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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012.
or
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             .
Commission File Number: 001-34779
 
 
HIGHER ONE HOLDINGS, INC.
 (Exact Name of Registrant as Specified in its Charter)
 
 
     
Delaware
 
26-3025501
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
115 Munson Street
New Haven, CT 06511
(Address of Principal Executive Offices)(Zip Code)
(203) 776-7776
(Registrant’s Telephone Number, Including Area Code)
N/A
(Former Name, Former Address and Former Fiscal Year, If Changes Since Last Report)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” or “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one).
             
Large accelerated filer
 
¨
  
Accelerated filer
 
x
       
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨

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

As of November 2, 2012 there were 52,707,809 shares of common stock, par value $0.001 per share, outstanding.
 
 

 
 
 
 
 
 
 
 
 
 

 
 
 
 
 


 
HIGHER ONE HOLDINGS, INC.
INDEX TO REPORT ON FORM 10-Q
FOR QUARTER ENDED SEPTEMBER 30, 2012

 
Page
 
 
 
 
 
 

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

 
 
 

 
 

 





 
 
 
 
 
 
 
 
 
 

 

 

PART I – FINANCIAL INFORMATION
 
Item 1.
Financial Statements (unaudited)
Higher One Holdings, Inc.
Condensed Consolidated Balance Sheets
 (In thousands of dollars, except share and per share amounts)
(unaudited)
   
December 31,
   
September 30,
 
   
2011
   
2012
 
Assets
           
Current assets:
           
Cash and cash equivalents
 
$
         39,085
   
$
          27,044
 
Investments in marketable securities and certificate of deposit
   
         15,743
     
               245
 
Accounts receivable
   
           3,672
     
            8,704
 
Income receivable
   
           5,961
     
            8,990
 
Deferred tax assets
   
                33
     
                 –
 
Income tax receivable
   
         12,671
     
            1,608
 
Prepaid expenses and other current assets
   
           6,774
     
            7,688
 
Restricted cash
   
                 –
     
            2,365
 
Total current assets
   
         83,939
     
          56,644
 
Deferred costs
   
           3,776
     
            3,306
 
Fixed assets, net
   
         46,088
     
          53,250
 
Intangible assets, net
   
         16,787
     
          38,283
 
Goodwill
   
         15,830
     
          46,910
 
Loan receivable related to New Markets Tax Credit financing
   
           7,633
     
            7,633
 
Other assets
   
              712
     
               619
 
Deferred tax assets
   
                 –
     
               1,423
 
Restricted cash
   
           1,250
     
            1,500
 
Total assets
 
$
       176,015
   
$
        209,568
 
                 
Liabilities and Stockholders' Equity
               
Current liabilities:
               
Accounts payable
 
$
           3,118
   
$
            3,798
 
Accrued expenses
   
         26,414
     
          12,125
 
Contingent consideration, current portion
   
                 –
     
            2,286
 
Deferred tax liabilities
     –        868  
Deferred revenue
   
           9,690
     
          16,861
 
Total current liabilities
   
         39,222
     
          35,938
 
Deferred revenue
   
           2,173
     
            2,210
 
Loan payable and deferred contribution related to New Markets Tax Credit financing
           9,801
     
            9,568
 
Debt
   
                 –
     
          30,000
 
Contingent consideration, non-current portion
   
                 –
     
          11,024
 
Deferred tax liabilities
   
           1,233
     
                  –
 
Total liabilities
   
         52,429
     
          88,740
 
Commitments and contingencies (Note 6)
               
                 
Stockholders' equity:
               
Common stock, $.001 par value; 200,000,000 shares authorized; 57,675,806 shares issued and 56,615,683 shares outstanding at December 31, 2011; 57,974,292 shares issued and 54,191,446 shares outstanding at September 30, 2012
   
                58
     
                 59
 
Additional paid-in capital
   
       161,268
     
        171,351
 
Treasury stock, 1,060,123 and 3,782,846 shares at December 31, 2011 and September 30, 2012, respectively
   
       (16,208
   
        (53,808
Accumulated earnings (deficit), net of 2008 stock tender transaction of $93,933
   
       (21,532
   
            3,226
 
Total stockholders' equity
   
       123,586
     
        120,828
 
Total liabilities and stockholders' equity
 
$
       176,015
   
$
        209,568
 
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 
 

 
 
 
1

 
Higher One Holdings, Inc.
Condensed Consolidated Statements of Operations
(In thousands of dollars, except share and per share amounts)
(unaudited)

 
   
Three Months
   
Nine Months
 
   
Ended September 30,
   
Ended September 30,
 
   
2011
   
2012
   
2011
   
2012
 
Revenue:
                       
Account revenue
 
$
      35,800
   
 $
      35,660
   
 $
    105,500
   
 $
    112,803
 
Payment transaction revenue
   
        6,603
     
        8,342
     
      13,988
     
      17,843
 
Higher education institution revenue
   
        4,595
     
        5,946
     
      12,696
     
      14,597
 
Other revenue
   
        1,142
     
        1,279
     
        2,406
     
        2,678
 
Total revenue
   
      48,140
     
      51,227
     
    134,590
     
    147,921
 
Cost of revenue
   
      19,630
     
      21,838
     
      50,486
     
      60,303
 
Gross margin
   
      28,510
     
      29,389
     
      84,104
     
      87,618
 
Operating expenses:
                               
General and administrative
   
        9,415
     
      11,902
     
      28,202
     
      34,205
 
Product development
   
        1,158
     
        1,380
     
        2,838
     
        3,371
 
Merger and acquisition related expenses
   
              –
     
        1,042
     
              –
     
        1,042
 
Sales and marketing
   
        4,698
     
        3,182
     
      16,863
     
        8,995
 
Total operating expenses
   
      15,271
     
      17,506
     
      47,903
     
      47,613
 
Income from operations
   
      13,239
     
      11,883
     
      36,201
     
      40,005
 
Interest income
   
             15
     
             23
     
             51
     
             87
 
Interest expense
   
            (66
   
          (185
   
          (196
)  
   
          (402
Other income
   
              –
     
             77
     
        1,500
     
           232
 
Net income before income taxes
   
      13,188
     
      11,798
     
      37,556
     
      39,922
 
Income tax expense
   
        4,720
     
        4,480
     
      13,292
     
      15,164
 
Net income
 
$
        8,468
   
 $
        7,318
   
 $
      24,264
   
 $
      24,758
 
  
                               
Net income available to common stockholders:
                               
Basic 
 
$
        8,468
   
 $
        7,318
   
 $
      24,264
   
 $
      24,758
 
Diluted 
 
$
        8,468
   
 $
        7,318
   
 $
      24,264
   
 $
      24,758
 
                                 
Weighted average shares outstanding
                               
Basic
   
55,470,457
     
54,511,509
     
55,154,973
     
54,837,154
 
Diluted
   
59,789,977
     
57,246,289
     
59,694,242
     
57,903,692
 
                                 
Net income available to common stockholders per common share:
                       
Basic 
 
$
          0.15
   
$
          0.13
   
$
          0.44
   
$
          0.45
 
Diluted 
 
$
          0.14
   
$
          0.13
   
$
          0.41
   
$
          0.43
 
 
  
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 

 
 
 
 
 
 
 
 
 
2

 
 
Higher One Holdings, Inc.
Condensed Consolidated Statement of Changes in Stockholders’ Equity
(In thousands of dollars, except shares)
(unaudited)

 
               
Additional
               
Total
 
   
Common Stock
   
Paid-in
   
Treasury
   
Accumulated
   
Stockholders'
 
   
Shares
   
Amount
   
Capital
   
Stock
   
Deficit
   
Equity
 
Balance at December 31, 2011
   
56,615,683
   
$
58
   
$
161,268
   
$
            (16,208
 
$
            (21,532
 
$
123,586
 
Stock-based compensation
   
 –
     
 –
     
           3,389
     
 –
     
 –
     
            3,389
 
Cancellation of shares
   
      (1,059,465
   
                  (1
   
                –
     
                    –
     
                    –
     
                  (1
Issuance of warrants
   
 –
     
 –
     
              960
     
 –
     
 –
     
               960
 
Tax benefit related to options
   
 –
     
 –
     
           2,796
     
 –
     
 –
     
            2,796
 
Repurchase of common stock
   
      (2,722,723
   
                  –
     
                –
     
            (37,600
   
                    –
     
         (37,600
Exercise of stock options
   
        1,357,951
     
                    2
     
           2,938
     
 –
     
 –
     
            2,940
 
Net income
   
 –
     
 –
     
 –
     
                    –
     
              24,758
     
          24,758
 
Balance at September 30, 2012
   
54,191,446
   
$
59
   
$
171,351
   
$
            (53,808
 
$
                3,226
   
$
120,828
 

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


 
 
 
 
 
 
 
 
 
3

 
 
Higher One Holdings, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands of dollars)
(unaudited)
 
   
Nine months ended
 
   
September 30,
 
   
2011
   
2012
 
Cash flows from operating activities
           
Net income
 
$
       24,264
   
 $
       24,758
 
Adjustments to reconcile net income to net cash  provided by operating activities:
               
Depreciation and amortization
   
         5,204
     
         7,336
 
Amortization of deferred finance costs
   
              54
     
            102
 
Stock-based customer acquisition expense
   
         9,233
     
               –
 
Stock-based compensation
   
         3,049
     
         3,226
 
Deferred income taxes
   
        (4,866
   
        (1,755
Income tax benefit related to exercise of stock options
   
        (5,274
   
        (2,796
Non-cash fair value adjustment of contingent consideration
   
               –
     
            310
 
Other income
   
               –
     
           (233
Gain on litigation settlement agreement
   
        (1,500
   
               –
 
Loss on disposal of fixed assets
   
            343
     
              35
 
Changes in operating assets and liabilities, net of effect of business combination:
               
Accounts receivable
   
        (2,912
   
        (2,624
Income receivable
   
        (2,574
   
        (3,029
Deferred costs
   
           (645
   
           (703
Prepaid expenses and other current assets
   
         3,964
     
       12,997
 
Other assets
   
               (9
   
           (114
Accounts payable
   
           (576
   
            799
 
Accrued expenses
   
            816
     
        (3,566
Deferred revenue
   
         2,764
     
         3,708
 
Net cash provided by operating activities
   
       31,335
     
       38,451
 
Cash flows from investing activities
               
Purchases of available for sale investment securities
   
      (11,192
   
      (11,230
Proceeds from sales of available for sale investment securities
   
               –
     
       14,634
 
Proceeds from maturities of available for sale investment securities
   
         8,000
     
       12,094
 
Purchases of fixed assets, net of changes in construction payables of $3,494 and ($11,799), respectively
   
