UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2014.

or

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

For the transition period from to .

Commission File Number: 001-34779

HIGHER ONE HOLDINGS, INC.

(Exact Name of Registrant as Specified in its Charter)

115 Munson Street

New Haven, CT 06511

(Address of Principal Executive Offices)(Zip Code)

(203) 776-7776

(Registrant's Telephone Number, Including Area Code)

N/A

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

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

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

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

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

As of November 6, 2014, there were 47,636,813 shares of common stock, par value $0.001 per share, outstanding.

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HIGHER ONE HOLDINGS, INC.

INDEX TO REPORT ON FORM 10-Q

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2014

 

 

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

 

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PART I – FINANCIAL INFORMATION

Item 1.

Financial Statements (unaudited)

Higher One Holdings, Inc.

Condensed Consolidated Balance Sheets

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

(unaudited)

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

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Higher One Holdings, Inc.

Condensed Consolidated Statements of Operations

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

(unaudited)

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

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Higher One Holdings, Inc.

Condensed Consolidated Statement of Changes in Stockholders' Equity

 (In thousands of dollars, except share amounts)

(unaudited)

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

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Higher One Holdings, Inc.

Condensed Consolidated Statements of Cash Flows

 (In thousands of dollars)

(unaudited)

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

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Higher One Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

(unaudited)

Higher One Holdings, Inc., or HOH, is a leading provider of technology, data analytics and payment services to the higher education industry. HOH, through its subsidiaries, provides a comprehensive suite of disbursement, payment and data analytics solutions specifically designed for higher education institutions and their students. We have developed and acquired proprietary software-based solutions to provide these services. HOH is incorporated in Delaware and maintains its headquarters in New Haven, Connecticut. HOH has a wholly-owned subsidiary, Higher One, Inc., or HOI, which has two wholly-owned subsidiaries, Higher One Machines, Inc., or HOMI, and Higher One Real Estate, Inc., or Real Estate Inc.  HOI and HOMI together own 99% of Higher One Financial Technology Private Limited, or HOFTPL.  Real Estate Inc. has a 98% ownership interest in Higher One Real Estate SP, LLC, or Real Estate LLC.  HOMI and HOFTPL perform certain of our operational support functions. Real Estate Inc. and Real Estate LLC were each formed to hold and operate certain of our real estate.

As further explained in "Note 5 – Credit Facility" and the Regulatory Examinations and Other Matters section within "Note 6 – Commitments and Contingencies," we recorded a reduction of our revenue of $8.75 million during the nine months ended September 30, 2014 as a result of an ongoing regulatory examination.  Please refer to "Note 5 – Credit Facility" and the Regulatory Examinations and Other Matters section within "Note 6 – Commitments and Contingencies" for additional information regarding this examination, the possibility of additional losses related to this matter and related impact on our liquidity and credit facility.

  

Basis of Presentation and Consolidation

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

The unaudited condensed consolidated financial statements have been prepared on a consistent basis with the audited consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2013, and in the opinion of management, include all normal recurring adjustments that are necessary for the fair statement of our interim period results reported herein.  The December 31, 2013 condensed consolidated balance sheet data included in this Form 10-Q was derived from our audited financial statements but does not include all disclosures required by GAAP. As described in "Note 7 - Business Combinations," we have revised the comparative balance sheet as of December 31, 2013 to include the effect of a measurement period adjustment.  Due to seasonal fluctuations and other factors, the results of operations for the three months ended September 30, 2014 are not necessarily indicative of the results to be expected for the full year.

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

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

Basic and Diluted Net Income (Loss) Available to Common Stockholders per Common Share

Basic net income (loss) per common share excludes dilution for potential common stock issuances and is computed by dividing net income (loss) available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted net income (loss) per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. For the calculation of diluted net income (loss) per common share, the basic weighted-average number of shares is increased by the dilutive effect of restricted stock, warrants and stock options using the treasury-stock method. The treasury-stock method assumes that the options or warrants are exercised at the beginning of the period (or date of issue if later), and that we use those proceeds to purchase common stock for treasury at the average price for the reporting period.

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The effect of stock options and warrants to purchase our common stock totaling 6,223,862 and 6,734,803 were not included in the computation of diluted net income (loss) per common share for the three months ended September 30, 2014 and 2013, respectively, as their effect would be anti-dilutive. The effect of stock options and warrants to purchase our common stock totaling 4,214,539 and 4,293,387 were not included in the computation of diluted net income per common share for the nine months ended September 30, 2014 and 2013, respectively, as their effect would be anti-dilutive. Anti-dilutive securities are securities that upon conversion or exercise increase earnings per share (or reduce the loss per share).  In periods when we recognize a net loss, including the three months ended September 30, 2013, we exclude the impact of outstanding stock awards from the diluted loss per share calculation as their inclusion would have an anti-dilutive effect.

Comprehensive Income

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

Other Arrangements

We accept payments on behalf of educational institutions and subsequently remit these payments to the education institutions. The amounts received are maintained in segregated accounts for the benefit of either the institution or the payer. There were approximately $294.5 million and $199.1 million of such funds as of September 30, 2014 and December 31, 2013, respectively. These deposits are not our funds and therefore are not included in the accompanying condensed consolidated balance sheets.

Recent Accounting Pronouncements

There were no accounting standards adopted during 2013 or during the nine months ended September 30, 2014 which had a material impact on our consolidated financial position, results of operations or liquidity.  

In May 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2014-09, Revenue From Contracts With Customers, that outlines a single model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance. The ASU is based on the principle that an entity should recognize revenue 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 ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. Entities have the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard. The ASU becomes effective for us at the beginning of our 2017 fiscal year; early adoption is not permitted. We are currently assessing the impact that this standard will have on our consolidated financial statements.

In June 2014, the FASB issued Accounting Standards Update No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period, which updated the accounting standards related to stock compensation. The update clarifies the accounting for share-based payments with a performance target that could be achieved after the requisite service period. Specifically, the update specifies the performance target should not be reflected in estimating the grant-date fair value of the award. Instead, the probability of achieving the performance target should impact vesting of the award. The standard is effective for interim and annual periods beginning after December 15, 2015 and early adoption is permitted. We are currently assessing the impact that this standard will have on our consolidated financial statements.

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The following table reflects the assets carried at fair value measured on a recurring basis (in thousands).  There were no liabilities carried at fair value measured on a recurring basis at either September 30, 2014 or December 31, 2013:

We had no unrealized gains or losses from investments as of September 30, 2014 or December 31, 2013 and there is no difference between the amortized cost and fair value of the securities we held. The carrying amounts of our cash equivalents, accounts receivable, accounts payable and accrued expenses approximates fair value because of the short-term nature of these instruments. The carrying amount of our debt outstanding under our Credit Facility (defined below) approximates fair value. Our loan receivable related to New Markets Tax Credit financing is a debt instrument that we classify as held to maturity and is recorded at amortized cost.  The carrying value of both our loan receivable and loan payable related to New Markets Tax Credit financing approximates fair value as of September 30, 2014.  Our loan payable and loan receivable related to New Markets Tax Credit financing was estimated using discounted cash flow analysis based on rates for similar types of arrangements and are considered Level 3 measurements.

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At the end of 2011, we completed a real estate development project and moved our headquarters into two commercial buildings located in New Haven, Connecticut.  During the nine months ended September 30, 2014, we received a payment of $3.5 million associated with state historic tax credits which were generated by the project.  This amount was recorded within prepaid expenses and other current assets, along with an offsetting reduction to our fixed assets, in our condensed consolidated balance sheet as of December 31, 2013. 

We provided separate guarantees to each of two departments of the state of Connecticut. One guaranty relates to our obligation to repay a grant if we fail to meet certain criteria, including a specified minimum average employment level in Connecticut for the years 2015 – 2018. The other guaranty relates to our obligation to repay sales and use tax exemptions if we fail to meet certain criteria, including a minimum employment threshold.  The maximum potential amount of repayments for these guarantees is approximately $7.0 million.  During the three months ended September 30, 2014, we recorded a liability, and corresponding increase in our fixed asset balance, totaling $1.3 million, which represents our best estimate of expected repayments resulting from these guarantees.  The liability of $1.3 million is recorded within deferred revenue and other non-current liabilities ($1.1 million), as it would not be due until 2019, and accrued expenses ($0.2 million) in our condensed consolidated balance sheet as of September 30, 2014.

We also provided a guaranty related to tax credits that are expected to be generated by an investment made by an unrelated entity into the real estate development project. In the event that we cause a recapture or disallowance of the tax credits expected to be generated under this program, we will be required to repay the disallowed or recaptured tax credits plus an amount sufficient to pay the taxes on such repayment, to the counterparty of the guaranty agreement. This guaranty will remain in place through 2018. The maximum potential amount of future payments of this guaranty is approximately $6.0 million. We currently believe that the requirement to make a payment under this guaranty is remote and we have thus not recorded any liability on our condensed consolidated balance sheet in connection with this guaranty.

In connection with the real estate project described above, we made an investment in FC Winchester Lofts Master Tenant, LLC, or the Master Tenant, which will maintain and operate a residential development project which is adjacent to our corporate headquarters. During the three months ended September 30, 2014, we sold our interest in the Master Tenant and recorded a loss on the transaction of $0.3 million, which is reflected in other income (loss) on our accompanying statement of operations.  As a result of the sale of our interest, we do not have any future obligations to the Master Tenant and we are no longer entitled to receive the pass-through of federal historic tax credits or any other cash flows generated by the project.  When we contributed capital to the project, the power to direct the economically significant activities of the project was held by the other member of the Master Tenant, as such we were not the primary beneficiary of the Master Tenant.  Accordingly, our investment in the Master Tenant was accounted for as an equity method investment. The equity investment totaled $3.9 million during the year ended December 31, 2013 and is included within other assets on the accompanying balance sheet as of December 31, 2013. 

