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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
FORM 10-Q
 
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2015
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
Commission File Number: 001-35462 
 
 
 
Vantiv, Inc.
(Exact name of registrant as specified in its charter)
 
 
 
Delaware
 
26-4532998
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
8500 Governor’s Hill Drive
Symmes Township, OH 45249
(Address of principal executive offices)
(513) 900-5250
(Registrant's telephone number, including area code)
 
 
 

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 o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. 
Large accelerated filer x
 
Accelerated filer o
Non-accelerated filer o
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o  No x
As of March 31, 2015, there were 145,954,701 shares of the registrant’s Class A common stock outstanding and 43,042,826 shares of the registrant’s Class B common stock outstanding.

 
 
 
 
 
 
 
 
 
 



VANTIV, INC.
FORM 10-Q
 
For the Quarterly Period Ended March 31, 2015
 
TABLE OF CONTENTS
 
 
Page
 
 

2
 
 
 


NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This Quarterly Report on Form 10-Q, including the sections entitled "Management’s Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors," contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  All statements other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, our objectives for future operations, and any statements of a general economic or industry specific nature, are forward-looking statements.  You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. Words such as "anticipate," "estimate," "expect," "project," "plan," "intend," "believe," "may," "will," "continue," "could," "should," "can have," "likely," or the negative or plural of these words and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe, based on information currently available to our management, may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs.  These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in the "Risk Factors" section of our most recent Annual Report on Form 10-K. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this report may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.
 
You should not rely upon forward-looking statements as predictions of future events. The events and circumstances reflected in the forward-looking statements may not be achieved or occur. Although we believe that the expectations and assumptions reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. We undertake no obligation to publicly update any forward-looking statement after the date of this report, whether as a result of new information, future developments or otherwise, or to conform these statements to actual results or revised expectations, except as may be required by law.


3
 
 
 


PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

Vantiv, Inc.
CONSOLIDATED STATEMENTS OF INCOME
Unaudited
(In thousands, except share data)
 


 
Three Months Ended
March 31,
 
 
2015
 
2014
Revenue:
 
 

 
 

External customers
 
$
686,376

 
$
518,312

Related party revenues
 
19,235

 
19,266

Total revenue
 
705,611

 
537,578

Network fees and other costs
 
331,146

 
249,046

Sales and marketing
 
116,055

 
78,444

Other operating costs
 
68,739

 
60,369

General and administrative
 
47,843

 
32,606

Depreciation and amortization
 
67,802

 
49,846

Income from operations
 
74,026

 
67,267

Interest expense—net
 
(26,011
)
 
(10,554
)
Non-operating expenses
 
(8,766
)
 

Income before applicable income taxes
 
39,249

 
56,713

Income tax expense
 
12,253

 
15,622

Net income
 
26,996

 
41,091

Less: Net income attributable to non-controlling interests
 
(8,007
)
 
(12,955
)
Net income attributable to Vantiv, Inc.
 
$
18,989

 
$
28,136

Net income per share attributable to Vantiv, Inc. Class A common stock:
 
 
 
 
Basic
 
$
0.13

 
$
0.20

Diluted
 
$
0.13

 
$
0.18

Shares used in computing net income per share of Class A common stock:
 
 

 
 

Basic
 
144,530,704

 
138,228,839

Diluted
 
200,715,138

 
198,949,977

 
See Notes to Unaudited Consolidated Financial Statements.


4
 
 
 


Vantiv, Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Unaudited
(In thousands)
 
 
 
Three Months Ended
March 31,
 
 
2015
 
2014
Net income
 
$
26,996

 
$
41,091

Other comprehensive income, net of tax:
 
 

 
 

Loss on cash flow hedges and other
 
(7,370
)
 
(1,653
)
Comprehensive income
 
19,626

 
39,438

Less: Comprehensive income attributable to non-controlling interests
 
(5,632
)
 
(12,379
)
Comprehensive income attributable to Vantiv, Inc.
 
$
13,994

 
$
27,059

 
See Notes to Unaudited Consolidated Financial Statements.



5
 
 
 


Vantiv, Inc.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
Unaudited
(In thousands, except share data) 
 
March 31,
2015
 
December 31,
2014
Assets
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
239,538

 
$
411,568

Accounts receivable—net
566,603

 
607,674

Related party receivable
6,654

 
6,164

Settlement assets
146,951

 
135,422

Prepaid expenses
28,068

 
26,906

Other
31,063

 
27,002

Total current assets
1,018,877

 
1,214,736

  Customer incentives
39,124

 
39,210

  Property, equipment and software—net
276,521

 
281,715

  Intangible assets—net
987,585

 
1,034,692

  Goodwill
3,293,687

 
3,291,366

  Deferred taxes
426,847

 
429,623

  Other assets
41,782

 
44,741

Total assets
$
6,084,423

 
$
6,336,083

Liabilities and equity
 

 
 

Current liabilities:
 

 
 

Accounts payable and accrued expenses
$
253,185

 
$
299,771

Related party payable
2,684

 
2,035

Settlement obligations
488,128

 
501,042

Current portion of note payable to related party
10,353

 
10,353

Current portion of note payable
106,148

 
106,148

Current portion of tax receivable agreement obligations to related parties
33,650

 
22,789

Current portion of tax receivable agreement obligations
20,814

 

Deferred income
9,084

 
5,480

Current maturities of capital lease obligations
8,916

 
8,158

Other
9,181

 
7,557

Total current liabilities
942,143

 
963,333

Long-term liabilities:
 

 
 

Note payable to related party
188,933

 
191,521

Note payable
2,860,359

 
3,085,716

Tax receivable agreement obligations to related parties
563,607

 
597,273

Tax receivable agreement obligations
138,615

 
152,420

Capital lease obligations
12,533

 
14,779

Deferred taxes
31,980

 
24,380

Other
14,940

 
6,075

Total long-term liabilities
3,810,967

 
4,072,164

Total liabilities
4,753,110

 
5,035,497

Commitments and contingencies (See Note 7 - Commitments, Contingencies and Guarantees)


 


Equity:
 

 
 

Class A common stock, $0.00001 par value; 890,000,000 shares authorized; 145,954,701 shares outstanding at March 31, 2015; 145,455,008 shares outstanding at December 31, 2014
1

 
1

Class B common stock, no par value; 100,000,000 shares authorized; 43,042,826 shares issued and outstanding at March 31, 2015 and December 31, 2014

 

Preferred stock, $0.00001 par value; 10,000,000 shares authorized; no shares issued and outstanding

 

Paid-in capital
658,684

 
629,353

Retained earnings
347,347

 
328,358

Accumulated other comprehensive loss
(8,763
)
 
(3,768
)
Treasury stock, at cost; 2,569,125 shares at March 31, 2015 and 2,173,793 shares at December 31, 2014
(66,549
)
 
(50,931
)
Total Vantiv, Inc. equity
930,720

 
903,013

Non-controlling interests
400,593

 
397,573

Total equity
1,331,313

 
1,300,586

Total liabilities and equity
$
6,084,423

 
$
6,336,083

 See Notes to Unaudited Consolidated Financial Statements.

6
 
 
 


Vantiv, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
(In thousands)
 
Three Months Ended March 31,
 
2015
 
2014
Operating Activities:
 

 
 

Net income
$
26,996

 
$
41,091

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

 
 

Depreciation and amortization expense
67,802

 
49,846

Amortization of customer incentives
3,872

 
1,894

Amortization and write-off of debt issuance costs
3,606

 
1,170

Share-based compensation expense
11,623

 
8,939

Excess tax benefit from share-based compensation
(11,594
)
 
(7,845
)
Tax receivable agreements non-cash items
7,009

 

Change in operating assets and liabilities:
 

 
 

Accounts receivable and related party receivable
40,577

 
(1,038
)
Net settlement assets and obligations
(24,443
)
 
(6,065
)
Customer incentives
(5,651
)
 
(3,873
)
Prepaid and other assets
(4,644
)
 
1,524

Accounts payable and accrued expenses
(17,569
)
 
(1,303
)
Payable to related party
649

 
(592
)
Other liabilities
3,608

 
948

Net cash provided by operating activities
101,841

 
84,696

Investing Activities:
 

 
 

Purchases of property and equipment
(15,669
)
 
(28,941
)
Acquisition of customer portfolios and related assets
(1,425
)
 
(17,394
)
Net cash used in investing activities
(17,094
)
 
(46,335
)
Financing Activities:
 

 
 

Repayment of debt and capital lease obligations
(230,823
)
 
(24,607
)
Proceeds from exercise of Class A common stock options
6,030

 
236

Repurchase of Class A common stock

 
(34,366
)
Repurchase of Class A common stock (to satisfy tax withholding obligations)
(15,618
)
 
(13,289
)
Payments under tax receivable agreements
(22,805
)
 
(8,639
)
Excess tax benefit from share-based compensation
11,594

 
7,845

Distributions to non-controlling interests
(2,528
)
 

Decrease in cash overdraft
(2,627
)
 

Net cash used in financing activities
(256,777
)
 
(72,820
)
Net decrease in cash and cash equivalents
(172,030
)
 
(34,459
)
Cash and cash equivalents—Beginning of period
411,568

 
171,427

Cash and cash equivalents—End of period
$
239,538

 
$
136,968

Cash Payments:
 

 
 

Interest
$
24,548

 
$
9,518

Taxes
4,561

 
12,756


 See Notes to Unaudited Consolidated Financial Statements.

7
 
 
 


Vantiv, Inc.
CONSOLIDATED STATEMENT OF EQUITY
Unaudited
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
Common Stock
 
 
 
 
 
 
 
 
 
Other
 
Non-
 
Total
 
Class A
 
Class B
 
Treasury Stock
 
Paid-in
 
Retained
 
Comprehensive
 
Controlling
 
Equity
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Capital
 
Earnings
 
Loss
 
Interests
Beginning Balance, January 1, 2015
$
1,300,586

 
145,455

 
$
1

 
43,043

 
$

 
2,174

 
$
(50,931
)
 
$
629,353

 
$
328,358

 
$
(3,768
)
 
$
397,573

Net income
26,996

 

 

 

 

 

 

 

 
18,989

 

 
8,007

Issuance of Class A common stock under employee stock plans, net of forfeitures
6,030

 
895

 

 

 

 

 

 
6,030

 

 

 

Tax benefit from employee share-based compensation
11,594

 

 

 

 

 

 

 
11,594

 

 

 

Repurchase of Class A common stock (to satisfy tax withholding obligation)
(15,618
)
 
(395
)
 

 

 

 
395

 
(15,618
)
 

 

 

 

Unrealized loss on hedging activities and other, net of tax
(7,370
)
 

 

 

 

 

 

 

 

 
(4,995
)
 
(2,375
)
Distributions to non-controlling interests
(2,528
)
 

 

 

 

 

 

 

 

 

 
(2,528
)
Share-based compensation
11,623

 

 

 

 

 

 

 
8,975

 

 

 
2,648

Reallocation of non-controlling interests of Vantiv Holding due to change in ownership

 

 

 

 

 

 

 
2,732

 

 

 
(2,732
)
Ending Balance, March 31, 2015
$
1,331,313

 
145,955

 
$
1

 
43,043

 
$

 
2,569

 
$
(66,549
)
 
$
658,684

 
$
347,347

 
$
(8,763
)
 
$
400,593

 
See Notes to Unaudited Consolidated Financial Statements.