      (21,623
   
      (22,499
Acquisition of Campus Labs
   
               –
     
      (37,280
Proceeds from development related subsidies
   
               –
     
            330
 
Additions to internal use software
   
               –
     
        (2,061
Deposits to restricted cash, net
   
               –
     
        (2,615
Payment to escrow agent
   
        (1,075
   
               –
 
Proceeds from escrow agent
   
         1,500
     
               –
 
Net cash used in investing activities
   
      (24,390
   
      (48,627
Cash flows from financing activities
               
Tax benefit related to exercise of stock options
   
         5,274
     
         2,796
 
Proceeds from exercise of stock options
   
            983
     
         2,939
 
Proceeds from line of credit
   
               –
     
       30,000
 
Repurchase of common stock
   
      (14,244
   
      (37,600
Net cash used in financing activities
   
        (7,987
   
        (1,865
Net change in cash and cash equivalents
   
        (1,042
   
      (12,041
Cash and cash equivalents at beginning of period
   
       34,484
     
       39,085
 
Cash and cash equivalents at end of period
 
$
       33,442
   
 $
       27,044
 

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

 

 
 
 
4

 
Higher One Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
 
Nature of Business and Organization
 
Higher One Holdings, Inc., or HOH, is a leading provider of technology and payment services to the higher education industry. The Company is incorporated in Delaware, maintains its headquarters in New Haven, Connecticut and provides a comprehensive suite of disbursement and payment solutions specifically designed for higher education institutions and their students. The Company has developed proprietary software-based solutions to provide these services. The Company has a wholly-owned subsidiary, Higher One, Inc., or HOI, which has two wholly-owned subsidiaries, Higher One Machines, Inc., or HOMI, and Higher One Real Estate, Inc., or Real Estate Inc.  HOI and HOMI together own 99% of Higher One Financial Technology Private Limited, or HOFTPL, an Indian entity formed during the quarter ending June 30, 2012 to perform certain of our operational support functions.  Higher One Payments, Inc., the acquired entity formerly known as Informed Decisions Corporation, or IDC, was previously a subsidiary and was merged into HOI in December 2011.  As of September 30, 2012, Real Estate Inc. has a 98% ownership interest in Higher One Real Estate SP, LLC, or Real Estate LLC.  HOMI and HOFTPL perform certain of our operational support functions. Real Estate Inc. and Real Estate LLC were each formed to hold and operate certain of our real estate.
  
2.  
Significant Accounting Policies

Basis of Presentation and Consolidation

The accompanying unaudited condensed consolidated financial statements and the related interim information contained within the notes to such condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, and the applicable rules of the Securities and Exchange Commission, or SEC, for interim information and quarterly reports on Form 10-Q.

The unaudited condensed consolidated financial statements have been prepared on a consistent basis with the audited consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2011, and in the opinion of management, include all normal recurring adjustments that are necessary for the fair statement of our interim period results reported herein.  The December 31, 2011 condensed consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by GAAP.  Due to seasonal fluctuations and other factors, the results of operations for the three months and nine months ended September 30, 2012 are not necessarily indicative of the results to be expected for the full year.

The unaudited condensed consolidated financial statements reflect our financial position and results of operations, including our majority and wholly-owned subsidiaries. All material intercompany transactions and balances have been eliminated in consolidation.

The preparation of financial statements in conformity with GAAP requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could materially differ from management’s estimates.

Basic and Diluted Net Income Available to Common Stockholders per Common Share

Basic net income per common share excludes dilution for potential common stock issuances and is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding for the period.  Diluted net income per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.  For the calculation of diluted net income per common share, the basic weighted-average number of shares is increased by the dilutive effect of restricted stock and stock options using the treasury-stock method.  The treasury-stock method assumes that the options or warrants are exercised at the beginning of the year (or date of issue if later), and that we use those proceeds to purchase common stock for treasury at the average price for the reporting period.
 
The dilutive effect of stock options totaling 1,057,115 and 2,022,512 were not included in the computation of diluted net income per common share for the three months ended September 30, 2011 and 2012, respectively, as their effect would be anti-dilutive. The dilutive effect of stock options totaling 1,057,115 and 1,936,438 were not included in the computation of diluted net income per common share for the nine months ended September 30, 2011 and 2012, respectively, as their effect would be anti-dilutive. Anti-dilutive securities are securities that upon conversion or exercise increase earnings per share (or reduce the loss per share). Restricted stock shares totaling 1,152,933 were not included in the computation of either basic or diluted earnings per share as all necessary conditions for vesting have not been satisfied by the end of the three and nine months ended September 30, 2011. In March 2012, 1,051,878 shares reverted back to us and were cancelled as a result of our exercise of certain repurchase rights pursuant to the purchase agreement with one of the officers of Educard, LLC.
 
Comprehensive Income

There are no comprehensive income items other than net income. There are no recorded unrealized gains or losses on the investments in marketable securities as of the balance sheet dates.  Comprehensive income equals net income for all periods presented.

 
5

Higher One Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
 
Restricted Cash

During the nine months ended September 30, 2012, we deposited various amounts of cash with our bank partners in connection with the deposit processing services that they provide to us.  The amounts are reflected in both current and non-current portions of restricted cash as of September 30, 2012.

Recent Accounting Pronouncements

There was no accounting standards adopted during 2011 or during the nine months ended September 30, 2012 which had a material impact on our consolidated financial position, results of operations or liquidity.  There are no new accounting standards issued which we expect to have a material impact on our consolidated financial position, results of operations, liquidity or disclosure.

3.
Real Estate Development Project

As of September 30, 2012, we have incurred approximately $32.8 million on a project to develop two existing commercial buildings located in New Haven, Connecticut. We moved our headquarters into these buildings at the end of 2011. We have provided two guarantees related to the real estate development project. We provided a guaranty to the State of Connecticut Department of Economic and Community Development related to our obligation to repay the amounts which were granted to us if we fail to meet certain criteria. The maximum potential amount of future payments of this guaranty is approximately $5.9 million.

We have also provided a guaranty related to tax credits that are expected to be generated by an investment made by an unrelated entity into the real estate development project. In the event that we cause either a recapture or disallowance of the tax credits expected to be generated under this program, then we will be required to repay the disallowed or recaptured tax credits plus an amount sufficient to pay the taxes on such repayment, to the counterparty of the guaranty agreement. This guaranty will remain in place through 2018. The maximum potential amount of future payments of this guaranty is approximately $6.0 million.

We currently believe that the likelihood of us being required to make a payment under either of the guaranties described above is remote and we have thus not recorded any liability on our balance sheet in connection with these guaranties.
 
4.  
Credit Facility

As of September 30, 2012, we had $30.0 in borrowings outstanding, at a rate of 2.0%, under our senior secured revolving credit facility established on December 31, 2010, or the Credit Facility.  We were in compliance with all of the applicable affirmative, negative and financial covenants of the Credit Facility.  

On October 16, 2012, HOI terminated the Credit Facility and entered into a new five-year senior secured revolving credit facility in an amount of $200.0 million, or the New Credit Facility.  All amounts outstanding under the Credit Facility, which was $30.0 million, was repaid in full using borrowings available under the New Credit Facility.  The New Credit Facility permits the issuance of letters of credit of up to $20.0 million and swing line loans of up to $10.0 million to fund working capital needs.  Loans drawn under the New Credit Facility are payable in a single maturity on October 16, 2017.

Each of HOH, HOMI, Real Estate Inc. and Real Estate LLC (or collectively, together with HOI, the Loan Parties) is a guarantor of HOI’s obligations under the New Credit Facility.  Loans drawn under the New Credit Facility are secured by a perfected first priority security interest in all of the capital stock of HOI and its domestic subsidiaries, and substantially all of each Loan Party’s tangible and intangible assets, including intellectual property.

At our option, amounts outstanding under the New Credit Facility accrue interest at a rate equal to either (i) the British Bankers Association LIBOR Rate, or BBA LIBOR, plus a margin of between 1.75% and 2.25% per annum (depending on our funded debt to EBITDA, as defined in the New Credit Facility, ratio) or (ii) a fluctuating base rate tied to the federal funds rate, the administrative agent’s prime rate and BBA LIBOR, subject to a minimum of 2%. Interest is payable on the last day of each interest period selected by us under the New Credit Facility and, in any event, at least quarterly.  We pay a commitment fee ranging from 0.25% and 0.375% on the daily average undrawn portion of revolving commitments under the New Credit Facility, which accrues and is payable quarterly in arrears.

The New Credit Facility contains certain affirmative covenants including covenants to furnish the lenders with financial statements and other financial information and to provide the lenders notice of material events and information regarding collateral.  The New Credit Facility also contains certain negative covenants that, among other things, restrict our ability, subject to certain exceptions, to incur additional indebtedness, grant liens on our assets, undergo fundamental changes, make investments, sell assets, make restricted payments, change the nature of our business and engage in transactions with our affiliates.  In addition, the New Credit Facility contains certain financial covenants that require us to maintain EBITDA, as defined in the New Credit Facility on a consolidated basis for the prior four fiscal quarters of at least $50 million, a funded debt to EBITDA ratio not of 2.50 to 1.00 or less between October 16, 2012 and December 31, 2014 and of 2.00 to 1.00 or less thereafter, and a fixed charge coverage ratio of at least 1.25 to 1.00.
 
 
6

 Higher One Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
 

5.  
Capital Stock

Treasury Stock

In August 2011, our board of directors authorized a share repurchase program pursuant to which we could repurchase up to $40 million of our issued and outstanding shares of common stock through September 7, 2012.  On August 1, 2012, our board of directors authorized a share repurchase program pursuant to which we may repurchase up to an additional $100 million of our issued and outstanding shares of common stock through August 15, 2013.  See “Part II, Item 2. Unregistered Sales of Equity Securities and Use of Proceeds” of this quarterly report on Form 10-Q for additional disclosure regarding our share repurchase programs.  In October 2012, we repurchased an additional 1,453,916 treasury shares at a cost of $18.2 million.

6.  
Commitments and Contingencies

From time to time we are subject to litigation relating to matters in the ordinary course of business, as well as regulatory examinations, information gathering requests, inquiries and investigations.

