Quarterly Report



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

FORM 10-Q

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

For the quarterly period ended   June 30, 2014
 
Commission file number 000-26621
 
LOGO
 
NIC INC.
(Exact name of registrant as specified in its charter)
 
Delaware
52-2077581
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
25501 West Valley Parkway, Suite 300, Olathe, Kansas 66061
(Address of principal executive offices, including Zip Code)

Registrant's telephone number, including area code:   (877) 234-3468


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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x   No o
   
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

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

As of July 23, 2014, the number of shares outstanding of the registrant’s common stock, $0.0001 par value per share, was 65,262,048.

 
 

 
 
PART I - FINANCIAL INFORMATION
ITEM 1.  CONSOLIDATED FINANCIAL STATEMENTS
 
NIC INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
thousands except par value amount
 
   
June 30, 2014
 
December 31, 2013
ASSETS
 
Current assets:
           
Cash
  $ 95,658     $ 74,245  
Cash restricted for payment of dividend
    -       22,982  
Trade accounts receivable, net
    61,211       52,818  
Deferred income taxes, net
    1,028       1,038  
Prepaid expenses & other current assets
    10,558       11,569  
Total current assets
    168,455       162,652  
Property and equipment, net
    13,674       15,167  
Intangible assets, net
    2,062       1,864  
Other assets
    332       290  
Total assets
    184,523     $ 179,973  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
Current liabilities:
               
Accounts payable
  $ 45,817     $ 39,112  
Accrued expenses
    18,384       20,822  
Dividend payable
    -       22,982  
Other current liabilities
    450       348  
Total current liabilities
    64,651       83,264  
                 
Deferred income taxes, net
    2,287       2,432  
Other long-term liabilities
    2,754       2,341  
Total liabilities
    69,692       88,037  
                 
Commitments and contingencies (Notes 1 and 2)
    -       -  
                 
Stockholders' equity:
               
Common stock, $0.0001 par, 200,000 shares authorized,
               
65,260 and 64,993 shares issued and outstanding
    6       6  
Additional paid-in capital
    90,887       88,397  
Retained earnings
    23,938       3,533  
Total stockholders' equity
    114,831       91,936  
Total liabilities and stockholders' equity
  $ 184,523     $ 179,973  
                 
The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.
 
 
2

 
 
NIC INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
thousands except per share amounts
 
     
Three months ended
 
Six months ended
     
June 30,
 
June 30,
Revenues:
   
2014
 
2013
 
2014
 
2013
     Portal revenues
  $ 66,809     $ 62,094     $ 128,291     $ 120,136  
     Software & services revenues
    4,346       3,844       8,261       7,026  
 
Total revenues
    71,155       65,938       136,552       127,162  
Operating expenses:
                               
     Cost of portal revenues, exclusive of depreciation & amortization
    38,533       34,899       74,930       67,661  
     Cost of software & services revenues, exclusive of depreciation & amortization
    1,214       1,189       2,174       2,292  
     Selling & administrative
    10,864       10,058       21,165       19,667  
     Depreciation & amortization
    2,277       2,049       4,527       4,076  
 
Total operating expenses
    52,888       48,195       102,796       93,696  
Operating income
    18,267       17,743       33,756       33,466  
Other expense, net
    (24 )     (2 )     (128 )     (21 )
Income before income taxes
    18,243       17,741       33,628       33,445  
Income tax provision
    7,213       6,933       13,223       12,681  
Net income
  $ 11,030     $ 10,808     $ 20,405     $ 20,764  
                                   
Basic net income per share (Note 1)
  $ 0.17     $ 0.16     $ 0.31     $ 0.32  
Diluted net income per share (Note 1)
  $ 0.17     $ 0.16     $ 0.31     $ 0.32  
                                   
Weighted average shares outstanding:
                               
     Basic
    65,245       64,890       65,151       64,800  
     Diluted
    65,245       64,890       65,151       64,800  
                                   
The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.
 
 
3

 
 
NIC INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
thousands
 
                    Additional                
    Common Stock   Paid-in                
    Shares   Amount   Capital   Retained Earnings    
Total   
Balance, January 1, 2014
    64,993     $ 6     $ 88,397     $ 3,533     $ 91,936  
Net income
    -       -       -       20,405       20,405  
Restricted stock vestings
    294       -       73       -       73  
Dividend equivalents cancelled upon forfeiture of
                               
    performance-based restricted stock awards
    -       -       35       -       35  
Shares surrendered and cancelled upon vesting of
                         
    restricted stock to satisfy tax withholdings
    (95 )     -       (1,928 )     -       (1,928 )
Stock-based compensation
    -       -       2,414       -       2,414  
Tax deductions relating to stock-based compensation
    -       -       897       -       897  
Shares issuable in lieu of dividend payments on unvested
                       
     performance-based restricted stock awards
    -       -       (108 )     -       (108 )
Issuance of common stock under employee stock purchase plan
    68       -       1,107       -       1,107  
Balance, June 30, 2014
    65,260     $ 6     $ 90,887     $ 23,938     $ 114,831  
                                         
The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.
 
