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Q3 2013 Earnings Call Transcript

Published: 7 Nov 2013

[Operator:]

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Q3 2013 Higher One Holdings, Inc. Earnings Conference Call hosted by Mark Volchek, CEO of Higher One Holdings. My name is Marie, and I will be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded. And now, I'd like to hand the call over to Mark Volchek, CEO. Please proceed.

[Kevin Leblanc:]

Thank you, Marie. This is Kevin LeBlanc, Director of Investor Relations with Higher One. I want to thank everyone for joining us today on the Higher One third quarter 2013 earnings call. Giving you prepared remarks on the call today would be our Chief Executive Officer, Mark Volchek; and our Chief Financial Officer, Chris Wolf. Mark will provide a summary of our quarterly performance and Chris will provide more detail on the financials before opening the call up for Q&A. There is a slide presentation that accompanies our discussion of the quarter that is available on our Investor Relations website at www.ir.higherone.com. This call contains statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Management's projections and expectations are subject to a number of risks and uncertainties that could cause actual performance to differ materially from that predicted or implied. Forward looking statements may be identified by the use of words such as expect, anticipate, believe, estimate, potential, should or similar words intended to identify information that is not historical in nature. Forward-looking statements contain are based on the current beliefs and expectations of Higher One and is subject to known and unknown risks and uncertainties. There are a number of risks and uncertainties that could cause actual results to differ materially from those contemplated by the forward-looking statements. These statements speak only as of the date they are made and the company does not intend to update or otherwise revise forward-looking information to reflect actual results of operations, changes in financial conditions, changes in estimates, expectations or assumptions, changes in general economic or industry conditions or other circumstances arising and/or existing since the preparation of the presentation, or to reflect the occurrence of any unanticipated events. The forward-looking statements in this presentation do not include the potential impact of any acquisitions or divestitures that may be announced or completed after the date thereof. For further information regarding risks associated with Higher One business, please refer to our filings with the Securities and Exchange Commission including annual reports on Form 10-K for the most recent fiscal year end, quarterly reports on Form 10-Q and current reports on form 8-K. Information about the factors that could affect future performance can be found in our future SEC dialings -- filings available on our website at www.ir.higherone.com. We will also provide certain metrics on a non-GAAP basis including adjusted EBITDA, adjusted EBITDA margin, adjusted net income, adjusted EPS and free cash flow. We believe that these non-GAAP measures, which exclude amortization of intangibles, stock-based compensation and certain non-recurring or noncash impacts to our results, provide useful information regarding normalized trends relating to the company's financial condition and results of operations. Reconciliations of these non-GAAP measures to the closest comparable GAAP measure are included in the appendix of the presentation that accompanies this call, as well as in our recent SEC filings. With that, I will now turn the call over to our CEO, Mark Volchek. Mark?

[Mark Volchek:]

