ITEM 1. BUSINESS
Overview
Blackhawk is a leading prepaid payment network utilizing proprietary technology to offer to consumers and businesses a broad range of prepaid cards in physical and electronic forms, as well as related prepaid products, payment services and incentives solutions. We distribute our prepaid products to consumers through our retail distribution partners and online through our websites or websites operated by third-party distribution partners. We also provide prepaid products and related services to business clients. Our prepaid products include closed loop gift cards which are redeemable at a specific merchant, open loop gift and incentive cards which are redeemable where the network association (Visa, MasterCard, American Express, or Discover) are accepted, prepaid telecom cards, and general-purpose reloadable (“GPR”) cards and related reload services. We currently offer our products and/or solutions directly or through commercial relationships in the United States and
25
other countries and can deliver solutions in over 100 countries.
We were founded in 2001 as a division of Safeway Inc. (“Safeway”, which merged with Albertsons Holdings LLC in January 2015 and is referred to hereinafter as “Albertsons/Safeway”). We were incorporated in Delaware in 2006 and completed our initial public offering in April 2013. In April 2014, Safeway distributed the remaining shares it then held to its shareholders (the “Spin-Off”). In May 2015, we converted all outstanding shares of our Class B common stock into shares of Class A common stock on a one-for-one basis and renamed Class A common stock as common stock which continues to trade on the Nasdaq exchange under the symbol “HAWK”.
We believe our extensive network provides significant benefits to our key constituents: consumers who purchase, receive or use the products and services we offer; content providers who offer branded gift cards and other prepaid products that are redeemable for goods and services; distribution partners who sell those products; and business clients that distribute our products as customer incentives or rewards, or offer one or more of our incentive platforms to their employees or sales forces. For consumers, we provide convenience and value by offering a broad variety of quality brands and content through physical and digital retail distribution locations or through loyalty, incentive and reward programs offered by our business clients. For our content providers, we drive incremental sales by providing access to millions of consumers and creating new customer relationships. For our retail distribution partners, we provide an important product category that can drive incremental in-store and online traffic and customer loyalty. For our business clients, we provide a wide array of services, software and prepaid products to enhance their customer loyalty, sales channel incentive and employee engagement programs. Our technology platforms allow us to efficiently and seamlessly connect our network participants and offer new products and services as payment technologies evolve. We believe the breadth of our distribution network and product content, combined with our consumer reach and technology platforms, create powerful network effects that enhance value for our constituents.
We are one of the largest third-party distributors of gift cards in the world based on the value of funds loaded on the cards we distribute. Our retail network connects to more than
900
content providers and over
252,000
active retail distribution locations, providing access to tens of millions of consumer visits per week. In addition, we sell physical and electronic gift cards or eGifts to consumers through leading online distributors, such as Amazon.com and Staples.com, and our websites GiftCards.com, GiftCardMall.com, GiftCardLab.com and Cardpool.com. With our acquisition of CashStar, Inc. and its subsidiaries (collectively, “CashStar”) in 2017, we are growing our first-party digital business, which enables retailers to distribute their digital and physical gift cards directly to consumers and businesses across a wide range of channels. Our retail channels accounted for over
$16.3 billion
in transaction dollar volume during fiscal
2017
.
We have also established a leading position in the incentives and rewards marketplace over the past four years through our acquisitions of InteliSpend Prepaid Solutions, LLC and its subsidiaries (collectively, “InteliSpend”) in 2013, Incentec Solutions, Inc. (“Incentec”), CardLab, Inc. and its subsidiaries (collectively, “CardLab”), Parago, Inc. and its subsidiaries (collectively, “Parago”) in 2014, Achievers Corp. and its subsidiaries (collectively, “Achievers”) in 2015, and IMShopping, Inc. and its subsidiary (collectively, “NimbleCommerce”), Omni Prepaid LLC and its subsidiaries (collectively, “GiftCards”), 888extramoney.com LLC (“Extrameasures”) and The Grass Roots Group Holdings Limited and its subsidiaries (collectively, “Grass Roots”) in 2016. We provide a broad variety of customized employee, consumer and sales channel incentives, loyalty and engagement solutions to over 20,000 business clients worldwide.
On January 15, 2018, we entered into an agreement and plan of merger (the “Merger Agreement”) with BHN Holdings, Inc., a Delaware corporation (“Parent”), and BHN Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Parent (“Merger Sub”). The Merger Agreement provides, among other things and subject to the terms and conditions set forth
therein, that Merger Sub will be merged with and into the Company (the “Merger”), with the Company continuing as the surviving corporation and as a wholly owned subsidiary of Parent. Parent has agreed to acquire the Company in an all-cash transaction for a total consideration of approximately $3.5 billion, which includes our debt. We currently expect the transaction, which is subject to stockholder and regulatory approvals, and other customary closing conditions, to close mid-2018. See Part I, Item 1A, “Risk Factors” and
Note 16
—
Subsequent Event
of the Notes to Consolidated Financial Statements included in Part II, Item 8, “Financial Statements and Supplementary Data” of this report.
Distribution
U.S. Retail Distribution
Our U.S. retail distribution network consists of our physical distribution partners such as grocery, specialty, convenience and other retail stores, our websites GiftCardMall.com, GiftCardLab.com, GiftCards.com and third-party online and digital merchants.
The following are selected examples of our U.S. direct distribution partners across various retail channels:
|
|
|
Grocery
|
Ahold, Albertsons/Safeway, Giant Eagle, Kroger, Publix, Whole Foods
|
Specialty/Other
|
Target, Bed Bath & Beyond, Best Buy, The Home Depot, Lowe’s, Michaels, Office Depot, Staples, Kohl’s
|
Convenience
|
QuikTrip, Wawa
|
Digital
|
Amazon.com, eBay.com, Staples.com, PayPal.com, Samsung Pay, Verizon, Chase Pay,
MileagePlus (United Airlines)
|
We typically enter into contracts with our retail distribution partners ranging from three years to five years in length. The agreements generally include varying degrees of exclusivity for our distribution of prepaid products in their stores. They also provide, among other things, that we will pay our distribution partner a negotiated commission based on a percentage of the content provider commission or purchase fee we receive upon the sale of our various products and services. We believe our extensive gift card content, some of which is exclusive, coupled with frequent marketing promotions and the relatively high productivity for the space utilized, is an incentive for our retail distribution partners to continue to renew our distribution agreements with them.
As of
December 30, 2017
, we had over
46,000
locations in the U.S. across approximately
140
retail distribution partners. Our largest U.S. retail distribution partner during each of the last three fiscal years was Kroger, where consumers activated prepaid products or purchased telecom handsets that generated
10.3%
,
11.8%
and
12.1%
of our total worldwide operating revenues for the fiscal years
2017
,
2016
and
2015
, respectively. Albertsons/Safeway and Giant Eagle each generated
5.9%
and
4.1%
of our
2017
total worldwide operating revenues, respectively,
5.0%
and
6.6%
of our
2016
total worldwide operating revenues, respectively, and
5.3%
and
9.2%
of our
2015
total worldwide operating revenues, respectively.
We also sell prepaid products online through our websites GiftCards.com, GiftCardMall.com and GiftCardLab.com, through third-party online retailers including Amazon.com, Staples.com and eBay.com, and through websites operated by certain of our retail distribution partners such as Albertsons/Safeway, Giant Eagle, Kroger and Meijer. In addition, we provide solutions including application program interfaces (“APIs”), to allow our “digital” distribution partners that have consumer-facing applications to incorporate gift cards and related prepaid capabilities and functions into their services. These partners include financial institutions, social networks, smartphone providers, retailers and other payment services companies, including Samsung Pay and Google Wallet.
Revenue from U.S. Retail sales totaled
55.3%
,
59.3%
and
64.8%
of our total operating revenues for
2017
,
2016
and
2015
, respectively.
Incentive, Loyalty and Engagement Programs
We provide incentives, loyalty and engagement solutions for consumers, customers, sales personnel, channels and employees. Our consumer incentives business provides end-to-end rebate processing and prepaid product fulfillment services directly to a wide range of manufacturers, retailers and service providers. We provide a hosted platform solution to businesses that allow them to manage integrated sales promotions and incentive programs for sales personnel and sales channels, using points, prepaid products and other rewards. We also offer directly to enterprise clients a hosted software-as-a-service solution to create a more engaged workforce through social recognition, wellness incentives and achievement awards. We provide physical prepaid card and eGift fulfillment services for organizations that have consumer loyalty programs such as financial institutions
and airlines. Our fulfillment services are also integrated to our incentives and reward solutions and provided to our direct business clients as well as to other providers of incentives programs. In addition, we sell customized network branded prepaid cards and merchant gift cards to business customers through our OmniCard.com website and other business partners. We provide these services, collectively, to over 20,000 business clients and generated revenues totaling
15.2%
,
14.7%
and
10.9%
of total worldwide operating revenues for
2017
,
2016
and
2015
, respectively.
International Distribution
Outside the United States, we have followed a similar retail strategy of distributing through leading grocery chains, but with a greater emphasis on convenience store chains which receive higher volume of consumer traffic as compared to the U.S.. In certain countries, we distribute through sub-distributors that contract with in-country retailers for sale of our products and in certain other countries, we operate through joint ventures with local businesses to distribute global and local content. As of
December 30, 2017
, our products were sold in over
206,000
locations across approximately
470
retail distribution partners.
Besides consumer sales through our international retail distribution partners, our regional teams sell prepaid products and incentives solutions directly to business clients and to other providers of incentives and rewards solutions. Our acquisition of Grass Roots in October 2016 significantly increased such sales, particularly in the United Kingdom. During 2017, we launched our direct-to-consumer and direct-to-business websites in additional countries outside the U.S. and we started offering our employee engagement platform to business customers outside the U.S. and Canada. Revenue from international sales totaled
29.5%
,
26.0%
and
24.3%
of our total operating revenues for
2017
,
2016
and
2015
, respectively (see
Note 12
—
Segment Reporting and Enterprise-Wide Disclosures
for information on long-lived assets internationally).
Products and Services
Prepaid products that we offer at retail are “activated” when a consumer loads funds (with cash or with a debit or credit card payment) at a retail store location or online. We also provide reloads for reloadable prepaid products, including prepaid telecom accounts and general-purpose reloadable (“GPR”) cards.
We typically negotiate multi-year contracts with our content providers. For many of our content providers, we have various types of exclusivity provisions related to certain of the retail channels through which we distribute their products. As of
December 30, 2017
, we had agreements with over
900
content providers.
Our incentives businesses provides software, consulting services, program management, reward processing and reward fulfillment to our business clients. The majority of rewards are fulfilled using a prepaid open loop (network-branded) gift card.
Apple Inc. is our largest content provider and represented
11.2%
,
12.7%
and
13.7%
of our total operating revenues for
2017
,
2016
and
2015
, respectively. No other content provider represented more than 10% of our total operating revenues during these periods.
For information on revenues and segment profit for our three reportable segments, see
Note 12
—
Segment Reporting and Enterprise-Wide Disclosures
in the notes to our consolidated financial statements.
Retail Products
Gift Cards
Closed Loop (Private-Branded) Gift Cards.
Closed loop (private-branded) gift cards are generally described as merchant or brand-specific prepaid cards, used for transactions exclusively at a particular merchant’s branded locations and websites (including franchise locations) or for a specific business’s services wherever they are provided. We distribute closed loop gift cards in categories including digital media and e-commerce, dining, electronics, entertainment, fashion, transportation, home improvement and travel. We also distribute a full range of prepaid wireless or cellular cards from major carriers including AT&T, Sprint’s Boost Network and Virgin Mobile brands, T-Mobile, TracFone and Verizon, that can be used to load airtime onto the prepaid handsets. We are continuing to expand relationships with partners that offer products or services for consumer self-use as much as for gifting, and for which our grocery and other retail distribution channels provide a convenient location to load funds onto these prepaid products. Examples include Airbnb, Uber, metropolitan transit cards and lottery. In 2015, we acquired Didix Gifting & Promotions B.V. and its subsidiaries (collectively, “Didix”), a provider of “aggregated category” gift and promotional-themed cards that can be redeemed at a variety of participating merchants grouped by category such as restaurants. In 2016, we acquired Spafinder Wellness, Inc. and its subsidiaries (collectively, “Spafinder”), a provider of prepaid cards that can be used at over 25,000 spas and salons in the U.S., Canada and the United Kingdom, and Samba Days Experience Group Ltd. and certain of its subsidiaries (collectively, “Samba”), a provider of aggregated content cards in Canada
and the United Kingdom. In 2017, we acquired CashStar, which supports the growth in our first-party digital business. Gift cards that we distribute for sale directly to consumers in physical or online locations carry no consumer fees, and funds associated with the cards generally do not expire. Closed loop products contributed
66.0%
of total operating revenues in
2017
.
|
|
|
Product Category
|
Selected Brands
|
Digital Media & e-commerce
|
Amazon.com, Facebook, Google Play, iTunes, Microsoft
|
Dining
|
Applebee’s, Outback Steakhouse, Starbucks, Subway
|
Electronics
|
Best Buy, GameStop
|
Entertainment and Leisure
|
AMC Theatres, Regal Entertainment Group
|
Fashion
|
Forever 21, JCPenney, Kohl’s, Macy’s, TJ Maxx
|
Transportation
|
DART, BP, Shell, Uber
|
Home Improvement and Office
|
Home Depot, Lowe’s, Office Depot, Staples
|
Travel
|
Airbnb, Southwest Airlines
|
Other Retail
|
Barnes & Noble, Bed Bath & Beyond, Target
|
Open Loop Gift Cards.
Open loop (network-branded) gift cards are prepaid gift cards associated with an electronic payment network (such as Visa, MasterCard, American Express, or Discover), and are honored at multiple, unaffiliated locations (wherever cards from these networks are generally accepted). They are not merchant-specific. We distribute non-reloadable open loop gift cards carrying the American Express, MasterCard and Visa brands in our retail channels. During 2016, we introduced “category cards” which are open loop gift cards that can only be redeemed at specific categories of merchants such as dining or fashion. We also introduced a Visa-branded card that can be used wherever Visa-branded cards are honored but that also provide a merchant loyalty incentive in the form of “cash back” that is loaded onto the card after the card is redeemed at a participating merchant location. With the acquisition of GiftCards, we began offering a fully customizable Visa electronic gift card delivered by email or to a mobile device. We serve as the program manager for our proprietary Visa gift cards that we distribute. Funds loaded on these cards by consumers at our retail distribution locations generally do not expire and can be redeemed at most merchant locations that accept the credit cards of the same network brand. In addition, we distribute GPR cards provided by Green Dot, NetSpend and other industry leaders in this product category. GPR cards have features similar to a typical bank checking account, including fee-free direct deposit, in-store and online purchasing capability wherever a credit card is accepted, bill payment and ATM cash access. We offer a proprietary reload network named Reloadit, which allows consumers to reload funds onto their previously purchased third-party GPR cards. In 2016, we sold our proprietary GPR product line branded PayPower to NetSpend in the U.S. and a financial services company in Canada and have discontinued sales of this branded product in 2017. Open loop products contributed
14.3%
of total operating revenues for
2017
.
Incentive, Loyalty and Engagement Programs
Our incentives businesses provide (i) solutions to allow businesses to manage consumer incentive programs, including in-store, online or mail-in rebate processing, (ii) a hosted software platform for managing sales person and sales channel incentive programs, (iii) bulk prepaid card ordering systems and websites to allow business and incentive program clients to use prepaid cards as part of their own incentive and reward programs, (iv) direct-to-participant fulfillment services for prepaid cards, checks and merchandise under client loyalty programs, and (v) employee engagement programs. Our prepaid products for the incentives businesses include open loop incentive cards, open loop reloadable incentive cards that allow multiple incentives and rewards to be loaded onto a recipient’s card, restricted authorization network incentive cards that permit redemption at only selected merchants as well as closed loop gift cards. Funds on open loop incentive cards that are offered by businesses as incentives, rewards, or promotions generally have expiration dates ranging from 90 days to one year from the date of card activation.
We offer a hosted software-as-a-service platform for enterprise customers to implement employee engagement programs. The functions and content of the programs can be configured for each customer’s requirements and are designed similarly to a social media application. Our solutions include mobile applications as well as web-based tools for both employers and employee-participants to give monetary-based and non-monetary recognition for various achievements, behavior or milestones. Points earned through our employee engagement businesses can be redeemed by recipients for prepaid cards or merchandise.
Revenues from our incentives businesses accounted
for
15.2%
of
total operating revenues for
2017
.
Cardpool Exchange Services
Cardpool, our gift card exchange business, offers consumers an online marketplace and various retail locations to sell unused gift cards that they do not want and an online sales website to purchase gift cards at a discount that others have sold to Cardpool. Cardpool contributed
2.7%
of total operating revenues in
2017
.
On October 9, 2017, the Board of Directors approved management’s plan to sell the Cardpool gift card exchange business. As a result, Cardpool’s assets and liabilities were accounted for as held for sale as of
December 30, 2017
. See
Note 6
—
Consolidated Financial Statement Details
for additional information.
Digital Services for Online and Mobile Applications
We have developed a technology platform to integrate prepaid products with other parties’ online, digital and mobile applications. In addition, we have developed application program interfaces, or APIs, that allow our digital distribution partners to offer gift cards and eGifts for purchase or for redemption in their online and mobile applications. Revenue contribution from the digital services business is incorporated into the operating revenues for the related businesses.
Other Services
We receive marketing funds from our content providers to promote their prepaid cards throughout our retail distribution network. In some instances, we may receive a portion of other fees such as account maintenance, interchange or referral fees for certain open loop cards. We also receive other fees related to certain closed loop programs. These revenues have been included in the applicable products detailed above. We also receive recurring monthly management fees from partners for certain program services.
We provide card production and processing services to some of our prepaid gift and telecom content providers. These services accounted for
1.8%
of total operating revenues in
2017
.
Description of Revenue Types
In a typical retail closed loop card transaction, the consumer purchases a gift card from our retail distribution partner who collects the transaction dollar volume. The retail distribution partner then forwards to us the collected amount, less the retail distribution partner’s share of the commission. We then remit the transaction dollar volume of each card, less the total amount of the commission and fees, to the applicable content provider. The cardholders access the value they loaded on a closed loop card by using the card to pay for goods or services at the content provider’s physical store point-of-sale system or online at the content provider’s website.
For a retail open loop card transaction, the consumer purchases a Visa, MasterCard or American Express branded gift card from our retail distribution partner who collects the transaction dollar volume and a purchase fee. For bank-issued cards, the retail distribution partner then forwards to us the transaction dollar volume and purchase fee, less the retail distribution partner’s share of the purchase fee. We then remit the transaction dollar volume of each card to the issuing bank, retaining the balance of the consumer purchase fee. The cardholders can access the value they loaded on an open loop card by using the card to pay for goods or services at any merchant that accepts the network-branded card. For such transactions, the issuing bank transfers funds through the network association to the merchant’s bank following the consumer’s purchase. The process is virtually the same with respect to American Express gift cards. In addition to the portion of the consumer purchase fee, we earn program management fees from issuing banks that are based on unspent card balances, as well as interchange fees, account service fees, merchant commissions from participating merchants on cash-back products and, in some countries, card expiration fees resulting from the balances on expired cards.
