3,742

 

5.0

 

3,296

 

4.9

 

446

 

Settlements and other losses

 

 

 

300

 

0.5

 

(300

)

Total operating expenses

 

$

61,302

 

82.3

%

$

55,808

 

82.7

%

$

5,494

 

 

Direct Operating Costs — Our direct operating costs were $35.5 million in the three months ended June 30, 2011, an increase of $5.2 million, or 17.1%, from the comparable period in 2010.  From the three months ended June 30, 2010 to the three months ended June 30, 2011, our direct operating costs increased from 44.9% of revenues to 47.7%.  This was primarily the result of an increase in our provision for fraud-related losses and because ACE, our largest distribution partner, achieved higher commission tiers during the quarter ended June 30, 2011 due to increasing volumes, resulting in higher commission expenses as compared to the prior year quarter.

 

Salaries, Benefits, and Other Personnel Costs — Our salaries, benefits, and other personnel costs were $12.8 million in the three months ended June 30, 2011, a decrease of $0.7 million, or 5.3%, from the comparable period in 2010. This net decrease was primarily the result of a $1.8 million decrease in annual bonus expense accrual levels as we significantly exceeded performance targets in 2010 but are tracking closer to the applicable performance targets during 2011. This decrease was partially offset by a $1.3 million increase in stock-based compensation expense as a result of grants issued in 2010 and the accelerated vesting of previously issued equity awards following the completion of our initial public offering in October 2010.

 

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Advertising, Marketing, and Promotion Costs — Our advertising, marketing, and promotion costs were $4.1 million in the three months ended June 30, 2011, an increase of $0.6 million, or 17.5% from the comparable period in 2010. This period-over-period increase was primarily the result of a $0.7 million increase in marketing costs related to our direct-to-consumer and online marketing programs.

 

Other General and Administrative Costs — Our other general and administrative costs were $5.1 million in the three months ended June 30, 2011, an increase of $0.3 million, or 5.3%, from the comparable period in 2010. This increase was primarily the result of an increase in legal and other professional expenses, insurance costs and other corporate expenses related to our recently completed initial public offering and status as a public reporting company.

 

Depreciation and Amortization — Our depreciation and amortization costs were $3.7 million in the three months ended June 30, 2011, an increase of $0.4 million, or 13.5% from the comparable period in 2010. This increase was primarily the result of increased depreciation expense associated with capital expenditures made in 2010.

 

Settlements and Other Losses — Settlements and other losses of $0.3 million in the three months ended June 30, 2010 were related to a $0.8 million loss associated with a contractual dispute with an issuing bank offset by a $0.5 million positive adjustment related to the resolution of a patent infringement dispute.  There were no similar losses or adjustments recorded in the three months ended June 30, 2011.

 

Other Income (Expense)

 

Other expenses were $0.5 million in the three months ended June 30, 2011, a decrease of $0.5 million, or 53.0% from the comparable period in 2010. This decline was the result of decreased interest expense due to a lower interest rate on borrowings under the credit facility we entered into during three months ended September 30, 2010 compared to our previous credit facility, and a reduction in the average amount owed under long term debt arrangements as a result of repayments made in 2010.

 

Income Tax Expense

 

The following table presents the breakdown of our effective tax rate among federal, state, and other:

 

 

 

Three Months Ended
June 30,

 

 

 

2011

 

2010

 

 

 

 

 

 

 

U.S. federal income tax

 

35.0

%

35.0

%

State income taxes, net of federal benefit

 

2.6

 

4.2

 

Other

 

2.5

 

0.2

 

Income tax expense

 

40.1

%

39.4

%

 

Our total income tax expense was $5.1 million during the three months ended June 30, 2011, an increase of $0.9 million, or 20.9%, from the same period in 2010. This increase was primarily the result of a period-over-period increase in our taxable income. Our effective tax rate during the three months ended June 30, 2011 increased by approximately 0.7% from the same period in 2010 primarily as a result of an increase in several business expenses that are not deductible for tax purposes.

 

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Comparison of Six Months Ended June 30, 2011 and 2010 (unaudited)

 

Operating Revenues

 

Operating Revenues — Our operating revenues totaled $155.2 million in the six months ended June 30, 2011, an increase of $18.2 million, or 13.3%, from the comparable period in 2010. Service fees represented approximately 76.6% of our revenue for the six months ended June 30, 2011 with the balance of our revenue consisting of interchange fees.  Service fee revenue increased $11.3 million, or 10.5%, from $107.6 million in the six months ended June 30, 2010 to $118.9 million in the comparable period in 2011.  The increase in service fee revenue was substantially driven by the expansion of product features across our direct deposit customer base and, to a lesser extent, a 5% increase in the number of active cards outstanding.

 

Interchange revenue represented approximately 23.4% of our operating revenues for the six months ended June 30, 2011.  Interchange revenue increased $6.9 million, or 23.5%, from $29.4 million in the six months ended June 30, 2010 to $36.3 million in the comparable period in 2011. This increase was primarily the result of a 18.4% increase in our gross dollar volume, combined with more favorable rates under contracts negotiated during the later part of 2010.