 
4

 
 
NIC INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
thousands
 
   
Six months ended
   
June 30,
   
2014
 
2013
Cash flows from operating activities:
           
Net income
  $ 20,405     $ 20,764  
Adjustments to reconcile net income to net cash provided by operating activities:
         
Depreciation & amortization
    4,527       4,076  
Stock-based compensation expense
    2,414       2,077  
Deferred income taxes
    (1,494 )     (820 )
Loss on disposal of property and equipment
    128       21  
Changes in operating assets and liabilities:
               
(Increase) in trade accounts receivable, net
    (8,393 )     (14,349 )
Decrease in prepaid expenses & other current assets
    2,370       3,133  
(Increase) in other assets
    (42 )     (2 )
Increase in accounts payable
    6,705       4,556  
(Decrease) in accrued expenses
    (4,416 )     (1,672 )
Increase in other current liabilities
    102       1,180  
Increase in other long-term liabilities
    413       714  
Net cash provided by operating activities
    22,719       19,678  
                 
Cash flows from investing activities:
               
Purchases of property and equipment
    (2,653 )     (2,258 )
Capitalized internal use software development costs
    (657 )     (730 )
Net cash used in investing activities
    (3,310 )     (2,988 )
                 
Cash flows from financing activities:
               
Proceeds from employee common stock purchases
    1,107       904  
Tax deductions related to stock-based compensation
    897       736  
Net cash provided by financing activities
    2,004       1,640  
                 
Net increase in cash
    21,413       18,330  
Cash, beginning of period
    74,245       62,358  
Cash, end of period
  $ 95,658     $ 80,688  
                 
Other cash flow information:
               
Non-cash investing activities:
               
Capital expenditures accrued but not yet paid
  $ 50     $ 86  
Cash payments:
               
Income taxes paid
  $ 13,837     $ 6,194  
Cash dividends on common stock previously restricted for payment of dividend
  $ 22,982     $ -  
                 
The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.
 
 
5

 
 
NIC INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
The Unaudited Consolidated Financial Statements of NIC Inc. and its subsidiaries (“NIC” or the “Company”) included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In management’s opinion, the Unaudited Consolidated Financial Statements reflect all adjustments (which include only normal recurring adjustments, except as disclosed) necessary to present fairly the consolidated financial position, results of operations and cash flows of the Company and its subsidiaries as of the dates and for the interim periods presented. These Unaudited Consolidated Financial Statements and Notes should be read in conjunction with the Audited Consolidated Financial Statements and related Notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on February 27, 2014, and Part I, Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Form 10-Q. The consolidated balance sheet data included herein as of December 31, 2013 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.
 
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the Unaudited Consolidated Financial Statements and accompanying Notes. Actual results could differ from those estimates. The results of operations for the three- and six-month periods ended June 30, 2014 are not necessarily indicative of the results to be expected for the full year ending December 31, 2014.

1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Company

NIC is a leading provider of eGovernment services that helps governments use the Internet to reduce internal costs, increase efficiencies and provide a higher level of service to businesses and citizens. The Company accomplishes this currently through two channels: its primary outsourced portal businesses and its software & services businesses.
 
In its primary outsourced portal businesses, the Company generally designs, builds, and operates Internet-based portals on an enterprise-wide basis on behalf of state and local governments desiring to provide access to government information and to complete secure government-based transactions through multiple online channels, including mobile devices. These portals consist of websites and applications the Company has built that allow businesses and citizens to access government information online and complete transactions, such as applying for a permit, retrieving government records, or filing a government-mandated form or report. Operating under multiple-year contracts (see Note 2), NIC markets the services and solicits users to complete government-based transactions and to enter into subscriber contracts permitting users to access the portal and the government information contained therein in exchange for transactional and/or subscription user fees. The Company typically manages operations for each contractual relationship through separate local subsidiaries that operate as decentralized businesses with a high degree of autonomy. NIC’s self-funded business model allows the Company to generate revenues by sharing in the fees the Company collects from eGovernment transactions. The Company’s government partners benefit through reducing their financial and technology risks, increasing their operational efficiencies, and gaining a centralized, customer-focused presence on the Internet, while businesses and citizens receive a faster, more convenient, and more cost-effective means to interact with governments. The Company is typically responsible for funding up-front investment and ongoing operations and maintenance costs of the outsourced government portals.
 
The Company’s software & services businesses primarily include its subsidiaries that provide software development and services, other than enterprise-wide outsourced portal services, to state and local governments as well as federal agencies (see Note 2).

