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PART IV

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549



Form 10-K

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

For the fiscal year ended December 31, 2012

Commission file number: 001-34915



NetSpend Holdings, Inc.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)
  20-2306550
(I.R.S. Employer
Identification No.)

701 Brazos Street
Suite 1300
Austin, Texas

(Address of principal executive offices)

 

78701-2582
(Zip Code)

Registrant's telephone number, including area code:
(512) 532-8200

         Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class   Name of Each Exchange on Which Registered
Common Stock, $.001 par value   The NASDAQ Stock Market LLC
(NASDAQ Global Select Market)

         Securities registered pursuant to Section 12(g) of the Act: None

         Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o    No ý

         Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 of the Act. Yes o    No ý

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

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

         Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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

Large accelerated filer ý   Accelerated filer o   Non-accelerated filer o
(Do not check if a
smaller reporting company)
  Smaller reporting company o

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

         The aggregate market value of the registrant's common equity held by non-affiliates based upon the last sale price of the common equity reported on the NASDAQ Global Select Market on June 30, 2012, was $756.8 million.

         The number of shares of the registrant's common stock outstanding on February 15, 2013 was 69,467,923.

DOCUMENTS INCORPORATED BY REFERENCE

         The information required by Part III of this report, to the extent not set forth herein, is incorporated by reference from the proxy statement the registrant will publish in connection with its 2013 annual meeting of stockholders. This proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of the registrant's 2012 fiscal year.

   


Table of Contents


TABLE OF CONTENTS

 
   
  Page  

PART I

       

Item 1.

 

Business

    2  

Item 1A.

 

Risk Factors

    15  

Item 1B.

 

Unresolved Staff Comments

    25  

Item 2.

 

Properties

    25  

Item 3.

 

Legal Proceedings

    26  

Item 4.

 

Mine Safety Disclosures

    29  

PART II

       

Item 5.

 

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

    30  

Item 6.

 

Selected Financial Data

    32  

Item 7.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

    37  

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

    53  

Item 8.

 

Financial Statements and Supplementary Data

    53  

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

    54  

Item 9A.

 

Controls and Procedures

    54  

Item 9B.

 

Other Information

    55  

PART III

       

Item 10.

 

Directors, Executive Officers and Corporate Governance

    56  

Item 11.

 

Executive Compensation

    56  

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

    56  

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

    57  

Item 14.

 

Principal Accounting Fees and Services

    57  

PART IV

       

Item 15.

 

Exhibits, Financial Statement Schedules

    58  

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DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

        This Annual Report on Form 10-K and the documents incorporated into this Annual Report on Form 10-K by reference contain forward-looking statements. These forward-looking statements include statements with respect to our financial condition, results of operations and business. The words "assumes," "believes," "expects," "budgets," "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "intends" or similar terminology identify forward-looking statements. These forward-looking statements reflect our current expectations regarding future events, results or outcomes. These expectations may not be realized. Some of these expectations may be based upon assumptions or judgments that prove to be incorrect. In addition, our business and operations involve numerous risks and uncertainties, many of which are beyond our control, that could result in our expectations not being realized, cause actual results to differ materially from our forward-looking statements and/or otherwise materially affect our financial condition, results of operations and cash flows. Please see the section below entitled "Risk Factors" for a discussion of examples of the risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. You should carefully review the risks described herein and in other documents we file from time to time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q we will file in 2013. We caution you not to place undue reliance on any forward-looking statements, which only speak as of the date hereof. Except as provided by law, we undertake no obligation to update any forward-looking statement based on changing circumstances or otherwise.

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PART I

ITEM 1.    BUSINESS

Overview

        NetSpend Holdings, Inc. (collectively with our subsidiaries, "we," "us" or the "Company") was formed as a Delaware corporation on February 18, 2004 in connection with the recapitalization of one our current subsidiaries, NetSpend Corporation, which was founded in 1999. We operate in one reportable business segment and we provide general purpose reloadable ("GPR") prepaid debit and payroll cards and alternative financial service solutions to underbanked and other consumers in the United States. The products we manage provide underbanked consumers with access to FDIC-insured depository accounts with a menu of pricing and features specifically tailored to their needs. We have an extensive distribution and reload network comprised of financial service centers and other retail locations throughout the United States. Our common stock trades on the NASDAQ stock exchange under the symbol "NTSP."

        We are a program manager for the FDIC-insured depository institutions that issue the card products that we develop, promote and distribute. We have agreements with, among others, Meta Payment Systems ("MetaBank"), a division of Meta Financial Group ("MFG"), Inter National Bank ("INB"), U.S. Bank ("USB"), SunTrust Bank ("SunTrust"), Regions Bank ("Regions"), BofI Federal Bank ("BofI"), a large bank based in New England and The Bancorp Bank ("Bancorp" and, collectively with MetaBank, INB, USB, SunTrust, Regions, BofI and our other bank, the "Issuing Banks") whereby the Issuing Banks issue MasterCard International ("MasterCard") or Visa USA, Inc. ("Visa") branded cards to customers. Our products may be used to purchase goods and services wherever MasterCard and Visa are accepted or to withdraw cash via automatic teller machines ("ATMs"). We have transferred the INB card portfolio to Bancorp and we are in the process of transferring the card portfolios of USB to another Issuing Bank.

        We are a leading program manager for providers of GPR cards and related alternative financial services to underbanked consumers in the U.S. GPR cards generally have the same functionality as traditional bank debit cards, serving as access devices to an FDIC-insured depository account with a bank. We also offer some of our cardholders features, such as direct deposit, interest-bearing savings accounts, bill pay functionality, card-to-card transfer capability, personal financial management tools and online and mobile phone card account access. Our strategy is to focus on increasing the number of cardholders that have funds (such as their paychecks or government benefits) electronically deposited onto their cards because these consumers typically generate more revenue for us than those who do not. In addition, consumers who receive direct deposits tend to remain in our programs longer than non-direct deposit cardholders. We had 1,082,000 and 865,000 direct deposit active cards as of December 31, 2012 and 2011, respectively. We had approximately 2,352,000 active cards (i.e. cards that had been loaded or used since October 1, 2012) as of December 31, 2012 and a gross dollar volume, also known in the industry as purchase volume, of debit transactions and cash withdrawals of $13.2 billion for the twelve months ended December 31, 2012. We primarily focus on the estimated 68 million underbanked consumers in the U.S. who do not have a traditional bank deposit account or who rely on alternative financial services.

        We market cards through multiple distribution channels, including alternative financial service providers, traditional retailers, direct-to-consumer and online marketing programs and contractual relationships with corporate employers. We plan to substantially increase our distribution activities through traditional retailers as well as our efforts to enable consumers to have their tax refunds directly deposited onto one of our cards in 2013 through our relationship with Intuit (TurboTax).

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The Proposed Merger

        On February 19, 2013, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Total System Services, Inc., a Georgia corporation ("Parent"), and General Merger Sub, Inc., a Delaware corporation and a wholly-owned subsidiary of Parent ("Sub"), pursuant to which, upon the terms and subject to the conditions set forth in the Merger Agreement, Sub will merge with and into the Company (the "Merger"), with the Company surviving the Merger as a wholly-owned subsidiary of Parent (the "Surviving Corporation"). The Merger Agreement has been approved unanimously by the Board of Directors of the Company.

        At the effective time of the Merger:

    each share of the Company common stock ("Common Stock") issued and outstanding immediately prior to the effective time (other than any dissenting shares, treasury shares, or shares held by the Company, Parent or Sub and their respective subsidiaries) will be cancelled and retired and converted into the right to receive from the Surviving Corporation an amount in cash, without interest, equal to $16.00 (the "Merger Consideration");

    each share of Series A Convertible Preferred Stock ("Preferred Stock") issued and outstanding immediately prior to the effective time (other than any dissenting shares) will be cancelled and retired and converted into the right to receive from the Surviving Corporation, an amount in cash, without interest, equal to $160.00;

    each outstanding option to purchase Common Stock (x) that is or will be vested on or prior to the effective time of the Merger (a "Vested Option"), will be canceled in exchange for the right to receive a cash payment equal to the product of (i) the number of shares of Common Stock subject to such Vested Option immediately prior to the effective time and (ii) the excess, if any, of the Merger Consideration over the per share exercise price of such Vested Option, (y) that is subject to a time based vesting condition and is unvested as of the effective time of the Merger (an "Unvested Option"), will be assumed by Parent and converted into options to acquire a number of shares of Parent common stock based on a customary conversion ratio and will continue to be governed by the same material terms and conditions as were applicable immediately prior to the effective time to the Unvested Option from which it was converted, and (z) any option that is not vested and is subject solely to a performance based vesting condition which performance condition has not been satisfied at or prior to the effective time of the Merger shall be cancelled without payment as of the effective time of the Merger. Notwithstanding the foregoing, Parent and the Company have agreed that the Company may accelerate the vesting of Unvested Options held by certain holders, and as a result, at the effective time of the Merger, such options will be converted into the right to receive a cash payment equal to the product of (i) the number of shares of Common Stock subject to such Unvested Option immediately prior to the effective time and (ii) a sum equal to the Merger Consideration less the exercise price of the Unvested Option; and

    each share of restricted stock and each restricted stock unit granted by the Company (x) that is or will be vested on or prior to the effective time of the Merger (a "Vested Restricted Share") and that is outstanding immediately prior to the effective time will be canceled in exchange for the right to receive a cash payment equal to the product of (i) the number of shares of Common Stock subject to such Vested Restricted Share immediately prior to the effective time and (ii) the Merger Consideration and (y) that is unvested as of the effective time of the Merger (a "Unvested Restricted Share") and that is outstanding immediately prior to the effective time will be converted into a right to acquire a number of shares of Parent common stock based on a customary conversion ratio and will continue to be governed by the same material terms and conditions as were applicable immediately prior to the effective time to the Unvested Restricted Share from which it was converted; provided that (i) any Unvested Restricted Shares that are subject to a performance based vesting condition will be modified to substitute a time-based

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      vesting condition, except with respect to certain Unvested Restricted Shares held by certain holders which shall become subject to revised performance based vesting conditions, and (ii) certain Unvested Restricted Shares held by certain holders will be forfeited. Notwithstanding the foregoing, Parent and the Company have agreed that the Company may accelerate the vesting of Unvested Restricted Shares held by certain holders, and as a result, at the effective time of the Merger, such restricted stock will be canceled and terminated in exchange for the right to receive a cash payment equal to the product of (i) the number of shares of Common Stock subject to such Unvested Restricted Share immediately prior to the effective time and (ii) the Merger Consideration.

        Consummation of the Merger is subject to customary conditions, including (i) the adoption of the Merger Agreement by the Company's stockholders, (ii) receipt of required antitrust and other regulatory approvals, (iii) the accuracy of the representations and warranties of the parties (generally subject to Material Adverse Effect (as defined in the Merger Agreement) or other materiality qualifications), (iv) the absence of any legal restrictions on the consummation of the Merger, (v) the absence of a Material Adverse Effect with respect to the Company, (vi) material compliance by the parties with their respective covenants and agreements under the Merger Agreement and (vii) the absence of any material security breach that has resulted in or is reasonably expect to result in losses to the Company of more than $25.6 million. The Merger is not subject to any financing condition.

        The Merger Agreement contains customary representations and warranties of the Company, Parent and Sub. The Merger Agreement also contains customary covenants and agreements, including with respect to the operation of the business of the Company and its subsidiaries between signing and closing, governmental filings and approvals, financing efforts and cooperation, public disclosures and similar matters. In addition, the Company is subject to a "no-shop" restriction on its ability to solicit alternative acquisition proposals, and to provide information to and engage in discussions with third parties. The no-shop restriction is subject to provisions that allow the Company under certain circumstances to provide information and participate in discussions with respect to unsolicited alternative acquisition proposals.

        The Merger Agreement contains certain termination rights of each of Parent and the Company, including the Company's right to terminate the Merger Agreement under certain circumstances to enter into a definitive agreement providing for a superior proposal, subject to a five (5) business day matching right by Parent and payment of the termination fee described below by the Company concurrently with such termination. Among other provisions, the Merger Agreement may also be terminated by either party if the Merger has not occurred on or before October 31, 2013 (the "Outside Date "). The Merger Agreement provides that, upon termination of the Merger Agreement under specified circumstances, the Company may be required to (i) reimburse Parent for its documented out-of-pocket expenses reasonably incurred in connection with the Merger Agreement, up to $10 million and/or (ii) pay Parent a termination fee of $52.6 million (less any expenses reimbursed).

        The foregoing description of the Merger Agreement and the transactions contemplated thereby does not purport to be complete and is subject to, and qualified in its entirety by, the full text of the Merger Agreement which is attached as Exhibit 2.1 to the Company's Current Report on Form 8-K filed on February 19, 2013 and incorporated herein by reference.

        The representations, warranties and covenants of the parties contained in the Merger Agreement have been made solely for the benefit of such parties. In addition, such representations, warranties and covenants (i) have been made only for purposes of the Merger Agreement, (ii) have been qualified by confidential disclosures made by the parties to each other in connection with the Merger Agreement, (iii) are subject to materiality qualifications contained in the Merger Agreement which may differ from what may be viewed as material by investors, (iv) were made only as of the date of the Merger Agreement or such other date as is specified in the Merger Agreement and (v) have been included in the Merger Agreement for the purpose of allocating risk between the contracting parties rather than

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establishing matters as facts. Accordingly, the Merger Agreement is included with this filing only to provide investors with information regarding the terms of the Merger Agreement, and not to provide investors with any other factual information regarding the parties or their respective businesses. Investors should not rely on the representations, warranties or covenants, or any descriptions thereof, as characterizations of the actual state of facts or condition of the parties or any of their respective subsidiaries or affiliates. Moreover, information concerning the subject matter of the representations and warranties may change after the date of the Merger Agreement, which subsequent information may or may not be fully reflected in the parties' public disclosures. The Merger Agreement should not be read alone, but should instead be read in conjunction with the other information regarding the parties and the Merger that is or will be contained in, or incorporated by reference into, the proxy statement that the Company will file in connection with the Merger, and the other documents that the parties will file, with the Securities and Exchange Commission ("SEC").


Additional Information and Where to Find It

        In connection with the proposed transaction, the Company will file a proxy statement with the SEC. INVESTORS AND SECURITY HOLDERS OF THE COMPANY ARE ADVISED TO READ THE PROXY STATEMENT AND ANY OTHER RELEVANT DOCUMENTS FILED WITH THE SEC WHEN THEY BECOME AVAILABLE, BECAUSE THEY WILL CONTAIN IMPORTANT INFORMATION ABOUT THE MERGER AND THE PARTIES THERETO.

        Investors and stockholders may obtain free copies of the proxy statement and other documents filed by the Company (when available), at the SEC's Web site at www.sec.gov or in the Investor Relations section of the Company's Web site at www.netspend.com. The proxy statement and such other documents may also be obtained, when available, for free from the Company by directing such request to NetSpend Holdings, Inc., Attn: Secretary, Telephone (512) 532-8200.

        The Company and its directors, executive officers and other members of its management and employees may be deemed to be participants in the solicitation of proxies from the Company's stockholders in connection with the proposed transaction. Information concerning the interests of those persons is set forth in the Company's proxy statement relating to the 2012 annual stockholder meeting and annual report on Form 10-K for the fiscal year ended December 31, 2011and quarterly reports on Form 10-Q for the quarters ended March 31, 2012, June 30, 2012 and September 30, 2012 filed with the SEC, and will also be set forth in the proxy statement relating to the transaction when it becomes available.


Market Opportunity

        The prepaid card market is one of the fastest growing segments of the payments industry in the U.S. This market has experienced significant growth in recent years due to consumers and merchants embracing improved technology, greater convenience, more product choices and greater flexibility. Prepaid debit cards have proven to be an attractive alternative to traditional bank accounts for certain segments of the population, particularly those without a checking or savings account and those reliant on alternative financial services such as non-bank money orders, check cashing, rent-to-own agreements and payday loans. We refer to this segment of the population as the "underbanked" and we believe approximately 68 million adults in the U.S. fall within this demographic. In our view, many underbanked consumers are dissatisfied with the traditional banking sector due to expensive fee structures, excessive minimum balance fees and overdraft charges, denial of access to credit products due to a lack of, or poor, credit history or a distrust in non-cash financial instruments. In addition, many traditional financial services providers are not open during hours or located in areas that are convenient for underbanked consumers.

        As a result of their lack of access to traditional bank services, many underbanked consumers have historically used cash as their primary payment vehicle. However, this reliance on cash inherently limits

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these consumers' purchasing power and flexibility. For this portion of the population, prepaid debit cards have emerged as an attractive alternative that allows them to conveniently participate in mainstream financial transactions. Our mission is to facilitate this transition.


Business Strategy

        Our goal is to be the leading program manager for financial institutions that provide GPR cards and related alternative financial services to underbanked consumers. We are pursuing a number of approaches to achieve this objective.

        We plan to increase cardholder usage and retention by increasing the number of cardholders who deposit their wages, government benefits or tax refunds directly onto their cards. We plan to continue to provide competitive pricing while adding functionality and complementary products and services that will encourage underbanked consumers to use their cards as the equivalent of a traditional bank account over longer periods of time.

        We also plan to develop new distribution relationships with leading financial service providers, national retailers and corporate employers in order to grow and diversify our cardholder base. We expect that our distribution relationships with PayPal and Intuit will assist us in developing and executing this expanded distribution approach. We also plan to continue our efforts to refine and improve our on-line distribution capabilities and our relationships with providers of alternative financial products. Our paycard business will also focus on continuing to add issuing banks and their corporate clients to our portfolio.


Products and Services

        GPR cards are the core product we manage. As of December 31, 2012, we managed programs that had approximately 2,352,000 active cards. We consider a GPR card to be "active" if a personal identification number, or PIN, or signature-based purchase transaction, a point-of-sale load transaction or an ATM withdrawal has been made with the card within the three month period preceding the date of determination.

        Funds may be loaded onto the GPR cards we market at locations within our distribution and reload network, through the direct deposit of wages, government benefits or tax refunds, from a cardholder's bank account through our online banking portal or through an electronic transfer by a third party.

        We provide a feature rich suite of products and services to our cardholders, including direct deposit, overdraft protection through our Issuing Banks, complimentary insurance coverage and online bill payment options. Our cardholders also have the ability to transfer funds to other cardholders and deposit a portion of their funds into an interest-bearing savings account linked to their GPR cards. We also provide certain cardholders with a "cushion" that allows them to overdraw their card accounts by up to $10 without a fee. Our website allows our cardholders to access their account information and effectively manage their budgets through our personal finance management tools. Our interactive voice response systems also provide account information and allow cardholders to activate their accounts and perform a range of transaction activities. In addition, we provide our cardholders with a text message service that automatically sends balance and transaction information to enrolled cardholders' mobile phones and allows them to interact with their account by sending text messages to us. We believe we were the first prepaid debit card provider to provide text message services to cardholders.

        The cards we market through corporate employers are promoted to their employees as an alternative method of wage payment and are designed to be compliant with state wage and hour laws governing payroll cards. Similar to the GPR cards we market through our distributors, cardholders may load their wages onto our employer-marketed GPR cards through direct deposit. Although our

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employer-marketed GPR cards may not generally be reloaded through our reload network, they may currently be reloaded at all MoneyGram and Western Union agent locations.

        In addition to GPR cards, we were also a provider of gift cards. Beginning in 2008, we decided to focus primarily on our GPR cards and we ceased marketing gift cards entirely in August 2010.


Distribution

        We have built a distribution and reload network throughout the U.S. comprised of diverse categories of alternative financial service providers, traditional retailers, corporate employers and our own direct-to-consumer and online marketing programs. As of December 31, 2012, we marketed GPR cards through more than 500 distributors at over 60,000 locations in the U.S. We also offered reload services through approximately 450 distributors at over 130,000 locations in the U.S. Our reload network is designed to provide convenient ways for our cardholders to add more funds to their cards and to provide our distributors with additional opportunities to earn revenue. Distributors typically collect a fee in connection with the reload of our GPR cards. We do not process reloads for other providers of GPR cards and so none of our revenues are derived from reloads of cards offered by other prepaid debit card companies. Our reload network is comprised of all of the alternative financial services provider locations and traditional retail locations through which we market GPR cards, as well as all MoneyGram and Western Union agent locations.

        Our long-term relationships include leading alternative financial services providers, such as ACE Cash Express ("ACE"), Advance America, Cash America International, Community Financial Service Center and Check City, leading grocery and convenience stores, such as H-E-B, Speedway, Murphy Oil and Winn-Dixie, and leading tax preparation service providers, such as Intuit and Liberty Tax Service. Our largest distributor is ACE with whom we have an exclusive distribution agreement through March 31, 2016 (this agreement will extend for an additional five years upon the consummation of the proposed Merger). GPR cards distributed through ACE accounted for approximately 36.6% of our total revenues in 2012. We have also entered into contractual relationships with Interactive Communications International ("InComm") and Blackhawk Network ("Blackhawk") to sell and reload GPR cards through certain of the retailers participating in their networks, such as 7-Eleven, Walgreens, CVS and Safeway.

        In October 2011, we announced that we entered into a Program Services Agreement with PayPal under which we will act as the exclusive (subject to certain limited exceptions) provider of program management and processing services for PayPal-branded GPR cards in the United States. We began marketing the PayPal-branded card online in early 2012. In late 2012, we announced that we entered into an agreement with Intuit, Inc. ("Intuit") pursuant to which we will provide the only GPR card that can be ordered through the use of its TurboTax software. We began marketing cards under this program in early 2013. Additionally, we also expect to offer GPR cards to the small business owners that use Intuit's Quickbooks software in the second quarter of 2013.

        We marketed payroll cards through more than 1,400 corporate employers as of December 31, 2012. These employers promote our cards to their underbanked employees as an alternative method of wage payment, allowing their employees to receive their wages on a debit card through direct deposit rather than a paper check and allowing the employers to avoid the costs associated with distributing paper checks. The corporate employers through which we market cards include Kohl's, Macy's, TravelCenters of America, Church's Chicken, Starwood Hotels & Resorts Worldwide, Hospital Corporation of America and Big Lots.

        We also market our cards directly to consumers through direct-to-consumer and online marketing programs. We have developed proprietary systems for optimizing the placement of information regarding our products on the Internet through affiliate marketing and search optimization and for identifying consumers likely to be receptive to offers to apply for a GPR card.

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Sales and Marketing

        Our marketing and promotional efforts are targeted at consumers as well as our distributors and corporate employers. Our sales force is comprised of approximately 80 business development and key account management professionals who are responsible for developing and maintaining our relationships with our distributors, online marketers and corporate employers. We principally market cards under the NetSpend and Skylight brands and in many cases have co-branding relationships with our distributors. We have also commenced marketing cards under the PayPal brand, to users of TurboTax and we are promoting a card branded "Control" through our relationship with BET Consumer Services, Inc. ("BET"). Our marketing programs focus principally on direct deposit enrollment and cardholder lifetime value optimization.


Operations

        Customer Acquisition and Account Activation.    Customers that acquire cards through our distributors and corporate employers are typically issued a temporary "Instant Issue" card with funds immediately available at reduced load and transaction limits. A customer may activate a temporary card either online or by telephone. Upon the approval of the application, the account is established and a permanent card personalized with the customer's name is sent to the customer within ten business days. Customers that acquire a card through our direct-to-consumer or online marketing campaigns submit a card application to us directly, either online or by telephone, and upon approval of the application the card is activated and, if not included in the original solicitation, a permanent card is sent to the customer. We accept or decline card applications based on a review of the personal data included in each customer's application against our own and third party databases in accordance with procedures designed to comply with applicable law.

        Customer Service and Support.    We provide a comprehensive set of services to cardholders for account and balance information, budgeting tools, person-to-person payments, dispute resolution, bill payment and similar services. Customer support is provided through a combination of live service agents, continuous access to our interactive voice response ("IVR") systems, our websites and other online and mobile phone based services. Our customer service team includes employees at our Austin, Texas facility and outsourced services through facilities in the Philippines and Guatemala. We provide certain of our large distributors with private-label customer support interfaces.

        Risk Management and Regulatory Compliance.    We perform substantially all aspects of portfolio and customer risk management, fraud controls, chargeback recovery and transaction and distributor monitoring on behalf of our Issuing Banks. We also support the anti-money laundering and the Office of Foreign Assets Control ("OFAC") compliance efforts of our Issuing Banks.

        Transaction Processing.    A transaction begins with an electronic message from a merchant or an ATM requesting funds from a cardholder's account followed by a response from us authorizing or denying the request. In the case of an authorization, the cardholder's account is updated to reduce the funds available in the cardholder's account. We electronically receive and respond to an authorization request through the MasterCard, Visa or PULSE networks. The transaction is completed when a subsequent settlement transaction indicating the final purchase or withdrawal amount is received by us, following which we debit the funds from the cardholder's account.

        We operate highly secure data centers in Austin, Texas and Las Vegas, Nevada with fault tolerant transaction processing capabilities. Our data centers have been engineered to ensure minimal exposure to system failures and unauthorized access. Physical security is maintained through restricted card key access and closed circuit television cameras. We use uninterruptible power supplies with battery backup and generators to ensure continuous flow of power to each data center in the event of any component failure or power outage. The facilities have dual-entrance, fiber optic SONET service for telecom redundancy.

        In addition, we operate a secure in-house data center in Atlanta, Georgia. The data center includes uninterruptible power supplies with battery backup to ensure continuous flow of power to systems in the event of a short term power outage. Physical security is maintained through two-factor authentication process and is monitored by closed circuit television cameras.

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        We are currently investing in a significant project intended to consolidate the operating platform of our employer-marketed payroll cards with our core NetSpend infrastructure in order to increase our operating efficiencies, give us the ability to expand our feature set across our cardholder base and reduce our technology costs. We expect to complete this platform consolidation in 2013.

        Network and Telecommunications.    We maintain our own networking systems that are designed to provide secure and reliable connections to our distributors, Issuing Banks, cardholders and other third parties, such as the card associations and other processors that are integrated into our platform.

        Customer Statements and Account Information.    Cardholders can verify their account status and recent transactions through our customer service agents, through our IVR or by text messages to their mobile phones. Full account statements can be accessed online and printed statements are available upon request.

        Clearing and Settlement Process.    We have agreements with our Issuing Banks to undertake funds management and settlement processes through the card associations and network organizations. All cardholder funds are held by our Issuing Banks in FDIC-insured custodial depository accounts. Members of our distribution and reload network collect our cardholders' funds and remit them by electronic transfer to our Issuing Banks for deposit in the card accounts. Loads made through direct deposit are routed from the originating depository financial institutions through the Federal Reserve to our Issuing Banks. We provide a series of daily reports and instructions to our Issuing Banks regarding the movement of cardholder funds to enable them to reconcile their accounts.


Issuing Bank Relationships

        We are dependent upon our Issuing Banks to provide us with critical products and services, including the FDIC-insured depository accounts tied to the GPR cards we manage, access to the ATM networks, membership in the card associations and network organizations and other banking functions. All cardholder funds are held by our Issuing Banks and our cardholders are charged fees by our Issuing Banks in connection with the programs we manage. Further, interchange fees are remitted by merchants to our Issuing Banks when cardholders make purchase transactions using their cards. Our Issuing Banks compensate us for our services based on these service charges and interchange fees.

        MetaBank, which has been one of our Issuing Banks since 2005, is a federal savings bank that is a leading issuer of prepaid debit cards. In January 2010, we amended our agreement with MetaBank and, in order to further align our strategic interests with MetaBank, we also acquired an equity interest in Meta Financial Group, Inc. ("MFG"), MetaBank's holding company. We made an additional investment in MFG in September 2012 and we currently hold approximately 3.6% of MFG's outstanding equity interests.

        In July 2011, MetaBank publicly disclosed that it stipulated and consented to a Cease and Desist Order (the "Order") issued by the Office of Thrift Supervision ("OTS"), now the Office of the Comptroller of the Currency ("OCC"). Under the Order, MetaBank remains subject to the Supervisory Directives issued by the OTS (the "OTS Directives") in October 2010. Under the OTS Directives, MetaBank is required to obtain the written approval of the OCC prior to, among other things, entering into any new third party agency agreements concerning any credit or deposit product (including prepaid access) or materially amending any such existing agreement.