In February 2011, the New York Regional Office of the Federal Deposit Insurance Corporation, or FDIC, notified us that it was prepared to recommend to the Director of FDIC Supervision that an enforcement action be taken against us for alleged violations of certain applicable laws and regulations principally relating to our compliance management system and policies and practices for past overdraft charging on persistently delinquent accounts, collections and transaction error resolution. We responded to the FDIC’s notification and have been in regular dialogue with the FDIC since 2010.  We voluntarily initiated a plan in December 2011 that provided credits to certain current and former customers that were previously assessed certain insufficient fund fees. As a result of this plan, we recorded a reduction in our revenue of approximately $4.7 million in 2011, which excludes the restitution of unpaid fees. The insufficient funds fees that were credited to customers under this plan were originally assessed beginning in 2008. Of the total charge of $4.7 million, an accrual of approximately $2.6 million was established for amounts which were not paid as of December 31, 2011. All amounts were paid to our customers as of March 31, 2012.  On August 8, 2012, we received a Consent Order, Order for Restitution, and Order to Pay Civil Money Penalty, or the Consent Order, dated August 7, 2012, issued by the FDIC to settle such alleged violations.  Pursuant to the terms of the Consent Order, we neither admitted nor denied any charges when agreeing to the terms of the Consent Order. Under the terms of the Consent Order, we are required to, among other things, review and revise our compliance management system and, to date, we have already substantially revised our compliance management system. Additionally, the Consent Order provides for restrictions on the charging of certain fees. The Consent Order further provides that we shall make restitution to less than 2% of our customers since 2008 for fees previously assessed, which restitution has been substantially completed through the voluntary customer credit plan described above, and pay a civil money penalty of $110,000.  As a result of the Consent Order and completion of the related examination, we believe that all material exposure related to this matter has been recorded and we do not expect any further losses as a result of this matter.
 
We are a defendant in certain similar putative class action lawsuits. While the specific causes of action differ in each suit, plaintiffs generally allege, among other things, violations of state consumer protection statutes (predicated, in part, on alleged violations of Department of Education rules and violations of the federal Electronic Funds Transfer Act) and various common law claims. Some cases also assert direct causes of action under the federal Electronic Funds Transfer Act. The cases are as follows: Sherry McFall, et al. v. Higher One Holdings, Inc. et al.,filed on April 18, 2012 in the Central District of California, Western Division (subsequently dismissed, re-filed in Ventura County Superior Court on April 24, 2012, removed back to the Central District of California on June 29, 2012, and voluntarily dismissed by plaintiffs on July 27, 2012); Ashley Parker, et al. v. Higher One Holdings, Inc. et al., filed on July 3, 2012 in the United States District Court for the Northern District of Mississippi, Eastern Division; Jeanette Price et al. v. Higher One Holdings, Inc. et al., filed on July 27, 2012 in the United States District Court for the District of Connecticut; John Brandon Kent et al. v. Higher One Holdings, Inc. et al., filed on August 17, 2012 in the United States District Court for the Middle District of Alabama, Northern Division; Jonathan Lanham et al. v. Higher One Holdings, Inc. et al., filed on October 2, 2012 in the United States District Court for the Western District of Kentucky, Louisville Division; and Jill Massey et al. v. Higher One Holdings, Inc. et al., filed on November 6, 2012 in the United States District Court for the Southern District of Illinois, East Saint Louis Division. We have filed a motion with the Judicial Panel on Multidistrict Litigation asking the Panel to transfer to a single court all of the above cases (and any additional tag-along cases) for coordinated or consolidated pretrial proceedings. (While the Lanham and Massey cases were not filed prior to our motion, we sought transfer of all tag-along cases and the Panel has been notified about the Lanham case and will be notified about the Massey case, as well as any additional tag-along cases.) We believe the claims in each of these actions to be without merit. Although we plan to defend these matters vigorously, there can be no assurances of our success in these matters.
 
 
7

Higher One Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
 
 
In February 2009 and September 2010, Higher One, Inc. filed two separate complaints against TouchNet Information Systems, Inc., or TouchNet, in the United States District Court for the District of Connecticut alleging patent infringement related to TouchNet’s offering for sale and sales of its “eRefund” product in violation of two of our patents. In the complaints, we sought judgments that TouchNet has infringed two of our patents, a judgment that TouchNet pay damages and interest on damages to compensate us for infringement, an award of our costs in connection with these actions and an injunction barring TouchNet from further infringing our patents. TouchNet answered the complaint and asserted a number of defenses and counterclaims, including that it does not infringe our patent, that our patent is invalid or unenforceable and certain allegations of unfair competition and state and federal antitrust violations. In addition, TouchNet’s counterclaims sought dismissal of our claims with prejudice, declaratory judgment that TouchNet does not infringe our patent and that our patent is invalid or unenforceable, as well as an award of fees and costs related to the action, and an injunction permanently enjoining us from suing TouchNet regarding infringement of our patent. The parties are currently in the discovery stage of the proceeding. We intend to pursue the matter vigorously. There can be no assurances of our success in these proceedings.
 
7.  
Business Combinations
 
On August 7, 2012, we entered into an Asset Purchase Agreement with Campus Labs, LLC, or Campus Labs, and Eric Reich and Michael Weisman, as the members of Campus Labs, to purchase substantially all of the assets of Campus Labs for consideration consisting of the following:

(i)  
$37.3 million in cash;
(ii)  
warrants to purchase 150,000 shares of our common stock, which were valued at $1.0 million utilizing a Black-Scholes pricing model; and
(iii)  
a potential earn-out payment calculated by multiplying the amount of 2013 revenues for the acquired business in excess of $12.5 million, if any, by 3.5 (subject to a maximum payment of $46.4 million).  The amount recognized as of the acquisition date for the potential earn-out payment was $13 million.  The estimated range of outcomes (undiscounted) for the remaining payments due under the earn-out is between approximately $7 million and $23 million.

We completed the acquisition on August 7, 2012, and used cash on hand and borrowings available under our Credit Facility to pay the cash portion of the purchase price and related transaction costs.  Campus Labs offers specialized, comprehensive assessment programs that combine data collection, reporting, organization, and campus-wide integration for higher education institutions, which we believe will help us deepen our relationships with higher education institutions by providing additional value-added services. The net assets and results of operations of the acquired assets of Campus Labs are included in our consolidated financial statements from August 8, 2012. Assets acquired and liabilities assumed were recorded at their fair values as of August 7, 2012.

Under the acquisition method of accounting, the total fair value of consideration transferred was allocated to Campus Lab’s net tangible and intangible assets based on their estimated fair values as of August 7, 2012. The preliminary allocation of fair value of consideration transferred was allocated as follows (in thousands):

 
August 7, 2012
 
         
Assets acquired:
  
     
Accounts receivable
  
$
2,408
  
Prepaid expenses
  
 
52
  
Fixed assets
  
 
577
  
Intangible assets
  
 
21,710
  
Goodwill
  
 
31,080
  
Total assets acquired
  
 
55,827
  
   
Liabilities assumed:
  
     
Accounts payable and accrued liabilities
  
 
1,087
  
Deferred revenue
  
 
3,500
  
Total liabilities assumed
  
 
4,587
  
Total fair value of consideration transferred
  
$
51,240
  

The preliminary purchase price allocations for the Campus Labs acquisition completed during the third quarter of fiscal 2012 were based upon a preliminary valuation and our estimates and assumptions for these acquisitions are subject to change as we obtain additional information for our estimates during the respective measurement periods. The primary areas of those purchase price allocations that are not yet finalized relate to certain identifiable intangible assets and residual goodwill.
 
 
8

Higher One Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
 
 
The following methods and inputs were utilized to determine fair value for the respective items:
Item
 
Valuation technique
 
Inputs
Deferred revenue
 
Income approach
 
Estimated costs and associated profit margin to service our remaining obligations on contracts assumed as a result of the acquisition, discount rate
Contingent consideration
 
Income approach
 
Estimated range of revenues for 2013, discount rate
Non-compete agreements
 
Income approach – lost profits
 
Estimated probability of the associated individual leaving and competing, estimated future revenue impact of potential future competition
Completed technology
 
Income approach – relief from royalty
 
Estimated future revenue attributable to technology completed as of the acquisition date, royalty rate and discount rate
Tradename
 
Income approach – relief from royalty
 
Estimated future revenue, expected probability of utilizing the acquired tradenames in the future, discount rate.
Customer relationships
 
Income approach – excess earnings
 
Estimated future revenues attributable to existing higher education institution customers as of the acquisition date, estimated income associated with such revenue, royalty rate and discount rate
 
The acquired intangible assets are amortized each year based on the ratio that the projected cash flows for the intangible assets bear to the total of current and expected future cash flows for the intangible assets (in thousands).

   
Weighted-average amortization period (in years)
   
Amount
 
Customer relationships
    12     $ 14,410  
Completed technology
    7       5,600  
Trademark
    9       700  
Non-compete agreements
    5       1,000  
      10     $ 21,710  

Goodwill represents the excess of the fair value of consideration transferred of an acquired business over the fair value of the net tangible and intangible assets acquired. Goodwill exists in the transaction as a result of value beyond that of the tangible and other intangible assets, attributable to synergies that exist in the combined business. Goodwill of $19.6 million is deductible for tax purposes.

Campus Labs does not constitute a separate operating segment. Our strategy is to integrate the Campus Labs business into our existing business. We have also concluded that our operating segment is a single reporting unit. Our single operating segment does not have any components that constitute a separate business for which discrete information will be available. We plan to operate the combined enterprise as one integrated business. Accordingly, the goodwill arising from the acquisition will be assigned to our single operating segment and single reporting unit.

Pro Forma Financial Information (Unaudited)

We reported revenues totaling approximately $1.0 million from the Campus Labs acquisition from the acquisition date of August 7, 2012 through September 30, 2012.  The financial information in the table below summarizes the combined results of operations of Campus Labs and us on a pro forma basis as though the companies had been combined as of the beginning of the period presented. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of each of the periods presented. The pro forma financial information for all periods presented also includes amortization expense from acquired intangible assets, adjustments to interest expense, interest income and related tax effects.

The pro forma financial information for the three and nine months ended September 30, 2011 and 2012 combines the historical results of us for the periods presented and the historical results for Campus Labs for the period from January 1, 2011 to August 7, 2012.
 