Basis of presentation

The Company classifies its revenues and cost of revenues into two categories: (1) portal and (2) software & services. The portal category generally includes revenues and cost of revenues from the Company’s subsidiaries operating enterprise-wide outsourced portals on behalf of state and local governments. The software & services category primarily includes revenues and cost of revenues from the Company’s subsidiaries that provide software development and services, other than enterprise-wide outsourced portal services, to state and local governments as well as federal agencies. The primary categories of operating expenses include: cost of portal revenues, cost of software & services revenues, selling & administrative and depreciation & amortization. Cost of portal revenues consists of all direct costs associated with operating government portals on an outsourced basis including employee compensation (including stock-based compensation), subcontractor labor costs, telecommunications, fees required to process credit/debit card and automated clearinghouse transactions, and all other costs associated with the provision of dedicated client service such as dedicated facilities. Cost of software & services revenues consists of all direct project costs to provide software development and services such as employee compensation (including stock-based compensation), subcontractor labor costs, and all other direct project costs including hardware, software, materials, travel and other out-of-pocket expenses. Selling & administrative expenses consist primarily of corporate-level expenses relating to human resource management, administration, information technology, security, legal, finance and accounting, internal audit and all costs of non-customer service personnel from the Company’s software & services businesses, including information systems and office rent. Selling & administrative expenses also consist of stock-based compensation and corporate-level expenses for market development and public relations. For the three- and six-month periods ended June 30, 2013, selling & administrative expenses also include legal fees and other third-party costs, net of directors’ and officers’ liability insurance received, incurred in connection with the previously disclosed SEC matter, which was successfully concluded in December 2013 (see Item 3, Legal Proceedings, and Note 7 in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on February 27, 2014). 
 
 
6

 
 
Earnings per share

Unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are considered participating securities and are included in the computation of earnings per share pursuant to the two-class method for all periods presented. The two-class method is an earnings allocation formula that treats a participating security as having rights to undistributed earnings that would otherwise have been available to common stockholders. The Company’s service-based restricted stock awards contain non-forfeitable rights to dividends and are considered participating securities. Accordingly, service-based restricted stock awards were included in the calculation of earnings per share using the two-class method for all periods presented. Unvested service-based restricted shares totaled approximately 0.7 million and 0.8 million at June 30, 2014 and 2013, respectively. Basic earnings per share is calculated by first allocating earnings between common stockholders and participating securities. Earnings attributable to common stockholders are divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated by giving effect to dilutive potential common shares outstanding during the period. The dilutive effect of shares related to the Company’s employee stock purchase plan is determined based on the treasury stock method. The dilutive effect of service-based restricted stock awards is based on the more dilutive of the treasury stock method or the two-class method assuming a reallocation of undistributed earnings to common stockholders after considering the dilutive effect of potential common shares other than the participating unvested restricted stock awards. The dilutive effect of performance-based restricted stock awards is based on the treasury stock method.

The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):
 
   
Three months ended
 
Six months ended
   
June 30,
 
June 30,
   
2014
 
2013
 
2014
 
2013
Numerator:
                       
Net income
  $ 11,030     $ 10,808     $ 20,405     $ 20,764  
Less: Income allocated to participating securities
    (109 )     (118 )     (203 )     (230 )
Net income available to common stockholders
  $ 10,921     $ 10,690     $ 20,202     $ 20,534  
Denominator:
                               
Weighted average shares - basic
    65,245       64,890       65,151       64,800  
Performance-based restricted stock awards
    -       -       -       -  
Weighted average shares - diluted
    65,245       64,890       65,151       64,800  
                                 
Basic net income per share:
                               
Net income
  $ 0.17     $ 0.16     $ 0.31     $ 0.32  
                                 
Diluted net income per share:
                               
Net income
  $ 0.17     $ 0.16     $ 0.31     $ 0.32  

Concentration of credit risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and accounts receivable. The Company limits its exposure to credit loss by depositing its cash with high credit quality financial institutions. The Federal Deposit Insurance Corporation (“FDIC”) provides deposit insurance coverage up to $250,000 per depositor for deposit accounts at each FDIC-insured depository institution. At June 30, 2014, the amount of cash covered by FDIC deposit insurance was approximately $10.7 million, and approximately $85.0 million of cash was above the FDIC deposit insurance limit. The Company performs ongoing credit evaluations of its customers and generally requires no collateral to secure accounts receivable.
 
 
7

 
 
Recent accounting pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued new authoritative literature, Revenue from Contracts with Customers , as part of a joint effort by FASB and the International Accounting Standards Board to enhance financial reporting by creating common revenue recognition guidance and thereby improve the consistency of requirements, comparability of practices and usefulness of disclosures. The new standard will supersede much of the existing authoritative literature for revenue recognition. The standard and related amendments will be effective for the Company for its annual reporting period beginning January 1, 2017, including interim periods within that reporting period. Early application is not permitted. Entities are allowed to transition to the new standard by either recasting prior periods presented or recognizing the cumulative effect of the change in accounting principle in beginning stockholders’ equity. The Company is currently evaluating the newly issued guidance, including which transition approach will be applied and the estimated impact it will have on the Company’s consolidated financial statements.