8
 
 
 


Vantiv, Inc.
CONSOLIDATED STATEMENT OF EQUITY
Unaudited
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
Common Stock
 
 
 
 
 
 
 
 
 
Other
 
Non-
 
Total
 
Class A
 
Class B
 
Treasury Stock
 
Paid-in
 
Retained
 
Comprehensive
 
Controlling
 
Equity
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Capital
 
Earnings
 
Income (Loss)
 
Interests
Beginning Balance, January 1, 2014
$
1,176,322

 
141,759

 
$
1

 
48,823

 
$

 
1,607

 
$
(33,130
)
 
$
597,730

 
$
203,066

 
$
264

 
$
408,391

Net income
41,091

 

 

 

 

 

 

 

 
28,136

 

 
12,955

Issuance of Class A common stock under employee stock plans, net of forfeitures
236

 
44

 

 

 

 

 

 
236

 

 

 

Tax benefit from employee share-based compensation
7,845

 

 

 

 

 

 

 
7,845

 

 

 

Repurchase of Class A common stock (to satisfy tax withholding obligation)
(13,289
)
 
(419
)
 

 

 

 
419

 
(13,289
)
 

 

 

 

Repurchase of Class A common stock
(34,366
)
 
(1,109
)
 

 

 

 

 

 
(34,366
)
 

 

 

Unrealized loss on hedging activities, net of tax
(1,653
)
 

 

 

 

 

 

 

 

 
(1,077
)
 
(576
)
Share-based compensation
8,939

 

 

 

 

 

 

 
6,637

 

 

 
2,302

Reallocation of non-controlling interests of Vantiv Holding due to change in ownership

 

 

 

 

 

 

 
9,541

 

 

 
(9,541
)
Ending Balance, March 31, 2014
$
1,185,125

 
140,275

 
$
1

 
48,823

 
$

 
2,026

 
$
(46,419
)
 
$
587,623

 
$
231,202

 
$
(813
)
 
$
413,531

 
See Notes to Unaudited Consolidated Financial Statements.



9
 
 
 


Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Description of Business
 
Vantiv, Inc., a Delaware corporation, is a holding company that conducts its operations through its majority-owned subsidiary, Vantiv Holding, LLC ("Vantiv Holding"). Vantiv, Inc. and Vantiv Holding are referred to collectively as the "Company," "Vantiv," "we," "us" or "our," unless the context requires otherwise.
 
The Company provides electronic payment processing services to merchants and financial institutions throughout the United States of America. The Company markets its services through diverse distribution channels, including national, regional and mid-market sales teams, third-party reseller clients and a telesales operation. The Company also has relationships with a broad range of referral partners that include merchant banks, independent software vendors ("ISVs"), value-added resellers ("VARs"), payment facilitators, independent sales organizations ("ISOs") and trade associations as well as arrangements with core processors.
 
Segments
 
The Company’s segments consist of the Merchant Services segment and the Financial Institution Services segment. The Company’s Chief Executive Officer ("CEO"), who is the chief operating decision maker ("CODM"), evaluates the performance and allocates resources based on the operating results of each segment. Below is a summary of each segment:
 
Merchant Services—Provides merchant acquiring and payment processing services to large national merchants, regional and small-to-mid sized businesses. Merchant services are sold to small to large businesses through diverse distribution channels. Merchant Services includes all aspects of card processing including authorization and settlement, customer service, chargeback and retrieval processing and interchange management.
 
Financial Institution Services—Provides card issuer processing, payment network processing, fraud protection, card production, prepaid program management, automated teller machine ("ATM") driving and network gateway and switching services that utilize the Company’s proprietary Jeanie debit payment network to a diverse set of financial institutions, including regional banks, community banks, credit unions and regional personal identification number ("PIN") networks. Financial Institution Services also provides statement production, collections and inbound/outbound call centers for credit transactions, and other services such as credit card portfolio analytics, program strategy and support, fraud and security management and chargeback and dispute services.

Basis of Presentation and Consolidation
 
The accompanying consolidated financial statements include those of Vantiv, Inc. and all subsidiaries thereof, including its majority-owned subsidiary, Vantiv Holding, LLC. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") and should be read in connection with the Company's 2014 audited financial statements and notes thereto included in the Company's Annual Report on Form 10-K. The accompanying consolidated financial statements are unaudited; however, in the opinion of management they include all normal and recurring adjustments necessary for a fair presentation of the Company's financial position, results of operations and cash flows for the periods presented. Results of operations reported for interim periods are not necessarily indicative of results for the entire year. All intercompany balances and transactions have been eliminated.
 
As of March 31, 2015, Vantiv, Inc. and Fifth Third Bank ("Fifth Third") owned interests in Vantiv Holding of 77.23% and 22.77%, respectively (see Note 6 - Controlling and Non-controlling Interests for changes in non-controlling interests).
 
The Company accounts for non-controlling interests in accordance with Accounting Standards Codification ("ASC") 810, Consolidation. Non-controlling interests primarily represent Fifth Third's minority share of net income or loss of and equity in Vantiv Holding. Net income attributable to non-controlling interests does not include expenses incurred directly by Vantiv, Inc., including income tax expense attributable to Vantiv, Inc. All of the Company’s non-controlling interests are presented after Vantiv Holding income tax expense in the accompanying consolidated statements of income as "Net income

10
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


attributable to non-controlling interests." Non-controlling interests are presented as a component of equity in the accompanying consolidated statements of financial position.

Share Repurchase Program

In February 2014, our board of directors authorized a program to repurchase up to $300 million of our Class A common stock. We have approximately $275 million of share repurchase authority remaining as of March 31, 2015 under this authorization. Purchases under the repurchase program are allowed from time to time in the open market, in privately negotiated transactions, or otherwise. The manner, timing, and amount of any purchases are determined by management based on an evaluation of market conditions, stock price, and other factors. The share repurchase program has no expiration date and the Company may discontinue purchases at any time that management determines additional purchases are not warranted.

Sponsorship
 
In order to provide electronic payment processing services, Visa, MasterCard and other payment networks require sponsorship of non-financial institutions by a member clearing bank. In June 2009, the Company entered into a ten-year agreement with Fifth Third (the "Sponsoring Member") to provide sponsorship services to the Company. The Company also has agreements with certain other banks that provide sponsorship into the card networks.
 
Use of Estimates
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amount 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 differ from those estimates.

Revenue Recognition
 
The Company has contractual agreements with its clients that set forth the general terms and conditions of the relationship including line item pricing, payment terms and contract duration. Revenues are recognized as earned (i.e., for transaction based fees, when the underlying transaction is processed) in conjunction with ASC 605, Revenue Recognition. ASC 605, Revenue Recognition, establishes guidance as to when revenue is realized or realizable and earned by using the following criteria: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the seller’s price is fixed or determinable; and (4) collectibility is reasonably assured.
 
The Company follows guidance provided in ASC 605-45, Principal Agent Considerations. ASC 605-45, Principal Agent Considerations, which states that whether a company should recognize revenue based on the gross amount billed to a customer or the net amount retained is a matter of judgment that depends on the facts and circumstances of the arrangement and that certain factors should be considered in the evaluation. The Company recognizes processing revenues net of interchange fees, which are assessed to the Company’s merchant customers on all processed transactions. Interchange rates are not controlled by the Company, which effectively acts as a clearing house collecting and remitting interchange fee settlement on behalf of issuing banks, debit networks, credit card associations and its processing customers. All other revenue is reported on a gross basis, as the Company contracts directly with the end customer, assumes the risk of loss and has pricing flexibility.
 
The Company generates revenue primarily by processing electronic payment transactions. Set forth below is a description of the Company’s revenue by segment. 

Merchant Services
 
The Company’s Merchant Services segment revenue is primarily derived from processing credit and debit card transactions. Merchant Services revenue is primarily comprised of fees charged to businesses, net of interchange fees, for payment processing services, including authorization, capture, clearing, settlement and information reporting of electronic transactions. The fees charged consist of either a percentage of the dollar volume of the transaction or a fixed fee, or both, and are recognized at the time of the transaction. Merchant Services revenue also includes a number of revenue items that are incurred by the Company and are reimbursable as the costs are passed through to and paid by the Company’s clients. These items primarily consist of Visa, MasterCard and other payment network fees. In addition, for sales through ISOs and certain other referral sources in which the Company is the primary party to the contract with the merchant, the Company records the

11
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


full amount of the fees collected from the merchant as revenue. Merchant Services segment revenue also includes revenue from ancillary services such as fraud management, equipment sales and terminal rent. Merchant Services revenue is recognized as services are performed. 

Financial Institution Services

The Company’s Financial Institution Services segment revenues are primarily derived from debit, credit and ATM card transaction processing, ATM driving and support, and PIN debit processing services. Financial Institution Services revenue associated with processing transactions includes per transaction and account related fees, card production fees and fees generated from the Company’s Jeanie network. Financial Institution Services revenue related to card transaction processing is recognized when consumers use their client-issued cards to make purchases. Financial Institution Services also generates revenue through other services, including statement production, collections and inbound/outbound call centers for credit transactions and other services such as credit card portfolio analytics, program strategy and support, fraud and security management and chargeback and dispute services. Financial Institution Services revenue is recognized as services are performed.
 
Financial Institution Services provides certain services to Fifth Third. Revenues related to these services are included in the accompanying statements of income as related party revenues.
 
Expenses
 
Set forth below is a brief description of the components of the Company’s expenses:
 
Network fees and other costs primarily consist of certain expenses incurred by the Company in connection with providing processing services to its clients which are passed through to its clients, including Visa and MasterCard network association fees, payment network fees, third party processing fees, telecommunication charges, postage and card production costs.
 