For our incentives businesses, we typically earn client purchase fees for the sale of incentive cards; fees for processing and fulfillment; program management fees from issuing banks that are based on expected balances remaining on cards after expiration or non-use, interchange and other fees from issuing banks; merchant commissions on the redemption of certain open loop incentive cards using our proprietary restricted authorization network; monthly or periodic fees for client use of our management software; and miscellaneous program management and integration fees. Our employee engagement business also earns revenue from redemption of employee rewards for merchandise or prepaid products.
The following table describes how fees are earned for each of the following products:
|
|
|
Products and Services
|
How We Earn Fees
|
|
|
Closed Loop Gift Cards
|
For our third-party gift card and first-party digital gift card businesses, content providers pay us commission and fees based on transaction dollar volume. For our third-party gift card business, we share commissions with our retail distribution partners where applicable.
For aggregated category gift cards that are issued and/or program-managed by Blackhawk, we earn commissions from the retail participants on redeemed balances, and also recognize revenues for unredeemed balances.
|
|
|
Open Loop Gift Cards
|
Consumers pay a purchase fee upon card activation depending on transaction dollar volume. We share this fee with our retail distribution partners and content providers.
Our issuing banks pay us additional program management fees and other fees for our Visa gift cards, based, in part, on unspent balances.
We also earn a portion of merchant interchange fees when customers use our proprietary Visa gift card for purchases. Merchants pay us a commission on “cash-back” cards when redeemed with them.
|
|
|
Incentive, Loyalty and Engagement Programs
|
We earn fees when we sell incentive cards to our business clients.
We earn fees for processing and fulfillment of consumer rebates.
Our issuing banks pay us additional program management fees and other fees for our open loop incentive cards.
We earn a portion of merchant interchange fees when consumers use our open loop incentive cards for purchases. We earn additional commissions when consumer make purchases using our restricted authorization network cards. We earn revenues when employees redeem points for merchandise or prepaid cards.
We earn subscription or periodic fees for use by customers of our employee engagement software platform.
|
|
|
Cardpool Exchange Services
|
We earn a markup on the sale of pre-owned closed loop gift cards, which we purchase from consumers at a discount to the amount of funds remaining on a card.
|
|
|
Digital Services for Online and Mobile Applications
|
Content providers pay us commission and fees based on transaction dollar volume for digital products sold using our technology platform that integrates prepaid products with other parties’ online, digital and mobile applications.
We also earn commissions from our digital distribution partners that offer gift cards and eGifts for purchase or for redemption in their online and mobile applications. Revenue contribution from the digital services business is incorporated into the operating revenues for the related businesses.
|
|
|
Other Fee Categories
|
Content providers pay us marketing funds to support programs that we coordinate with our retail distribution partners for the in-store or online promotion of their gift cards.
We earn revenue for card production and packaging services for content providers.
We earn fees related to certain closed loop card programs. We earn a split and/or fees on merchant promotions purchased through the NimbleCommerce.com website.
We earn management fees, transaction fees and technology fees from our business clients.
|
Technology
We own and operate the critical components of our technology platforms including our transaction acquiring switch, prepaid card processing system, settlement systems, order management/fulfillment system and digital platforms. These integrated systems are designed to allow us to authorize, process and settle transactions, fulfill products to distribution partners or consumers, address security and regulatory compliance, rapidly onboard new retail distribution partners and content providers and provide customer service across our network’s broad points of contact and electronic mediums. We own and operate various technology platforms related to our Incentives business.
Our product and service offerings are enabled by our technology platform in the following ways:
Gift Cards
.
We have made a significant investment in direct connections to our retail distribution partners to ensure high reliability of the gift card activation transaction at the point of sale. We process activation transactions primarily through direct connections to the card processing systems of our content providers or their service providers. In addition, for our proprietary Visa gift cards, we process all post-activation transactions, including redemptions, directly on our proprietary cloud-based processing platform. We have value-added features enabled through our processing platform that we believe can help differentiate our proprietary prepaid cards in the market.
Incentive, Loyalty and Engagement Programs.
Blackhawk incentives platforms include software used by business clients for purchase and management of incentives and rewards, a consumer rebate processing platform that digitizes all rebate claims submitted and applies automated program rules for validation of claims, software platforms that provide a social media-like interface for employee engagement, and reward fulfillment platforms that allow us to immediately fulfill approved rewards with prepaid cards or merchandise. We also provide reports and analytical tools for our business clients to evaluate the effectiveness of their programs. Most open loop incentive cards we issue are also processed on our proprietary cloud-based processing platform.
Cardpool Exchange Services.
Cardpool operates on a proprietary platform built on an open source web framework that manages pricing, spreads, orders and inventory for our gift card exchange marketplace and provides a web-based interface for customers and an API-based interface for partners.
Digital Services for Online and Mobile Applications
.
Our digital platform is built on a scalable and configurable web platform. It deploys a service-oriented architecture in which web services enable other digital providers to utilize the prepaid services we offer.
Over the past three years, our capital expenditures related to the development of these technology platforms, other card management platforms and related hardware totaled
$154 million
, including
$52 million
in
2017
. Over the past several years, we have also acquired multiple platforms as a result of acquisitions, some of which we have consolidated into a single platform during 2017, and others which we intend to consolidate.
We believe our technology capabilities, enhanced by the platforms we acquired to provide scalable loyalty, incentive and reward solutions, provide us with significant competitive advantages and cannot be easily replicated. Our systems are designed to be secure, highly reliable and scalable. Our technology capital expenditures included expenditures for hardware, licensed software and internally developed software for processing and switching technologies, mobile applications and enhancements to our enterprise resource planning and other infrastructure systems.
Sales and Marketing
Our sales and marketing teams manage our relationships with content providers, retail distribution partners and incentive business clients. They also develop retail marketing programs and communication strategies to reach consumers. We provide or fund product display fixtures and provide or coordinate merchandising visits intended to maintain in-stock conditions on the displays. We also manage or participate in the design of effective in-store marketing programs funded jointly by our content partners and distribution partners. In addition, we use online marketing in connection with GiftCards.com, GiftCardMall.com, GiftCardLab.com, OmniCard.com and Cardpool.com. For our incentive business clients, we provide research papers, consumer and employee analyses and other tools and services to develop their incentive and reward programs.
Operations and Customer Service
Our operations services include production and fulfillment of prepaid products for which we contract with third-party card printing, warehouse and fulfillment logistics providers. Contracts with these providers are typically for terms of three to four years. In the United States, Canada and the United Kingdom, we have integrated our order management systems with our third-party service providers’ warehouse management systems to optimize fulfillment to stores. For select retail distribution partners that elect to participate, we also operate an inventory tracking and replenishment system and deliver automated re-orders directly to individual stores to optimize in-stock positions. In the U.S., we provide in-store merchandising services for certain retail distribution partners.
Our services also include a customer service function that utilizes both in-house and third-party call centers to support our proprietary open loop products, fulfillment and card activation for our retail distribution channel, online gift card sales and our business incentive and reward channel. Our in-house call centers are located in Reno, Nevada, in San Salvador, El Salvador and in Miramichi, Canada. We employ second level customer and partner support personnel at our corporate headquarters in Pleasanton, California, and our various regional offices. We utilize Interactive Voice Response systems, web-based support and email support in our customer service efforts. We also operate Network and Security Operations Centers to monitor systems and partner connections worldwide.
Bank Partners
We derive a material amount of our revenue from our program-managed proprietary open loop products, which include our proprietary Visa gift and open loop incentive cards. For the year ended
December 30, 2017
, these programs represented
16.5%
of our total operating revenues. The issuing banks for these programs, as well as issuing banks for other network-branded card programs for which we act as program manager, provide Federal Deposit Insurance Corporation (“FDIC”) insured depository accounts tied to prepaid open loop cards, access to ATM networks, membership in the card associations and other banking functions. The issuing banks hold cardholder funds, charge applicable fees on certain products and collect interchange fees charged to merchants when cardholders make purchase transactions using prepaid open loop cards. Our issuing banks remit some or all of those fees to us plus additional fees for our program management services.
In the United States, we currently serve as program manager for two issuing banks for our proprietary open loop products: MetaBank and Sunrise Bank, N.A. MetaBank has been an issuing bank for our proprietary Visa gift cards since 2007, was an issuing bank for the incentive and reward products for InteliSpend, Parago and Extrameasures prior to our acquisitions of these companies, and will continue as an issuing bank for incentive and rewards products for our incentives businesses. For the fiscal years ended
December 30, 2017
,
December 31, 2016
and
January 2, 2016
, the MetaBank program represented
12.9%
,
13.2%
and
15.2%
, respectively, of our total operating revenues. Sunrise Bank, N.A. has been an issuing bank for our proprietary Visa gift card program since November 2011.
Outside the United States, we contract with several issuing banks for open loop gift cards for which we act as program manager. For the year ended
December 30, 2017
, these programs represented approximately
1.5%
of our total operating revenues.
Please see “Risk Factors—Risks Related to Our Business and Industry—We rely on relationships with card issuing banks for services related to products for which we act as program manager, and our business, results of operations and financial condition could be materially and adversely affected if we fail to maintain these relationships or if we maintain them under new terms that are less favorable to us” and “Risk Factors—A data security breach could expose us to costly government enforcement actions, liability and protracted and costly litigation, and could adversely affect our reputation and operating revenues” for additional information.
Competition
Due to the breadth of our product offerings and distribution channels, we face a number of competitors across different business sectors domestically and internationally in our Retail Products business, including some competitors whose products we distribute in select locations. Many of our existing competitors with respect to our closed loop and open loop business are larger than we are and have greater resources, larger and more diversified customer bases and greater name recognition than we do. Our competitors include Visa, Western Union, MoneyGram, Green Dot, NetSpend, Euronet and InComm. New companies, or alliances among existing companies, may be formed that rapidly achieve a significant market position. Our Incentives business competes with others who provide rebate and incentive processing services such as Young America, ACB and other providers of traditional travel and merchandise incentives and awards such as Maritz, Aimia and OC Tanner as well as companies focused on employee incentives such as Globoforce. Our incentives and rewards business also competes with other prepaid products companies for fulfillment of awards including Citibank Prepaid Solutions, InComm, and multiple other prepaid card providers for the incentives business. We also face competition from companies who are developing new prepaid access technologies and from businesses outside of the prepaid industry, including traditional providers of financial services such as banks and money services providers like First Data Corporation, and card issuers that offer credit cards, private label retail cards and gift cards. Retailers and other content partners who have a widely used prepaid card like Apple iTunes and Amazon may offer their own programs as an alternative for incentives and rewards or payments. Some of these competitors offer digital solutions that do not require plastic cards for redemption by the consumer and allow for the sale of prepaid cards through new or existing online and mobile channels.
Overall, our ability to continue to compete effectively will be based on a number of factors, including customer service, quality and range of products and services offered, reliability and security of our technology platforms, price, reputation, customer convenience and other considerations. For additional information about competition, please see “Risk Factors—Risks Related to Our Business and Industry—We face intense competitive pressure, which may materially and adversely affect our revenues and profitability. Continued consolidation within our industry could increase the bargaining power of our current and future clients and vendors and further increase our client concentration or reduce competition among our third-party vendors;” “—We rely on our content providers for our product and service offerings, and the loss of one or more of our top content providers or a decline in the contracted commission when such a content provider renews its agreement with us or a decline in demand for their products, or our failure to maintain existing exclusivity arrangements with certain content providers or to attract new content providers to our network, could have a material adverse effect on our business, results of operations and financial condition;” and “—If our retail distribution partners fail to actively and effectively promote our products and services, or if they implement operational decisions that are inconsistent with our interests, our future growth and results of operations may suffer.”
Seasonal Variations
For our retail business, a significant portion of gift card sales occurs in late December each year during the holiday selling season. As a result, we earn a significant portion of our revenues, net income and cash flows during the fourth quarter of each year and remit the majority of the cash, less commissions, to our content providers in January of the following year. The timing of our fiscal year-end, December holiday sales and the related January cash settlement with content providers significantly increases our Cash and cash equivalents, Settlement receivables and Settlement payables balances at the end of each fiscal year relative to normal daily balances. We also experience an increase in revenues, net income and cash flows during the second quarter of each year, which we primarily attribute to the Mother’s Day, Father’s Day and graduation gifting season and the Easter holiday. Depending on when the Easter holiday occurs, the associated increase is in either the first or second quarter. As a result, quarterly financial results are not necessarily reflective of the results to be expected for the year or any other interim or future period. Seasonality also impacts our incentives businesses, but such impact is smaller in comparison to our retail business.
For additional information about the effects of seasonality on our business, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Quarterly Results of Operations and Seasonality.”
Intellectual Property
The technologies used in the payments industry are protected by a wide array of intellectual property rights. Our intellectual property is important to our continued success. Like other companies in our industry, we rely on patent, trademark and copyright laws and trade secret protection in the United States and other countries, as well as employee and third-party nondisclosure agreements and other methods to protect our intellectual property and other proprietary rights. We also license technology from third parties which provide various levels of protection against technology infringement by third parties.
We pursue the registration of our intellectual property rights, such as domain names, trademarks, service marks and patents, in the United States and in various other countries. We own dozens of registered trademarks, including the Blackhawk
Network, Reloadit, InteliSpend, Parago, Achievers, GiftCards and Everywhere gift card trademarks. We also have many pending trademark applications. Through agreements with our retail distribution partners and customers, we authorize and monitor the use of our trademarks in connection with their activities with us.
As of
December 30, 2017
, we own, or are the exclusive licensee of,
80
patents in various countries providing coverage for systems and methods relating to prepaid product loads and reloads, ewallet services, eGift card transactions, swipe/scan reload, packaging, card design, processing, online services, card exchange, and fraud prevention in eGift card transactions. These patents expire at various dates, ranging from
2020 to 2033
. Additionally, we have over
140
patent applications in various countries for various card assemblies and packaging, security features, activation and processing methods, and online prepaid services and have licensed exclusive rights that arise from ten patent applications. We do not know whether any of our pending patent applications will result in the issuance of patents or whether the examination process will require us to narrow our claims. We believe a robust patent portfolio to protect our intellectual property rights and proprietary systems will become increasingly important as the prepaid industry continues to expand.
Regulation
We operate in an ever-evolving and complex legal and regulatory environment. We, the products and services that we offer and market, and those for which we provide processing services, are subject to a variety of federal, state and foreign laws and regulations, including, but not limited to:
|
|
•
|
federal anti-money laundering laws and regulations, including the USA PATRIOT Act (the “Patriot Act”), the Bank Secrecy Act (the “BSA”), anti-terrorist financing laws and regulations and anti-bribery and corrupt practices laws and regulations in the U.S., and similar international laws and regulations;
|
|
|
•
|
state unclaimed property laws and regulations and state money transmitter or similar licensing laws and regulations;
|
|
|
•
|
federal and state consumer protection laws, including the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the “CARD Act”), and the Durbin Amendment to Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), and laws and regulations relating to privacy and data security; and
|
|
|
•
|
foreign jurisdiction payment services industry laws and regulations.
|
Anti-Money Laundering Regulation.
We are subject to a comprehensive federal anti-money laundering (“AML”) regulatory regime that is constantly evolving. The AML laws and regulations to which we are subject include the BSA, as amended by the Patriot Act. The BSA requires U.S. financial institutions to assist U.S. government agencies to detect and prevent money laundering by: (a) developing, implementing and maintaining an AML program; (b) implementing a customer identification program; (c) not engaging in business with foreign shell banks; (d) establishing customer due diligence procedures and, where appropriate, enhanced customer due diligence procedures for certain customers and foreign correspondent and private banking accounts; and (e) sharing certain information with other financial institutions and the U.S. government. Pursuant to the BSA, we have instituted a BSA/AML compliance program. Please see “Risk Factors—Risks Related to Our Business and Industry—We are increasingly facing more stringent anti-money laundering laws and regulations, compliance with which may increase our costs of operation, decrease our operating revenues and disrupt our business” for additional information.
Our subsidiary, Blackhawk Network California, Inc. (“Blackhawk Network California”), is registered as a money services business with the Financial Crimes Enforcement Network (“FinCEN”) of the Treasury Department and is subject to certain reporting, recordkeeping and AML requirements under the BSA and its implementing regulations. In addition, the Prepaid Access Rule promulgated by FinCEN, under its authority to implement the BSA, imposes certain obligations, such as registration and collection of consumer information, on “providers of prepaid access” for certain prepaid access programs, including certain prepaid products issued by banks. FinCEN has taken the position that where the issuing bank has principal oversight and control of such prepaid access programs, no other participant in the distribution chain, including us as the program manager of such prepaid access programs, is required to register as a provider of prepaid access under the Prepaid Access Rule. On November 4, 2013, FinCEN affirmed that it did not expect Blackhawk to register as a provider of prepaid access under the Prepaid Access Rule for the bank-issued products for which we serve as a program manager.
In order to qualify for certain exclusions under the Prepaid Access Rule, some of our content providers modified operational elements of their products, such as limiting the amount that can be loaded onto a card in any one day. In addition, pursuant to the Prepaid Access Rule, we and some of our retail distribution partners have adopted policies and procedures to prevent the sale of more than $10,000 in prepaid access (including closed loop and open loop prepaid access products) to any one person during any one day.
Anti-Terrorism and Anti-Bribery Regulation.
We are also subject to an array of federal anti-terrorism and anti-bribery legislation. For example, the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”) administers a series of laws and regulations that impose economic and trade sanctions against targeted foreign countries and regimes, terrorists, international narcotics traffickers, those engaged in activities related to the proliferation of weapons of mass destruction, and other entities and persons that pose threats to the national security, foreign policy or economy of the United States. As part of its enforcement efforts, OFAC publishes a list of individuals and companies owned or controlled by, or acting for or on behalf of, targeted countries, as well as those, such as terrorists and narcotics traffickers designated under programs that are not country-specific, with whom U.S. persons are generally prohibited from dealing.
The Foreign Corrupt Practices Act (“FCPA”) prohibits the payment of bribes to foreign government officials and political figures and includes anti-bribery provisions enforced by the Department of Justice and accounting provisions enforced by the Securities and Exchange Commission (the “SEC”). The FCPA has a broad reach, covering all U.S. companies and citizens doing business abroad, among others, and defining a foreign official to include not only those holding public office but also local citizens affiliated with foreign government-run or -owned organizations. The FCPA also requires maintenance of appropriate books and records and maintenance of adequate internal controls to prevent and detect possible FCPA violations. Please see “Risk Factors—Risks Related to Our Business and Industry—Abuse of our prepaid products for purposes of financing sanctioned countries, terrorist funding, bribery or corruption could cause reputational or other harm that could have a material adverse effect on our business, results of operations and financial condition” for additional information.