2. OUTSOURCED GOVERNMENT CONTRACTS

Outsourced Portal Contracts

The Company’s outsourced government portal contracts generally have an initial multi-year term with provisions for renewals for various periods at the option of the government. The Company’s primary business obligation under these contracts is generally to design, build, and operate Internet-based portals on an enterprise-wide basis on behalf of governments desiring to provide access to government information and to complete government-based transactions online. NIC typically markets the services and solicits users to complete government-based transactions and to enter into subscriber contracts permitting the user to access the portal and the government information contained therein in exchange for transactional and/or subscription user fees. The Company enters into separate agreements with various agencies and divisions of the government to provide specific services and to conduct specific transactions. These agreements preliminarily establish the pricing of the electronic transactions and data access services the Company provides and the division of revenues between the Company and the government agency. The government oversight authority must approve prices and revenue sharing agreements. The Company has limited control over the level of fees it is permitted to retain. Any changes made to the amount or percentage of fees retained by NIC, or to the amounts charged for the services offered, could materially affect the profitability of the respective contract to NIC.

The Company is typically responsible for funding up-front investment and ongoing operations and maintenance costs of the government portals, and generally owns all of the intellectual property in connection with the applications developed under these contracts. After completion of a defined contract term, the government partner typically receives a perpetual, royalty-free license to use the software only in its own portal. However, certain customer management, billing and payment processing software applications that the Company has developed and standardized centrally and that are utilized by the Company’s portal businesses, are being provided to an increasing number of government partners on a software-as-a-service, or “SaaS,” basis, and thus would not be included in any royalty-free license. If the Company’s contract was not renewed after a defined term or if the contract was terminated by the government partner for cause, the government agency would be entitled to take over the portal in place with no future obligation of the Company, except as otherwise provided in the contract and except for services provided by the Company on a SaaS basis, which would be available to the partners on a fee-for-service basis.

Any renewal of these contracts beyond the initial term by the government is optional and a government may terminate its contract prior to the expiration date if the Company breaches a material contractual obligation and fails to cure such breach within a specified period or upon the occurrence of other events or circumstances specified in the contract. In addition, 17 contracts under which the Company provides outsourced state portal services can be terminated by the other party without cause on a specified period of notice. Collectively, revenues generated from these contracts represented 59% and 58%, respectively, of the Company’s total consolidated revenues for the three- and six-month periods ended June 30, 2014. In the event that any of these contracts is terminated without cause, the terms of the respective contract may require the government to pay a fee to the Company in order to continue to use the Company’s software in its portal. In addition, the loss of one or more of the Company’s larger state portal partners, such as Alabama, Arkansas, Colorado, Indiana, Montana, New Jersey, Pennsylvania, Tennessee, Texas, or Utah, as a result of the expiration, termination or failure to renew the respective contract, if such partner is not replaced, could significantly reduce the Company’s revenues and profitability. See the discussion below under “Expiring Contracts” regarding the expiration of the Company’s contracts with the states of Arizona and Delaware.

At June 30, 2014, the Company was bound by performance bond commitments totaling approximately $6.6 million on certain outsourced portal contracts. Under a typical portal contract, the Company is required to fully indemnify its government clients against claims that the Company’s services infringe upon the intellectual property rights of others and against claims arising from the Company’s performance or the performance of the Company’s subcontractors under the contract. The Company has never had any defaults resulting in draws on performance bonds.
 
 
8

 

The following is a summary of the portals in each state through which the Company provides enterprise-wide outsourced portal services to multiple government agencies:
 
 
NIC Portal Entity
 
Portal Website (State)
Year Services
Commenced
Contract Expiration Date
(Renewal Options Through)
Connecticut Interactive, LLC
www.ct.gov (Connecticut)
2014
1/9/2017 (1/9/2020)
Wisconsin Interactive Network, LLC
www.wisconsin.gov (Wisconsin)
2013
5/13/2018 (5/13/2023)
Pennsylvania Interactive, LLC
www.pa.gov (Pennsylvania)
2012
11/30/2017 (11/30/2022)
NICUSA, OR Division
www.oregon.gov (Oregon)
2011
11/22/2021
NICUSA, MD Division 
www.maryland.gov (Maryland)
2011
8/10/2016 (8/10/2019)
Delaware Interactive, LLC
www.delaware.gov (Delaware)
2011
9/30/2014
Mississippi Interactive, LLC
www.ms.gov (Mississippi)
2011
12/31/2015 (12/31/2021)
New Jersey Interactive, LLC
www.nj.gov (New Jersey)
2009
10/30/2014
Texas NICUSA, LLC
www.Texas.gov (Texas)
2009
8/31/2016 (8/31/2018)
West Virginia Interactive, LLC
www.WV.gov (West Virginia)
2007
6/30/2014 (contract has been temporarily extended to allow the state time to finalize contract terms and conditions)
Vermont Information Consortium, LLC
www.Vermont.gov (Vermont)
2006
6/8/2016 (6/8/2019)
Colorado Interactive, LLC
www.Colorado.gov (Colorado)
2005
4/30/2019 (4/30/2023)
South Carolina Interactive, LLC
www.SC.gov (South Carolina)
2005
7/15/2019 (7/15/2021)
Kentucky Interactive, LLC
www.Kentucky.gov (Kentucky)
2003
8/31/2015
Alabama Interactive, LLC
www.Alabama.gov (Alabama)
2002
2/28/2015 (2/28/2017)
Rhode Island Interactive, LLC
www.RI.gov (Rhode Island)
2001
7/1/2017 (7/1/2019)
Oklahoma Interactive, LLC
www.OK.gov (Oklahoma)
2001
12/31/2014
Montana Interactive, LLC
www.MT.gov (Montana)
2001
12/31/2015 (12/31/2020)
NICUSA, TN Division
www.TN.gov (Tennessee)
2000
9/30/2014 (3/30/2016)
Hawaii Information Consortium, LLC
www.eHawaii.gov (Hawaii)
2000
1/3/2016 (unlimited 3-year renewal options)
Idaho Information Consortium, LLC
www.Idaho.gov (Idaho)
2000
6/30/2015
Utah Interactive, LLC
www.Utah.gov (Utah)
1999
6/5/2016 (6/5/2019)
Maine Information Network, LLC
www.Maine.gov (Maine)
1999
7/1/2016 (7/1/2018)
Arkansas Information Consortium, LLC
www.Arkansas.gov (Arkansas)
1997
6/30/2018
Iowa Interactive, LLC
www.Iowa.gov (Iowa)
1997
6/30/2016 (6/30/2020)
Indiana Interactive, LLC
www.IN.gov (Indiana)
1995
7/31/2016
Nebraska Interactive, LLC
www.Nebraska.gov (Nebraska)
1995
1/31/2016
Kansas Information Consortium, Inc.
www.Kansas.gov (Kansas)
1992
12/31/2021 (annual 1-year renewal options)