        We understand that the OTS Directives require MetaBank to obtain OCC approval prior to MetaBank executing third party agency agreements with new distributors for its existing program managers, including NetSpend. This means that we remain unable, without MetaBank obtaining the prior written approval of OCC, to enter into new agreements with distributors that are also required to enter into third party agency agreements with MetaBank. This restriction includes any distributors that have the capability to distribute cards issued by MetaBank and accept funds to be loaded onto those cards. Our programs that do not involve distributors that accept funds to be loaded onto cards, such as our direct-to-consumer and online marketing programs do not require third party agency agreements

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with our Issuing Banks. Similarly, as a general matter, extensions or renewals of our existing distributor agreements do not require new or amended third party agency agreements to be executed with our Issuing Banks, including MetaBank. Therefore, MetaBank is able to continue to operate under the third party agreements in place at the time the Order was issued, including our card program management agreement, and to maintain the agency agreements with our distributors that it had at that time. We have not entered into any distributor agreements that require MetaBank to extend agency since the issuance of the Order.

        We are actively pursuing our own money transmitter licenses in the jurisdictions where we do not currently have them in order to reduce our dependence on the ability of our Issuing Banks to enter into agency relationships with our distributors. We currently have money transmitter licenses in 41 jurisdictions and applications pending in 4 jurisdictions. Our goal is to acquire licenses in all of the jurisdictions where our current or expected activities, or the activities of our distributors or reload partners, require licenses.

        We are pursuing a bank diversification strategy pursuant to which we intend to distribute our GPR card issuing activities across at least three Issuing Banks, in addition to the banks that issue the payroll cards we manage. We are focused on doing so in a manner that balances our diversification strategy with the protection of existing cardholder and direct deposit relationships and other operational considerations. In furtherance of this strategy we entered into a program management agreement with The Bancorp Bank ("Bancorp") in January 2011. Bancorp began issuing our cards in a pilot program in April 2011 and began issuing cards as part of a more expanded commercial roll-out in October 2011. Our PayPal branded card is issued by Bancorp and Bancorp also issues the cards used to support our TurboTax program. In September 2012, we entered into an agreement with BofI Federal Bank ("BofI") pursuant to which BofI would act as an issuer of GPR and payroll cards. BofI began issuing GPR cards in early 2013. We are also continuing our discussions with other prospective issuing banks.

        In May 2011, we amended our agreement with Inter National Bank ("INB") to extend the date by which we agreed to transition the GPR cards issued by INB to another bank from July 2011 to September 2011. We have transitioned the distributors of INB cards to other Issuing Banks and we transitioned the INB cardholder portfolio to Bancorp in February 2013.

        U.S. Bank ("USB") and SunTrust Bank ("SunTrust") act as issuers of our payroll cards. We are actively seeking to transfer the USB portfolio to BofI and we currently expect to complete this transition in February 2013. In September 2012, we extended our contract with SunTrust until September 2015. We are actively seeking to sign agreements with additional banks that would act as issuers of payroll cards. As a result of these efforts, in October 2011, we signed an agreement with a large bank based in New England pursuant to which we will act as the program manager for the payroll cards to be issued by it, commencing in 2013. This relationship may also be expanded to include GPR cards in the future. We have also signed an agreement with Regions Bank ("Regions") pursuant to which it began issuing payroll cards in November 2012.


Technology

        We develop and maintain all critical operations software applications in-house. Our integrated end-to-end operational and technology platform supports a wide variety of core processing, client servicing and operational functions. Our proprietary systems include an account hosting database infrastructure, an integrated layer of banking, cardholder acquisition, cardholder relationship management and transactions processing applications, a range and variety of third-party client interfaces and a real-time reporting infrastructure. In addition to our core systems, we have also developed a number of ancillary systems that support a variety of customized operational needs, including regulatory compliance, risk management, customer servicing and financial reconciliation and reporting. We use OFAC screening services provided by a third party.

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Intellectual Property

        We rely on a combination of patent, copyright, trademark and trade secret laws, employee and third-party nondisclosure agreements and other methods to protect our intellectual property and other proprietary rights. In addition, we license technology from third parties.

        We have one registered patent and have applied for additional patents related to some of the unique features of our products. Most of our services and products are based on proprietary software and related payments systems solutions. Protecting our rights to our proprietary software and the patents, copyrights and trade secrets related to them is important as it enhances our ability to offer distinctive services and products to our cardholders, distributors and Issuing Banks that differentiate us from our competitors. We have U.S. federal trademark registrations for the marks "NetSpend," "Skylight" and "All-Access" and several other marks.


Competition

        The financial services industry, including the prepaid card market, is subject to intense and increasing competition. We directly compete with a number of companies that market open-loop prepaid debit cards through retail and online distribution, including Green Dot Corporation, American Express, Chase Bank, Account Now, Inc. and UniRush, LLC. Many transaction processors, such as First Data Corporation, Total System Services, Inc., Fidelity National Information Services and Galileo Processing, Inc., have the ability to manage the processing of prepaid programs and are increasingly soliciting large distributors of prepaid cards to transfer their programs to their technology platforms. Such a migration essentially eliminates our role as program manager for their card portfolios and we have lost some distributors as a result of this dynamic. In addition, we compete with banks that offer demand deposit accounts and other traditional issuers of debit cards. We also compete against large retailers, such as Wal-Mart, who are seeking to integrate more financial services into their product offerings and our competitors Green Dot and American Express currently market their cards through Wal-Mart stores (we offer reload services through Wal-Mart). We anticipate increased competition from alternative financial services providers who are often well-positioned to service the underbanked and who may wish to develop their own prepaid debit card programs. Although the increased desire of banks, retailers and alternative financial services providers to promote and develop prepaid debit card programs creates an increased awareness of prepaid products in the marketplace, it could also have an adverse effect on our business, including increased price competition and loss of distributor relationships.

        The principal means upon which we compete in the GPR and payroll card market are the experience we have gained in serving underbanked consumers over the last ten years and the understanding we have of the purchasing habits and needs of this demographic, price, the robustness of our distribution and reload network and familiarity with the regulatory environment. We also have scale advantages over some of our smaller and newer competitors. In addition, we believe that the fact that we use our own technology platform is unique among the leading GPR card providers. Having our own technology infrastructure enhances our product development capabilities and speed to market with differentiated product offerings. Processing transactions on our own platform also gives us insight into the attitudes, characteristics and purchasing behavior of underbanked consumers that we use to better tailor the products and services offered to this consumer segment.


Regulation

        Our industry is heavily regulated. We, and the products and services that we market and provide processing services for, are subject to a variety of federal and state laws and regulations, including, but not limited to:

    Banking laws and regulations;

    Money transmitter and payment instrument laws and regulations;

    State wage payment laws and regulations;

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    Anti-money laundering laws;

    Privacy and data security laws and regulations;

    Consumer protection laws and regulations;

    Unclaimed property laws; and

    Card association and network organization rules.

Banking Laws and Regulations

        The cards we market are the products of our Issuing Banks and are subject to various federal and state laws and regulations, including those discussed below. MetaBank and BofI are federally chartered thrift institutions primarily regulated by the Office of the Comptroller of the Currency, or the OCC, and their respective holding companies are primarily regulated by the Board of Governors of the Federal Reserve System, or the FRB. INB and USB are national banks primarily regulated by the OCC, and their respective holding companies are primarily regulated by the FRB. Bancorp is a Delaware state-chartered bank principally regulated by the Delaware Office of the State Bank Commissioner and the FRB, and its holding company is also principally regulated by the FRB. SunTrust is a Georgia state-chartered bank principally regulated by the Georgia Department of Banking and Finance and the FRB, and its holding company is also principally regulated by the FRB. Regions Bank is an Alabama state-chartered bank principally regulated by the Alabama Banking Department and the FRB, and its holding company is also principally regulated by the FRB. As the deposits of each of our Issuing Banks are insured by the Federal Deposit Insurance Corporation, or the FDIC, up to the applicable limit, the FDIC also serves as the secondary federal regulator for each of our Issuing Banks. As an agent of, and third-party service provider to, our Issuing Banks, we are subject to indirect regulation and direct audit and examination by the agencies that regulate them.

        The GPR cards we market through corporate employers as payroll cards are subject to certain portions of the FRB's Regulation E, which implements the Electronic Fund Transfers Act, or the EFTA. Additionally, while our other GPR cards are not expressly subject to the provisions of the EFTA and Regulation E, with the exception of those provisions comprising the CARD Act described below, we, and our Issuing Banks, treat our GPR cards as being subject to certain provisions of the EFTA and Regulation E, such as those related to disclosure requirements, periodic reporting, error resolution procedures and liability limitations.

        In 2010, the FRB issued a final rule implementing Title IV of the Credit Card Accountability, Responsibility, and Disclosure Act of 2009, or CARD Act, which imposes requirements relating to disclosures, fees and expiration dates that are generally applicable to gift certificates, store gift cards and general-use prepaid cards. We believe that our GPR cards, and the maintenance fees charged on our GPR cards, are exempt from the requirements of this rule, as they fall within an express exclusion for cards which are reloadable and not marketed or labeled as a gift card or gift certificate. However, this exclusion is not available if the issuer, the distributor selling the card to a consumer or the program manager promotes, even if occasionally, the use of the card as a gift card or gift certificate. As a result, we provide distributors with instructions and policies regarding the display and promotion of our GPR cards so that distributors do not place our GPR cards on a display that does not separate or otherwise distinguish our GPR cards from gift cards.

Money Transmitter and Payment Instrument Laws and Regulations

        Nearly every state regulates the business of money transmitters. While a large number of states expressly exempt banks and their agents from such regulation, others purport to regulate the money transmittal business of banks and their agents to the extent not conducted through bank branches. Historically, we have taken the position that state money transmitter statutes do not generally apply to our business because, among other reasons, we do not receive or handle any consumer funds related to our cards at any time. Instead, our distributors collect all consumer funds related to the sale or load of our prepaid debit cards and remit them by electronic transfer directly to our Issuing Banks. In addition,

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we and our distributors acted as the agents of nationally chartered banks that were exempt from state regulation in the past. We are actively pursuing our own money transmitter licenses in the jurisdictions where we do not currently have them in order to reduce our dependence on the ability of our Issuing Banks to enter into agency relationships with proposed new distributors. We currently have money transmitter licenses in 41 jurisdictions and applications pending in 4 jurisdictions. The remaining 6 jurisdictions either do not regulate money transmitters or interpret their laws in a manner that excludes our activities. Our goal is to acquire licenses in all of the jurisdictions where our current or expected activities, or the activities of our distributors or reload partners, require licenses.

        In those states where we are licensed as a money transmitter, we are subject to direct supervision and regulation by the relevant state banking departments or similar agencies charged with enforcement of the money transmitter statutes and we must comply with various requirements, such as those related to the maintenance of a certain level of net worth, surety bonding, selection and oversight of our authorized agents, maintaining permissible investments in an amount equal to our outstanding payment obligations, 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, distributors and other third parties, privacy and data security policies and procedures and other matters related to our business.

        We understand that state banking departments, which are charged with regulating the business of money transmission, have traditionally taken the position that the offering of payroll cards does not constitute money transmission and so we do not believe that we are required to obtain state money transmission licenses in order to engage in this activity.

State Wage Payment Laws and Regulations

        The use of payroll card programs as means for an employer to remit wages or other compensation to its employees or independent contractors is governed by state labor laws related to wage payments. Our paycard business includes payroll cards and convenience checks and is designed to allow employers to comply with applicable state wage and hour laws. Most states permit the use of payroll cards as a method of paying wages to employees, either through statutory provisions allowing such use or, in the absence of specific statutory guidance, the adoption by state labor departments of formal or informal policies allowing for their use. Nearly every state allowing payroll cards places certain requirements and/or restrictions on their use as a wage payment method, the most common of which involve obtaining the prior written consent of the employee, limitations on fees and disclosure requirements.

Anti-Money Laundering Laws and Regulations

        In July 2011, the Financial Crimes Enforcement Network of the U.S. Department of the Treasury, or FinCEN, issued a final rule regarding the applicability of the Bank Secrecy Act's anti-money laundering provisions to "prepaid access programs." This rulemaking clarifies the anti-money laundering obligations for entities, such as us and our distributors, engaged in the provision and sale of prepaid access devices like our GPR cards. We have registered with FinCEN as a "money services business." This registration results in our having direct responsibility to maintain and implement an anti-money laundering compliance program. We have historically performed the required activities under the agreements we have with each of our Issuing Banks and so complying with the final rule did not result in any material increase in our costs of operations.

        The final rule also imposes certain anti-money laundering and record keeping requirements on persons who are considered "sellers" of prepaid access. We generally seek to configure our GPR programs so that the members of our load and reload networks are eligible for an exemption from these requirements.

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Privacy and Data Security Laws and Regulations

        We collect and store personally identifiable information about our cardholders, including names, addresses, social security numbers, driver's license numbers and account numbers and maintain a database of cardholder data relating to specific transactions, including account numbers, in order to process transactions and prevent fraud. As a result, we are required to comply with the privacy provisions of the Gramm-Leach-Bliley Act ("GLBA") and its implementing regulations, various other federal and state privacy statutes and regulations and the Payment Card Industry Data Security Standard, each of which is subject to change at any time. In order to comply with our obligations under GLBA and applicable state laws, and our agreements with our Issuing Banks, we are required to safeguard and protect the privacy of such personally identifiable information, make disclosures to our cardholders regarding the applicable privacy and information sharing policies and give cardholders the opportunity to prevent us and our Issuing Banks from releasing information about them to unaffiliated third parties for marketing and other purposes. The privacy laws of certain states, including California, impose more stringent limitations on access and use of personal information than GLBA, requiring cardholders to affirmatively opt-in to certain categories of disclosures. We continue to work with our Issuing Banks to implement and maintain appropriate policies and programs as well as adapt our business practices in order to comply with applicable privacy laws and regulations.

Consumer Protection Laws and Regulations

        We are, or may be, subject to various federal and state consumer protection laws, including those related to unfair and deceptive trade practices. We continue to implement and maintain policies and procedures to assist us in our compliance with such laws, which are subject to frequent change due to the increased focus on this area by federal and state legislatures, regulatory authorities and consumer protection groups.

Card Association and Payment Network Operating Rules

        In providing certain of our services to our Issuing Banks, we are required to comply with the operating rules promulgated by various card associations and network organizations, including certain data security standards, with such obligations arising either under our agreements with each Issuing Bank or as a condition to access or otherwise participate in the relevant card association or network organization. Each card association and network organization audits us from time to time to ensure our compliance with these standards. We continue to work with our Issuing Banks to implement and maintain appropriate policies and programs as well as adapt our business practices in order to comply with all applicable rules and standards.


Employees

        As of December 31, 2012, we had 502 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.


Website

        Our website address is www.netspend.com. Through a link on the Investor Relations section of our website, we make available the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. All such filings are available free of charge.

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ITEM 1A.    RISK FACTORS

Risks Relating to Our Business

The market for prepaid debit cards and alternative financial services is highly competitive and competition is increasing as more companies, many that are larger and have greater resources than we do, endeavor to address the needs of underbanked consumers.

        The financial services industry, including the prepaid card market, is subject to intense and increasing competition. We directly compete with a number of companies that market open-loop prepaid debit cards through retail and online distribution, including Green Dot Corporation, American Express, Chase Bank, Account Now, Inc. and UniRush, LLC. Many transaction processors, such as First Data Corporation, Total System Services, Inc., Fidelity National Information Services and Galileo Processing, Inc., have the ability to manage the processing of prepaid programs and are increasingly soliciting large distributors of prepaid cards to transfer their programs to their technology platforms. Such a migration essentially eliminates our role as program manager for their card portfolios and we have lost some distributor relationships as a result of this dynamic. In addition, we compete with banks that offer demand deposit accounts and other traditional issuers of debit cards. We also compete against large retailers such as Wal-Mart who are seeking to integrate more financial services into their product offerings and our competitors Green Dot and American Express currently market GPR cards at Wal-Mart stores. We anticipate increased competition from alternative financial services providers who are often well-positioned to service the underbanked and who may wish to develop their own prepaid debit card programs. The increased desire of banks, retailers, processors and alternative financial services providers to develop and promote prepaid debit card programs could have an adverse effect on our business, including increased price competition and the loss of distributor relationships.

        Our ability to grow our business is dependent on our ability to compete effectively against other providers of GPR cards and alternative financial services. Many existing and potential competitors have longer operating histories and greater name recognition than we do. In addition, many of our existing and potential competitors are substantially larger than we are and have substantially greater financial and other resources than we do. We also face strong price competition. To stay competitive, we may have to increase the incentives that we offer to our distributors and decrease the prices of our products and services, which could adversely affect our operating results.

The loss of, or changes to, our relationships with MetaBank or our other Issuing Banks could adversely affect our business, results of operations and financial position.

        We rely on the arrangements we have with our Issuing Banks to provide us with critical products and services, including the FDIC-insured depository accounts tied to the cards we manage, access to the ATM networks, membership in the card associations and network organizations (collectively, the "Networks") and other banking services. As of December 31, 2012, the majority of our active cards were issued through MetaBank. If our relationship with MetaBank deteriorates, it could hinder our ability to grow our business and have an adverse impact on our operating results. If any material adverse event were to affect MetaBank, including as a result of the directives issued by the OCC against MetaBank, or one or more of our other Issuing Banks or if we were to lose MetaBank or one or more of our other Issuing Banks, we would be forced to find an alternative provider of these critical banking services.

        We may not be able to find a replacement bank on terms that are acceptable to us or at all. Any change in our Issuing Banks could disrupt our business or result in arrangements with new banks that are less favorable to us than those we have with our existing Issuing Banks, either of which could have a material adverse impact on our results of operations and our financial condition.

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        In addition, because some of our Issuing Banks have appointed us and our distributors as their agents for purposes of providing services in connection with our prepaid debit cards in various states, the termination of our relationship with one or more of these Issuing Banks would force us and our distributors to cease offering prepaid debit cards and related services to the extent that we rely on our status as their agent in order to do so.

Unauthorized disclosure of cardholder data, whether through breach of our computer systems or otherwise, could expose us to liability and protracted and costly litigation.

        We collect and store personally identifiable information about our cardholders, including names, addresses, social security numbers, driver's license numbers and account numbers and we maintain a database of cardholder data relating to specific transactions, including account numbers, in order to process transactions and prevent fraud. As a result, we are required to comply with the privacy provisions of the Gramm-Leach-Bliley Act, various other federal and state privacy statutes and regulations, and the Payment Card Industry Data Security Standard, each of which is subject to change at any time. Compliance with these requirements is often difficult and costly, and our failure, or our distributors' failure, to comply may result in significant fines or civil penalties, regulatory enforcement action, liability to our Issuing Banks and termination of our agreements with one or more of our Issuing Banks, each of which could have a material adverse effect on our financial position and/or operations. In addition, a significant breach could result in our being prohibited from processing transactions for any of the relevant Network organizations, including Visa, MasterCard or PULSE, which would also have a significant material adverse impact on our financial position and/or results of operations.

        Any data breach or failure to comply with any applicable privacy requirements could result in damage to our reputation, which could reduce the use and acceptance of the prepaid cards we market and manage, cause our Issuing Banks or distributors to cease doing business with us or lead to greater regulation, each of which could have a material adverse impact on our business, results of operations, financial position or potential for growth.

        Furthermore, if our computer systems are breached by unauthorized users, we may be subject to liability, including claims for unauthorized purchases with misappropriated bank card information, impersonation or similar fraud claims. We could also be subject to liability for any failure to comply with laws governing required notifications of such a breach. These claims also could result in protracted and costly litigation. In addition, we could be subject to penalties or sanctions from the Networks.

We and our distributors may be subject to claims of patent infringement.

        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 may assert infringement and misappropriation claims against us from time to time based on our general business operations or the equipment, software or services we use or provide. Various third parties have asserted or suggested the possibility of asserting patent infringement claims against us from time to time in the past and we are currently the defendant in one ongoing dispute related to a patent held by MiCash, Inc. (see "Item 3. Legal Proceedings" contained in this Annual Report on Form 10-K).

        Whether or not an infringement or misappropriation claim is valid or successful, it could adversely affect our business by diverting management's attention and involving us in costly and time-consuming litigation. In the event a claim of infringement against us is successful, we may be required to pay past and future royalties to use technology or other intellectual property rights then in use, enter into a license agreement and pay license fees or stop using the relevant technology or other intellectual property. We may be unable to obtain the necessary licenses from third parties at a reasonable cost or within a reasonable time. In addition, our distributors may be subject to infringement or

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misappropriation claims that, if successful, could preclude them from distributing our products and services or cause them to increase the fees they charge us. In addition, if claims made against our distributors arise out of their distribution of our products and services, we are required to indemnify them against any losses. We may not be fully protected against all losses associated with an infringement or misappropriation claim involving the licensors and suppliers who provide us with the software and technology that we use in our business. In addition, any such suppliers may refuse to, or may be unable to, pay any damages or honor their defense and indemnification obligations to us, which may result in us having to bear such losses.

The majority of our revenues result from GPR cards marketed pursuant to agreements we have entered into with distributors. If we are unable to maintain relationships with our distributors on terms that are favorable to us, our business, financial condition and operating results may be materially adversely affected.

        Our business model depends in large part on establishing agreements with distributors, primarily alternative financial services providers as well as grocery and convenience stores and other traditional retailers. While we continually seek to diversify the sources of our revenues and card distribution, the majority of our revenue streams have historically depended on cards distributed through these channels. In 2012, GPR cards distributed through our largest distributor, ACE, accounted for approximately 36.6% of our revenues. Our current contract with ACE expires in March 2016 (this agreement will extend for an additional five years upon consummation of the proposed Merger). Cards distributed through retailers associated with Blackhawk and InComm account for a relatively small, but growing, percentage of our revenues.

        The success of our business depends substantially on our ability to attract and retain retailers with a large number of locations that are convenient for our cardholders to purchase and reload their GPR cards. Some of our distributors may endeavor to internally develop their own prepaid debit card programs or enter into exclusive relationships with our competitors to distribute their products. The loss of, or a substantial decrease in revenues from, one or more of our top distributors, particularly ACE, could have a material adverse effect on our business and operating results. In addition, any loss of or disruption in our relationship with InComm or Blackhawk could materially delay or inhibit our ability to pursue our retail expansion strategy. Most of our distribution agreements have terms ranging from three to five years and are typically renewable automatically for subsequent terms of at least one year unless we or the distributor affirmatively elect to discontinue the agreement within the required notice period. If we want to continue a contractual relationship with a distributor after the expiration of the agreement, we are typically required to renegotiate the terms of the agreement upon its expiration and in some circumstances we may be forced to modify the terms of the agreement before it expires. Our negotiations to renew some distribution agreements have resulted in, and in the future may result in, financial and other terms that are less favorable to us than the terms of the prior agreements, such as improved royalty rates and terms that permit the distributors to market prepaid debit cards that compete with our GPR cards. Further, we may not succeed in renewing these agreements when they expire, which would result in a complete loss of new revenue from these distributors. If we are required to pay higher revenue-sharing amounts or agree to other less favorable terms to retain our distributors, or if we are not able to renew our relationships with our distributors upon the expiration of our agreements, our business, financial condition and operating results would be harmed.

We depend on our distributors' sale and promotion of our products and services, but their interests and operational decisions might not always align with our interests.

        A significant portion of our operating revenues are derived from our products and services sold at the stores of our distributors. Because we often compete with many other providers of consumer and financial products for placement and promotion of products in these stores, our success depends on the

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willingness of our distributors to promote our products and services successfully. In general, these third parties are able to exercise significant discretion over the placement and promotion of our products in their locations and they can chose to give greater prominence to the products and services of other prepaid debit card providers. In many instances, our distributors have greater incentives to promote other products or services to consumers. If our distributors do not actively and effectively promote the sale of our cards, our growth will be limited and our operating results will suffer.

We are subject to extensive and complex federal and state regulation and new regulations and/or changes to existing regulations could adversely affect our business.

        As an agent of, and third-party service provider to, our Issuing Banks, we are subject to indirect regulation and direct audit and examination by the OCC, the FRB, the Georgia Department of Banking and Finance, the Delaware Office of the State Bank Commissioner, the Alabama Banking Department and the Federal Deposit Insurance Corporation, or the FDIC. We will become subject to additional regulators as we add new issuing banks. We are also subject to direct regulation by those states in which we are licensed as a money transmitter.

        Because each of our distributors offers prepaid cards and reload services either as an agent of NetSpend, Blackhawk, InComm or one of our Issuing Banks, we do not believe that the distributors are themselves required to become licensed as money transmitters in order to engage in such activity. However, there is a risk that a federal or state regulator will take a contrary position and initiate enforcement or other proceedings against a distributor, us, our Issuing Banks or our other distribution partners. Such a development could have an adverse impact on our business, even if the relevant party were to ultimately prevail in such proceedings. It is also possible that the relevant party could be unsuccessful in making a persuasive argument that it should not be subject to such licensing requirements, and therefore could be deemed to be in violation of one or more of the state money transmitter statutes. Such failure to comply could result in the imposition of fines, the suspension of the relevant party's ability to offer some or all of our GPR cards and related services in the relevant jurisdiction, civil liability and criminal liability, each of which would likely have a material adverse impact on our revenues.

        State and federal legislatures and regulatory authorities have become increasingly focused upon the regulation of the financial services industry and continue to adopt new legislation which could result in significant changes in the regulatory landscape for financial institutions (such as our Issuing Banks) and other financial services companies (including our business). For example, the establishment of the federal Consumer Financial Protection Bureau ("CFPB") will likely expose us to increased regulatory oversight and possibly more burdensome regulation that could have an adverse impact on our revenue and profits. In May 2012, the CFPB announced an intention to propose regulations regarding the prepaid card industry, although no rule has yet been published. Additionally, changes to the disclosures which must be provided with our products and services or limitations placed on the overdraft and other fees associated with them could negatively impact our financial position by increasing our costs and reducing our revenue (we currently generate approximately 7% of our revenue from overdraft fees assessed on the GPR cards that we market through distributors and through direct-to-consumer and online marketing programs). Furthermore, states may adopt statutes which could limit the application of certain fees or otherwise increase the costs incurred, or negatively impact the revenue received, by our Issuing Banks in connection with the provision of prepaid debit cards, which would have an indirect adverse impact on our revenue (Vermont has adopted such a law and we are winding down our activities in this jurisdiction). Finally, if the federal or one or more state governments impose additional legislative or regulatory requirements on us, our Issuing Banks or our distributors, or prohibit or limit our activities as currently conducted, we may be required to modify or terminate some or all of our products and services offered in the relevant jurisdiction or certain of our Issuing Banks may terminate their relationship with us, which in turn could adversely affect our business. Any failure, or perceived

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failure, by us, our Issuing Banks or our distributors to comply with all applicable statutes and regulations could result in fines, penalties, regulatory enforcement actions, civil liability, criminal liability, and/or limitations on our ability to operate our business, each of which could significantly harm our reputation and have a material adverse impact on our business, results of operations and financial condition.

        In 2010, the FRB issued a final rule implementing Title IV of the Credit Card Accountability, Responsibility, and Disclosure Act of 2009, or CARD Act, which imposes requirements relating to disclosures, fees and expiration dates that are generally applicable to gift certificates, store gift cards and general-use prepaid cards. We believe that the GPR cards we manage, and the maintenance fees charged on them, are exempt from the requirements of this rule, as they fall within an express exclusion for cards which are reloadable and not marketed or labeled as a gift card or gift certificate. However, this exclusion is not available if the issuer, the distributor selling the card to a consumer or the program manager promotes, even if occasionally, the use of the card as a gift card or gift certificate. As a result, we provide distributors with instructions and policies regarding the display and promotion of our GPR cards. It is possible, however, that despite our instructions and policies to the contrary, a distributor engaged in offering GPR cards to consumers could take an action with respect to one or more of the cards that would cause them to be viewed as being marketed or labeled as a gift card. In such event, it is possible that the GPR cards we manage would lose their eligibility for such exclusion to the CARD Act and the rule's requirements and therefore our program could be deemed to be in violation of the CARD Act and the rule. Such a violation 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 Issuing Banks to apply certain fees to their GPR cards, each of which would likely have a material adverse impact on our revenues.

The providers of alternative financial services that distribute our products are subject to extensive and complex federal and state regulations and new regulations and/or changes to existing regulations could adversely affect their ability to offer GPR cards through their locations, which in turn could have an adverse impact on our business.