Sales and marketing expense primarily consists of salaries and benefits paid to sales personnel, sales management and other sales and marketing personnel, residual payments made to ISOs and referral partners, and advertising and promotional costs.
 
Other operating costs primarily consist of salaries and benefits paid to operational and IT personnel, costs associated with operating the Company’s technology platform and data centers, information technology costs for processing transactions, product development costs, software consulting fees and maintenance costs.

General and administrative expenses primarily consist of salaries and benefits paid to executive management and administrative employees, including finance, human resources, product development, legal and risk management, share-based compensation costs, equipment and occupancy costs and consulting costs.

Non-operating expenses during the three months ended March 31, 2015 primarily relate to the change in fair value of a tax receivable agreement (see Note 8 - Fair Value Measurements) and the write-off of deferred financing fees and original issue discount ("OID") associated with a $200 million early principal payment on the term B loan in January 2015 (see Note 4 - Long-Term Debt).

Share-Based Compensation
 
The Company expenses employee share-based payments under ASC 718, Compensation—Stock Compensation, which requires compensation cost for the grant-date fair value of share-based payments to be recognized over the requisite service period. The Company estimates the grant date fair value of the share-based awards issued in the form of options using the Black-Scholes option pricing model. The fair value of restricted stock awards and performance awards is measured based on the market price of the Company’s stock on the grant date. For the three months ended March 31, 2015 and 2014 total share-based compensation expense was $11.6 million and $8.9 million, respectively.

Earnings Per Share
 
Basic earnings per share is computed by dividing net income attributable to Vantiv, Inc. by the weighted average shares outstanding during the period. Diluted earnings per share is computed by dividing net income attributable to Vantiv, Inc.,

12
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


adjusted as necessary for the impact of potentially dilutive securities, by the weighted-average shares outstanding during the period and the impact of securities that would have a dilutive effect on earnings per share. See Note 9 - Net Income Per Share for further discussion.

Dividend Restrictions

The Company does not intend to pay cash dividends on its Class A common stock in the foreseeable future. Vantiv, Inc. is a holding company that does not conduct any business operations of its own. As a result, Vantiv, Inc.’s ability to pay cash dividends on its common stock, if any, is dependent upon cash dividends and distributions and other transfers from Vantiv Holding, which are subject to certain Fifth Third consent rights in the Amended and Restated Vantiv Holding Limited Liability Company Agreement. These consent rights require the approval of Fifth Third for certain significant matters, including the payment of all distributions by Vantiv Holding other than certain permitted distributions, which relate primarily to the payment of tax distributions and tax-related obligations. The amounts available to Vantiv, Inc. to pay cash dividends are also subject to the covenants and distribution restrictions in its subsidiaries’ loan agreements. As a result of the restrictions on distributions from Vantiv Holding and its subsidiaries, essentially all of the Company's consolidated net assets are held at the subsidiary level and are restricted as of March 31, 2015.

Income Taxes
 
Vantiv, Inc. is taxed as a C corporation for U.S. income tax purposes and is therefore subject to both federal and state taxation at a corporate level.
 
Income taxes are computed in accordance with ASC 740, Income Taxes, and reflect the net tax effects of temporary differences between the financial reporting carrying amounts of assets and liabilities and the corresponding income tax amounts. The Company has deferred tax assets and liabilities and maintains valuation allowances where it is more likely than not that all or a portion of deferred tax assets will not be realized. To the extent the Company determines that it will not realize the benefit of some or all of its deferred tax assets, such deferred tax assets will be adjusted through the Company’s provision for income taxes in the period in which this determination is made. As of March 31, 2015 and December 31, 2014, the Company had recorded no valuation allowances against deferred tax assets.

The Company's consolidated interim effective tax rate is based upon expected annual income from operations, statutory tax rates and tax laws in the various jurisdictions in which the Company operates. Significant or unusual items, including adjustments to accruals for tax uncertainties, are recognized in the quarter in which the related event occurs.

The Company's effective tax rates were 31.2% and 27.5%, respectively, for the three months ended March 31, 2015 and 2014. The effective tax rate for each period reflects the impact of the Company's non-controlling interests.
 
Cash and Cash Equivalents
 
Cash on hand and investments with original maturities of three months or less (that are readily convertible to cash) are considered to be cash equivalents. Cash equivalents consist primarily of overnight EuroDollar sweep accounts which are maintained at reputable financial institutions with high credit quality and therefore are considered to bear minimal credit risk.
 
Accounts Receivable—net
 
Accounts receivable primarily represent processing revenues earned but not collected. For a majority of its customers, the Company has the authority to debit the client’s bank accounts through the Federal Reserve’s Automated Clearing House; as such, collectibility is reasonably assured. The Company records a reserve for doubtful accounts when it is probable that the accounts receivable will not be collected. The Company reviews historical loss experience and the financial position of its customers when estimating the allowance. As of March 31, 2015 and December 31, 2014, the allowance for doubtful accounts was not material to the Company’s statements of financial position.
 
Customer Incentives
 
Customer incentives represent signing bonuses paid to customers. Customer incentives are paid in connection with the acquisition or renewal of customer contracts, and are therefore deferred and amortized using the straight-line method based on the contractual agreement. Related amortization is recorded as contra-revenue.
 

13
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


Property, Equipment and Software—net
 
Property, equipment and software consists of the Company’s facilities, furniture and equipment, software, land and leasehold improvements. These assets are depreciated on a straight-line basis over their respective useful lives, which are 15 to 40 years for the Company’s facilities and related improvements, 2 to 10 years for furniture and equipment, 3 to 5 years for software and 3 to 10 years for leasehold improvements or the lesser of the estimated useful life of the improvement or the term of lease. Also included in property, equipment and software is work in progress consisting of costs associated with software developed for internal use which has not yet been placed in service. Accumulated depreciation as of March 31, 2015 and December 31, 2014 was $208.0 million and $202.8 million, respectively.
 
The Company capitalizes certain costs related to computer software developed for internal use and amortizes such costs on a straight-line basis over an estimated useful life of 3 to 5 years. Research and development costs incurred prior to establishing technological feasibility are charged to operations as such costs are incurred. Once technological feasibility has been established, costs are capitalized until the software is placed in service.
 
Goodwill and Intangible Assets
 
In accordance with ASC 350, Intangibles—Goodwill and Other, the Company tests goodwill for impairment for each reporting unit on an annual basis, or when events occur or circumstances indicate the fair value of a reporting unit is below its carrying value. If the fair value of a reporting unit is less than its carrying value, an impairment loss is recorded to the extent that fair value of the goodwill within the reporting unit is less than its carrying value. The Company performed its most recent annual goodwill impairment test for all reporting units as of July 31, 2014 using market data and discounted cash flow analyses. Based on this analysis, it was determined that the fair value of all reporting units were substantially in excess of the carrying value. There have been no other events or changes in circumstances subsequent to the testing date that would indicate impairment of these reporting units as of March 31, 2015.

Intangible assets consist of acquired customer relationships, trade names and customer portfolios and related assets that are amortized over their estimated useful lives. The Company reviews finite lived intangible assets for possible impairment whenever events or changes in circumstances indicate that carrying amounts may not be recoverable. As of March 31, 2015, there have been no such events or circumstances that would indicate potential impairment of finite lived intangible assets.
 
Settlement Assets and Obligations
 
Settlement assets and obligations result from Financial Institution Services when funds are transferred from or received by the Company prior to receiving or paying funds to a different entity. This timing difference results in a settlement asset or obligation. The amounts are generally collected or paid the following business day.
 
The settlement assets and obligations recorded by Merchant Services represent intermediary balances due to differences between the amount the Sponsoring Member receives from the card associations and the amount funded to the merchants. Such differences arise from timing differences, interchange expenses, merchant reserves and exception items. In addition, certain card associations limit the Company from accessing or controlling merchant settlement funds and, instead, require that these funds be controlled by the Sponsoring Member. The Company follows a net settlement process whereby, if the settlement received from the card associations precedes the funding obligation to the merchant, the Company temporarily records a corresponding liability. Conversely, if the funding obligation to the merchant precedes the settlement from the card associations, the amount of the net receivable position is recorded by the Company, or in some cases, the Sponsoring Member may cover the position with its own funds in which case a receivable position is not recorded by the Company.
 
Derivatives
 
The Company accounts for derivatives in accordance with ASC 815, Derivatives and Hedging. This guidance establishes accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the statement of financial position at fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and the hedged item will be recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portion of the change in the fair value of the derivative will be recorded in accumulated other comprehensive income ("AOCI") and will be recognized in the statement of income when the hedged item affects earnings. The Company does not enter into derivative financial instruments for speculative purposes.

14
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)



Tax Receivable Agreements

As of March 31, 2015, the Company is party to tax receivable agreements ("TRAs") with Fifth Third, which were executed in connection with its initial public offering ("IPO"). One provides for the payment by the Company to Fifth Third of 85% of the amount of cash savings, if any, in U.S. federal, state, local and foreign income tax that the Company actually realizes as a result of the increases in tax basis that may result from the purchase of Vantiv Holding units from Fifth Third or from the future exchange of units by Fifth Third for cash or shares of the Company's Class A common stock, as well as the tax benefits attributable to payments made under such tax receivable agreement. Any actual increase in tax basis, as well as the amount and timing of any payments under the agreement, will vary depending upon a number of factors, including the timing of exchanges, the price of shares of our Class A common stock at the time of the exchange, the extent to which such exchanges are taxable, and the amount and timing of the Company's income. The other tax receivable agreement provides for the payment by the Company to Fifth Third of 85% of the amount of cash savings according to Fifth Third's respective ownership interests in Vantiv Holding immediately prior to our initial public offering, if any, in U.S. federal, state, local and foreign income tax that National Processing Company ("NPC") actually realizes as a result of its use of its net operating losses ("NOLs") and other tax attributes.

Simultaneously and in connection with the completion of the acquisition of Mercury Payment Systems, LLC ("Mercury"), the Company entered into a TRA (the "Mercury TRA") with pre-acquisition owners of Mercury (the "Mercury TRA Holders"). The Mercury TRA generally provides for the payment by the Company to the Mercury TRA Holders of 85% of the value of the amount of cash savings, if any, in U.S. federal, state, local and foreign income tax that the Company actually realizes as a result of the increase in tax basis of the assets of Mercury and the use of the net operating losses and other tax attributes of Mercury. The Mercury TRA is considered contingent consideration under ASC 805, Business Combinations ("ASC 805") as it is part of the consideration payable to the former owners of Mercury. In accordance with ASC 805, the contingent consideration is initially measured at fair value at the acquisition date and recorded as a liability. The Mercury TRA liability is therefore recorded at fair value based on estimates of discounted future cash flows associated with estimated payments to the Mercury TRA Holders. The liability recorded by the Company for the Mercury TRA obligations will be re-measured at fair value at each reporting date with the change in fair value recognized in earnings as a non-operating expense.