Thank you, Kevin, and thank you, everyone, for joining us today. With me on the call is Chris Wolf, who will provide our financial update. We also have our President, Miles Lasater; and our Chief Operating Officer, Casey McGuane, available to answer questions after our prepared remarks. We have a number of topics to cover in today's call so let's get started. Please refer to the accompanying slide deck that is available on our Investor Relations website as I discuss the quarter and other topics. Turning to Slide 3. Total revenue was 11.5% higher compared to the third quarter last year. This was driven by payment transaction and higher education revenue that were higher than last year's results. Significant increases in revenue came from our acquisition of the Campus Labs and Campus Solutions businesses. Account revenue declined due to changes we made to our fee structure over the past several quarters. We will continue to evaluate our fee structures to ensure that we deliver good value for students. Operating expenses were up during the quarter, which is mainly the result of added employee cost from our recent acquisitions, as well as increased cost of compliance and regulation. This results in our adjusted EPS of $0.14 per share for the third quarter. We have seen strong growth in non-refund deposits with an increase of 24%. These deposits constitute a small but growing portion of overall account funding and were approximately 10% of total deposits in the accounts during the quarter. This indicates that students are making an affirmative choice to deposit more dollars into their OneAccounts. Part of our strategy to drive primary usage of the OneAccounts with our student base is to offer highly differentiated and competitive features via our mobile app. Mobile app users are more engaged customers and contribute the healthy increase in non-refund deposits. We recently launched a feature for the Higher One debit card that empowers student to turn their card on or off at their convenience. This feature is an ideal fit for a student's busy lifestyle or can be used as a self-budgeting tool. We also integrated the easy deposit mobile check capture app into the Higher One banking app to facilitate more streamlined mobile experience. In addition to providing detail in refunds, our proposed legal settlement and Campus Solutions progress, I will also cover updates on sales and the regulatory compliance environment. Turning to Slide 4. We know that disbursement trends are topic that many investors are interested in, so we'll start off with what we saw during the quarter and through October on refunds. This refund season, on a same school basis, we saw the number of unique recipients down 3%. To explain what that means, there has been a 3% decline in the aggregate number of students receiving a refund at all clients that we processed disbursements for in both the fall of 2012 and fall of 2013. Enrollment data is released on 1-year lagging basis, so this is the best proxy we have when looking at our enrollment in our client institutions. We've also seen financial aid dollars per unique recipient down around 3% on the same-school basis. Within this, we saw 2-year schools down 5%, while 4-year schools were down 1%. The number of unique recipients and the Financial Aid disbursement per recipient, are inputs and are macro factors that impact our business. Together, they caused total Financial Aid disbursement dollars to be down 6% on a same-school basis. Now turning to Slide 5. Growth in the launched SSE of students enrolled at schools for OneDisburse was good, up about 8% from the prior year. However, the growth in total dollars disbursed, including newly launched schools, was only up 2%. The last slide covers as there was a 6% decrease in dollars disbursed at existing clients, driven by a decline in the number of unique recipients and an average refund per recipient. This is the main driver of the delta between the growth in launched SSE and the growth in total refund dollars disbursed. In aggregate, including newly launched schools, the percent of refund dollars disbursed in the OneAccounts was down 4%, so the actual dollars disbursed in the OneAccounts was down 2%. So I've just given you a lot of numbers, so I'll revisit the highlights from my perspective. In the quarter, we grew a launched SSE by 8%, but dollars disbursed into OneAccount were down 2%. While there are components in the delta that are macro factors, we remain focused on increasing our student base, required relationships and improving the student value proposition so that students will continue to choose the OneAccount. Turning to Slide 6. I'd now like to talk about sales and our Campus Solutions progress. I'm pleased to report our third quarter new sales of OneDisburse was our best sales quarter since second quarter of 2012, with 131,000 OneDisburse SSE sold. The Campus Labs revenue growth rate has been over 30% since our acquisition last year and we continue to be pleased with the progress of this acquisition. Shortly after our acquisition our second quarter call in 2012, we expected Campus Labs to grow by 30% and are now pleased to see the growth came through. There are seasonal variations in the Campus Labs business and our sales team is continuing to growth that business. We believe that a key selling point to our clients is our reputation for delivering quality products with outstanding customer service. We are grateful for our clients that have worked with us this refund season through changes to some of our processes as we continue to strengthen our compliance. However, for various reasons, we do lose a client from time to time. During the third quarter, we had 3 OneDisburse clients that left representing about 40,000 SSE, with a net increase of 91,000 SSE for OneDisburse for the quarter, excluding the impact of annual IPED's enrollment update. Our retention rate for OneDisburse is still greater than 98%. Turning to Slide 7. I'm happy with the progress we're making with Campus Solutions. Looking at the refund side of Campus Solutions, we have continued signing clients to migrate from the Campus Solutions' legacy refund product to OneDisburse. Since closing the acquisition through October, we have signed 21 Campus Solutions clients to OneDisburse with an SSE count of 220,000. In addition to selling these schools, we have a team focused on training and scheduling the migration of Campus Solutions clients to OneDisburse. Implementation of OneDisburse for these former Campus Solutions clients will take place in the coming months, many of which will be live for the Springs disbursement cycle. Turning to Slide 8. Earlier this week, we disclosed an agreement in principal on a key terms of a settlement that would resolve the class action litigation that was filed against us in 2012. The parties remain in negotiations and a final settlement agreement is contingent upon reaching agreement on the remaining terms, of attaining corporate approval to the final agreement and court approval. The practice changes resulting from the litigation have largely already been implemented and are not expected to further materially impact our revenue moving forward. During the quarter, we accrued an expense of $16.3 million, which includes the proposed $15 million settlement fund amount and $1.3 million related to our estimated legal cost and other cost to administrators the settlement. We maintain, and have always maintained, that our business practices are lawful and proper and that the claims and lawsuit are without merit. We continue to believe that we offer outstanding products to both colleges and students and have entered into this agreement in principle to avoid a lengthy and costly litigation process, and to minimize business disruption in offering our valued services to students and institutions of higher education. This settlement if finalized and approved, would resolve all outstanding class action litigation against Higher One, involving the marketing usage of our OneAccount suite. At this point, there could be no assurances that the proposed settlement will be finalized as contemplated in agreement in principle. Turning to Slide 9. Our business model covers 2 highly regulated industries