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On October 16, 2012, HOI entered into a five-year, $200.0 million, senior secured revolving credit facility, or the Credit Facility. As of September 30, 2014, there were $94.0 million in borrowings outstanding, at a weighted average interest rate of 2.4%, under the Credit Facility. The Credit Facility permits the issuance of letters of credit of up to $20.0 million and swing line loans of up to $10.0 million to fund working capital needs.  Loans drawn under the Credit Facility are payable in a single maturity on October 16, 2017. We are in compliance with all of the applicable affirmative, negative and financial covenants of the Credit Facility. One of the financial covenants in the Credit Facility relates to a requirement to have a minimum of $50.0 million of EBITDA (as defined in the Credit Facility) over the prior twelve months.  In addition, a settlement with regulatory authorities in an amount exceeding $10.0 million could cause a default under other covenants in our Credit Facility. As of September 30, 2014, our trailing twelve month EBITDA (as defined in the Credit Facility) was $53.7 million. 

The allowance for customer restitution reduced our revenue and trailing twelve month EBITDA by $8.75 million during the nine months ended September 30, 2014.  If there is any event of any default under our credit agreement, all amounts then outstanding may be immediately due and payable and may require us to apply all of our available cash to repay these amounts. We may also need to seek alternative forms of financing or other sources of liquidity in order to repay these amounts. There can be no assurances that such alternative forms of financing or other sources of liquidity would be available to us on favorable terms or at all. The acceleration of indebtedness under our credit agreement could have a material adverse effect on our business, financial condition and results of operations. Please refer to the Regulatory Examinations and Other Matters section within "Note 6 – Commitments and Contingencies" for additional information about the regulatory matters and their impact on the covenants associated with our Credit Facility.

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

Regulatory Examinations and Other Matters

As previously disclosed, the Federal Reserve Bank of Chicago notified us and a former bank partner of potential violations of the Federal Trade Commission Act relating to marketing and disclosure practices related to the OneAccount during the period it was offered by such former bank partner. On May 9, 2014, the Federal Reserve Banks of Chicago (the responsible Reserve Bank for a former bank partner) and Philadelphia (the responsible Reserve Bank for a current bank partner) notified us that the Staff of the Board of Governors of the Federal Reserve System intended to recommend that the Board of Governors of the Federal Reserve System, or the Board of Governors, seek an administrative order against us with respect to asserted violations of the Federal Trade Commission Act. The cited violations relate to our activities with both a former and current bank partner and our marketing and disclosure practices related to the process by which students may select the OneAccount option for financial aid refund. We are in discussions with the Staff of the Board of Governors and the Reserve Banks on this matter. The Staff of the Board of Governors has asserted that any administrative order may seek damages, including customer restitution and civil money penalties, totaling as much as $35 million, and changes to certain of our business practices.

Approximately 55% of the OneAccounts are held at our bank partner regulated by the FDIC and we will need to consider voluntarily providing restitution to those OneAccounts held at that bank partner. In the event we do provide restitution to these OneAccounts on the same basis as an order from the Board of Governors, it is reasonably possible that our loss related to this matter will increase accordingly and increase our total exposure by an additional amount of approximately $35 million, or approximately $70 million in total.

During the nine months ended September 30, 2014, we recorded a liability of $8.75 million related to this matter, which is shown as an allowance for customer restitution on our consolidated statement of operations.  While we believe that it is probable that we will have a loss related to this regulatory matter, in view of the inherent difficulty of predicting the outcomes of regulatory matters, we cannot predict the eventual outcome of this pending matter, the timing of the ultimate resolution of this matter or an exact amount of loss associated with this matter.  The liability, which was recorded at June 30, 2014, and continues to be recorded at September 30, 2014, reflects the minimum amount we expect to pay related to this matter, although, there is a reasonable possibility that the liability will increase in future periods. Although the ultimate amount of restitution or civil money penalties is subject to many uncertainties and therefore impossible to predict, it is possible the amounts could reach levels that would cause an event of default under our Credit Facility. As described in "Note 5 – Credit Facility", our EBITDA, as defined in the Credit Facility, as of September 30, 2014 for the trailing twelve months was $53.7 million, which exceeds the required minimum EBITDA required in our credit agreement by $3.7 million.

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In July 2014, we received a civil investigative demand from the Office of the Attorney General of the Commonwealth of Massachusetts pursuant to the Commonwealth's Consumer Protection Act. The Massachusetts Attorney General has informed us that its investigation relates to our debt collection practices. We have provided information requested by the civil investigative demand, which included information and records about us and certain of our business practices, particularly as they relate to Massachusetts residents, institutes of higher education and students. We cannot predict whether we will become subject to any other action by the Massachusetts Attorney General or any other state agencies.

Consumer Class Action

HOI and HOH are defendants in a series of putative class action lawsuits filed in 2012: Ashley Parker, et al. v. Higher One Holdings, Inc. et al., filed on July 3, 2012 in the United States District Court for the Northern District of Mississippi, Eastern Division; Jeanette Price et al. v. Higher One Holdings, Inc. et al., filed on July 27, 2012 in the United States District Court for the District of Connecticut; John Brandon Kent et al. v. Higher One Holdings, Inc. et al., filed on August 17, 2012 in the United States District Court for the Middle District of Alabama, Northern Division; Jonathan Lanham et al. v. Higher One Holdings, Inc. et al., filed on October 2, 2012 in the United States District Court for the Western District of Kentucky, Louisville Division; Aisha DeClue et al. v. Higher One, Inc., et al., filed on November 5, 2012 in the St. Louis County Circuit Court of Missouri; and Jill Massey et al. v. Higher One Holdings, Inc. et al., filed on November 6, 2012 in the United States District Court for the Southern District of Illinois, East Saint Louis Division. The Judicial Panel on Multidistrict Litigation transferred all of these cases to the District of Connecticut for coordinated or consolidated pretrial proceedings. The proceedings are referred to as the "In re Higher One OneAccount Marketing and Sales Practices Litigation" or the "MDL." Plaintiffs have filed a consolidated amended complaint in the MDL that generally alleges, among other things, violations of state consumer protection statutes (predicated, in part, on alleged violations of ED rules and violations of the federal Electronic Funds Transfer Act) and various common law claims. On April 22, 2013, we filed a motion to dismiss the case, which the court denied as moot on March 11, 2014 in light of the parties' settlement, discussed below.

In October 2013, we reached an agreement in principle on the key terms of a settlement that would resolve all of the above class action litigation that was filed against us in 2012. In February 2014, we executed a settlement agreement, the terms of which included a payment of $15.0 million to a settlement fund, an agreement to pay the cost of notice to the class, and an agreement to make and/or maintain certain practice changes. We made the payment of $15.0 million to the settlement fund in February 2014. On February 14, 2014, plaintiffs asked the court to preliminarily approve the settlement. On June 2, 2014, the court issued an order preliminarily approving the settlement, directing that notice of the settlement be sent to the class, setting relevant filing deadlines, and scheduling a final fairness hearing for November 24, 2014. On October 6, 2014, plaintiffs asked the court for final approval of the settlement. The court must approve the settlement before it becomes final and binding. There is no assurance that the court will approve the settlement. During the year ended December 31, 2013, we recorded an accrual for an estimated charge of $16.3 million to reflect our current estimate of the resolution, inclusive of additional legal and other administrative costs, based on the agreement in principle. While this estimate is consistent with our view of the current exposure based on the signed settlement agreement, the actual loss could vary materially from the current estimate if the settlement is not finalized and approved.

Securities Class Action

On May 27, 2014, a putative class action captioned Brian Perez v. Higher One Holdings, Inc., No. 3:14-cv-755-AWT, was filed by HOH shareholder Brian Perez in the United States District Court for the District of Connecticut. HOH and certain employees have been named as defendants. Mr. Perez generally alleges that HOH and the other named defendants made certain misrepresentations in public filings in violation of the federal securities laws and seeks an unspecified amount of damages. Mr. Perez seeks to represent a class of any person who purchased HOH securities between August 7, 2012 and May 12, 2014. On July 28, 2014, Mr. Perez filed a motion to be appointed lead plaintiff. No other motions to appoint lead plaintiff were filed. Mr. Perez's motion remains pending. Each Defendant's deadline to respond to the complaint currently is December 5, 2014. HOH intends to vigorously defend itself against these allegations. HOH is currently unable to predict the outcome of this lawsuit and therefore cannot determine the likelihood of loss nor estimate a range of possible loss.

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TouchNet

In February 2009 and September 2010, Higher One, Inc. filed two separate complaints against TouchNet Information Systems, Inc., or TouchNet, in the United States District Court for the District of Connecticut alleging patent infringement related to TouchNet's offering for sale and sales of its "eRefund" product in violation of two of our patents. In the complaints, we sought judgments that TouchNet has infringed two of our patents, a judgment that TouchNet pay damages and interest on damages to compensate us for infringement, an award of our costs in connection with these actions and an injunction barring TouchNet from further infringing our patents. TouchNet answered the complaint and asserted a number of defenses and counterclaims, including that it does not infringe our patent, that our patent is invalid or unenforceable and certain allegations of unfair competition and state and federal antitrust violations. In addition, TouchNet's counterclaims sought dismissal of our claims with prejudice, declaratory judgment that TouchNet does not infringe our patent and that our patent is invalid or unenforceable, as well as an award of fees and costs related to the action, and an injunction permanently enjoining us from suing TouchNet regarding infringement of our patent. The parties are currently in the discovery stage of the proceeding. We intend to pursue the matter vigorously. There can be no assurances of our success in these proceedings.

In accordance with applicable accounting guidance, we establish a liability for a matter of the type describe above if and when it presents loss contingencies that are both probable and reasonably estimable.

 

 

On May 7, 2013, we entered into an Asset Purchase Agreement with Sallie Mae, Inc., or Sallie Mae, to purchase substantially all of the assets of Sallie Mae's Campus Solutions business, or Campus Solutions, for consideration of approximately $47.3 million in cash, $5.2 million of which was deposited into escrow at closing. All escrowed amounts have been released as further described below in this Note 7.

During the three months ended March 31, 2014, we recorded a measurement period adjustment which resulted in a change in the fair values attributed to the contingently returnable escrow receivable, intangible assets and goodwill. We revised the comparative balance sheet as of December 31, 2013 to include the effect of the measurement period adjustment as if the accounting had been completed on the acquisition date. The fair value of the contingently returnable escrow receivable was reduced by $3.2 million and the fair values of intangible assets and goodwill were increased by $2.3 million and $0.9 million, respectively. The fair value of the contingently returnable escrow receivable decreased as a result of additional client contracts which were assigned to us, compared to our earlier assessments.  The remaining disclosures related to the acquisition of Campus Solutions have been updated to reflect this measurement period adjustment.  There were no changes to goodwill during the nine months ended September 30, 2014, other than the change related to the measurement period adjustment described above.