State Unclaimed Property Regulation.
For some of our prepaid products, we or our issuing banks are required to remit unredeemed funds to certain (but not all) states pursuant to unclaimed property laws and regulations. However, unclaimed property laws and regulations are subject to change. Please see “Risk Factors—Risks Related to Our Business and Industry—Costs of compliance or penalties for failure to comply with or changes in state unclaimed property laws and regulations and changes in state tax codes could have a material adverse effect on our business, financial condition and results of operations” for additional information.
Money Transmitter License Regulation
.
Most states regulate the business of sellers of traveler’s checks, money orders, drafts and other monetary instruments, which we refer to collectively as money transmitters. While many states expressly exempt banks and their agents from regulation as money transmitters, others purport to regulate the money transmittal businesses of bank agents or do not extend exemptions to non-branch bank agents. We have historically taken the position that state money transmitter statutes do not apply to our core prepaid card distribution business. Nonetheless, in connection with our open loop business, we rely on the money transmitter licenses of Blackhawk Network California in connection with our bank-issued products in some of those states; and for our core retail distribution business, Blackhawk Network, Inc., is licensed in connection with gift card distribution in two states, Maryland and West Virginia.
Blackhawk Network California is a licensed money transmitter in 48 U.S. jurisdictions and Puerto Rico. The remaining U.S. jurisdictions in which our open loop business operates do not currently issue licenses or otherwise regulate money transmitters or have determined that we do not need to be licensed in connection with our current businesses. In those states where we are licensed, we are subject to direct supervision and regulation by the relevant state licensing authorities charged with enforcement of the money transmitter statutes and must comply with various restrictions and requirements, such as those related to the maintenance of certain levels of net worth, surety bonding, selection and oversight of our authorized delegates, permissible investments in an amount equal to our outstanding payment obligations with respect to some of the products subject to licensure, recordkeeping and reporting, and disclosures to consumers. We are also subject to periodic examinations by the relevant licensing authorities, which may include reviews of our compliance practices, policies and procedures, financial position and related records, various agreements that we have with our issuing banks, retail distribution partners and other third parties, privacy and data security policies and procedures, and other matters related to our business. As a regulated entity, Blackhawk Network California incurs significant costs associated with regulatory compliance. We anticipate that compliance costs and requirements will increase in the future for our regulated subsidiaries and that additional subsidiaries may become subject to these or new regulations. Please see “Risk Factors—Risks Related to Our Business and Industry—If we fail to maintain our existing money transmitter licenses or permits, or fail to obtain new licenses or permits in a timely manner, our business, results of operations and financial condition could be materially and adversely affected” for additional information.
Consumer Protection Regulation.
We are subject to various federal, state and foreign consumer protection laws and regulations, including those related to unfair and deceptive trade practices as well as privacy and data security, which are discussed under “Risk Factors—Risks Related to Our Business and Industry—Failure to comply with, or further expansion of, consumer protection regulations could have a material adverse effect on our business, results of operations and financial condition,” “—Data protection and regulations related to privacy, data protection and information security could increase our costs, as well as negatively impact our growth,” and “—A data security breach could expose us to costly government enforcement actions, liability and protracted and costly litigation, and could adversely affect our reputation and operating revenues” for additional information.
Federal Regulation.
Congress and federal regulatory agencies have enacted and implemented laws and regulations that affect the prepaid industry, such the CARD Act and FinCEN’s Prepaid Access Rule. Products of certain non-bank financial services companies, including money transmitters and prepaid access providers, are now regulated at the federal level by the Consumer Financial Protection Bureau (the “CFPB”), which began operations in July 2011, bringing additional uncertainty to the regulatory system and its impact on our business. Please see “Risk Factors—Risks Related to Our Business and Industry—We are increasingly facing more stringent anti-money laundering laws and regulations, compliance with which may increase our costs of operation, decrease our operating revenues and disrupt our business,” “—Abuse of our prepaid products for purposes of financing sanctioned countries, terrorist funding, bribery or corruption could cause reputational or other harm that could have a material adverse effect on our business, results of operations and financial condition,” “—Failure to comply with, or further expansion of, consumer protection regulations could have a material adverse effect on our business, results of operations and financial condition,” and “—If we fail to comply with federal banking regulation, we may be subject to fines and penalties and our relationships with our issuing banks may be harmed” for additional information.
Privacy Regulation.
In the ordinary course of our business, we collect and store personally identifiable information about customers of our various websites, users of our incentive platforms, and holders of our proprietary Visa gift and open loop incentive cards. This information may include names, addresses, email addresses, social security numbers, driver’s license numbers and account numbers. We also maintain a database of cardholder data for our proprietary Visa gift card relating to specific transactions, including account numbers, in order to process transactions and prevent fraud. These activities subject us to certain privacy and information security laws, regulations and rules in the United States (including, for example, the privacy provisions of the Gramm-Leach-Bliley Act and its implementing regulations and various other federal and state privacy and information security statutes and regulations) and the Payment Card Industry Data Security Standard (“PCI DSS”) issued by the Payment Card Industry Security Standards Council, as well as foreign regulation imposed by the European Union and certain Asia-Pacific countries.
These laws, as well as our agreements with our issuing banks, contain restrictions relating to the collection, processing, storage, disposal, use and disclosure of personal information and require that we have in place policies regarding information privacy and security. We have in effect a privacy policy, as well as business processes, relating to personal information provided to us in connection with requests for information or services, and we continue to work with our issuing banks and other third parties to update our policies and processes and adapt our business practices in order to comply with applicable privacy laws and regulations. Certain state laws and regulations also require us to notify affected individuals of certain kinds of security breaches of their personal information. These laws and regulations may also require us to notify state law enforcement, regulators or consumer reporting agencies in the event of a data breach. Please see “Risk Factors—Risks Related to Our Business and Industry—Failure to comply with, or further expansion of, consumer protection regulations could have a material adverse effect on our business, results of operations and financial condition,” “—Data protection and regulations related to privacy, data protection and information security could increase our costs, as well as negatively impact our growth,” and “—A data security breach could expose us to costly government enforcement actions, liability and protracted and costly litigation, and could adversely affect our reputation and operating revenues” for additional information.
Card Association and Network Organization Rules.
In addition to the laws and regulations discussed above, we and our issuing banks are also subject to card association and debit network rules and standards. These rules and standards apply to a variety of activities, including how consumers and merchants may use their cards and data security. Each applicable card association and network organization audits us from time to time to ensure our compliance with these rules and standards. Noncompliance with these rules or standards due to our acts or omissions or the acts or omissions of businesses that work with us could result in fines and penalties or the termination of the card association registrations held by us or any of our issuing banks. Please see “Risk Factors—Risks Related to Our Business and Industry—Changes in card association rules or standards set by Visa, MasterCard and Discover, or changes in card association and debit network fees or products or interchange rates, could materially and adversely affect our business, financial condition and results of operations” for additional information.
Foreign Regulation.
We are subject to regulation by foreign governments and must maintain permits and licenses in certain foreign jurisdictions in order to conduct our business. Our Blackhawk Network (UK) Limited subsidiary is regulated as an electronic money institution in the United Kingdom and issues an open loop product. We have “passported” the money license to Germany, Belgium and the Netherlands under EU regulations. Upon the United Kingdom’s exit from the European Union, we may be required to obtain a license in the EU for the conduct of our business in that region. Foreign regulations also present obstacles to, or increased costs associated with, our expansion into international markets. For example, in certain jurisdictions we face costs associated with repatriating funds to the United States, administrative costs associated with payment settlement and other compliance costs related to doing business in foreign jurisdictions. We are also subject to foreign privacy and other regulations, including the General Data Protection Regulation (GDPR), which will become effective in the EU in May 2018. The GDPR will impose additional obligations and risks upon our businesses, including the risk of substantially increased penalties for non-compliance. These foreign regulations often differ in kind, scope and complexity from U.S. regulations. Please see “Risk Factors—Risks Related to Our Business and Industry—We are subject to added business,
political, regulatory, operational, financial and economic risks associated with our international operations” and “—Data protection and regulations related to privacy, data protection and information security could increase our costs, as well as negatively impact our growth” for additional information.
For additional information about the regulatory environment in which we operate, please see “Risk Factors—Risks Related to Our Business and Industry—We operate in a highly and increasingly regulated environment, and failure by us or our partners and clients to comply with applicable laws and regulations could have a material adverse effect on our business, results of operations and financial condition” and “—Changes in laws and regulations to which we are subject, or to which we may become subject in the future, may materially increase our costs of operation, decrease our operating revenues and disrupt our business.”
Employees
As of
December 30, 2017
, we had
3,190
employees. We are not subject to any collective bargaining agreement and have never been subject to a work stoppage. We believe that we have maintained good relationships with our employees.
Corporate and Available Information
Our principal executive offices are located at 6220 Stoneridge Mall Road, Pleasanton, California 94588, and our telephone number at that location is (925) 226-9990. Our website is www.blackhawknetwork.com. The information available on or that can be accessed through our website is not incorporated by reference into and is not a part of this Annual Report and should not be considered to be part of this Annual Report.
We file reports with the SEC, including Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any other filings required by the SEC. We make available on our Investor Relations website, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information on our website is not incorporated by reference into this Annual Report or in any other report or document we file with the SEC.
The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.
ITEM 1A. RISK FACTORS
Our business faces significant risks, some of which are set forth below to enable readers to assess, and be appropriately apprised of, many of the risks and uncertainties applicable to the forward-looking statements made in this Annual Report on Form 10-K. You should carefully consider these risk factors as each of these risks could adversely affect our business, operating results, cash flows and financial condition. If any of the events or circumstances described in the following risks actually occurs, our business may suffer, the trading price of our common stock and our 2022 Notes could decline and our financial condition and results of operations could be harmed. Given these risks and uncertainties, you are cautioned not to place undue reliance on forward-looking statements. These risks should be read in conjunction with the other information set forth in this Annual Report on Form 10-K. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us, or that we currently believe to be immaterial, may also adversely affect our business.
Risks Related to the Merger
The Merger is subject to receipt of approval from our stockholders as well as the satisfaction of other closing conditions, including consents and approvals, in the Merger Agreement.
On January 15, 2018, we entered into an agreement and plan of merger (the “Merger Agreement”) with BHN Holdings, Inc., a Delaware corporation (“Parent”), and BHN Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Parent (“Merger Sub”) which provides, among other things and subject to the terms and conditions set forth therein, that Merger Sub will be merged with and into us (the “Merger”), with us continuing as the surviving corporation and as a wholly owned subsidiary of Parent. The Merger Agreement contains a number of conditions to completion of the Merger, including, among others, (i) the adoption of the Merger Agreement by the holders of a majority of outstanding shares of our common stock entitled to vote thereon at a stockholders meeting duly called and held for such purpose, (ii) the expiration or earlier
termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, (iii) the receipt of certain consents and approvals and the expiration or termination of related statutory waiting periods, (iv) the absence of any law, order or injunction of a court or governmental entity of competent jurisdiction prohibiting the consummation of the Merger or the other transactions contemplated thereby, (v) the accuracy of the representations and warranties contained in the Merger Agreement (subject to certain qualifications), and (vi) the performance by the parties of their respective obligations under the Merger Agreement in all material respects. The obligation of Parent to complete the Merger is also conditioned on (i) the absence of a Material Adverse Effect (as defined in the Merger Agreement) on the Company after the date of the Merger Agreement and (ii) no more than 10% of the outstanding shares of our common stock exercising dissenting rights. We can provide no assurance that all required consents and approvals will be obtained or that all closing conditions will otherwise be satisfied (or waived, if applicable), and, if all required consents and approvals are obtained and all closing conditions are satisfied (or waived, if applicable), we can provide no assurance as to the terms, conditions and timing of such consents and approvals or the timing of the completion of the Merger. Many of the conditions to completion of the Merger are not within either our or Parent’s control, and neither company can predict when or if these conditions will be satisfied (or waived, if applicable). Any delay in completing the Merger could cause us not to realize some or all of the benefits that we expect to achieve if the Merger is successfully completed within its expected timeframe.
Failure to complete the Merger could materially adversely affect our stock price, future business operations and financial results.
If the Merger is not completed for any reason, including as a result of our stockholders failing to adopt the Merger Agreement, our stockholders will not receive any payment for their shares in connection with the Merger. Instead, Blackhawk will remain an independent public company, and the shares will continue to be traded on the Nasdaq. Moreover, our ongoing business may be materially adversely affected and we would be subject to a number of risks, including the following:
|
|
•
|
we may experience negative reactions from the financial markets, including negative impacts on our stock price, and it is uncertain when, if ever, the price of the shares would return to the prices at which the shares currently trade;
|
|
|
•
|
we may experience negative publicity, which could have an adverse effect on our ongoing operations including, but not limited to, retaining and attracting employees, distribution partners, content partners, business clients, customers, providers, advertisers and others with whom we do business;
|
|
|
•
|
we will still be required to pay certain significant costs relating to the Merger, such as legal, accounting, financial advisor, printing and other professional services fees, which may relate to activities that we would not have undertaken other than in connection with the Merger;
|
|
|
•
|
we may be required to pay a cash termination fee and/or expense reimbursement as required under the Merger Agreement;
|
|
|
•
|
the Merger Agreement places certain restrictions on the conduct of our business, which may have delayed or prevented us from undertaking business opportunities that, absent the Merger Agreement, we may have pursued;
|
|
|
•
|
matters relating to the Merger require substantial commitments of time and resources by our management, which could result in the distraction of management from ongoing business operations and pursuing other opportunities that could have been beneficial to us; and
|
|
|
•
|
litigation related to the Merger or related to any enforcement proceeding commenced against us to perform our obligations under the Merger Agreement.
|
If the Merger is not consummated, the risks described above may materialize and they may have a material adverse effect on our business operations, financial results and stock price, especially to the extent that the current market price of our common stock reflects an assumption that the Merger will be completed.
We will be subject to various uncertainties while the Merger is pending that may cause disruption and may make it more difficult to maintain relationships with distribution partners, content partners, business clients, customers, providers, advertisers and others with whom we do business.
Uncertainty about the effect of the Merger on employees, distribution partners, content partners, business clients, customers, providers, advertisers and others with whom we do business may have an adverse effect on us. These uncertainties may impair our ability to attract, retain and motivate key personnel until the Merger is completed, and could cause distribution partners, content partners, business clients, customers, providers, advertisers and others with whom we do business to attempt to change existing business relationships with us. Retention and motivation of certain employees may be challenging while the Merger is pending, as certain employees may experience uncertainty about their future roles. If key employees depart, our
business could be harmed. In addition, there could be distractions to or disruptions for our employees and management associated with obtaining the required consents and approvals to close the Merger. Our distribution partners, content partners, business clients, customers, providers, advertisers and others with whom we do business may experience uncertainty with the Merger, including with respect to current or future business relationships following the Merger. Our business relationships may be subject to disruption as distribution partners, content partners, business clients, customers, providers, advertisers and others with whom we do business may attempt to negotiate changes in existing business relationships or consider entering into business relationships with parties other than us. These disruptions could have an adverse effect on our business operations and financial results. The risks and adverse effects, of such disruptions could be exacerbated by a delay in completion of the Merger or termination of the Merger Agreement.
We are subject to certain restrictions in the Merger Agreement that may hinder operations pending the consummation of the Merger.
Whether or not the Merger is completed, the pending Merger may disrupt our current plans and operations, which could have an adverse effect on our business and financial results. The Merger Agreement generally requires us to operate our business in the ordinary course of business consistent with past practice pending completion of the Merger and it also restricts us from taking certain actions with respect to our business and financial affairs, subject to certain exceptions. These restrictions could be in place for an extended period of time if the consummation of the Merger is delayed, which may delay or prevent us from undertaking business opportunities that, absent the Merger Agreement, we might have pursued, or from effectively responding to competitive pressures or industry developments. For these and other reasons, the pendency of the Merger could adversely affect our business and financial results.
If the Merger Agreement is terminated, we may, under certain circumstances, be obligated to pay a termination fee to Parent and/or reimburse Parent for its expenses. These costs could require us to use cash that would have otherwise been available for other uses.
If the Merger is not completed, in certain circumstances, we could be required to pay a termination fee of up to $109 million to Parent and certain expenses up to $6.8 million, or less under specified circumstances. If the Merger Agreement is terminated, the termination fee we may be required to pay, if any, under the Merger Agreement may require us to use available cash that would have otherwise been available for general corporate purposes or other uses. For these and other reasons, termination of the Merger Agreement could materially adversely affect our business operations and financial results, which in turn would materially and adversely affect the price of our common stock.
Risks Related to Our Business and Industry
We may not be able to grow at historic rates in the future, if at all.
Our revenues grew from
$1.9 billion
in 2016 to
$2.2 billion
in
2017
, representing a growth rate of
18%
, which was slightly lower than the average growth rate of
19%
in the immediately preceding three years. There can be no assurance that we will be able to continue our historic growth rates in future periods. Our ability to maintain and grow our business depends on a number of factors, many of which are outside our control. These include:
|
|
•
|
changes in consumer and corporate preferences and demand for the products and services that we offer;
|
|
|
•
|
our ability to retain and attract new retail and corporate customers;
|
|
|
•
|
our ability to maintain and expand our distribution network and business partners;
|
|
|
•
|
our ability to maintain and expand the supply and variety of products and services that we distribute and offer;
|
|
|
•
|
our ability to increase the productivity of our distribution partners’ stores;
|
|
|
•
|
our ability to anticipate and adapt to technological changes in the industry, as well as to develop new technologies to deliver our product and service offerings;
|
|
|
•
|
our ability to maintain our relationships with banks that issue open loop prepaid cards (“card issuing banks”) and other industry participants;
|
|
|
•
|
pricing pressure in the face of increasing competition and other market forces;
|
|
|
•
|
regulatory changes or uncertainties that increase compliance costs, decrease the attractiveness of the products and services we offer or make it more difficult or less attractive for us, our distribution partners or our content providers, including card issuing banks, to participate in our industry; and
|
|
|
•
|
consumer acceptance of our product and services offerings in international markets, and our ability to grow our international operations and manage related regulatory compliance and foreign currency fluctuations.
|
Even if we are successful in increasing our operating revenues through our various initiatives and strategies, we may experience a decline in growth rates and/or an increase in expenses, which could have a material adverse effect on our business, results of operations and financial condition.
Our future growth and profitability depend upon our continued expansion within the markets in which we currently operate and the further expansion of these markets. As part of our strategy to achieve this expansion, we look for acquisition opportunities, investments and alliance relationships with other businesses that will allow us to increase our market penetration, technological capabilities, product offerings and distribution capabilities. We may not be able to successfully identify suitable acquisition, investment and partner candidates in the future, and if we do, they may not provide us with the value and benefits we anticipate.
Our operating revenues may decline if we lose one or more of our top retail distribution partners, fail to maintain existing relationships with our retail distribution partners or fail to attract new retail distribution partners to our network, or if the financial performance of our retail distribution partners’ businesses declines.