During the first quarter of 2014, the Company was awarded a three-year contract by the state of Connecticut to manage its government portal, which includes renewal options for the government to extend the contract up to an additional three years. In addition, the Company was awarded a new five-year contract from the state of Colorado, which includes an option for the government to extend the contract up to an additional four years.

During the second quarter of 2014, the Company was awarded a new three-year contract by the state of Rhode Island, which includes renewal options for the government to extend the contract for two additional one-year periods. In addition, the Company was awarded a new two-year contract by the state of Iowa, which includes renewal options for the government to extend the contract for four additional one-year periods. The Company also received a one-year contract extension from the Commonwealth of Kentucky.

During the third quarter of 2014, the Company was awarded a new seven-year contract by the state of Kansas, which includes annual renewal options for the government to extend the contract for additional one-year periods. In addition, the Company executed a two-year contract extension with the state of Indiana. The Company was also awarded a new five-year contract by the state of South Carolina, which includes renewal options for the government to extend the contract up to an additional two years.
 
Other Outsourced State Contracts
 
The Company’s subsidiary, New Mexico Interactive, LLC, has a contract to manage eGovernment services for the New Mexico Motor Vehicle Division (“MVD”) and its parent, the New Mexico Taxation and Revenue Department. During the third quarter of 2014, the Company was awarded a new two-year contract by the MVD to manage eGovernment services through June 30, 2016. The contract includes a renewal option for the government to extend the contract for two additional one-year periods.
 
 
9

 
 
During the second quarter of 2013, the Company’s subsidiary, Virginia Interactive, LLC (“VI”), signed an agreement with the Virginia Department of Game and Inland Fisheries to provide eGovernment services from September 1, 2013 through February 28, 2015, which includes an option for the agency to extend the contract for one additional six-month period through August 31, 2015. During the third quarter of 2013, VI signed an agreement with the Office of the Executive Secretary of the Supreme Court of Virginia to provide eGovernment services from September 1, 2013 through August 31, 2014, which includes an option for the agency to extend the contract for one additional 12-month period through August 31, 2015.

Outsourced Federal Contracts

The Company’s subsidiary, NIC Technologies, LLC (“NIC Technologies”) has a contract with the Federal Motor Carrier Safety Administration (“FMCSA”) to develop and manage the FMCSA’s Pre-Employment Screening Program (“PSP”) for motor carriers nationwide, using the self-funded, transaction-based business model. During the first quarter of 2014, the FMCSA exercised the fourth of its four one-year renewal options for the PSP contract, extending its term through February 16, 2015. During the third quarter of 2014, the Company received a six-month contract extension from the FMCSA, extending its term through August 16, 2015.

The PSP contract expires August 16, 2015, and the contract can be terminated by the FMCSA without cause prior to expiration on a specified period of notice. The loss of the contract as a result of the expiration, termination or failure to renew the contract, if not replaced, could significantly reduce the Company’s revenues and profitability. In addition, the Company has limited control over the level of fees it is permitted to retain under the contract with the FMCSA. Any changes made to the amount or percentage of fees retained by the Company, or to the amounts charged for the services offered, could materially affect the profitability of this contract.

Expiring Contracts

As of June 30, 2014, there were 12 contracts under which the Company provides outsourced portal services or software development and services that have expiration dates within the 12-month period following June 30, 2014. Collectively, revenues generated from these contracts represented 32% and 31% of the Company’s total consolidated revenues for the three- and six-month periods ended June 30, 2014. As described above, if a contract is not renewed after a defined term, the government partner would be entitled to take over the portal in place with no future obligation of the Company, except as otherwise provided in the contract and except for the services the Company provides on a SaaS basis, which would be available to the government agency on a fee-for-service basis.