        Our distributors include a large number of companies in industries that are highly regulated, such as payday lending. It is possible that changes in the legal regime governing such businesses could limit their ability to distribute our products or adversely impact their business and thereby have an indirect adverse impact on our business. For example, a large number of states have either prohibited, or imposed substantial restrictions upon, the offering of "payday loans" and this activity continues to draw substantial scrutiny from federal and state legislatures, regulatory authorities and various consumer groups. Furthermore, the federal financial reform legislation enacted in July 2010 grants supervisory authority over entities engaged in this activity to the CFPB, which is directed to promulgate regulations which may significantly impact the operations and/or viability of various entities, including those engaged in the business of offering payday loans. As a number of our distributors, including our largest distributor, ACE, are engaged in offering payday loans, further legislative and regulatory restrictions that negatively impact their ability to continue their operations could have a corresponding negative impact on our ability to offer GPR cards through their locations, potentially resulting in a significant decline in our revenue.

We are subject to extensive and complex federal and state regulation relating to the distribution of cards through corporate employers and new regulations and/or changes to existing regulations could adversely affect our business.

        We understand that state banking departments, which are charged with regulating the business of money transmission, have traditionally taken the position that the offering of payroll cards does not constitute money transmission and so we are not required to obtain a state money transmission license

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in order to engage in this activity. However, there is a risk that a federal or state regulator will take a contrary position and initiate enforcement or other proceedings against us or our Issuing Banks, which in turn could have an adverse impact on our business, even if we were to ultimately prevail in such proceedings. It is also possible that we could be unsuccessful in making a persuasive argument that we should not be subject to such licensing requirements and could be deemed to be in violation of one or more of the state money transmitter statutes. Such a violation could result in the imposition of fines, the suspension of our ability to offer cards through corporate employers in the relevant jurisdiction, civil liability and criminal liability, any of which would likely have a material adverse impact on our revenues.

        The use of payroll cards as a means for an employer to remit wages or other compensation to its employees or independent contractors is also governed by state labor laws related to wage payments. Most states permit the use of payroll cards as a method of paying wages to employees, either through statutory provisions allowing such use, or, in the absence of specific statutory guidance, the adoption by state labor departments of formal or informal policies allowing for the use of such cards. Nearly every state allowing payroll cards places certain requirements and/or restrictions on their use as a wage payment method, the most common of which involve obtaining the prior written consent of the employee, limitations on fees and disclosure requirements. There is a risk that one or more states or state labor departments that currently permit the use of payroll cards as a wage payment method will take a contrary position, either through revised legislation, regulation or policies, as applicable, or will impose additional requirements on the provision and use of such cards, each of which could have an adverse impact on our business. We currently generate approximately 15% of our revenue through the management of payroll card programs.

Our card programs are subject to strict regulation under federal law regarding anti-money laundering and anti-terrorist financing. Failure to comply with such laws, or abuse of our card programs for purposes of money laundering or terrorist financing, could have a material adverse impact on our business.

        Provisions of the USA PATRIOT Act, the Bank Secrecy Act and other federal laws impose substantial regulations on financial institutions that are designed to prevent money laundering and the financing of terrorist organizations. Increasing regulatory scrutiny of our industry with respect to money laundering and terrorist financing matters could result in more aggressive enforcement of these laws or the enactment of more onerous regulation, which could have a material adverse impact on our business. In addition, abuse of our prepaid card programs for purposes of money laundering or terrorist financing, notwithstanding our efforts to prevent such abuse through our regulatory compliance and risk management programs, could cause reputational or other harm that would have a material adverse impact on our business.

        In July 2011, the Financial Crimes Enforcement Network of the U.S. Department of the Treasury, or FinCEN, issued a final rule regarding the applicability of the Bank Secrecy Act's anti-money laundering provisions to "prepaid access programs." This rulemaking clarifies the anti-money laundering obligations for entities, such as us and our distributors, engaged in the provision and sale of prepaid access devices like GPR cards. We have registered with FinCEN as a "money services business" in our capacity as the manager of our prepaid and paycard programs. The final rule also imposes certain anti-money laundering and record keeping requirements on persons who are considered "sellers" of prepaid access. We generally configure our GPR programs so that the members of our load and reload networks are eligible for an exemption from this definition. The final rule requires, however, that persons who load and reload prepaid cards (including closed-loop cards) must also implement policies and procedures reasonably adapted to prevent the sale of prepaid access to funds that exceed $10,000 (the "Daily Limit") to any person during any given day in order to avoid being considered a "seller" of prepaid access. Persons considered "sellers" of prepaid access are required to maintain an effective anti-money laundering program; report suspicious activity; comply

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with certain recordkeeping requirements relating to customer identifying information and transaction data; and respond to law enforcement requests. These requirements became effective in March 2012.

        It is possible that some distributors will conclude that instituting the policies and procedures needed to provide reasonable assurance that their aggregated prepaid sales to any person do not exceed the Daily Limit on any day is also unduly burdensome. Such a development could make it materially more difficult for us to attract new distributors and retain our existing distributors. This would make it harder for us to sell cards to consumers and could have a material adverse effect on our future revenue and profits. Further, it is possible that FinCEN, or another federal or state regulator, could adopt additional laws or rules that would lead to a similar result.

Our business is dependent on our continued participation in the Networks, and the termination of our participation in the Networks or changes in the Network rules could materially adversely affect our business.

        We derive substantially all of our revenue from the compensation paid by our Issuing Banks for the program management and processing services that we provide in support of their prepaid debit cards. Because we are not a bank, we are not eligible for membership in the Networks. The rules and regulations of the Networks require us to be sponsored by a bank in order to process prepaid debit card transactions and serve as a program manager for our Issuing Banks' prepaid debit card programs. We currently participate in the Networks through sponsorship by our Issuing Banks. If we or one of our Issuing Banks fails to comply with the rules and regulations of the Networks or we fail to comply with the applicable program requirements of our Issuing Banks, the Networks could limit, suspend or terminate our participation in their organizations or levy fines against us.

        The termination of our participation in the Networks, or any changes in their rules and regulations or our Issuing Banks' program requirements that would impair our participation in the Networks, could require us to alter or suspend the processing services that we provide to the Issuing Banks with respect to their prepaid debit cards, which would adversely affect our business. Further, if any of our Issuing Banks loses its sponsorship in the Networks, and we are unable to secure another bank to sponsor us with such Network, we would not be able to process transactions with respect to prepaid debit cards and our business would be materially and adversely affected.

The information technology systems and networks maintained by us and the third parties on whom we rely could fail due to factors, including those beyond our control, which could negatively impact our existing customer relationships and our business reputation.

        We depend on the efficient and uninterrupted operation of our technology platforms. These platforms are comprised of a complex system of computers, software, data centers and networks. Our ability to efficiently process transactions also depends on the systems of a wide variety of third parties, including our Issuing Banks, distributors, the Networks and processors over which we have limited or no control. Our technology platforms, and the third party systems on which we rely, could be exposed to damage or interruption from, among other things, fire, natural disaster, power loss, telecommunications failure, acts of terrorism, unauthorized entry and computer viruses. Our property and business interruption insurance may not be adequate to compensate for all losses or failures that may occur. Protracted or frequent system failures could negatively impact our existing customer relationships and our business reputation, which could have a material adverse effect on our results of operations.

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We have entered into outsourcing and other agreements related to certain business operations, and any difficulties experienced in these arrangements could result in additional expense, loss of cardholders and revenue or an interruption of our services.

        We have entered into outsourcing agreements with third parties to provide certain customer service and related support functions to our cardholders, including the outsourcing of customer service through facilities located in the Philippines and Guatemala. As a result, we must rely on third parties over which we have limited control to perform certain of our operations and, in certain circumstances, interface with cardholders. If these third parties are unable to perform to our requirements, we may be forced to pursue alternative strategies to provide these services, which could result in delays, interruptions, additional expenses and loss of cardholders.

        Due to their location in developing nations, these providers may be more susceptible to certain events, including political upheavals, war, terrorist attacks, strikes, natural disasters and pandemics. If our suppliers experience any of these events, our systems and networks may not function properly, we may lose customers and revenues and we may have difficulty attracting new customers, any of which could have a material adverse impact on our business, financial condition and results of operations. The business interruption insurance we carry may not cover any or all of the losses we may experience as a result of such events. Any significant losses that are not covered by insurance could negatively affect our financial condition and results of operations.

We are subject to risks and write-offs resulting from fraudulent activities and losses from overdrawn cardholder accounts that could adversely impact our financial performance and results of operations.

        Our prepaid card programs expose us to threats involving the misuse of cards, collusion, fraud, identity theft and systemic attacks on our systems. Although a large portion of the fraudulent activity associated with the cards we manage is addressed through the chargeback systems and procedures maintained by the Networks, we are often responsible for other losses due to merchant, cardholder and other types of fraud. No system or procedures established to detect and reduce the impact of fraud are entirely effective and we recorded losses of $18.7 million due to fraud in 2012. Although we actively devote efforts to effectively manage risk and prevent fraud, we could nevertheless experience an increase in fraud losses over our historical experience.

        Our cardholders can in some circumstances incur charges in excess of the funds available in their accounts and are liable for the resulting overdrawn account balance. Although we generally decline authorization attempts for amounts that exceed the available balance in a cardholder's account, the application of the Networks' rules and regulations, the timing of the settlement of transactions and the assessment of subscription, maintenance or other fees can, among other things, result in overdrawn card accounts. We also provide, as a courtesy and at our discretion, certain cardholders with a "cushion" which allows them to overdraw their card accounts by up to $10. In addition, eligible cardholders may enroll in our Issuing Banks' overdraft protection programs and fund transactions that exceed the available balance in their accounts. We generally provide the funds used as part of this overdraft program (MetaBank will advance the first $1.0 million on behalf of its cardholders) and are responsible to our Issuing Banks for any losses associated with any overdrawn account balances. As of December 31, 2012, our cardholders' overdrawn account balances totaled $11.7 million.

        Although we maintain reserves for fraud and other losses, our exposure to these types of risks may exceed our reserve levels for a variety of reasons, including our failure to predict the actual recovery rate, failure to effectively manage risk and failure to prevent fraud. Accordingly, our business, results of operations and financial condition could be materially and adversely affected to the extent that we incur losses resulting from overdrawn cardholder accounts and fraudulent activity that exceed our designated reserves or if we determine that it is necessary to increase our reserves substantially in order to address any increased recovery risk.

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We may not increase cardholder direct deposit participation and therefore may not achieve all of our strategic growth objectives.

        The ability of consumers to electronically load funds directly onto their reloadable prepaid debit cards has increased the attractiveness of such cards and their utility to underbanked consumers. Because direct deposit cardholders on average initiate more debit transactions and generate more revenues for us than cardholders without direct deposit, increasing cardholder adoption of direct deposit is an important part of our strategy. We are devoting significant resources to the further development of our direct deposit programs and our growth profile depends on increasing direct deposit participation by our cardholders. Some of our existing contracts with our distributors prohibit us from directly promoting direct deposit to their customers. It is possible that other distributors will insist on similar restrictions in the future, which could limit our ability to grow direct deposit participation. If we are unable to increase direct deposit participation as projected, we will be unable to meet our growth projections, and our business and results of operations will be adversely affected.

The final rule to be adopted by the Department of Treasury could prevent us from loading federal benefits directly on to our cards.

        In January 2011 the Department of the Treasury issued an interim final rule that would prohibit the electronic deposit of federal benefits, wages and tax refunds to prepaid debit cards that do not meet certain criteria, including one that requires that the card not have an attached line of credit or loan feature that triggers automatic repayment from the card. The cardholder must also be afforded all of the consumer protections that apply to a payroll card. The public comment period for the rule expired in April 2011. Although we believe that our GPR cards comply with the interim final rule in all respects, the Department of the Treasury could change the rule in light of the comments it receives during the public comment period in a manner that would limit or prohibit the electronic deposit of federal benefits, wages and tax refunds onto our GPR cards, which would result in a material adverse impact on our revenues.

We have engaged, and may engage in the future, in mergers, acquisitions or strategic transactions that could disrupt our business and harm our financial condition.

        We may in the future further expand our distribution channels, technology platform or other aspects of our business through the acquisition of other businesses, assets or technologies. These types of transactions can entail risk, may require a disproportionate amount of our management and financial resources and may create operating and financial challenges, including:

    difficulty integrating the acquired technologies, services, products, operations and personnel of the acquired business;

    disruption to our existing business;

    increased regulatory and compliance requirements;

    negative impact on our cash and available credit lines for use in financing future growth and working capital;

    inability to achieve projected synergies;

    increasing costs and complexity associated with the maintenance of adequate internal control and disclosure controls and procedures; and

    loss of key personnel.

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        The anticipated benefit to us of any strategic transactions, acquisitions or mergers may never materialize. Future investments, acquisitions or dispositions could result in dilutive issuances of our equity securities, a reduction in our cash reserves, the incurrence of additional debt, contingent liabilities or amortization expenses, or write-offs of goodwill, any of which could have an adverse effect on our business, financial condition and operating results.

If we are unable to adequately protect our intellectual property and other proprietary rights, we may lose a valuable competitive advantage or be forced to incur costly litigation to protect our rights.

        Our success depends in part on developing and protecting our intellectual property and other proprietary rights. We rely on a combination of patent, copyright, trademark and trade secret laws, employee and third-party nondisclosure agreements and other methods to protect our intellectual property and other proprietary rights. In addition, we license technology from third parties. We have one registered patent and have applied for additional patents related to some of the unique features of our products. Our patent applications may not become issued patents. If they do not become issued patents, we will not be able to prevent our competitors from using the inventions we sought to patent.

        Existing laws afford only limited protection for our intellectual property rights. Intellectual property rights or registrations granted to us may provide an inadequate competitive advantage to us or be too narrow to protect our products and services. The protections outlined above may not be sufficient to prevent unauthorized use, misappropriation or disclosure of our intellectual property or technology and may not prevent our competitors from copying, infringing or misappropriating our products and services. It is possible that others will independently develop, design around or otherwise acquire equivalent or superior technology or intellectual property rights. If we are unable to adequately protect our intellectual property rights, our business and growth prospects could be materially and adversely affected.


Risks Related to Ownership of Our Common Stock

Our stock price could decline due to the large number of outstanding shares of our common stock eligible for future sale.

        As of December 31, 2012, we had 76,266,748 shares of common stock outstanding (assuming the conversion into common stock of 199,995 shares of non-voting Series A Convertible Preferred Stock ("Series A Stock") by JLL Fund IV and 500,005 shares of Series A Stock held by JLL Fund V). 33,058,580 of these shares were owned by Oak Investment Partners X, LP (11,042,089 shares), Oak X Affiliates Fund, LP (177,266 shares), JLL Fund IV (6,239,627 shares, assuming the conversion of the shares of Series A Stock held by such fund) and JLL Fund V (15,599,598 shares, assuming the conversion of the shares of Series A Stock held by such fund). The shares held by these affiliates are eligible for sale, subject to certain restrictions under the Securities Act of 1933, as amended (the "Securities Act"). In addition, these stockholders have the ability to require us to file a registration statement with respect to their shares under the Securities Act. If we register their shares, these stockholders could sell those shares in the public market without being subject to the volume and other restrictions of Rule 144 of the Securities Act. These funds could, and in the past the Oak funds have, also distribute their shares directly to their limited and other partners who could then seek to sell their shares in the public market. Sales of substantial amounts of our common stock in the public market, or the perception that these sales could occur, could cause the market price of our common stock to decline. These sales could also make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.

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Provisions in our charter documents and under Delaware law may prevent or delay a change of control of us and could also limit the market price of our common stock.

        Certain provisions of Delaware law and of our certificate of incorporation and bylaws could have the effect of making it more difficult for a third party to acquire, or attempt to acquire, control of us, even if such a change in control would be beneficial to our stockholders or result in a premium price being paid for our outstanding shares of common stock. These provisions may also prevent or frustrate attempts by our stockholders to replace or remove our management. These provisions include:

    limitations on the removal of directors;

    the ability of our board of directors, without stockholder approval, to issue preferred stock with terms determined by our board of directors and to issue additional shares of our common stock;

    advance notice requirements for stockholder proposals and nominations;

    the inability of stockholders to act by written consent or to call special meetings; and

    the ability of our board of directors to make, alter or repeal our bylaws.

        The affirmative vote of the holders of at least 75% (or 80% in the case of the provision related to stockholder action by written consent) of our voting shares of capital stock is necessary to amend or repeal the above provisions that are contained in our certificate of incorporation. Absent approval of our board of directors, our bylaws may only be amended or repealed by the affirmative vote of the holders of at least 75% of our voting shares of capital stock.

        In addition, we are subject to the provisions of Section 203 of the Delaware General Corporation Law, which limits business combination transactions with stockholders of 15% or more of our outstanding voting stock that our board of directors has not approved. These provisions and other similar provisions make it more difficult for existing stockholders or potential acquirers to acquire us.

        These provisions could limit the price that investors are willing to pay in the future for shares of our common stock. These provisions might also discourage a potential acquisition proposal or tender offer, even if the acquisition proposal or tender offer is at a premium over the then current market price for our common stock.

If securities analysts do not continue to publish research or reports about our business or if they publish negative evaluations of our stock, the price of our stock could decline.

        We believe that the trading price for our common stock is affected by research or reports that industry or financial analysts publish about us or our business. If one or more of the analysts who may elect to cover us downgrade their evaluations of our stock, the price of our stock could decline. If one or more of these analysts cease coverage of our company, we could lose visibility in the market for our stock, which in turn could cause our stock price to decline.

ITEM 1B.    UNRESOLVED STAFF COMMENTS

        None.

ITEM 2.    PROPERTIES

        Our principal executive offices are located in Austin, Texas, where we lease approximately 54,000 square feet (we also lease a separate 21,000 square foot facility in Austin where some of our customer support staff is housed). We also maintain leased offices in Atlanta, Georgia, San Mateo, California, Kansas City, Kansas and Charlotte, North Carolina. We believe that our existing and planned facilities are adequate to support our existing operations and that, as needed, we will be able to obtain suitable additional facilities on commercially reasonable terms.

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ITEM 3.    LEGAL PROCEEDINGS

        We are involved from time to time in various litigation and regulatory matters arising in the ordinary course of business. The amount, if any, of our ultimate liability with respect to these matters cannot be determined, and the resolution of any pending matters may have a material adverse effect on our business and financial condition.

    Alexsam Litigation

        On October 24, 2007, Alexsam, Inc. filed suit against NetSpend Corporation ("NetSpend") in the District Court of Travis County, Texas, 419th Judicial District, asserting breach of a license agreement entered into between NetSpend and Alexsam in 2004 and seeking monetary damages, attorneys' fees, costs and interest. The license agreement was entered into by the parties following Alexsam's assertion and subsequent dismissal without prejudice of a claim of patent infringement against NetSpend in 2003. NetSpend asserted counterclaims against Alexsam for breach of contract. In October 2010, Alexsam filed an amended petition, which added a claim by Alexsam that NetSpend fraudulently induced Alexsam to give up its prior patent infringement claims against NetSpend and enter into the license agreement.

        The case was tried to a jury in a trial that concluded on April 27, 2012, with the jury finding that NetSpend had breached its license agreement with Alexsam and awarding Alexsam $18 million in royalties for the period from March 2004 through December 31, 2011. The jury did not find that NetSpend had engaged in any fraudulent conduct. This amount did not include prejudgment interest or attorneys' fees, which we estimated could approximate an aggregate of $6 million, nor did it include royalties that could become payable in future periods if NetSpend was unable to successfully appeal the jury's verdict.

        On November 5, 2012, NetSpend and Alexsam executed an agreement (the "License Agreement") pursuant to which we paid $24 million to Alexsam in exchange for a fully paid up license under the patents underlying the dispute in this case (U.S. Patent Nos. 6,000,608 and 6,189,787 (collectively, the "Licensed Patents")). Following the execution of the License Agreement, the Alexsam case was dismissed with prejudice.

        The License Agreement grants to NetSpend and its affiliates a non-exclusive, irrevocable, nontransferable (subject to certain exceptions), perpetual, fully paid-up, worldwide right and license under the Licensed Patents to, among other things, make, use, distribute or sell any Licensed Product, including to process card activations, recharges, signature debit transactions, PIN debit transactions and ATM withdrawals. "Licensed Product" under the License Agreement means any product with respect to which we serve as (i) a processor for the accounts and/or sub-accounts associated with such product, (ii) a program manager or (iii) an issuer, or any system or method associated with or related to such a product, where the product, system or method, either alone, or in conjunction with other components or activities, infringes or may infringe any claim of the Licensed Patents.

        The license granted under the License Agreement extends to our distributors, retailers, agents, issuing banks, marketers, branding partners, aggregators, accountholders, card associations, authorization networks, and other persons through or for whom we offer, distribute, activate, load, reload or otherwise provide a Licensed Product, including any such person who may contract with us to offer a Licensed Product under, in whole or in part, such person's own name or marks. The license does not extend to activities by third parties that do not pertain to a Licensed Product.

    Baker

        Frederick J. Baker ("Baker") filed a purported consumer class action case against NetSpend, as well as one of its Issuing Banks and card associations (collectively, the "Defendants"), in the U.S

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District Court (the "Court") for the District of New Jersey in November 2008 seeking damages and unspecified equitable relief. In May 2009 Baker filed an amended complaint alleging that the Defendants violated the New Jersey Consumer Fraud Act (CFA), the New Jersey Truth-in-Consumer Contract, Warranty, and Notice Act (TCCWNA) and claiming unjust enrichment in connection with the Defendants' alleged marketing, advertising, sale and post-sale handling of NetSpend's gift card product in the State of New Jersey. In March 2011, the court heard oral arguments on Defendants' motion to dismiss Baker's amended complaint. In January 2012, the court granted Defendants' motion in part and dismissed all claims except for the cause of action based on the alleged violation of the CFA. We filed our answer and affirmative defenses in February 2012. We have reached an agreement in principle with the attorneys representing the purported plaintiffs in this case to contribute approximately $0.1 million to a fund that would be used to reimburse the consumers who may have been inadvertently overcharged and to reimburse the attorneys representing the plaintiffs for up to $0.3 million in fees. This settlement is subject to approval by the Court.

    Florida Office of the Attorney General

        In May 2011, NetSpend, along with a number of other participants in the prepaid debit card industry, received a subpoena from the Florida Attorney General's office requesting information regarding NetSpend's marketing materials, fees charged to cardholders and the disclosures provided to them. NetSpend completed its initial documentary response to this request in June 2011. In October 2012, NetSpend, while denying that the Florida's Attorney General's office had jurisdiction over it and denying that it had failed to comply with applicable law, entered into an Assurance of Voluntary Compliance (the "AVC") with the Florida Attorney General's office documenting NetSpend's commitment to continue to recommend to the Issuing Banks that they utilize clear and effective communications when marketing cards to Florida consumers. Under the AVC, NetSpend will reimburse the Florida Attorney General's office for the cost of its investigation and make a contribution to a non-profit entity that promotes financial literacy among young people. NetSpend does not believe that compliance with the AVC will require material modifications to its method of doing business.

    Inter National Bank

        In 2009, NetSpend, in conjunction with two of its Issuing Banks, identified funds related to several years of chargebacks and fee-related recoveries from card associations that were being retained by NetSpend's Issuing Banks and that should have been paid to NetSpend. It was determined that one Issuing Bank owed NetSpend approximately $4.8 million and that another Issuing Bank owed NetSpend approximately $5.8 million. It was also determined that one of NetSpend's Issuing Banks was holding approximately $10.0 million that should have been allocated to the other Issuing Bank. The parties entered into an agreement providing for the appropriate payment and distribution of the funds at issue and agreed to release and discharge each other from any further claims and disputes related to this matter.

        On July 13, 2012, Inter National Bank ("INB"), one of NetSpend's Issuing Banks and a party to the 2009 settlement, filed a lawsuit against NetSpend in the 398th District Court of Hidalgo County, Texas related to the settlement and various related issues. In general, INB's claims relate to an asserted cumulative $10.5 million shortfall (overdraft) in certain administrative accounts at INB that are associated with the NetSpend card program. There is no deficit or other irregularity in the account where cardholder funds are held. INB seeks a declaration that it has no liability for the shortfall and that the shortfall is instead NetSpend's responsibility. Related to the shortfall and the surrounding circumstances, INB has also asserted claims against NetSpend for breach of contract, fraud/failure to disclose, breach of fiduciary duty, negligence, and unjust enrichment. INB also seeks an accounting of all transactions that flowed through INB's accounts from April 21, 2009 to July 31, 2011. INB seeks to recover from NetSpend its damages and its costs and attorneys' fees incurred in connection with the

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lawsuit. INB also asserted "provisional claims" of negligence and unjust enrichment against BDO Seidman, an accounting firm involved with the 2009 settlement, and MetaBank, which was also a party to the 2009 settlement, in the event INB suffers any loss in connection with the alleged shortfall. Neither BDO Seidman nor MetaBank has been served or appeared in the lawsuit.

        NetSpend has filed a counterclaim against INB, which alleges that INB has refused, in contravention of the requirements of the contract between NetSpend and INB, to transfer the cardholder accounts to a successor bank and that INB has threatened to stop administering the cardholder accounts, which NetSpend alleges INB was required to continue to administer until the account transfer is completed. NetSpend's counterclaim sought a declaration that INB may not refuse to complete the account transfer based on the status of the shortfall, that INB cannot condition completion of the account transfer on resolution of the shortfall, that INB cannot refuse to continue to administer the NetSpend card accounts at this time and that NetSpend has no liability for the shortfall.

        When INB filed its lawsuit, INB obtained a temporary restraining order enjoining NetSpend from allowing the total amount in several of INB's accounts to fall below $10.5 million. This order expired on August 1, 2012. On August 10, 2012, the parties agreed to an interim order, which provided that NetSpend would deposit money into one or more accounts at INB if necessary to maintain the NetSpend-related accounts at INB at or above a total balance of $10.5 million, with any such money so deposited to be returned to NetSpend upon expiration of the interim order. The agreed interim order also required INB to continue to administer the NetSpend card program in the ordinary course. This order was extended several times and expired on October 22, 2012. NetSpend did not deposit any funds with INB pursuant to this order.

        On October 22, 2012, NetSpend and INB agreed to the entry of an order pursuant to which: (i) the parties agreed to undertake their best efforts to move the existing pooled INB cardholder account to another Issuing Bank on or before December 31, 2012 (or by February 16, 2013 if the parties were making substantial progress but the December 31 deadline could not be met despite the good faith efforts of the parties), (ii) INB would continue to administer its card program in the ordinary course pending the account transfer and, (iii) NetSpend will contribute any funds needed to maintain an aggregate non-negative balance in the accounts at INB associated with the INB card program and to cause the accounts associated with the INB card program to close with a zero balance after completion of the account transfer. The amount required to balance the accounts was approximately $10.5 million and we established a $10.5 million reserve for this contingency and correspondingly recognized a pretax operating expense during the year ended December 31, 2012 for a like amount.

        NetSpend agreed to make this contribution to ensure an orderly migration of the INB portfolio to another Issuing Bank (the INB portfolio represents less than 10% of our outstanding GPR cards), and the parties have stipulated that NetSpend's agreement to fund the asserted deficiency is not to be construed as an admission by NetSpend that it has any liability for the shortfall or to prejudice its claim that INB is solely responsible for the amount of the shortfall. NetSpend's contribution of funds will be reimbursable to NetSpend at the conclusion of the litigation, subject to the terms of any final judgment. Further proceedings in this case were suspended pending the completion of the transfer of the INB card portfolio and processing of all remaining cardholder activities which is expected to conclude around February 22, 2013.

        NetSpend intends to vigorously contest INB's suit and to vigorously pursue its own counterclaims as appropriate. There is no scheduling order or trial date set at this time. NetSpend is in process of determining whether its existing insurance coverage applies should any monetary settlement be reached with INB in the future.

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    MiCash, Inc.

        MiCash, Inc. ("MiCash") filed a patent infringement case against NetSpend in the U.S. District Court for the Eastern District of Texas in April 2012. MiCash asserts in its complaint that NetSpend has been infringing a patent (United States Patent No. 7,258,274) issued in August of 2007 to MiCash because NetSpend has, among other things, allegedly used, sold or offered to sell prepaid card services which permit and authorize transfers of funds between prepaid debit cards. MiCash is seeking: a judgment that NetSpend has infringed its patent; an injunction prohibiting NetSpend from continuing to infringe its patent; damages for NetSpend's alleged prior infringing activity; attorneys' fees and costs; and if NetSpend's infringement of the patent at issue is determined to be willful, enhanced damages. On June 18, 2012, NetSpend answered the complaint denying all of MiCash's allegations, raising affirmative defenses and asserting counterclaims for declaratory judgment of non-infringement and invalidity. Discovery began in August 2012. We have not established reserves or ranges of possible loss related to these proceedings as, at this time, it has not been determined that a loss is probable and the amount of any possible loss is not reasonably estimable.