The success of our business depends in large part upon our relationships with retail distribution partners. During
2017
,
2016
and
2015
, products sold through our top five largest retail distribution partners accounted for approximately
25.7%
,
28.5%
and
32.2%
of our operating revenues, respectively.
Many of our retail distribution partner agreements are subject to renewal every three to five years. Upon expiration of their agreements with us, our distribution partners may enter into relationships with our competitors instead of renewing their agreements with us, renew all or a portion of their agreements with us on less favorable terms or establish direct relationships with our content providers. In addition, a distribution partner may file for bankruptcy or otherwise sell off or wind-down its business. There is no assurance that we will be able to continue our relationships with these distribution partners on the same or similar terms, or at all, in future periods. Among other things, many of our distribution partner agreements contain varying degrees of exclusivity for us as the provider of prepaid products in their stores, and it is important to our competitive positioning to maintain those exclusive relationships. Our operating results could be materially and adversely affected if any of our significant distribution partners terminates, fails to renew or fails to renew on similar or more favorable terms, its agreement with us; and any publicity regarding such loss could harm our reputation, making it more difficult to attract and retain other distribution partners. In addition, exclusive relationships between potential distribution partners and our competitors as well as other commercial arrangements may make it difficult for us to attract new distribution partners to our network.
The success of our business also depends on the continued success of our distribution partners’ businesses. Accordingly, our operating results may fluctuate with the performance of our partners’ businesses, including their ability to maintain and increase consumer traffic in their stores.
In addition, the Merger could affect our relationships with current or prospective retail distribution partners. Please see the Risk Factor titled “We will be subject to various uncertainties while the Merger is pending that may cause disruption and may make it more difficult to maintain relationships with distribution partners, content partners, business clients, customers, providers, advertisers and others with whom we do business.”
If our retail distribution partners fail to actively and effectively promote our products and services, or if they implement operational decisions that are inconsistent with our interests, our future growth and results of operations may suffer.
Approximately
79.1%
of our
2017
operating revenues were derived from sales of our products and services through our retail distribution partners. Our success depends heavily on the prepaid products selected for display by our distribution partners and how our distribution partners actually display and promote the prepaid products, which we can influence and facilitate, but do not control. For example, the in-store placement and size of our prepaid card displays, as well as the marketing and merchandising efforts of our distribution partners for our products and services, all have an impact on the number and transaction dollar volume of products and services sold. Although we advise our distribution partners concerning optimal display of the card content, our contracts allow distribution partners to exercise significant discretion over the placement and promotion of our products in their stores. In addition, our distribution partners who only have basic displays of our products may not be willing or able to implement enhanced displays and marketing efforts, which could significantly harm our ability to grow our business. If our distribution partners give more favorable placement or promotion to the products and services of our competitors, or otherwise fail to effectively market our products and services, or implement changes in their systems that disrupt the integration with our processing systems, our results of operations may suffer.
Historically, inclusion of our products and services in certain of our distribution partners’ customer loyalty programs has resulted in significant increases in sales of our products at such partners. A part of our growth strategy is to continue to expand inclusion and promotion of our products in these loyalty programs. However, customer participation in these loyalty programs may decline, or our distribution partners may fail to adopt new loyalty programs that include our distributed products and services, change their existing loyalty programs in a manner that reduces or eliminates inclusion of our products and services or reduces the programs’ effectiveness or terminate their existing loyalty programs altogether. For example, some of these loyalty programs provide for discounts on gasoline. Fuel price declines or reduction of the fuel discount by our distribution partners, could cause customer participation in these loyalty programs to decline. Any of these events could have a material adverse effect on our business, results of operations and financial condition.
In addition, the Merger could affect our relationships with current or prospective retail distribution partners. Please see the Risk Factor titled “We will be subject to various uncertainties while the Merger is pending that may cause disruption and may make it more difficult to maintain relationships with distribution partners, content partners, business clients, customers, providers, advertisers and others with whom we do business.”
We rely on our content providers for our product and service offerings, and the loss of one or more of our top content providers, a decline in the contracted commission when such a content provider renews its agreement with us, a decline in demand for their products, or our failure to maintain existing exclusivity arrangements with certain content providers or to attract new content providers to our network, could have a material adverse effect on our business, results of operations and financial condition.
The success of our business depends, in large part, on our ability to offer a wide array of quality content. Our agreements with our content providers generally range from one to three years in length. There can be no assurance that we will be able to negotiate a renewal of those agreements on satisfactory economic or other terms or at all. Some of these agreements also permit the content providers to terminate their agreements with us prior to expiration if we fail to meet certain operational performance standards, among other reasons. In addition, we distribute the open loop gift and reloadable products of certain of our competitors, such as American Express, Green Dot and NetSpend. These content providers may choose to cease doing business with us for competitive or other reasons.
Many of our content provider agreements specify varying degrees of exclusivity for Blackhawk as a third-party distributor. Failure to maintain the same level of exclusivity of any of our agreements, whether upon renewal with our content providers or otherwise, could adversely affect our business, results of operations and financial condition. The exclusive arrangements that we have been able to negotiate vary widely, and in many instances exclusivity is limited to particular channels, such as conventional grocery retailer channels. Our content providers with limited or no exclusivity arrangements may decide to establish direct relationships with our distribution partners or use other third-party distributors to sell through existing or other channels. Our content providers may also eliminate their third-party distribution relationships entirely and offer their cards only in their own physical and online retail locations. Certain of our content providers represent a significant portion of our revenues, one of which (Apple Inc.) represented
11.2%
,
12.7%
and
13.7%
of our total operating revenues in
2017
,
2016
and
2015
, respectively.
Some of our contracts with content providers require a bank letter of credit to secure a portion of our payment obligations. Failure to provide adequate security or our failure to demonstrate our creditworthiness to certain content providers, or to prospective new content providers, may adversely affect our ability to maintain our relationships with our content providers or adversely affect our cash flows. Please see the Risk Factor titled “Our senior secured credit facility contains certain restrictions that limit our flexibility in operating our business and, in the event of a default, could have a material adverse impact on our business and results of operations.”
Our ability to grow our business depends, in part, on our ability to expand our product offerings by adding new content providers. Some prospective content providers could have exclusive relationships with our competitors. In addition, some of our agreements with content providers prohibit us from offering products of those providers’ competitors. If we are not able to attract new content providers due to exclusivity arrangements, competition or other factors, our business may suffer.
In addition, the Merger could affect our relationships with current or prospective content providers. Please see the Risk Factor titled “We will be subject to various uncertainties while the Merger is pending that may cause disruption and may make it more difficult to maintain relationships with distribution partners, content partners, business clients, customers, providers, advertisers and others with whom we do business.”
The success of our business is heavily dependent on consumer demand for our content providers’ products and services. Any factors negatively affecting our content providers or their industries, including those discussed elsewhere in this “Risk Factors” section, could have a material adverse effect on our business, results of operations and financial condition.
We rely on relationships with card issuing banks for services related to products for which we act as program manager, and our business, results of operations and financial condition could be materially and adversely affected if we fail to maintain these relationships or if we maintain them under new terms that are less favorable to us.
We rely on card issuing banks for critical services, such as membership in the Visa card association and provision of depository accounts insured by the Federal Deposit Insurance Corporation (the “FDIC”) tied to our program-managed open loop card programs, including gift cards and incentive debit cards. MetaBank is one of the card issuing banks for our proprietary U.S. open loop card programs. In 2017, it was the card issuing bank for the substantial majority of such programs. The MetaBank program represented approximately
12.9%
,
13.2%
and
15.2%
of our total operating revenues for
2017
,
2016
and
2015
, respectively.
If our relationship with MetaBank deteriorates, it could hinder our ability to grow our business and have a material adverse effect on our business, results of operations and financial condition. Under our agreement with MetaBank, we meet periodically with its representatives to review program management fees MetaBank pays us and we have agreed, from time to time, to adjust such fees on new card activations based on trends in consumer use of these prepaid cards and, in particular, the aggregate percent redeemed. Historically, these adjustments have been fee reductions based on changing redemption patterns. There can be no assurance that such fees will not continue to decline, which could have a material adverse effect on our revenues and, accordingly, our business, results of operations and financial condition. In addition, we may not be able to renew our existing agreements with similar terms or in their entirety with card issuing banks or enter into relationships with additional banks on acceptable terms, or at all
.
Furthermore, consumer spending patterns may change, resulting in a decrease of unredeemed card balances, which, in turn, could adversely affect our program revenues from our card issuing banks, results of operations and financial condition.
We have agreements with Sunrise Bank, N.A. as a second card issuing bank for proprietary Visa gift cards. There can be no assurance that we will be able to reduce the risk associated with our reliance on MetaBank through our agreements with Sunrise Bank, N.A. or otherwise. We continue to use MetaBank as the card issuing bank for a substantial majority of our proprietary Visa gift cards, and we cannot provide any assurance that we will continue to achieve comparable financial terms related to these programs. In addition, there has been increased regulatory scrutiny of products and services that are offered by card issuing banks in general (including our card issuing banks) in conjunction with third parties. For example, on June 30, 2016, the FDIC published industry guidance, in the form of Frequently Asked Questions, with respect to identifying, accepting and reporting brokered deposits. The FDIC articulated its view that, subject to certain limitations, funds obtained from consumers in connection with the sale of bank-issued general purpose reloadable (“GPR”) cards at retail stores or other venues qualify as brokered deposits. An insured depository institution is prohibited from accepting brokered deposits unless the depository institution is “well capitalized.” The FDIC may waive this prohibition if the depository institution is merely “adequately capitalized,” but the prohibition cannot be waived if the depository institution is “undercapitalized.”
As a result of the increased regulatory scrutiny, generally, we have also faced increased compliance costs. To the extent that our card issuing banks continue to face increased regulatory pressure, we may face further increased compliance costs and limits on our product offerings, among other consequences. If any material adverse event were to affect MetaBank, Sunrise Bank, N.A.
or any other card issuing bank with which we have a relationship, including a decline in their financial condition, a determination that they were not sufficiently capitalized to allow them to utilize our distribution network for selling GPR cards, a decline in the quality of their services, loss of their deposits, their failure or inability to comply with applicable banking and financial regulatory requirements, a systems failure or their inability to pay us fees or outstanding receivable balances, then our business, results of operations and financial condition could be materially and adversely affected.
In addition, the Merger could affect our relationships with card issuing banks. Please see the Risk Factor titled “We will be subject to various uncertainties while the Merger is pending that may cause disruption and may make it more difficult to maintain relationships with distribution partners, content partners, business clients, customers, providers, advertisers and others with whom we do business.”
We face intense competitive pressure, which may materially and adversely affect our revenues and profitability. Continued consolidation within our industry could increase the bargaining power of our current and future clients and vendors and further increase our client concentration or reduce competition among our third-party vendors.
The prepaid industry is highly competitive. We face a number of competitors across different sectors both domestically and internationally. We compete with a number of other industry participants in the United States and internationally in connection with prepaid card issuance, program management, product distribution, offers, marketing and processing, secondary card exchange and business-to-business transactions involving corporate incentives, rebates and consumer promotions, including some competitors with which we contract for various products or services. We also face competition from e-gift and digital gift card providers and sellers, as those form factors grow in popularity. We also face competition from companies that are developing new prepaid access technologies and products and from businesses outside of the prepaid industry, including processors, providers of financial services such as banks and money services businesses, and card issuers that offer credit cards,
private label retail cards and gift cards. We also face competition for retail shelf space and end caps at our distribution partners with other consumer packaged goods.
We operate a reload network, branded as the Reloadit network, which currently competes with other reload networks, including those for Green Dot, NetSpend and InComm. The nature of that competitive pressure has changed due to fraud issues. Please see the Risk Factor titled “Fraudulent and other illegal activity involving our products and services could lead to reputational and financial harm to us or our partners and reduce the use and acceptance of our prepaid access products and services” for additional information.
Many of our current or potential competitors have longer operating histories and greater name recognition than we do. Some have larger or more diversified customer bases. Many also are substantially larger than we are, may have substantially greater financial or other resources than we have, may develop and introduce a wider or more innovative range of products and services than we offer or may implement more effective marketing strategies than we do, thus achieving broader brand recognition, customer awareness and market penetration. To stay competitive, we may need to decrease our commissions and fees earned from content providers, increase the commissions and incentives that we share with our distribution partners, lower our fees from business clients, or make modifications to the agreements with our content providers and distribution partners that are not favorable to us, any of which could reduce or eliminate our profitability. Increased pricing pressure also increases the importance of cost containment and increased productivity in other areas, including through investments in technology development to support our network, and we may not succeed in these efforts. Some of our distribution partners may decide to bypass our services by purchasing physical gift cards for sale at retail directly from content providers. These content providers and distribution partners could arrange direct purchases themselves. Our failure to compete effectively against any of the foregoing competitive threats could have a material adverse effect on our business, results of operations and financial condition.
In addition, if our clients merge with or are acquired by entities that are not our clients, our clients may cease to exist or take their business to our competitors if the acquiring corporation has a pre-existing relationship with them, thereby negatively impacting our existing agreements and projected revenues with these clients. Even if clients merge with entities that are also our clients, we will need to modify our agreements accordingly, which may reduce our profitability. Continued consolidation within our industry could increase the bargaining power of our current and future clients and vendors and further increase our client concentration or reduce competition among our third-party vendors.
In addition, the Merger may affect our relationships with our clients and partners. Please see the Risk Factor titled “We will be subject to various uncertainties while the Merger is pending that may cause disruption and may make it more difficult to maintain relationships with distribution partners, content partners, business clients, customers, providers, advertisers and others with whom we do business.”
Fluctuations in our financial results from quarter to quarter could cause significant price swings in our common stock.
Our revenues, expenses, operating results, liquidity and cash flows have fluctuated, and may in the future fluctuate, significantly from quarter to quarter due to a number of factors, many of which are outside our control. In addition to the effects of seasonality described below under the Risk Factor titled “Due to seasonal fluctuations in our business, adverse events that occur during the second or fourth fiscal quarter could have a disproportionate effect on our results of operations and financial condition,” factors that may contribute to these fluctuations include the following:
|
|
•
|
the addition or loss of one or more significant distribution partners or content providers;
|
|
|
•
|
consumer spending patterns and preferences;
|
|
|
•
|
business spending patterns and preferences;
|
|
|
•
|
general economic conditions affecting consumer spending;
|
|
|
•
|
the overall business condition of our distribution partners and content providers;
|
|
|
•
|
the development and expansion of new product and service offerings by our competitors;
|
|
|
•
|
changes in pricing and fee structures, whether driven by competitive factors, card issuing banks, card associations, regulatory requirements or otherwise;
|
|
|
•
|
changes to our product and service offerings or changes in the way our products and services are sold, whether due to regulatory requirements or otherwise;
|
|
|
•
|
changes in our product and service mix;
|
|
|
•
|
changes in regulations or changes in interpretations of existing regulations;
|
|
|
•
|
the institution of new, or the adverse resolution of pending, litigation or regulatory investigations applicable to us;
|
|
|
•
|
business and service interruptions resulting from natural disasters, fraud, security breach or cyber attack, or network infrastructure failures;
|
|
|
•
|
the timing of our distribution partners’ roll out of new programs and content; and
|
|
|
•
|
other factors discussed elsewhere in this “Risk Factors” section.
|
Our fiscal year consists of a 52-week or 53-week period ending on the Saturday closest to December 31, and our fiscal quarters consist of three 12-week periods and one 16-week or 17-week period ending on a Saturday. As a result, our fourth fiscal quarter of each year contains not only the holiday gifting season, but also an extra four weeks (or five weeks for 53-week fiscal years) when compared to our first three fiscal quarters, a fact that exacerbates our quarterly fluctuations and makes it difficult to evaluate our operating results from quarter to quarter.
As a result of quarterly fluctuations caused by these and other factors, comparisons of our operating results across different fiscal quarters may not be accurate indicators of our future performance. Any quarterly fluctuations that we report in the future may differ from the expectations of market analysts and investors, which could cause the price of our common stock to fluctuate significantly.
Due to seasonal fluctuations in our business, adverse events that occur during the second or fourth fiscal quarter could have a disproportionate effect on our results of operations and financial condition.
Seasonal consumer spending habits significantly affect our business. During 2017, we derived approximately
19.6%
of our annual revenues in the last four weeks of our fiscal year. A significant portion of gift card sales occurs in late December of each year as a result of the holiday selling season. As a result, we earn a significant portion of our revenues and generate a higher portion of our net income during the fourth fiscal quarter of each year. The timing of December holiday sales, cash inflows from our distribution partners and cash outflows to our content providers also results in significant but temporary increases in our cash flow and certain balance sheet items at the end of each fiscal year relative to normal daily balances. We also experience an increase in revenues and cash flows in the second fiscal quarter of each year, which we primarily attribute to Mother’s Day, Father’s Day and graduation gifting season. Depending on when the Easter holiday occurs, the associated increase in revenues and cash flows could occur in either our first or second fiscal quarter. Adverse events that occur during the second or fourth fiscal quarter could have a disproportionate effect on our results of operations for the entire fiscal year.
Our closed loop and open loop gift card business could suffer if there is a decline in the attractiveness of gift cards to consumers.
Consumer demand for gift cards may stagnate or decline. Consumer perception of gift cards as impersonal gifts may become more widespread, which may deter consumers from purchasing gift cards for gifting purposes in general and through our distribution program in particular. This perception may increase to the extent that electronic gift cards become more prevalent. In addition, a move from traditional gift cards to other gifting technologies could harm our business, as discussed in the Risk Factor titled “Our failure to keep pace with the rapid technological developments in our industry and the greater electronic payments industry may materially and adversely affect our business, results of operations and financial condition.” Moreover, during periods of economic uncertainty and decline, consumers may become increasingly concerned about the value of gift cards due to fears that content providers may become insolvent and be unable to honor gift card balances. Finally, consumers may remain concerned about expiration dates, despite the fact that few gift cards are subject to expiration. Decline or stagnation in consumer acceptance of and demand for gift cards, or a failure of demand to grow as expected, could have a material adverse effect on our business, results of operations and financial condition.
Our corporate incentives, rebates and consumer promotions business could suffer if there is a decline in demand for certain types of programs, or for prepaid cards as customer rewards, consumer rebates and employee rewards under such programs.