  
 
Three months ended
   
Nine months ended
 
     
September 30,
   
September 30,
 
in thousands (other than share and per share information)
  
 
2011
   
  
2012
   
2011
 
  
2012
 
Revenues
  
$
49,974
  
  $
52,299
  
 139,457
  $
153,369
  
Net income
  
$
8,228
  
  $
7,345
  
23,223
  $
24,635
  
Basic earnings per share
  
$
0.15
  
  $
0.13
  
 0.42
  $
0.45
  
Basic weighted average number of common shares outstanding
  
 
55,470,457
  
 
  
54,511,509
  
 
55,154,973
 
  
54,837,154
  
Diluted earnings per share
  
$
0.14
  
  $
0.13
  
 0.39
  $
0.43
  
Diluted weighted average number of common and common equivalent shares outstanding    
59,789,977
     
57,246,289
     59,694,242      57,903,692  
 
9

Higher One Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
 
 
8.             Investments in Marketable Securities and Fair Value Measurements

The following table reflects the assets carried at fair value measured on a recurring basis (in thousands):
 
   
Total
   
Quoted Prices in Active Markets for Identical Assets (Level 1)
   
Significant Other Observable Inputs (Level 2)
   
Unobservable Inputs (Level 3)
 
Fair values at September 30, 2012
                       
Assets:
                       
Certificate of deposit
   $ 245      $      $ 245      $  
                                 
Liabilities:
                               
Contingent consideration
   $ 13,310      $      $      $ 13,310  
                                 
Fair values at December 31, 2011
                               
Assets:
                               
U.S. government debt securities
   $ 15,498      $ 15,498      $      $  
Certificate of deposit
    245             245        
Total assets
   $ 15,743      $ 15,498      $ 245      $  
 
A summary of the activity of the fair value of the liabilities using unobservable inputs (Level 3 Liabilities) for the nine months ended September 30, 2012 is as follows (in thousands):
 
   
Beginning Value of Level 3 Liabilities
 
New Level 3 Liabilities
 
Loss Recognized in Earnings
 
Ending Fair Value of Level 3 Liabilities
 
Contingent consideration
   $      $ 13,000      $ 310      $ 13,310  
 
Our contingent consideration liability was valued using probability-weighted, future possible expected outcomes and an appropriate discount rate.  The unobservable input utilized in the determination of this liability includes our estimation of the range of revenues which will be achieved by Campus Labs during 2013.  The approximate range of revenues utilized to estimate the contingent consideration liability was between $14.5 and $19 million.  The loss of $0.3 million recognized in earnings during the nine months ended September 30, 2012 was recorded in merger and acquisition related expense.  As a result of the nature of the contingent consideration obligation, the liability is sensitive to changes in our estimate of revenues to be achieved by Campus Labs during 2013.  For each $1 million increase or decrease in the estimated revenues to be achieved by Campus Labs during 2013, the contingent consideration liability would increase or decrease by approximately $3.5 million (undiscounted).

We had no unrealized gains or losses from investments as of December 31, 2011 and September 30, 2012 and there is no difference between the amortized cost and fair value of the securities we held.

The carrying amounts of our cash equivalents, accounts receivable, accounts payable and accrued expenses, approximate fair value because of the short-term nature of these instruments. Our loan receivable related to New Markets Tax Credit financing is a debt instrument that we classify as held to maturity and is recorded at amortized cost.  The carrying value of both our loan receivable and loan payable related to New Markets Tax Credit financing approximates fair value as of September 30, 2012.  Our loan payable and loan receivable related to New Markets Tax Credit financing was estimated using discounted cash flow analysis based on rates for similar types of arrangements.

 
 
 
 
10

 


 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The information contained in this section should be read in conjunction with our audited consolidated financial statements and related notes as included in our annual report on Form 10-K for the year ended December 31, 2011 and information contained elsewhere in such annual report on Form 10-K and in this quarterly report on Form 10-Q. The discussion contains forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995) involving risks, uncertainties and assumptions that could cause our results to differ materially from expectations. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects,” “should” and similar expressions are intended to identify forward-looking statements. Factors that might cause these differences include those described under “Risk Factors” and elsewhere in the annual report on Form 10-K and in this quarterly report on Form 10-Q. The forward-looking statements included in this quarterly report on Form 10-Q are made only as of the date of this report. We do not undertake any obligation to update or supplement any forward-looking statements to reflect subsequent events or circumstances, except as required by law. We cannot assure you that projected results or events will be achieved or will occur.

Overview

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

On August 7, 2012 Higher One completed the acquisition of substantially all of the assets of Campus Labs, LLC, a data analytics company focused on higher education.  Campus Labs helps school administrators collect campus-wide data and provide comprehensive assessments critical to supporting institutional outcomes.  Additionally, Campus Labs helps schools better understand factors for student success and offers tools for institutions to benchmark against peer institutions, provide course evaluations, analyze strategic plan alignment, and assist with the accreditation process.  Campus Labs’ technology allows schools to aggregate previously unstructured, static information into dynamic assessment data with full reporting functionality in a centralized platform.

Our products and services for our higher education institution clients include our OneDisburse® Refund Management® funds disbursement service, our CASHNet® suite of payment transaction products and services and our Campus Labs® suite of data analytics products. Through our bank partners, we offer our OneAccount service to the students of our higher education institution clients, which includes an FDIC-insured checking account, a OneCard, which is a debit MasterCard® ATM card, and other retail banking services.

As of September 30, 2012, more than 600 campuses, serving more than 4.5 million students, had purchased the OneDisburse service. We service approximately 2.1 million OneAccounts as of September 30, 2012.  As of September 30, 2012 more than 1,300 campuses, serving more than 10.8 million students had purchased at least one of our OneDisburse, CASHNet or Campus Labs products or services.

During the three months ended September 30, 2012, the amount of disbursements which we delivered to individuals that had selected the OneAccount as their preferred method of receiving a refund from their higher education institution was slightly lower than it was compared to the three months ended September 30, 2011.  At the same time, the total amount of disbursements we processed on behalf of our OneDisburse higher education institution clients increased.  The increase in total disbursements which we processed was a result of new higher education institution clients during the three months ended September 30, 2012, compared to September 30, 2011.  This increase offset a decline in both the average size and unique number of individuals for which we processed a disbursement for higher education institution that were OneDisburse clients both last year and the current year.  During the three months ended September 30, 2012, the ratio of individuals selecting to receive a disbursement for their higher education institution to a OneAccount was lower than the comparative time period. We believe that a portion of this ratio decrease will lead to longer and deeper customer relationships with the individuals that do choose the OneAccount as their preferred method of receiving a disbursement; however, the impact of that longer and deeper customer relationship period has not yet had a material impact on our financial results.  During the three months ended September 30, 2012, we announced plans to introduce a new version of the OneAccount, OneAccount Edge, which will launch later this year and which includes one fee of $4.95 per month.  The account eliminates fees for PIN activity, overdraft or non-sufficient funds, inactivity and other service charges normally associated with traditional checking accounts and does not include a minimum deposit requirement.

Our revenue fluctuates over the course of the year as a result of seasonal factors related to the academic year. A large proportion of our revenue is either directly or indirectly dependent on academic financial aid received by students and in turn the number of students enrolled at our higher education institution clients. Higher education institution clients typically disburse financial aid refunds to students at the start of each academic term. Distribution of financial aid disbursements through our OneDisburse service (1) indirectly generates revenue through deposits of financial aid into OneAccounts, which generates account revenue, and (2) directly generates revenue through our higher education institution clients’ use of the OneDisburse service, which generates higher education institution revenue.
 
 
11

 
 
Results of Operations for the Three Months Ended September 30, 2011 and 2012

The following table summarizes key components of our results of operations for the periods indicated, both in dollars and as a percentage of total revenue:
   
Three Months Ended
   
September 30,
   
(Unaudited)
   
2011
   
2012
   
$ Change
 
% Change
 
2011 % of Revenue
   
2012 % of Revenue
 
   
(in thousands)
                 
Account revenue
 
$
  35,800
   
 $
 35,660
   
 $
    (140
     (0.4)
%
 
         74.4
%
   
        69.6
%
Payment transaction revenue
   
    6,603
     
   8,342
     
   1,739
 
     26.3
%
 
         13.7
%
   
        16.3
%
Higher education institution revenue
   
    4,595
     
   5,946
     
   1,351
 
     29.4
%
 
           9.5
%
   
        11.6
%
Other revenue
   
    1,142
     
   1,279
     
      137
 
     12.0
%
 
           2.4
%
   
          2.5
%
Total revenue
   
  48,140
     
 51,227
     
   3,087
 
       6.4
%
 
       100.0
%
   
      100.0
%
Cost of revenue
   
  19,630
     
 21,838
     
   2,208
 
     11.2
%
 
         40.8
%
   
        42.6
%
Gross margin
   
  28,510
     
 29,389
     
      879
 
       3.1
%
 
         59.2
%
   
        57.4
%
General and administrative
   
    9,415
     
 11,902
     
   2,487
 
     26.4
%
 
         19.6
%
   
        23.2
%
Product development
   
    1,158
     
   1,380
     
      222
 
     19.2
%
 
           2.3
%
   
          2.7
%
Merger and acquisition related expenses
 
          –
     
   1,042
     
   1,042
 
   100.0
%
 
            –
%
   
          2.0
%
Sales and marketing
   
    4,698
     
   3,182
     
 (1,516
   (32.3)
%
 
           9.8
%
   
          6.2
%
Income from operations
   
  13,239
     
 11,883
     
 (1,356
   (10.2)
%
 
         27.5
%
   
        23.2
%
Interest income
   
         15
     
        23
     
          8
 
     53.3
%
 
            –
%
   
           –
%
Interest expense
   
        (66
   
     (185
   
    (119
   180.3
%
 
         (0.1)
%
   
        (0.4)
%
Other income
   
          –
     
        77
     
        77
 
   100.0
%
 
            –
%
   
          0.2
%
Net income before income taxes
   
  13,188
     
 11,798
     
 (1,390
   (10.5)
%
 
         27.4
%
   
        23.0
%
Income tax expense
   
    4,720
     
   4,480
     
    (240
     (5.1)
%
 
           9.8
%
   
          8.7
%
Net income
 
$
    8,468
   
 $
   7,318
   
 $
 (1,150
   (13.6)
%
 
         17.6
%
   
        14.3
%

Three Months Ended September 30, 2012 Compared to the Three Months Ended September 30, 2011

Revenue

Account revenue
Account revenue remained in-line with the prior year amount while the number of OneAccounts grew by approximately 3.4%.  Our revenue per average OneAccount has decreased slightly from the prior year as a result of several factors, including certain changes we made to our fee schedule over the last twelve months which reduced certain service fees assessed to our OneAccounts and a slightly lower average disbursement received by individuals during the three months ended September 30, 2012 compared to the three months ended September 30, 2011.  An increase in OneAccounts due to students choosing the OneAccount at higher education institutions that became clients after September 30, 2011 offset a decrease in the number of OneAccounts at higher education institutions that were clients prior to September 30, 2011.  The decrease in the number of OneAccounts at higher education institutions that were clients as of and prior to September 30, 2011 is attributed to two factors.  Beginning in June 2012, we made changes whereby we close small balance, inactive accounts in a shorter time period than our prior practice. We also experienced a decrease in the ratio of students at our higher education institution clients who open a OneAccount relative to all students for whom we processed a disbursement during the three months ended September 30, 2012 compared to the prior year period, which resulted in both fewer new OneAccounts for new higher education institution clients as well as existing higher education institution clients.