During the three months ended June 30, 2014, we received $1.6 million from the amounts that were deposited into escrow. The determination of the amount that we would receive did not occur until after the measurement period related to the Campus Solutions acquisition ended and was based on facts and circumstances negotiated during the three months ended June 30, 2014. As a result, we recorded the receipt of $1.6 million as other income in the accompanying condensed consolidated statement of operations. As of June 30, 2014, all amounts had been released from escrow.

Under the acquisition method of accounting, the total fair value of consideration transferred was allocated to Campus Solutions' net tangible and intangible assets based on their estimated fair values as of May 7, 2013. The allocation of fair value of consideration transferred was allocated as follows (in thousands):

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The following methods and inputs were utilized to determine fair value for the respective items:

The acquired intangible assets will be amortized each year based on a straight-line method over the estimated useful life of each asset.  The amount to be amortized is presented in thousands.

Goodwill represents the excess of the fair value of consideration transferred for an acquired business over the fair value of the net tangible and intangible assets acquired. Goodwill exists in the transaction as a result of value beyond that of the tangible and other intangible assets, attributable to synergies that exist in the combined business, including a planned migration to a single technology platform. Goodwill of $19.3 million is deductible for tax purposes.

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

We reported revenues totaling approximately $13.1 million from the Campus Solutions acquisition during the nine months ended September 30, 2014.

The pro forma financial information for the three and nine months ended September 30, 2013 is provided for illustrative purposes only and assumes that the acquisition of the Campus Solutions business occurred on January 1, 2013. This pro forma financial information (in thousands, except per share data) should not be relied upon as being indicative of the historical results that would have been obtained if the acquisitions had actually occurred on that date, nor of the results that may be obtained in the future. The pro forma financial information for the periods presented also includes amortization expense from acquired intangible assets, adjustments to interest expense, interest income and related tax effects.

 

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The information contained in this section should be read in conjunction with our audited consolidated financial statements and related notes as included in our annual report on Form 10-K for the year ended December 31, 2013 and information contained elsewhere in such annual report on Form 10-K and in this quarterly report on Form 10-Q. The discussion contains forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995) involving risks, uncertainties and assumptions that could cause our results to differ materially from expectations. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believes," "anticipates," "plans," "expects," "should" and similar expressions are intended to identify forward-looking statements. Factors that might cause these differences include those described under "Risk Factors" and elsewhere in the annual report on Form 10-K and in this quarterly report on Form 10-Q. The forward-looking statements included in this quarterly report on Form 10-Q are made only as of the date of this report. We do not undertake any obligation to update or supplement any forward-looking statements to reflect subsequent events or circumstances, except as required by law. We cannot assure you that projected results will be achieved or that anticipated events will occur.

Overview

General

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

Our products and services for our higher education institution clients include our Refund Management service, our Payment Processing suite, and our Educational Services suite. Through our bank partners, we offer the OneAccount, which includes an FDIC-insured checking account, a debit MasterCard® ATM card and other retail banking services, to the students of our higher education institution clients that use our Refund Management service.

As of September 30, 2014, more than 800 campuses serving approximately 5.0 million students purchased our Refund Management service.  The number of students as of September 30, 2014 reflects a decrease of 112,000 students as a result of changing from the fall 2012 enrollment figures to the fall 2013 enrollment figures, which were released on a provisional basis through the Integrated Postsecondary Education Data System, or IPEDS, this quarter.  We report the number of students enrolled at institutions that have purchased our Refund Management service using the most up-to-date fall enrollment IPEDS data that is available.  In total, there are more than 1,900 campuses servicing nearly 13 million students contracted to use at least one of our services.  As of September 30, 2014, we also serviced approximately 2.2 million OneAccounts.

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

While revenue fluctuates over the course of our fiscal year, many of our expenses remain relatively constant, resulting in disparities in our net income and adjusted net income from quarter to quarter. Typically, the second quarter accounts for the smallest proportion of our revenues. This is primarily because the majority of financial aid is disbursed outside of this time period and higher education institutions tend to enroll more new students during the first and third fiscal quarters. We expect this trend to continue going forward.

Department of Education

In early 2014, the Department of Education, or ED, formed a negotiated rulemaking committee. Our Chief Operating Officer was selected by ED to serve on the committee as a primary negotiator. The committee convened in February, March, April and May of 2014 to discuss and work toward revising existing regulations to potentially address, among other things, consumer safeguards regarding debit and prepaid cards associated with Title IV Cash Management (including fees associated with such debit and prepaid cards), marketing of financial products (including sending unsolicited cards to students and co-branding of the card and materials) by institutions and their preferred banks or contractors, ATM access and availability, revenue sharing arrangements, and the potential for a government-sponsored debit or prepaid card solution. The negotiated rulemaking committee concluded its efforts in May 2014 and a consensus was not reached on any proposed regulations. Since that time, there have been no proposed regulations related to Title IV Cash Management published in the Federal Register; therefore, we believe, should ED issue a Notice of Proposed Rulemaking on Title IV Cash Management regulations, complete the public comment process and publish a final rule in the Federal Register by November 1, 2015, these new Title IV Cash Management related regulations would likely not go into effect until July 1, 2016.

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Regulatory Matters

The Federal Reserve Bank of Chicago notified us and a former bank partner of potential violations of the Federal Trade Commission Act relating to marketing and disclosure practices related to the OneAccount during the period it was offered by such former bank partner. On May 9, 2014, the Federal Reserve Banks of Chicago (the responsible Reserve Bank for a former bank partner) and Philadelphia (the responsible Reserve Bank for a current bank partner) notified us that the Staff of the Board of Governors of the Federal Reserve System intended to recommend that the Board of Governors of the Federal Reserve System, or the Board of Governors, seek an administrative order against us with respect to asserted violations of the Federal Trade Commission Act. The cited violations relate to our activities with both a former and current bank partner and our marketing and disclosure practices related to the process by which students may select the OneAccount option for financial aid refund. We are in discussions with the Staff of the Board of Governors and the Reserve Banks on this matter. The Staff of the Board of Governors has asserted that any administrative order may seek damages, including customer restitution and civil money penalties, totaling as much as $35 million, and changes to certain of our business practices.

Approximately 55% of the OneAccounts are held at our bank partner regulated by the FDIC and we will need to consider voluntarily providing restitution to those OneAccounts held at that bank partner. In the event we do provide restitution to these OneAccounts on the same basis as an order from the Board of Governors, it is reasonably possible that our loss related to this matter will increase accordingly and increase our total exposure by an additional amount of approximately $35 million, or approximately $70 million in total.

During the nine months ended September 30, 2014, we recorded a liability of $8.75 million related to this matter, which is shown as a reduction of revenue on our consolidated statement of operations. While we believe that it is probable that we will have a loss related to this regulatory matter, in view of the inherent difficulty of predicting the outcomes of regulatory matters, we cannot predict the eventual outcome of this pending matter, the timing of the ultimate resolution of this matter or an exact amount of loss associated with this matter. The liability, which was recorded at June 30, 2014, and continues to be recorded at September 30, 2014, reflects the minimum amount we expect to pay related to this matter, although, there is a reasonable possibility that the liability will increase in future periods. Although the ultimate amount of restitution or civil money penalties is subject to many uncertainties and therefore impossible to predict, it is possible the amounts could reach levels that would cause an event of default under our Credit Facility. As disclosed in "Note 5 – Credit Facility" of our condensed consolidated financial statements, our EBITDA, as defined in the Credit Facility, as of September 30, 2014 for the trailing twelve months was $53.7 million, which exceeds the required minimum EBITDA required in our credit agreement by $3.7 million. In addition, a settlement with regulatory authorities in an amount exceeding $10 million could trigger a material adverse change or cause a default under other covenants in our Credit Facility.

We believe that our cash flows from operations, together with our existing liquidity sources, will be sufficient to fund our operations and anticipated capital expenditures over the next twelve months. However, we may be required to pay material customer restitution and civil money penalties related to certain regulatory proceedings as described above. Although the ultimate amounts of customer restitution or civil money penalties are subject to many uncertainties and therefore are impossible to predict, it is possible the amount we are required to pay could reach levels that would exceed our available cash flows from operations and existing liquidity sources available through our Credit Facility. In that case, we would seek additional forms of financing or other sources of liquidity to supplement our existing liquidity sources. There can be no assurances that such alternative forms of financing or other sources of liquidity would be available to us on favorable terms or at all.

It is possible the charge related to the regulatory proceedings described above could be of such a magnitude that it would cause an event of default under our Credit Facility. In the event of a default, depending on the amount of loss, we believe that we may be able to obtain relief under certain of our current covenants; however there can be no assurance we would receive such an amendment or waiver. If there is any event of default under our Credit Facility, all amounts then outstanding may be immediately due and payable. In such an event, we would need to seek alternative forms of financing or other sources of liquidity in order to repay the amounts outstanding under our Credit Facility, but there can be no assurances that such alternative forms of financing or other sources of liquidity would be available to us on favorable terms or at all.

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Results of Operations for the Three Months Ended September 30, 2014 and 2013

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

Three Months Ended September 30, 2014 Compared to the Three Months Ended September 30, 2013

Revenue

Account Revenue

The decrease in account revenue during the three months ended September 30, 2014, was primarily due to a decrease in amounts spent by OneAccounts, which had the effect of reducing both interchange revenue and service fee revenue when compared to the same period in the prior year. There was an approximate 4% decrease in the total dollars deposited into OneAccounts compared to the same period in the prior year, which led to an approximate 2% decrease in amounts spent from OneAccounts. The amounts deposited and spent from OneAccounts typically move by similar amounts though may vary by several percentage points from one reporting period to the next depending on specific deposit and spending behavior. We believe that the decrease in dollars deposited into OneAccounts was due primarily to a decrease in the rate at which students selected to receive their financial aid refund to a OneAccount, as opposed to other refund disbursement options. In addition, while there was an increase in financial aid disbursements for institutions that became clients after September 30, 2013, the increase associated with these new institutions was offset by decreases in financial aid distributed both for those institutions that were clients last year and this year and also those institutions that are no longer using our refund management service. We experienced an approximate 16% increase in amounts deposited to OneAccounts from non-refund sources, including payroll direct deposit, Reload @ the Register® and "Cash In" with MoneyPak® deposit options and EasyDeposit^SM mobile check deposits. Deposits from non-financial aid refund sources constituted approximately 12% of all deposits made to OneAccounts during the three months ended September 30, 2014, an increase from 10% during the comparable prior year period.