Business demand for incentive programs in general or some of our programs in particular may stagnate or decline if business promotional strategies change (e.g., from rebates to instant discounts) or if broader economic downturns cause businesses or employers to either end or significantly reduce their use of incentive programs and prepaid cards in connection with the incentive programs. In addition, businesses may choose an alternative form of incentive (e.g., markdowns, instant discounts, coupons, or alternative forms of reward programs). Consumer or employee perception of certain types of incentive and reward programs may decline, which may cause businesses to use alternate promotional strategies. Consumer or employee perception of prepaid cards as valued incentives or rewards may decline, which may deter businesses from using such cards for reward, rebate, engagement or incentive purposes in general and through our program in particular. Consumer perceptions of
gift cards and changes in gifting technologies could harm our incentives business as discussed in the Risk Factors titled “Our closed loop and open loop gift card business could suffer if there is a decline in the attractiveness of gift cards to consumers” and “Our failure to keep pace with the rapid technological developments in our industry and the greater electronic payments industry may materially and adversely affect our business, results of operations and financial condition.” Finally, legislative, regulatory or judicially imposed limitations on promotional strategies or use of prepaid cards in connection with incentive programs may also result in a decline in the use of certain types of incentive programs, or the use of prepaid cards as a reward option under such programs, or a decline in consumer perception of such programs. Decline or stagnation in business demand for, or use of prepaid cards or consumer acceptance of and demand for, prepaid cards as rewards, incentives or rebates, or a failure of demand to grow as expected, could have a material adverse effect on our business, results of operations and financial condition.
Our ability to increase our revenues from prepaid financial services products will depend, in large part, upon the overall success of the prepaid financial services industry.
We earn fees when prepaid cards are loaded or reloaded through our network or are used by consumers. If consumers do not maintain or increase their usage of prepaid cards, our operating revenues may remain at current levels or decline. As the financial services industry evolves, consumers may find prepaid financial products and services to be less attractive than traditional payment instruments, new products offered by others or other financial services. Prepaid financial products and services may fail to maintain or achieve greater popularity for any number of reasons, including the general perception of the prepaid industry, fees associated with the use of prepaid cards, the potential for fraud in connection with these products, changes to these products from time to time, including those that result from new regulatory requirements, new technologies and a decrease in our distribution partners’ willingness to sell these products as a result of a more challenging regulatory environment. There could also be a change in a card issuing bank’s ability to qualify for an exemption from certain portions of the Dodd-Frank Act’s interchange provisions. Negative publicity surrounding other prepaid financial products and service providers could adversely affect our business or our industry as a whole. “Victim-assisted” fraud using financial services products has become more prevalent and either measures taken to reduce such fraud or regulations requiring additional consumer protections could adversely impact our business in this area. See the Risk Factor titled “Fraudulent and other illegal activity involving our products and services could lead to reputational and financial harm to us or our partners and reduce the use and acceptance of our prepaid access products and services.”
Predictions by industry analysts and others concerning the growth of prepaid financial services as an electronic payment mechanism may overstate the growth of an industry, segment or category, and investors should not rely upon them. The projected growth may not occur or may occur more slowly than estimated. If consumer acceptance of prepaid financial services does not continue to develop or develops more slowly than expected, or if there is a shift in the mix of payment forms, such as cash, credit cards and traditional bank debit cards, away from our products and services, our business, results of operations and financial condition could be materially and adversely affected.
Our operating revenues could be materially and adversely affected by declines in consumer confidence or spending, or changes in consumer preferences.
The prepaid industry depends upon the overall level of consumer spending. Prepaid card sales for gifting purposes are particularly dependent on discretionary consumer spending. Consumer spending may be adversely affected by general economic conditions, including consumer confidence, interest and tax rates, employment levels, salary and wage levels, the availability of consumer credit, the housing market and energy and food costs. The effects of these conditions on our business may be exacerbated by changes in consumer demand for prepaid products and services in general or for the products and services we offer. Adverse economic conditions in the United States or other regions where we conduct business may reduce the number and transaction dollar volume of prepaid cards that are purchased or reloaded through our distribution network, the number of transactions involving those cards and the use of our reload network and related services, all of which could have a material and adverse effect on our business, results of operations and financial condition. As consumer preferences for gift card purchasing changes, the number and transaction dollar volume of prepaid cards will change and could decline, which could have a material and adverse effect on our business, results of operations and financial condition.
Recent and future acquisitions or investments could disrupt our business and harm our financial condition.
Our recent and future acquisitions might prove detrimental to our business and financial condition. During 2017, we completed an acquisition of a rebates and incentives business, acquired certain assets of a full-service recognition and reward provider with operations primarily in Australia and acquired CashStar, Inc. and its subsidiaries, which provide a digital commerce platform for the sales, marketing and distribution of digital and physical gift cards. In the future, we may pursue other acquisitions or investments that we believe will help us achieve our strategic objectives.
The process of integrating an acquired business, product or technology can create unforeseen operating difficulties, expenditures and other challenges such as:
|
|
•
|
potentially increased regulatory and compliance requirements;
|
|
|
•
|
potential regulatory restrictions on revenue streams of acquired businesses;
|
|
|
•
|
implementation or remediation of controls, procedures and policies at the acquired company;
|
|
|
•
|
diversion of management time and focus from operation of our then-existing business to acquisition integration challenges;
|
|
|
•
|
coordination of product, sales, marketing and program and systems management functions;
|
|
|
•
|
transition of the acquired company’s users and customers onto our systems;
|
|
|
•
|
retention of employees from the acquired company;
|
|
|
•
|
integration of employees from the acquired company into our organization;
|
|
|
•
|
integration of the acquired company’s accounting, information management, human resources and other administrative systems and operations into our systems and operations;
|
|
|
•
|
integration of the acquired companies’ technology and platforms into our environment;
|
|
|
•
|
liability for activities of the acquired company prior to the acquisition, including violations of law, commercial disputes, escheat and tax and other known and unknown liabilities; and
|
|
|
•
|
litigation or other claims in connection with the acquired company, including claims brought by terminated employees, customers, former stockholders or other third parties.
|
If we are unable to address these difficulties and challenges or other problems encountered in connection with our acquisitions in 2017 or any future acquisition or investment, we might not realize the anticipated benefits of those acquisition or investment and we might incur unanticipated costs, liabilities or otherwise suffer harm to our business generally. The difficulties and challenges of successful integration of any acquired company are increased when the integration involves multiple acquired companies or companies with operations or material vendors outside the United States. Consequently, we may not be able to integrate successfully our recently acquired companies or to achieve anticipated cost saving across channels and infrastructure.
To the extent that we pay any earn outs or the consideration for any future acquisitions or investments in cash, it would reduce the amount of cash available to us for other purposes. Such payments also may increase our cash flow and liquidity risk and could result in increased borrowings under our Credit Agreement. See the Risk Factor titled “Our debt could adversely impact our operating income and growth prospects and make us vulnerable to adverse economic and industry conditions.” Future acquisitions or investments could also result in dilutive issuances of our equity securities or the incurrence of debt, contingent liabilities, amortization expenses or impairment charges against goodwill or intangible assets on our balance sheet, any of which could have a material adverse effect on our business, results of operations and financial condition.
We operate in a highly and increasingly regulated environment, and failure by us or our partners and clients to comply with applicable laws and regulations could have a material adverse effect on our business, results of operations and financial condition.
We and our content providers, distribution partners and card issuing banks are subject to a wide variety of federal, state, local and foreign laws and regulations. This legal and regulatory landscape has significantly expanded and has become increasingly complex in recent years. These laws and regulations presently include, among others:
|
|
•
|
federal and state anti-money laundering laws and regulations, including the USA PATRIOT Act (the “Patriot Act”), the Bank Secrecy Act (“BSA”), anti-terrorist financing laws and regulations, anti-bribery and corrupt practice laws and regulations and similar international laws and regulations;
|
|
|
•
|
consumer protection laws, regulations and rules, including those issued by the Consumer Financial Protection Bureau (“CFPB”);
|
|
|
•
|
federal economic sanctions laws overseen by the Office of Foreign Assets Control (“OFAC”);
|
|
|
•
|
state unclaimed property (escheat) laws and regulations;
|
|
|
•
|
state money transmitter licensing laws and regulations;
|
|
|
•
|
data privacy protection and cyber-security laws and regulations; and
|
|
|
•
|
foreign jurisdiction payment services industry laws and regulations.
|
Costs of compliance or penalties for failure to comply with these laws and regulations could have a material adverse effect on our business, financial condition and results of operations.
The laws and regulations applicable to our business, and to the businesses of our content providers, distribution partners and card issuing banks, are often unclear and may differ or conflict among jurisdictions, rendering compliance difficult and costly. In addition, recent changes in federal government agencies could cause the interpretation and enforcement of laws and regulations to become less predictable and increase the difficulty and costs associated with compliance.
Failure by us and our regulated subsidiaries or businesses to comply with all applicable laws and regulations could result in fines and penalties, limitations on our ability to conduct our business, or governmental or third-party actions. Regulatory agencies in these matters may seek recovery of large or indeterminate amounts or seek to have aspects of our business or that of our business partners modified or suspended. The outcome of regulatory proceedings or investigations is difficult to predict. Any fines, penalties or limitations on our business could significantly harm our reputation with consumers and other program participants, as well as the reputation of the banks that issue open loop cards that we manage, any and all of which could materially and adversely affect our business, operating results and financial condition, including potentially decreasing acceptance and use of, and loyalty to, our products and services. In addition, if our content providers, distribution partners or other customers have adverse experiences resulting from regulatory compliance obligations arising from their relationships with us, they may seek to curtail, terminate or adversely modify those relationships, which could harm our business, operating results and financial condition. In addition, we perform various compliance functions on behalf of our card issuing banks, and any failure to perform those functions properly could result in contractual claims brought against us by our card issuing banks or actions brought by regulatory agencies.
Changes in laws and regulations to which we are subject, or to which we may become subject in the future, may materially increase our costs of operation, decrease our operating revenues and disrupt our business.
Changes in laws and regulations, or the interpretation or enforcement thereof, may occur that could:
|
|
•
|
impair or eliminate our ability to conduct certain aspects of our business;
|
|
|
•
|
increase our compliance and other costs of doing business;
|
|
|
•
|
require significant product redesign or systems redevelopment;
|
|
|
•
|
prohibit or suspend our data transfer from the European Union to the United States;
|
|
|
•
|
render our products or services less profitable, obsolete or less attractive compared to competing products;
|
|
|
•
|
affect our distribution partners’ or content providers’ willingness to do business with us or operate in our industry;
|
|
|
•
|
affect our Cardpool exchange partners’ willingness to do business with us;
|
|
|
•
|
reduce the amount of revenues that we derive from unredeemed prepaid products;
|
|
|
•
|
cause loyalty, awards and promotional cards to be treated like other prepaid cards; and
|
|
|
•
|
discourage distribution partners from offering, and consumers from purchasing, our prepaid products.
|
Any of these potential changes could have a material adverse effect on our business, results of operations and financial condition. In light of current economic conditions, legislators and regulators have increased their focus on the banking and consumer financial services industry. As a result, in recent years there has been a significant increase in the regulation of the prepaid industry that is intended to further protect consumers and help detect and prevent money laundering, terrorist financing and other illicit activities. Please see the Risk Factor titled “Failure to comply with, or further expansion of, consumer protection regulations could have a material adverse effect on our business, results of operations and financial condition.”
In addition, additional changes and proposed changes to other laws and regulations, both domestically and internationally, may materially increase our costs of operation, decrease our operating revenues and disrupt our business. Please see the Risk
Factors titled “Failure to comply with, or further expansion of, consumer protection regulations could have a material adverse effect on our business, results of operations and financial condition” and “We are subject to added business, political, regulatory, operational, financial and economic risks associated with our international operations.”
We are increasingly facing more stringent anti-money laundering laws and regulations, compliance with which may increase our costs of operation, decrease our operating revenues and disrupt our business.
In the U.S., we are subject to the BSA, as amended by the Patriot Act, and we are subject to similar laws and regulations in other jurisdictions, including the Proceeds of Crime (Money Laundering) and Terrorist Financing Act in Canada. In the U.S., Blackhawk Network California is a registered money services business subject to anti-money laundering reporting and recordkeeping requirements under the BSA and its implementing regulations. A more aggressive enforcement of the BSA and other anti-money laundering and terrorist financing prevention laws and regulations or more onerous regulation could increase our or our distribution partners’ or card issuing banks’ compliance costs or require changes in, or place limits upon, the products and services we offer. For example, the Financial Crimes Enforcement Network of the Department of the Treasury (“FinCEN”) recently issued regulations under the BSA that enhance the customer due diligence requirements for banks and certain other financial institutions by requiring, among other things, the identification and verification of the beneficial owners of all legal entity customers at the time a new account is opened, subject to certain exceptions. Even though these regulations do not directly apply to us, we may face increased compliance costs and limits on our product offerings, among other consequences, to the extent these regulations increase the compliance costs of our card issuing banks. In addition, our compliance obligations require significant personnel resources, as well as extensive contact with legal counsel and consultants to stay abreast of applicable law and regulations, which results in additional costs. Each of these could have a material adverse effect on our business, results of operations and financial condition.
We are subject to examination by the Internal Revenue Service since Blackhawk Network California is a registered money services business under the BSA. To the extent that we fail to comply with the BSA, we are subject to enforcement jurisdiction by FinCEN and potentially other federal and state regulatory agencies, and we may incur fines and penalties as well as harm our relationships with our card issuing banks, all of which could have a material adverse effect on our business, results of operations and financial condition.
In addition, abuse of our prepaid products or our Cardpool business for purposes of money laundering or terrorist financing could cause reputational or other harm that could have a material adverse effect on our business, results of operations and financial condition. Please see the Risk Factor titled “Fraudulent and other illegal activity involving our products and services could lead to reputational and financial harm to us or our partners and reduce the use and acceptance of our prepaid access products and services” for additional information.
Abuse of our prepaid products for purposes of financing sanctioned countries, terrorist funding, bribery or corruption could cause reputational or other harm that could have a material adverse effect on our business, results of operations and financial condition.
We are subject to an array of federal anti-terrorism and anti-bribery legislation, such as federal economic sanctions laws administered by OFAC and the Foreign Corrupt Practices Act. Abuse of our prepaid products for purposes of financing sanctioned countries, terrorists, bribery or corruption could cause reputational or other harm that could have a material adverse effect on our business, results of operations and financial condition. Increasing regulatory scrutiny of our industry with respect to terrorist financing or corruption could result in more aggressive enforcement of such laws or more onerous regulation, which could increase our compliance costs or require changes in, or place limits upon, the products and services we offer, and which in turn could have a material adverse effect on our business, results of operations and financial condition.
Failure to comply with, or further expansion of, consumer protection regulations could have a material adverse effect on our business, results of operations and financial condition.
We are subject to federal regulation aimed at consumer protection. For example, the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the “CARD Act”) imposes requirements relating to disclosures, fees and expiration dates that are generally applicable to gift certificates and prepaid cards. We believe that GPR cards and the maintenance fees charged on our partners’ GPR cards distributed through our distribution partners are exempt from these requirements under an express exclusion for cards that are reloadable and not marketed or labeled as a gift card or gift certificate. However, this exclusion is not available if the issuer, the distribution partner or the program manager promotes, even if occasionally, the use of the GPR card as a gift card or gift certificate. We provide our distribution partners with instructions and policies regarding the display and promotion of our partners’ GPR cards distributed through our distribution partners so that retailers do not market such GPR cards as gift cards. For example, we instruct retailers to separate or otherwise distinguish such GPR cards from gift cards on their displays. However, we do not control our distribution partners and cannot assure that they will comply with our instructions and policies. If displayed incorrectly, it is possible that our partners’ GPR cards distributed through our
distribution partners would lose their eligibility for this exclusion from the CARD Act requirements, and therefore could be deemed to be in violation of the CARD Act, which could result in the imposition of fines, the suspension of our ability to offer GPR cards, civil liability, criminal liability and the inability of our card issuing banks to apply certain fees to the GPR cards distributed through our distribution partners. Since we may have contractual obligations for the damages suffered by our partners who distribute their GPR cards through our distribution partners due to our distribution partners’ failure to comply with our instructions and policies, each of the adverse effects suffered by our partners that distribute GPR cards through our distribution partners could have an indirect adverse effect on our business, results of operations and financial condition.
In addition, on October 5, 2016, the CFPB issued a final rule to regulate certain prepaid accounts (the “Prepaid Account Rule”). The Prepaid Account Rule covers certain products we distribute. With respect to covered products, the Prepaid Account Rule mandates, among other things: (i) extensive pre-purchase and post-purchase disclosures; (ii) expanded electronic billing statements; (iii) adherence to certain requirements of Regulation E, including requirements regarding limitations on customer liability and billing error resolution; (iv) adherence to certain requirements of Regulation Z for prepaid accounts that permit negative balances (including overdraft features); and (v) public posting of account agreements and submission of such agreements to the CFPB, which will publish them on a public CFPB-maintained website. On April 20, 2017, the CFPB issued a final rule to extend the effective date of the Prepaid Account Rule for six months to April 1, 2018, and on December 21, 2017, issued a statement indicating that it would issue a final rule amending the Prepaid Account Rule “soon after the new year” and that it expected to further extend the effective date of the Prepaid Account Rule. On January 25, 2018, the CFPB issued a final rule to finalize modifications to the Prepaid Account Rule, including with respect to error resolution and limitations on liability for certain prepaid accounts and application of credit-related provisions to digital wallets, and extend the effective date of the Prepaid Account Rule to April 1, 2019. Certain components of the Prepaid Account Rule may be disruptive to the business of our partners that distribute GPR cards through our distribution partners and may materially increase their costs of operation. As a result, there could be an indirect adverse effect to our business.
We also may become subject to further regulation by the CFPB, which on July 17, 2012, issued a final rule defining certain nonbank “larger participants” in markets for consumer financial products or services. It is uncertain whether the CFPB will include money transmission and prepaid cards within the definition of larger participant as well as whether we will be considered a larger participant subject to CFPB regulatory, supervisory and enforcement powers. The CFPB can obtain cease and desist orders, which may include orders for restitution or rescission of contracts as well as other kinds of affirmative relief, and monetary penalties ranging from $5,000 per day for ordinary violations of federal consumer financial laws to $25,000 per day for reckless violations and $1 million per day for knowing violations. Also, where a company has violated the Dodd-Frank Act or CFPB regulations, the Dodd-Frank Act empowers state attorneys general and state regulators to bring civil actions for the type of cease and desist orders available to the CFPB. Expanded CFPB jurisdiction over our business may increase our compliance costs and risks, which could have a material adverse effect on our business, results of operations and financial condition.
Nonbank entities providing consumer financial products or services are subject to the CFPB’s regulatory and enforcement authority, and, as a result, the CFPB may conduct examinations or request information from supervised entities. If the CFPB determines that there is a need to examine us or requests significant information from us, it could increase our costs of operation or disrupt our business.
Furthermore, failure by us to comply with federal and state privacy and information safeguard laws could result in fines and penalties from regulators and harm to our reputation with our customers and business partners, all of which could have a material adverse effect on our business, results of operations and financial condition.
If we fail to comply with federal banking regulation, we may be subject to fines and penalties, and our relationships with our card issuing banks may be harmed.