Payment Transaction Revenue
The majority of the increase in payment transaction revenue was due to new higher education institution clients that began utilizing the CASHNet payment module, ePayment, after September 30, 2011.  The remainder of the increase was due to an increase in payments processed at higher education institutions that were clients prior to September 30, 2011 and as a result of payments made to us in connection with our new fully serviced tuition payment plans that we offer to students on behalf of client institutions.
 
Higher Education Institution Revenue
The increase in higher education institution revenue was primarily due to our acquisition of Campus Labs in August 2012.  The Campus Labs product suite contributed approximately $1.0 million in revenue to our higher education institution revenue during the three months ended September 30, 2012.  The remainder of the increase is primarily related to subscription revenue for our CASHNet suite of payment products as a result of sales of the CASHNet suite of payment products to new higher education institution clients over the course of the last twelve months. 

 
12

 
 
Cost of Revenue

We generally expect cost of revenue to increase proportionally with our revenue as many of these costs are variable and associated with either the number of OneAccounts or the dollar volume of transactions processed through our CASHNet payment module.  During the three months ended September 30, 2012, our cost of revenue increased at a higher rate than revenue, which resulted in a lower gross margin compared to the three months ended September 30, 2011.  A portion of our amortization expense related to our acquisition of Campus Labs is included within cost of revenue increase, which contributed to approximately $153 of the increase in cost of revenue this period.  Our data processing costs increased compared to the three months ended September 30, 2011 as a result of an increase in our number of OneAccounts which exceeded the growth in overall transaction volume.
 
General and Administrative Expense

While we generally expect general and administrative expenses to increase at a slower rate than revenue, such expenses increased at a higher rate than our revenue growth during the three months ended September 30, 2012.  Consistent with the trend through June 30, 2012, the increase in general and administrative expenses was driven primarily by an increase in facilities and occupancy costs, including depreciation, as a result of our corporate headquarters being placed in service as of December 31, 2011, personnel related costs and telecommunications costs.  In addition, during the three months ended September 30, 2012, we experienced higher professional fees that the three months ended September 30, 2011.  Our professional fees increase or decrease from time to time depending on specific business activities.  We also experienced an increase in general and administrative expenses as a result of additional personnel from our acquisition of Campus Labs.

Product Development Expense

The increase in product development expense was primarily due to increases in personnel costs related to our acquisition of Campus Labs.

Merger and Acquisition Related Expenses

Our merger and acquisition related expenses during the three months ended September 30, 2012 related to our acquisition of Campus Labs in August 2012.  These expenses include professional fees associated with the acquisition and related audit, a fair value adjustment to the contingent consideration component of the purchase price and certain employee related costs related to a bonus to be paid to employees previously employed by Camps Labs following a specified time period of employment by Higher One.  We will continue to record fair value adjustments to the contingent consideration liability as necessary until the payment of all amounts due under the agreement.  The employee related costs will continue to generate expense through the six-month anniversary of the acquisition date.

Sales and Marketing Expense

The decrease in sales and marketing expense was primarily due to a decrease of $2.3 million in non-cash, stock-based sales acquisition expense related to the vesting of certain shares issued in connection with the acquisition of EduCard, LLC.  The vesting time period related to the acquisition of EduCard, LLC expired at December 31, 2011 and therefore there are no subsequent additional associated expenses.  The decrease in non-cash stock-based sales acquisition expense was partially offset by increases in marketing efforts support business growth, including incentives we provided to our customers to increase the amount of direct deposits we receive into the OneAccounts of our customers.

Interest Expense

The increase in interest expense was primarily due an increase in outstanding borrowings under our Credit Facility, as defined below in “Liquidity and Capital Resources”, in connection with our acquisition of Campus Labs.  We borrowed $30.0 million under our Credit Facility, which was outstanding for the period after our acquisition of Campus Labs.

Income Tax Expense

The decrease in income tax expense was primarily due a decrease in our net income before income taxes.  The effective tax rates for the three months ended September 30, 2011 and 2012 were 35.8% and 38.0%, respectively.  Our effective rate is expected to be between 37% and 39% for the 2012 fiscal year.
 
 
13

 
 
Results of Operations for the Nine Months Ended September 30, 2011 and 2012

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

   
Nine Months Ended
   
September 30,
   
(Unaudited)
   
2011
   
2012
   
$ Change
 
% Change
 
2011 % of Revenue
   
2012 % of Revenue
 
   
(In thousands)
                 
Account revenue
 
$
 105,500
   
$
 112,803
   
$
   7,303
 
          6.9
%
 
         78.4
%
   
        76.3
%
Payment transaction revenue
   
   13,988
     
   17,843
     
   3,855
 
        27.6
%
 
         10.4
%
   
        12.1
%
Higher education institution revenue
   
   12,696
     
   14,597
     
   1,901
 
        15.0
%
 
           9.4
%
   
          9.9
%
Other revenue
   
     2,406
     
     2,678
     
      272
 
        11.3
%
 
           1.8
%
   
          1.7
%
Total revenue
   
 134,590
     
 147,921
     
 13,331
 
          9.9
%
 
       100.0
%
   
      100.0
%
Cost of revenue
   
   50,486
     
   60,303
     
   9,817
 
        19.4
%
 
         37.5
%
   
        40.8
%
Gross margin
   
   84,104
     
   87,618
     
   3,514
 
          4.2
%
 
         62.5
%
   
        59.2
%
General and administrative
   
   28,202
     
   34,205
     
   6,003
 
        21.3
%
 
         21.0
%
   
        23.1
%
Product development
   
     2,838
     
     3,371
     
      533
 
        18.8
%
 
           2.1
%
   
          2.3
%
Merger and acquisition related expenses
 
           –
     
     1,042
     
   1,042
 
      100.0
%
 
            –
%
   
          0.7
%
Sales and marketing
   
   16,863
     
     8,995
     
  (7,868
       (46.7)
%
 
         12.5
%
   
          6.1
%
Income from operations
   
   36,201
     
   40,005
     
   3,804
 
        10.5
%
 
         26.9
%
   
        27.0
%
Interest income
   
          51
     
          87
     
        36
 
        70.6
%
 
            –
%
   
          0.1
%
Interest expense
   
       (196
   
       (402
   
     (206
      105.1
%
 
         (0.1)
%
   
        (0.3)
%
Other income
   
     1,500
     
        232
     
  (1,268
       (84.5)
%
 
           1.1
%
   
          0.2
%
Net income before income taxes
   
   37,556
     
   39,922
     
   2,366
 
          6.3
%
 
         27.9
%
   
        27.0
%
Income tax expense
   
   13,292
     
   15,164
     
   1,872
 
        14.1
%
 
           9.9
%
   
        10.3
%
Net income
 
$
   24,264
   
$
   24,758
   
$
      494
 
          2.0
%
 
         18.0
%
   
        16.7
%
 
Nine Months Ended September 30, 2012 Compared to the Nine Months Ended September 30, 2011

Revenue

Account revenue
The increase in account revenue was primarily due to a net increase of 3.4%, or 68 thousand, in the number of OneAccounts from September 30, 2011 to September 30, 2012.  An increase in OneAccounts due to students choosing the OneAccount at higher education institutions that became clients after September 30, 2011 offset a decrease in the number of OneAccounts at higher education institutions that were clients prior to September 30, 2011.  The decrease in the number of OneAccounts at higher education institutions that were clients as of and prior to September 30, 2011 is attributed to two factors.  Beginning in June 2012, we made changes whereby we close small balance, inactive accounts in a shorter time period than our prior practice. We also experienced a decrease in the ratio of students at our higher education institution clients who open a OneAccount relative to all students for whom we processed a disbursement during the three months ended September 30, 2012 compared to the prior year period, which resulted in both fewer new OneAccounts for new higher education institution clients as well as existing higher education institution clients.  Our revenue per average OneAccount has decreased slightly from the prior year as a result of several factors, including certain changes we made to our fee schedule over the last twelve months which reduced certain service fees assessed to our OneAccounts and a slightly lower average disbursement received by individuals during the three months ended September 30, 2012 compared to the three months ended September 30, 2011.

Payment Transaction Revenue
The increase in payment transaction revenue was due both to the inclusion of new higher education institution clients that began utilizing the CASHNet payment module, ePayment, after September 30, 2011 and also an increase in payments processed at higher education institutions that were clients prior to September 30, 2011.  In particular, there were a number of schools that started utilizing ePayment during the fall semester of 2011 that now have a full nine months of utilization during the nine months ended September 30, 2012.
 
Higher Education Institution Revenue
The increase in higher education institution revenue was primarily due to our acquisition of Campus Labs in August 2012.  The Campus Labs product suite contributed approximately $1.0 million in revenue to our higher education institution revenue during the nine months ended September 30, 2012.  The remainder of the increase is primarily related to subscription revenue for our CASHNet suite of payment products as a result of sales of the CASHNet suite of payment products to new higher education institution clients over the course of the last twelve months. 

 
14

 

Cost of Revenue

We generally expect cost of revenue to increase proportionally with our revenue as many of these costs are variable and associated with either the number of OneAccounts or the dollar volume of transactions processed through our CASHNet payment module.  During the nine months ended September 30, 2012, our cost of revenue increased at a higher rate than revenue, which resulted in a lower gross margin compared to the nine months ended September 30, 2011.  Consistent with the six months ended June 30, 2012, during the nine months ended September 30, 2012, our data processing costs and our provision for operational loss both increased at higher rates than our revenue growth.  The year over year increase in our provision for operational losses was lower through as of the nine months ended September 30, 2012 compared to the six months ended June 30, 2012. The increase in data processing costs is due to the increase in our number of OneAccounts exceeding the growth in overall transaction volume.
 