[Christopher W. Wolf:]

Thanks, Mark. At this point, I'll begin the discussion of our financial results for the quarter, starting on Page 10 of the accompanying slide presentation. Please remember that all growth rates I mention will be year-over-year unless otherwise specified. Turning to Slide 10. I'll begin our discussion on revenue. Total revenue for the third quarter was $57.1 million compared to $51.2 million during the third quarter of last year, an increase of approximately 11.5%. The current quarter was aided by $4.4 million of revenue from the recently acquired Campus Solutions business and an incremental $2.1 million from Campus Labs. I'll discuss the driver of revenue changes in more detail on the upcoming slides. Gross profit margin for the current quarter was 56.2% compared to 57.4% last year, in absolute dollars gross margin increased over the same period last year due to the addition of our new businesses, along with the strong quarter from SmartPay, offsetting lower service fees. The change in gross profit margin was affected by the mix of revenue with lower account revenue, primarily service fees and higher amount of lower margin payments transaction revenue. The increases in our cost of revenue also included other expenses, including customer service costs and expenses associated with both of our recent acquisitions, including amortization expense of acquiring intangible assets and personnel related costs. We also incurred costs related to our transition service agreements with Sallie Mae where they provide certain services to us until the migration to the Higher One platform is complete. Offsetting these increases, we have continued to experience a significantly decrease in our provision for operational losses. The provision includes uncollectible fees and was impacted favorably by the elimination of the delinquent account fee. We've had a lot of discussion on changes to our account revenue over the last year. Slide 11 illustrates the impact of the different drivers that have impacted our account revenue. For this presentation, we've tried to isolate the impact of a number of changes that have happened over the course of the past 12 months. While we have shown them in separate columns, changes in 1 factor will also -- will often impact another factor. We have estimated the revenue impact based on the relationships that existed as of the third quarter of 2012. To be clear, this is an illustrative example to show directionally the moving parts of account revenue, and the impact that one factor can have on revenue. We [indiscernible] expected our account revenue to increase by approximately $2.9 million based on our launches of new schools compared to last year. As you can see, this expected increase was offset by a combination of lower enrollment and Financial Aid disbursements compared to last year, as well as a decrease in overall account adoption year-over-year. The outlook for adoption was mixed coming out of the third quarter as we saw some improvements during the quarter over prior year rates. Mark spoke about the increase in our non-refund deposits. This had an estimated $600,000 positive effect on revenue. The biggest impact year-over-year is the change that we've made to our fee schedule compared to the last year. The fees that we have eliminated or reduced led to a decrease of approximately $3.6 million in account revenue year-over-year. Let's review the variety of fee schedule updates, which took place over the past year that continues to impact our account revenue, specifically changes that went into effect in the first quarter are

[Operator:]

[Operator Instructions] And we have our first question, and it comes from the line of Andrew Jeffrey from SunTrust.

[Andrew W. Jeffrey:]

Mark, can you comment on the progress you're making with the Sallie Mae, Campus Solutions SSE converted? It's 220,000. It's a pretty good number. Can you give us a sense what the trajectory looks like out over the next few quarters, recognizing that you're not giving sort of high-level guidance?