We are subject to federal banking regulation through our relationships with our card issuing banks. The open loop products for which we serve as program manager are the products of MetaBank and Sunrise Bank, N.A., which we refer to collectively as our card issuing banks and which are subject to various federal and state laws and regulations administered by a number of authorities, including the Office of the Comptroller of the Currency (“OCC”), the Federal Reserve Board (“FRB”), the FDIC, and the Delaware Office of the State Bank Commissioner. As a third-party service provider to our card issuing banks, we are subject to regulation and audit and examination by the OCC, FRB and FDIC. As an agent of our card issuing banks, we are considered “institution-affiliated parties” of our card issuing banks and subject to the enforcement jurisdiction of these federal banking agencies for our activities in that capacity. To the extent that we fail to comply with such federal banking regulations, we may incur fines and penalties and our relationships with our card issuing banks may be harmed, all of which could have a material adverse effect on our business, results of operations and financial condition.
On October 30, 2013, the OCC issued guidance on third-party relationships and associated risk management by federally-chartered banks (the “2013 Bulletin”). The 2013 Bulletin states that the OCC expects each bank to have risk management processes that are commensurate with the level of risk and complexity involving third parties providing the bank with “critical” activities. The “critical” activities include certain services that we perform for our card issuing banks. On October 20, 2017, the OCC issued guidance on offering new, modified, or expanded products and services by federally-chartered banks (the “2017 Bulletin”). The OCC expects bank management to establish appropriate risk management processes for new activity development and to measure, monitor and control the risks associated with new activities. Consequently, to enable our card issuing banks to meet their obligations under the 2013 Bulletin and the 2017 Bulletin, they may impose on us (and, in turn, our distribution partners) additional obligations, including record keeping and reporting requirements, as well as examinations. Compliance with these potential additional obligations could increase our and our distribution partners’ compliance costs or disrupt our business, which in turn could have a material adverse effect on our business, results of operations and financial condition.
Data protection and regulations related to privacy, data protection and information security could increase our costs, as well as negatively impact our growth.
We are subject to regulations related to privacy, data protection and information security in the jurisdictions in which we do business. As privacy, data protection and information security laws are interpreted and applied, compliance costs may increase, particularly in the context of ensuring that adequate data protection and data transfer mechanisms are in place.
In recent years, there has been increasing regulatory enforcement and litigation activity in the areas of privacy, data protection and information security in the United States and in various countries in which we operate. In addition, legislators and/or regulators in the United States, the European Union and other jurisdictions in which we operate are increasingly adopting or revising privacy, data protection and information security laws that could create compliance uncertainty and could increase our costs or require us to change our business practices in a manner adverse to our business. For example, the E.U. and U.S. Privacy Shield framework was designed to allow for legal certainty regarding transfers of data. However, the agreement itself faces a number of legal challenges and is subject to annual review. This has resulted in some uncertainty and compliance obligations. Moreover, compliance with current or future privacy, data protection and information security laws could significantly impact our current and planned privacy, data protection and information security related practices, our collection, use, sharing, retention and safeguarding of consumer and/or employee information, and some of our current or planned business activities. Our failure to comply with privacy, data protection and information security laws could result in fines, sanctions or other penalties, which could materially and adversely affect our results of operations and overall business, as well as have an impact on our reputation. For example, the General Data Protection Regulations of the E.U. take effect in May 2018 and will require us to undertake enhanced data protection safeguards, with fines for non-compliance up to 4% of global revenue.
Costs of compliance or penalties for failure to comply with or changes in state unclaimed property laws and regulations and changes in state tax codes could have a material adverse effect on our business, financial condition and results of operations.
Certain state unclaimed property laws require that card issuers track information on card products and services and that, if customer funds are unclaimed at the end of an applicable statutory abandonment period, the proceeds of the unclaimed property be remitted to the appropriate jurisdiction. In certain instances, we are responsible for compliance with applicable state unclaimed property laws, and we have also agreed to provide information to our card issuing banks on card usage to enable them to comply with unclaimed property laws with respect to our program-managed bank-issued products for our retail and
incentive businesses.
We have derived approximately
2%
of our revenues in each of the last three fiscal years from consumers’ failure to redeem prepaid products that we issue and/or program manage.
We also earn program management and other fees from the banks that issue our program-managed open loop gift and incentive cards that may be adversely impacted to the extent that unredeemed funds on such products become increasingly subject to state unclaimed property laws. Such fees represented
10.3%
,
11.0%
and
10.2%
of total revenues in
2017
,
2016
and
2015
, respectively.
Unclaimed property laws vary from state to state and apply differently to different types of products. State regulators could interpret definitions in escheatment statutes and regulations in a manner that may adversely affect unredeemed balances that the card issuing banks provide us as program management and other fees. Should such state regulators choose to do so, they may initiate collection or other litigation action for unreported abandoned property. Such actions may, among other things, seek to assess fines and penalties. In addition, states may periodically revise their unclaimed property laws to increase state revenues relating to collection of unclaimed property. Moreover, states may also revise their tax codes to introduce new or higher taxes
relating to our products and services. Thus, changes in law or regulatory activity, individually or in the aggregate, could adversely affect our margins and make our products and services less attractive to consumers.
U.S. federal income tax reform could adversely affect us
.
On December 22, 2017, the U.S. Tax Cuts and Jobs Act (the “Tax Reform Act”) was signed into law by the President of the United States. The Tax Reform Act significantly revised the U.S. corporate income tax regime by, among other things, lowering the U.S. federal corporate tax rate from 35% to 21% effective for our fiscal year ending December 29, 2018, while also implementing a territorial tax system and imposing a repatriation tax on deemed repatriated earnings of foreign subsidiaries. U.S. GAAP requires that the impact of tax legislation be recognized in the period in which the law was enacted.
As of December 30, 2017, we have recorded a provisional income tax expense but have not completed our accounting for the tax effects of the Tax Reform Act. The provisional income tax expense is subject to revisions as we complete our analysis of the Tax Reform Act, collect and prepare necessary data, and interpret any additional guidance issued by the U.S. Treasury Department, Internal Revenue Service, Financial Accounting Standards Board, and other standard-setting and regulatory bodies. Adjustments may materially impact our provision for income taxes and effective tax rate in the period in which the adjustments are made. Our accounting for the tax effects of the Tax Reform Act will be completed during the measurement period, which should not extend beyond one year from the enactment date.
Changes in card association rules or standards set by Visa, MasterCard and Discover, or changes in card association and debit network fees or products or interchange rates, could materially and adversely affect our business, financial condition and results of operations.
We and our card issuing banks are subject to Visa and MasterCard card association and debit network rules and standards. Noncompliance with these rules or standards due to our acts or omissions or the acts or omissions of businesses that work with us could subject us or our card issuing banks to fines or penalties imposed by card associations or networks, and we may be required to indemnify the banks for the fines and penalties they incur. The termination of the card association registrations held by us or any of our card issuing banks or any changes in card association or other debit network rules or standards, including interpretation and implementation of existing rules or standards, that increase the cost of doing business or limit our ability to provide our products and services could have a material adverse effect on our business, results of operations and financial condition.
In addition, from time to time, card associations increase the organization and/or processing fees that they charge, which could increase our operating expenses, reduce our profit margin and have a material adverse effect on our business, results of operations and financial condition. A portion of the revenue derived from our proprietary open loop cards is derived from our share of the fees charged to merchants for services provided in settling transactions routed through the networks of the card associations and network organizations, referred to as interchange fees. The enactment of the Dodd-Frank Act required the FRB to implement regulations that have substantially limited interchange fees for many issuers of debit cards and prepaid cards. While we believe that the exemption from the limits imposed by the FRB available to qualifying card issuing banks with less than $10 billion in assets, which currently include MetaBank and Sunrise Bank, N.A., will apply to our program-managed cards, it remains possible that the card associations and network organizations could reduce the interchange fees applicable to transactions conducted by the holders of cards issued by these banks. If interchange rates decline, whether due to actions by the payment networks, our card issuing banks or existing or future legislation or regulation, or the interpretation or enforcement thereof, we may need to adjust our fee structure to offset the loss of interchange revenues. Any price increase in our products and services may make it difficult to acquire customers and to maintain or expand card usage and customer retention, and we consequently could suffer reputational damage and become subject to greater regulatory scrutiny. We may also need to discontinue certain products or services. As a result, our business, results of operations and financial condition could be materially and adversely affected.
Delays in complying with industry security standards related to credit and debit cards have negatively impacted, and could continue to negatively impact, sales of our products, results of operations and financial condition.
Technological changes continue to significantly impact the financial services and payment services industries, such as continuing development of technologies in the areas of smart cards, radio frequency and proximity payment devices, electronic wallets and mobile commerce, among others. The payment networks’ rules and regulations are generally subject to change, and they may modify their rules and regulations from time to time. Our retail distribution partners’ inability to react timely to changes in the rules and regulations, or their interpretation or application, may result in substantial disruption to our business and negatively impact our results of operations.
For example, payment processors Europay, MasterCard and Visa (collectively “EMV”) set a deadline of October 2015 for retailers to install and implement in their point-of-sale systems new terminals that would accept credit and debit cards that have an embedded chip on them. The chip is used in the transaction checkout instead of the magnetic strip and has information about
the card holder and a unique transaction identification number that can only be used once. This chip-on-card technology prevents fraudulent duplication of credit and debit cards and helps eliminate one of the primary sources of fraud at point of sale.
If a retailer did not achieve EMV-compliance by October 2015, liability for payment fraud losses incurred by such retailer shifted from the banks issuing the credit and debit cards to the EMV-non-compliant retailers. In response, a significant number of our retail distribution partners that were not EMV compliant by the October 2015 deadline took measures in their stores to limit their exposure to liability for fraud losses by limiting or controlling the sales of higher denomination gift cards. While almost all of our retail distribution partners became EMV compliant by the end of 2016, we believe some consumers changed their shopping behavior away from our distribution partners or our products, and it will take time and marketing expenditures to restore these customers’ prior shopping habits. Some of these customers may not return to shop for our products at our retail distribution partners. That, together with several distribution partners that are still non-compliant with EMV requirements, is expected to result in some amount of ongoing adverse impact on our results of operations.
If we fail to maintain our existing money transmitter licenses or permits, or fail to obtain new licenses or permits in a timely manner, our business, results of operations and financial condition could be materially and adversely affected.
Most U.S. states regulate the business of sellers of traveler’s checks, money orders, drafts and other monetary instruments, which we refer to collectively as money transmitters. While a large number of states expressly exempt banks and their agents from regulation as money transmitters, others purport to regulate the money transmittal businesses of bank agents or do not extend exemptions to non-branch bank agents. We have historically taken the position that state money transmitter statutes do not apply to our core gift card distribution business. Nonetheless, we rely on the money transmitter licenses of Blackhawk Network California in connection with our bank-issued products in certain states, our Reloadit product, and certain of our partners’ products distributed through our network. Our core distribution business operated by our wholly owned subsidiary Blackhawk Network, Inc. is licensed in connection with gift card distribution in two states, Maryland and West Virginia. Blackhawk Network California is a licensed money transmitter in 48 U.S. jurisdictions and in Puerto Rico. On June 9, 2016, South Carolina enacted the South Carolina Anti-Money Laundering Act, which regulates money transmission effective upon the publication in the State Register of final rules implementing the Act. The remaining U.S. jurisdictions either do not currently regulate money transmitters or do not regulate our current businesses.
In addition, our Blackhawk Network (UK) Limited subsidiary is regulated as an electronic money institution in the United Kingdom and issues an open loop product. We have “passported” the money license to Germany, Belgium and the Netherlands under EU regulations. If the U.K.’s planned withdrawal from the EU causes us to lose our ability to “passport” our money license to Germany, Belgium or the Netherlands, we may have to seek alternatives in another EU country, the process of which may cause uncertainty and may increase our compliance costs.
If our regulated subsidiaries fail to maintain their existing licenses or permits, or fail to obtain new licenses or permits in a timely manner, our business, results of operations and financial condition could be materially and adversely affected.
Fraudulent and other illegal activity involving our products and services could lead to reputational and financial harm to us or our partners and reduce the use and acceptance of our prepaid access products and services.
Issuers of prepaid products have suffered significant losses in recent years with respect to the theft of cardholder data that has been illegally exploited. Criminals are using increasingly sophisticated methods to acquire or activate prepaid cards illegally or to use prepaid cards in connection with illegal activities. In addition, we are subject to the security vulnerabilities of third parties who provide transaction processing services to us or to our content providers and distribution partners. Furthermore, our Cardpool business subjects us to additional fraud risks associated with previously owned cards or with “merchandise credits.” Merchandise credits function much like a prepaid gift card once issued. Such credits may result from organized retail theft, typically in the form of returns of stolen or fraudulently obtained goods by organized groups of professional shoplifters, or “boosters,” who then convert such goods into merchandise credits, which are sometimes then exchanged for cash. To the extent that our content providers view the exchange of merchandise credits by our Cardpool business as contrary to their efforts to reduce organized retail crime, our relationships with those content providers may be adversely affected. Content providers may also change their merchandise credit practices in a way that hurts our business. In addition, law enforcement agencies have advised us of investigations into the exchange activities of certain customer programs they believe may involve illicit activity by retail criminals. Although we have enhanced anti-fraud and anti-crime measures, such as improved “know your customer” and suspicious activity reporting in connection with our Cardpool business in an effort to reduce our fraud risk and the risk of illegal activity (including money laundering) being associated with our Cardpool business, the outcome of investigations by law enforcement agencies is difficult to predict. The monetary and other impacts of these investigations and our ongoing risk management actions may remain unknown for a substantial period of time.
Our Reloadit product, which allows the consumer to use the PIN method of reloading GPR cards, has been the subject of fraudulent activity. The most prevalent form of fraud related to this product involves a scammer calling an unsuspecting consumer, convincing the consumer to buy a Reloadit product and providing the scammer with information that allows the scammer to transfer the funds to the scammer’s own GPR card. This kind of victim-assisted fraud, in which a willing victim purposely gives away his or her personal information to a stranger, has proven difficult to stop. We have implemented significant measures to prevent and mitigate different types of fraud, including victim-assisted fraud, and have secured and developed certain technology to enhance our fraud protections for vulnerable populations and to deter scammers from targeting the Reloadit product as a useful vehicle to commit fraud. Nevertheless, our progressive fraud mitigation strategy may not be successful, which could result in losses and reputational damage, which could in turn reduce the use and acceptance of the products and services that we offer, cause distribution partners, content providers or reload network participants to cease doing business with us, lead to new legislation or greater regulation, or lead to civil or criminal proceedings and liability, all of which would increase our compliance costs or increase our direct or indirect expenses associated with fraud and illegal activity, and also could cause us to discontinue or materially change the Reloadit product.
In addition, fraudulent or criminal activity involving “spoofing,” “cloning,” and “phishing” that appears related to our products or services could harm our business, as discussed in the Risk Factor titled “A data security breach could expose us to costly government enforcement actions, liability and protracted and costly litigation, and could adversely affect our reputation and operating revenues.”
A significant incident of theft or fraud, or results of these investigations involving customers of our business, or the prepaid industry or card exchange industry more generally, could also result in losses and reputational damage, which could in turn reduce the use and acceptance of the products and services that we offer, cause distribution partners, content providers or reload network participants to cease doing business with us, lead to civil or criminal proceedings and liability, lead to fines and penalties by the credit card associations or lead to greater regulation that would increase our or our partners’ compliance costs or increase our direct or indirect expenses associated with preventing and detecting both fraud and illegal activity.
Prior to customers’ purchases of our gift cards, we, or our content providers or our distribution partners generally bear losses due to theft and fraudulent access based on which party’s card processing systems are at fault. Following activation, whether a cardholder bears the loss of any theft, fraudulent access or other loss of a card depends upon the issuer’s cardholder terms and conditions and protective provisions imposed by applicable laws, regulations or system rules.
Any changes we make to our product and service offerings to prevent fraudulent or illegal activities could have a material adverse effect on our business, results of operations and financial condition.
Our business depends on the efficient and uninterrupted operation of our transaction processing systems, including our computer network systems and data centers, and if such systems are disrupted, our business, results of operations and financial condition could be materially and adversely affected.
Our ability to provide reliable service to consumers, distribution partners, content providers and other customers depends on the efficient and uninterrupted operation of our computer network systems and data centers, as well as those of our content providers, distribution partners and third-party processors. Our business involves the movement of large sums of money, the processing of large numbers of transactions and the management of the data necessary to do both. As part of our operations, we rely on technologies and software - some of which we develop and some of which are supplied by third parties - that may contain errors, viruses or defects. Our success depends on our ability and the ability of our partners and respective vendors to process and facilitate these transactions in an efficient, uninterrupted and error-free manner.
Our transaction processing systems and websites (or those of our content providers, distribution partners or third-party processors) may experience service interruptions, delays or degradation as a result of processing or other technology malfunction, software defects, technology installation difficulties or delays, fire, natural disasters, power loss, disruptions in long distance or local telecommunications access, fraud, civil unrest, political instability or military activity, terrorism, security breach or cyber attack, physical break-in or accident. Additionally, we rely on service providers for the timely transmission of information to or across our data network. If a service provider fails to provide the communications capacity or services we require, the failure could interrupt or delay our services. In the event of a service interruption, delay or degradation of our transaction processing systems, the preventive measures we have taken, including the implementation of disaster recovery plans and back-up systems, may not be successful, and we could suffer financial loss, loss of customers, regulatory sanctions and damage to our reputation. If we face system interruptions or failures, our business interruption insurance may not be adequate to cover the losses or damages that we incur, or we may determine in the future to self-insure against some of these risks. Any of these events could have a material adverse effect on our business, results of operations and financial condition.
A data security breach could expose us to costly government enforcement actions, liability and protracted and costly litigation, and could adversely affect our reputation and operating revenues.
We and our content providers and distribution partners receive, transmit and store confidential customer, card and other information in connection with the sale and use of our prepaid products and services. The encryption software and other technologies we use to provide security for storage, processing and transmission of confidential customer and other information may not be effective to protect against data security breaches by third parties. The risk of unauthorized circumvention of our security measures has been heightened in recent years by advances in computer capabilities and the increasing sophistication of hackers, and companies that store, process and transmit similar information have been specifically and increasingly targeted by sophisticated criminals in an effort to obtain confidential customer or system access information and utilize it for fraudulent transactions. We regularly experience unauthorized attempts to access our systems. While we have multiple security measures in place to both prevent and detect intrusions, rapid advances in computer capabilities and the increasing sophistication of hackers may expose us to unauthorized access. Also, the encryption software and other technologies we use to protect the storage, processing and transmission of confidential customer, card data and other confidential information may not be effective protection.
Our card issuing banks, as well as our other content providers, distribution partners and third-party processors and certain vendors, also may experience similar security breaches involving the receipt, transmission and storage of our confidential customer and other information. Improper access to our or these third parties’ systems or databases could result in the theft, publication, deletion or modification of confidential customer information and/or card data, including theft of funds on the card or counterfeit reproduction of the cards. If we experience a significant data security breach or fail to detect and appropriately respond to a significant data security breach, we could be exposed to government enforcement actions, costs associated with data breach notifications, and private litigation. In addition, consumers could lose confidence in our ability to protect their personal information, which could cause them to stop buying prepaid products that we offer. A significant data security breach involving company employees could hurt our reputation, cause us recruiting and retention challenges, increase our labor costs and affect how we operate our business.