General and Administrative Expense

While we generally expect general and administrative expenses to increase at a slower rate than revenue, such expenses continued to increase at a slightly higher rate than our revenue growth during the nine months ended September 30, 2012.  The increase in general and administrative expenses was driven primarily by an increase in facilities and occupancy costs, including depreciation, as a result of our corporate headquarters being placed in service as of December 31, 2011, personnel related costs, professional fees and telecommunications costs. Our professional fees increase or decrease from time to time depending on specific business activities. We also experienced an increase in general and administrative expenses as a result of additional personnel from our acquisition of Campus Labs.

Product Development Expense

The increase in product development expense was primarily due to increases in personnel costs, due both to additional personnel hired in connection with our acquisition of Campus Labs and also in part to support the transition from an outsourced hosted platform for certain of our services to an internally hosted platform.

Sales and Marketing Expense

The decrease in sales and marketing expense was primarily due to a decrease of $9.2 million in non-cash, stock-based sales acquisition expense related to the vesting of certain shares issued in connection with the acquisition of EduCard, LLC.  The vesting time period related to the acquisition of EduCard, LLC expired at December 31, 2011 and therefore there are no subsequent additional associated expenses.  The decrease in non-cash stock-based sales acquisition expense was partially offset by increases in marketing efforts and higher employee compensation costs to support business growth, including incentives we provided to our customers to increase the amount of direct deposits we receive into the OneAccounts of our customers.

Interest Expense

The increase in interest expense was primarily due to an increase in outstanding borrowings under our Credit Facility, as defined below in “Liquidity and Capital Resources”, in connection with our acquisition of Campus Labs.  We borrowed $30.0 million under our Credit Facility, which was outstanding for the period after our acquisition of Campus Labs.

Other Income

We recorded $1.5 million of other income during the nine months ended September 30, 2011 as a result of the settlement agreement reached with the former stockholders of IDC.  

Income Tax Expense

The increase in income tax expense was primarily due to the increase in net income before taxes as well as a non-taxable gain of $1.5 million recorded in the prior year.  The effective tax rates for the nine months ended September 30, 2011 and 2012 were 35.4% and 38.0%, respectively.  The non-taxable gain we recorded during the nine months ended September 30, 2011 resulted in a decrease of approximately 1.5 percentage points of our effective tax rate for that time period.  Our effective rate is expected to be between 37% and 39% for the 2012 fiscal year.

Liquidity and Capital Resources

Sources of Liquidity

Our primary sources of liquidity are cash flows from operations, borrowings under our Credit Facility and New Credit Facility, as defined below, and available-for-sale investments. As of September 30, 2012, we had $27.0 million in cash and cash equivalents, $0.2 million in available-for-sale investments and $20.0 million in borrowing capacity available under our Credit Facility. Our primary liquidity requirements are for working capital, capital expenditures, product development expenses and general corporate needs. Also, to the extent we consider it appropriate, we utilize our liquidity to purchase shares of our outstanding equity securities pursuant to our share repurchase program authorized by our board of directors.  As of September 30, 2012, we had working capital of $23.0 million.

 
 
15

 
Senior Secured Revolving Credit Facility

Higher One, Inc. established a senior secured revolving credit facility dated as of December 31, 2010, which we refer to as the Credit Facility. As of September 30, 2012, $30.0 million in borrowings were outstanding under the Credit Facility and $20.0 million remained available to us under the Credit Facility.

On October 16, 2012, HOI terminated the Credit Facility and entered into a new five-year senior secured revolving credit facility in an amount of $200.0 million, or the New Credit Facility.  All amounts outstanding under the Credit Facility were repaid in full using borrowings available under the New Credit Facility.  The New Credit Facility permits the issuance of letters of credit of up to $20 million and swing line loans of up to $10 million to fund working capital needs.  Loans drawn under the New Credit Facility are payable in a single maturity on October 16, 2017.

Each of HOH, HOMI, Real Estate Inc. and Real Estate LLC (or collectively, together with HOI, the Loan Parties) is a guarantor of HOI’s obligations under the New Credit Facility.  Loans drawn under the New Credit Facility are secured by a perfected first priority security interest in all of the capital stock of HOI and its domestic subsidiaries, and substantially all of each Loan Party’s tangible and intangible assets, including intellectual property.
 
At our option, amounts outstanding under the New Credit Facility accrue interest at a rate equal to either (i) the British Bankers Association LIBOR Rate, or BBA LIBOR, plus a margin of between 1.75% and 2.25% per annum (depending on our funded debt to EBITDA, as defined in the New Credit Facility, ratio) or (ii) a fluctuating base rate tied to the federal funds rate, the administrative agent’s prime rate and BBA LIBOR, subject to a minimum of 2%. Interest is payable on the last day of each interest period selected by us under the New Credit Facility and, in any event, at least quarterly.  We pay a commitment fee ranging from 0.25% and 0.375% on the daily average undrawn portion of revolving commitments under the New Credit Facility, which accrues and is payable quarterly in arrears.

The New Credit Facility contains certain affirmative covenants including covenants to furnish the lenders with financial statements and other financial information and to provide the lenders notice of material events and information regarding collateral.  The New Credit Facility also contains certain negative covenants that, among other things, restrict our ability, subject to certain exceptions, to incur additional indebtedness, grant liens on our assets, undergo fundamental changes, make investments, sell assets, make restricted payments, change the nature of our business and engage in transactions with our affiliates.  In addition, the New Credit Facility contains certain financial covenants that require us to maintain EBITDA, as defined in the New Credit Facility on a consolidated basis for the prior four fiscal quarters of at least $50 million, a funded debt to EBITDA ratio of 2.50 to 1.00 or less between October 16, 2012 and December 31, 2014 and of 2.00 to 1.00 or less thereafter, and a fixed charge coverage ratio of at least 1.25 to 1.00.
 
Cash Flows

The following table presents information regarding our cash flows and cash and cash equivalents for the nine months ended September 30, 2011 and 2012:
   
Nine Months Ended September 30,
 
   
2011
   
2012
   
$ Change
 
   
(unaudited)
 
   
(in thousands)
 
Net cash provided by (used in):
                 
Operating activities
 
$
      31,335
   
$
   38,451
   
$
     7,117
 
Investing activities
   
     (24,390
   
 (48,627
   
 (24,237
Financing activities
   
       (7,987
   
   (1,865)
     
     6,122
 
Change in cash and cash equivalents
   
       (1,042
   
 (12,041
   
 (10,998
Cash and cash equivalents, end of period
 
$
      33,442
   
$
   27,044
   
$
   (6,397

The increase in net cash provided by operating activities was primarily comprised of a $7.1 million increase in the cash provided by changes in working capital accounts during the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011.  During the nine months ended September 30, 2012, we received a federal tax refund which was recorded as a receivable as of December 31, 2011.   
 
The increase in net cash used in investing activities primarily relates to our acquisition of Campus Labs in August 2012, offset by an increase in the sales and maturities of available for sale securities at the same time to finance a portion of the acquisition.
 
As of September 30, 2012, we have incurred approximately $32.8 million net of the grants, credits and subsidies on a project in which we rehabilitated two commercial buildings located in New Haven, Connecticut that now serve as our corporate headquarters.  We moved our headquarters into the redeveloped buildings at the end of 2011.  We have received approximately $14.2 million in grants, credits and subsidies as of September 30, 2012.  
 
The cash used by financing activities was primarily related to our common stock repurchases of $37.6 million, which was offset by a borrowing under our Credit Facility of $30.0 million to fund a portion of the Campus Labs acquisition and approximately $5.7 million of cash benefit related to the exercise of stock options.

We believe that our cash flows from operations, together with our existing liquidity sources, will be sufficient to fund our operations and anticipated capital expenditures over at least the next 24 months. 
 
16

 
 
Supplemental Financial and Operating Information

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2012
   
2011
   
2012
 
   
(unaudited)
   
(unaudited)
 
(in thousands)
(in thousands)
                         
Adjusted EBITDA (1)
 
$
18,218
   
$
16,708
   
$
54,195
   
$
51,841
 
Adjusted net income (2)
 
$
11,120
   
$
9,259
   
$
32,647
   
$
29,502
 
                                 
Number of students enrolled at OneDisburse client higher education institutions at end of period
   
3,970
     
4,589
     
3,970
     
4,589
 
                                 
Number of students enrolled at all higher education institution clients at end of period
     5,802        10,843      
5,802
     
10,843
 
                                 
Number of OneAccounts at end of period
   
2,015
     
2,083
     
2,015
     
2,083
 
 
(1)           We define adjusted EBITDA as net income before interest, income taxes and depreciation and amortization, or EBITDA, further adjusted to remove the effects of (a) stock-based customer acquisition expense related to our grants of common stock in connection with our acquisition of EduCard, LLC in 2008, (b) cash-based customer acquisition expense related to the acquisition of Informed Decisions Corporation, or IDC, (c) stock-based compensation expense, (d) incremental expenses, certain of which are non-cash, directly related to merger and acquisition activities and (e) the gain we recorded in connection with the settlement of our litigation with the former stockholders of IDC. Neither EBITDA nor adjusted EBITDA should be considered as an alternative to net income, operating income or any other measure of financial performance calculated and presented in accordance with GAAP. Our EBITDA and adjusted EBITDA may not be comparable to similarly titled measures of other organizations because other organizations may not calculate EBITDA and adjusted EBITDA in the same manner as we do.  

The following table presents a reconciliation of net income, the most comparable GAAP measure, to EBITDA and adjusted EBITDA for each of the periods indicated:
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2012
   
2011
   
2012
 
   
(unaudited)
   
(unaudited)
 
   
(in thousands)
   
(in thousands)
 
                         
Net income
 
$
         8,468
   
 $
         7,318
   
 $
       24,264
   
 $
       24,758
 
Interest income
   
             (15
   
             (23
   
             (51
   
             (87
Interest expense
   
              66
     
            185
     
            196
     
            402
 
Income tax expense
   
         4,720
     
         4,480
     
       13,292
     
       15,164
 
Depreciation and amortization
   
         1,770
     
         2,805
     
         5,204
     
         7,336
 
EBITDA
   
       15,009
     
       14,765
     
       42,905
     
       47,573
 
Stock-based and other customer acquisition expense
   
         2,320
     
               –
     
         9,741
     
               –
 
Stock-based compensation expense
   
            889
     
            901
     
         3,049
     
         3,226
 
Merger and acquisition related expenses
   
               –
     
         1,042
     
               –
     
         1,042
 
Other income
   
               –
     
               –
     
        (1,500
   
               –
 
Adjusted EBITDA
 
$
       18,218
   
 $
       16,708
   
 $
       54,195
   
 $
       51,841
 
 
 (2)           We define adjusted net income as net income, adjusted to eliminate (a) stock-based compensation expense related to incentive stock option grants and the gain we recorded in connection with the settlement of our litigation with the former stockholders of IDC and (b) after giving effect to tax adjustments, (1) stock-based compensation expense related to non-qualified stock option grants, (2) stock-based customer acquisition expense related to our grant of common stock in connection with our acquisition of EduCard, LLC in 2008, (3) cash-based customer acquisition expense related to the acquisition of IDC, (4) incremental expenses, certain of which are non-cash, directly related to merger and acquisition activities and (5) amortization expenses related to intangible assets and financing costs. Adjusted net income should not be considered as an alternative to net income, operating income or any other measure of financial performance calculated and presented in accordance with GAAP. Our adjusted net income may not be comparable to similarly titled measures of other organizations because other organizations may not calculate adjusted net income in the same manner as we do.
 