All TRA obligations are recorded based on the full and undiscounted amount of the expected future payments, except for the Mercury TRA which represents contingent consideration relating to an acquired business, and is recorded at fair value for financial reporting purposes (See Note 8 - Fair Value Measurements). 

Payments under each of the TRAs discussed above are required to the extent the Company realizes cash savings as a result of the underlying tax attributes. The cash savings realized by the Company are computed by comparing the Company's actual income tax liability to the amount of such taxes the Company would have been required to pay had there been no deductions related to the tax attributes discussed above. The Company retains the benefit of the remaining 15% of these tax savings.

The timing and/or amount of aggregate payments due under the TRAs may vary based on a number of factors, including the amount and timing of the taxable income the Company generates in the future and the tax rate then applicable, the use of loss carryovers and amortizable basis. Payments under the TRAs, if necessary, are required to be made no later than January 5th of the second year immediately following the current taxable year. A payment under the TRA obligations of approximately $22.8 million was paid during January 2015. The term of the TRAs will continue until all such tax benefits have been utilized or expired, unless we exercise our right to terminate the TRAs for an amount based on the agreed payments remaining to be made under the agreements.

New Accounting Pronouncements
 
In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update ("ASU") 2014-09, "Revenue From Contracts With Customers." The ASU supersedes the revenue recognition requirements in ASC 605, Revenue Recognition. The amendment provides a five-step analysis of transactions to determine when and how revenue is recognized, based upon the core principal that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amendment also requires additional disclosures regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The amendment is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016, with early adoption prohibited. The amendment allows companies to use either a full retrospective or a modified retrospective approach to adopt this ASU. In April 2015, the FASB proposed a one-

15
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


year deferral of this standard. The Company is currently evaluating which transition approach to use and assessing the impact of the adoption of this principle on the Company's consolidated financial statements.    

2. BUSINESS COMBINATIONS

Acquisition of Mercury Payment Systems, LLC

On June 13, 2014, the Company completed the acquisition of Mercury, acquiring all of the outstanding voting interest. Mercury was a payment technology and service leader whose solutions are integrated into point-of-sale software applications and brought to market through dealer and developer partners. This acquisition helps to accelerate the Company's growth in the integrated payments channel.

The acquisition was accounted for as a business combination under ASC 805. The purchase price was allocated to the assets acquired and the liabilities assumed based on the estimated fair value at the date of acquisition. The excess of the purchase price over the fair value of the net assets acquired was allocated to goodwill, a significant portion of which is deductible for tax purposes. Goodwill, assigned to Merchant Services, consists primarily of the acquired workforce and growth opportunities, none of which qualify as an intangible asset. The table below presents an updated purchase price allocation from the preliminary amounts reported as of December 31, 2014 (in thousands):
Cash acquired
$
22,485

Current assets
47,417

Property, equipment and software
32,257

Intangible assets
391,100

Goodwill
1,350,074

Deferred tax assets
16,626

Other non-current assets
1,176

Current and non-current liabilities
(42,096
)
Total purchase price
$
1,819,039


The above estimated fair values of assets acquired and liabilities assumed are preliminary and are based on the information that was available as of the reporting date to estimate the fair value of assets acquired and liabilities assumed. The Company believes that the information provides a reasonable basis for estimating the fair values of the acquired assets and assumed liabilities, but the potential for measurement period adjustments exists based on the Company’s continuing review of matters related to the acquisition. The Company expects to complete the purchase price allocation as soon as practicable, but no later than one year from the acquisition date.


16
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


The following pro forma information shows the Company’s results of operations for the three months ended March 31, 2014 as if the Mercury acquisition had occurred January 1, 2013. The pro forma information is presented for informational purposes only and is not necessarily indicative of what would have occurred if the acquisition had been made as of that date, nor is it intended to be indicative of future operating results.
 
Three Months Ended March 31, 2014
 
(Pro forma)
 
(in thousands, except share data)
Total revenue
$
616,268

Income from operations
66,187

Net income including non-controlling interests
31,365

Net income attributable to Vantiv, Inc.
20,914

Net income per share attributable to Vantiv, Inc. Class A common stock:
 

Basic
$
0.15

Diluted
$
0.13

Shares used in computing net income per share of Class A common stock:
 

Basic
138,228,839

Diluted
198,949,977

 

The pro forma results include certain pro forma adjustments that were directly attributable to the business combination as follows:
additional amortization expense that would have been recognized relating to the acquired intangible assets, and
an adjustment of interest expense to reflect the additional borrowings of the Company in conjunction with the acquisition and removal of Mercury historical debt.

3. GOODWILL AND INTANGIBLE ASSETS

Changes in the carrying amount of goodwill, by business segment, are as follows (in thousands):

 
Merchant Services
 
Financial Institution Services
 
Total
Balance as of December 31, 2014
 
$
2,716,516

 
$
574,850

 
$
3,291,366

Goodwill attributable to acquisition of Mercury (1)
 
2,321

 

 
2,321

Balance as of March 31, 2015
 
$
2,718,837

 
$
574,850

 
$
3,293,687

 
(1) Amount represents adjustments to goodwill associated with the acquisition of Mercury as a result of an update to the purchase price allocation, primarily related to revisions of certain estimates from the preliminary amounts reported as of December 31, 2014.

17
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)



As of March 31, 2015 and December 31, 2014, the Company's intangible assets consisted of the following (in thousands):
 
 
March 31,
2015
 
December 31,
2014
Customer relationship intangible assets
 
$
1,596,581

 
$
1,596,581

Trade names - finite lived
 
65,833

 
65,833

Customer portfolios and related assets
 
59,508

 
57,383

 
 
1,721,922

 
1,719,797

 
 
 
 
 
Less accumulated amortization on:
 
 
 
 
  Customer relationship intangible assets
 
697,566

 
655,017

Trade names - finite lived
 
7,502

 
5,105

  Customer portfolios and related assets
 
29,269

 
24,983

 
 
734,337

 
685,105

 
 
$
987,585

 
$
1,034,692

  
Customer portfolios and related assets acquired during the three months ended March 31, 2015 have a weighted-average amortization period of 4.4 years. Amortization expense on intangible assets for the three months ended March 31, 2015 and 2014 was $49.2 million and $33.3 million, respectively.

The estimated amortization expense of intangible assets for the next five years is as follows (in thousands):
Nine months ending December 31, 2015
 
$
141,911

2016
 
176,702

2017
 
163,045

2018
 
155,074

2019
 
147,671

2020
 
82,735


4. LONG-TERM DEBT

As of March 31, 2015 and December 31, 2014, the Company’s debt consisted of the following: 
 
March 31,
2015
 
December 31,
2014
 
(in thousands)
$2,050.0 million term A loan, maturing on June 13, 2019, and bearing interest at a variable base rate (LIBOR) plus a spread rate (200 basis points) (total rate of 2.17% at March 31, 2015) and amortizing on a basis of 1.25% per quarter during each of the first twelve quarters, 1.875% per quarter during the next four quarters and 2.50% during the next three quarters with a balloon payment due at maturity
$
1,973,125

 
$
1,998,750

$1,400.0 million term B loan, maturing on June 13, 2021, and bearing interest at a variable base rate (LIBOR) with a floor of 75 basis points plus a spread rate (300 basis points) (total rate of 3.75% at March 31, 2015) and amortizing on a basis of 0.25% per quarter, with a balloon payment due at maturity
1,189,500

 
1,393,000

$10.1 million leasehold mortgage, expiring on August 10, 2021 and bearing interest payable monthly at a fixed rate (rate of 6.22% at March 31, 2015)
10,131

 
10,131

Less: Current portion of note payable and current portion of note payable to related party
(116,501
)
 
(116,501
)
Less: Original issue discount
(6,963
)
 
(8,143
)
Note payable and note payable to related party
$
3,049,292

 
$
3,277,237


2014 Debt Refinancing

18
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


    
On June 13, 2014, Vantiv, LLC completed a debt refinancing by entering into an amended and restated loan agreement ("Amended Loan Agreement"). The Amended Loan Agreement provides for senior secured credit facilities comprised of a $2.05 billion term A loan, a $1.4 billion term B loan and a $425 million revolving credit facility. Proceeds from the refinancing were primarily used to fund the Mercury acquisition and repay the prior term A loan with an outstanding balance of approximately $1.8 billion as of the date of refinancing. The prior revolving credit facility was also terminated. The maturity date and debt service requirements relating to the new term A and term B loans are listed in the table above. The new revolving credit facility matures in June 2019 and includes a $100 million swing line facility and a $40 million letter of credit facility. The commitment fee rate for the unused portion of the revolving credit facility is 0.375% per year. There were no outstanding borrowings on the revolving credit facility at March 31, 2015.
    
As of March 31, 2015 and December 31, 2014, Fifth Third held $199.3 million and $201.9 million, respectively, of the term A loans.

On January 6, 2015, the Company made an early principal payment of $200 million on the term B loan. The Company expensed approximately $1.8 million in non-operating expenses related to the write-off of deferred financing fees and OID in connection with the early principal payment.
Guarantees and Security
 
The Company's debt obligations at March 31, 2015 are unconditional and are guaranteed by Vantiv Holding and certain of Vantiv Holding’s existing and subsequently acquired or organized domestic subsidiaries. The refinanced debt and related guarantees are secured on a first-priority basis (subject to liens permitted under the Amended Loan Agreement) by substantially all the capital stock (subject to a 65% limitation on pledges of capital stock of foreign subsidiaries and domestic holding companies of foreign subsidiaries) and personal property of Vantiv Holding and any obligors as well as any real property in excess of $10 million in the aggregate held by Vantiv Holding or any obligors (other than Vantiv Holding), subject to certain exceptions. 

Covenants
 
There are certain financial and non-financial covenants contained in the Amended Loan Agreement for the refinanced debt, which are tested on a quarterly basis. The financial covenants require maintenance of certain leverage and interest coverage ratios. At March 31, 2015, the Company was in compliance with these financial covenants.