During the first quarter of 2013, the Company’s subsidiary, NICUSA, Inc. (“NICUSA”), chose not to respond to a request for proposal issued by the state of Arizona for a new contract. NICUSA provided transition services as required by the contract through March 26, 2014. The costs incurred in transitioning out of NICUSA’s contract with the state of Arizona, including employee retention bonuses, operating lease termination costs, and fixed asset impairment, did not have a material impact on the Company’s consolidated results of operations, cash flows, or financial condition. For the three- and six-months ended June 30, 2014, revenues from the legacy Arizona portal contract were $0 and approximately $0.8 million, respectively. For the three- and six-months ended June 30, 2013, revenues from the legacy Arizona portal contract were approximately $1.1 million and $2.0 million, respectively.

The Company’s subsidiary, Delaware Interactive, LLC (“DI”), has a contract with the state of Delaware to manage the state’s official government portal through September 30, 2014. Currently, the primary revenue source for DI under the contract is an annual portal management fee of approximately $2.2 million paid to DI by the state. During the second quarter of 2014, the state informed DI that due to fiscal constraints, it does not intend to renew its contact with DI when the current contract term expires. The Company does not believe the expiration of its contract with the state of Delaware will have a material impact on the Company’s consolidated results of operations, cash flows or financial condition.

3.  STOCKHOLDERS’ EQUITY

On October 28, 2013, the Company’s Board of Directors declared a special cash dividend of $0.35 per share, payable to stockholders of record as of November 8, 2013. The dividend, totaling approximately $23.0 million, was paid on January 2, 2014 on 64,987,854 outstanding shares of common stock. A dividend equivalent of $0.35 per share was also paid simultaneously on 676,281 unvested shares of service-based restricted stock granted under the Company’s 2006 Amended and Restated Stock Option and Incentive Plan. The dividend was paid out of the Company’s available cash. In addition, holders of performance-based restricted stock granted under the Company’s 2006 Amended and Restated Stock Option and Incentive Plan accrued dividend equivalents for the dividends declared, that could be earned and become payable in the form of shares of common stock at the end of the respective performance period to the extent that the underlying shares of performance-based restricted stock were earned.

 
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4. STOCK BASED COMPENSATION

During the three- and six-month periods ended June 30, 2014, the Board of Directors of the Company granted to certain management-level employees and executive officers, service-based restricted stock awards totaling 7,416 shares and 233,466 shares, respectively, with a grant-date fair value totaling approximately $0.1 million and $4.5 million, respectively. Such restricted stock awards vest beginning one year from the date of grant in cumulative annual installments of 25%. In addition, during the three-month period ended June 30, 2014, non-employee directors of the Company were granted service-based restricted stock awards totaling 39,560 shares with a grant-date fair value totaling approximately $0.7 million. Such restricted stock awards vest one year from the date of grant. Restricted stock is valued at the date of grant, based on the closing market price of the Company’s common stock, and expensed using the straight-line method over the requisite service period (generally the vesting period of the award). The Company excludes compensation cost related to awards not expected to vest based upon estimated forfeitures.

During the first quarter of 2014, the Board of Directors of the Company also granted to certain executive officers performance-based restricted stock awards pursuant to the terms of the Company’s executive compensation program totaling 96,706 shares, with a grant-date fair value of $19.31 per share, totaling approximately $1.9 million, which represents the maximum number of shares able to be earned by the executive officers at the end of a three-year performance period ending December 31, 2016. The actual number of shares earned will be based on the Company’s performance related to the following performance criteria over the performance period:

Operating income growth (three-year compound annual growth rate);
 
Total consolidated revenue growth (three-year compound annual growth rate); and
 
Cash flow return on invested capital (three-year average).
 
At the end of the three-year period, the executive officers are eligible to receive up to a specified number of shares based upon the Company’s performance relative to these performance criteria over the performance period. In addition, the executive officers will accrue dividend equivalents for any cash dividend declared during the performance period, payable in the form of shares of Company common stock, based upon the maximum number of shares to be earned by the executive officers for each performance-based restricted stock award. Such hypothetical cash dividend payment shall be divided by the fair value of the Company’s common stock on the dividend payment date to determine the maximum number of notional shares to be awarded. At the end of the three-year performance period and on the date some or all of the shares are paid under the agreement, a pro rata number of notional dividend shares will be converted into an equivalent number of dividend shares paid and granted to the executive officers based upon the actual number of underlying shares earned during the performance period.

At December 31, 2013, the three-year performance period related to the performance-based restricted stock awards granted to certain executive officers on March 7, 2011 ended. Based on the Company’s actual financial results from 2011 through 2013, 85,365 of the shares subject to the awards and 4,350 dividend shares were earned and vested on March 7, 2014.

Stock-based compensation cost for performance-based restricted stock awards is measured at the grant date based on the fair value of shares expected to be earned at the end of the performance period, and is recognized as expense over the performance period based upon the probable number of shares expected to vest. The Company estimates and excludes compensation cost related to awards not expected to vest based upon estimated forfeitures.