ITEM 4.    MINE SAFETY DISCLOSURES

        Not applicable.

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PART II

ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

        Our common stock has been listed on the NASDAQ stock market under the symbol "NTSP" since October 19, 2010. Prior to that date, there was no public trading market for our common stock. Our initial public offering ("IPO") was priced at $11.00 per share. The following table sets forth for the periods indicated the high and low sales prices per share of our common stock as reported on NASDAQ stock market.

 
  High   Low  

Year ended December 31, 2012

             

Fourth Quarter

  $ 11.97   $ 8.85  

Third Quarter

  $ 9.94   $ 7.18  

Second Quarter

  $ 9.20   $ 6.41  

First Quarter

  $ 9.70   $ 7.39  

Year ended December 31, 2011

             

Fourth Quarter

  $ 8.16   $ 4.36  

Third Quarter

  $ 10.09   $ 3.90  

Second Quarter

  $ 11.78   $ 7.53  

First Quarter

  $ 15.90   $ 8.97  

Year ended December 31, 2010

             

Fourth Quarter (beginning October 19)

  $ 16.21   $ 11.02  

        On February 15, 2013, the last reported sales price of our common stock on the NASDAQ stock market was $12.69 per share and, as of December 31, 2012, there were 126 holders of record of our common stock. Because many of our shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by the stockholders of record.

Dividend Policy

        We did not pay cash dividends on our common stock during 2012 or 2011 and we do not expect to pay cash dividends on our common stock for the foreseeable future. We did expend $92.6 million to repurchase approximately 10.3 million shares of common stock during 2012 and $32.7 million to repurchase approximately 4.3 million shares of common stock during 2011. Any future determination to pay cash dividends on our common stock would be subject to the discretion of our board of directors and would depend upon various factors, including our results of operations, financial condition and liquidity requirements, restrictions that may be imposed by applicable law and our contracts and other factors deemed relevant by our board of directors. In addition, the terms of our credit facility currently restricts our ability to pay dividends.

Unregistered Sales of Equity Securities

        In August 2011, we created a new series of preferred stock consisting of 1,500,000 shares that are designated as "Series A Convertible Preferred Stock" (the "Series A Preferred Stock"). The shares of Series A Preferred Stock are essentially identical to our Common Stock, except that the Series A Preferred Stock has no voting rights other than as may be required by applicable law. Shares of Series A Preferred Stock are convertible into Common Stock at the rate of ten shares of Common Stock for each share of Series A Preferred Stock; provided, however, that no holder of shares of

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Series A Preferred Stock may convert any of their shares into Common Stock if (i) upon completing such conversion the holder, together with its affiliates, would own or control shares of Common Stock representing 24.9% or more of our outstanding voting securities or (ii) such conversion would require prior approval or notice under any state law then applicable to us or our subsidiaries.

        Concurrently with the creation of the Series A Preferred Stock we entered into a Share Exchange Agreement (the "Exchange Agreement"), with JLL Partners Fund IV, L.P., a Delaware limited partnership ("JLL Fund IV"), and JLL Partners Fund V, L.P., a Delaware limited partnership ("JLL Fund V" and , collectively with JLL Fund IV, the "JLL Funds").

        Pursuant to the Exchange Agreement, JLL Fund IV (1,999,950 shares) and JLL Fund V (5,000,050 shares) exchanged (the "Exchange") an aggregate of 7,000,000 shares of the Common Stock held by them for an aggregate of 700,000 shares of Series A Preferred Stock in a transaction exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to Section 3(a)(9) thereof. No commissions or other remuneration was or will be paid or given, directly or indirectly, to the JLL Funds or any other person in connection with the Exchange. The shares of Series A Preferred Stock issued to the JLL Funds will be automatically re-converted into shares of Common Stock (at the rate of ten shares of Common Stock for each share of Series A Preferred Stock) if they are sold or otherwise transferred to a person who is not affiliated with the JLL Funds and does not require that a notice be given under any applicable state law.

        We created the Series A Preferred Stock and entered into the Exchange Agreement because the JLL Funds and their affiliates were close to owning 25% of our outstanding Common Stock as a result of the repurchases conducted by us pursuant to our stock repurchase plans. Under the statutes pursuant to which we are licensed as a money transmitter, having a stockholder acquire in excess of 25% of our outstanding voting shares can result in various filing and notification requirements. Following the consummation of this transaction, the JLL Funds and their affiliates owned less than 20% of our outstanding voting securities.

        During the twelve months ended December 31, 2010, we issued and sold 1,000,215 shares of common stock to certain of our employees and consultants upon the exercise of options to purchase common stock granted pursuant to our Amended and Restated NetSpend Holdings, Inc. 2004 Equity Incentive Plan (the "2004 Plan") at exercise prices ranging from $0.25 per share to $3.53 per share. The issuance of such shares was exempt from the registration requirements of the Securities Act of 1933 in reliance on Section 4(2) thereof, and the rules and regulations promulgated thereunder, or Rule 701 promulgated under Section 3(b) of the Securities Act, as transactions by an issuer not involving a public offering or transactions pursuant to compensatory benefit plans and contracts relating to compensation as provided under such Rule 701.

        During the twelve months ended December 31, 2010, we granted options to purchase an aggregate of 3,244,574 shares of common stock to certain of our employees and consultants pursuant to the 2004 Plan at a weighted average exercise price of $5.22 per share. The issuance of such options was exempt from the registration requirements of the Securities Act of 1933 in reliance on Section 4(2) thereof, and the rules and regulations promulgated thereunder, or Rule 701 promulgated under Section 3(b) of the Securities Act, as transactions by an issuer not involving a public offering or transactions pursuant to compensatory benefit plans and contracts relating to compensation as provided under such Rule 701.

        During the twelve months ended December 31, 2010, we granted an aggregate of 674,043 shares of restricted common stock to certain of our employees pursuant to the 2004 Plan. The issuance of such shares was exempt from the registration requirements of the Securities Act of 1933 in reliance on Section 4(2) thereof, and the rules and regulations promulgated thereunder, or Rule 701 promulgated under Section 3(b) of the Securities Act, as transactions by an issuer not involving a public offering or transactions pursuant to compensatory benefit plans and contracts relating to compensation as provided under such Rule 701.

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Description of Equity Compensation Plans

        The description of our equity compensation plans required by Item 201(d) of Regulation S-K is incorporated herein by reference to "Part III—Item 12—Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters" of this Annual Report on Form 10-K.

Issuer's Purchases of Equity Securities

        On June 13, 2011, we announced a $25 million share repurchase program. The share repurchases were made on the open market and through a 10b5-1 plan. The repurchase program commenced in June 2011 and was completed in September 2011. We are holding the repurchased shares in treasury for general corporate purposes. We purchased 3,276,093 shares at an average price of $7.63 per share pursuant to this program. The average price paid per share is calculated on a trade date basis and excludes commissions.

        On November 23, 2011, we announced an additional $25 million share repurchase program. The share repurchases were made through open market purchases pursuant to a 10b5-1 plan. The repurchase program commenced November 30, 2011 and was completed on February 10, 2012. We are holding the repurchased shares in treasury for general corporate purposes. We repurchased 2,050,959 shares in 2012 and a total of 3,094,710 shares at an average price of $8.08 per share pursuant to this program. The average price paid per share is calculated on a trade date basis and excludes commissions.

        In June 2012, our board of directors approved a $75 million share repurchase program that was completed in August 2012. The share repurchases were made through a 10b5-1 plan and block trades. We are holding the repurchased shares in treasury for general corporate purposes. We repurchased 8,216,059 shares at an average price of $9.13 per share pursuant to this program. The average price paid per share is calculated on a trade date basis and excludes commissions.

        We made no repurchases of our common stock during the three months ended December 31, 2012.

ITEM 6.    SELECTED FINANCIAL DATA

        The tables below set forth selected consolidated financial data for the periods indicated. The consolidated balance sheet data as of December 31, 2012 and 2011 and statement of operations data for the years ended December 31, 2012, 2011 and 2010 have been derived from the audited consolidated financial statements of NetSpend Holdings, Inc. included elsewhere in this Form 10-K. The consolidated balance sheet data as of December 31, 2010, 2009 and 2008 and statement of operations data for the years ended December 31, 2009 and 2008 have been derived from the audited consolidated financial statements of NetSpend Holdings, Inc. not included in this Form 10-K. It is important that you read this information together with "Management's Discussion and Analysis of Financial Condition and Results of Operations" beginning on page 37, and our consolidated financial statements and related notes beginning on page 64.

        Our historical results for any prior period are not necessarily indicative of results to be expected in any future period.

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Consolidated Statement of Operations Data

 
  Year Ended December 31,  
 
  2012   2011   2010   2009   2008  
 
  (in thousands of dollars, except per share data)
 

Revenues

  $ 351,332   $ 306,255   $ 275,387   $ 225,000   $ 183,170  

Direct operating costs

    169,066     146,199     130,783     106,572     80,216  

Other operating expenses

    111,349     102,132     99,029     92,842     76,983  

Goodwill and intangible asset impairment

                    26,285  

Settlement (gains) and other losses

    36,988     515     4,300     (10,229 )    

Operating income (loss)

    33,929     57,409     41,275     35,815     (314 )

Income (loss) before income taxes

    31,470     55,060     37,100     30,677     (4,338 )

Income tax expense

    12,603     21,814     14,368     12,503     7,307  

Net income (loss)

  $ 18,867   $ 33,246   $ 22,732   $ 18,174   $ (11,645 )

Net income (loss) per common share:

                               

Basic

                               

Common stock

  $ 0.23   $ 0.37   $ 0.26   $ 0.21   $ (0.74 )

Class B common stock

  $   $   $   $ 0.21   $ (0.74 )

Diluted

                               

Common stock

  $ 0.22   $ 0.36   $ 0.26   $ 0.21   $ (0.74 )

Class B common stock

  $   $   $   $ 0.21   $ (0.74 )

Balance Sheet Data

 
  As of December 31,  
 
  2012   2011   2010   2009   2008  
 
  (in thousands of dollars)
 

Cash and cash equivalents

  $ 30,619   $ 72,076   $ 67,501   $ 21,154   $ 21,490  

Total assets

    252,593     272,742     263,903     222,285     216,747  

Long-term debt, net of current portion

    70,000     58,500     58,500     51,979     76,875  

Total stockholders' equity

    117,646     170,853     156,816     109,352     88,345  

Other Financial and Operating Data

 
  Year Ended December 31,  
 
  2012   2011   2010   2009   2008  
 
  (in thousands, except percentages)
 
 
  (unaudited)
 

Adjusted EBITDA(1)(3)

  $ 96,159   $ 84,197   $ 65,568   $ 40,367   $ 37,343  

Adjusted net income(2)(3)

  $ 49,315   $ 42,476   $ 32,262   $ 16,854   $ 7,800  

Number of active cards (at period end)(4)

    2,352     2,063     2,100     1,868     1,578  

Number of active cards with direct deposit (at period end)(5)

    1,082     865     719     515     361  

Gross dollar volume(6)

  $ 13,156,091   $ 11,159,181   $ 9,810,515   $ 7,570,339   $ 5,690,842  

Percentage of direct deposit active accounts(7)

    46.0 %   41.9 %   34.2 %   27.6 %   22.9 %

(1)
We use a non-GAAP financial metric that we label "Adjusted EBITDA" to evaluate our financial performance. We compute Adjusted EBITDA by adjusting net income or net loss to remove the

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    effect of income and expenses related to interest, taxes, depreciation and amortization ("EBITDA") and then adjusting for stock-based compensation and non-recurring gains and losses. We believe that Adjusted EBITDA is an important metric for the following reasons:

    It provides a meaningful comparison of our operating results over several periods because it removes the impact of income and expense items that are not a direct result of our core operations, such as goodwill and intangible impairments, legal settlements and one-time settlement gains, losses on the early extinguishment of long-term debt and other infrequent losses;

    We use it as a tool to assist in our planning for the effect of strategic operating decisions and for the prediction of future operating results; and

    We use it to evaluate our capacity to incur and service debt, fund capital expenditures and expand our business.

(2)
In addition to Adjusted EBITDA, we use a second non-GAAP financial metric that we label "Adjusted Net Income" to evaluate our financial performance. We compute Adjusted Net Income by adjusting net income or net loss to remove tax-effected amortization expense, stock-based compensation and non-recurring gains and losses. We believe that Adjusted Net Income is an important metric that is useful to our board of directors, management and investors for the following reasons:

Assets being depreciated will often have to be replaced in the future and Adjusted EBITDA does not reflect any expenditure for these items;

Adjusted EBITDA does not reflect the interest expense or the payments necessary to service interest payments on our debt;

Adjusted Net Income provides a meaningful comparison of our operating results over several periods because it removes the impact of income and expense items that are not a direct result of our core operations, such as goodwill and intangible impairments, legal settlements and one-time settlement gains, losses on the early extinguishment of long-term debt and other infrequent losses;

Adjusted Net Income per share on a diluted basis functions as a threshold target for our company-wide employee bonus compensation and other stock-based awards issued to certain of our key employees; and

We believe Adjusted Net Income measurements are used by investors as a supplemental measure to evaluate the overall operating performance of companies in our industry.

(3)
By providing this non-GAAP financial measure, together with the below reconciliation, we believe we are enhancing investors' understanding of our business and our results of operations, as well as assisting investors in evaluating how well we are executing strategic initiatives. Our Adjusted EBITDA and Adjusted Net Income are not necessarily comparable to what other companies define as Adjusted EBITDA and Adjusted Net Income. In addition, Adjusted EBITDA and Adjusted Net Income are not measures defined by U.S. GAAP and should not be considered as substitutes for or alternatives to net income, operating income, cash flows from operating activities or other financial information as determined by U.S. GAAP. Our presentation of Adjusted EBITDA and Adjusted Net Income should not be construed as an implication that our future results will be unaffected by unusual or non-recurring items.

(4)
Number of active cards represents the total number of GPR cards that have had a PIN or signature-based purchase transaction, a point-of-sale load transaction or an ATM withdrawal within three months of the date of determination.

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(5)
Number of active cards with direct deposit represents the number of active cards that have had a direct deposit load within three months of the date of determination.

(6)
Gross dollar volume, also known in the industry as purchase volume, represents the total dollar volume of debit transactions and cash withdrawals made using the GPR cards we manage.

(7)
Percentage of active cards with direct deposit represents the percentage of active GPR cards that have had a direct deposit load within three months of the date of determination.

        The following is a reconciliation of our net income (loss) for the years ended December 31, 2012, 2011, 2010, 2009 and 2008 to Adjusted EBITDA.

 
  Year Ended December 31,  
 
  2012   2011   2010   2009   2008  
 
  (in thousands of dollars)
 

Net income (loss)

  $ 18,867   $ 33,246   $ 22,732   $ 18,174   $ (11,645 )

Interest income

    (139 )   (108 )   (85 )   (32 )   (384 )

Interest expense

    2,598     2,457     3,526     5,170     4,408  

Income tax expense

    12,603     21,814     14,368     12,503     7,307  

Depreciation and amortization

    13,778     15,031     12,725     10,297     8,899  
                       

EBITDA

    47,707     72,440     53,266     46,112     8,585  

Stock-based compensation expense

    11,464     11,242     7,268     4,484     2,473  

Goodwill and acquired intangible asset impairment

                    26,285  

Settlement (gains) and other losses

    36,988     515     4,300     (10,229 )    

Loss on extinguishment of debt

            734          
                       

Adjusted EBITDA

  $ 96,159   $ 84,197   $ 65,568   $ 40,367   $ 37,343  
                       

    Settlement (gains) and other losses of $37.0 million during the year ended December 31, 2012 primarily relates to accruals for legal contingencies and settlements. Settlement (gains) and other losses $0.5 million during the year ended December 31, 2011 primarily relates to severance costs incurred in connection with the consolidation of some of our processing platforms and call center activities. Settlement (gains) and other losses during the year ended December 31, 2010 relates to a $3.5 million loss related to a patent infringement dispute and a $0.8 million loss associated with a contractual dispute with an Issuing Bank. Settlement (gains) and other losses during the year ended December 31, 2009 relates to $9.0 million of funds received from our Issuing Banks for fee and chargeback recoveries and $1.2 million resulting from the settlement of certain litigation.

    The loss on extinguishment of debt during the year ended December 31, 2010 relates to a $0.7 million write-off of the remaining capitalized debt issuance costs associated with our prior credit facility.

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        The following is a reconciliation of our net income (loss), the most comparable GAAP measure, for the years ended December 31, 2012, 2011, 2010, 2009 and 2008 to Adjusted Net Income.

 
  Year Ended December 31,  
 
  2012   2011   2010   2009   2008  
 
  (in thousands of dollars)
 

Net income (loss)

  $ 18,867   $ 33,246   $ 22,732   $ 18,174   $ (11,645 )

Stock-based compensation expense

    11,464     11,242     7,268     4,484     2,473  

Goodwill and acquired intangible asset impairment

                    26,285  

Amortization of intangibles

    2,295     3,524     3,245     3,516     3,224  

Settlement (gains) and other losses

    36,988     515     4,300     (10,229 )    

Loss on extinguishment of debt

            734          
                       

Total pre-tax adjustments

    50,747     15,281     15,547     (2,229 )   31,982  

Tax rate(1)

    40.0 %   39.6 %   38.7 %   40.8 %   39.2 %

Tax adjustment

    20,299     6,051     6,017     (909 )   12,537  
                       

Adjusted net income

  $ 49,315   $ 42,476   $ 32,262   $ 16,854   $ 7,800  
                       

    Settlement (gains) and other losses of $37.0 million during the year ended December 31, 2012 primarily relates to accruals for legal contingencies and settlements. Settlement (gains) and other losses of $0.5 million during the year ended December 31, 2011 primarily relates to severance costs incurred in connection with the consolidation of some of our processing platforms and call center activities. Settlement (gains) and other losses during the year ended December 31, 2010 relates to a $3.5 million loss related to a patent infringement dispute and a $0.8 million loss associated with a contractual dispute with an Issuing Bank. Settlement (gains) and other losses during the year ended December 31, 2009 relates to $9.0 million of funds received from our Issuing Banks for fee and chargeback recoveries and $1.2 million resulting from the settlement of certain litigation.

    The loss on extinguishment of debt during the year ended December 31, 2010 relates to a $0.7 million write-off of the remaining capitalized debt issuance costs associated with our prior credit facility.

(1)
The 2008 tax rate was adjusted to remove the impact of a goodwill impairment charge recorded during 2008 in order to establish the rate used to book taxes in the absence of this impairment charge consistent with the pre-tax adjustments used to calculate adjusted net income.

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ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

        The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Form 10-K, particularly in "Risk Factors."


Overview

        NetSpend is a leading program manager for FDIC-insured depository institutions that issue general-purpose reloadable prepaid debit cards, or GPR cards, and provide related alternative financial services to underbanked consumers in the United States. The programs managed by the Company empower underbanked consumers by providing them with innovative and affordable financial products and services tailored to meet their particular financial services needs and preferences in a manner that traditional banking institutions have not historically met. In addition, the products and services we manage provide our distributors an opportunity to enhance their customer relationships and generate incremental, ongoing revenue streams.

        Cardholders may use their GPR cards to make purchase transactions at any merchant that participates in the MasterCard, Visa or PULSE networks and to withdraw funds from participating ATMs. MetaBank holds the majority of the cardholder funds. We own approximately 3.6% of the outstanding equity interests in Meta Financial Group, Inc. ("MFG"), MetaBank's holding company.

        Our principal operating company, predecessor and current subsidiary, NetSpend Corporation ("NetSpend"), was incorporated in Texas in 1999. In May 2004, Oak Investment Partners acquired a controlling equity interest in NetSpend through a recapitalization transaction pursuant to which we, as a newly-formed holding company incorporated in Delaware, acquired all of the capital stock of NetSpend. In 2008, we acquired Skylight Financial, Inc. ("Skylight"), a payroll card provider, in a stock-for-stock merger. Entities affiliated with one of our significant shareholders, the JLL Funds, were previously the majority owners of Skylight.

        We have built an extensive and diverse distribution and reload network in the United States to support the marketing and ongoing use of the GPR cards we manage. We market cards through multiple distribution channels, including alternative financial service providers, traditional retailers, direct-to-consumer and online marketing programs and to corporate employers as an alternative method of wage payment for their employees. Beginning in 2008, we decided to focus primarily on GPR cards and we ceased marketing gift cards entirely in August 2010.

        We have developed and operate a proprietary technology platform. Our in-house platform is end-to-end in that it encompasses the critical functions required for us to acquire cardholders, process transactions, maintain account-level data, communicate with cardholders, manage risk, ensure regulatory compliance and connect to our Issuing Banks and distributors. These integrated capabilities allow us to customize our products and services for different markets, distribution channels and customer segments. Further, by processing transactions on our own platform, we gain unique and extensive insight into the attitudes, characteristics and purchasing behavior of the holders of the cards we manage.

        We are pursuing a bank diversification strategy and we are distributing our card issuing activities across three issuing banks, in addition to the banks that issue our payroll cards. We are focused on balancing our diversification strategy with the protection of existing cardholder and direct deposit

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relationships and other operational considerations. In furtherance of this strategy we entered into an agreement with The Bancorp Bank ("Bancorp") in January 2011 pursuant to which Bancorp serves as an Issuing Bank for some of our new and existing card programs, including the cards we distribute through traditional retailers. We have also signed an agreement with BofI Federal Bank ("BofI") pursuant to which we will manage GPR and payroll cards to be issued by it. BofI began issuing GPR cards in January 2013.We are continuing our discussions with other prospective issuing banks.

        In May 2011, we amended our agreement with Inter National Bank ("INB") to extend the date by which we agreed to transition the GPR cards issued by INB to another bank from July 2011 to September 2011. We have transitioned the distributors of cards issued by INB to other Issuing Banks and we transferred INB's cardholder portfolio to Bancorp in February 2013. We and INB are engaged in an active dispute regarding the contractual obligations of the parties in connection with the transition of INB's portfolio.

        U.S. Bank ("USB") and SunTrust Bank ("SunTrust") act as issuers of our payroll cards. We currently intend to transfer the USB portfolio to BofI. Our contract with SunTrust has been extended to September 2015. We are actively seeking to sign agreements with additional banks to act as issuers of payroll cards. As a result of these efforts, we signed an agreement with Regions Bank pursuant to which we will act as the program manager for the payroll cards to be issued by it.


Recent Developments

    Share Repurchase Programs

        In November 2011, our board of directors approved a $25 million share repurchase program that was completed in February 2012. In June 2012, our board of directors approved a $75 million share repurchase program that was completed in August 2012. The share repurchases were made through a 10b5-1 plan and through block trades. We intend to hold the repurchased shares in treasury for general corporate purposes. During 2012, we repurchased approximately 10.3 million shares of common stock at an average price of $9.00 per share pursuant to these programs. The average price paid per share is calculated on a trade date basis and excludes commissions.


Key Business Metrics

        As a leading manager of providers of GPR card programs and related alternative financial services to underbanked consumers, we evaluate a number of business metrics to monitor our performance and manage our business. We believe the following metrics are the primary indicators of our performance.

        Number of Active Cards—represents the total number of GPR cards that have had a PIN or signature-based purchase transaction, a point-of-sale load transaction or an ATM withdrawal within three months of the date of determination. The programs we manage had approximately 2,352,000, 2,063,000 and 2,100,000 active cards as of December 31, 2012, 2011 and 2010, respectively.

        Number of Active Cards with Direct Deposit—represents the number of active cards that have had a direct deposit load within three months of the date of determination. We managed 1,082,000, 865,000 and 719,000 direct deposit active cards as of December 31, 2012, 2011 and 2010, respectively. Our strategy is to focus on increasing the number of cards that receive direct deposits because cardholders who use direct deposit generate more revenue for us than those who do not. Additionally, consumers who receive direct deposits tend to remain in our programs longer than non-direct deposit cardholders.

        Percentage of Active Cards with Direct Deposit—represents the percentage of active GPR cards that have had a direct deposit load within three months of the date of determination. The percentage of active cards that were direct deposit active cards as of December 31, 2012, 2011 and 2010, was approximately 46%, 42%, and 34%, respectively.

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        Gross Dollar Volume ("GDV")—represents the total dollar volume of debit transactions and cash withdrawals made using the GPR cards we manage. Our gross dollar volume, also known in the industry as purchase volume, was $13.2 billion, $11.2 billion and $9.8 billion for the years ended December 31, 2012, 2011 and 2010, respectively. Approximately 82.7%, 78.0% and 71.8% of the gross dollar volume for the years ended December 31, 2012, 2011 and 2010, respectively, was made using active cards with direct deposit.


Key Components of Our Results of Operations

Operating Revenues

        Our operating revenues primarily consist of a portion of the service fees and interchange revenues received by our Issuing Banks in connection with the programs we manage.

        Cardholders are charged fees in connection with our programs, as follows:

    Transactions—Cardholders are typically charged a fee for each PIN and signature-based purchase transaction made using their GPR cards, unless the cardholder is on a monthly or annual service plan, in which case the cardholder is instead charged a monthly or annual subscription fee, as applicable. Cardholders are also charged fees for ATM withdrawals and other transactions conducted at ATMs.

    Customer Service and Maintenance—Cardholders are typically charged fees for balance inquiries made through our call centers. Cardholders are also charged a monthly maintenance fee after a specified period of inactivity.

    Additional Products and Services—Cardholders are charged fees associated with additional products and services offered in connection with certain of our cards, including the use of overdraft features, a variety of bill payment options, custom card designs and card-to-card transfers of funds initiated through our call centers.

    Other—Cardholders are charged fees in connection with the acquisition and reloading of our GPR cards at distributors and we receive a portion of these amounts in some cases.

        Revenue resulting from the service fees charged to our cardholders described above is recognized when the fees are charged because the earnings process is substantially complete, except for revenue resulting from the initial activation of our cards and annual subscription fees. Revenue resulting from the initial activation of our cards is recognized ratably, net of commissions paid to our distributors, over the average account life, which is approximately one year for our GPR cards (three months for the gift cards we marketed prior to August 2010). Revenue resulting from annual subscription fees is recognized ratably over the annual period to which the fees relate.

        Our revenues also include fees charged in connection with program management and processing services we provide for private-label programs, as well as fees charged to MetaBank based on interest earned on cardholder funds. Under our current arrangement with MetaBank, we would only be entitled to receive interest on cardholder funds if market interest rates rose significantly above current levels. Revenue resulting from these fees is recognized when we have fulfilled our obligations under the underlying service agreements.

        We earn revenues from a portion of the interchange fees remitted by merchants when cardholders make purchase transactions using their cards. Subject to applicable law, interchange fees are fixed by the Networks. Interchange revenues are recognized net of sponsorship, licensing and processing fees charged by the Networks for services they provide in processing transactions routed through them. Interchange revenue is recognized during the period that the purchase transactions occur. Also included in interchange revenue are fees earned from branding agreements with the Networks.

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        Our quarterly operating revenues fluctuate as a result of certain seasonal factors. The most significant increases in the number of our active cards and our GDV typically occur in the first three months of each year as a result of consumers acquiring new cards and loading them with their tax refunds. We expect this seasonal variance to become more pronounced in 2013 due to an agreement with Intuit, Inc. ("Intuit") pursuant to which we will provide the only GPR card that can be ordered through the use of its TurboTax software. We began marketing cards under this program in early 2013.

Operating Expenses

        We classify our operating expenses into the following categories:

        Direct Operating Costs—Direct operating costs consist primarily of the commissions we pay to members of our distribution and reload network for their services, ATM processing fees, card supply costs, costs for fraud and other losses related to the card programs we manage, customer verification costs, customer service costs and fees paid to our Issuing Banks. These costs are driven by transaction volumes and the number of active cards.

        Salaries, Benefits and Other Personnel Costs—Salaries, benefits and other personnel costs consist of the compensation costs associated with our employees, including base salaries, benefits, bonus compensation and stock-based compensation. This excludes any personnel costs associated with customer service personnel. Costs associated with these employees are included in direct operating costs.

        Advertising, Marketing and Promotion Costs—Advertising, marketing and promotion costs primarily consist of the costs of our efforts to market the products we manage to potential cardholders including direct mailings, internet and television advertising, promotional events run in conjunction with our distributors, conferences, trade shows and the creation of marketing collateral and other materials.

        Other General and Administrative Costs—Other general and administrative costs primarily consist of costs for legal, accounting, information technology, travel, facility and other corporate expenses.