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In addition to overall volume decreases noted above, service fees earned on OneAccounts during the three months ended September 30, 2014 decreased relative to the comparable prior year period. During the three months ended September 30, 2014, we provided our customers with a limited number of fee-free foreign ATM withdrawals and in-person teller withdrawals, which resulted in a reduction of service fee revenue of approximately $0.5 million. Our service fee revenue decreased as a result of a change we made to our account fee schedule during the third quarter of 2013, including the removal of a fee assessed to customers that had not repaid an overdraft balance within an allotted time period, and also the elimination of several student banking options that were offered by Campus Solutions.

Payment Transaction Revenue

The majority of the increase in payment transaction revenue was due to higher volume of transactions processed through the SmartPay payment module during the three months ended September 30, 2014, which led to increases in payment transaction revenue. In total, payment transaction revenue associated with our CASHNet suite of payment solutions, including SmartPay, increased to $14.2 million during the three months ended September 30, 2014, from $11.3 million during the comparable prior year period. The increase in payment transaction volume was primarily due to the addition of higher education institution clients that began utilizing the SmartPay payment module after September 30, 2013, which generated approximately $2.5 million of the total increase in payment transaction revenue.

The Campus Solutions business contributed approximately $4.0 million of payment transaction revenue during the three months ended September 30, 2014, an increase of $0.6 million compared to the comparable prior year period. The increase in revenue from the Campus Solutions business is primarily related to a delay in the assignment of certain contracts to us after our acquisition of Campus Solutions. Certain contracts were not assigned to us until the second quarter of 2014, and therefore revenue was not recorded on these contracts during the prior year period.

Higher Education Institution Revenue

The increase in higher education institution revenue was primarily due to increases related to our Campus Labs business and CASHNet suite of payment products. The revenue associated with Campus Labs increased to $3.7 million during the three months ended September 30, 2014, compared to $3.1 million during the comparable prior year period.  The increase in Campus Labs revenue was due primarily to sales to new higher education institution clients over the past twelve months.

The revenue associated with our CASHNet suite of payment solutions increased to $4.2 million during the three months ended September 30, 2014, from $3.7 million in the comparable prior year period.  The increase in CASHNet revenue was primarily related to sales of the CASHNet suite to new clients.

The revenue associated with Campus Solutions decreased to $0.4 million during the three months ended September 30, 2014, from $0.7 million in the comparable prior year period. The decrease in Campus Solutions revenue is primarily due to our no longer providing refund management disbursement services to those clients of the Campus Solutions business which did not sign contracts to use Higher One's refund disbursement platform. The Campus Solutions refund disbursement platform was no longer offered to those former clients. The revenue associated with our Refund Management services, increased to $1.6 million during the three months ended September 30, 2014, from $1.4 million in the comparable prior year period.

Cost of Revenue

During the three months ended September 30, 2014, our gross margin percentage decreased to 52.9%, largely as a result of a decrease in margin associated with the OneAccount and Refund Management services.

While revenue associated with OneAccounts decreased as described above, our cost of revenue to support OneAccounts and Refund Management increased to $16.1 million during the three months ended September 30, 2014, from $14.6 million in the comparable prior year period. A decrease in service fee revenue generated from the OneAccounts does not typically result in significant decreases in our costs of revenue which reduces our gross margin percentage.  The increase in our cost of revenue is primarily due to higher fraud-related costs related to support OneAccount services. We incurred costs totaling approximately $1.2 million during the three months ended September 30, 2013 associated with the student banking options that were offered by Campus Solutions in the prior year. As these banking options were discontinued as of June 30, 2014, such costs did not occur during the three months ended September 30, 2014, resulting in a year over year expense decrease of $1.2 million.

Our cost of revenue to support the CASHNet suite of payment products and Campus Solutions payment platforms increased to approximately $11.7 million during the three months ended September 30, 2014, from $8.7 million in the comparable prior year period.  The increase in costs was primarily related to the growth of SmartPay transaction volume and costs associated with the Campus Solutions contracts that were assigned to us, both of which are described above in "Revenue – Payment Transaction Revenue". Approximately $0.5 million of the cost of revenue during the three months ended September 30, 2014, and $0.1 million of the increase in cost of revenue compared to the prior year, are due to acquisition-related amortization of intangible assets.

Our cost of revenue to support the Campus Labs business was $0.4 million in each of the three months ended September 30, 2014 and 2013.  The majority of the Campus Labs costs are due to acquisition-related amortization of intangible assets.

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General and Administrative Expense

General and administrative expenses increased by less than one percent from the prior year.  The prior year period included approximately $1.0 million of non-recurring bank partner transition costs. The impact of that non-recurring expense in the prior year was offset by increases in other expenses, primarily depreciation, amortization and stock-based compensation.

Product Development Expense

The decrease in product development expense was due to a combination of several factors. First, we experienced a decrease in certain transition-related product development expenses associated with the Campus Solutions acquisition compared to the prior year period.  Second, we had lower personnel related costs as a result of a decrease in the number of employees dedicated to product development compared to the prior year period. Third, there was an increase, in 2014, of internal costs which are capitalized rather than expensed. These costs are related to internal use software development projects that have advanced beyond the preliminary project stage and have met the criteria for capitalization under U.S. GAAP.

Sales and Marketing Expense

The decrease in sales and marketing expense was primarily due to a decrease in personnel related costs and also corporate branding costs which were incurred during the prior year period which did not recur in the current quarterly period. Offsetting these decreased expenses was an increase in amortization expense, of approximately $0.4 million, related to the acceleration of amortization of a marketing software platform no longer being utilized.

Litigation Settlement and Related Costs

During the three months ended September 30, 2013, we recorded an accrual for an estimated charge of $16.3 million. This accrual reflected our estimate of the costs of resolution, inclusive of additional legal and other administrative costs, of a settlement, which was preliminary at the time, which would resolve the class action litigation that was filed against us in 2012. In February 2014, we executed a settlement agreement, the terms of which included a payment of $15.0 million to a settlement fund, an agreement to pay the cost of notice to the class, and an agreement to make and/or maintain certain practice changes. We made the payment of $15.0 million to the settlement fund in February 2014. The court must approve the settlement before it becomes final and binding. There is no assurance that the court will approve the settlement. While this estimate is consistent with our view of the current exposure based on the signed settlement agreement, the actual loss could vary materially from the current estimate if the settlement is not finalized and approved.

Merger and Acquisition Related

Our merger and acquisition related expenses included professional fees associated with the acquisition of the Campus Solutions business in May 2013 of approximately $0.2 million, and a fair value adjustment to the contingent consideration component of the purchase price of the Campus Labs acquisition from August 2012, which resulted in a net reduction in operating expenses during the three months ended September 30, 2013.  There were no such costs during the three months ended September 30, 2014.

Interest Expense

Our interest expense decreased compared to the prior period primarily due to a decrease in the average amount outstanding on our Credit Facility. The average amount outstanding on our Credit Facility was $94.0 million during the three months ended September 30, 2014, compared to an average of $111.9 million during the three months ended September 30, 2013. The average interest rate during the three months ended September 30, 2014 was 2.4%, an increase from 2.3% for the three months ended September 30, 2013.

Other Income (Loss)

We recorded a loss of $0.3 million during the three months ended September 30, 2014 as a result of the disposition of our interest in FC Winchester Lofts Master Tenant, LLC, which resulted in a loss of $0.3 million.

Income Tax Expense (Benefit)

The change in income tax expense (benefit) was primarily due to the increase in net income before taxes. The effective tax rates for the three months ended September 30, 2014 and 2013 were 37.3% and 34.8%, respectively. The increase in the effective tax rate relates primarily to the prior year's net loss before income taxes and associated tax benefit which was realized at a lower rate as a result of the loss recorded for the litigation settlement.  Our effective tax rate is expected to be between 39% and 41% for the 2014 fiscal year.

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Results of Operations for the Nine Months Ended September 30, 2014 and 2013

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

Nine Months Ended September 30, 2014 Compared to the Nine Months Ended September 30, 2013

Revenue

Account Revenue

The decrease in account revenue was primarily due to a decrease in amounts spent from OneAccounts, which had the effect of reducing both interchange and service fee revenue when compared to the same period in the prior year. There was an approximate 2% decrease in the total dollars deposited into OneAccounts compared to the same period in the prior year, which led to an approximate 1% decrease in amounts spent from OneAccounts. The amounts deposited and spent from OneAccounts typically move by similar amounts though may vary by several percentage points from one reporting period to the next depending on specific deposit and spending behavior. The decrease in dollars deposited into OneAccounts was the result of fewer financial aid refunds being deposited to OneAccounts, partially offset by an increase in the amount of non-financial aid deposits made into OneAccounts. We experienced an approximate 16% increase in amounts deposited to OneAccounts from non-refund sources, including payroll direct deposit, Reload @ the Register® and "Cash In" with MoneyPak® deposit options and EasyDeposit^SM mobile check deposits. Deposits from non-financial aid refund sources constituted approximately 14% of all deposits made to OneAccounts during the nine months ended September 30, 2014, an increase from 12% during the comparable prior year period.

In addition, our service fee revenue decreased as a result of a change we made to our account fee schedule during the second half of 2013, including the removal of a fee assessed to customers that had not repaid an overdraft balance within an allotted time period. The removal of this fee was partially offset by increases in amounts earned from other fees.