 
 
17

 

The following table presents a reconciliation of net income, the most comparable GAAP measure, to adjusted net income for each of the periods indicated:
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2012
   
2011
   
2012
 
   
(unaudited)
   
(unaudited)
 
(in thousands)
(in thousands)
                         
            Net income
 
$
         8,468
   
 $
         7,318
   
 $
       24,264
   
 $
       24,758
 
                                 
            Stock-based and other customer acquisition expense
   
         2,320
     
               –
     
         9,741
     
               –
 
            Stock-based compensation expense - incentive stock option grants
   
            480
     
            487
     
         1,368
     
         1,490
 
            Stock-based compensation expense - non-qualified stock option grants
   
            409
     
            414
     
         1,681
     
         1,736
 
            Merger and acquisition related expense
   
               –
     
         1,042
     
               –
     
         1,042
 
            Other income
   
               –
     
               –
     
        (1,500
   
               –
 
            Amortization of intangibles
   
            768
     
            863
     
         2,303
     
         2,386
 
Amortization of deferred finance costs
   
              18
     
              34
     
              54
     
            102
 
            Total pre-tax adjustments
   
         3,995
     
         2,840
     
       13,647
     
         6,756
 
            Tax rate
   
38.2
%
   
38.2
%
   
38.2
%
   
38.2
%
            Tax adjustment (a)
   
         1,343
     
            899
     
         5,264
     
         2,012
 
            Adjusted net income
 
$
       11,120
   
 $
         9,259
   
 $
       32,647
   
 $
       29,502
 
 
(a)           We have tax effected, utilizing our estimated statutory rate, all the pre-tax adjustments except for stock-based compensation expense for incentive stock options, which are generally not tax deductible and other income which is not tax deductible.

            The adjusted EBITDA and adjusted net income measures presented in this Quarterly Report on Form 10-Q may not be comparable to similarly titled measures presented by other companies, and may not be identical to corresponding measures used in our various agreements, in particular our Credit Facility and our New Credit Facility.
 
Contractual Obligations

The following table summarizes our contractual obligations as of September 30, 2012 and the effect such obligations are expected to have on our liquidity and cash flows in future periods.
 
   
Payments Due by Period
 
   
Total
   
Less Than
1 Year
   
1 to 3
Years
   
3 to 5
Years
   
5+
Years
   
All
Other
 
   
(in thousands)
 
Long-term debt obligations (1)
 
$
37,633
   
$
   
$
   
$
   
$
37,633
   
$
 
Operating lease obligations (2)
      3,675         543        1,047        589         1,496          
Purchase obligations (3)
   
13,403
     
2,348
     
5,486
     
5,569
     
     
 
Contingent consideration obligation (4)
   
15,800
     
2,650
     
13,150
        —         —         —  
Uncertain tax positions and related interest (5)
      520                     —               520  
Total contractual obligations
 
$
  71,031    
$
  5,541    
$
19,683    
$
  6,158    
$
  39,129    
$
  520  
 
(1)
We have a loan payable in the amount of $7,633 related to our New Markets Tax Credit financing which has a maturity date of 2041 and in which payments commence in 2019. We also had $30,000 outstanding under our Credit Facility, which in connection with having terminating such Credit Facility and entering into our New Credit Facility, is not due until October 2017.
(2)
We lease certain property in Oakland, California; Atlanta, Georgia and Buffalo, New York under non-cancelable operating leases. The leases in are due to expire in January 2016, September 2022 and March 2015, respectively.
(3)
Purchase obligations include minimum amounts committed under contracts for services.
(4)
We have a contingent consideration obligation based on revenues earned through 2013 and the obligation will be paid through February 2014.
(5)
We are unable to reasonably estimate the timing of such liability and interest payments in individual years due to uncertainties in the timing of the effective settlement of tax positions.

 
18

 
 
Off-Balance Sheet Arrangements

We are not a party to any material off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Critical Accounting Policies

The significant accounting policies and basis of preparation of our consolidated financial statements are described in Note 2, “Significant Accounting Policies” of our notes to consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2011 and in this Quarterly Report on Form 10-Q. Under accounting principles generally accepted in the United States, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities in our financial statements. Actual results could differ materially from those estimates.

We believe the judgments, estimates and assumptions associated with the following critical accounting policies have the greatest potential impact on our consolidated financial statements:
·  
Provision for operational losses;
·  
Stock-based compensation;
·  
Income taxes; and
·  
Business combinations

For a complete discussion of these critical accounting policies, refer to “Critical Accounting Policies” within “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our annual report on Form 10-K for the year ended December 31, 2011.  At September 30, 2012, the only accounting policy that has had a material change compared to the Critical Accounting Policies described therein is with respect to business combinations as a result of our acquisition of Campus Labs in August 2012.

Business combinations

In recording the fair value of assets acquired and liabilities assumed in a business combination, we make estimates and assumptions regarding customer retention rates, discount rates and future revenues among other things.  The effect of these estimates and assumptions may be material to our financial statements.  Changes in these estimates would have an impact on the amount of value assigned to our assets acquired and therefore impact the amount of amortization that is recorded in future periods and the amount of goodwill recorded at the time of the business combination.

In August 2012, we acquired substantially all the assets of Campus Labs and under the acquisition method of accounting, the total fair value of consideration transferred was allocated to Campus Lab’s net tangible and intangible assets based on their estimated fair values as of August 7, 2012. In determining the fair value of these amounts, we made estimates regarding (i) the amount of future revenues to be derived from the technology in existence at the time of the acquisition, (ii) the amount of future revenues to be derived from the existing customers of Campus Labs at the time of the acquisition, (iii) the amount of revenues to be earned in 2013 which will determine the amount of our contingent consideration earn-out payment to be made to the former owners of Campus Labs, (iv) the period of time over which the technology in existence at the time of the acquisition will be replaced, (v) the operating margin to be earned in the future, and (vi) the appropriate discount rates to use for each acquired asset and liability.  In most cases, an increase in our expected future revenues would have the impact of increasing the value ascribed to our identifiable intangible assets and thereby increasing future amortization expense and decreasing the amount of goodwill recorded.  In the case of our contingent consideration arrangement, increases in expected future revenues would increase our contingent consideration liability and also the amount of goodwill recorded.  We utilized discount rates ranging between 16% and 19% to determine the fair value of the acquired intangible assets and contingent consideration liability.  Increases or decreases of 1% in the discount rate would not have a material impact on the amount of acquired intangible assets, contingent consideration liability or goodwill recorded in the transaction.

Our contingent consideration liability is considered a liability measured at fair value on a recurring basis which relies on unobservable inputs.  During the three and nine months ended September 30, 2012, $310 of unrealized losses were recorded as a result of the passage of time between the date the liability was established and the determination of fair value of the liability at the end of the reporting period.  We believe that the fair value of the liability, as measured at September 30, 2012, may diverge materially from the amount that we expect to pay to settle the liability as a result of the time that will pass between September 30, 2012 and when we make payments under the earn-out arrangement in 2013 and 2014.
 
 
19

 
 
Recent Accounting Pronouncements

We review new accounting standards to determine the expected financial impact, if any, that the adoption of each such standard will have. As of the filing of this report, there were no new accounting standards issued that we expect to have a material impact on our consolidated financial position, results of operations or liquidity.
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
Our principal market risk relates to interest rate sensitivity, which is the risk that future changes in interest rates will reduce our net income or net assets. Other than as noted below, there have been no material changes in our principal market risk exposures from the information disclosed in our annual report on Form 10-K for the year ended December 31, 2011.

At September 30, 2012, we had total variable interest rate debt of $30.0 million. As of September 30, 2012, an increase in our interest rate of one percentage point would result in an increase in interest expense of approximately $0.3 million per year. We are currently at the lowest interest rate available under the terms of our Credit Facility and New Credit Facility and therefore will not experience a benefit from any decrease in variable interest rates.

In addition, we receive processing fees paid from our bank partners, based on prevailing interest rates and the total deposits held in our OneAccounts. Since 2008, processing fees paid by our bank partners have been relatively small because of historically low interest rates. A change in interest rates would affect the amount of processing fees that we earn and therefore would have an effect on our revenue, cash flows and results of operations.
 
Item 4.
Controls and Procedures
 
Our management, with the participation of our Principal Executive Officer and Principal Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act) as of September 30, 2012. Based on this evaluation, our Principal Executive Officer and Principal Financial Officer concluded that, as of September 30, 2012, our disclosure controls and procedures were effective to provide reasonable assurance that information is accumulated and communicated to our management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure, and ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Security and Exchange Commission’s rules and forms.

There has been no change in our internal controls over financial reporting during the three months ended September 30, 2012 identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the period covered by this report that has materially affected, or is reasonable likely to materially affect, our internal controls over financial reporting.