A data security breach of our or our partners’ systems could lead to theft and fraudulent activity involving our products and services, monetary loss or penalties, reputational damage, private claims or regulatory actions against us and increased compliance costs. Any such data security breach could result in protracted and costly litigation. If unsuccessful in defending that litigation, we might be forced to pay damages and/or change our business practices, any of which could have a material adverse effect on our business, results of operations and financial condition. Further, a significant data security breach could lead to additional legislation or regulation, which could result in new and costly compliance obligations. We may have to replace any card issuing bank or third-party processor that has a security breach, which may not be possible on acceptable terms, or at all. Any of these events could have a material adverse effect on our business, results of operations and financial condition.
As a merchant that accepts debit and credit cards for payment and as a company that program manages and processes open loop gift card transactions carrying card network brands, we are subject to the Payment Card Industry Data Security Standard (“PCI DSS”) issued by the Payment Card Industry Security Standards Council. PCI DSS contains compliance guidelines and standards with regard to our security surrounding the physical and electronic storage, processing and transmission of individual cardholder data. Our removal from networks’ lists of PCI DSS compliant service providers could mean that existing customers, sales partners or other third parties may cease using or referring our services or our card issuing banks could terminate our existing processing arrangements with them. Also, prospective customers, sales partners or other third parties may choose to terminate negotiations with us, or delay or choose not to do business with us. In addition, the card networks could refuse to allow us to process through their networks, impose fines or require us to take steps to remediate our data security program.
We and our web customers, as well as those of other companies, may be targeted by parties using fraudulent “spoof” and “phishing” emails or using fraudulent websites that have cloned websites or other social engineering tactics, to misappropriate passwords, credit card numbers, or other personal information or to introduce viruses or other malware through “trojan horse” programs to our customers’ computers. Spoof or phishing emails and cloned websites appear to be legitimate emails sent by, or legitimate websites operated by, our company. However, these emails or cloned websites may direct recipients to false websites or request confidential information that can be utilized by third parties and could result in the unauthorized access to systems theft, publication, deletion or modification of confidential customer information and/or card data, including theft of funds on the card or in an account. Despite our efforts to mitigate “spoofing,” “cloning,” “phishing,” and social engineering through product improvements, website enhancements, user education, training and other means, these tactics remain threats that may damage our brands, discourage use of our websites or products, and increase our costs.
We maintain insurance coverage that may cover certain aspects of cyber risks, including coverage for damages suffered by others resulting from actual or alleged acts, errors or omissions in performance of a professional service; damages suffered by others resulting from a failure of computer security, including liability caused by theft or disclosure of confidential information, unauthorized access, unauthorized use, denial of service or transmission of virus; costs to restore or recreate electronic data, computer systems resources, and information assets- including electronically stored credit card numbers and customer
databases - damaged due to a network security failure caused by a computer attack; business interruption in certain circumstances; costs to respond to a data privacy or security incident; and costs for investigations brought by PCI in connection with failure to protect private information and/or failure of network security possibly resulting from PCI DSS non-compliance. Nonetheless, such insurance coverage may be insufficient to cover all losses we incur as a result of a data breach or fraud resulting from cyber risks, which could have a material adverse effect on our business, results of operations and financial condition.
We may not be able to operate and scale our technology or integrate acquired technology effectively to match our business growth.
Our ability to continue our expansion, to provide our products and services to a growing number of content providers, distribution partners and business clients, as well as to enhance our existing products and services and offer new products and services, is dependent on our ability to apply our existing information technology or to develop new applications to meet the particular service needs of the growing markets. We may not have adequate financial or technological resources to develop effective and secure services and distribution channels that will satisfy the demands of these growing markets. We may fail to integrate the variety of technology platforms acquired pursuant to our recent series of acquisitions. If we are unable to manage the technology associated with our business effectively, we could experience increased costs, reductions or outages in system availability or performance and losses of our network participants. As a result, we may not be able to continue to grow our revenues and earnings.
Our failure to keep pace with the rapid technological developments in our industry and the greater electronic payments industry may materially and adversely affect our business, results of operations and financial condition.
The electronic payments industry is subject to rapid and significant technological changes, including ongoing technological advancement in the areas of smart cards, radio frequency and proximity payment devices (such as contactless cards), e-commerce and mobile commerce, and real-time reloading for prepaid telecom products, among others. We cannot predict the effect of technological changes on our business. We expect that new services and technologies applicable to the electronic payments industry will continue to emerge and that these new services and technologies may be superior to, or render obsolete, the technologies and related business practices we currently use in our distributed products and services. Successful implementation of our strategy will depend in part on our ability to develop and implement technological changes and to respond effectively and quickly to changes in our industry.
We expect to invest in new technologies, services and infrastructure to further our strategic objectives, strengthen our existing businesses and remain competitive. These initiatives may be costly, could be delayed and may not be successful. In addition, in some areas, such as mobile interfaces, electronic gift card solutions and digital wallet integration, we may rely on strategic partners to develop or co-develop our solutions, or to incorporate our solutions into broader platforms for the electronic payments industry. We may not be able to enter into such relationships on attractive terms, or at all, and these relationships may not be successful. In addition, these partners, some of whom may be our competitors or potential competitors, may choose to develop competing solutions on their own or with third parties. Even if we or our partners are successful in developing new services and technologies, these new services and technologies may not achieve broad acceptance due to a variety of factors, including a lack of industry-wide standards, competing products and services or resistance to these changes from our content providers and distribution partners, third-party processors or consumers. In addition, we may not be able to derive revenue from these efforts.
Our future success will depend, in large part, upon our ability to develop new technologies and adapt to technological changes and evolving industry standards. These initiatives are inherently risky, and they may not be successful. The failure of these initiatives could have a material adverse effect on our business, results of operations and financial condition.
Changes in the telecom industry, consumers’ purchasing preferences and distribution partners’ support could cause our prepaid telecom business to decline.
We are subject to changes in the telecom industry, including changes in distribution strategies for carriers that may reduce our market share. Our telecom providers may choose to distribute their products through other third-party distributors or establish physical or online distribution channels that allow them to reach consumers directly. For example, certain carriers have designated “preferred” distributors for their products in certain channels. In the future, some carriers may de-emphasize or choose to exit the prepaid market, thus reducing the scope of our telecom offerings and overall profitability.
Our prepaid telecom offerings generally have been sold in an unassisted manner, as opposed to an assisted sales environment in which sales employees are available to answer questions and demonstrate product features and functionality. As handsets become more sophisticated, consumers may prefer purchasing their handsets in an assisted sales environment, which
could lead to a shift in our business model toward assisted sales, resulting in increased costs, or cause sales of our prepaid telecom products to decline or grow at a slower rate than expected or not at all.
Our distribution partners may not devote sufficient retail space to effectively market our telecom products. In addition, our distribution partners may choose to discontinue offering telecom products due to legislative and regulatory developments that result in additional costs or compliance burdens in the retail sales environment.
Litigation, investigations or regulatory examinations could lead to significant settlements, fines, penalties or compliance costs.
We are involved, and in the future may be involved, in various litigation, indemnification and regulatory matters arising in the ordinary course of business. We also are subject to ongoing regulatory examinations related to our state money transmitter licenses. We may also be subject to other regulatory investigations from time to time. These matters can result in substantial costs and diversions of management time and other resources. While we do not anticipate any material negative outcomes related to these matters, we can provide no assurance that any pending or future matters will not have a material adverse effect on our business, results of operations and financial condition.
Assertions by third parties of infringement by us, our distribution partners or our content providers of their intellectual property rights could result in significant costs and substantially harm our business and operating results.
The technologies used in the payments industry are protected by a wide array of patents and other intellectual property rights. As a result, third parties have in the past and may in the future assert infringement and misappropriation claims against us, our distribution partners or our content providers from time to time. In the past, we successfully defended litigation asserting that we had infringed a third party’s patents. There can be no assurance that any future assertions of infringement or misappropriation will not result in liability or damages payable by us.
In addition, in the past, we have received letters from various other parties claiming to have enforceable patent rights and asserting infringement of them by us. There can be no assurance that these assertions, or any such future assertions, will not result in liability or damages payable by us. Consequently, there can be no assurance that these assertions will not lead to litigation, liability or damages payable by us.
Our distribution partners may be subject to infringement or misappropriation claims that, if successful, could preclude the distribution partner from distributing our products and services. In addition, some of our agreements require that if claims related to our products and services are made against our distribution partners or content providers, we are required to indemnify them against any losses. For example, we previously incurred legal fees and costs to defend a number of our partners in connection with matters alleging patent infringement in connection with activation of prepaid cards.
Whether or not an infringement or misappropriation claim is valid or successful, it could adversely affect our business by diverting management’s attention or involving us in costly and time-consuming litigation. If we are not successful in defending any such claim, we may be required: (i) to pay past and future royalties to use technology or other intellectual property rights then in use, we may be required (ii) enter into a license agreement and pay license fees; and/or (iii) stop using the technology or other intellectual property rights then in use. In the latter case we may then have to develop, license or otherwise use other non-infringing technology. Any of these results could have a material adverse effect on our business, results of operations and financial condition.
If we are unable to adequately protect our brands and the intellectual property rights related to our distributed products and services, our competitive position could be harmed and we could be forced to engage in costly litigation to protect our rights.
Our success depends in part on developing and protecting our intellectual property and other proprietary rights in our technology, including various aspects of our card activation and management platforms, our customized employee incentive and recognition solutions, and our technology related to gift card exchange. In addition, the Blackhawk brand, our Gift Card Mall, GiftCards.com, OmniCard.com, Cashstar.com and our other proprietary brands such as the Achievers’ Employee Success Platform, Engagement Solutions, Extrameasures, Grass Roots, NimbleCommerce, Cardpool and CashStar are important to our business. We rely on a combination of patent, trademark and copyright laws, trade secret protection and confidentiality agreements to protect our intellectual property and other proprietary rights, all of which offer only limited protection. Some of our technology and other intellectual property may not be protected by intellectual property laws, particularly in foreign jurisdictions. The loss of our intellectual property or the inability to secure or enforce our intellectual property rights could have a material adverse effect on our business, results of operations and financial condition.
We face settlement risk from distribution partners that sell our distributed products and services.
Substantially all of our third-party distribution business is conducted through distribution partners. Our distribution partners collect payment from consumers and then remit these funds to us. In select cases, we have agreed to pay our closed loop content providers whether or not the distribution partners have paid us. In other limited cases in our third-party distribution business, we have relationships with intermediaries that are responsible for collection of payments from merchants and subsequent remittance of such payments to us. In such cases, our settlement risk is increased due to reliance on these intermediaries.
For open loop products for which we act as program manager, we are liable for payments to the card issuing bank whether or not the distribution partners have paid us. With respect to our Reloadit Pack, as the issuer, we are responsible for payment to the consumer regardless of any nonpayment by distribution partners. With respect to telecom products in most cases we are liable for payments to the telecom provider regardless of any nonpayment by distribution partners. For our online e-commerce business, we collect payment from customers and the amount could be charged back to our company in the case of non-payment by the customer. A charge back occurs when a consumer refuses to pay a charge on his or her credit card account for a variety of reasons, including product returns, billing errors and fraudulent charges.
Settlement risk is affected by the seasonality of our business and peaks at year-end as a result of the holiday selling season. As of fiscal year-end December 30, 2017, we estimate that we had settlement risk of
$370 million
, or
30.3%
of total
Settlement receivables
.
We are not insured against these risks.
We have in the past experienced settlement losses when a distribution partner or intermediary service provider failed to remit payment to us. These losses over the past three fiscal years have been immaterial.
While we have undertaken additional efforts to minimize the impact of our distribution partners’, content providers’ or intermediaries’ adverse financial conditions on Blackhawk, there is no assurance that these efforts will adequately mitigate potential losses. In the past few years, several of our distribution partners have faced adverse financial conditions, including a few which filed for bankruptcy or receivership protection. While none of the pending bankruptcy or receivership matters is individually or collectively material, significant settlement losses resulting from the adverse financial conditions of our distribution partners or intermediaries or due to other factors whether or not directly related to our business (such as economic downturns) could have a material adverse effect on our business, results of operations and financial condition.
We receive important services from third-party vendors, and replacing them would be difficult and disruptive to our business.
In addition to card issuing banks, we rely on third-party vendors to provide certain services relating to our business, including software engineering, customer service, warehousing and distribution, in-store merchandising, card production, transaction processing functions, customer verification services and credit validation. Some of our third-party vendors providing software engineering services to us operate internationally from locations that are subject to disruptions, some of which are out of our or their control, including those discussed under the Risk Factor titled “Our business depends on the efficient and uninterrupted operation of our transaction processing systems, including our computer network systems and data centers, and if such systems are disrupted, our business, results of operations and financial condition could be materially and adversely affected.” Our profitability depends on the ability of these third-party vendors and service providers to deliver their products and services in a timely manner and in accordance with our specifications, as well as on our effective oversight of their performance. It would be difficult to replace some of our third-party vendors in a timely manner, in particular, our warehousing and distribution providers for the United States and Canada and the software developers for our proprietary platforms, if they were unwilling or unable to provide us with these services in the future, and consequently our business and operations could be adversely affected. If we are required to replace a vendor, we may not be able to do so on commercially acceptable terms, or at all. Also, to the extent that any third-party vendor fails to deliver services, either in a timely, satisfactory manner, or at all, our business, results of operations and financial condition could be materially and adversely affected.
Our future success depends upon our ability to attract and retain key personnel.
We depend on a number of key personnel who have substantial experience relevant to the payments industry and our operations. Our executive officers are at-will employees. This means that they may terminate their employment with us at any time. Our future success will depend, to a significant extent, on our ability to identify, attract and retain key personnel, namely our management team and experienced sales, marketing, technical and systems management personnel, as well as finance, legal and compliance personnel. Qualified individuals are in high demand, particularly in the San Francisco Bay Area, where our principal offices are located, and we may incur significant costs to attract and retain them. In addition, we may experience difficulty assimilating our newly hired personnel and assimilating personnel from acquisition activity, which could have a material adverse effect on our business, results of operations and financial condition. Competitors have in the past and may in the future attempt to recruit our top management and employees. If we fail to identify, attract and retain key personnel, our business, results of operations and financial condition could be materially and adversely affected.
Our business could be negatively affected by the actions of stockholders.
Actions of our stockholders could adversely affect our business. Specifically, actions of some stockholders, including public proposals, requests to pursue a strategic combination or other transaction or special demands or requests, could disrupt our operations, be costly and time-consuming or divert the attention of our management and employees and increase the volatility of our stock. In addition, perceived uncertainties as to our future direction relative to the actions of our stockholders may result in the loss of potential business opportunities, which may be exploited by our competitors and make it more difficult to attract and retain personnel as well as customers, service providers and partners. Actions by our stockholders may also cause fluctuations in our stock price based on speculative market perceptions or other factors that do not necessarily reflect the underlying fundamentals and prospects of our business.
We are subject to added business, political, regulatory, operational, financial and economic risks associated with our international operations.
We currently conduct business in the United States and
25
other countries (with our international business accounting for approximately
30.7%
of our total revenues in
2017
), and an important element of our business strategy is the expansion of our business in our existing and new international markets. We are subject to a number of risks related to our foreign operations, including:
|
|
•
|
challenges caused by distance, language and cultural differences;
|
|
|
•
|
multiple, conflicting and changing laws and regulations, and difficulties in understanding and ensuring compliance with those laws by our employees and business partners, including compliance of data privacy regulations which may affect how we transfer data in our various markets;
|
|
|
•
|
foreign laws and regulations that impose greater compliance obligations and costs;
|
|
|
•
|
foreign currency fluctuations;
|
|
|
•
|
differing and potentially adverse tax laws and interpretations;
|
|
|
•
|
foreign tax authorities requiring tax collection or withholding from non-residents of the foreign jurisdiction;
|
|
|
•
|
higher costs associated with doing business internationally, such as costs associated with tax planning and repatriating funds to the United States, administrative costs associated with payment settlement and other compliance costs related to doing business in foreign jurisdictions;
|
|
|
•
|
difficulties in staffing and managing international operations;
|
|
|
•
|
restrictions on the transfer of funds among countries and back to the United States;
|
|
|
•
|
differing levels of social and technological acceptance of prepaid products and services;
|
|
|
•
|
limitations on the level of intellectual property protection;
|
|
|
•
|
trade sanctions, political unrest, terrorism, war and epidemics or threats of any of these events;
|
|
|
•
|
lack of acceptance of our distributed products or of prepaid products generally;
|
|
|
•
|
the potential for disputes with our business partners; and
|
|
|
•
|
competitive environments that favor local businesses.
|
Uncertainty caused by political change in the United States and in foreign countries may heighten regulatory uncertainty and risks in these areas. For example, the current administration has indicated an intention to request Congress to make significant changes to immigration including the visa program, and development and investment in the territories and countries where we or our partners operate. Any such changes could materially adversely impact our business, results of operations and financial condition.
In addition, in certain markets, we have entered into and plan to enter into additional distribution agreements with local partners. Accordingly, our success in those markets depends in large part on the success of our commercial partners. We do not control those partners and there is no assurance that they will devote the time or resources, or have the capability, necessary to make our expansion into new markets successful.
The materialization of these risks could harm our current international operations, as well as our expansion efforts, which could in turn have a material adverse effect on our business, results of operations and financial condition.
Our balance sheet includes significant amounts of goodwill and intangible assets. The impairment of a significant portion of these assets would negatively affect our business, financial condition and results of operations.
As a result of our acquisitions, a significant portion of our total assets consist of goodwill and intangible assets. Combined goodwill and intangible assets, net of amortization, accounted for approximately
24.0%
and
25.6%
of the total assets on our balance sheet as of
December 30, 2017
and
December 31, 2016
, respectively. We may not realize the full value of our intangible assets and goodwill. We expect to engage in additional acquisitions, which may result in our recognition of additional intangible assets and goodwill. We routinely evaluate whether all or a portion of our goodwill and other intangible assets may be impaired. If it is determined that an impairment has occurred, we would be required under current accounting rules to write-off the impaired portion of goodwill and such intangible assets, resulting in a charge to our earnings. An impairment of a significant portion of goodwill or intangible assets could have a material adverse effect on our business, financial condition and results of operations.
Our headquarters and certain of our data centers are located near known earthquake fault zones and in areas of elevated wild fire danger. The occurrence of an earthquake, fire or any other catastrophic event could disrupt our operations or the operations of third parties who provide vital support functions, which in turn could have a material adverse effect on our business, results of operations and financial condition.