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Payment Transaction Revenue

The majority of the increase in payment transaction revenue was due to the higher volume of transactions processed through the SmartPay payment module during the nine months ended September 30, 2014, which led to increases in payment transaction revenue. In total, payment transaction revenue associated with our CASHNet suite of payment products, including SmartPay, increased to $32.0 million during the nine months ended September 30, 2014, from $23.2 million during the comparable prior year period. The increase in payment transaction volume is primarily due to the introduction of Visa as a payment method for SmartPay. In addition, approximately $4.0 million of the increase in payment transaction revenue was due to higher education institution clients that began utilizing the SmartPay payment module after September 30, 2013.

The Campus Solutions business contributed approximately $10.7 million of payment transaction revenue during the nine months ended September 30, 2014, an increase of $6.4 million compared to the comparable prior year period. The increase in revenue from the Campus Solutions business is primarily related to the inclusion of a full nine months of activity in the current year period, compared to less than five months of activity in the comparable prior year period.

Higher Education Institution Revenue

The increase in higher education institution revenue was primarily due to increases related to our Campus Labs business and CASHNet suite of payment products. The revenue associated with Campus Labs increased to $10.5 million during the nine months ended September 30, 2014, compared to $7.8 million during the comparable prior year period.  Approximately $1.1 million of the increase in Campus Labs revenue was due to acquisition-related fair value adjustments to deferred revenue, which reduced revenue during the nine months ended September 30, 2013. The remaining increase in revenue is due to year-over-year increases in higher education institution client billings.

The revenue associated with our CASHNet suite of payment products increased to $12.3 million during the nine months ended September 30, 2014, from $11.0 million in the comparable prior year period. The increase in CASHNet subscription revenue for our payment processing products is due to a combination of new client sales, as well as additional sales to existing schools. The revenue associated with Campus Solutions increased to $2.2 million during the nine months ended September 30, 2014, from $1.2 million in the comparable prior year period. The increase in revenue from the Campus Solutions business is primarily related to the inclusion of a full nine months of activity in the current year period, compared to less than five months of activity in the comparable prior year period.

The revenue associated with our Refund Management services increased to $4.0 million during the nine months ended September 30, 2014, from $3.9 million in the comparable prior year period.

Allowance for Customer Restitution

As further described in "Note 6 – Commitments and Contingencies" to our condensed consolidated financial statements and the "Regulatory Matters" section within "Management's Discussion and Analysis of Financial Condition and Results of Operations – Overview," we recorded a liability of $8.75 million during the nine months ended September 30, 2014, related to the potential requirement to provide restitution to certain OneAccount customers.

Cost of Revenue

During the nine months ended September 30, 2014, our gross margin percentage decreased to 50.2%, largely as a result of the allowance for customer restitution described above. Excluding the impact of the allowance for customer restitution, our non-GAAP gross margin percentage would have been 55.3% during the nine months ended September 30, 2014, compared to 57.8% in the comparable prior year period.

While revenue associated with OneAccounts decreased as described above, our cost of revenue to support OneAccounts and Refund Management services increased to $46.2 million during the nine months ended September 30, 2014, from $43.8 million in the comparable prior year period. The increase in our cost of revenue is primarily due to higher costs related to providing zero liability protection on unauthorized purchases from OneAccounts. Costs associated with the student banking options that were offered by Campus Solutions decreased from $1.9 million during the nine months ended September 30, 2013, to $1.2 million during the nine months ended September 30, 2014.

Our costs to support the CASHNet suite of payment products and Campus Solutions payment platforms increased to approximately $28.3 million during the nine months ended September 30, 2014, from $18.1 million in the comparable prior year period. The increase in costs is a combination of the inclusion of a full nine months of activity for Campus Solutions in 2014, compared to less than five months of activity during the nine months ended September 30, 2013, and costs to support the growth of SmartPay transaction volume.  Approximately $1.5 million of cost of revenue during the nine months ended September 30, 2014, and $0.5 million of the increase in cost of revenue compared to the prior year period, is due to acquisition-related amortization of intangible assets.

Our costs to support the Campus Labs business was $1.2 million during the nine months ended September 30, 2014, a decrease from $1.4 million during the comparable prior year period. Approximately $0.8 million of costs in both the current and prior year period is due to acquisition-related amortization of intangible assets.

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General and Administrative Expense

The increase in general and administrative expenses is primarily attributable to the following three factors: (i) our personnel costs increased compared to the nine months ended September 30, 2013, a portion of which is due to employees added from the acquisition of the Campus Solutions business, (ii) higher professional fees related to additional compliance and regulatory related activities, and, to a lesser extent, (iii) increases in depreciation and amortization.

Product Development Expense

The decrease in product development expense is primarily attributable to an increase, in 2014, of internal costs which are capitalized rather than expensed. These costs are related to internal use software development projects that have advanced beyond the preliminary project stage and have met the criteria for capitalization under U.S. GAAP.

Sales and Marketing Expense

The increase in sales and marketing expense was primarily due to increased amortization expense of $0.9 million related to acquired intangible assets associated with the acquisition of the Campus Solutions business.

Litigation Settlement and Related Costs

During the nine months ended September 30, 2013, we recorded an accrual for an estimated charge of $16.3 million. This accrual reflected our estimate of the costs of resolution, inclusive of additional legal and other administrative costs, of a settlement, which was preliminary at the time, which would resolve the class action litigation that was filed against us in 2012. In February 2014, we executed a settlement agreement, the terms of which included a payment of $15.0 million to a settlement fund, an agreement to pay the cost of notice to the class, and an agreement to make and/or maintain certain practice changes. We made the payment of $15.0 million to the settlement fund in February 2014. The court must approve the settlement before it becomes final and binding. There is no assurance that the court will approve the settlement. While this estimate is consistent with our view of the current exposure based on the signed settlement agreement, the actual loss or range of such loss could vary materially from the current estimate if the settlement is not finalized and approved.

Merger and Acquisition Related

Our merger and acquisition related expenses during the nine months ended September 30, 2013 included professional fees associated with the acquisitions of the Campus Labs and Campus Solutions businesses and a fair value adjustment to the contingent consideration component of the purchase price of the Campus Labs acquisition from August 2012 which resulted in a net reduction in operating expenses. During the nine months ended September 30, 2013, we recorded an adjustment of $5.8 million as a result of a change in the fair value of the contingent consideration liability. There were no such costs during the nine months ended September 30, 2014.

Interest Expense

Our interest expense increased compared to the prior period primarily due to an increase in the average interest rate in effect during the nine months ended September 30, 2014, compared to the prior year. The average interest rate during the nine months ended September 30, 2014 was 2.4%, an increase from 2.2% for the nine months ended September 30, 2013. The average amount outstanding on our Credit Facility increased to $94.5 million during the nine months ended September 30, 2014, compared to an average of $94.0 million during the nine months ended September 30, 2013.

Other Income (Loss)

The increase in other income was a result of an agreement related to the resolution of certain escrow balances that were part of the acquisition of the Campus Solutions business, which resulted in income of $1.6 million. We recorded other loss of $0.3 million during the nine months ended September 30, 2014 as a result of the disposition of our interest in FC Winchester Lofts Master Tenant, LLC.

Income Tax Expense

The increase in income tax expense was primarily due to the increase in net income before taxes.  The effective tax rates for the nine months ended September 30, 2014 and 2013 were 38.9% and 40.4%, respectively.  Our effective rate is expected to be between 39% and 41% for the 2014 fiscal year.

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Liquidity and Capital Resources

Sources of Liquidity

Our primary sources of liquidity are cash flows from operations and borrowings under our Credit Facility, as defined below.  As of September 30, 2014, we had $32.4 million in cash and cash equivalents, $0.2 million in available-for-sale investments and approximately $32.5 million in borrowing capacity available under our Credit Facility. Our primary liquidity requirements are for working capital, capital expenditures, product development expenses and general corporate needs. As of September 30, 2014, we had working capital of $6.0 million.

Senior Secured Revolving Credit Facility

In October 2012, we terminated our then existing credit facility and entered into a new five-year senior secured revolving credit facility in an amount of $200.0 million, or the Credit Facility, which has since been amended.  As of September 30, 2014, we had $94.0 million in borrowings outstanding, at a weighted average interest rate of 2.4%, under the Credit Facility.  The Credit Facility permits the issuance of letters of credit of up to $20.0 million and swing line loans of up to $10.0 million to fund working capital needs.  Loans drawn under the Credit Facility are payable in a single maturity on October 16, 2017.

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

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

The Credit Facility contains certain affirmative covenants including covenants to furnish the lenders with financial statements and other financial information and to provide the lenders notice of material events and information regarding collateral.  The Credit Facility also contains certain negative covenants that, among other things, restrict our ability, subject to certain exceptions, to incur additional indebtedness, grant liens on our assets, undergo fundamental changes, make investments, sell assets, make restricted payments, change the nature of our business and engage in transactions with our affiliates.  In addition, the Credit Facility contains certain financial covenants that require us to maintain (1) EBITDA, as defined in the Credit Facility, on a consolidated basis for the prior four fiscal quarters of at least $50 million, (2) a funded debt to EBITDA ratio, or leverage ratio, of 2.50 to 1.00 or less through December 31, 2014 and of 2.00 to 1.00 or less thereafter, and (3) a fixed charge coverage ratio of at least 1.25 to 1.00. We were in compliance with each of the applicable affirmative, negative and financial covenants of the Credit Facility as of September 30, 2014. As noted above, one of the financial covenants relates to a requirement to have a minimum of $50 million of EBITDA over the prior twelve months. As of September 30, 2014, our trailing twelve month EBITDA was $53.7 million. The allowance for customer restitution explained in "Note 6 – Commitments and Contingencies" of our condensed consolidated financial statements, reduced our trailing twelve month EBITDA by $8.75 million during the nine months ended September 30, 2014. Our leverage ratio was 1.89 to 1.00 as of September 30, 2014.

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Cash Flows

The following table presents information regarding our cash flows and cash and cash equivalents for the nine months ended September 30, 2014 and 2013:

The decrease in net cash provided by operating activities was primarily the result of changes in working capital balances during the nine months ended September 30, 2014 compared to the prior year.  The litigation settlement of $15.0 million, which was recorded as an expense during the nine months ended September 30, 2013 and an accrued liability as of December 31, 2013, was paid in cash during the nine months ended September 30, 2014. This payment is a significant component of the overall change in working capital balances and decrease in cash provided by operating activities compared to the prior year. While we have recorded an allowance for customer restitution of $8.75 million during the nine months ended September 30, 2014, such amount has not been paid and therefore has not impacted our cash flows.  Our income receivable balance has increased from the prior year partially due to a delay in settlement of the revenue proceeds associated with the Campus Solutions business compared to the prior year.