[Mark Volchek:]

Sure. Thanks for the question. I can give you a little bit more color and sort of maybe a breakdown of the 220,000 SSE to give you some idea how that's rolled out. Looking at sort of rolling back kind of into Q2, we signed about 40,000 SSE in Q2. And so there's kind of 2 ways that we get SSEs. One is from actual Campus Solutions legacy refund clients that had a Campus Solutions product implemented and now converting to OneDisburse; and then there's also Campus Solutions payments clients that we're now converting to OneDisburse, which is kind of the second priority. So out of the first category, about 40,000 were converted in the second quarter, about 100,000 in the third quarter and an additional 60,000 in October. So as you can see, that's a pretty good trajectory and picking up. Additionally, we sold about 20,000 SSE to Campus Solutions clients that were payments clients that now have decided to implement a disbursement solution. That's kind of how it rolled out through the end of October. As we had talked about at the time of the acquisition, in that sort of Campus Solutions legacy refund product bucket, there's about 1 million SSE. And that's sort of our target and we strive to keep every single one of those even though that's difficult to do. But as you know, we have a passion for working with our clients and providing the best services. And the goal is to convert all of the legacy refund clients by Q2 of next year, so we still have a lot of work in front of us, or at least to sign them by Q2 of next year. There's a lot of work to do, but I think we're on a good path in terms of what we had expected at the time of the acquisition.

[Andrew W. Jeffrey:]

That's nice progress, especially the uptick in October. And then with regards to account revenue or revenue per account, I should say. We saw a deceleration in the decline. It sounds like there's still some moving parts in your overall fee structure. Do you feel like the -- although it would appear that the revenue per accounts clients will continue, do you feel like that the pace of the decline is now decelerating in a sustainable way?

[Christopher W. Wolf:]

Andrew, this is Chris. I'll take that question. Obviously, as we've made some of the fee changes in the beginning of the year, they've run their course through the year and we still have, it's still going to have to run through into Q4. So we'll still see another quarter of that behavior. In addition, with the delinquent account fee being suspended as of August 1, we're still going to have some run through that into the next year as well. But I wouldn't say that as we get more time, we are understanding the behavior a little bit better and we're getting a little bit better at analyzing that. So I won't go as far as saying pure stabilization there, but we're getting a better understanding of the behavior behind that. And then one other thing I do want to point out there is that the denominator has changed and we do have more accounts that would have been closed down because of fees in previous periods. So the denominator is a little bit higher this year makes comparability to the prior year a little bit more difficult than that, it will have to run itself through as the fee annualizes on a 12-month basis.

[Andrew W. Jeffrey:]

Got it. Okay. That's helpful. And then one more, if I may. Just with regard to initiatives to a drive adoption. It sounds like perhaps, the adoption rates have -- maybe not met your expectations. Are there some specifics things you're doing outside of focusing on mobile and trying to drive non-disbursement deposits into the OneAccounts?

[Miles Lasater:]

This is Miles. I'll be happy to talk about that. We do want to make sure we're doing our best to continue to strengthen the value proposition for students and for customers on the account base and we've been doing that in a number of ways. We did talk about mobile, we have some other things in the pipeline. And we also have adjusted the prices in the fee schedule to make sure the value proposition is right, and we'll continue to evaluate that given the competitive market dynamics, the regulatory environment and feedback from customers. We do also work to communicate the value proposition effectively. We've been doing some testing, for example, with more paid media. We've been doing some testing with different messaging in different ways to make sure that students and others understand our value proposition. And we've also been investing in understanding our customers better, both in the data we already have and otherwise. So there's a number of things that we're doing to tackle that.

[Operator:]

And our next question comes from the line of Chris Shutler from William Blair.

[Christopher Shutler:]

On the Campus Solutions business, when you guys are on boarding new clients, given the regulatory overhang that persists, are clients requesting that contracts be structured any differently than our past? So is there -- are there more flexible terms, shorter lengths, et cetera?

[Mark Volchek:]

Sure. I'll take that question, this is Mark. So we have not seen really a change to the contract, to the length. I think the impact we have seen is that schools are doing even more due diligence, spending more time during the buying process, evaluating, looking into the value proposition, looking into our product, doing a more thorough job analyzing it, having a committee involving students. So I think more it's impacting the timeline to closing deals, not necessarily the terms or the structure of the contracts per se.

[Christopher Shutler:]

Okay. Makes sense. And to follow up on that question earlier about the ultimate number you think you can get to out of that $1 million total available SSE from Campus Solutions. Is there any way to think about how many schools at this point have said that they're not going to be moving to Higher One? Or I mean, can you give us any more clarity on how that -- the TAM is today versus maybe where it was 6 months ago?