We and some of the third-party service providers on which we depend for various support functions, such as customer service, warehousing and distribution, card production, transaction processing functions, customer verification services and credit validation, are vulnerable to damage from catastrophic events, such as power loss, natural disasters, terrorism and similar unforeseen events beyond our control. Our principal offices and one of our data centers, for example, are situated in the San Francisco Bay Area near known earthquake fault zones and areas of elevated wild fire danger. If a catastrophic event were to occur, our ability to operate our business in the normal course could be seriously impaired. The measures we have taken to prepare for such an event may not be successful, and we may experience unforeseen problems unrelated to catastrophic events. In addition, we might not have adequate insurance to cover our losses resulting from catastrophic events or other significant business interruptions. Any significant losses that are not recoverable under our insurance policies, as well as the damage to, or interruption of, our infrastructure and processes, could have a material adverse effect on our business, results of operations and financial condition.
Risks Related to Ownership of Our Common Stock
The market prices of our common stock may be volatile, which could cause the value of an investment in our stock to decline.
The market price of our common stock may fluctuate substantially due to a variety of factors, many of which are beyond our control. Factors that may contribute to fluctuations in the market prices of our common stock include:
|
|
•
|
failure to sustain an active, liquid trading market for our shares;
|
|
|
•
|
changes in financial estimates or recommendations by securities analysts or failure to meet analysts’ performance expectations;
|
|
|
•
|
changes in market valuations of similar companies;
|
|
|
•
|
changes in our capital structure, such as future issuances of securities or the incurrence of debt;
|
|
|
•
|
sales of our capital stock by our directors or executive officers;
|
|
|
•
|
the gain or loss of significant distribution partners, content providers, or business clients;
|
|
|
•
|
actual or anticipated developments in our business or our competitors’ businesses, such as announcements by us or our competitors of significant contracts, acquisitions or strategic alliances, or in the competitive landscape generally;
|
|
|
•
|
litigation involving us, our industry or both;
|
|
|
•
|
additions or departures of key personnel;
|
|
|
•
|
regulatory developments in the United States and/or foreign countries;
|
|
|
•
|
investors’ general perception of us; and
|
|
|
•
|
changes in general economic, industry and market conditions.
|
The stock markets in general have experienced substantial volatility that has often been unrelated to the operating performance of particular companies. These types of broad market fluctuations may adversely affect the trading price of our common stock.
In the past, stockholders have sometimes instituted securities class action litigation against companies following periods of volatility in the market price of their securities. Any similar litigation against us could result in substantial costs, divert management’s attention as well as our other resources and could have a material adverse effect on our business, results of operations and financial condition.
In addition, the Merger, or the failure to complete the Merger, may affect our stock price. Please see the Risk Factor titled “Failure to complete the Merger could materially adversely affect our stock price, future business operations and financial results.”
We incur significant costs as a public company and laws and regulations applicable to public companies may divert management’s attention and affect our ability to attract and retain qualified board members.
As a public company, we incur significant legal, accounting and other expenses that we did not incur as a private company, including costs associated with public company reporting requirements. We also incur costs associated with the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), the Dodd-Frank Act and related rules implemented or to be implemented by the SEC and the Nasdaq Stock Market. The expenses incurred by public companies generally for reporting and corporate governance purposes have been increasing, although the future of regulations applicable to public companies has become less certain as the current administration has recently taken steps to restructure and potentially eliminate major provisions of the Dodd-Frank Act. The rules and regulations associated with being a public company and any changes to these rules and regulations also may make it more difficult or costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept constraints on policy limits and coverage or incur substantially higher costs to obtain coverage. These laws and regulations and any changes to these rules and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as our executive officers and may divert management’s attention. Furthermore, if we are unable to satisfy our obligations as a public company, we could be subject to delisting of our common stock, fines, sanctions and other regulatory action and potentially civil litigation.
We are required to assess our internal control over financial reporting on an annual basis and any future adverse findings from such assessment could result in a loss of investor confidence in our financial reports, significant expenses to remediate any internal control deficiencies and ultimately have an adverse effect on the market prices of our common stock.
We are required, under Section 404 of the Sarbanes-Oxley Act, to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting. This assessment must include disclosure of any material weaknesses identified by our management in our internal control over financial reporting, as well as an opinion from our independent registered public accounting firm on the effectiveness of our internal control over financial reporting. A material weakness is a control deficiency or combination of control deficiencies that results in more than a remote likelihood that a material misstatement of annual or interim financial statements will not be prevented or detected.
The rules governing the standards that must be met for management to assess our internal control over financial reporting are complex and require significant documentation, testing and possible remediation. We may not be able to complete our evaluation, testing and any required remediation in a timely fashion. During the evaluation and testing process, if we identify one or more material weaknesses in our internal control over financial reporting, we will be unable to assert that our internal controls are effective. We cannot provide any guarantee that there will not be material weaknesses or significant deficiencies in our internal controls. If our internal control over financial reporting is not effective, we could suffer material misstatements in our financial statements and fail to meet our reporting obligations and lose investor confidence in the accuracy and completeness of our financial reports, which would cause the price of our common stock to decline. Additionally, ineffective internal control over financial reporting could expose us to increased risk of fraud or misuse of corporate assets and subject us to potential delisting from the Nasdaq Global Select Market, regulatory investigations, civil or criminal sanctions and class action litigation.
If securities or industry analysts do not publish research or reports about our business, or publish negative reports about our business, our share price and trading volume could decline.
The trading market for our common stock depends, in part, on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who cover us downgrade our stock or publish inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of our company or fails to publish reports on us regularly, demand for our stock could decrease, which might cause our stock price and trading volume to decline.
Our anti-takeover provisions may delay or prevent a change of control, which could adversely affect the prices of our common stock.
Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that may make it difficult to remove our board of directors and management and may discourage or delay “change of control” transactions, which could adversely affect the price of our common stock. These provisions include, among others:
|
|
•
|
no cumulative voting in the election of directors, which may have an effect to prevent the minority stockholders from electing director candidates;
|
|
|
•
|
the exclusive right of our board of directors to elect a director to fill a vacancy created by the expansion of the board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors;
|
|
|
•
|
a prohibition on stockholder action by written consent, which forces stockholder action to be taken at an annual or special meeting of our stockholders;
|
|
|
•
|
special meetings of our stockholders can be called only by the Chairman of the Board or by our corporate secretary at the direction of our board of directors;
|
|
|
•
|
advance notice and other requirements that stockholders, must comply with in order to nominate candidates to our board of directors and propose matters to be brought before an annual meeting of our stockholders, which may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer’s own slate of directors or otherwise attempting to obtain control of our company;
|
|
|
•
|
a majority stockholder vote is required for removal of a director only for cause (and a director may only be removed for cause), and a 75% stockholder vote is required for the amendment, repeal or modification of certain provisions of our certificate of incorporation and bylaws; and
|
|
|
•
|
our board of directors may, without stockholder approval, issue series of preferred stock, or rights to acquire preferred stock, that could dilute the interest of, or impair the voting power of, holders of our common stock or could also be used as a method of discouraging, delaying or preventing a change of control.
|
Certain anti-takeover provisions under Delaware law also apply to our company. Under Section 203 of the Delaware General Corporation Law, a corporation may not, in general, engage in a business combination with any holder of 15% or more of its voting stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction. Furthermore, our amended and restated certificate of incorporation specifies that the Court of Chancery of the State of Delaware will be the sole and exclusive forum for most legal actions involving actions brought against us by stockholders. We believe this provision benefits us by providing increased consistency in the application of Delaware law by chancellors particularly experienced in resolving corporate disputes, efficient administration of cases on a more expedited schedule relative to other forums and protection against the burdens of multi-forum litigation. However, the provision may have the effect of discouraging lawsuits against our directors and officers. The enforceability of similar choice of forum provisions in other companies’ certificates of incorporation has been challenged in legal proceedings, and it is possible that, in connection with any applicable action brought against us, a court could find the choice of forum provisions contained in our amended and restated certificate of incorporation to be inapplicable or unenforceable in such action.
We may need to raise additional capital to support our business in the future, and this capital may not be available on acceptable terms or at all, which may prevent us from growing our business.
We may need to raise additional funds to finance our future capital needs, including developing new products and technologies, operating expenses, and to make repayments under the Credit Agreement. If our unrestricted cash and cash equivalents balances and any cash generated from operations are insufficient to meet our future cash needs, we will need to access additional capital to fund our operations. We may also need to raise additional capital to take advantage of new business or acquisition opportunities. We may seek to raise capital by, among other things, issuing additional shares of our common stock or other equity securities or debt securities. If we raise additional funds through the sale of equity securities, these transactions may dilute the value of our outstanding common stock. If we decide to issue debt securities, such securities may
have rights, preferences and privileges senior to our common stock. We may be unable to raise additional funds on terms favorable to us or at all. If financing is not available or is not available on acceptable terms, we may be unable to fund our future needs and we may be required to modify our operating plans to take into account the limitations of available funding, which would harm our ability to maintain or grow our business.
Risks Related to Our Credit Agreement and Our 2022 Notes
Our senior secured credit facility contains certain restrictions that limit our flexibility in operating our business and, in the event of a default, could have a material adverse impact on our business and results of operations.
On July 27, 2016, we entered into an Amended and Restated Credit Agreement (the “Credit Agreement”) with the lenders party thereto and Wells Fargo Bank, National Association as administrative agent (the “Administrative Agent”). The Credit Agreement consists of a revolving loan facility in an aggregate principal amount not to exceed $400 million (the “Revolving Credit Facility”) and term loans up to $300 million (the “Term Loan Facility”). No additional amounts may be borrowed under the Term Loan Facility unless lenders agree to provide additional term loan commitments. We have the ability from time to time to request increases to the commitments under the Revolving Credit Facility and/or the Term Loan Facility (subject to compliance with specified conditions), with the aggregate amount of all such Revolving Credit Facility and/or Term Loan Facility increases not to exceed an incremental $300 million. The Revolving Credit Facility and the Term Loan Facility mature on July 27, 2021. The Credit Agreement and other related agreements contain customary restrictions on us and our subsidiaries. Subject to a number of important exceptions, these limitations include covenants that limit or restrict us and our subsidiaries from:
•
incurring additional indebtedness or modifying subordinated indebtedness;
|
|
•
|
granting liens on or with respect to any of our property;
|
•
making investments;
•
consolidating or merging with, or acquiring, another business;
•
selling or otherwise disposing of our assets;
•
paying dividends and making other distributions to our stockholders;
•
entering into certain transactions with our affiliates;
•
redeeming or repurchasing our stock;
•
amending our charter documents;
•
changing the nature of our business;
•
entering into sale-leaseback agreements; and
•
disposing of our interests in certain subsidiaries.
Our obligations under the Credit Agreement are secured by security interests in all of our present and future personal property and that of certain current and future subsidiaries (other than our regulated assets). In addition, the Credit Agreement contains financial covenants that require us to maintain specified financial ratios and satisfy certain financial condition tests. This may require that we take action to reduce our debt or to act in a manner contrary to our business objectives.
The breach of any of these covenants would result in a default under the Credit Agreement. Any default, if not waived, could result in our lenders terminating commitments to make loans or extend other credit to us. In the event of a default, the lenders also could accelerate and declare all or any obligations immediately due, and could take possession of or liquidate collateral. If any of these events occur, we may be unable to refinance the Credit Agreement on favorable terms, if at all, which could have a material adverse effect on our business, results of operations and financial condition. In addition, the termination of the Credit Agreement may adversely affect our ability to maintain our relationships with our content providers or adversely affect our cash flows.
Servicing our debt requires a significant amount of cash, and we may not have sufficient cash flow from our business to pay our substantial debt.
On July 21, 2016, we completed an offering of $500 million principal amount of our 2022 Notes. The 2022 Notes bear interest at a rate of 1.5% per year, payable semiannually in arrears on January 15 and July 15 of each year, beginning on January 15, 2017, and mature on January 15, 2022. In addition, on July 27, 2016, we entered into the Credit Agreement. Please see the Risk Factor titled “Our senior secured credit facility contains certain restrictions that limit our flexibility in operating our business and, in the event of a default, could have a material adverse impact on our business and results of operations” for additional information. Our ability to make scheduled payments of the principal of, to pay interest on or to refinance our indebtedness, including the notes and our Credit Agreement, depends on our future performance, which is subject to economic, financial, competitive and other factors beyond our control. Our business may not continue to generate cash flow from operations in the future sufficient to service our debt and make necessary capital expenditures. If we are unable to generate such cash flow, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt or obtaining additional equity capital on terms that may be onerous or highly dilutive. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations.
Despite our current debt levels, we may still incur substantially more debt or take other actions which would intensify the risks discussed above.
Despite our current consolidated debt levels, we and our subsidiaries may be able to incur substantial additional debt in the future, subject to the restrictions contained in our debt instruments, some of which may be secured debt. We will not be restricted under the terms of the indenture governing the 2022 Notes from incurring additional debt, securing existing or future debt, recapitalizing our debt or taking a number of other actions that are not limited by the terms of the indenture governing the 2022 Notes that could have the effect of diminishing our ability to make payments on the notes when due.
We may not have the ability to raise the funds necessary to settle conversions of the 2022 Notes or to repurchase the 2022 Notes upon a fundamental change, and our future debt may contain limitations on our ability to pay cash upon conversion or repurchase of the 2022 Notes.
Holders of our 2022 Notes have the right to require us to repurchase their notes upon the occurrence of a fundamental change at a fundamental change repurchase price equal to 100% of the principal amount of our notes to be repurchased,
plus
accrued and unpaid interest, if any. In addition, upon conversion of the notes, unless we elect to deliver solely shares of our common stock to settle such conversion (other than paying cash in lieu of delivering any fractional share), we will be required to make cash payments in respect of the notes being converted. However, we may not have enough available cash or be able to obtain financing at the time we are required to make repurchases of notes surrendered or notes being converted. In addition, our ability to repurchase the notes or to pay cash upon conversions of the notes may be limited by law, by regulatory authority or by agreements governing our future indebtedness. Our failure to repurchase notes at a time when the repurchase is required by the indenture or to pay any cash payable on future conversions of the notes as required by the indenture would constitute a default under the indenture. A default under the indenture or the fundamental change itself could also lead to a default under agreements governing our future indebtedness. If the repayment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and repurchase the 2022 Notes or make cash payments upon conversions of the 2022 Notes.
The conditional conversion feature of the 2022 Notes, if triggered, may adversely affect our financial condition and operating results.
If the conditional conversion feature of the 2022 Notes is triggered, holders of the notes will be entitled to convert them at any time during specified periods at their option. If one or more holders elect to convert their notes, unless we elect to satisfy our conversion obligation by delivering solely shares of our common stock (other than paying cash in lieu of delivering any fractional share), we would be required to settle a portion or all of our conversion obligation through the payment of cash, which could adversely affect our liquidity. In addition, even if holders do not elect to convert their notes, we could be required under applicable accounting rules to reclassify all or a portion of the outstanding principal of the notes as a current rather than long-term liability, which would result in a material reduction of our net working capital.
The accounting method for convertible debt securities that may be settled in cash, such as the 2022 Notes, could have a material effect on our reported financial results.
In May 2008, the FASB issued FASB Staff Position No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement), which has subsequently been codified as Accounting Standards Codification 470-20, Debt with Conversion and Other Options, which we refer to as ASC 470-20. Under
ASC 470-20, an entity must separately account for the liability and equity components of the convertible debt instruments (such as the notes) that may be settled entirely or partially in cash upon conversion in a manner that reflects the issuer’s economic interest cost. The effect of ASC 470-20 on the accounting for the notes is that the equity component is required to be included in the additional paid-in capital section of stockholders’ equity on our consolidated balance sheet, and the value of the equity component would be treated as original issue discount for purposes of accounting for the debt component of the notes. As a result, we will be required to record a greater amount of non-cash interest expense in current periods presented as a result of the amortization of the discounted carrying value of the notes to their face amount over the term of the notes. We will report lower net income in our financial results because ASC 470-20 will require interest to include both the current period’s amortization of the debt discount and the instrument’s coupon interest, which could adversely affect our reported or future financial results, the trading price of our common stock and the trading price of the notes.
In addition, under certain circumstances, convertible debt instruments (such as the notes) that may be settled entirely or partly in cash are currently accounted for utilizing the treasury stock method, the effect of which is that the shares issuable upon conversion of the notes are not included in the calculation of diluted earnings per share except to the extent that the conversion value of the notes exceeds their principal amount. Under the treasury stock method, for diluted earnings per share purposes, the transaction is accounted for as if the number of shares of common stock that would be necessary to settle such excess, if we elected to settle such excess in shares, are issued. We cannot be sure that the accounting standards in the future will continue to permit the use of the treasury stock method. If we are unable to use the treasury stock method in accounting for the shares issuable upon conversion of the notes, then our diluted earnings per share would be adversely affected.
The convertible note hedge and warrant transactions related to our 2022 Notes may affect the value of our common stock.
In connection with the 2022 Notes offering, we entered into convertible note hedge transactions with affiliates of the initial purchasers of the 2022 Notes, which we refer to as the “option counterparties.” The convertible note hedge transactions are expected generally to reduce the potential dilution upon conversion of the 2022 Notes and/or offset any cash payments we are required to make in excess of the principal amount of converted notes, as the case may be. We also entered into warrant transactions with the option counterparties. The warrant transactions could separately have a dilutive effect on our common stock to the extent that the market price per share of our common stock exceeds the applicable strike price of the warrants.
We are subject to counterparty risk with respect to the convertible note hedge transactions.
We are subject to the risk that the option counterparties may default under the convertible note hedge transactions. Our exposure to the credit risk of the option counterparties will not be secured by any collateral. In the past, economic conditions have resulted in the actual or perceived failure or financial difficulties of a number of financial institutions. If the option counterparties become subject to insolvency proceedings, we will become an unsecured creditor in those proceedings with a claim equal to our exposure at that time under our transactions with such counterparties. Our exposure will depend on many factors but, generally, the increase in our exposure will be correlated to the increase in the market price and in the volatility of our common stock. In addition, upon a default by the option counterparties, we may suffer adverse tax consequences and more dilution than we currently anticipate with respect to our common stock. We can provide no assurances as to the financial stability or viability of the option counterparties.
Our debt could adversely impact our operating income and growth prospects and make us vulnerable to adverse economic and industry conditions.
Our indebtedness could make it more challenging for us to obtain additional financing to fund our business strategy, acquisitions, debt service requirements, capital expenditures and working capital. Our indebtedness could increase our vulnerability to general adverse economic and industry conditions, including interest rate fluctuations, because a portion of our indebtedness is and will continue to be at variable rates of interest. This could limit our flexibility in planning for or reacting to changes in our business and our markets and place us at a competitive disadvantage relative to our competitors that have less debt, and limit among other things, our ability to borrow additional funds.
Future economic and credit market conditions may limit our access to additional capital, at a time when the Credit Agreement would otherwise permit additional financing, or may preclude our ability to refinance our existing indebtedness. If our lenders suffer from declining financial conditions, their ability to fund their commitments may be adversely affected, in which case we could be required yet unable to obtain replacement financing on similar or acceptable terms, if at all. A deterioration in the credit markets generally could further affect our ability to access sufficient financing or capital. Such limitations could have a material adverse impact on our operations and thus on our operating income, growth prospects and financial condition.