The decrease in net cash used by investing activities primarily relates to our acquisition of the Campus Solutions business during the nine months ended September 30, 2013, which totaled $47.3 million. In addition, during the nine months ended September 30, 2014, we had cash provided by investing activities of (1) $3.6 million related to the disposition of an equity method investment and (2) $3.5 million associated with state historic tax credits generated by the construction of our headquarters.

The cash provided by financing activities in the nine months ended September 30, 2014 was primarily related to amounts drawn on our Credit Facility. During the nine months ended September 30, 2014, we borrowed $15.0 million on our Credit Facility and made repayments of $10.0 million, compared to net borrowings on our Credit Facility of $20.0 million during the nine months ended September 30, 2013. During the nine months ended September 30, 2013, we used approximately $6.0 million to purchase our common stock through our authorized share purchase program, which did not recur in the nine months ended September 30, 2014.

We believe that our cash flows from operations, together with our existing liquidity sources, will be sufficient to fund our operations and anticipated capital expenditures over the next twelve months. However, as described in "Management's Discussion and Analysis of Financial Condition and Results of Operations – Overview" we may be required to pay material customer restitution and civil money penalties related to certain regulatory proceedings. Please refer to the "Regulatory Matters" section within "Management's Discussion and Analysis of Financial Condition and Results of Operations – Overview" for the impact that such regulatory matters may have on our liquidity.

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Supplemental Financial and Operating Information

We define adjusted EBITDA as net income before interest, income taxes and depreciation and amortization, or EBITDA, further adjusted to remove the effects of stock-based compensation expense, incremental expenses, certain of which are non-cash, directly related to merger and acquisition activities, the receipt of a settlement amount from Sallie Mae, Inc. related to our Campus Solutions acquisition and the allowance for customer restitution recorded during the nine months ended September 30, 2014. Neither EBITDA nor adjusted EBITDA should be considered an alternative to net income, operating income or any other measure of financial performance calculated and presented in accordance with GAAP. Our EBITDA and adjusted EBITDA may not be comparable to similarly titled measures of other organizations because other organizations may not calculate EBITDA and adjusted EBITDA in the same manner as we do.  In addition, adjusted EBITDA may not be identical to the corresponding measure used in our various agreements, in particular our Credit Facility.

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

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We define adjusted net income as net income, adjusted to eliminate (a) stock-based compensation expense related to incentive stock option grants and (b) after giving effect to tax adjustments, (1) stock-based compensation expense related to non-qualified stock option and restricted stock grants, (2) incremental expenses, certain of which are non-cash, directly related to merger and acquisition activities, (3) the receipt of a settlement amount from Sallie Mae, Inc. related to our Campus Solutions acquisition, (4) the allowance for customer restitution recorded during the nine months ended September 30, 2014, and (5) amortization expenses related to acquired intangible assets and financing costs. Adjusted net income should not be considered as an alternative to net income, operating income or any other measure of financial performance calculated and presented in accordance with GAAP. Our adjusted net income may not be comparable to similarly titled measures of other organizations because other organizations may not calculate adjusted net income in the same manner as we do.

 

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

(a)           We have tax effected, utilizing an estimated statutory rate, all of the pre-tax adjustments, except for stock-based compensation expense for incentive stock options which are generally not tax deductible.

Contractual Obligations

Except for the increase in the amount owed under our Credit Facility, there have been no material changes to our contractual commitments from those disclosed in our annual report on Form 10-K for the year ended December 31, 2013.

Off-Balance Sheet Arrangements

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

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Critical Accounting Policies

The significant accounting policies and basis of preparation of our consolidated financial statements are described in "Note 2 – Significant Accounting Policies" of our notes to consolidated financial statements included in each of our Annual Report on Form 10-K for the year ended December 31, 2013 and in this Quarterly Report on Form 10-Q. Under accounting principles generally accepted in the United States, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities in our financial statements. Actual results could differ materially from those estimates.

We believe the judgments, estimates and assumptions associated with the following critical accounting policies have the greatest potential impact on our consolidated financial statements:

For a complete discussion of these critical accounting policies, refer to "Critical Accounting Policies" within "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations" included within our annual report on Form 10-K for the year ended December 31, 2013. As of September 30, 2014, there have been no material changes to any of the Critical Accounting Policies described above other than the addition of loss contingencies to the list of our critical accounting policies and the information included below with respect to our goodwill and intangible assets.

Loss Contingencies

We are currently involved in various claims and legal proceedings. These include litigation relating to matters in the ordinary course of business, as well as regulatory examinations, information gathering requests, inquiries and investigations. Each quarter, we review the status of each significant matter and assess its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and the determination as to whether an exposure is reasonably estimable. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to our pending claims and litigation, and may revise our estimates. These revisions in the estimates of the potential liabilities could have a material impact on our results of operations and financial position.

Goodwill and Intangible Assets

We have one operating segment and reporting unit for purposes of our goodwill testing as a result of the integrated way that the entire business is managed. We performed the annual impairment test as of October 31, 2013, and determined that the fair value of our reporting unit exceeded its carrying value by more than 400%.

We assess the impairment of identifiable intangible assets and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include the following:

As a result of the potential changes that the Department of Education may make to Title IV cash management regulations, the regulatory matters related to the Federal Reserve Banks and the decrease in our stock price during the third quarter, we assessed our goodwill balance for potential impairment. As of September 30, 2014, our reporting unit exceeded its carrying value; however the percentage by which the fair value exceeded the carrying value had decreased to approximately 33%. As we only have one operating segment and one reporting unit, we primarily rely on the indicated fair value of the enterprise from the trading price of our common stock. If the trading price of our common stock continues to decrease, or if our estimate of future operating cash flows diminishes, the estimated fair value of our reporting unit could decrease further and potentially lead to an indicator of impairment.

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Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Our principal market risk relates to interest rate sensitivity, which is the risk that future changes in interest rates will reduce our net income or net assets. Our Credit Facility accrues interest at a rate equal to a base rate or Eurodollar rate plus an applicable margin (depending on our leverage ratio). Based upon a sensitivity analysis at October 1, 2014, assuming average outstanding borrowings during the nine months ended September 30, 2014 of $94.5 million, a hypothetical 50 basis point increase in interest rates would result in an increase in interest expense of approximately $0.5 million for an annual period.

Item 4.

Controls and Procedures

Our management, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act) as of September 30, 2014. Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of September 30, 2014, our disclosure controls and procedures were effective to provide reasonable assurance that information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure, and ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms.

There has been no change in our internal controls over financial reporting during the three months ended September 30, 2014 identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the period covered by this report that has materially affected, or is reasonable likely to materially affect, our internal controls over financial reporting.

PART II – OTHER INFORMATION

Item 1.

Legal Proceedings

The following information supplements and amends our discussion set forth under Part I, Item 3. "Legal Proceedings" in our Annual Report on Form 10-K for the year ended December 31, 2013.

As described in "Note 5 – Credit Facility" and "Note 6 – Commitments and Contingencies" to our condensed consolidated financial statements and the "Regulatory Matters" section within "Management's Discussion and Analysis of Financial Condition and Results of Operations – Overview", the Federal Reserve Bank of Chicago notified us and a former bank partner of potential violations of the Federal Trade Commission Act relating to marketing and disclosure practices related to the OneAccount during the period it was offered by such former bank partner.  Please refer to the aforementioned sections for relevant information concerning this matter.

In addition, see "Note 6 – Commitments and Contingencies" to our condensed consolidated financial statements for other developments related to our legal proceedings.

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Item 1A.

Risk Factors

There have been no material changes to our risk factors from those disclosed in our annual report on Form 10-K for the year ended December 31, 2013, other than the following:

We are subject to substantial federal and state governmental regulation that could change and thus force us to make modifications to our business. Compliance with the various complex laws and regulations is costly and time consuming, and failure to comply could have a material adverse effect on our business. Additionally, increased regulatory requirements on our services may increase our costs, which could materially and adversely affect our business, financial condition and results of operations.

As a payments processor to higher education institutions that takes payment instructions from institutions and their constituents, including students and employees, and gives them to our Bank Partners, we are directly or indirectly subject to a variety of federal and state laws and regulations. Our contracts with most of our higher education institution clients and our Bank Partners require us to comply with applicable laws and regulations, including but not limited to, where applicable:

Higher Education Regulations

Third-Party Servicer. Because of the services we provide to some institutions with regard to the handling of Title IV funds, we are considered a "third-party servicer" under the Title IV regulations. Those regulations require a third-party servicer annually to submit a compliance audit conducted by outside independent auditors that cover the servicer's Title IV activities. Each year we submit a "Compliance Attestation Examination of the Title IV Student Financial Assistance Programs" audit to ED, which includes a report by an independent audit firm. In addition, the yearly compliance audit submission to ED provides comfort to our higher education institution clients that we are in compliance with the third-party servicer regulations that may apply to us. We also provide this compliance audit report to clients upon request to help them fulfill their compliance audit obligations as Title IV participating institutions.

Under ED's regulations, a third party servicer that contracts with a Title IV institution acts in the nature of a fiduciary in the administration of Title IV programs. Among other requirements, the regulations provide that a third-party servicer is jointly and severally liable with its client institution for any liability to ED arising out of the servicer's violation of Title IV or its implementing regulations, which could subject us to material fines related to acts or omissions of entities beyond our control. ED is also empowered to limit, suspend or terminate the violating servicer's eligibility to act as a third-party servicer and to impose significant civil penalties on the violating servicer. Additionally, on behalf of our higher education institution clients, we are required to comply with ED's cash management regulations regarding payment of financial aid credit balances to students and providing bank accounts to students that may be used for receiving such payments. In the event ED concluded that we had violated Title IV or its implementing regulations and should be subject to one or more of these sanctions, our business and results of operations could be materially and adversely affected. There is limited enforcement and interpretive history of Title IV regulations.