The following table presents stock-based compensation expense included in the Company’s unaudited consolidated statements of income (in thousands):
 
   
Three months ended
 
Six months ended
   
June 30,
 
June 30,
   
2014
 
2013
 
2014
 
2013
 
Cost of portal revenues, exclusive of depreciation & amortization
  $ 320     $ 306     $ 602     $ 563  
Cost of software & services revenues, exclusive of depreciation & amortization
    14       19       26       36  
Selling & administrative
    1,080       874       1,786       1,478  
Stock-based compensation expense before income taxes
    1,414       1,199       2,414       2,077  
Income tax benefit
    (559 )     (469 )     (949 )     (788 )
Net stock-based compensation expense
  $ 855     $ 730     $ 1,465     $ 1,289  
 
 
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5. INCOME TAXES

The Company’s effective tax rate was approximately 40% and 39%, respectively, for the three- and six-month periods ended June 30, 2014, compared to 39% and 38%, respectively, in the corresponding prior year periods. The Company’s effective tax rate in the current quarter and year-to-date periods was higher than in the prior year periods, mainly due to the expiration of the federal research and development tax credit on December 31, 2013. For the three- and six-month periods ended June 30, 2013, the Company recognized a favorable benefit related to the federal research and development tax credit totaling approximately $0.1 million and $0.6 million, respectively. Legislation extending the research and development tax credit beyond December 31, 2013 has not been enacted.

6. SEGMENTS AND RELATED INFORMATION

The Outsourced Portals segment is the Company’s only reportable segment and includes the Company’s subsidiaries operating outsourced state and local government portals and the corporate divisions that directly support portal operations. The Other Software & Services category primarily includes the Company’s subsidiaries that provide software development and services, other than enterprise-wide outsourced portal services, to state and local governments as well as federal agencies. Each of the Company’s businesses within the Other Software & Services category is an operating segment and has been grouped together to form the Other Software & Services category, as none of the operating segments meets the quantitative threshold of a separately reportable segment. Unallocated corporate-level expenses are reported in the reconciliation of the segment totals to the related consolidated totals as “Other Reconciling Items.” There have been no significant intersegment transactions for the periods reported. The summary of significant accounting policies applies to all reportable and operating segments.
  
The measure of profitability by which management, including the Company’s chief operating decision maker, evaluates the performance of its segments and allocates resources to them is operating income (loss). Segment assets or other segment balance sheet information is not presented to the Company’s chief operating decision maker. Accordingly, the Company has not presented information relating to segment assets.
 
The table below reflects summarized financial information for the Company’s reportable and operating segments for the three-month period ended June 30 (in thousands):
 
   
Outsourced
Portals
 
Other Software
& Services
 
Other Reconciling
Items
 
Consolidated
Total
2014
                       
Revenues
  $ 66,809     $ 4,346     $ -     $ 71,155  
Costs & expenses
    41,888       1,259       7,464       50,611  
Depreciation & amortization
    2,198       10       69       2,277  
Operating income (loss)
  $ 22,723     $ 3,077     $ (7,533 )   $ 18,267  
                                 
2013
                               
Revenues
  $ 62,094     $ 3,844     $ -     $ 65,938  
Costs & expenses
    37,463       1,321       7,362       46,146  
Depreciation & amortization
    1,971       14       64       2,049  
Operating income (loss)
  $ 22,660     $ 2,509     $ (7,426 )   $ 17,743  

The following is a reconciliation of total segment operating income to total consolidated income before income taxes for the three-month period ended June 30 (in thousands):
 
   
2014
 
2013
Total segment operating income
  $ 25,800     $ 25,169  
Other reconciling items
    (7,533 )     (7,426 )
Other expense, net
    (24 )     (2 )
Consolidated income before income taxes
  $ 18,243     $ 17,741  
 
 
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The table below reflects summarized financial information for the Company’s reportable segments for the six-month period ended June 30 (in thousands):
 
   
Outsourced
Portals
 
Other Software
& Services
 
Other Reconciling
 Items
 
Consolidated
Total
2014
                       
Revenues
  $ 128,291     $ 8,261     $ -     $ 136,552  
Costs & expenses
    81,330       2,215       14,724       98,269  
Depreciation & amortization
    4,367       20       140       4,527  
Operating income (loss)
  $ 42,594     $ 6,026     $ (14,864 )   $ 33,756  
                                 
2013
                               
Revenues
  $ 120,136     $ 7,026     $ -     $ 127,162  
Costs & expenses
    72,338       2,526       14,756       89,620  
Depreciation & amortization
    3,918       29       129       4,076  
Operating income (loss)
  $ 43,880     $ 4,471     $ (14,885 )   $ 33,466  

The following is a reconciliation of total segment operating income to total consolidated income before income taxes for the six-month period ended June 30 (in thousands):
 
   
2014
 
2013
Total segment operating income
  $ 48,620     $ 48,351  
Other reconciling items
    (14,864 )     (14,885 )
Other expense, net
    (128 )     (21 )
Consolidated income before income taxes
  $ 33,628     $ 33,445  

For both the three- and six-month periods ended June 30, 2014, the Company’s Texas portal contract accounted for approximately 21% of the Company’s total consolidated revenues. For the three- and six-month periods ended June 30, 2013, the Company’s Texas portal contract accounted for approximately 22% and 23%, respectively, of the Company’s total consolidated revenues. No other state portal contract accounted for more than 10% of the Company’s total consolidated revenues for the three- and six-month periods ended June 30, 2014 or 2013.