        Depreciation and Amortization—Depreciation and amortization consists of depreciation of our long-lived assets and amortization of finite-lived intangibles.

        Other Losses—Other losses consist of legal contingencies and settlements and other infrequent losses.

Other Income (Expense)

        Other income (expense) primarily consists of interest income and interest expense. Interest income represents interest we receive on our cash and cash equivalents. Interest expense is associated with our long-term debt and capital leases.

Income Tax Expense

        Income tax expense primarily consists of corporate income taxes on our profits.

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Consolidated Statements of Operations Data

 
  Year Ended December 31,  
 
  2012   2011   2010  
 
  (in thousands of dollars)
 

Operating Revenues

  $ 351,332   $ 306,255   $ 275,387  

Operating Expenses

                   

Direct operating costs

    169,066     146,199     130,783  

Salaries, benefits and other personnel costs

    56,328     52,736     54,032  

Advertising, marketing and promotion costs

    20,127     14,230     14,038  

Other general and administrative costs

    21,116     20,135     18,234  

Depreciation and amortization

    13,778     15,031     12,725  

Other losses

    36,988     515     4,300  
               

Total operating expenses

    317,403     248,846     234,112  
               

Operating income

    33,929     57,409     41,275  

Other Income (Expense)

                   

Interest income

    139     108     85  

Interest expense

    (2,598 )   (2,457 )   (3,526 )

Loss on extinguishment of debt

            (734 )
               

Total other expense

    (2,459 )   (2,349 )   (4,175 )
               

Income before income taxes

    31,470     55,060     37,100  

Provision for income taxes

   
12,603
   
21,814
   
14,368
 
               

Net income

  $ 18,867   $ 33,246   $ 22,732  
               

 
  As a Percentage of Total
Operating Revenues
 
 
  Year Ended December 31,  
 
  2012   2011   2010  

Operating Revenues

    100.0 %   100.0 %   100.0 %

Operating Expenses

                   

Direct operating costs

    48.1     47.7     47.5  

Salaries, benefits and other personnel costs

    16.1     17.2     19.6  

Advertising, marketing and promotion costs

    5.7     4.7     5.1  

Other general and administrative costs

    6.0     6.6     6.6  

Depreciation and amortization

    3.9     4.9     4.6  

Other losses

    10.5     0.2     1.6  
               

Total operating expenses

    90.3     81.3     85.0  
               

Operating income

    9.7     18.7     15.0  

Other Income (Expense)

                   

Interest income

    0.1     0.1      

Interest expense

    (0.8 )   (0.8 )   (1.3 )

Loss on extinguishment of debt

            (0.2 )
               

Total other expense

    (0.7 )   (0.7 )   (1.5 )
               

Income before income taxes

    9.0     18.0     13.5  

Provision for income taxes

   
3.6
   
7.1
   
5.2
 
               

Net income

    5.4 %   10.9 %   8.3 %
               

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Comparison of Fiscal 2012 and 2011

Operating Revenues

        Our operating revenues totaled $351.3 million in fiscal 2012, an increase of $45.0 million, or 14.7%, from the $306.3 million seen in fiscal 2011. Service fees represented approximately 77.5% of our revenue for fiscal 2012 with the balance of our revenue consisting of interchange fees. Service fee revenue increased $34.5 million, or 14.5%, from $237.6 million in fiscal 2011 to $272.1 million in fiscal 2012. This year-over-year increase in service fee revenue was substantially driven by the increase in direct deposit accounts (cardholders with direct deposit generally initiate more transactions and generate more revenues for us than those that do not take advantage of this feature) and, to a lesser extent, the expansion of product features across our direct deposit customer base.

        Interchange revenue represented approximately 22.5% of our revenue for fiscal 2012 and 22.4% of our revenue for fiscal 2011. Interchange revenue increased $10.6 million, or 15.5%, from $68.6 million in fiscal 2011 to $79.2 million in fiscal 2012. This increase was primarily the result of a 17.9% year-over-year increase in our gross dollar volume.

Operating Expenses

        The following table presents the breakdown of operating expenses among direct operating costs, personnel costs, advertising and marketing costs, other general and administrative costs, depreciation and amortization and other components of operating expenses:

 
  Year Ended December 31,    
 
 
  2012   2011    
 
 
  Amount   Percentage of
Total
Operating
Revenues
  Amount   Percentage of
Total
Operating
Revenues
  Change  
 
  (in thousands of dollars)
 

Operating Expenses

                               

Direct operating costs

  $ 169,066     48.1 % $ 146,199     47.7 % $ 22,867  

Salaries, benefits and other personnel costs

    56,328     16.1     52,736     17.2     3,592  

Advertising, marketing and promotion costs

    20,127     5.7     14,230     4.7     5,897  

Other general and administrative costs

    21,116     6.0     20,135     6.6     981  

Depreciation and amortization

    13,778     3.9     15,031     4.9     (1,253 )

Other losses

    36,988     10.5     515     0.2     36,473  
                       

Total operating expenses

  $ 317,403     90.3 % $ 248,846     81.3 % $ 68,557  
                       

        Direct Operating Costs—Our direct operating costs were $169.1 million in fiscal 2012, an increase of $22.9 million, or 15.7%, from fiscal 2011. As a percentage of revenues, our direct operating costs increased from 47.7% in fiscal 2011 to 48.1% in fiscal 2012. This net increase, as a percentage of revenue, was primarily caused by an increase in investment in our distribution activities through traditional retailers and direct-to-consumer acquisition activities and an increase in our provision for fraud-related losses. This percentage increase was partially offset by a decrease, as a percentage of revenue, in commissions paid to our distributors caused by a greater proportion of cardholder loads being generated through our online, direct marketing and traditional retail channels because we do not pay distributor commissions on these loads.

        Salaries, Benefits and Other Personnel Costs—Our salaries, benefits and other personnel costs were $56.3 million in fiscal 2012, an increase of $3.6 million, or 6.8%, from fiscal 2011. As a percentage of revenues, our salaries, benefits and other personnel costs decreased from 17.2% of revenues in fiscal 2011 to 16.1% in fiscal 2012. This decrease was primarily the result of relatively consistent levels of

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stock based compensation expenses during a period of increasing revenues, and, to a lesser extent, an increase in capitalized personnel costs (which has the effect of reducing salaries, benefits and other personnel costs) associated with the internal development of software for our processing platforms.

        Advertising, Marketing and Promotion Costs—Our advertising, marketing and promotion costs were $20.1 million in fiscal 2012, an increase of $5.9 million, or 41.5% from fiscal 2011. This increase was largely due to an increase in our investment in direct-to-consumer marketing through internet, television and direct mail advertising. We expect to see increased investment in our advertising costs in future periods.

        Other General and Administrative Costs—Our other general and administrative costs were $21.1 million in fiscal 2012, an increase of $1.0 million, or 5.0%, from fiscal 2011. As a percentage of revenues, our other general and administrative costs decreased from 6.6% in fiscal 2011 to 6.0% in fiscal 2012. This decrease, as a percentage of revenue, was primarily a result of greater efficiencies of scale.

        Depreciation and Amortization—Our depreciation and amortization costs were $13.8 million in fiscal 2012, a decrease of $1.2 million, or 8.0%, from fiscal 2011. This decrease was primarily the result of fully amortizing certain long-lived assets during 2012.

        Other Losses—Other losses of $37.0 during fiscal 2012 related to accruals for legal contingencies and settlements, primarily Alexsam ($24.0 million) and INB ($10.5 million) (see "Item 3. Legal Proceedings" contained in this Annual Report on Form 10-K). Other losses of $0.5 million during fiscal 2011 primarily related to severance and other related restructuring costs incurred in connection with the consolidation of some of our processing platforms and call center activities.

Income Tax Expense

        The following table presents the breakdown of our effective tax rate among federal, state and other taxes:

 
  Year Ended December 31,  
 
  2012   2011  

U.S. federal income tax

    35.0 %   35.0 %

State income taxes, net of federal benefit

    2.4     2.8  

Other

    2.6     1.8  
           

Income tax expense

    40.0 %   39.6 %
           

        Our income tax expense was $12.6 million in fiscal 2012, a decrease of $9.2 million from fiscal 2011. This decrease was primarily the results of a period-over-period decrease in our taxable income.


Comparison of Fiscal 2011 and 2010

Operating Revenues

        Our operating revenues totaled $306.3 million in fiscal 2011, an increase of $30.9 million, or 11.2%, from $275.4 million seen in fiscal 2010. Service fees represented approximately 77.6% of our revenue for fiscal 2011 with the balance of our revenue consisting of interchange fees. Service fee revenue increased $21.8 million, or 10.1%, from $215.8 million in fiscal 2010 to $237.6 million in fiscal 2011. This year-over-year increase in service fee revenue was substantially driven by the increase in direct deposit accounts (cardholders with direct deposit generally initiate more transactions and generate more revenues for us than those that do not take advantage of this feature) and, to a lesser extent, the expansion of product features across our direct deposit customer base.

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        Interchange revenue represented approximately 22.4% of our revenue for fiscal 2011 and 21.6% of our revenue for fiscal 2010. Interchange revenue increased $9.0 million, or 15.1%, from $59.6 million in fiscal 2010 to $68.6 million in fiscal 2011. This increase was primarily the result of a 14.3% year-over-year increase in our gross dollar volume, combined with more favorable rates on some of our interchange revenue contracts negotiated during the later part of 2010.

        Our total operating revenues of $306.3 million in fiscal 2011 was comprised of $305.1 million related to our GPR cards and the remaining $1.2 million related to our gift cards. Our GPR card related revenues increased by $36.0 million, or 13.4%, from fiscal 2010. Our gift card related revenues decreased by $5.1 million, or 81.0%, from fiscal 2010 as we ceased marketing gift cards in August 2010.

Operating Expenses

        The following table presents the breakdown of operating expenses among direct operating costs, personnel costs, advertising and marketing costs, other general and administrative costs, depreciation and amortization and other components of operating expenses:

 
  Year Ended December 31,    
 
 
  2011   2010    
 
 
  Amount   Percentage of
Total
Operating
Revenues
  Amount   Percentage of
Total
Operating
Revenues
  Change  
 
  (in thousands of dollars)
 

Operating Expenses

                               

Direct operating costs

  $ 146,199     47.7 % $ 130,783     47.5 % $ 15,416  

Salaries, benefits and other personnel costs

    52,736     17.2     54,032     19.6     (1,296 )

Advertising, marketing and promotion costs

    14,230     4.7     14,038     5.1     192  

Other general and administrative costs

    20,135     6.6     18,234     6.6     1,901  

Depreciation and amortization

    15,031     4.9     12,725     4.6     2,306  

Other losses

    515     0.2     4,300     1.6     (3,785 )
                       

Total operating expenses

  $ 248,846     81.3 % $ 234,112     85.0 % $ 14,734  
                       

        Direct Operating Costs—Our direct operating costs were $146.2 million in fiscal 2011, an increase of $15.4 million, or 11.8%, from fiscal 2010. As a percentage of revenues, our direct operating costs increased from 47.5% in fiscal 2010 to 47.7% in fiscal 2011. These increases were primarily due to an increase in our provision for fraud-related losses, increased overdraft defaults and an increase in commissions we paid to our distributors because ACE, our largest distribution partner, reached their maximum commission tier more often in 2011 due to increasing volumes. We also saw an increase in ATM processing fees resulting from an increase in the number of ATM transactions by our cardholders. Partially offsetting these increases was a decline in call center costs as a result of greater efficiencies of scale from our back office systems as well as cost savings achieved on some of our outsourced call center contracts negotiated in late 2010.

        Salaries, Benefits and Other Personnel Costs—Our salaries, benefits and other personnel costs were $52.7 million in fiscal 2011, a decrease of $1.3 million, or 2.4%, from fiscal 2010. This year-over-year change reflects a $4.5 million decrease in bonus expense as we significantly exceeded our performance targets in 2010 but were somewhat below our 2011 targets, offset by a $4.0 million increase in stock-based compensation expense as a result of awards issued in 2010 and 2011 and the accelerated vesting of previously issued equity awards following the completion of our initial public offering in October 2010. In addition, we also saw an increase in capitalized personnel costs (which has the effect of reducing salaries, benefits and other personnel costs) for internally developed fixed assets in connection with the consolidation of some of our processing platforms and call center activities.

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        Advertising, Marketing and Promotion Costs—Our advertising, marketing and promotion costs were $14.2 million in fiscal 2011, which was relatively consistent with the $14.0 spent in fiscal 2010.

        Other General and Administrative Costs—Our other general and administrative costs were $20.1 million in fiscal 2011, an increase of $1.9 million, or 10.4%, from fiscal 2010. This year-over-year increase was primarily the result of an increase in legal and other professional expenses, insurance costs and other corporate expenses related to our status as a public reporting company during 2011. We were a private company during the first nine months of 2010. In addition, we incurred greater software maintenance, licensing and support fees in fiscal 2011 compared to fiscal 2010 as a result of capital expenditures and assets placed into service in 2010.

        Depreciation and Amortization—Our depreciation and amortization costs were $15.0 million in fiscal 2011, an increase of $2.3 million, or 18.1%, from fiscal 2010. This increase was primarily the result of increased depreciation resulting from capital expenditures and assets placed into service in 2010.

        Other Losses—Other losses of $0.5 million during fiscal 2011 primarily related to severance and other related restructuring costs incurred in connection with the consolidation of some of our processing platforms and call center activities. In fiscal 2010, other losses of $4.3 million related to a $3.5 million loss related to a patent infringement dispute and $0.8 million related to a contractual dispute with an Issuing Bank.

Income Tax Expense

        The following table presents the breakdown of our effective tax rate among federal, state and other taxes:

 
  Year Ended
December 31,
 
 
  2011   2010  

U.S. federal income tax

    35.0 %   35.0 %

State income taxes, net of federal benefit

    2.8     3.2  

Other

    1.8     0.5  
           

Income tax expense

    39.6 %   38.7 %
           

        Our income tax expense was $21.8 million in fiscal 2011, an increase of $7.4 million from fiscal 2010. This increase in expense is due to an increase in income before taxes combined with an increase in our effective tax rate. The increase in the effective rate from 2010 to 2011 was primarily caused by a reduced amount of benefits related to research and development tax credits for internally developed software in 2011 as compared to 2010.

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Liquidity and Capital Resources

        Our primary sources of liquidity are cash flow from our operating activities and access to borrowings under our revolving credit facility. We believe our current level of cash and short-term financing capabilities, along with the expected future cash flows from our operations, are sufficient to meet the needs of our business for at least the next twelve months.

Comparison of Fiscal 2012, 2011 and 2010

 
  Year Ended December 31,  
 
  2012   2011   2010  
 
  (in thousands of dollars)
 

Net cash provided by operating activities

  $ 37,978   $ 48,847   $ 52,101  

Net cash used in investing activities

    (16,525 )   (10,088 )   (9,259 )

Net cash provided by (used in) financing activities

    (62,910 )   (34,184 )   3,505  
               

Net change in cash and cash equivalents

  $ (41,457 ) $ 4,575   $ 46,347  
               

Cash Flows from Operating Activities

        During fiscal 2012, our operating activities provided $38.0 million of cash, resulting from $18.9 million of net income and an adjustment of $45.5 million for non-cash items, offset by $26.4 million in cash used by operating assets and liabilities. The $45.5 million adjustment for non-cash items primarily relates to $10.9 million of litigation contingency reserves, $13.8 million of depreciation and amortization expense, an $18.7 million provision for cardholder losses and $11.5 million of non-cash stock-based compensation expense, offset by $6.8 million in deferred income taxes and a $2.7 million tax benefit associated with the exercise of stock options. The $26.4 million in cash used by changes in operating assets and liabilities was primarily the result of $19.0 million of payments against our cardholders' reserve, a $9.8 million increase in other long-term assets driven primarily by prepaid commissions to distributors that will be amortized over the terms of the related contracts, a $1.5 million increase in prepaid card supply and a $3.1 million increase in accounts receivable. These changes were partially offset by a $7.2 million increase in our accounts payable and accrued liabilities.

        The $38.0 million of 2012 operating cash flows represents a $10.8 million decrease over 2011 operating cash flows of $48.8 million. The $10.8 million decrease in operating cash flows primarily relates to $14.4 million decrease in net income and a $5.1 million decrease in cash provided by changes in operating assets and liabilities, partially offset by an $8.7 million increase in non-cash adjustments to net income. During 2011, $21.3 million of cash was used by changes in operating assets and liabilities while $26.4 million of cash was used by changes in operating assets and liabilities during 2012. This $5.1 million increase in cash used by changes in operating assets and liabilities was primarily caused by an $11.1 million increase in cash provided by changes in accounts payable and accrued liabilities, partially offset by an $7.4 million increase in cash used in payment for long-term assets.

        During fiscal 2011, our operating activities provided $48.8 million of cash, resulting from $33.2 million of net income and an adjustment of $36.9 million for non-cash items, offset by $21.3 million in cash used by operating assets and liabilities. The $36.9 million adjustment for non-cash items primarily relates to $15.0 million of depreciation and amortization expense, a $14.4 million provision for cardholder losses and $11.2 million of stock-based compensation expense, offset by $2.6 million in deferred income taxes and $1.5 million of tax benefits associated with stock options. The $21.3 million in cash used by changes in operating assets and liabilities was primarily the result of a $3.8 million decrease in our accounts payable and accrued liabilities primarily caused by the payout in 2011 of bonuses earned in 2010 as well as final payout in 2011 of a 2010 settlement loss related to a patent infringement dispute, $15.3 million of write-offs flowing against our cardholders' reserve, a $2.3 million

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increase in other long-term assets and a $2.1 million increase in accounts receivable, offset by a $2.9 million increase in income tax payable.

        The $48.8 million of 2011 operating cash flows represents a $3.3 million decrease over 2010 operating cash flows of $52.1 million. The $3.3 million decrease in operating cash flows primarily relates to a $23.3 million decrease in cash provided by changes in operating assets and liabilities, partially offset by a $10.5 million increase in net income and a $9.5 million increase in non-cash item adjustments. During 2010, $2.0 million of cash was provided by changes in operating assets and liabilities while $21.3 million of cash was used by changes in operating assets and liabilities during 2011. This $23.3 million decrease in cash provided by changes in operating assets and liabilities was primarily due to a $6.7 million decrease in cash provided by accounts payable and accrued liabilities as well as $8.3 million of incremental write-offs flowing against our cardholders' reserve during 2011 as compared to 2010 due to incremental fraud losses and the expansion of our overdraft program.

        During fiscal 2010, our operating activities provided $52.1 million of cash, resulting from $22.7 million of net income and an adjustment of $27.4 million for non-cash items and $2.0 million in cash provided by operating assets and liabilities. The $27.4 million adjustment for non-cash items primarily relates to $12.7 million of depreciation and amortization expense, a $10.3 million provision for cardholder losses, $7.3 million of stock-based compensation expense offset by $1.5 million in deferred income taxes and $2.5 million in tax benefits associated with stock options.

Cash Flows from Investing Activities

        Investing activities used $16.5 million of cash in fiscal 2012, primarily for purchases of property, equipment and software ($14.6 million), a long-term investment in Meta Financial Group, Inc., the holding company for one of our Issuing Banks ($1.1 million) and premiums paid on the life insurance policies issued to support our obligations under our deferred compensation plan ($0.5 million). Investing activities used $10.1 million of cash in fiscal 2011, primarily for purchases of property equipment and software ($9.2 million) and premiums paid on the life insurance policies issued to support our obligations under our deferred compensation plan ($0.9 million). Investing activities used $9.3 million of cash in fiscal 2010, which related primarily to $6.0 million of purchases of property equipment and software and a $3.2 million long-term investment in Meta Financial Group, Inc., the holding company for one of our Issuing Banks.

Cash Flows from Financing Activities

        Financing activities used $63.0 million of cash in fiscal 2012, primarily related to $68.5 million in principal payments on debt and $92.6 million used to repurchase outstanding shares of common stock. These cash outflows were partially offset by $90.0 million in proceeds drawn from our revolving line of credit, $5.3 million of cash received upon the exercise of stock options and a $2.7 million tax benefit associated with stock options.

        Financing activities used $34.2 million of cash in fiscal 2011, primarily to repurchase outstanding shares of common stock ($32.7 million) and for payments under a capital lease ($3.3 million). These cash outflows were partially offset by $1.5 million of tax benefits associated with stock options and $1.4 million of cash received upon the exercise of stock options.

        Financing activities provided $3.5 million of cash in fiscal 2010, primarily related to $21.0 million in proceeds, net of offering costs, from our initial public offering in October 2010, a $2.5 million income tax benefit associated with stock options and $0.9 million of cash received upon the exercise of stock options and warrants. These proceeds were partially offset by $6.5 million in scheduled debt payments and a $9.0 million revolving debt payment. In September 2010 we entered into a new credit facility. The initial borrowings under this new credit facility of $58.5 million were used to repay the remaining $56.3 million outstanding indebtedness under our prior credit facility, $0.7 million of accrued

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interest and $1.5 million of debt issuance costs associated with the new credit facility. The remainder of the cash used in financing activities for fiscal 2010 was comprised primarily of a $5.7 million repurchase of common stock.

Sources of Financing

        Since the inception of NetSpend Holdings in February 2004, we have primarily financed our operations through cash flows from operations, debt financing and the net proceeds received from our initial public offering in October 2010. We believe that our existing cash balances, together with the amounts we expect to generate from operations and the amounts available through our revolving credit facility will be sufficient to meet our operating needs for the next twelve months, including working capital requirements, capital expenditures and debt repayment obligations.

        In connection with the acquisition of Skylight on July 15, 2008, we entered into a credit agreement (the "prior credit facility"), which provided financing of $105.0 million, consisting of a $30.0 million revolving credit facility and a $75.0 million term loan. In September 2010, we repaid our borrowings under the prior credit facility. The weighted average interest rate for outstanding borrowings under the prior credit facility was 6.0%.

        In September 2010, we entered into a new credit facility with a syndicate of banks with SunTrust Bank as administrative agent. The new credit facility provides a $135.0 million revolving credit facility with the ability to request increases to the facility of up to $50.0 million. The initial borrowings under this credit facility of $58.5 million were used to repay the outstanding indebtedness under our prior credit facility and $1.5 million of debt issuance costs associated with the new credit facility. Our current credit facility has a maturity date in September 2015 and includes a $5.0 million swingline facility and $15.0 million letter of credit facility. At our option, we may prepay any borrowings in whole or in part, without any prepayment penalty or premium.

        As of December 31, 2012, we owed $80.0 million in outstanding borrowings under our current credit facility. During the year ended December 31, 2012, the weighted average interest rate applicable to the outstanding borrowings on this credit facility was 3.2%.

        The outstanding borrowings under the current credit facility bear interest, at our election, at either a base rate or a Eurodollar loan rate. Base rate loans bear annual interest at the base rate (the greater of the federal funds rate plus 0.50%, the prime rate or one-month LIBOR plus 1.00%) plus a spread of 1.50% to 2.25%, depending on our leverage ratio. Eurodollar loans bear interest at the adjusted LIBOR for the interest period in effect for such borrowings plus a spread of 2.50% to 3.25%, depending on our leverage ratio. Our interest rate on Eurodollar loans, which comprised all of our outstanding borrowings as of December 31, 2012, was 2.7% as of that date.

        The agreement related to our current credit facility contains certain financial and non-financial covenants and requirements, including a leverage ratio, fixed charge ratio and certain restrictions on our ability to make investments, pay dividends or sell assets. It also provides for customary events of default as defined in the agreement, including failure to pay any principal or interest when due, failure to comply with covenants and a change of control. We were in compliance with these covenants as of December 31, 2012.

        Under our current credit facility, letters of credit may be issued for a period of up to one year (subject to any automatic renewal provisions), although all such letters of credit must expire at least ten business days prior to the current credit facility's maturity date. As of December 31, 2012, we had issued $6.9 million in letters of credit to two of our Issuing Banks as security for our settlement obligations.

        During 2009, we entered into a capital lease arrangement with a software provider for perpetual database licenses. The capital lease arrangement resulted in the recording of $3.4 million in capitalized

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computer software. During 2011, we modified the capital lease arrangement, extending it for one year and purchasing $1.9 million of additional computer software. During the years ended December 31, 2011 and 2010, we made payments of $3.3 million and $1.4 million, respectively, towards the capital lease, which included interest payments at an effective interest rate of 6.0%. The capital lease was paid in full in 2011.

Off-Balance Sheet Arrangements

        Our off-balance sheet arrangements are comprised of settlement indemnifications and overdraft guarantees issued in favor of our Issuing Banks. We have no off-balance sheet debt, other than operating leases, purchase orders and other commitments entered into in the ordinary course of business as discussed below and reflected in our contractual obligations and commitments table.

        A significant portion of our business is conducted through distributors that provide load and reload services to cardholders at their locations. Members of our distribution and reload network collect cardholder funds and remit them by electronic transfer to our Issuing Banks for deposit in the cardholder accounts. Our Issuing Banks typically receive cardholders' funds no earlier than three business days after they are collected by the distributor. If any distributor fails to remit cardholders' funds to our Issuing Banks, we typically reimburse our Issuing Banks for the shortfall created thereby. We manage the risk associated with this process through a formalized set of credit standards, volume limits and deposit requirements for certain distributors and by typically maintaining the right to offset any settlement shortfall against the commissions payable to the relevant distributor. To date, we have not experienced any significant losses associated with settlement failures and we have not recorded a settlement guarantee liability as of December 31, 2012. As of December 31, 2012, our estimated gross settlement exposure was $13.5 million.

        Cardholders can incur charges in excess of the funds available in their accounts and are liable for the resulting overdrawn account balance. Although we generally decline authorization attempts for amounts that exceed the available balance in a cardholder's account, the application of the rules and regulations of the Networks, the timing of the settlement of transactions and the assessment of subscription, maintenance or other fees can, among other things, result in overdrawn card accounts. We also provide, as a courtesy and at our discretion, certain cardholders with a "cushion" which allows them to overdraw their card accounts by up to $10. In addition, certain eligible cardholders may enroll in our Issuing Banks' overdraft protection programs and fund transactions that exceed the available balance in their accounts. We generally provide the funds used as part of these overdraft programs (MetaBank will advance the first $1.0 million on behalf of its cardholders) and are responsible to our Issuing Banks for any losses associated with any overdrawn account balances. As of December 31, 2012, our cardholders' overdrawn account balances totaled $11.7 million. As of December 31, 2012, our reserve for the losses we estimate will arise from processing customer transactions, debit card overdrafts, chargebacks for unauthorized card use and merchant-related chargebacks due to non-delivery of goods or services was approximately $3.6 million.

Contractual Obligations and Commitments

        During the year ended December 31, 2010 we entered into a credit facility with a syndicate of banks with SunTrust Bank as administrative agent. The initial borrowings under this facility of $58.5 million were used to repay the $56.3 million outstanding indebtedness under our prior credit facility, $0.7 million of accrued interest on such indebtedness and $1.5 million of debt issuance costs associated with the credit facility. See "Note 9—Debt" to the consolidated financial statements included in this Form 10-K for a discussion of the terms of our credit facility.

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        Our contractual commitments and contingencies will have an impact on our future liquidity. The following table summarizes our contractual obligations that represent material expected or contractually committed future obligations as of December 31, 2012:

 
  Payments Due by Period
As Of December 31, 2012
 
 
  Total   Less than
1 Year
  1 - 3 Years   3 - 5 Years   More than
5 Years
 
 
  (in thousands of dollars)
 

Long-term debt obligations(1)

  $ 89,017   $ 12,729   $ 76,288   $   $  

Operating lease obligations(2)

    6,891     1,553     3,165     2,173      

Other long-term obligations(3)

    34,075     17,965     14,863     1,247      
                       

Total

  $ 129,983   $ 32,247   $ 94,316   $ 3,420   $  
                       

(1)
Long-term debt obligations consisted of outstanding principal and expected interest payments under our credit facility as of December 31, 2012. These future expected payments include $80.0 million of principal that is expected to be repaid upon or prior to the maturity of this facility in September 2015 and $9.0 million in future interest payments applicable to the currently outstanding borrowings at an expected interest rate of 4.7% per year through September 2015.

(2)
Operating lease obligations primarily include future payments related to the lease for our offices in Austin, Texas. This lease expires in 2017.

(3)
Other long-term obligations consist of required minimum future payments under contracts with our distributors and other service providers.