On May 1, 2012, ED published in the Federal Register a notice of intent to establish a negotiated rulemaking committee to draft proposed regulations designed to prevent fraud through the use of electronic fund transfers to students' bank accounts, ensure proper use of federal financial aid funds, address the use of debit cards and other banking products for disbursing federal financial aid funds, and improve and streamline campus' financial aid programs. We provided written and oral comments at a hearing held by ED in connection with the negotiated rulemaking process and have provided additional information to ED. On April 16, 2013, ED announced additional topics for consideration, and in early 2014, formed a negotiated rulemaking committee. Our Chief Operating Officer was selected by ED to serve on the committee as a primary negotiator. The committee convened in February, March, April and May of 2014 to discuss and work toward revising existing regulations to potentially address, among other things, consumer safeguards regarding debit and prepaid cards associated with Title IV Cash Management  (including fees associated with such debit and prepaid cards), marketing of financial products (including sending unsolicited cards to students and co-branding of the card and materials) by institutions and their preferred banks or contractors, ATM access and availability, revenue sharing arrangements, and the potential for a government-sponsored debit or prepaid card solution. The negotiated rulemaking committee concluded their efforts in May 2014 and a consensus was not reached on any proposed regulations. Since that time, there have been no proposed regulations related to Title IV Cash Management published in the Federal Register; therefore we believe, should ED issue a Notice of Proposed Rulemaking on Title IV Cash Management regulations, complete the public comment process and publish a final rule in the Federal Register by November 1, 2015, these new Title IV Cash Management related regulations would likely not go into effect until July 1, 2016. In the event that the revised or new regulations that are promulgated alter, restrict or prohibit our ability to offer and provide our services to higher education institutions and students in the manner that we currently provide them, our business, financial condition and results of operations could be materially and adversely affected.

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FERPA. Our higher education institution clients are subject to FERPA, which provides, with certain exceptions, that an educational institution that receives any federal funding under a program administered by ED may not have a policy or practice of disclosing education records or "personally identifiable information" from education records, other than directory information to third parties without the student's or parent's written consent. Our higher education institution clients that use the Refund Managements services disclose to us certain non-directory information concerning their students, including contact information, student identification numbers and the amount of students' credit balances. Additionally, our higher education institution clients that use Campus Labs products also share personally identifiable information with us. We believe that our higher education institution clients may disclose this information to us without the students' or their parents' consent pursuant to one or more exceptions under FERPA. However, if ED asserts that we do not fall into one of these exceptions or if future changes to legislation or regulations required student consent before our higher education institution clients could disclose this information to us, a sizeable number of students may cease using our products and services, which could materially and adversely affect our business, financial condition and results of operations.

Additionally, as we are indirectly subject to FERPA, we may not permit the transfer of any personally identifiable information to another party other than in a manner in which a higher education institution may disclose it. In the event that we re-disclose student information in violation of this requirement, FERPA requires our clients to suspend our access to any such information for a period of five years. Any such suspension could have a material adverse effect on our business, financial condition or results of operations.

State Laws. We may also be subject to similar state laws and regulations that restrict higher education institutions from disclosing certain personally identifiable information of students. State attorneys general and other enforcement agencies may monitor our compliance with state and federal laws and regulations pertaining to higher education and banking and conduct investigations of our business that are time consuming and expensive and could result in fines and penalties that have a material adverse effect on our business, financial condition and results of operations. In July 2014, we received a civil investigative demand from the Office of the Attorney General of the Commonwealth of Massachusetts pursuant to the Commonwealth's Consumer Protection Act. The Massachusetts Attorney General has informed us that its investigation relates to our debt collection practices. We provided the information requested by the civil investigative demand, which included information and records about our company and certain of our business practices, particularly as they relate to Massachusetts residents, institutions of higher education located in Massachusetts, and students who attended those institutions. We cannot predict whether we will become subject to any other action by the Massachusetts Attorney General or any other state agencies.

Additionally, individual state legislatures may propose and enact new laws that restrict or otherwise affect our ability to offer our products and services as we currently do, which could have a material adverse effect on our business, financial condition and results of operations. For example, legislatures in the States of Oregon and California have recently considered proposed legislation that would further regulate the disbursement of financial aid refunds and associated financial products and services.

Regulation of OneAccounts

Anti-Money Laundering; USA PATRIOT ACT; Office of Foreign Assets Control. Our Bank Partners are insured depository institutions and funds held at our bank partners are insured by the FDIC up to applicable limits. As insured depository institutions, our bank partners are subject to comprehensive government regulation and supervision and, in the course of making their services available to our customers, we are required to assist our bank partners in complying with certain of their regulatory obligations. In particular, the anti-money laundering provisions of the USA PATRIOT Act require that customer identifying information be obtained and verified whenever a checking account is established. For example, because we facilitate the opening of checking accounts at our bank partners on behalf of our customers, we assist our bank partners in collecting the customer identification information that is necessary to open an account. In addition, both we and our bank partners are subject to the laws and regulations enforced by the Office of Foreign Assets Control, or OFAC, which prohibit U.S. persons from engaging in transactions with certain prohibited persons. Our failure to comply with any of these laws or rights could materially and adversely affect our business, financial condition and results of operations.

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Compliance; Audit. As a service provider to insured depository institutions, we are required under applicable federal and state laws to agree to submit to examination by our bank partners' regulators. We also are subject to audit by our bank partners to ensure that we comply with our obligations to them appropriately. Failure to comply with our responsibilities properly could negatively affect our operations. Our bank partners are required under their respective agreements with us to, and we rely on our bank partners' ability to, comply with state and federal banking regulations. The failure of our bank partners to maintain regulatory compliance could result in significant disruptions to our business and have a material adverse effect on our business, financial condition and results of operations.

Electronic Fund Transfer Act; Regulation E. Our bank partners provide depository services for OneAccounts through a private label relationship. We provide processing services for OneAccounts for our bank partners. These services are subject to, among other things, the requirements of the Electronic Fund Transfer Act and the CFPB's Regulation E, which govern automatic deposits to and withdrawals from deposit accounts and customers' rights and liabilities arising from the use of ATMs, debit cards and certain other electronic banking services. We may assist our bank partners with fulfilling their compliance obligations pursuant to these requirements. See "Fees for financial services are subject to increasingly intense legislative and regulatory scrutiny, which could have a material adverse effect on our business, financial condition, results of operations and prospects for future growth" in our annual report on Form 10-K for additional discussion. Failure to comply with applicable regulations could materially and adversely affect our business, financial condition and results of operations.

Money Transmitter Regulations. Because our technology services are provided in connection with the financial products of our bank partners, our activities are occasionally reviewed by regulatory agencies to ensure that we do not impermissibly engage in activities that require licensing at the state or federal level. In the ordinary course of business, we receive letters and inquiries concerning the nature of our business as it applies to state "money transmitter" licensing and regulations from different state regulatory agencies. If a state agency were to conclude that we are required to be licensed as a "money transmitter," we may need to undergo a costly licensing process in that state, and failure to comply could be a violation of state and potentially federal law.

Privacy and Data Regulation

We are subject to laws and regulations relating to the collection, use, retention, security and transfer of personally identifiable information and data regarding our customers and their financial information. In addition, we are bound by our own privacy policies and practices concerning the collection, use and disclosure of user data, which are posted on certain of our website pages.

In conjunction with the disbursement, payroll and tuition payment services we make available through our bank partners, it is necessary to collect certain information from our customers (such as bank account and routing numbers) to transmit to our bank partners. Our bank partners use this information to execute the funds transfers requested by our customers, which are effected primarily by means of ACH networks and other wire transfer systems, such as FedWire. To the extent the data required by these electronic funds networks change, the information that we will be required to request from our clients may also change.

We are subject, either directly or by virtue of our contractual relationship with our bank partners, to the privacy and security standards of the GLBA privacy regulations, as well as certain state data protection laws and regulations. The GLBA privacy regulations require that we develop, implement and maintain a written comprehensive information security program prescribing safeguards that are appropriate to our size and complexity, the nature and scope of our activities and the sensitivity of any personally identifiable information we access for processing purposes or otherwise maintain. As a service provider of our bank partners, we also are limited in our use and disclosure of the personal information we receive from our bank partners, which we may use and disclose only for the purposes for which it was provided to us and consistent with the bank's own data privacy and security obligations. We also are subject to the standards set forth in guidance on data security issued by the Federal Financial Institution Examination Council, as well as the data security standards imposed by the card associations, including Visa, Inc., and MasterCard. In addition, we are subject to similar data security breach laws enacted by a number of states.

Any failure or perceived failure by us to comply with any legal or regulatory requirements or orders or other federal or state privacy or consumer protection-related laws and regulations, or with our own privacy policies, could result in fines, sanctions, litigation, negative publicity, limitation of our ability to conduct our business and injury to our reputation, any of which could materially and adversely affect our business, financial condition and results of operations.

New legislation and regulations in this area have been proposed, both at the federal and state level. Such measures, including pending Federal legislation, would potentially impose additional obligations on us, including requiring that we provide notifications to consumers and government authorities in the event of a data breach or unauthorized access or disclosure, beyond what state law already requires. These laws and regulations could cause us to incur substantial costs or require us to change our business practices in a manner materially adverse to our business.

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Compliance

We monitor our compliance through an internal audit program. Our full-time internal group works with a third-party internal audit firm to conduct annual reviews to ensure compliance with the regulatory requirements described above. The costs of these audits and the costs of complying with the applicable regulatory requirements are significant. Increased regulatory requirements on our products and services, such as in connection with the matters described above, could materially increase our costs or reduce revenue.

It is impossible to determine the extent of the impact of any new laws, regulations or initiatives that may be proposed, or whether any of the proposals will become law. The imposition of any new laws or regulations could make compliance more difficult and expensive and affect the manner in which we conduct business. In addition, many of these laws and regulations are evolving, unclear and inconsistent across various jurisdictions. If we were deemed to be in violation of any laws or regulations that are currently in place or that may be promulgated in the future, including but not limited to those described above, we could be exposed to financial liability and adverse publicity or forced to change our business practices or stop offering some of our products and services. We also could face significant legal fees, delays in extending our product and services offerings, and damage to our reputation that could harm our business and reduce demand for our products and services. Even if we are not required to change our business practices, we could be required to obtain licenses or regulatory approvals that could cause us to incur substantial costs and delays.