 

Our total operating revenues of $155.2 million in the six months ended June 30, 2011 were comprised of $154.2 million related to our GPR cards and $1.0 million related to our gift cards. Our GPR card related revenues increased by $21.2 million, or 15.9%, from the comparable period in 2010. Our gift card related revenues decreased by $3.0 million, or 75.0%, from the comparable period in 2010 as we ceased marketing gift cards in August 2010.

 

Operating Expenses

 

The following table presents the breakdown of our operating expenses among direct operating costs, personnel costs, other general and administrative costs, advertising and marketing costs, depreciation and amortization and other components of operating expenses:

 

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Table of Contents

 

 

 

Six Months Ended June 30,

 

 

 

 

 

2011

 

2010

 

 

 

 

 

Amount

 

Percentage
of Total
Operating
Revenues

 

Amount

 

Percentage
of Total
Operating
Revenues

 

Change

 

 

 

(in thousands of dollars)

 

 

 

 

 

 

 

 

 

 

 

 

 

Direct operating costs

 

$

75,622

 

48.7

%

$

63,017

 

46.1

%

$

12,605

 

Salaries, benefits, and other personnel costs

 

27,721

 

17.9

 

26,583

 

19.4

 

1,138

 

Advertising, marketing, and promotion costs

 

7,732

 

5.0

 

7,369

 

5.4

 

363

 

Other general and administrative costs

 

10,303

 

6.6

 

9,088

 

6.6

 

1,215

 

Depreciation and amortization

 

7,440

 

4.8

 

6,075

 

4.4

 

1,365

 

Settlement and other losses

 

 

 

4,300

 

3.1

 

(4,300

)

Total operating expenses

 

$

128,818

 

83.0

%

$

116,432

 

85.0

%

$

12,386

 

 

Direct Operating Costs — Our direct operating costs were $75.6 million in the six months ended June 30, 2011, an increase of $12.6 million, or 20.0%, from the comparable period in 2010. From the six months ended June 30, 2010 to the six months ended June 30, 2011, our direct operating costs increased from 46.1% of revenue to 48.7%.  This was primarily the result of an increase in our provision for fraud-related losses and an increase in commissions we paid to our distributors caused by ACE, our largest distribution partner, regularly reaching their maximum commission tier due to increasing volumes.

 

Salaries, Benefits, and Other Personnel Costs — Our salaries, benefits, and other personnel costs were $27.7 million in the six months ended June 30, 2011, an increase of $1.1 million, or 4.3%, from the comparable period in 2010. This net increase was primarily the result of a $3.0 million increase in stock-based compensation expense as a result of grants issued in 2010 and the accelerated vesting of previously issued equity awards following the completion of our initial public offering in October 2010.  This increase was partially offset by a $2.0 million decrease in annual bonus expense accrual levels as we significantly exceeded performance targets in 2010 but are tracking closer to the applicable performance targets in 2011.

 

Advertising, Marketing, and Promotion Costs — Our advertising, marketing, and promotion costs were $7.7 million in the six months ended June 30, 2011, an increase of $0.4 million, or 4.9%, from the comparable period in 2010. This increase was primarily the result of a $0.8 million increase in marketing costs related to our direct-to-consumer and online marketing programs, partially offset by a $0.3 million decrease in amounts paid for advertising agency expenses.

 

Other General and Administrative Costs — Our other general and administrative costs were $10.3 million in the six months ended June 30, 2011, an increase of $1.2 million, or 13.4%, from the comparable period in 2010. This increase was primarily the result of an increase in legal and other professional expenses, insurance costs and other corporate expenses related to our recently completed initial public offering and status as a public reporting company.

 

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Table of Contents

 

Depreciation and Amortization — Our depreciation and amortization costs were $7.4 million in the six months ended June 30, 2011, an increase of $1.4 million, or 22.5% from the comparable period in 2010. This increase was primarily the result of increased depreciation resulting from capital expenditures made in 2010.

 

Settlements and Other Losses — Settlements and other losses of $4.3 million in the six months ended June 30, 2010 were related to a $3.5 million loss related to a patent infringement dispute and a $0.8 million loss related to a contractual dispute with an issuing bank.  There were no similar losses recorded in the six months ended June 30, 2011.

 

Other Income (Expense)

 

Our other expense was $1.0 million in the six months ended June 30, 2011, a decrease of $1.0 million, or 52.5% from the comparable period in 2010.  This decline was the result of decreased interest expense due to a reduction in September 2010 in the interest rate on borrowings under the credit facility we entered into during three months ended September 30, 2010 and a reduction in the average amount owed under this facility as a result of repayments made in 2010.

 

Income Tax Expense

 

The following table presents the breakdown of our effective tax rate among federal, state, and other:

 

 

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

 

 

 

 

 

 

U.S. federal income tax

 

35.0

%

35.0

%

State income taxes, net of federal benefit

 

2.7

 

4.5

 

Other

 

1.8

 

0.8

 

Income tax expense

 

39.5

%

40.3

%

 

Our total income tax expense was $10.0 million during the six months ended June 30,2011, an increase of $2.6 million from the same period in 2010, which was primarily the result of a period-over-period increase in our taxable income. Our effective tax rate during the six months ended June 30, 2011 decreased by approximately 0.8% from the same period in 2010 primarily as a result of a decrease in our state tax rate.