5. DERIVATIVES AND HEDGING ACTIVITIES
 
Risk Management Objective of Using Derivatives
 
The Company enters into derivative financial instruments to manage differences in the amount, timing and duration of its known or expected cash payments related to its variable-rate debt. As of March 31, 2015 and December 31, 2014, the Company’s derivative instruments consisted of interest rate swaps, which hedged the variable rate debt by converting floating-rate payments to fixed-rate payments. These swaps are designated as cash flow hedges for accounting purposes.
 
Accounting for Derivative Instruments
 
The Company recognizes derivatives in other current and non-current assets or liabilities in the accompanying consolidated statements of financial position at their fair values. Refer to Note 8 - Fair Value Measurements for a detailed discussion of the fair value of its derivatives. The Company designates its interest rate swaps as cash flow hedges of forecasted interest rate payments related to its variable-rate debt.
 
The Company formally documents all relationships between hedging instruments and underlying hedged transactions, as well as its risk management objective and strategy for undertaking hedge transactions. This process includes linking all derivatives that are designated as cash flow hedges to forecasted transactions. A formal assessment of hedge effectiveness is performed both at inception of the hedge and on an ongoing basis to determine whether the hedge is highly effective in offsetting changes in cash flows of the underlying hedged item. Hedge effectiveness is assessed using a regression analysis. If it

19
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


is determined that a derivative ceases to be highly effective during the term of the hedge, the Company will discontinue hedge accounting for such derivative.
 
The Company’s interest rate swaps qualify for hedge accounting under ASC 815, Derivatives and Hedging. Therefore, the effective portion of changes in fair value were recorded in AOCI and will be reclassified into earnings in the same period during which the hedged transactions affected earnings.

Cash Flow Hedges of Interest Rate Risk
 
The Company's objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish these objectives, the Company uses interest rate swaps as part of its interest rate risk management strategy. As of March 31, 2015, the Company had a total of 18 outstanding interest rate swaps that were designated as cash flow hedges of interest rate risk. Of the 18 outstanding interest rate swaps, 12 of them cover an exposure period from June 2014 through June 2017 and have a combined notional balance of $1.3 billion (amortizing to $1.1 billion). The remaining 6 interest rate swaps cover an exposure period from January 2016 through January 2019 and have a combined notional balance of $500 million. Fifth Third is the counterparty to 7 of the 18 outstanding interest rate swaps with notional balances ranging from $318.8 million to $250.0 million.
 
The Company does not offset derivative positions in the accompanying consolidated financial statements. The table below presents the fair value of the Company’s derivative financial instruments designated as cash flow hedges included within the accompanying consolidated statements of financial position (in thousands):
 
Consolidated Statement of
Financial Position Location
 
March 31, 2015
 
December 31, 2014
Interest rate swaps
Other long-term assets
 
$

 
$
104

Interest rate swaps
Other current liabilities
 
6,714

 
5,205

Interest rate swaps
Other long-term liabilities
 
11,063

 
2,283

 
Any ineffectiveness associated with such derivative instruments will be recorded immediately as interest expense in the accompanying consolidated statements of income. As of March 31, 2015, the Company estimates that $7.0 million will be reclassified from accumulated other comprehensive income as an increase to interest expense during the next 12 months.

The table below presents the effect of the Company’s interest rate swaps on the accompanying consolidated statements of income for the three months ended March 31, 2015 and 2014 (in thousands): 
 
Three Months Ended
March 31,
 
2015
 
2014
Derivatives in cash flow hedging relationships:
 

 
 

Amount of loss recognized in OCI (effective portion) (1)
$
(11,435
)
 
$
(2,599
)
Amount of loss reclassified from accumulated OCI into earnings (effective portion)
(1,041
)
 
(335
)
Amount of loss recognized in earnings (2)
(1
)
 
(158
)
 
(1)
"OCI" represents other comprehensive income.
(2)
Amount represents hedge ineffectiveness and is recorded as a component of interest expense-net in the accompanying consolidated statement of income.

Credit Risk Related Contingent Features

The Company has agreements with each of its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, then the Company could also be declared in default on its derivative obligations.

As of March 31, 2015, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $19.3 million. As of March 31, 2015, the Company has not posted any collateral related to these agreements. If the Company had breached any of these provisions at March 31, 2015, it could have been required to settle its obligations under the agreements at their termination value of $19.3 million.

20
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)



6. CONTROLLING AND NON-CONTROLLING INTERESTS
 
The Company has various non-controlling interests that are accounted for in accordance with ASC 810, Consolidation ("ASC 810"). As discussed in Note 1 - Basis of Presentation and Summary of Significant Accounting Policies, Vantiv, Inc. owns a controlling interest in Vantiv Holding, and therefore consolidates the financial results of Vantiv Holding and its subsidiaries and records non-controlling interest for the economic interests in Vantiv Holding held by Fifth Third. In addition, the Company and People's United Bank (“PUB”) formed People’s United Merchant Services (“PUMS”) during May 2014, which represents a joint venture that provides customers a comprehensive suite of payment solutions. Vantiv Holding owns 51% of PUMS and PUB owns 49%. PUMS will be consolidated by the Company in accordance with ASC 810 and records non-controlling interest for the economic interests in PUMS held by PUB.

As of March 31, 2015, Vantiv, Inc.’s interest in Vantiv Holding was 77.23%. Changes in units and related ownership interest in Vantiv Holding are summarized as follows:
 
Vantiv, Inc.
 
Fifth Third
 
Total
As of December 31, 2014
145,455,008

 
43,042,826

 
188,497,834

% of ownership
77.17
%
 
22.83
%
 
 

Equity plan activity (a)
499,693

 

 
499,693

As of March 31, 2015
145,954,701

 
43,042,826

 
188,997,527

% of ownership
77.23
%
 
22.77
%
 
 

 
(a)
Includes stock issued under the equity plans less Class A common stock withheld to satisfy employee tax withholding obligations upon vesting or exercise of employee equity awards and forfeitures of restricted Class A common stock awards.

As a result of the changes in ownership interests in Vantiv Holding, an adjustment of $2.7 million was recognized during the three months ended March 31, 2015 in order to reflect the portion of net assets of Vantiv Holding attributable to non-controlling unit holders based on changes in the proportionate ownership interests in Vantiv Holding since December 31, 2014.
 
The table below provides a reconciliation of net income attributable to non-controlling interests based on relative ownership interests as discussed above (in thousands):
 
Three Months Ended March 31,
 
2015
 
2014
Net income
$
26,996

 
$
41,091

Items not allocable to non-controlling interests:
 

 
 

Vantiv, Inc. expenses (a)
7,810

 
9,192

Vantiv Holding net income
$
34,806

 
$
50,283

Net income attributable to non-controlling interests of Fifth Third (b)
$
7,903

 
$
12,955

Net income attributable to PUMS non-controlling interest (c)
104

 

Total net income attributable to non-controlling interests
$
8,007

 
$
12,955

 
 
 (a)                    Primarily represents income tax expense related to Vantiv, Inc.
(b)                     Net income attributable to non-controlling interests of Fifth Third reflects the allocation of Vantiv Holding’s net income based on the proportionate ownership interests in Vantiv Holding held by the non-controlling unit holders. The net income attributable to non-controlling unit holders reflects the changes in ownership interests summarized in the table above.
(c)
Reflects net income attributable to the non-controlling interest of PUMS.

In connection with the separation from Fifth Third, Fifth Third received a warrant that allows for the purchase of up to 20.4 million Class C Non-Voting Units of Vantiv Holding. The warrant is exercisable, in whole or in part, and from time to time, but not during a restricted period. A restricted period means a period during which Vantiv Holding (or any successor thereto) is treated as a partnership for U.S. federal income tax purposes; provided that the restricted period shall terminate upon the earlier of (i) a change of control, and (ii) in the event Vantiv, Inc. is no longer a public company owning Vantiv Holding, both as defined in

21
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


the warrant agreement. The warrant expires upon the earliest to occur of the 20th anniversary of the issue date or a change of control where the price paid per unit in such change of control minus the exercise price of the warrant is less than zero. Fifth Third is entitled to purchase the underlying Units of the warrant at a price of $15.98 per unit. The warrant was valued at approximately $65.4 million at June 30, 2009, the issuance date, using a Black-Scholes option valuation model using probability weighted scenarios. The warrant is recorded as a component of the non-controlling interest on the accompanying statements of financial position as of March 31, 2015 and December 31, 2014.

7. COMMITMENTS, CONTINGENCIES AND GUARANTEES

Legal Reserve
 
From time to time, the Company is involved in various litigation matters arising in the ordinary course of its business. While it is impossible to ascertain the ultimate resolution or range of financial liability with respect to these contingent matters, management believes none of these matters, either individually or in the aggregate, would have a material effect upon the Company’s consolidated financial statements.

8. FAIR VALUE MEASUREMENTS
 
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company uses the hierarchy prescribed in ASC 820, Fair Value Measurement, based upon the available inputs to the valuation and the degree to which they are observable or not observable in the market. The three levels in the hierarchy are as follows:
 
Level 1 Inputs—Quoted prices (unadjusted) for identical assets or liabilities in active markets that are accessible as of the measurement date.
 
Level 2 Inputs—Inputs other than quoted prices within Level 1 that are observable either directly or indirectly, including but not limited to quoted prices in markets that are not active, quoted prices in active markets for similar assets or liabilities and observable inputs other than quoted prices such as interest rates or yield curves.
 
Level 3 Inputs—Unobservable inputs reflecting the Company’s own assumptions about the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk.
 
The following table summarizes assets and liabilities measured at fair value on a recurring basis as of March 31, 2015 and December 31, 2014 (in thousands):
 
March 31, 2015
 
December 31, 2014
 
Fair Value Measurements Using
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
$

 
$

 
$

 
$

 
$
104

 
$

Liabilities:
 

 
 

 
 

 
 

 
 

 
 

Interest rate swaps
$

 
$
17,777

 
$

 
$

 
$
7,488

 
$

  Mercury TRA

 

 
159,429

 

 

 
152,420


The following table summarizes carrying amounts and estimated fair values for financial assets and liabilities, excluding assets and liabilities measured at fair value on a recurring basis, as of March 31, 2015 and December 31, 2014 (in thousands):
 
March 31, 2015
 
December 31, 2014
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
Liabilities:
 

 
 

 
 

 
 

Note payable
$
3,165,793

 
$
3,149,238

 
$
3,393,738

 
$
3,310,181

 
We consider that the carrying value of cash and cash equivalents, receivables, accounts payable and accrued expenses approximates fair value (Level 1) given the short-term nature of these items. The fair value of the Company’s note payable was

22
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


estimated based on rates currently available to the Company for bank loans with similar terms and maturities and is classified in Level 2 of the fair value hierarchy.
 