[Mark Volchek:]

Sure. That's a tough question. Since as we had said, our goal is really to keep every single one of those clients and that's really what we're striving for. Obviously, the financial deals works at a much lower number. So when we had originally run the model since from a financial perspective, we assumed significantly less than 1 million SSE to make the deal financially attractive and make that work. I think from an operational perspective, we've take it very seriously to make sure clients don't have a disruption and that we can continue providing services to them. And that's a really difficult thing to project, is how many those million we can get to. There are certainly are some clients that are having a difficult time and don't necessarily want to change what they're doing. But we have contractual commitments with Sallie Mae to end certain products by Q2 of next year, and so we'll continue to work with clients to figure out how to get them to OneDisburse and what we can do to make that -- the best solution for them and their students.

[Christopher Shutler:]

Okay. Makes sense. Just last one on a different topic. The comment that you made in the prepared remarks on Visa. Could you just review that for me again? Did you say that, that was a good part of the increase in the transaction revenue was adding Visa as an option of SmartPay? I just want to clarify.

[Christopher W. Wolf:]

Chris, this is Chris. That is correct. We introduced them as a card and I think in June the end of Q2 and we did see a pretty high volume of transactions from the card.

[Miles Lasater:]

This is Miles. I can add a little bit of context there. The driver primarily for that was a rule change of Visa, which allowed the addition of that. And we were excited to do that, so were our clients and we saw a nice upswing there.

[Operator:]

And our next question comes from the line of Michael Tarkan from Compass Point.

[Michael Tarkan:]

So you mentioned 3 clients that left OneDisburse. Can you just provide a little more color there as to why they left? Did they sign up with another competitor? Just any other color on that. And then as a follow-up, can you talk about how long your contracts with schools typically run and how many contracts could come up for renewal this year?

[Casey McGuane:]

Michael, this is Casey, thanks for the question. So the comment on Q3 and maybe before that. Just overall client support and retention remains really strong. If you recall, through Q1, we were 100% renewal on OneDisburse for 10 consecutive quarters. And in Q3, we did have 3 deconversions from OneDisburse a little bit deeper color there is 2 of the clients went to a competing service, and 1 brought the solution back in-house. To your second question, we typically see on average of about 3 years for a term on OneDisburse. I hope that helps.

[Michael Tarkan:]

Yes, that's great. And then I don't think you mentioned this quarter, but how many OneDisburse campuses and total campuses do you currently serve? Those numbers were around 600 and 1,600 or so last time?

[Mark Volchek:]

Yes, they are about the same and we don't update those numbers. Every quarter, what we really focused on is the number of SSE, so actually what we focus. So we have that a significant number of campuses and I the think we have that exact number in front of us nor do we publish the exact number of campuses.

[Michael Tarkan:]

Understood. And then one more. Any update to the ATM fleet? And how do you handle the conversions from Sallie Mae over to OneDisburse? I don't think Sallie Mae had their own ATM fleet. So are you building ATMs on those campuses, are you opening up your network for them? Any kind of color there.

[Miles Lasater:]

This is Miles. Yes. The ATM fleet is something that's an important part of the offering for a Refund Management and we do typically put an ATM on every campus, that's our goal. And we're usually successful in doing that. So as clients do sign up to convert as part of our standard implementation, we'll look at opportunities for where we can put ATMs in the best location for the school and the students, and we'll install them. And for schools that haven't had one before, I think that is an improvement for the student value proposition. There were some Campus Solutions clients that did have ATMs historically. But you're right, that it was not the norm.

[Operator:]

And our next question comes from the line of Mr. Mike Grondahl from Piper Jaffray.

[Michael J. Grondahl:]

The first one, the reg education getting pushed out and really without a date out there. How big of a hurdle is that as you're talking to new schools and whatnot?