 

Liquidity and Capital Resources

 

Our primary sources of liquidity are cash flow from our operating activities and access to borrowings under our revolving credit facility.

 

Comparison of Six Months Ended June 30, 2011 and 2010 (unaudited)

 

 

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

 

 

(in thousands of dollars)

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

14,590

 

$

22,577

 

Net cash used in investing activities

 

(5,581

)

(7,479

)

Net cash used in financing activities

 

(12,515

)

(20,868

)

Net change in cash and cash equivalents

 

$

(3,506

)

$

(5,770

)

 

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Cash Flows from Operating Activities

 

During the six months ended June 30, 2011, our operating activities provided $14.6 million of cash resulting from $15.4 million of net income, increased by $17.6 million of non-cash adjustments to net income and decreased by $18.4 million in cash used by changes in operating assets and liabilities. The $17.6 million adjustment to net income for non-cash items primarily relates to $7.4 million of depreciation and amortization expense, $7.0 million of provision for cardholder losses and $6.0 million of stock-based compensation expense, offset by $1.8 million of deferred income taxes and $1.0 million from a tax benefit associated with stock options. The $18.4 million in cash used by changes in operating assets and liabilities was primarily the result of a $5.3 million decrease in our accounts payable and accrued liabilities primarily caused by the payout of bonuses earned in 2010, $8.1 million of write-offs flowing through our cardholders’ reserve, a $0.9 million increase in other current assets, a $2.0 million increase in other long-term assets, a $1.1 million increase in accounts receivable, a $1.7 million decrease in income tax payable and a $0.6 million increase in prepaid expenses. These items were offset by a $1.2 million increase in other liabilities.

 

The $8.0 million decrease in operating cash flows from the six months ended June 30, 2010 to the six months ended June 30, 2011 relates to a $20.1 million decrease in cash provided by changes in operating assets and liabilities.  During the first six months of 2010, $1.7 million of cash was provided by changes in operating assets and liabilities while $18.4 million of cash was used by changes in operating assets and liabilities during the first six months of 2011. This $20.1 million decrease in cash provided by changes in operating assets and liabilities, which was partially offset by a $4.3 million increase in net income and a $7.8 million increase in non-cash item adjustments, was primarily caused by an $7.6 million decrease in cash provided by accounts payable and accrued liabilities as well as $4.9 million of incremental write-offs flowing through our cardholders’ reserve during the six months ended June 30, 2011 as compared to the six months ended June 30, 2010.

 

Cash Flows from Investing Activities

 

Investing activities used $5.6 million of cash for the six months ended June 30, 2011, which was caused by an $0.8 million increase in premiums paid on cash surrender value life insurance policies issued to support our obligations under our deferred compensation plan, and $4.8 million in purchases of property and equipment. Cash used by investing activities for the six months ended June 30, 2010 was $7.5 million, reflecting a $3.2 million investment in MFG and $4.3 million in purchases of property and equipment.

 

Cash Flows from Financing Activities

 

Financing activities used $12.5 million of cash for the six months ended June 30, 2011, primarily related to $10.7 million used to repurchase outstanding shares of common stock and $2.6 million in payments towards our capital lease. These cash outflows were partially offset by a $1.0 million tax benefit associated with stock options.  For the six months ended June 30, 2010, financing activities used $20.9 million of cash, $15.2 million of which was used to repay debt under our prior credit facility and capital lease, and $5.7 million of which was used to repurchase outstanding shares of common stock.

 

Off-Balance Sheet Arrangements

 

Our off-balance sheet arrangements are comprised of settlement indemnifications and overdraft guarantees with our issuing banks. We enter into operating leases, purchase orders, and other commitments in the ordinary course of business as discussed below and reflected in our contractual obligations and commitments table.

 

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Table of Contents

 

During the three months ended June 30, 2011, we executed a lease for office space in Austin, Texas and Leawood, Kansas.  During the six months ended June 30, 2011, we executed a lease for office space in Atlanta, Georgia.

 

As of June 30, 2011, future minimum operation lease commitments under non-cancelable leases were as follows:

 

 

 

(in thousands of
dollars)

 

 

 

 

 

Remainder of 2011

 

$

717

 

2012

 

821

 

2013

 

1,027

 

2014

 

983

 

2015

 

1,036

 

Thereafter

 

1,508

 

Total minimum payments

 

$

6,092

 

 

We have agreements with various third-party vendors and members of our distribution network to provide card issuance services, card processing services, internet data center services, advertising and other consulting services. We generally make payments under these agreements on a monthly basis.  The remaining term of these agreements ranges from one to four years.

 

As of June 30, 2011, future minimum commitments under non-cancelable service agreements were as follows:

 

 

 

(in thousands of
dollars)

 

 

 

 

 

Remainder of 2011

 

$