Interest Rate Swaps
 
The Company uses interest rate swaps to manage interest rate risk. The fair value of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on the expectation of future interest rates (forward curves) derived from observed market interest rate curves. In addition, to comply with the provisions of ASC 820, Fair Value Measurements, credit valuation adjustments, which consider the impact of any credit enhancements to the contracts, are incorporated in the fair values to account for potential nonperformance risk. In adjusting the fair value of its interest rate swaps for the effect of nonperformance risk, the Company has considered any applicable credit enhancements such as collateral postings, thresholds, mutual puts, and guarantees.
 
Although the Company determined that the majority of the inputs used to value its interest rate swaps fell within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its interest rate swaps utilized Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of March 31, 2015 and December 31, 2014, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its interest rate swaps and determined that the credit valuation adjustment was not significant to the overall valuation of its interest rate swaps. As a result, the Company classified its interest rate swap valuations in Level 2 of the fair value hierarchy. See Note 5 - Derivatives and Hedging Activities for further discussion of the Company’s interest rate swaps.

Mercury TRA

The Mercury TRA is considered contingent consideration as it is part of the consideration payable to the former owners of Mercury. Such contingent consideration is measured at fair value and is based on significant inputs not observable in the market, which is classified in Level 3 of the fair value hierarchy. The Mercury TRA is recorded at fair value based on estimates of discounted future cash flows associated with the estimated payments to the Mercury TRA Holders. The significant unobservable inputs used in the fair value measurement of the Mercury TRA are the discount rate, projections of Mercury taxable income and effective tax rates for Mercury. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. The liability recorded is re-measured at fair value at each reporting period with the change in fair value recognized in earnings as a non-operating expense. The Company recorded non-operating expenses of $7.0 million related to the change in fair value during the three months ended March 31, 2015. See Note 1 - Basis of Presentation and Summary of Significant Accounting Policies for further discussion of the Mercury TRA.

9.  NET INCOME PER SHARE
 
Basic net income per share is calculated by dividing net income attributable to Vantiv, Inc. by the weighted-average shares of Class A common stock outstanding during the period.

Diluted net income per share is calculated assuming that Vantiv Holding is a wholly-owned subsidiary of Vantiv, Inc., therefore eliminating the impact of Fifth Third's non-controlling interest. Pursuant to the Exchange Agreement, the Class B units of Vantiv Holding ("Class B units"), which are held by Fifth Third and represent the non-controlling interest in Vantiv Holding, are convertible into shares of Class A common stock on a one-for-one basis. Based on this conversion feature, diluted net income per share is calculated assuming the conversion of the Class B units on an "if-converted" basis. Due to the Company's structure as a C corporation and Vantiv Holding's structure as a pass-through entity for tax purposes, the numerator in the calculation of diluted net income per share is adjusted accordingly to reflect the Company's income tax expense assuming the conversion of the Fifth Third non-controlling interest into Class A common stock. The adjusted effective tax rate used in the calculation was 36.0% for the three months ended March 31, 2015 and 36.5% for the three months ended March 31, 2014. As of March 31, 2015 and 2014, there were approximately 43.0 million and 48.8 million Class B units outstanding, respectively.
 
In addition to the Class B units discussed above, potentially dilutive securities during the three months ended March 31, 2015 and 2014 included restricted stock awards, the warrant held by Fifth Third which allows for the purchase of Class C units of Vantiv Holding, stock options and performance share awards.
 
The shares of Class B common stock do not share in the earnings or losses of the Company and are therefore not participating securities. Accordingly, basic and diluted net income per share of Class B common stock has not been presented.

23
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)



The following table sets forth the computation of basic and diluted net income per share (in thousands, except share data): 
 
Three Months Ended
March 31,
 
2015
 
2014
Basic:
 
 
 

Net income attributable to Vantiv, Inc.
$
18,989

 
$
28,136

Shares used in computing basic net income per share:
 
 
 
Weighted-average Class A common shares
144,530,704

 
138,228,839

Basic net income per share
$
0.13

 
$
0.20

Diluted:
 
 
 
Consolidated income before applicable income taxes
$
39,249

 
$
56,713

Income tax expense excluding impact of non-controlling interest
14,130

 
20,700

Net income attributable to Vantiv, Inc.
$
25,119

 
$
36,013

Shares used in computing diluted net income per share:


 
 
Weighted-average Class A common shares
144,530,704

 
138,228,839

Weighted-average Class B units of Vantiv Holding
43,042,826

 
48,822,826

Warrant
11,377,450

 
10,007,028

Restricted stock awards
1,206,484

 
1,826,035

Stock options
557,674

 
65,249

Diluted weighted-average shares outstanding
200,715,138

 
198,949,977

Diluted net income per share
$
0.13

 
$
0.18


10. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
 
The activity of the components of accumulated other comprehensive income (loss) related to cash flow hedging and other activities for the three months ended March 31, 2015 and 2014 is presented below (in thousands):
 
 
 
 
Total Other Comprehensive Income (Loss)
 
 
 
 
 AOCI Beginning Balance
 
Pretax Activity
 
Tax Effect
 
 Net Activity
 
Attributable to non-controlling interests
 
Attributable to Vantiv, Inc.
 
AOCI Ending Balance
Three months ended March 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Net change in fair value recorded in accumulated OCI
 
$
(5,288
)
 
$
(11,435
)
 
$
3,329

 
$
(8,106
)
 
$
2,612

 
$
(5,494
)
 
$
(10,782
)
 Net realized loss reclassified into earnings (a)
 
1,732

 
1,041

 
(305
)
 
736

 
(237
)
 
499

 
2,231

 Other
 
(212
)
 

 

 

 

 

 
(212
)
 Net change
 
$
(3,768
)
 
$
(10,394
)
 
$
3,024

 
$
(7,370
)
 
$
2,375

 
$
(4,995
)
 
$
(8,763
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Net change in fair value recorded in accumulated OCI
 
$
(5
)
 
$
(2,599
)
 
$
704

 
$
(1,895
)
 
$
663

 
$
(1,232
)
 
$
(1,237
)
 Net realized loss reclassified into earnings (a)
 
269

 
335

 
(93
)
 
242

 
(87
)
 
155

 
424

 Net change
 
$
264

 
$
(2,264
)
 
$
611

 
$
(1,653
)
 
$
576

 
$
(1,077
)
 
$
(813
)
 


24
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


(a)    The reclassification adjustment on cash flow hedge derivatives affected the following lines in the accompanying consolidated statements of income:    
 OCI Component
 
   Affected line in the accompanying consolidated statements of income
Pretax activity(1)
 
Interest expense-net
Tax effect
 
Income tax expense
OCI Attributable to non-controlling interests
 
Net income attributable to non-controlling interests
 
 
 
 
 
 
 
 
 
 
 
 
(1) The three months ended March 31, 2015 and 2014 reflect amounts of losses reclassified from AOCI into earnings, representing the effective portion of the hedging relationships, and is recorded in interest expense-net.

11. SEGMENT INFORMATION
     
Segment operating results are presented below (in thousands). The results reflect revenues and expenses directly related to each segment. The Company does not evaluate performance or allocate resources based on segment asset data, and therefore such information is not presented.
 
Segment profit reflects total revenue less network fees and other costs and sales and marketing costs of the segment. The Company’s CODM evaluates this metric in analyzing the results of operations for each segment. 
 
Three Months Ended March 31, 2015
 
Merchant
Services
 
Financial
Institution
Services
 
Total
Total revenue
$
586,712

 
$
118,899

 
$
705,611

Network fees and other costs
296,030

 
35,116

 
331,146

Sales and marketing
110,175

 
5,880

 
116,055

Segment profit
$
180,507

 
$
77,903

 
$
258,410

 
 
Three Months Ended March 31, 2014
 
Merchant
Services
 
Financial
Institution
Services
 
Total
Total revenue
$
418,766

 
$
118,812

 
$
537,578

Network fees and other costs
213,440

 
35,606

 
249,046

Sales and marketing
71,751

 
6,693

 
78,444

Segment profit
$
133,575

 
$
76,513

 
$
210,088


 A reconciliation of total segment profit to the Company’s income before applicable income taxes is as follows (in thousands):
 
Three Months Ended March 31,
 
2015
 
2014
Total segment profit
$
258,410

 
$
210,088

Less: Other operating costs
(68,739
)
 
(60,369
)
Less: General and administrative
(47,843
)
 
(32,606
)
Less: Depreciation and amortization
(67,802
)
 
(49,846
)
Less: Interest expense—net
(26,011
)
 
(10,554
)
Less: Non-operating expenses
(8,766
)
 

Income before applicable income taxes
$
39,249

 
$
56,713


* * * * *

25
 
 
 

Vantiv, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
This management's discussion and analysis provides a review of the results of operations, financial condition and liquidity and capital resources of Vantiv, Inc. ("Vantiv", "we", "us", "our", or the "company" refer to Vantiv, Inc. and its consolidated subsidiaries) and outlines the factors that affected recent results, as well as factors that may affect future results. Our actual results in the future may differ materially from those anticipated in these forward looking statements as a result of many factors, including those set forth under "Risk Factors," "Forward Looking Statements" and elsewhere in this report, as well as in our 10-K filed with the SEC on February 12, 2015. The following discussion should be read in conjunction with our unaudited consolidated financial statements and related notes appearing elsewhere in this report. as well as management's discussion and analysis and consolidated financial statements for the year ended December 31, 2014 included in our most recent Annual Report on Form 10-K.

General

We are the second largest merchant acquirer and the largest PIN debit acquirer by transaction volume, according to the Nilson Report, and a leading payment processor in the United States differentiated by our integrated technology platform, breadth of distribution and superior cost structure. Our integrated technology platform enables us to efficiently provide a comprehensive suite of services to both merchants and financial institutions of all sizes as well as to innovate, develop and deploy new services, while providing us with significant economies of scale. Our broad and varied distribution provides us with a growing and diverse client base of merchants and financial institutions.

We offer a broad suite of payment processing services that enable our clients to meet their payment processing needs through a single provider, including in omni-channel environments that span point-of-sale, ecommerce and mobile devices. We enable merchants of all sizes to accept and process credit, debit and prepaid payments and provide them supporting value-added services, such as security solutions and fraud management, information solutions, and interchange management. We also provide mission critical payment services to financial institutions, such as card issuer processing, payment network processing, fraud protection, card production, prepaid program management, ATM driving and network gateway and switching services that utilize our proprietary Jeanie PIN debit payment network.