Critical Accounting Policies and Estimates

        We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP. In many cases, the accounting treatment of a particular transaction is specifically dictated by U.S. GAAP and does not require management's judgment in its application. In other cases management's judgment is required in selecting among available alternative accounting standards that allow different accounting treatment for similar transactions. The preparation of consolidated financial statements also requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Accordingly, actual results could differ significantly from our estimates. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. We believe that the accounting policies discussed below are critical to understanding our historical and future performance because these policies relate to the more significant areas involving management's judgments and estimates.

Revenue Recognition

        Our operating revenues principally consist of a portion of the service fees and interchange revenues received by our Issuing Banks in connection with the programs we manage. Revenue is recognized when there is persuasive evidence of an arrangement, the relevant services have been rendered, the price is fixed or determinable and collectability is reasonably assured.

        Cardholders are charged fees in connection with our products and services as follows:

    Transactions—Cardholders are typically charged a fee for each PIN and signature-based purchase transaction made using their GPR cards, unless the cardholder is on a monthly or

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      annual service plan, in which case the cardholder is instead charged a monthly or annual subscription fee, as applicable. Cardholders are also charged fees for ATM withdrawals and other transactions conducted at ATMs.

    Customer Service and Maintenance—Cardholders are typically charged fees for balance inquiries made through our call centers. Cardholders are also charged a monthly maintenance fee after a specified period of inactivity.

    Additional Products and Services—Cardholders are charged fees associated with additional products and services offered in connection with certain of our GPR cards, including the use of overdraft features, a variety of bill payment options, custom card designs and card-to-card transfers of funds initiated through our call centers.

    Other—Cardholders are charged fees in connection with the acquisition and reloading of our GPR cards at retailers and we receive a portion of these amounts in some cases.

        Revenue resulting from the service fees charged to our cardholders described above is recognized when the fees are charged because the earnings process is substantially complete, except for revenue resulting from the initial activation of our cards and annual subscription fees. Revenue resulting from the initial activation of our cards is recognized ratably, net of commissions paid to our distributors, over the average account life, which is approximately one year for our GPR cards (three months for the gift cards we marketed prior to August 2010). Revenue resulting from annual subscription fees is recognized ratably over the annual period to which the fees relate.

        Our revenues also include fees charged in connection with program management and processing services we provide for private-label programs, as well as fees charged to MetaBank based on interest earned on cardholder funds. Under our current arrangement with MetaBank, we would only be entitled to receive interest on cardholder funds if market interest rates rose significantly above current levels. Revenue resulting from these fees is recognized when we have fulfilled our obligations under the underlying service agreements.

        We earn revenues from a portion of the interchange fees remitted by merchants when cardholders make purchases at their locations using their GPR cards. Subject to applicable law, interchange fees are fixed by the Networks. Interchange revenues are recognized net of sponsorship, licensing and processing fees charged by the Networks for services they provide in processing purchase transactions routed through them. Interchange revenue is recognized during the period that the purchase transactions occur. Also included in interchange revenue are fees earned from branding agreements with the Networks.

Litigation

        In the normal course of business, we are at times subject to pending and threatened legal actions and proceedings. It is our policy to routinely assess the likelihood of any adverse judgments or outcomes related to legal or regulatory matters as well as ranges of probable losses. A determination of the amount of the reserves required, if any, for these contingencies is made after analysis of each known issue and consultation our internal and external legal counsel. We record reserves related to legal matters when it is determined that a loss is probable and the range of such loss can be reasonably estimated. Management discloses facts regarding material matters assessed as reasonably possible and the associated potential exposure, if estimable. We expense legal costs as incurred.

Stock-Based Compensation

        In October 2010, we adopted a new equity incentive plan, the Amended and Restated NetSpend Holdings, Inc. 2004 Equity Incentive Plan (the "2004 Plan"), which amended and replaced our prior option plan. We measure stock options at fair value on the date of grant using the Binomial Lattice

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model for determining fair value. Compensation expense is recognized on a straight-line basis over the requisite service period, net of estimated forfeitures. We consider many factors when estimating expected forfeitures, including the award type, the employee class and historical experience. We present excess tax benefits from the exercise of stock options as financing cash flows.

        In April 2012, our stockholders approved the NetSpend Holdings, Inc. 2012 Employee Stock Purchase Plan (the "ESPP"). Subject to certain limitations, the ESPP enables eligible employees to utilize after-tax payroll deductions to purchase shares of our common stock at the lesser of 85% of its fair market value on the first or last business day of each quarterly purchase period (six months with respect to the first purchase period in 2012). The discount associated with the stock purchased by participants in the ESPP is expensed as incurred.

Goodwill

        Goodwill represents the excess of the purchase price of an acquired company over the fair value of the assets acquired and liabilities assumed. We evaluate goodwill and intangible assets with indefinite lives for impairment annually or at an interim period if events occur or circumstances indicate it is more likely than not that the carrying value of the associated reporting unit exceeds its fair value. We assign goodwill to our reporting units for the purpose of impairment testing. In 2011, we adopted amendments to the guidelines for testing goodwill for impairment contained in Accounting Standards Update ("ASU") 2011-08 issued by the Financial Accounting Standard Board (the "FASB"). The amendments permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform a subsequent two-step goodwill impairment test. If an entity concludes that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it does not need to perform the two-step impairment test for that reporting unit. In the first step of the two step impairment test, the estimated fair value of the respective reporting unit is compared to its carrying amount. If the carrying value is less than fair value, no indication of impairment exists and no impairment loss is recorded. If the carrying value of the reporting unit is greater than fair value, a second step in the impairment test is performed to determine the implied fair value of goodwill and the amount of the impairment loss, if any.

Cardholders' Reserve

        We are exposed to losses due to cardholder fraud, payment defaults and other forms of cardholder activity as well as losses due to non-performance of third parties who receive cardholder funds for transmittal to our Issuing Banks. We have established a reserve for the losses we estimate will arise from processing customer transactions, debit card overdrafts, chargebacks for unauthorized card use and merchant-related chargebacks due to non-delivery of goods or services. We establish these reserves based upon historical loss and recovery rates and cardholder activity for which specific losses can be identified. We regularly update our reserve estimates as new facts become known and events occur that may impact the settlement or recovery of losses.

        Establishing the reserve for cardholder losses is an inherently uncertain process and the actual losses experienced by us may vary from the current estimate.

Income Taxes

        We recognize tax benefits or expenses on the temporary difference between the financial reporting and tax basis of our assets and liabilities. We measure deferred tax assets and liabilities using statutorily enacted tax rates expected to apply to taxable income in the years in which we expect those temporary differences to be recovered or settled. We are required to adjust our deferred tax assets and liabilities in the period in which tax rates or the provisions of the income tax laws change. Valuation allowances

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are established when necessary to reduce deferred tax assets to the amount for which we believe recovery is more likely than not. We classify interest and penalties associated with uncertain tax positions as a component of income tax expense.


Recent Accounting Pronouncements

        New accounting pronouncements or changes in existing accounting pronouncements may have a significant effect on our results of operations financial condition and on the net worth of our business operations.

        In June 2011, the FASB issued amendments to the guidelines on presenting comprehensive income. The amendments require that all nonowner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendments are effective for the first reporting period beginning after December 15, 2011 and are to be applied retrospectively. We adopted these amendments during 2012. The adoption of these amendments did not have a material effect on our consolidated financial statements.

        In July 2012, the FASB issued amendments to the guidelines for testing indefinite-lived intangible assets other than goodwill. The amendments permit an entity to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test described in FASB ASC Topic 350. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. We adopted these amendments for our quarterly and annual reporting periods ending December 31, 2012. The adoption of these amendments did not have a material effect on our consolidated financial statements.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        We are exposed to certain market risks as part of our ongoing business operations. These risks are primarily associated with fluctuating interest rates for borrowings under our revolving credit facility. Borrowings under this facility bear interest based on current market rates. We have not historically used derivative financial instruments to manage this market risk. As of December 31, 2012, we had borrowed $80.0 million under our revolving credit facility. This facility has a maturity date of September 2015. Interest on this debt accrued at a weighted average rate of 3.2% during fiscal 2012. A 1.0% increase or decrease in interest rates would have had a $0.5 million impact on our operating results and cash flows for fiscal 2012.

        The table below presents principal amounts and related weighted average interest rates as of December 31, 2012 for our revolving credit facility:

(in thousands of dollars)

 
   
 

Revolving credit facility

  $ 80,000  

Weighted average interest rate

    3.2 %

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

        The information required by this item is set forth in the consolidated financial statements appearing on pages 64 through 109 hereof.

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ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

        There were no changes in or disagreements with our accountants on accounting and financial disclosure matters.

ITEM 9A.    CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

        Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2012. The term "disclosure controls and procedures" is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act to mean controls and other procedures of a company that are designed to ensure that information required to be disclosed by it in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Based on the evaluation of our disclosure controls and procedures as of December 31, 2012, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

        Control systems, no matter how well conceived and operated, are designed to provide a reasonable, but not an absolute, level of assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Because of the inherent limitations in any control system, misstatements due to error or fraud may occur and not be detected.

Management's Report on Internal Control Over Financial Reporting

        Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2012. Based on management's assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2012 using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework.

        Our internal control over financial reporting is designed to provide reasonable, but not absolute, assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles. There are inherent limitations to the effectiveness of any system of internal control over financial reporting. These limitations include the possibility of human error, the circumvention or overriding of the system and reasonable resource constraints. Because of its inherent limitations, our internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

        The effectiveness of our internal control over financial reporting as of December 31, 2012 has been audited by KPMG LLP, an independent registered public accounting firm, and their opinion appears on page 65 as part of our consolidated financial statements.

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Changes in Internal Control Over Financial Reporting

        There were no changes in our internal control over financial reporting that occurred during the year ended December 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B.    OTHER INFORMATION

        Not applicable.

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PART III

        Certain information required by Part III is omitted from this Annual Report on Form 10-K and will be included in the definitive proxy statement that we will file with the Securities and Exchange Commission in connection with our 2013 meeting of stockholders. We will file our 2013 proxy statement (the "Proxy Statement") not later than April 30, 2012.

ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

        The information required by this Item will be included in our Proxy Statement and is incorporated herein by reference.

ITEM 11.    EXECUTIVE COMPENSATION

        The information required by this Item will be included in our Proxy Statement and is incorporated herein by reference.

ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

        The information required by this Item pursuant to Item 403 of Regulation S-K will be included in our Proxy Statement and is incorporated herein by reference.

Equity Compensation Plan Information

    Equity Incentive Plan

        In October 2010, the compensation committee of the Company's board of directors adopted a new equity incentive plan, the Amended and Restated NetSpend Holdings, Inc. 2004 Equity Incentive Plan (the "2004 Plan"), which amended and replaced our prior option plan. As of December 31, 2012, the Company had reserved 27,436,995 shares of its common stock for issuance under the 2004 Plan. The number of shares reserved for issuance under the 2004 Plan will increase annually by a number of shares equal to the lesser of (1) 3% of the total outstanding shares of the Company's capital stock immediately prior to the increase, (2) 3,000,000 or (3) such lesser amount as is determined by our board of directors. The 2004 Plan authorizes the award of stock options, stock appreciation rights, restricted stock awards, performance units and other equity-based awards.

        In 2012, the Company granted 1,573,790 options and issued 2,240,741 shares of restricted stock under the 2004 Plan.

    Employee Stock Purchase Plan

        In April 2012, the stockholders of the Company approved the NetSpend Holdings, Inc. 2012 Employee Stock Purchase Plan (the "ESPP"). Subject to certain limitations, the ESPP enables eligible employees to utilize after-tax payroll deductions to purchase shares of Company's common stock at the lesser of 85% of its fair market value on the first or last business day of each quarterly purchase period (six months with respect to the first purchase period in 2012). A total of 2,000,000 of the Company's treasury shares have been reserved for issuance under the ESPP.

        Employees purchased approximately 0.1 million shares at a weighted average price of $7.40 during the year ended December 31, 2012 pursuant to the ESPP.

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        The following table provides information as of December 31, 2012, with respect to shares of our common stock that may be issued under the 2004 Plan (subject to certain vesting requirements) and the ESPP:

 
  A   B   C  
 
  Number of securities
to be issued upon the
exercise of
outstanding options
and awards
  Weighted-average
exercise price of
outstanding options
and awards
  Number of securities
remaining available for
future issuance under
equity compensation
securities reflected in
column (A)
 

Equity compensation plans approved by security holders

    10,945,235   $ 6.01     5,254,537  

Equity compensation plans not approved by security holders

             
               

Total

    10,945,235   $ 6.01     5,254,537  
               

        The number of shares reserved for issuance under the 2004 Plan increased by 2,288,002 on January 1, 2013 and there were 5,602,088 shares available for future awards under this Plan on January 1, 2013.

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

        The information required by this Item will be included in our Proxy Statement and is incorporated herein by reference.

ITEM 14.    PRINCIPAL ACCOUNTANT FEES AND SERVICES

        The information required by this Item will be included in our Proxy Statement and is incorporated herein by reference.

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PART IV

ITEM 15.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a)
Documents Filed with Report

(1)
Financial Statements

    (2)
    Financial Statement Schedules

        The following financial statement schedule should be read in conjunction with the consolidated financial statements of NetSpend Holdings, Inc. filed as part of this Report:

        Schedule II—Valuation and Qualifying Accounts

        Schedules other than that listed above have been omitted since they are either not required or not applicable or because the information required is included in the consolidated financial statements included elsewhere herein or the notes thereto.

    (3)
    Exhibits

Exhibit
Number
  Description of Exhibits
  3.1   Form of Third Amended and Restated Certificate of Incorporation (filed as Exhibit 3.1 to NetSpend Holdings, Inc.'s Form S-1/A (Reg. No. 333-168127) on September 21, 2010 (the "September 21 S-1") and incorporated by reference herein)

 

3.2

 

Form of Amended and Restated Bylaws (filed as Exhibit 3.2 to the September 21 S-1 and incorporated by reference herein)

 

4.1

 

Specimen common stock certificate (filed as Exhibit 4.1 to NetSpend Holdings, Inc.'s Form S-1/A (Reg. No. 333-168127) on September 28, 2010 (the "September 28 S-1") and incorporated by reference herein)

 

4.2

 

Form of Registration Rights Agreement (filed as Exhibit 4.2 to the September 21 S-1 and incorporated by reference herein)

 

4.3

 

Certificate of the Designations, Powers, Preferences and Rights of Series A Convertible Preferred Stock of NetSpend Holdings, Inc., dated August 17, 2011 (filed as Exhibit 99.1 to NetSpend Holdings,  Inc.'s Current Report on Form 8-K on August 17, 2011 (the "August 2011 8-K") and incorporated by reference herein)

 

10.1

 

Credit Agreement, dated as of September 24, 2010, by and among NetSpend Holdings, Inc., the lenders party thereto and SunTrust Bank, as Administrative Agent (filed as Exhibit10.1 to the September 28 S-1 and incorporated by reference herein)

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Exhibit
Number
  Description of Exhibits
  10.2   Pledge and Security Agreement, dated as of September 24, 2010, by and among NetSpend Holdings, Inc., NetSpend Corporation, Skylight Acquisition I, Inc., Skylight Financial, Inc., NetSpend Payment Services and SunTrust Bank, as Administrative Agent (filed as Exhibit 10.2 to the September 28 S-1 and incorporated by reference herein)

 

10.3

 

Guaranty, dated as of September 24, 2010, by and among NetSpend Corporation, Skylight Acquisition I, Inc., Skylight Financial, Inc., NetSpend Payment Services, Inc. and SunTrust Bank, as Administrative Agent (filed as Exhibit 10.3 to the September 28 S-1 and incorporated by reference herein)

 

10.4

 

Amended and Restated Employment Agreement, dated as of September 20, 2010, by and among Daniel Henry, NetSpend Corporation and NetSpend Holdings, Inc. (filed as Exhibit 10.4 to the September 21 S-1 and incorporated by reference herein)

 

10.5

 

First Amendment, dated October 5, 2012, to Amended and Restated Employment Agreement and First Amendment to Performance-Based Option by and among NetSpend Corporation, NetSpend Holdings, Inc. and Daniel R. Henry (filed as Exhibit 10.1 to NetSpend Holdings, Inc.'s Current Report on Form 8-K filed on October 10, 2012 and incorporated herein by reference)

 

10.6

 

Employment Agreement, dated as of April 21, 2010, by and between George W. Gresham and NetSpend Corporation (filed as Exhibit 10.5 to NetSpend Holdings, Inc.'s Form S-1/A (Reg. No. 333-168127) on August 31, 2010 (the "August 31 S-1") and incorporated by reference herein)

 

10.7

 

Employment Agreement, dated as of January 4, 2010, by and between James DeVoglaer and NetSpend Corporation (filed as Exhibit 10.7 to the August 31 S-1 and incorporated by reference herein)

 

10.8

 

Amendment to Employment Agreement, dated as of April 20, 2010, by and between James DeVoglaer and NetSpend Corporation (filed as Exhibit 10.8 to the August 31 S-1 and incorporated by reference herein)

 

10.9

 

Employment Agreement, dated as of April 1, 2010, by and between Anh Vazquez (now known as Anh Hatzopoulos) and NetSpend Corporation (filed as Exhibit 10.9 to the August 31 S-1 and incorporated by reference herein)

 

10.10

 

Employment Agreement, dated as of June 1, 2010, by and between Charles Harris and NetSpend Corporation (filed as Exhibit 10.11 to the August 31 S-1 and incorporated by reference herein)

 

10.11

 

Employment Agreement, dated as of June 20, 2011, by and between Steven F. Coleman and NetSpend Corporation (filed as Exhibit 10.3 to NetSpend Holdings, Inc.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011 (the "June 2011 10-Q") and incorporated herein by reference)

 

10.12

 

Form of Indemnification Agreement by and between NetSpend Holdings, Inc. and each of its directors (filed as Exhibit 10.12 to the September 21 S-1 and incorporated by reference herein)

 

10.13

 

Amended and Restated NetSpend Holdings, Inc. 2004 Equity Incentive Plan (filed as Exhibit 10.13 to the September 28 S-1 and incorporated by reference herein)

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Exhibit
Number
  Description of Exhibits
  10.14   NetSpend Holdings, Inc. 2012 Employee Stock Purchase Plan (filed as Exhibit 10.38 to NetSpend Holdings, Inc.'s Annual Report on Form 10-K for the year ended December 31, 2011 (the "2011 10-K") filed on February 24, 2012 and incorporated herein by reference)

 

10.15

 

Amended and Restated Stock Option Award Agreement between NetSpend Holdings, Inc. and Daniel Henry, dated March 11, 2008 (Performance-Based Vesting) (filed as Exhibit 10.22 to the September 21 S-1 and incorporated by reference herein)

 

10.16

 

Stock Option Award Agreement between NetSpend Holdings, Inc. and Daniel Henry, dated March 11, 2008 (Time-Based Vesting) (filed as Exhibit 10.23 to the August 31 S-1 and incorporated by reference herein)

 

10.17

 

Stock Option Award Agreement between NetSpend Holdings, Inc. and Charles Harris, dated July 1, 2010 (filed as Exhibit 10.24 to the August 31 S-1 and incorporated by reference herein)

 

10.18

 

Restricted Stock Agreement between NetSpend Holdings, Inc. and Charles Harris, dated July 1, 2010 (filed as Exhibit 10.25 to the August 31 S-1 and incorporated by reference herein)

 

10.19

 

James Jerome stock option amendment, dated December 18, 2008 (filed as Exhibit 10.1 to NetSpend Holdings, Inc.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 2012 (the "June 2012 10-Q") and incorporated herein by reference)

 

10.20

 

James Jerome stock option amendment, dated April 20, 2010 (filed as Exhibit 10.2 to the June 2012 10-Q and incorporated herein by reference)

 

10.21

 

James Jerome stock option amendment, dated April 27, 2010 (filed as Exhibit 10.3 to the June 2012 10-Q and incorporated herein by reference)

 

10.22

 

Schedule indentifying option agreement amendments omitted pursuant to Instruction 2 to Item 601 of Regulation S-K (filed as Exhibit 10.4 to the June 2012 10-Q and incorporated herein by reference)

 

10.23

 

Form of Anh Vazquez retention grant (filed as Exhibit 10.3 to the September 2012 10-Q and incorporated herein by reference)

 

10.24

 

Form of NetSpend Holdings, Inc. Stock Option Award Agreement (Time-Based Vesting) (filed as Exhibit 10.28 to the August 31 S-1 and incorporated by reference herein)

 

10.25

 

Form of NetSpend Holdings, Inc. Stock Option Award Agreement (Event-Based Vesting) (filed as Exhibit 10.29 to the August 31 S-1 and incorporated by reference herein)

 

10.26

 

Form of NetSpend Holdings, Inc. Stock Option Award Agreement (Director Awards) (filed as Exhibit 10.30 to the August 31 S-1 and incorporated by reference herein)

 

10.27

 

Form of NetSpend Holdings, Inc. Stock Option Award Agreement (Performance-Based Vesting) filed as Exhibit 10.31 to the August 31 S-1 and incorporated by reference herein)

 

10.28

 

Prior Form of NetSpend Holdings, Inc. Restricted Stock Agreement (filed as Exhibit 10.27 to the August 31 S-1 and incorporated by reference herein)

 

10.29

 

Form of NetSpend Holdings, Inc. Restricted Stock Agreement (Employees) (filed as Exhibit 10.1 to NetSpend Holdings, Inc.'s Current Report on Form 8-K filed on February 14, 2012 and incorporated herein by reference)

 

10.30

 

Form of NetSpend Holdings, Inc. Restricted Stock Agreement (Directors) (filed as Exhibit 10.2 to NetSpend Holdings, Inc.'s Current Report on Form 8-K filed on February 14, 2012 and incorporated herein by reference)

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Exhibit
Number
  Description of Exhibits
  10.31   Form of NetSpend Holdings, Inc. Restricted Stock Agreement (Performance-Based) (filed as Exhibit 10.2 to NetSpend Holdings, Inc.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012 (the "September 2012 10-Q") and incorporated herein by reference)

 

10.32

 

NetSpend Holdings, Inc. Deferred Compensation Plan (filed as Exhibit 10.39 to the 2011 10-K and incorporated herein by reference)

 

10.33

 

Office Lease, dated as of August 11, 2003, by and between Crescent Real Estate Funding VIII, L.P. and NetSpend Corporation (filed as Exhibit 10.14 to the August 31 S-1 and incorporated by reference herein)

 

10.34

 

First Amendment to Office Lease, dated as of August 2, 2005, by and between Crescent Real Estate Funding VIII, L.P. and NetSpend Corporation (filed as Exhibit 10.15 to the August 31 S-1 and incorporated by reference herein)

 

10.35

 

Second Amendment to Office Lease, dated as of September 6, 2006, by and between Crescent Real Estate Funding VIII, L.P. and NetSpend Corporation (filed as Exhibit 10.16 to the August 31 S-1 and incorporated by reference herein)

 

10.36

 

Third Amendment to Office Lease, dated as of August 1, 2007, by and between WTCC Austin Investors V, L.P. and NetSpend Corporation (filed as Exhibit 10.17 to the August 31 S-1 and incorporated by reference herein)

 

10.37

 

Fourth Amendment to Office Lease, dated as of March 13, 2009, by and between WTCC Austin Investors V, L.P. and NetSpend Corporation (filed as Exhibit 10.18 to the August 31 S-1 and incorporated by reference herein)

 

10.38

 

Fifth Amendment to Office Lease, dated as of April 18, 2011, by and between WTCC Austin Investors V, L.P. and NetSpend Corporation (filed as Exhibit 10.1 to the June 2011 10-Q and incorporated herein by reference)

 

10.39

 

Fourth Amended and Restated Independent Agency Agreement, dated as of June 2, 2008, by and between ACE Cash Express, Inc. and NetSpend Corporation (filed as Exhibit 10.19 to the September 17 S-1 and incorporated by reference herein)

 

10.40

 

Second Amended and Restated Card Program Management Agreement, dated as of February 1, 2010, by and between MetaBank, dba Meta Payment Systems, and NetSpend Corporation (filed as Exhibit 10.20 to the September 17 S-1 and incorporated by reference herein)

 

10.41

 

Card Program Management Agreement, dated as of February 1, 2010, by and between MetaBank, dba Meta Payment Systems, and Skylight Financial, Inc. (filed as Exhibit 10.21 to the September 17 S-1 and incorporated by reference herein)

 

10.42

 

Memorandum of Understanding, dated as of September 9, 2010, by and between ACE Cash Express, Inc. and NetSpend Corporation (filed as Exhibit 10.32 to the September 17 S-1 and incorporated by reference herein)

 

10.43

 

Share Exchange Agreement, dated August 17, 2011, by and among JLL Partners Fund IV, L.P., JLL Partners Fund V, L.P. and NetSpend Holdings, Inc. (filed as Exhibit 10.1 of the August 2011 8-K and incorporated herein by reference)

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Exhibit
Number
  Description of Exhibits
  10.44   Settlement and License Agreement, dated November 5, 2012, by and among NetSpend Corporation, NetSpend Holdings, Inc. and Alexsam, Inc. (filed as Exhibit 10.1 to NetSpend Holdings, Inc.'s Current Report on Form 8-K filed on November 9, 2012 and incorporated herein by reference)

 

10.45

 

Description of NetSpend Holdings, Inc. 2012 Non-affiliated Independent Director Compensation Program

 

21.1

 

List of subsidiaries (filed as Exhibit 21.1 to NetSpend Holdings, Inc.'s Form S-1 (Reg. No. 333-168127) on July 15, 2010, and incorporated herein by reference)

 

23.1

 

Consent of KPMG LLP

 

24.1

 

Powers of Attorney

 

31.1

 

Certification by principal executive officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

31.2

 

Certification by principal financial officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

32.1

 

Certification by principal executive officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

32.2

 

Certification by principal financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

101*

 

The following materials from the NetSpend Holdings, Inc. Annual Report on Form 10-K for the year ended December 31, 2012, formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Statements of Operations, (ii) the Consolidated Balance Sheets, (iii) the Consolidated Statements of Changes in Stockholders' Equity, (iv) the Consolidated Statements of Cash Flows, (v) Notes to Consolidated Financial Statements and (vi) Schedule II—Valuation and Qualifying Accounts.

*
—Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

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SIGNATURES

        Pursuant to the requirements of the Securities Act of 1933, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Austin, State of Texas on the 22nd day of February, 2013.

    NETSPEND HOLDINGS, INC.

 

 

By:

 

/s/ DANIEL R. HENRY

Daniel R. Henry
Chief Executive Officer

        Pursuant to the requirements of the Securities Act of 1934, as amended, this report has been signed by the following persons in the listed capacities on February 22, 2013:

Name
 
Title

 

 

 

 

 
/s/ DANIEL R. HENRY

Daniel R. Henry
  Chief Executive Officer and Director (Principal Executive Officer)

/s/ GEORGE W. GRESHAM

George W. Gresham

 

Chief Financial Officer (Principal Accounting and Financial Officer)

*

Andrew Adams

 

Director

*

Alexander R. Castaldi

 

Director

*

Ann H. Lamont

 

Director

*

Thomas McCullough

 

Director

*

Francisco Rodriguez

 

Director

*

Daniel M. Schley

 

Director

*

Stephen A. Vogel

 

Director

*By

 

/s/ DANIEL R. HENRY

Daniel R. Henry
Attorney-in-Fact

 

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
NetSpend Holdings, Inc.:

        We have audited the accompanying consolidated balance sheets of NetSpend Holdings, Inc. and subsidiaries (the "Company") as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2012. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedule II. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

        We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NetSpend Holdings, Inc. and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

        We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), NetSpend Holdings Inc.'s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 22, 2013 expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.

/s/ KPMG LLP

Austin, Texas
February 22, 2013

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
NetSpend Holdings, Inc.:

        We have audited NetSpend Holdings, Inc.'s (the "Company") internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.

        We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

        A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

        Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

        In our opinion, NetSpend Holdings, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

        We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of NetSpend Holdings, Inc. as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2012, and our report dated February 22, 2013 expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP

Austin, Texas
February 22, 2013

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NetSpend Holdings, Inc.