Reviews, examinations and enforcement actions by regulatory authorities under banking and consumer protection laws and regulations, and possible changes to those laws and regulations by legislative or regulatory action, may result in changes to our business practices or may expose us to the risk of fines, restitution and litigation.

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

In February 2011, the New York Regional Office of the FDIC notified us that it was prepared to recommend to the Director of FDIC Supervision that an enforcement action be taken against us for alleged violations of certain applicable laws and regulations principally relating to our compliance management system and policies and practices for past overdraft charging on persistently delinquent accounts, collections and transaction error resolution. We responded to the FDIC's notification, and have been in regular dialogue with the FDIC since 2010. We voluntarily initiated a plan in December 2011, which provided credits to certain current and former customers that were previously assessed certain insufficient fund fees. As a result of this plan, we recorded a reduction in our revenue of approximately $4.7 million in 2011. On August 8, 2012, we received a Consent Order, Order for Restitution, and Order to Pay Civil Money Penalty, or the Consent Order, dated August 7, 2012, issued by the FDIC to settle such alleged violations.  Pursuant to the terms of the Consent Order, we neither admitted nor denied any charges when agreeing to the terms of the Consent Order. Under the terms of the Consent Order, we are required to, among other things, review and revise our compliance management system and, to date, we have substantially revised our compliance management system. Additionally, the Consent Order provides for restrictions on the charging of certain fees. The Consent Order further provides that we shall make restitution to less than 2% of our customers since 2008 for fees previously assessed, which restitution has been substantially completed through the voluntary customer credit plan described above, and pay a civil money penalty of $0.1 million.  We remain subject to the jurisdiction and examination of the FDIC and further action could be taken to the extent we do not comply with the terms of the Consent Order or if the FDIC were to identify additional violations of certain applicable laws and regulations.

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Please also refer to the "Regulatory Matters" section within, "Management's Discussion and Analysis of Financial Condition and Results of Operations – Overview" of this Quarterly Report on Form 10-Q for information related to the notification that we received from the Staff of the Board of Governors of the Federal Reserve System which asserted violations of the Federal Trade Commission Act.

In a separate regulatory matter, we are currently considering the merits of voluntarily refunding certain fees previously assessed to accountholders as a result of a separate compliance examination which was recently completed.

The terms of our credit agreement may restrict our current and future operations, which could adversely affect our ability to respond to changes in our business and to manage our operations.

Our credit agreement contains, and any future indebtedness of ours would likely contain, a number of restrictive covenants that impose significant operating and financial restrictions on us, including restrictions on our ability to, among other things:

•	create liens;

•	make investments and acquisitions;

•	incur additional debt;

•	transfer all or substantially all of our assets or enter into merger or consolidation transactions;

•	dispose of assets;

•	pay dividends or make any other distributions with respect to our stock;

•	issue stock, warrants, options or other rights to purchase stock or securities convertible into or exchangeable for shares of stock;

•	engage in any material line of business substantially different from the lines of business we currently conduct or any business substantially related or incidental thereto; and

•	enter into transactions with affiliates.

Our ability to comply with these covenants may be affected by events beyond our control, and any material deviations from our forecasts could require us to seek waivers or amendments of covenants or alternative sources of funding. We cannot be sure that such waivers, amendments or alternative sources of funding could be obtained, or if obtained, would be on terms acceptable to us.

Our credit agreement also requires us to maintain certain liquidity levels and satisfy certain financial ratios, including a minimum amount of EBITDA ($50.0 million for the trailing twelve months), maximum total leverage ratio (2.5 times through December 31, 2014) and a minimum interest coverage ratio (1.25 times to 1). A failure by us to comply with the covenants contained in our credit agreement could result in an event of default which could adversely affect our ability to respond to changes in our business and manage our operations. Our EBITDA, as defined in our credit agreement, as of September 30, 2014 for the trailing twelve months was $53.3 million, which exceeds the required minimum EBITDA required in our credit agreement by $3.3 million. An event of default would also occur under our credit agreement if we undergo a change of control or if we experience a material adverse change in our operations, condition or prospects. Among other things, a settlement with regulatory authorities in an amount exceeding $10 million could trigger a material adverse change or cause a default under other covenants in our credit agreement. See "Reviews, examinations and enforcement actions by regulatory authorities under banking and consumer protection laws and regulations, and possible changes to those laws and regulations by legislative or regulatory action, may result in changes to our business practices or may expose us to the risk of fines, restitution and litigation" above and "Regulatory Matters" in the "Management's Discussion and Analysis of Financial Condition and Results of Operations – Overview" section of this report. We have discussed the possibility of the receipt of an administrative order from the Board of Governors with the lenders in our credit agreement. In the event of a default, depending on the amount of loss, we believe that we may be able to obtain relief under certain of our current covenants, however there can be no assurance we would receive such an amendment or waiver. If there is an event of any default under our credit agreement, the amounts then outstanding may be immediately due and payable and may require us to apply all of our available cash to repay these amounts. We may also need to seek alternative forms of financing or other sources of liquidity in order to repay these amounts. There can be no assurances that such alternative forms of financing or other sources of liquidity would be available to us on favorable terms or at all. The acceleration of indebtedness under our credit agreement could have a material adverse effect on our business, financial condition and results of operations.

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Our operating results may suffer because of substantial and increasing competition in the industries in which we do business.

The market for our products and services is competitive, continually evolving and, in some cases, subject to rapid technological change. Our disbursement services compete against all forms of payment, including paper-based transactions (principally cash and checks), electronic transactions such as wire transfers and Automated Clearing House, or ACH, payments and other electronic forms of payment, including card-based payment systems. Many competitors, including TouchNet Information Systems, Inc., PNC Financial Services Group, Inc. and Nelnet, Inc., provide payment software, products and services that compete with those we offer. During the third quarter of 2014, Heartland Payment Systems, Inc. announced that it had completed the acquisition of TouchNet Information Systems, Inc. In addition, the OneAccount, which we provide through our Bank Partners, also competes with banks active in the higher education market, including U.S. Bancorp and Wells Fargo & Company and national, regional and local banks. Future competitors may begin to focus on higher education institutions in a manner similar to us.

Many of our competitors have substantially greater financial and other resources than we have, may in the future offer a wider range of products and services and may use advertising and marketing strategies that achieve broader brand recognition or acceptance. In addition, our competitors may develop new products, services or technologies that render our products, services or technologies obsolete or less marketable. If we cannot continue to compete effectively against our competitors, our business, financial condition and results of operations will be materially and adversely affected.

We outsource critical operations, which exposes us to risks related to our third-party vendors, and we have begun to in-source certain technology functions, which exposes us to other risks.

We have entered into contracts with third-party vendors to provide critical services, technology and software in our operations. These outsourcing partners include: Fiserv, which provides back-end account and transaction data processing for OneAccounts; MasterCard, which provides the payment network for our debit MasterCard ATM cards, as well as for certain other transactions; and Comerica and Global Payments, which provide transaction processing and banking services for payment processing related to the SmartPay feature of our ePayment service. In the event that these service providers fail to maintain adequate levels of support, do not provide high quality service, discontinue their lines of business, terminate our contractual arrangements or cease or reduce operations, we may be required to pursue new third-party relationships, which could materially disrupt our operations and our ability to provide our products and services, and could divert management's time and resources. Replacement technology or services provided by replacement third-party vendors could be more expensive than those we have currently, while the process of transitioning services and data from one provider to another can be complicated and time consuming. If we are unable to complete a transition to a new provider on a timely basis, or at all, we could be forced to temporarily or permanently discontinue certain services, which could disrupt services to our customers and materially and adversely affect our business, financial condition and results of operations. We may be unable to establish comparable new third-party relationships on as favorable terms or at all, which could materially and adversely affect our business, financial condition and results of operations. With respect to the technology and operational support functions that we have in-sourced to date or that we seek to in-source, we may encounter difficulty or delays in developing and supporting an appropriate infrastructure to be able to perform these functions ourselves. For example, we brought the web and application hosting services, which were previously provided by Verizon Terremark, into our internally managed data center during the three months ended June 30, 2014. We may also not realize the full value of our investments in these projects.

We depend on our founders and other key members of executive management and the loss of their services could have a material adverse effect on our business.

We have historically depended on the efforts, skill and reputations of our founders and senior executive team, including Marc Sheinbaum (President and Chief Executive Officer), Mark Volchek (Founder and Director), Miles Lasater (Founder and Director), Casey McGuane (Chief Operating Officer), Robert Reach (Chief Sales Officer and Executive General Manager) and Christopher Wolf (Chief Financial Officer). We do not currently maintain key person life insurance policies with respect to our executive officers. None of our executive officers have entered into employment agreements with us that would prevent them from terminating their involvement with us at any time and/or pursuing other opportunities. In December 2013, Messrs Volchek and Lasater announced that they would be transitioning out of their roles as CEO and President, respectively, with Mr. Lasater reducing his hours to part-time and Mr. Volchek continuing as President and CEO until a new CEO was hired and a transition was completed. In April 2014, Mr. Sheinbaum replaced Mr. Volchek as our President and Chief Executive Officer with Mr. Volchek reducing his hours to part-time. The retirement of Messers Volchek and Lasater or the loss of any of our executive officers or other members of management could have a material adverse effect on our ability to manage our company, growth prospects, business, financial condition and results of operations.

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Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.

Defaults Upon Senior Securities

None.

Item 4.

Mine Safety Disclosures

Not applicable.

Item 5.

Other Information

None.

Item 6.

Exhibits

*	Filed herewith

(1)	Incorporated by reference to exhibit filed with Registrant's Report on Form 8-K filed on August 19, 2014.

(2)

The material contained in Exhibit 32.1 and Exhibit 32.2 is not deemed "filed" with the SEC and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language contained in such filing, except to the extent that the registrant specifically incorporates it by reference.

(3)

Pursuant to Rule 406T of Regulation S-T, the XBRL related information in Exhibits 101 to this Quarterly Report on Form 10-Q shall not be deemed to be "filed" for purposes of Section 18 of the Exchange Act of 1934, as amended, or otherwise subject to liability under that section, and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, except as expressly set forth by specific reference in such filing.

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SIGNATURES

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

Date: November 10, 2014

 

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