Our integrated technology platform provides our merchant and financial institution clients with differentiated payment processing solutions and provides us with significant strategic and operational benefits. Our clients access our processing solutions primarily through a single point of service, which is easy to use and enables our clients to acquire additional services as their business needs evolve. Small and mid-sized merchants are able to easily connect to our integrated technology platform using our application process interfaces, or APIs, software development kits, or SDKs, and other tools we make available to technology partners, which we believe enhances our capacity to sell to such merchants. Our integrated technology platform allows us to collect, manage and analyze data across both our Merchant Services and our Financial Institution Services segments that we can then package into information solutions for our clients. It provides insight into market trends and opportunities as they emerge, which enhances our ability to innovate and develop new value-added services, including security solutions and fraud management, and it allows us to easily deploy new solutions that span the payment processing value chain, such as ecommerce and mobile services, which are high growth market opportunities. It is highly scalable, which enables us to efficiently manage, update and maintain our technology, increase capacity and speed, and realize significant operating leverage. We believe our integrated technology platform is a key differentiator from payment processors that operate on multiple technology platforms and provides us with a significant competitive advantage.

We distribute our services through multiple sales channels that enable us to efficiently and effectively target a broad range of merchants and financial institutions. Our sales channels include direct and indirect sales forces as well as referral partner relationships, which provide us with a growing and diverse client base. We have a national sales force that targets financial institutions and large national merchants, a regional and mid-market sales team that sell solutions to merchants and third-party reseller clients and a telesales operation that targets small and mid-sized merchants. Our indirect sales force includes Independent Sales Organizations, or ISOs, that target small and mid-sized merchants. We have referral partner relationships with merchant banks, independent software vendors, or ISVs, value-added resellers, or VARs, payment facilitators, and trade associations that target a broad range of merchants, including difficult to reach small and mid-sized merchants. We also have relationships with third-party reseller partners and arrangements with core processors that target small and mid-sized financial institutions.


26
 
 
 


Executive Overview

Revenue for the three months ended March 31, 2015 increased 31% to $705.6 million from $537.6 million in 2014.     

Income from operations for the three months ended March 31, 2015 increased 10% to $74.0 million from $67.3 million in 2014.

Net income for the three months ended March 31, 2015 decreased 34% to $27.0 million from $41.1 million in 2014. Net income attributable to Vantiv, Inc. for the three months ended March 31, 2015 decreased 33% to $19.0 million from $28.1 million in 2014. See the "Results of Operations" section of this management's discussion and analysis for a discussion of our financial results.

In February 2014, our board of directors authorized a program to repurchase up to $300 million of our Class A common stock. We have approximately $275 million of share repurchase authority remaining as of March 31, 2015 under this authorization.    

On June 13, 2014, Vantiv, LLC completed a debt refinancing by entering into an amended and restated loan agreement, or Amended Loan Agreement. The Amended Loan Agreement provides for senior secured credit facilities comprised of a $2.05 billion term A loan maturing in June 2019, a $1.4 billion term B loan maturing in June 2021 and a $425 million revolving credit facility that matures in June 2019. Proceeds from the refinancing were primarily used to fund the acquisition of Mercury Payment Systems, LLC, or Mercury, as further discussed below, and repay the prior term A loan with an outstanding balance of approximately $1.8 billion. On January 6, 2015, we made an early principal payment of $200 million on the term B loan.
 
Recent Acquisitions

On June 13, 2014, we acquired Mercury for approximately $1.68 billion in cash and $137.9 million in contingent consideration related to a tax receivable agreement, or Mercury TRA, entered into with pre-acquisition owners of Mercury, or Mercury TRA Holders, in connection with the Mercury acquisition. We funded the acquisition by borrowing an additional $1.7 billion through an amendment and refinancing of our senior secured credit facilities as discussed above. Mercury is a payment technology and service leader whose solutions are integrated into point-of-sale software applications and brought to market through dealer and developer partners. This acquisition helps to accelerate our growth in the integrated payments channel. The operations of Mercury are included in our Merchant Services segment operating results.

Our Segments, Revenue and Expenses
 
Segments
 
We report our results of operations in two segments, Merchant Services and Financial Institution Services. We evaluate segment performance based upon segment profit, which is defined as net revenue, which represents total revenue less network fees and other costs, less sales and marketing expense attributable to that segment.

Merchant Services

We provide a comprehensive suite of payment processing services to our merchant services clients. We authorize, clear, settle and provide reporting for electronic payment transactions, as further discussed below. Our merchant client base includes over 600,000 merchant locations across the United States and is heavily-weighted in non-discretionary everyday spend categories where spending has generally been more resilient during economic downturns.

Acquiring and Processing. We provide merchants with a broad range of credit, debit and prepaid payment processing services. We give them the ability to accept and process Visa, MasterCard, American Express, Discover and PIN debit network card transactions originated at the point of sale as well as for ecommerce and mobile transactions. This service includes all aspects of card processing, including authorization and settlement, customer service, chargeback and retrieval processing and network fee and interchange management.

Value-added Services. We offer value-added services that help our clients operate and manage their businesses including omni-channel acceptance, prepaid services and gift card solutions. We also provide security solutions such as point-to-point encryption and tokenization both at the point of sale and for ecommerce transactions.


27
 
 
 


We provide our services to merchants of varying sizes, which provides us with a number of key benefits. Due to the large transaction volume that they generate, large national merchants provide us with significant operating scale efficiencies and recurring revenues. Small and mid-sized merchants are more difficult to reach on an individual basis, but generally generate higher per transaction fees.

We distribute our comprehensive suite of services to a broad range of merchants through multiple sales channels, as further described below.

Direct: Includes a national sales force that targets large national merchants, a regional and mid-market sales team that sells solutions to merchants and third party reseller clients, and a telesales operation that targets small and mid-sized merchants.
Indirect: Includes ISOs that target small and mid-sized merchants.
Merchant Bank: Includes referral partner relationships with financial institutions that target their financial services customers as merchant referrals to us.
Integrated Payments, or IP: Includes referral partner relationships with ISVs, VARs, and payment facilitators that target their technology customers as merchant referrals to us.
eCommerce: Includes a sales force that targets internet retail, online services and direct marketing merchants.

These sales channels utilize multiple strategies and leverage relationships with referral partners that sell our business solutions to small and mid-sized merchants. We believe our sales structure provides us with broad geographic coverage and access to various industries and verticals.

Financial Institution Services

We provide integrated card issuer processing, payment network processing and value-added services to our financial institution services clients, as further discussed below. Our financial institution client base is generally well diversified and includes approximately 1,400 financial institutions, including regional banks, community banks, credit unions and regional PIN debit networks. We generally focus on small to mid-sized financial institutions with less than $15 billion in assets. Smaller financial institutions generally do not have the scale or infrastructure typical of large financial institutions and are more likely to outsource payment processing needs. We provide a turnkey solution to such institutions to enable them to offer payment processing solutions.

Integrated Card Issuer and Processing. We process and service credit, debit, ATM and prepaid transactions. We process and provide statement production, collections and inbound/outbound call centers. Our card processing solution includes processing and other services such as card portfolio analytics, program strategy and support, fraud and security management and chargeback and dispute services. We also offer processing for specialized accounts, such as business cards, home equity lines of credit and health savings accounts. We provide authorization support in the form of online or batch settlement, as well as real-time transaction research capability and archiving and daily and monthly cardholder reports for statistical analysis. Our call center handles inbound and outbound calls and billing issues for customers of our financial institution clients.

Value-added Services. We provide additional services to our financial institution clients that complement our issuing and processing services. These services include fraud protection, card production, prepaid cards, ATM driving, portfolio optimization, data analytics and card program marketing. We also provide network gateway and switching services that utilize our Jeanie PIN network. Our Jeanie network offers real-time electronic payment, network bill payment, single point settlement, shared deposit taking and customer select PINs.

We distribute our financial institution services by utilizing direct sales forces as well as a diverse group of referral partner relationships. These sales channels utilize multiple strategies and leverage relationships with core processors that sell our solutions to small and mid-sized financial institutions.

Revenue
 
We generate revenue primarily by processing electronic payment transactions. Set forth below is a description of our revenues by segment and factors impacting segment revenues.

 Our Merchant Services segment revenues are primarily derived from processing credit and debit card transactions. Merchant Services revenue is primarily comprised of fees charged to businesses, net of interchange fees, for payment processing services, including authorization, capture, clearing, settlement and information reporting of electronic transactions. The fees charged consist of either a percentage of the dollar volume of the transaction or a fixed fee, or both, and are

28
 
 
 


recognized at the time of the transaction. Merchant Services revenue also includes a number of revenue items that are incurred by us and are reimbursable as the costs are passed through to and paid by our clients. These items primarily consist of Visa, MasterCard and other payment network fees. In addition, for sales through referral partners in which we are the primary party to the contract with the merchant, we record the full amount of the fees collected from the merchant as revenue. Associated residual payments made to referral partners are included in sales and marketing expenses. Merchant Services revenue also includes revenue from ancillary services such as fraud management, equipment sales and terminal rent. Revenue in our Merchant Services segment is impacted primarily by transaction volume, average transaction size, the mix of merchant types in our client portfolio, the performance of our merchant clients and the effectiveness of our distribution channels.
    
Our Financial Institution Services revenues are primarily derived from debit, credit and ATM card transaction processing, ATM driving and support, and PIN debit processing services. Financial Institution Services revenue associated with processing transactions includes per transaction and account related fees, card production fees and fees generated from our Jeanie network. Financial Institution Services revenue is impacted by the number of financial institutions using our services as well as their transaction volume. The number of financial institutions in the United States has declined as a result of prevailing economic conditions and consolidation, as well as other market and regulatory pressures. These factors have contributed to industry-wide pricing compression of the fees that financial institutions are willing to pay for payment processing. Since 2011, pricing compression in the Financial Institution Services segment has represented on average 3% or less of segment net revenue on an annual basis.
 
Network Fees and Other Costs
 
Network fees and other costs primarily consist of certain expenses incurred by us in connection with providing processing services to our clients which we pass through to our clients, including Visa and MasterCard network association fees, payment network fees, third party processing expenses, telecommunication charges, postage and card production costs.
 
Net Revenue
 
Net revenue is revenue, less network fees and other costs and reflects revenue generated from the services we provide to our clients. Management uses net revenue to assess our operating performance. We believe that net revenue, when reviewed together with revenue, is meaningful to our investors in order to understand our performance.
 