Consolidated Balance Sheets

As of December 31, 2012 and 2011

 
  2012   2011  
 
  (in thousands of
dollars, except
share data)

 

Assets

             

Current assets

             

Cash and cash equivalents

  $ 30,619   $ 72,076  

Accounts receivable, net of allowance for doubtful accounts of $518 as of December 31, 2012 and $581 as of December 31, 2011

    10,622     7,552  

Prepaid card supply

    3,535     2,000  

Prepaid expenses

    4,007     3,326  

Other current assets

    1,360     2,179  

Income tax receivable

    59      

Deferred tax assets

    7,620     4,138  
           

Total current assets

    57,822     91,271  

Property, equipment and software, net

    23,743     20,631  

Goodwill

    128,567     128,567  

Intangible assets

    20,246     22,227  

Long-term investment

    4,560     2,497  

Other assets

    17,655     7,549  
           

Total assets

  $ 252,593   $ 272,742  
           

Liabilities & Stockholders' Equity

             

Current liabilities

             

Accounts payable (includes $451 and $0 of related party payables as of December 31, 2012 and 2011, respectively)

  $ 4,908   $ 3,183  

Accrued expenses (includes $4,033 and $3,791 of related party expenses as of December 31, 2012 and 2011, respectively)

    26,362     20,937  

Income tax payable

        1,733  

Cardholders' reserve

    3,633     3,892  

Deferred revenue

    1,765     1,585  

Current litigation contingencies

    10,900      

Long-term debt, current portion

    10,000      
           

Total current liabilities

    57,568     31,330  

Long-term debt, net of current portion

    70,000     58,500  

Deferred tax liabilities

    4,224     7,431  

Other non-current liabilities

    3,155     4,628  
           

Total liabilities

    134,947     101,889  
           

Commitments and contingencies (Note 15)

             

Stockholders' equity

             

Series A convertible preferred stock, $0.001 par value; 1,500,000 shares authorized; outstanding: 700,000 as of December 31, 2012 and 2011, respectively

    1     1  

Common stock, $0.001 par value; 225,000,000 shares authorized; outstanding: as of December 31, 2012—87,269,623 issued less 18,002,875 held in treasury and as of December 31, 2011—85,492,234 issued less 7,758,386 held in treasury

    87     85  

Treasury stock at cost; shares held: 18,002,875 as of December 31, 2012 and 7,758,386 as of December 31, 2011

    (137,222 )   (44,753 )

Additional paid-in capital

    184,819     165,298  

Accumulated other comprehensive income (loss)

    160     (712 )

Retained earnings

    69,801     50,934  
           

Total stockholders' equity

    117,646     170,853  
           

Total liabilities & stockholders' equity

  $ 252,593   $ 272,742  
           

   

See accompanying notes to the consolidated financial statements.

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NetSpend Holdings, Inc.

Consolidated Statements of Operations

Years Ended December 31, 2012, 2011 and 2010

 
  2012   2011   2010  
 
  (in thousands, except per share data)
 

Operating Revenues (includes related party revenues of $5,911 in 2012, $5,401 in 2011 and $4,611 in 2010)

  $ 351,332   $ 306,255   $ 275,387  

Operating Expenses

                   

Direct operating costs (includes related party expenses of $53,664 in 2012, $49,812 in 2011 and $38,625 in 2010)

    169,066     146,199     130,783  

Salaries, benefits and other personnel costs

    56,328     52,736     54,032  

Advertising, marketing and promotion costs

    20,127     14,230     14,038  

Other general and administrative costs (includes related party expenses of $276 in 2012, $226 in 2011 and $210 in 2010)

    21,116     20,135     18,234  

Depreciation and amortization

    13,778     15,031     12,725  

Other losses

    36,988     515     4,300  
               

Total operating expenses

    317,403     248,846     234,112  
               

Operating income

    33,929     57,409     41,275  

Other Income (Expense)

                   

Interest income

    139     108     85  

Interest expense

    (2,598 )   (2,457 )   (3,526 )

Loss on extinguishment of debt

            (734 )
               

Total other expense

    (2,459 )   (2,349 )   (4,175 )

Income before income taxes

   
31,470
   
55,060
   
37,100
 

Provision for income taxes

   
12,603
   
21,814
   
14,368
 
               

Net income

  $ 18,867   $ 33,246   $ 22,732  
               

Net income per share of common stock:

                   

Basic

  $ 0.23   $ 0.37   $ 0.26  

Diluted

  $ 0.22   $ 0.36   $ 0.26  

Shares used in computation of earnings per common share:

                   

Basic

    73,251     84,504     85,394  

Diluted

    84,321     91,284     88,991  

   

See accompanying notes to the consolidated financial statements.

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NetSpend Holdings, Inc.

Consolidated Statements of Comprehensive Income

Years Ended December 31, 2012, 2011 and 2010

 
  2012   2011   2010  
 
  (in thousands)
 

Net Income

  $ 18,867   $ 33,246   $ 22,732  

Other comprehensive income (loss) Investment securities, available-for-sale net unrealized gain (loss), net of tax

    872     430     (1,142 )
               

Other comprehensive income (loss)

    872     430     (1,142 )
               

Comprehensive income

  $ 19,739   $ 33,676   $ 21,590  
               

   

See accompanying notes to the consolidated financial statements.

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NetSpend Holdings, Inc.

Consolidated Statements of Changes in Stockholders' Equity

Years Ended December 31, 2012, 2011 and 2010

 
  Series A
Convertible
Preferred Stock
   
   
  Class B
Common Stock
   
   
   
   
   
   
 
 
  Common Stock   Treasury Stock    
  Accumulated
Other
Comprehensive
Income (Loss)
  Retained
Earnings
(Accumulated
Deficit)
   
 
 
  Additional
Paid-in
Capital
  Total
Stockholders'
Equity
 
 
  Shares   Amount   Shares   Amount   Shares   Amount   Shares   Amount  
 
  (in thousands of dollars, except share data)
 

Balances as of December 31, 2009

      $     77,198,193   $ 77     10,244,609   $ 10     (1,870,000 ) $ (5,704 ) $ 119,484   $   $ (4,515 ) $ 109,352  

Purchase of treasury stock

                            (1,500,000 )   (5,670 )               (5,670 )

Stock-based compensation

                                    7,268             7,268  

Exercise of options for common stock

            1,000,215     1                     850             851  

Tax benefit associated with stock options

                                    2,536             2,536  

Exercise of warrants for common stock

            609,587     1                     82             83  

Vesting of restricted stock

                      215,050     1                         1  

Common stock issued in public offering, net of issuance costs (Note 11)

            2,272,727     2                     20,979             20,981  

Conversion of Class B common stock to common stock

            10,459,659     11     (10,459,659 )   (11 )                        

Dividend equivalents paid

                                            (176 )   (176 )

Unrealized loss on available-for-sale investment

                                        (1,142 )       (1,142 )

Net income

                                            22,732     22,732  
                                                   

Balances as of December 31, 2010

      $     91,540,381   $ 92       $     (3,370,000 ) $ (11,374 ) $ 151,199   $ (1,142 ) $ 18,041   $ 156,816  

Purchase of treasury stock

                            (4,319,844 )   (32,718 )               (32,718 )

Tax withholding on restricted stock

                            (68,542 )   (661 )               (661 )

Stock-based compensation

                                    11,242             11,242  

Exchange of shares

    700,000     1     (7,000,000 )   (7 )                   6              

Exercise of options for common stock

            588,247                         1,405             1,405  

Tax benefit associated with stock options

                                    1,541             1,541  

Vesting of restricted stock

            363,606                                      

Issuance cost of public offering

                                    (95 )           (95 )

Dividend equivalents paid

                                            (353 )   (353 )

Unrealized gain on available-for-sale investment

                                        430         430  

Net income

                                            33,246     33,246  
                                                   

Balances as of December 31, 2011

    700,000   $ 1     85,492,234   $ 85       $     (7,758,386 ) $ (44,753 ) $ 165,298   $ (712 ) $ 50,934   $ 170,853  

Purchase of treasury stock

                            (10,267,018 )   (92,559 )               (92,559 )

Tax withholding on restricted stock

                            (37,020 )   (351 )               (351 )

Re-issuance of treasury stock under employee stock purchase plan

                            59,549     441                 441  

Stock-based compensation

                                    11,464             11,464  

Exercise of options for common stock

            1,650,129     2                     5,316             5,318  

Tax benefit associated with stock options

                                    2,741             2,741  

Vesting of restricted stock

            127,260                                      

Unrealized gain on available-for-sale investment

                                        872         872  

Net income

                                            18,867     18,867  
                                                   

Balances as of December 31, 2012

    700,000   $ 1     87,269,623   $ 87       $     (18,002,875 ) $ (137,222 ) $ 184,819   $ 160   $ 69,801   $ 117,646  
                                                   

See accompanying notes to the consolidated financial statements.

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NetSpend Holdings, Inc.

Consolidated Statements of Cash Flows

Years Ended December 31, 2012, 2011 and 2010

 
  2012   2011   2010  
 
  (in thousands of dollars)
 

Cash flows from operating activities

                   

Net income

  $ 18,867   $ 33,246   $ 22,732  

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

                   

Depreciation and amortization

    13,778     15,031     12,725  

Amortization of debt issuance costs

    326     326     424  

Loss on extinguishment of debt

            734  

Stock-based compensation

    11,464     11,242     7,268  

Tax benefit associated with stock options

    (2,741 )   (1,541 )   (2,536 )

Provision for cardholder losses

    18,741     14,441     10,254  

Deferred income taxes

    (6,785 )   (2,646 )   (1,505 )

Change in cash surrender value of life insurance policies

    (159 )   8      

Litigation contingencies, current

    10,900          

Changes in operating assets and liabilities

                   

Accounts receivable

    (3,070 )   (2,111 )   (928 )

Income tax receivable or payable

    949     2,942     5,243  

Prepaid card supply

    (1,535 )   (395 )   178  

Prepaid expenses

    (681 )   (946 )   (23 )

Other current assets

    819     (1,172 )   838  

Other long-term assets

    (9,752 )   (2,316 )   (972 )

Accounts payable and accrued expenses

    7,150     (3,797 )   2,942  

Cardholders' reserve

    (19,000 )   (15,338 )   (7,085 )

Deferred revenue

    180     252     (825 )

Other liabilities

    (1,473 )   1,621     2,637  
               

Net cash provided by operating activities

    37,978     48,847     52,101  
               

Cash flows from investing activities

                   

Purchase of property, equipment and software

    (14,595 )   (9,182 )   (6,045 )

Purchase of intangible assets

    (314 )   (12 )   (4 )

Long-term investment

    (1,095 )       (3,210 )

Premiums paid on cash surrender value life insurance policies

    (521 )   (894 )    
               

Net cash used in investing activities

    (16,525 )   (10,088 )   (9,259 )
               

Cash flows from financing activities

                   

Dividend equivalents paid

        (353 )   (176 )

Proceeds from exercise of common stock warrants

            83  

Proceeds from exercise of common stock options

    5,318     1,405     851  

Proceeds from the re-issuance of treasury stock under employee stock purchase plan

    441          

Tax benefit associated with stock options

    2,741     1,541     2,536  

Net cash proceeds (disbursements) from initial public offering

        (95 )   20,981  

Proceeds from issuance of long-term debt

    90,000         58,500  

Issuance costs of long-term debt

            (1,462 )

Principal payment on debt

    (68,500 )   (3,303 )   (72,138 )

Treasury stock purchase

    (92,559 )   (32,718 )   (5,670 )

Tax withholding on restricted stock

    (351 )   (661 )    
               

Net cash provided by (used in) financing activities

    (62,910 )   (34,184 )   3,505  

Net change in cash and cash equivalents

   
(41,457

)
 
4,575
   
46,347
 

Cash and cash equivalents at beginning of year

   
72,076
   
67,501
   
21,154
 
               

Cash and cash equivalents at end of year

  $ 30,619   $ 72,076   $ 67,501  
               

Supplemental disclosure of cash flow information

                   

Cash paid for interest

  $ 2,330   $ 2,591   $ 2,764  

Cash paid for income taxes

    18,403     21,432     10,682  

Non-cash investing activities

                   

Capital lease entered into for the purchase of software

  $   $ 1,949   $  

   

See accompanying notes to the consolidated financial statements.

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements

December 31, 2012, 2011 and 2010

NOTE 1: ORGANIZATION AND BUSINESS

        NATURE OF OPERATIONS—NetSpend Holdings, Inc. (the "Company") was formed as a Delaware corporation on February 18, 2004 in connection with the recapitalization of one of the Company's current subsidiaries, NetSpend Corporation, which was founded in 1999. The Company operates in one reportable business segment to provide general purpose reloadable ("GPR") prepaid debit and payroll cards and alternative financial service solutions to underbanked and other consumers in the United States. The products marketed and managed by the Company provide consumers with access to FDIC-insured depository accounts with a menu of pricing and features specifically tailored to their needs. The Company has an extensive distribution and reload network comprised of financial service centers and other retail locations throughout the United States.

        The Company's common stock trades on the NASDAQ stock exchange under the symbol "NTSP."

        The Company is a program manager for the FDIC-insured depository institutions that issue the card products that the Company develops, promotes and distributes. The Company has agreements with, among others, Meta Payment Systems ("MetaBank"), a division of Meta Financial Group ("MFG"), Inter National Bank ("INB"), U.S. Bank ("USB"), SunTrust Bank ("SunTrust"), Regions Bank ("Regions"), BofI Federal Bank ("BofI") and The Bancorp Bank ("Bancorp" and, collectively with MetaBank, INB, USB, SunTrust, Regions and BofI, the "Issuing Banks") whereby the Issuing Banks issue MasterCard International ("MasterCard") or Visa USA, Inc. ("Visa") branded cards to customers. The Company has an agreement with another bank under which it will implement a paycard program in 2013. The products managed by the Company may be used to purchase goods and services wherever MasterCard and Visa are accepted or to withdraw cash via automatic teller machines ("ATMs").

        PRINCIPLES OF CONSOLIDATION—The accompanying consolidated financial statements include the accounts of NetSpend Holdings, Inc. and its wholly owned subsidiaries, NetSpend Corporation, Skylight Financial, Inc. and NetSpend Payment Services, Inc. All intercompany transactions have been eliminated in consolidation.

        USE OF ESTIMATES—The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") requires management to make estimates and assumptions about future events. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and reported amounts of revenues and expenses during the reporting period. Among the more significant assumptions are those that relate to the valuation of goodwill and intangible assets, cardholders' reserve, legal contingencies and stock-based compensation. These accounting estimates reflect the best judgment of management. Actual results could significantly differ from management's estimates and judgments.

NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

        CASH AND CASH EQUIVALENTS—The Company considers cash invested in interest-bearing deposits and short-term investments with original maturities of three months or less at the date of purchase to be cash equivalents.

        The Company has established compensating balances at certain of its Issuing Banks as security for its obligation to reimburse the Issuing Banks for overdrawn cardholder accounts that are not repaid by

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

the cardholder. Some of these compensating balance accounts are included in the Consolidated Balance Sheets as cash and cash equivalents because there are no legal or contractual restrictions over the deposits in these accounts. As of December 31, 2012 and 2011 these compensating balances totaled $0.2 million.

        RESTRICTED CASH—Restricted cash is cash with statutory or contractual restrictions that prevent it from being used in the Company's operations. Restricted cash is classified in other non-current assets on the Company's Consolidated Balance Sheets.

        As of December 31, 2012 and 2011, the Company had restricted cash of $0.6 million and $0.5 million, respectively.

        ACCOUNTS RECEIVABLE—Accounts receivable primarily represents amounts due from cardholders for service and card activation fees and for interchange revenues related to merchant point of sale transactions. These receivables are generally settled by the issuing and merchant acquiring banks within a few days. Accounts receivable are recorded net of the allowance for doubtful accounts. The Company records an allowance when it becomes probable that a receivable will not be collected and receivables are written off against the allowance when management makes the determination to cease collection efforts.

        PREPAID CARD SUPPLY—Prepaid card supply consists of costs incurred primarily for purchasing card stock and embossing, encoding, packaging and shipping cards. Prepaid card supply costs associated with personalized cards are expensed to direct operating costs within the Consolidated Statements of Operations when the cards are shipped from the Company's fulfillment warehouses into the distribution channel or to end customers. Prepaid card supply costs associated with temporary cards are also expensed when shipped from the Company's fulfillment warehouses unless they are shipped to a retail warehouse. Costs associated with those shipments are deferred and expensed over the related merchandising cycle.

        UP-FRONT DISTRIBUTOR PAYMENTS—Occasionally, the Company makes up-front contractual payments to third-party distribution partners. The Company assesses each up-front payment to determine whether it meets the criteria of an asset (having a future benefit) as defined by U.S. GAAP. If these criteria are met, the Company capitalizes the up-front payment and recognizes the capitalized amount as expense ratably over the benefit period, which is generally the contract period. If the contract requires the distributor to perform specific acts (i.e. achieve a sales goal) and no other conditions exist for the distributor to earn or retain the up-front payment, then the Company capitalizes the payment and recognizes it as an expense when the performance conditions have been met. Up-front distributor payments are classified on the Consolidated Balance Sheets as other non-current assets and recorded as a direct operating cost in the Consolidated Statements of Operations.

        PROPERTY, EQUIPMENT AND SOFTWARE, NET—Property, equipment and software are stated at cost and depreciated using the straight-line method over their estimated useful lives. Office equipment and furniture and fixtures are depreciated over three to seven years, computer equipment is depreciated over three to five years, computer software is depreciated over three years and leasehold improvements are amortized over the shorter of their estimated useful life or the term of the related lease. When assets are sold or retired, the cost and accumulated depreciation are removed from the

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

accounts and any gain or loss is credited or charged to income. Costs for repairs and maintenance are expensed as incurred.

        The costs of internally developed and purchased software are amortized over their estimated useful lives of three years. Qualifying internally developed software costs are expensed during the preliminary project stage and post implementation stage. Capitalization begins when the preliminary project stage, which includes evaluating needs and selecting from alternatives, is completed and the appropriate level of management authorizes and commits to funding the project. Amortization begins at the point a computer software project is substantially complete and ready for its intended use. Development costs incurred in the development and enhancement of software used in connection with services provided by the Company that do not otherwise qualify for capitalization treatment are expensed as incurred. Capitalized software is included in property equipment and software, net in the Company's Consolidated Balance Sheets.

        Property, equipment and software are assessed for impairment whenever events or circumstances indicate the carrying value of an asset group may not be fully recoverable by comparing the carrying value to the estimated total future undiscounted cash flows associated with the assets being evaluated. Impairment is recorded for long-lived assets equal to the excess of the carrying amount of the asset group over its estimated fair value. The Company did not recognize any significant impairment losses related to long-lived assets during the years ended December 31, 2012, 2011 or 2010.

        GOODWILL—Goodwill represents the excess of the purchase price of an acquired company over the fair value of the assets acquired and liabilities assumed. The Company evaluates goodwill for impairment annually or at an interim period if events occur or circumstances indicate it is more likely than not that the carrying value of the associated reporting unit exceeds its fair value.

        The Company assigns goodwill to its reporting units for the purpose of impairment testing. In 2011, the Company adopted amendments to the guidelines for testing goodwill for impairment contained in Accounting Standards Update ("ASU") 2011-08 issued by the Financial Accounting Standard Board (the "FASB"). The amendments permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform a subsequent two-step goodwill impairment test. If the Company concludes that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it does not need to perform the two-step impairment test for that reporting unit. In the first step of the two step impairment test, the estimated fair value of the respective reporting unit is compared to its carrying amount. If the carrying value is less than fair value, no indication of impairment exists and no impairment loss is recorded. If the carrying value of the reporting unit is greater than fair value, a second step in the impairment test is performed to determine the implied fair value of goodwill and the amount of impairment loss, if any.

        INTANGIBLE ASSETS—Intangible assets with indefinite lives are evaluated for impairment annually, or at an interim period if events occur or circumstances indicate it is more likely than not that their carrying value exceeds their fair value. Any excess carrying value of an intangible asset with an indefinite life over its fair value is recognized as an impairment loss. Finite lived intangible assets are amortized over their estimated useful lives using the straight-line method. Distributor and partner relationships have a useful life of between eight and ten years, developed technology has a useful life of between three and seven years, license agreements have a useful life of twelve years, patents and

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

trademarks have a useful life of between twelve and twenty years. The Company's acquired tradenames have indefinite lives. Intangible assets with finite lives are assessed for impairment whenever events or changes in circumstances indicate that their carrying value exceeds the future discounted cash flows associated with them.

        CARDHOLDERS' RESERVE—The Company is exposed to losses due to cardholder fraud, payment defaults and other forms of cardholder activity as well as losses due to non-performance of third parties who receive cardholder funds for transmittal to the Issuing Banks. The Company establishes a reserve for the losses it estimates will arise from processing customer transactions, debit card overdrafts, chargebacks for unauthorized card use and merchant-related chargebacks due to non-delivery of goods or services. These reserves are established based upon historical loss and recovery rates and cardholder activity for which specific losses can be identified. The cardholders' reserve was approximately $3.6 million and $3.9 million as of December 31, 2012 and 2011, respectively. The provision for cardholder losses is included in direct operating costs in the Consolidated Statements of Operations. The Company regularly updates its reserve estimate as new facts become known and events occur that may impact the settlement or recovery of losses.

        Establishing the reserve for cardholder losses is an inherently uncertain process and the actual losses experienced by the Company may vary from the current estimate.

        LITIGATION—In the normal course of business, the Company is at times subject to pending and threatened legal actions and proceedings. It is the Company's policy to routinely assess the likelihood of any adverse judgments or outcomes related to legal or regulatory matters as well as ranges of probable losses. A determination of the amount of the reserves required, if any, for these contingencies is made after analysis of each known issue and consultation with the Company's internal and external legal counsel. The Company records reserves related to legal matters when it is determined that a loss is probable and the range of such loss can be reasonably estimated. Management discloses facts regarding material matters assessed as reasonably possible and the associated potential exposure, if estimable. The Company expenses legal costs as incurred.

        INCOME TAXES—The Company recognizes tax benefits or expenses on the temporary differences between the financial reporting and tax basis of its assets and liabilities. Deferred tax assets and liabilities are measured using statutorily enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Company is required to adjust its deferred tax assets and liabilities in the period in which tax rates or the provisions of the income tax laws change. Valuation allowances are established when necessary to reduce deferred tax assets to the amount for which recovery is deemed more likely than not. The Company's policy is to classify interest and penalties associated with uncertain tax positions as a component of income tax expense.

        STOCK-BASED COMPENSATION—In October 2010, the Company adopted a new equity incentive plan, the Amended and Restated NetSpend Holdings, Inc. 2004 Equity Incentive Plan (the "2004 Plan"), which amended and replaced the Company's prior option plan. The Company measures the fair value of stock options on the date of grant using the Binomial Lattice model. Compensation expense is recognized on a straight-line basis over the requisite service period, net of estimated forfeitures. The Company considers multiple factors when estimating expected forfeitures, including the

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

employee class and historical experience. The Company presents excess tax benefits from the exercise of stock options as financing cash flows.

        In April 2012, the stockholders of the Company approved the NetSpend Holdings, Inc. 2012 Employee Stock Purchase Plan (the "ESPP"). Subject to certain limitations, the ESPP enables eligible employees to utilize after-tax payroll deductions to purchase shares of Company's common stock at the lesser of 85% of its fair market value on the first or last business day of each quarterly purchase period (six months with respect to the first purchase period in 2012). The discount associated with the stock purchased by participants in the ESPP is expensed as incurred.

        EARNINGS PER SHARE—Basic earnings per common share excludes dilution for potential common stock issuances and is calculated by dividing net income available to common stockholders by the weighted average number of common shares issued and outstanding during the period. Diluted earnings per common share is calculated by dividing net income by the weighted average number of common shares issued and outstanding during the period plus amounts representing the dilutive effect of stock options, warrants and restricted stock and convertible preferred stock, as applicable. The Company calculates basic and diluted earnings per common share using the treasury stock method, the as-if-converted method and the two-class method, as applicable.

        REVENUE RECOGNITION—The Company's operating revenue principally consists of a portion of the service fees and interchange revenues received by the Issuing Banks in connection with the programs managed by the Company. Revenue is recognized when there is persuasive evidence of an arrangement, the relevant services have been rendered, the price is fixed or determinable and collectability is reasonably assured.

        Cardholders are charged fees in connection with the products and services provided, as follows:

    Transactions—Cardholders are typically charged a fee for each PIN and signature-based purchase transaction made using their GPR cards, unless the cardholder is on a monthly or annual service plan, in which case the cardholder is instead charged a monthly or annual subscription fee, as applicable. Cardholders are also charged fees for ATM withdrawals and other transactions conducted at ATMs.

    Customer Service and Maintenance—Cardholders are typically charged fees for balance inquiries made through the Company's call centers. Cardholders are also charged a monthly maintenance fee after a specified period of inactivity.

    Additional Products and Services—Cardholders are charged fees associated with additional products and services offered in connection with certain GPR cards, including the use of overdraft features, a variety of bill payment options, custom card designs and card-to-card transfers of funds initiated through the Company's call centers.

    Other—Cardholders are charged fees in connection with the acquisition and reloading of the Company's GPR cards at retailers and the Company receives a portion of these amounts in some cases.

        Revenue resulting from the service fees charged to cardholders described above is recognized when the fees are charged because the earnings process is substantially complete, except for revenue resulting from the initial activation of the Company's cards and annual subscription fees. Revenue resulting from

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

the initial activation of cards is recognized ratably, net of commissions paid to distributors, over the average account life, which is approximately one year for GPR cards (three months for the gift cards the Company marketed prior to August 2010). Revenue resulting from annual subscription fees is recognized ratably over the annual period to which the fees relate.

        Revenues also include fees charged in connection with program management and processing services the Company provides for private-label programs, as well as fees charged to MetaBank based on interest earned on cardholder funds. Under the Company's current arrangement with MetaBank, the Company would only be entitled to receive interest on cardholder funds if market interest rates rose significantly above current levels. Revenue resulting from these fees is recognized when the Company has fulfilled its obligations under the underlying service agreements.

        The Company earns revenues from a portion of the interchange fees remitted by merchants when cardholders make purchase transactions using their GPR cards. Subject to applicable law, interchange fees are fixed by the card associations and network organizations (collectively, the "Networks"). Interchange revenues are recognized net of sponsorship, licensing and processing fees charged by the Networks for services they provide in processing purchase transactions routed through them. Interchange revenue is recognized during the period that the purchase transactions occur. Also included in interchange revenue are fees earned from branding agreements with the Networks.

        DIRECT OPERATING COSTS—Direct operating costs consist of internal and external customer service costs, commissions paid to third-party distributors, ATM processing fees, card supply costs, costs for fraud and other losses related to the Company's card programs, customer verification costs, customer service costs and fees paid to the Issuing Banks. These costs are driven by transaction volumes and the number of active cards.

        SALARIES, BENEFITS AND OTHER PERSONNEL COSTS—Salaries, benefits and other personnel costs primarily consist of expenses related to non-customer service employee wages, bonuses, equity-based compensation and benefits, including 401(k) matching expenses and the Company's portion of employee health insurance costs. Salaries, benefits and other personnel costs related to customer service employees are included in direct operating costs in the Consolidated Statements of Operations.

        ADVERTISING COSTS—The Company expenses advertising costs as they are incurred except for direct-response advertising and television advertising production costs. Direct-response advertising consists of commissions paid to affiliate marketers for the new funded customer accounts generated by them. Direct-response advertising costs are capitalized and amortized over the average life of the new accounts, which is approximately one year. Television advertising production costs consist of the costs of developing and filming television ads. Television advertising production costs are capitalized when the production services are received and expensed in the period when the advertising first takes place.

        As of December 31, 2012 and 2011, $0.1 million and $0.2 million, respectively, of capitalized direct response advertising costs and television advertising production costs were included in current assets on the Consolidated Balance Sheets.

        SIGNIFICANT CONCENTRATIONS—Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. A significant portion of the Company's cash is deposited in cash and money market funds at large

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

depository institutions and is not eligible for FDIC insurance. The Company has not experienced any losses on its deposits to date. None of the Company's cash and cash equivalents are held in offshore accounts and the Company does not have any direct exposure to risks associated with European sovereign debt. Accounts receivable as of December 31, 2012 and 2011 are primarily receivables due from cardholders for service fees and for interchange revenues due from the Networks related to merchant point of sale transactions.

        Cardholder funds and deposits related to the Company's products are held at FDIC insured Issuing Banks for the benefit of the cardholders. Although the Company currently has active agreements with seven Issuing Banks, MetaBank holds a large majority of cardholder funds.