PART II – OTHER INFORMATION
 
Item 1.
Legal Proceedings

In February 2011, the New York Regional Office of the Federal Deposit Insurance Corporation, or FDIC, notified us that it was prepared to recommend to the Director of FDIC Supervision that an enforcement action be taken against us for alleged violations of certain applicable laws and regulations principally relating to our compliance management system and policies and practices for past overdraft charging on persistently delinquent accounts, collections and transaction error resolution. We responded to the FDIC’s notification and have been in regular dialogue with the FDIC since 2010.  We voluntarily initiated a plan in December 2011 that provided credits to certain current and former customers that were previously assessed certain insufficient fund fees. As a result of this plan, we recorded a reduction in our revenue of approximately $4.7 million in 2011, which excludes the restitution of unpaid fees. The insufficient funds fees that were credited to customers under this plan were originally assessed beginning in 2008. Of the total charge of $4.7 million, an accrual of approximately $2.6 million was established for amounts which were not paid as of December 31, 2011. All amounts were paid to our customers as of March 31, 2012.  On August 8, 2012, we received a Consent Order, Order for Restitution, and Order to Pay Civil Money Penalty, or the Consent Order, dated August 7, 2012, issued by the FDIC to settle such alleged violations.  Pursuant to the terms of the Consent Order, we neither admitted nor denied any charges when agreeing to the terms of the Consent Order. Under the terms of the Consent Order, we are required to, among other things, review and revise our compliance management system and, to date, we have already substantially revised our compliance management system. Additionally, the Consent Order provides for restrictions on the charging of certain fees. The Consent Order further provides that we shall make restitution to less than 2% of our customers since 2008 for fees previously assessed, which restitution has been substantially completed through the voluntary customer credit plan described above, and pay a civil money penalty of $110,000.  As a result of the Consent Order and completion of the related examination, we believe that all material exposure related to this matter has been recorded and we do not expect any further losses as a result of this matter.
 
 
20

 
 
We are a defendant in certain similar putative class action lawsuits.  While the specific causes of action differ in each suit, plaintiffs generally allege, among other things, violations of state consumer protection statutes (predicated, in part, on alleged violations of Department of Education rules and violations of the federal Electronic Funds Transfer Act) and various common law claims.  Some cases also assert direct causes of action under the federal Electronic Funds Transfer Act.  The cases are as follows: Sherry McFall, et al. v. Higher One Holdings, Inc. et al.,filed on April 18, 2012 in the Central District of California, Western Division (subsequently dismissed, re-filed in Ventura County Superior Court on April 24, 2012, removed back to the Central District of California on June 29, 2012, and voluntarily dismissed by plaintiffs on July 27, 2012); Ashley Parker, et al. v. Higher One Holdings, Inc. et al., filed on July 3, 2012 in the United States District Court for the Northern District of Mississippi, Eastern Division; Jeanette Price et al. v. Higher One Holdings, Inc. et al., filed on July 27, 2012 in the United States District Court for the District of Connecticut; John Brandon Kent et al. v. Higher One Holdings, Inc. et al., filed on August 17, 2012 in the United States District Court for the Middle District of Alabama, Northern Division; Jonathan Lanham  et al. v. Higher One Holdings, Inc. et al., filed on October 2, 2012 in the United States District Court for the Western District of Kentucky, Louisville Division; and Jill Massey et al. v. Higher One Holdings, Inc. et al., filed on November 6, 2012 in the United States District Court for the Southern District of Illinois, East Saint Louis Division.  We have filed a motion with the Judicial Panel on Multidistrict Litigation asking the Panel to transfer to a single court all of the above cases (and any additional tag-along cases) for coordinated or consolidated pretrial proceedings.  (While the Lanham and Massey cases were not filed prior to our motion, we sought transfer of all tag-along cases and the Panel has been notified about the Lanham case and will be notified about the Massey case, as well as any additional tag-along cases.)  We believe the claims in each of these actions to be without merit. Although we plan to defend these matters vigorously, there can be no assurances of our success in these matters.
 
In February 2009 and September 2010, Higher One, Inc. filed two separate complaints against TouchNet Information Systems, Inc., or TouchNet, in the United States District Court for the District of Connecticut alleging patent infringement related to TouchNet’s offering for sale and sales of its “eRefund” product in violation of two of our patents. In the complaints, we sought judgments that TouchNet has infringed two of our patents, a judgment that TouchNet pay damages and interest on damages to compensate us for infringement, an award of our costs in connection with these actions and an injunction barring TouchNet from further infringing our patents. TouchNet answered the complaint and asserted a number of defenses and counterclaims, including that it does not infringe our patent, that our patent is invalid or unenforceable and certain allegations of unfair competition and state and federal antitrust violations. In addition, TouchNet’s counterclaims sought dismissal of our claims with prejudice, declaratory judgment that TouchNet does not infringe our patent and that our patent is invalid or unenforceable, as well as an award of fees and costs related to the action, and an injunction permanently enjoining us from suing TouchNet regarding infringement of our patent. The parties are currently in the discovery stage of the proceeding. We intend to pursue the matter vigorously. There can be no assurances of our success in these proceedings.

Except as described above, there have been no material developments in our legal proceedings since we filed our annual report on Form 10-K for the year ended December 31, 2011.
 
Item 1A.
Risk Factors
 
There have been no material changes to our risk factors from those disclosed in our annual report on Form 10-K for the year ended December 31, 2011, except as follows:
 
 
Reviews and enforcement actions by regulatory authorities under banking and consumer protection laws and regulations, and possible changes to those laws and regulations by legislative or regulatory action, may result in changes to our business practices or may expose us to the risk of fines, restitution and litigation.

Our operations and the operations of our Bank Partners are subject to the jurisdiction and examination of federal, state and local regulatory authorities, including the FDIC, which is The Bancorp Bank’s and Wright Express FSC’s primary federal regulator, the Office of the Comptroller of the Currency, or OCC, which is UTB’s primary federal regulator, and the Federal Reserve Bank, which is Cole Taylor’s primary federal regulator. Our business practices, including the terms of our products, are reviewed and approved by our Bank Partners and subject to both periodic and special reviews by such regulatory authorities, which can range from investigations into specific consumer complaints or concerns to broader inquiries into our practices generally. We and our Bank Partners are subject to ongoing and routine examination by the FDIC, OCC and Federal Reserve Bank.  If, as part of an examination or review, the regulatory authorities conclude that we are not complying with applicable laws or regulations, they could request or impose a wide range of remedies, including, but not limited to, requiring changes to the terms of our products (such as decreases in fees), the imposition of fines or penalties or the institution of enforcement proceedings or other similar actions against us alleging that our practices constitute unfair or deceptive acts or practices. As part of an enforcement action, the regulators can seek restitution for affected customers and impose civil money penalties. In addition, negative publicity relating to any specific inquiry or investigation or any related fine could adversely affect our stock price, our relationships with various industry participants, or our ability to attract new clients and retain existing clients, which could have a material adverse effect on our business, financial condition and results of operations.
 
 
 
21

 

In February 2011, the New York Regional Office of the FDIC notified us that it was prepared to recommend to the Director of FDIC Supervision that an enforcement action be taken against us for alleged violations of certain applicable laws and regulations principally relating to our compliance management system and policies and practices for past overdraft charging on persistently delinquent accounts, collections and transaction error resolution. We have responded to the FDIC’s notification, been in regular dialogue with the FDIC since 2010 and voluntarily amended certain practices. We voluntarily initiated a plan in December 2011, which provided credits to certain current and former customers that were previously assessed certain insufficient fund fees. As a result of this plan, we recorded a reduction in our revenue of approximately $4.7 million in 2011. The insufficient funds fees that are credited to customers under this plan were originally assessed beginning in 2008. Of the total charge of $4.7 million, an accrual of approximately $2.6 million was established for amounts which were not paid as of December 31, 2011. All amounts have been paid to our customers as of March 31, 2012. On August 8, 2012, we received a Consent Order, Order for Restitution, and Order to Pay Civil Money Penalty, or the Consent Order, dated August 7, 2012, issued by the FDIC to settle such alleged violations.  Pursuant to the terms of the Consent Order, we neither admitted nor denied any charges when agreeing to the terms of the Consent Order. Under the terms of the Consent Order, we are required to, among other things, review and revise our compliance management system and, to date, we have already substantially revised our compliance management system. Additionally, the Consent Order provides for restrictions on the charging of certain fees. The Consent Order further provides that we shall make restitution to less than 2% of our customers since 2008 for fees previously assessed, which restitution has been substantially completed through the voluntary customer credit plan described above, and pay a civil money penalty of $110,000.  While we believe that agreeing to the Consent Order reduces our risk with respect to the FDIC, we remain subject to the jurisdiction and examination of the FDIC and further action could be taken to the extent we do not comply with the terms of the Consent Order or if the FDIC were to identify additional violations of certain applicable laws and regulations.
 
Earlier in the year, we received and responded to information requests from certain federal legislators.  These requests sought information related to our financial aid refund processing and the related services which we provide to students.  Certain federal legislators have also sent communications regarding similar matters to various federal agencies.  These inquiries or others could lead to further action by these or other governmental actors or agencies, including the introduction of legislation, which could have a material adverse effect on our business, financial condition and results of operations.
 
We depend on our relationship with higher education institutions and, in turn, student usage of our products and services for future growth of our business.
 
Our future growth depends, in part, on our ability to enter into agreements with higher education institutions. While we have experienced significant growth since 2002 in the number of our higher education institution clients, our contracts with these clients can generally be terminated at will and, therefore, there can be no assurance that we will be able to maintain these clients. We may also be unable to maintain our agreements with these clients on terms and conditions acceptable to us.  Further, the vast majority of the Campus Labs customer contracts contain a one-year term with no provision for automatic renewal.  In addition, we may not be able to continue to establish new relationships with higher education institution clients at our historical growth rate or at all. The termination of our current client contracts or our inability to continue to attract new clients could have a material adverse effect on our business, financial condition and results of operations.
 
Not only are establishing new client relationships and maintaining current ones critical to our business, but they are also essential components of our strategy for attracting new student customers, deepening the relationship we have with existing customers and maximizing customer usage of our products and services. A reduction in enrollment, a failure to attract and maintain student customers, as well as any future demographic or other trends that reduce the number of higher education students could materially and adversely affect our capability for both revenue and cash generation and, as a result, could have a material adverse effect on our business, financial condition and results of operations. For example, during the three and nine months ended September 30, 2012, we experienced a decrease in the proportion of OneAccounts that received a financial aid refund compared to the prior year periods. This decrease had a negative impact on our results of operations during the three and nine months ended September 30, 2012 and could have a further negative impact on our results of operations if this trend continues.
 
Our business and future success may suffer if we are unable to cross-sell our products and services.

A significant component of our growth strategy is dependent on our ability to cross-sell products and services to new and existing customers. In particular, our growth strategy depends on our ability to successfully cross-sell our disbursement, payments and data analytics services to clients that do not already use our entire suite of products. We may not be successful in cross-selling our products and services because our customers may find our additional products and services unnecessary or unattractive. Our failure to sell additional products and services to new and existing customers could have a material adverse effect on our prospects, business, financial condition and results of operations.

The fees that we generate through our relationships with higher education institutions and their campus communities are subject to competitive pressures and are subject to change, which may materially and adversely affect our revenue and profitability.

We generate revenue from, among other sources, the banking serv