[Miles Lasater:]

This is Miles. It certainly is a factor in the macro environment that we believe does impact the sales process. Mark talked a little bit earlier about how we've seen sales cycles lengthen as people are doing more due diligence. And there are certainly those that asked about the part we're making process and want to have more certainty. Our perspective is we've been through change with the Department of Education before in 2008. These -- the rules around delivering refunds changed and we updated our systems as the rules became more complex and updated our processes that protected clients, existing clients at the time from change. And so that's part of what we want clients to understand, is that as experts in this area, we can help protect them from change. Although there is some level of uncertainty and it does impact the sales process and no one can predict for certain what the outcome of that will making process will be. It's really barely begun.

[Michael J. Grondahl:]

Okay. And then with a couple of recent acquisitions, can you help us or just remind us to think about the seasonality in the payment transaction line? And also the higher-ed line?

[Mark Volchek:]

This is Mark. I can give you some general thoughts and then we can follow up with more specifics. Looking historically -- but on the higher-ed line, generally that does not have much seasonality as the rest of the business because those are subscription fees that schools pay and are often annual on a amortized kind of over a period. Season of the cash flow for some of those may be seasonal from a P&L perspective. There's less seasonality, again, but those are recognized over the annual period. And in terms of payment transaction revenue, there's really 2 different components now that are in there. There's the SmartPay type revenue that's linked to specific transactions, and then there's payment plan revenue, which is spread over the period of service again over the period of the payment plan. And so depending on the quarter, some quarters like Q3, are strong in terms of the actual transaction revenue. End of Q4 or early Q1, again creates a significant amount of transaction revenue. The payment plan revenue, again, is less seasonal because it's spread over the payment plan period. So if I would have to pick, it's kind of Q3 historically, sees the most transactions in Q2 probably the least and kind of the others in between. And that kind of helps you with seasonality around the business.

[Michael J. Grondahl:]

Okay, I appreciate that update. And then, 1 last question, kind of 2 parts. Can you provide what the interchange mix on account revenue was in 2012? And then in terms of the August 1 fee adjustment, what is the size of that relative to the changes you made in January?

[Christopher W. Wolf:]

Sure. This is Chris. On interchange, I think at this point, we just decided that we want to put this number out so we're going to make it a perspective, if you will announce it for folks say we just basically emphasize not to release the prior period that we hadn't. And so just putting a line in the sand and we'll provide this data on a perspective basis. So if you can oblige us on that, we'll continue to provide that data mix. And part of the reason that we've decided to do it now, as we mentioned, is that the shift is interchange is becoming more and more a piece of account revenues. So we think it's relevant, its size is growing at such, so I think this is a good period to start that and this is a relevant period to start that. As far as the fees, we don't talk about specific fees, but I will say directionally that the delinquent account fee was lesser than the changes that we did see at the beginning of the year. That's actually one of the issues that we had coming into the year. That account was actually underperforming. Believe it or not, from expectations. And so directionally, it's less but I don't want to minimize that it is a material fee and it will have an impact on our revenues through the rest of the year until it annualizes next August.

[Operator:]

And our next question comes from the line of Gary Prestopino from Barrington Research.

[Gary F. Prestopino:]

Most questions have been answered, but in terms on the highlights, non-refund deposits of 24%. Is that really dwelling into the fact that you're starting to get some traction or success with some of these cards that -- now have maybe more GPR card characteristics such as depositing payroll, things like that?

[Miles Lasater:]

This is Miles. Yes. I think it is a good sign that we're getting more traction with customers in understanding our value proposition as we continue to improve it. I think it's reflective of some of the enhancements that we've been able to make and we have even more enhancements that we want to make to make sure that the accounts in the experience of working with the Higher One from a student's perspective, is fully differentiated. And that number is healthy growth from a small base. But I like that nice 24% growth and we're going to be concentrating on trying to continue to grow that as much as we are able to. There's a lot of things that we're juggling in terms of the regulatory environment and I do think that continuing to strengthen the student value proposition can be helpful in managing some of that complexity.

[Operator:]

So, ladies and gentlemen, that concludes our questions for today. And now, I'd like to hand back to Kevin LeBlanc for closing remarks.

[Kevin Leblanc:]

Thank you, Marie. I'd like to thank everyone for joining us on the call this morning. We sincerely appreciate your interest in the company and we look forward to updating you on the next earnings call. I hope you have a great day. Thank you.

[Operator:]

Thank you. Ladies and gentlemen, that concludes your conference call for today. Thank you for joining us, and you may now disconnect. Thank you.