        Interchange revenue, which is recorded net of sponsorship, licensing and processing fees charged by the Networks for the services they provide in processing purchase transactions routed through them, represented approximately 22.5%, 22.4% and 21.6% of the Company's revenues during the years ended December 31, 2012, 2011 and 2010, respectively. The amounts of these fees were previously fixed by the Networks in their sole discretion. The enactment of the Dodd Frank Wall Street Reform and Consumer Protection Act in May 2010 and the issuance of final regulations under this Act in June 2011 has imposed limits on the interchange fees that can be paid in connection with certain prepaid programs, effective October 2011. The Company programs are largely exempt from these restrictions.

        The Company derived more than one-third of its revenues during each of the years ended December 31, 2012, 2011 and 2010 from cardholders acquired through one of its third-party distributors, ACE Cash Express, Inc. ("ACE"). The Company's current distribution agreement with ACE is effective through March 2016 (this agreement will extend for an additional five years upon the consummation of the proposed merger with Total System Services, Inc. (see "Note 19").

NOTE 3: RECENT ACCOUNTING PRONOUNCEMENTS

        New accounting pronouncements or changes in existing accounting pronouncements may have a significant effect on the results of operations, financial condition or net worth of the Company's business operations.

        In June 2011, the FASB issued amendments to the guidelines on presenting comprehensive income. The amendments require that all nonowner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendments are effective for the first reporting period beginning after December 15, 2011 and are to be applied retrospectively. The Company adopted these amendments during 2012. The adoption of these amendments did not have a material effect on the Company's consolidated financial statements.

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 3: RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

        In July 2012, the FASB issued amendments to the guidelines for testing indefinite-lived intangible assets other than goodwill. The amendments permit an entity to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test described in FASB ASC Topic 350. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The Company adopted these amendments for its quarterly and annual reporting periods ending December 31, 2012. The adoption of these amendments did not have a material effect on the Company's consolidated financial statements.

NOTE 4: PROPERTY, EQUIPMENT AND SOFTWARE

        Property, equipment and software consisted of the following as of December 31, 2012 and 2011:

 
  December 31,  
 
  2012   2011  
 
  (in thousands of
dollars)

 

Computer and office equipment

  $ 20,172   $ 17,563  

Computer software

    37,738     31,812  

Furniture and fixtures

    1,990     1,431  

Leasehold improvements

    3,186     1,639  

Construction in progress

    4,165     4,013  
           

    67,251     56,458  

Less: Accumulated depreciation

    (43,508 )   (35,827 )
           

  $ 23,743   $ 20,631  
           

        During 2011, the Company modified the capital lease arrangement with a software provider, extending it for one year and purchasing $1.9 million of additional computer software. The computer software is included in property, equipment and software on the Company's Consolidated Balance Sheets.

        Depreciation expense, which includes amortization of the capital lease described above, was approximately $11.5 million for each of the years ended December 31, 2012 and 2011, respectively, and was $9.5 million for the year ended December 31, 2010.

NOTE 5: GOODWILL

        The Company's goodwill balance is the result of acquiring: all of the capital stock of NetSpend Corporation through a recapitalization transaction in 2004; the acquisition of Skylight Financial, Inc. ("Skylight") in 2008, a company that is focused on the market for direct deposit payroll accounts; and Procesa International, LLC ("Procesa"), a service provider for direct, cross-border and cell phone top-up payment services for Latin America in 2008.

        Goodwill is tested for impairment annually or if an event occurs or conditions change that would more likely than not reduce the fair value of the reporting unit below its carrying value. In 2010, the

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 5: GOODWILL (Continued)

Company performed the first step of the two-step impairment test and determined that the fair value of its goodwill exceeded its carrying value. In 2011 and 2012, the Company adopted the amendments included in the FASB's ASU 2011-08 under which it first assessed qualitative factors to determine whether the existence of events or circumstances would lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Based on its analysis, the Company determined it was not more likely than not that that the fair values of its reporting units were less than their respective carrying amounts, and no further impairment testing was performed. Accordingly, no goodwill impairment charges were recorded in the years ended December 31, 2012, 2011 or 2010.

NOTE 6: INTANGIBLE ASSETS

        Intangible assets consisted of the following as of December 31, 2011:

 
  December 31, 2011  
 
  Gross
Carrying
Amount
  Accumulated
Amortization
  Net
Carrying
Amount
 
 
  (in thousands of dollars)
 

Distributor and partner relationships

  $ 26,426   $ (15,345 ) $ 11,081  

Developed technology

    7,261     (6,865 )   396  

Other

    184     (49 )   135  
               

Amortized intangible assets

  $ 33,871   $ (22,259 ) $ 11,612  

Unamortized intangible assets:

                   

Tradenames

    10,615         10,615  
               

Total intangible assets

  $ 44,486   $ (22,259 ) $ 22,227  
               

        Intangible assets consisted of the following as of December 31, 2012:

 
  December 31, 2012  
 
  Gross
Carrying
Amount
  Accumulated
Amortization
  Net
Carrying
Amount
 
 
  (in thousands of dollars)
 

Distributor and partner relationships

  $ 26,426   $ (17,395 ) $ 9,031  

Developed technology

    7,261     (7,073 )   188  

Other

    498     (86 )   412  
               

Amortized intangible assets

  $ 34,185   $ (24,554 ) $ 9,631  

Unamortized intangible assets:

                   

Tradenames

    10,615         10,615  
               

Total intangible assets

  $ 44,800   $ (24,554 ) $ 20,246  
               

        As part of the Company's acquisition of Skylight in 2008, the Company acquired the "Skylight" trade name. Based on the reputation of the Skylight trade name and the anticipated future benefits and cash flows the trade name is expected to contribute, the Company accounts for the trade name as an

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 6: INTANGIBLE ASSETS (Continued)

indefinite lived intangible asset. As of December 31, 2012, the Skylight trade name continues to have an indefinite life as the Company continues to use the Skylight trade name on certain of its products.

        No impairment charges were recorded in respect of the Company's intangible assets in the years ended December 31, 2012, 2011 or 2010.

        Amortization expense for the years ended December 31, 2012, 2011 and 2010 was $2.3 million, $3.5 million and $3.2 million, respectively. As of December 31, 2012, estimated amortization expense for the next five years and thereafter was as follows:

 
  (in thousands of
dollars)
 

2013

  $ 1,731  

2014

    1,731  

2015

    1,701  

2016

    1,659  

2017

    1,658  

Thereafter

    1,151  
       

  $ 9,631  
       

NOTE 7: INVESTMENTS

        During the year ended December 31, 2010, the Company purchased 150,000 shares of the common stock of Meta Financial Group ("MFG"), the holding Company of MetaBank, one of the Company's Issuing Banks, for $3.2 million. During the year ended December 31, 2012, the Company purchased 50,000 shares of the common stock of MFG for $1.1 million. The investments in MFG are available-for-sale securities and are included in the Consolidated Balance Sheets as a long-term investment.

        As of December 31, 2012, the Company's investment in MFG is stated at fair value using its quoted price on the NASDAQ stock market. As of December 31, 2012, the fair value of the Company's investment in MFG was $4.6 million.

NOTE 8: ACCRUED EXPENSES

        Accrued expenses as of December 31, 2012 and 2011 consisted of the following:

 
  December 31,  
 
  2012   2011  
 
  (in thousands of
dollars)

 

Commissions payable to distributors

  $ 7,469   $ 5,057  

Accrued wages and related personnel expenses

    6,016     5,035  

Other accrued expenses

    12,877     10,845  
           

  $ 26,362   $ 20,937  
           

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 9: DEBT

        The Company's outstanding borrowings as of December 31, 2012 and 2011 consisted of the following:

 
  December 31,  
 
  2012   2011  
 
  (in thousands of
dollars)

 

Revolving credit facility

  $ 80,000   $ 58,500  
           

Total long-term debt

    80,000     58,500  

Less:

             

Long-term debt, current portion

    10,000      
           

Long-term debt, net of current portion

  $ 70,000   $ 58,500  
           

        In connection with its acquisition of Skylight in 2008, the Company entered into a credit facility with a syndicate of banks with JP Morgan as administrative agent (the "prior credit facility"). Loans under the prior credit facility bore interest at the greater of 6.0% per annum or at a market rate based on either the alternate base rate or LIBOR, plus a spread. The Company repaid all amounts owed under the prior credit facility in September 2010.

        In September 2010, the Company entered into a new credit facility with a syndicate of banks with Sun Trust Bank as administrative agent. This facility provides a $135.0 million revolving credit facility with an accordion feature that allows the Company to request increases to the facility of up to $50.0 million. The initial borrowings of $58.5 million under this facility were used to repay the $56.3 million of outstanding indebtedness under the Company's prior credit facility, $0.7 million of accrued interest on such indebtedness and $1.5 million of debt issuance costs associated with the current credit facility. In 2010, the Company recorded a $0.7 million loss related to the write-off of remaining capitalized debt issuance costs associated with its prior credit facility.

        Amounts borrowed under the current credit facility may be used for working capital, capital expenditures, acquisitions and other general corporate purposes. This facility has a maturity date of September 2015 and provides for a $5.0 million swingline facility and commitments for up to $15.0 million in letters of credit. At the Company's option, the Company may prepay any borrowings in whole or in part, without any prepayment penalty or premium.

        The outstanding borrowings under the current credit facility bear interest, at the Company's election, as either base rate or Eurodollar loans. Base rate loans bear annual interest at the base rate (the greater of the federal funds rate plus 0.50%, the prime rate or one-month LIBOR plus 1.00%) plus a spread of 1.50% to 2.25%, depending on the Company's leverage ratio. Eurodollar loans bear interest at the adjusted LIBOR for the interest period in effect for such borrowings plus a spread of 2.50% to 3.25%, depending on the Company's leverage ratio. During the year ended December 31, 2012, the weighted average interest rate applicable to the outstanding borrowings on this credit facility was 3.2%. The Company's interest rate on Eurodollar loans, which comprised all of the Company's outstanding borrowings as of December 31, 2012, was 2.7% as of that date.

        The current credit facility contains certain financial and non-financial covenants and requirements, including a leverage ratio, fixed charge ratio and certain restrictions on the Company's ability to make

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 9: DEBT (Continued)

investments, pay dividends or sell assets. It also provides for customary events of default, including failure to pay any principal or interest when due, failure to comply with the covenants set forth in the credit agreement and certain changes in control. The Company was in compliance with these covenants as of December 31, 2012.

        Under the current credit facility, letters of credit may be issued for a period of up to one year (subject to any automatic renewal provisions), although all such letters of credit must expire at least ten business days prior to the current credit facility's maturity date. The Company pays a participation fee with respect to each issued letter of credit. This fee accrues at the rate of 2.5% per annum on the average daily amount of the letters of credit outstanding. The Company also pays a fronting fee of 0.25% per annum on the average daily amount of outstanding letter of credit exposure from the issue date to the date on which there ceases to be any letter of credit exposure, as well as the issuing bank's standard fees. Participation fees and fronting fees are payable in arrears on the last day of each calendar quarter. During the years ended December 31, 2012 and 2011, the Company paid $0.2 million and less than $0.1 million, respectively, in participation or fronting fees. The Company did not pay any participation or fronting fees during the year ended December 31, 2010.

        The terms of the current credit facility require the Company to pay a commitment fee based on its average daily unused amount. This fee accrues at a rate of 0.45% to 0.50% per annum, depending on the Company's leverage ratio and is payable in arrears on the last day of each calendar quarter. During each of the years ended December 31, 2012 and 2011, the Company paid $0.3 million in commitment fees. During the year ended December 31, 2010, the Company paid $0.1 million in commitment fees.

        As of December 31, 2012, the aggregate amount outstanding under the Company's revolving credit facility was $80.0 million and the Company had $6.9 million in letters of credit outstanding. As of December 31, 2012, the Company had $8.1 million of unused letters of credit.

        The following table presents the availability under the $135.0 million revolving credit facility as of December 31, 2012:

 
  (in thousands of
dollars)
 

Total available revolving credit facility

  $ 135,000  

Less: outstanding revolving credit loans

    (80,000 )

Less: outstanding swingline loans

     

Less: outstanding letters of credit

    (6,900 )
       

Remaining availability under the revolving credit facility

  $ 48,100  
       

        During 2009, the Company entered into a capital lease arrangement with a software provider for perpetual database licenses. The capital lease arrangement resulted in the recording of $3.4 million in capitalized computer software. During 2011, the Company modified the capital lease arrangement, extending it for one year and purchasing $1.9 million of additional computer software. During the years ended December 31, 2011 and 2010, the Company made payments of $3.3 million and $1.4 million, respectively, towards the capital lease, which included interest payments at an effective interest rate of 6.0%. The capital lease was paid in full in 2011.

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 10: FAIR VALUE OF ASSETS AND LIABILITIES

        U.S. GAAP defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between arms-length market participants at the measurement date. When determining the fair value of its assets and liabilities, the Company considers the principal or most advantageous market in which it would transact and considers assumptions market participants would use, such as inherent risk, transfer restrictions and risk of nonperformance.

        The Company's financial instruments include cash, cash equivalents, accounts receivable, long-term investments, investment in company-owned life insurance, accounts payable, obligations under its deferred compensation plan and borrowings under its revolving credit facility. As of December 31, 2012 and 2011, the fair values of the Company's cash, cash equivalents, accounts receivable and accounts payable approximated the carrying values of these instruments presented in the Company's Consolidated Balance Sheets because of their short-term nature.

        The following table is a summary of the Company's assets and liabilities measured at fair value on a recurring basis:

 
  Fair Value Measurement as of December 31 Using  
 
  Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
  Significant Other
Observable
Inputs
(Level 2)
  Significant
Unobservable
Inputs
(Level 3)
 
 
  2012   2011   2012   2011   2012   2011  

Assets

                                     

Long-term investment

                                     

Equity security

    4,560     2,497                  

Other assets

                                     

Investment in company-owned life insurance

            2,091     1,411          

Debt

                                     

Borrowings under revolving credit facility          

            80,000     58,500          

Other liabilities

                                     

Deferred compensation

            2,059     1,449          

        Fair value is estimated by applying a hierarchy that prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:

            Level 1—Quoted prices in active markets for identical assets or liabilities;

            Level 2—Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and

            Level 3—Inputs that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or liability.

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 10: FAIR VALUE OF ASSETS AND LIABILITIES (Continued)

        The Company had no significant transfers between Level 1, Level 2 or Level 3 assets during the years ended December 31, 2012 or 2011.

        As of December 31, 2012 and 2011, the Company's long-term investments in MFG (see "Note 7") were recorded at their fair value based on a quoted price in an active market (Level 1).

        The Company's obligations under its deferred compensation plan represent amounts deferred by participants under this plan. Amounts deferred by a participant are credited with earnings and investment gains and losses by assuming that the deferral was invested in one or more investment options selected by the participant from a family of money market funds and mutual funds chosen by the Company. These funds were recorded at their fair value as of December 31, 2012 and 2011 based on quoted prices in non-active markets and observable inputs other than quoted prices (Level 2).

        The Company's investment in company-owned life insurance consists of life insurance policies on some of the participants in its deferred compensation plan and related investments in money market funds and mutual funds that were recorded at their fair value as of December 31, 2012 and 2011 based on quoted prices in non-active markets and observable inputs other than quoted prices (Level 2). Under the Company's deferred compensation program, the cash surrender value of the company-owned life insurance policies is invested in instruments and in amounts that mirror the investment elections made by participants in the Company's deferred compensation plan.

        As of December 31, 2012 and 2011, the fair value of the Company's borrowings under its revolving credit agreement were categorized as a Level 2 hierarchy and approximated their carrying value based on prevailing market rates for borrowings with similar ratings and maturities.

        The following table presents the amortized cost, gross unrealized gains and losses and fair value for the Company's investment in MFG:

 
  December 31, 2012   December 31, 2011  
 
   
  Gross
Unrealized
   
   
  Gross
Unrealized
   
 
 
  Amortized
Cost
   
  Amortized
Cost
   
 
 
  Gains   Losses   Fair Value   Gains   Losses   Fair Value  
 
  (in thousands of dollars)
 

December 31:

                                                 

Available-for-sale security

                                                 

Equity security

    4,305     255         4,560     3,209         (712 )   2,497  

NOTE 11: STOCKHOLDERS' EQUITY

Common and Preferred Stock

        Prior to its IPO in 2010, the Company's certificate of incorporation authorized the Company to issue 150,000,000 shares of class A common stock, par value $0.001 per share, 15,000,000 shares of class B common stock, par value $0.001 per share and 10,000,000 shares of undesignated preferred stock, par value $0.001 per share. Each share of class B common stock was convertible into one share of class A common stock as set forth in the Company's certificate of incorporation.

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 11: STOCKHOLDERS' EQUITY (Continued)

        On October 22, 2010, the Company completed an offering (the "IPO") through which 18,536,043 shares of common stock were sold to the public at an offering price of $11.00 per share. 2,272,727 of these shares were sold by the Company and 16,263,316 shares were sold by existing stockholders. The Company generated net proceeds of approximately $20.9 million after deducting underwriting discounts and commissions and $2.4 million in total expenses incurred in connection with the offering. Effective upon the completion of the IPO, certain selling stockholders exercised warrants to purchase 696,270 shares of class A common stock at a weighted-average exercise price of $1.69 per share. 102,065 of these shares were retained as payment of the warrant exercise price and the remaining 594,205 shares were sold in the offering. In addition, certain employees exercised options to purchase 890,594 shares of the Company's common stock, at a weighted average exercise price of $2.96 per share, and sold the 651,085 net shares received thereby in connection with the closing of the IPO.

        Upon the completion of the IPO in 2010, the Company's certificate of incorporation was amended and restated to: reflect the reclassification of the Company's class A common stock into common stock; increase the total number of authorized shares of common stock from 150,000,000 to 225,000,000; and provide that all shares of the Company's class B common stock would automatically convert into shares of common stock on a one-for-one basis upon the occurrence of certain events. Immediately following completion of the Company's IPO in October 2010, Skylight Holdings I, LLC transferred all of the shares of the Company's class B common stock held by it to its members. As a result of the transfer, Skylight Holdings I, LLC, JLL Partners Fund IV, L.P. ("JLL Fund IV"), JLL Partners Fund V, L.P. (collectively with JLL Fund IV, the "JLL Funds") and their affiliates ceased to own or control 25% or more of the Company's voting securities and, pursuant to the terms of the Company's amended and restated certificate of incorporation, all of the shares of the Company's class B common stock held by them, which constituted all of the outstanding share of class B common stock, automatically converted into shares of common stock on a one-for-one basis.

        In 2011 the Company created a new series of preferred stock consisting of 1,500,000 shares, par value of $0.001 per share, pursuant to the Company's articles of incorporation which authorizes the Company to issue up to 10,000,000 shares of $0.001 par value preferred stock. The new series of preferred stock is designated as Series A Convertible Preferred Stock (the "Series A Stock").

        Holders of the Series A Stock have no voting rights, other than as may be required by applicable law and no holder of Series A Stock has a preemptive or preferential right to acquire or subscribe for any shares of securities of any class. The Series A Stock is not redeemable or assessable or entitled to the benefits of any sinking fund. Shares of Series A Stock may be converted at the option of the holder, at any time, into shares of the Company's common stock at the rate of ten shares of common stock for each share of Series A Stock; provided, however, that no holder of shares of Series A Stock may convert any of their shares into common stock if (i) upon completing such conversion the holder, together with its affiliates, would own or control shares of common stock representing 24.9% or more of the outstanding voting securities of the Company or (ii) such conversion would require prior approval or notice under any state law then applicable to the Company or its subsidiaries.

        In the event any dividends are declared or paid on the Company's common stock, holders of Series A Stock would be entitled to receive dividends in an amount equal to the amount of the dividends that the holder would have received had their Series A Stock been converted into common stock as of the date immediately prior to the record date for such dividend.

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 11: STOCKHOLDERS' EQUITY (Continued)

        In the event of liquidation, dissolution or winding up of the Company, any assets and funds legally available for distribution would be distributed ratably among the holders of the common stock and Series A Stock in proportion to the number of shares of such stock owned by each such holder. In the case of holders of Series A Stock, any such distribution would be based on the number of shares of common stock that they would have received had their Series A Stock been converted into common stock immediately prior to such distribution.

        During 2011, the JLL Funds exchanged 7,000,000 shares of common stock held by them for an aggregate of 700,000 shares of Series A Stock in a transaction exempt from the registrations requirements of the Securities Act of 1933, as amended, pursuant to Section 3(a)(9) thereof. The JLL Funds beneficially owned more than five percent of the Company's outstanding common stock as of December 31, 2012. No commissions or other remuneration was or will be paid or given, directly or indirectly, to the JLL Funds or any other person in connection with the exchange. The shares of Series A Stock issued to the JLL Funds will be automatically re-converted into shares of common stock (at the rate of ten shares of common stock for each share of Series A Stock) if they are sold or otherwise transferred to a person who (i) upon completing such transfer the holder, together with its affiliates, would own or control shares of common stock representing 24.9% or more of the outstanding voting securities of the Company or (ii) such transfer would require prior approval or notice under any state law then applicable to the Company or its subsidiaries.

Treasury Stock Transactions

        Treasury stock is accounted for under the cost method and is included as a component of stockholders' equity.

        In 2010, the Company repurchased 1,500,000 shares of its common stock for $5.7 million.

        In 2011, the Company's board of directors approved two $25 million share repurchase programs, the first of which was completed in September 2011. The Company repurchased 3,276,093 shares of common stock for $25.1 million pursuant to the first share repurchase program. The Company repurchased 1,043,751 shares of common stock for $7.7 million pursuant to the second share repurchase program during 2011.

        In February 2012, the Company completed the second $25 million share repurchase program that was authorized in 2011. In 2012, the Company repurchased 2,050,959 shares of common stock for $17.4 million pursuant to this program. In June 2012, the Company's board of directors approved an additional $75 million share repurchase program that was completed in August 2012. The Company repurchased 8,216,059 shares of common stock for $75.2 million pursuant to this program.

Dividend Equivalents

        Certain of the stock options issued to the Company's Chief Executive Officer (the "CEO") prior to the Company's IPO in October 2010 contain rights to dividend equivalents. The dividend equivalents relate to dividends paid by the Company in 2008 and were paid when the underlying options vested. During the years ended December 31, 2011 and 2010, the Company paid $0.4 million and $0.2 million, respectively, in cash dividend equivalents. The Company did not pay any cash dividend equivalents during the year ended December 31, 2012.

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 12: SHARE BASED PAYMENT

Stock Incentive Plans

        In October 2010, the Company adopted a new equity incentive plan, the Amended and Restated NetSpend Holdings, Inc. 2004 Equity Incentive Plan (the "2004 Plan"), which amended and replaced the Company's prior option plan. As of December 31, 2012, the Company had reserved 27,436,995 shares of its common stock for issuance under the 2004 Plan. The number of shares reserved for issuance under the 2004 Plan will increase annually by a number of shares equal to the lesser of (1) 3% of the total outstanding shares of the Company's capital stock as of immediately prior to the increase, (2) 3,000,000 or (3) such lesser amount as is determined by the Company's board of directors. Options granted under the 2004 Plan generally expire ten years from the effective date of grant.

        The 2004 Plan provides for the grant of stock options and other stock-based awards to key employees, directors and consultants, including executive officers. Under the 2004 Plan, the Company is authorized to issue standard, event-based and performance-based options, restricted stock awards and other awards.

        In April 2012, the stockholders of the Company approved the NetSpend Holdings, Inc. 2012 Employee Stock Purchase Plan (the "ESPP"). Subject to certain limitations, the ESPP enables eligible employees to utilize after-tax payroll deductions to purchase shares of Company's common stock at the lesser of 85% of its fair market value on the first or last business day of each quarterly purchase period (six months with respect to the first purchase period in 2012). A total of 2,000,000 of the Company's treasury shares have been reserved for issuance under the ESPP.

Stock Options

        Standard options issued to employees generally vest and become exercisable in four equal installments on the four succeeding anniversaries of the applicable grant date. Standard options issued to members of the board of directors generally vest and become exercisable in three equal installments on the three succeeding anniversaries of the applicable grant date. In each case, vesting of the options is subject to the holder of the option continuing to provide services to the Company during the applicable vesting period. The Company expenses the grant-date fair value of standard options, net of estimated forfeitures, over the vesting period on a straight-line basis. During the years ended December 31, 2012, 2011 and 2010, the Company issued 1.6 million, 1.7 million and 2.4 million standard options, respectively.

        Event-based options vest upon the earlier of (1) a change in control of the Company or (2) the second anniversary of the closing of an IPO. During the year ended December 31, 2010, the Company issued 0.9 million event-based options to employees. The Company did not issue any event-based options during the years ended December 31, 2012 or 2011.

        Performance-based options carry service, market and performance conditions different from the Company's other stock option agreements. The terms of the performance-based options specify that the options vest at the earlier of: (1) the Company's achievement of a performance condition and the option holder's continued employment with the Company over a four-year period, or (2) the option holder's continued employment with the Company over a six-year period. The Company did not issue any performance-based options during the years ended December 31, 2012, 2011 or 2010.

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NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 12: SHARE BASED PAYMENT (Continued)

        During the year ended December 31, 2010, the board of directors modified the performance condition of certain performance-based options. Prior to the modification, the performance condition for employee option holders was the Company's achievement of a pre-determined equity value hurdle in connection with an IPO or a change of control. The performance condition for all performance-based employee options, with the exception of those held by the Company's CEO, was modified to be the earlier of (1) the Company's achievement of a pre-determined equity value hurdle in or subsequent to an IPO, (2) a change in control prior to December 31, 2011 or (3) the Company's achievement of a pre-determined earnings target. During the year ended December 31, 2010, the Company recorded additional compensation expense of approximately $0.2 million related to this modification. In 2012, the performance targets associated with these options were met, and in the first quarter of 2013, the Compensation Committee of the Company's Board of Directors certified the performance achievement. As a result, approximately 1.0 million options will vest in the first quarter of 2013.

        Also in 2010, the board of directors modified the terms of certain options held by a former member of the Company's board of directors to allow them to continue vesting subsequent to the termination of the holder's board membership. The modification was approved by the board of directors in exchange for consulting services. The services were deemed non-substantive and additional compensation expense of approximately $0.2 million was recognized during the year ended December 31, 2010. In addition, restricted stock awards held by former executives and employees of the Company were accelerated in accordance with their employment agreements. The Company recorded additional compensation expense of $0.5 million related to this acceleration.

        The fair value of the stock options issued under the 2004 Plan during the years ended December 31, 2012, 2011 and 2010 was $7.3 million, $12.0 million and $10.7 million, respectively. The total fair value of options vested under the 2004 Plan during the years ended December 31, 2012, 2011 and 2010 was $7.2 million, $3.0 million and $4.6 million, respectively.

        The following table presents a summary of stock option activity for the year ended December 31, 2012:

 
  Shares   Weighted
Average
Exercise
Price per
Share
  Weighted
Average
Remaining
Contractual
Term
  Aggregate
Intrinsic Value
 

Outstanding December 31, 2011

    11,397,710   $ 5.31   6.9 years   $ 42,674,370  

Granted

    1,573,790     8.86            

Exercised

    (1,650,129 )   3.23            

Expired

    (244,730 )   4.63            

Forfeited

    (131,406 )   5.30            
                   

Outstanding December 31, 2012

    10,945,235   $ 6.01   6.7 years   $ 67,330,588  
                   

Vested and expected to vest at December 31, 2012

    10,291,403   $ 5.99   6.6 years   $ 63,542,785  

Exercisable at December 31, 2012

   
4,640,428
 
$

4.83
 
6.1 years
 
$

33,436,736
 

88


Table of Contents


NetSpend Holdings, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2012, 2011 and 2010

NOTE 12: SHARE BASED PAYMENT (Continued)

        The aggregate intrinsic value in the table above represents the total pre-tax value of the options shown. This amount is equal to the difference between the Company's closing stock price on December 31, 2012 ($11.82 per share) and the exercise prices of the options shown, multiplied by the number of in-the-money options. This is the aggregate amount that would have been received by the option holders if they had all exercised their options on December 31, 2012 and sold the shares received thereby at the closing price of the Company's stock on that date. This amount changes based on the fair value of the Company's stock. The intrinsic value of options exercised during 2012, 2011 and 2010 was $10.6 million, $3.7 million and $9.2 million, respectively.

        Options with the following characteristics were outstanding as of December 31, 2012:

 
  Options Outstanding   Options Exercisable  
Exercise Prices
  Number of
Shares
  Weighted
Average
Remaining
Contractual
Life (Years)
  Weighted
Average
Exercise Price
  Number
Exercisable
  Weighted
Average
Exercise Price
 
$0.25 - $3.47     1,270,558     5.5   $ 3.38     583,858   $ 3.28  
3.53     4,610,618     5.3