Expenses
 
Set forth below is a brief description of the components of our expenses, aside from the network fees and other costs discussed above:
 
Sales and marketing expense primarily consists of salaries and benefits paid to sales personnel, sales management and other sales and marketing personnel, residual payments made to ISOs and referral partners, and advertising and promotional costs.

Other operating costs primarily consist of salaries and benefits paid to operational and IT personnel, costs associated with operating our technology platform and data centers, information technology costs for processing transactions, product development costs, software consulting fees and maintenance costs.
 
General and administrative expenses primarily consist of salaries and benefits paid to executive management and administrative employees, including finance, human resources, product development, legal and risk management, share-based compensation costs, equipment and occupancy costs and consulting costs.

Depreciation and amortization expense consists of our depreciation expense related to investments in property, equipment and software as well as our amortization of intangible assets, principally customer relationships acquired in connection with the acquisition of a majority interest in Vantiv Holding in June 2009 and our subsequent acquisitions.

Interest expense—net consists primarily of interest on borrowings under our senior secured credit facilities less interest income earned on our cash and cash equivalents.

Income tax expense represents federal, state and local taxes based on income in multiple jurisdictions.


29
 
 
 


Non-operating expenses during the three months ended March 31, 2015 primarily relate to the change in fair value of the Mercury TRA and the write-off of deferred financing fees and original issue discount, or OID, associated with a $200 million early principal payment on the term B loan in January 2015.

Non-Controlling Interest
 
As a result of the non-controlling ownership interests in Vantiv Holding held by Fifth Third, our results of operations include net income attributable to non-controlling interests. Future sales or redemptions of ownership interests in Vantiv Holding by Fifth Third will continue to reduce the amount recorded as non-controlling interest and increase net earnings attributable to our Class A stockholders. In addition, net income attributable to non-controlling interests includes the non-controlling interest in the People's United Merchant Services, or PUMS, joint venture held by People's United Bank, or PUB. Net income attributable to non-controlling interests for the three months ended March 31, 2015 and 2014 was $8.0 million and $13.0 million, respectively.

Factors and Trends Impacting Our Business and Results of Operations
 
We expect a number of factors will impact our business, results of operations and financial condition. In general, our revenue is impacted by the number and dollar volume of card based transactions which in turn are impacted by general economic conditions, consumer spending and the emergence of new technologies and payment types, such as ecommerce, mobile payments, and prepaid cards. In our Merchant Services segment, our net revenues are impacted by the mix of the size of merchants that we provide services to as well as the mix of transaction volume by merchant category. In our Financial Institution Services segment, our net revenues are also impacted by the mix of the size of financial institutions to which we provide services as well as consolidation and market and industry pressures, which have contributed and are expected to continue to contribute to pricing compression of payment processing fees in this segment. See "Results of Operations" below for a discussion of factors impacting our results in the three months ended March 31, 2015.

Pro Forma Adjusted Net Income
 
We use pro forma adjusted net income for financial and operational decision making as a means to evaluate period-to-period comparisons of our performance and results of operations. Pro forma adjusted net income is also incorporated into performance metrics underlying certain share-based payments issued under the 2012 Vantiv, Inc. Equity Incentive Plan and our annual incentive plan. We believe pro forma adjusted net income provides useful information about our performance and operating results, enhances the overall understanding of past financial performance and future prospects and allows for greater transparency with respect to key metrics used by management in its financial and operational decision making.

In calculating pro forma adjusted net income, we make certain non-GAAP adjustments, as well as pro forma adjustments, to adjust our GAAP operating results for the items discussed below. This non-GAAP measure should be considered together with GAAP operating results.
 
Non-GAAP Adjustments

Transition, Acquisition and Integration Costs
 
In connection with our acquisitions, we incurred costs associated with the acquisitions and related integration activities, consisting primarily of consulting fees for advisory, conversion and integration services and related personnel costs. Also included are certain costs associated with our separation from Fifth Third in June 2009. In addition, these expenses include costs related to employee termination benefits and other transition activities. These transition, acquisition and integration costs are included in other operating costs and general and administrative expenses.

Share-Based Compensation
 
We have granted share-based awards to certain employees and members of our board of directors and intend to continue to grant additional share-based awards in the future. Share-based compensation is included in general and administrative expense.
 

30
 
 
 


Intangible Amortization Expense

These expenses represent amortization of intangible assets acquired through business combinations and customer portfolio and related asset acquisitions.

Non-operating Expenses
 
Non-operating expenses were $8.8 million for the three months ended March 31, 2015, which consisted of the change in fair value of the Mercury TRA and the write-off of deferred financing fees and OID associated with a $200 million early principal payment on the term B loan in January 2015.

Pro Forma Adjustments

Income Tax Expense Adjustments
 
Our effective tax rate reported in our results of operations reflects the impact of our non-controlling interest not being taxed at the statutory corporate tax rate. For purposes of calculating pro forma adjusted net income, income tax expense is adjusted to reflect an effective tax rate assuming conversion of Fifth Third's non-controlling interests into shares of Class A common stock, including the income tax effect of the non-GAAP adjustments described above. The adjusted effective tax rate was 36.0% for the three months ended March 31, 2015 and 36.5% for the three months ended March 31, 2014.
 
Tax Adjustments

In addition to the adjustment described above, income tax expense is also adjusted for the cash tax benefits resulting from certain tax attributes, primarily the amortization of tax intangible assets resulting from or acquired with our acquisitions, the tax basis step up associated with our separation from Fifth Third and the purchase or exchange of Class B units of Vantiv Holding, net of payment obligations under TRAs established at the time of our IPO and in connection with our acquisition of Mercury. The estimate of the cash tax benefits is based on the consistent and highly predictable realization of the underlying tax attributes.
 
The table below provides a reconciliation of pro forma adjusted net income to GAAP income before applicable income taxes for the three months ended March 31, 2015 and 2014:
 
Three Months Ended March 31,
 
2015
 
2014
 
(in thousands)
Income before applicable taxes
$
39,249

 
$
56,713

Non-GAAP Adjustments:
 
 
 
Transition, acquisition and integration costs
14,674

 
7,601

Share-based compensation
11,623

 
8,939

Intangible amortization
47,225

 
32,248

Non-operating expenses
8,766

 

Non-GAAP Adjusted Income Before Applicable Taxes
121,537

 
105,501

Pro Forma Adjustments:
 
 
 
Income tax expense adjustment
(43,753
)
 
(38,508
)
Tax adjustments
11,692

 
10,629

   Less: JV non-controlling interest
(68
)
 

Pro Forma Adjusted Net Income
$
89,408

 
$
77,622




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Results of Operations
 
The following tables set forth our statements of income in dollars and as a percentage of net revenue for the periods presented.
 
Three Months Ended
March 31,
 
 
 
 
 
2015
 
2014
 
$ Change
 
% Change
 
(dollars in thousands)
Revenue
$
705,611

 
$
537,578

 
$
168,033

 
31
%
Network fees and other costs
331,146

 
249,046

 
82,100

 
33
%
Net revenue
374,465

 
288,532

 
85,933

 
30
%
Sales and marketing
116,055

 
78,444

 
37,611

 
48
%
Other operating costs
68,739

 
60,369

 
8,370

 
14
%
General and administrative
47,843

 
32,606

 
15,237

 
47
%
Depreciation and amortization
67,802

 
49,846

 
17,956

 
36
%
Income from operations
$
74,026

 
$
67,267

 
$
6,759

 
10
%
Non-financial data:
 

 
 

 
 

 
 

Transactions (in millions)
5,363

 
4,217

 
 

 
27
%
     
As a Percentage of Net Revenue
Three Months Ended
March 31,
 
2015
 
2014
Net revenue
100.0
%
 
100.0
%
Sales and marketing
31.0
%
 
27.2
%
Other operating costs
18.3
%
 
20.9
%
General and administrative
12.8
%
 
11.3
%
Depreciation and amortization
18.1
%
 
17.3
%
Income from operations
19.8
%
 
23.3
%

Three Months Ended March 31, 2015 Compared to Three Months Ended March 31, 2014

Revenue

Revenue increased 31% to $705.6 million for the three months ended March 31, 2015 from $537.6 million for the three months ended March 31, 2014. The increase was due primarily to transaction growth of 27%, including the impact of the Mercury acquisition, which expanded our integrated payments channel and contributed to higher revenue per transaction.

Network Fees and Other Costs

Network fees and other costs increased 33% to $331.1 million for the three months ended March 31, 2015 from $249.0 million for the three months ended March 31, 2014. The increase was due primarily to transaction growth of 27%, including the impact of the Mercury acquisition, and to a lesser extent an increase in third party processing costs.

Net Revenue

Net revenue, which is revenue less network fees and other costs, increased 30% to $374.5 million for the three months ended March 31, 2015 from $288.5 million for the three months ended March 31, 2014 due to the factors discussed above.

 Sales and Marketing

Sales and marketing expense increased 48% to $116.1 million for the three months ended March 31, 2015 from $78.4 million for the three months ended March 31, 2014. The increase was primarily attributable to the Mercury acquisition, higher sales and marketing personnel and related costs and higher residual payments to referral partners as a result of increased revenue.

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Other Operating Costs
 
Other operating costs increased 14% to $68.7 million for the three months ended March 31, 2015 from $60.4 million for the three months ended March 31, 2014. The increase was primarily attributable to the Mercury acquisition and an increase in information technology infrastructure in support of growth initiatives.
 
General and Administrative

General and administrative expenses increased 47% to $47.8 million for the three months ended March 31, 2015 from $32.6 million for the three months ended March 31, 2014. The increase was primarily attributable to the Mercury acquisition, continued investment in our infrastructure in support of growth initiatives, and increases in acquisition and integration costs and share-based compensation of $7.2 million and $2.7 million, respectively.
 
Depreciation and Amortization

Depreciation expense associated with our property, equipment and software increased 12% to $18.6 million for the three months ended March 31, 2015 from $16.5 million for the three months ended March 31, 2014. The increase during the period reflects depreciation expense associated with increased capital expenditures during the last year largely related to our continued investment in information technology infrastructure in support of growth initiatives, as well as assets acquired in connection with the Mercury acquisition.

Amortization expense associated with intangible assets, which consist primarily of customer relationship intangible assets, increased 48% to $49.2 million for the three months ended March 31, 2015 from $33.3 million for the three months ended March 31, 2014. The increase during the period was primarily attributable to intangible assets acquired in connection with the Mercury acquisition.

Income from Operations

Income from operations increased 10% to $74.0 million for the three months ended March 31, 2015 from $67.3 million for the three months ended March 31, 2014.