7. SUBSEQUENT EVENT

On August 6, 2014, the Company entered into an amendment to extend its $10 million unsecured revolving credit agreement with Bank of America, N.A. to May 1, 2016. This revolving credit facility is available to finance working capital, issue letters of credit and finance general corporate purposes. The Company can obtain letters of credit in an aggregate amount of $5 million, which reduces the maximum amount available for borrowing under the facility. Interest on amounts borrowed is payable at the bank’s prime rate or a LIBOR rate plus a margin (as selected by the Company), in each case as defined in the agreement. That margin, and the fees on outstanding letters of credit are either 1.50% (if the Company’s consolidated leverage ratio is less than or equal to 1.25:1) or 1.75% (if the Company’s consolidated leverage ratio is greater than 1.25:1) of face value per annum. The Company will pay a one-time upfront fee of $18,750 related to the amendment of the credit facility.

The terms of the agreement provide for customary representations and warranties, affirmative and negative covenants and events of default. The amendment also continues to require the Company to maintain compliance with the following financial covenants (in each case, as defined in the agreement):
 
Consolidated tangible net worth of at least $36 million (plus the amount of net proceeds from equity issued, or debt converted to equity, in each case after the date of the credit agreement); and
 
Consolidated maximum leverage ratio of 1.5:1 (the ratio of total funded debt to EBITDA).

The Company was in compliance with each of the covenants listed above at June 30, 2014. The Company issues letters of credit as collateral for certain office leases, and to a lesser extent, as collateral for performance on certain of its outsourced government portal contracts. These irrevocable letters of credit are generally in force for one year. In total, the Company and its subsidiaries had unused outstanding letters of credit of approximately $1.4 million and $1.6 million, respectively, at June 30, 2014 and December 31, 2013. The Company is not currently required to cash collateralize these letters of credit. The Company had $3.6 million in available capacity to issue additional letters of credit and $8.6 million of unused borrowing capacity at June 30, 2014 under the facility. Letters of credit may have an expiration date of up to one year beyond the expiration date of the credit agreement. The credit agreement also includes an accordion feature that will allow the Company to increase the available capacity under the credit agreement by a total of up to $50.0 million, subject to securing additional commitments from the bank.
 
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTION ABOUT FORWARD-LOOKING STATEMENTS

Statements in this Quarterly Report on Form 10-Q regarding NIC Inc. and its subsidiaries (the “Company”, “NIC”, “we” or “us”) and its business, which are not current or historical facts, are “forward-looking statements” that involve risks and uncertainties. Forward-looking statements include, but are not limited to, statements of plans and objectives, statements of future economic performance or financial projections, statements regarding the planned implementation of new portal contracts, statements of assumptions underlying such statements, and statements of the Company’s or management’s intentions, hopes, beliefs, expectations, or predictions of the future. For example, statements like we “expect,” we “believe,” we “plan,” we “intend,” or we “anticipate” are forward-looking statements. Investors should be aware that our actual operating results and financial performance may differ materially from our expressed expectations because of risks and uncertainties about the future including those risks discussed in this Quarterly Report on Form 10-Q and in our 2013 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on February 27, 2014.

There are a number of important factors that could cause actual results to differ materially from those suggested or indicated by such forward-looking statements. These include, among others, NIC’s ability to successfully integrate into its operations recently awarded eGovernment contracts; NIC’s ability to implement its new portal contracts and new projects under existing portal contracts in a timely and cost-effective manner; NIC’s ability to successfully increase the adoption and use of eGovernment services; the possibility of reductions in fees or revenues as a result of budget deficits, government shutdowns, or changes in government policy; the success of the Company in renewing existing contracts and in signing contracts with new states and federal government agencies; continued favorable government legislation; NIC’s ability to develop new services; existing states and agencies adopting those new services; acceptance of eGovernment services by businesses and citizens; competition; the possibility of security breaches through cyber attacks and any resulting liability; and general economic conditions and the other factors discussed under “CAUTIONS ABOUT FORWARD LOOKING STATEMENTS” in Part I and “RISK FACTORS” in Part I, Item 1A of NIC’s 2013 Annual Report on Form 10-K filed on February 27, 2014 with the SEC. Investors should read all of these discussions of risks carefully.

All forward-looking statements made in this Form 10-Q speak only as of the date of this report. We will not necessarily update the information in this Form 10-Q if any forward-looking statement later turns out to be inaccurate. Investors are cautioned not to put undue reliance on any forward-looking statement.

WHAT WE DO – AN EXECUTIVE SUMMARY

We are a leading provider of eGovernment services that helps governments use the Internet to reduce internal costs, increase efficiencies, and provide a higher level of service to businesses and citizens. We accomplish this currently through two channels: our primary outsourced portal businesses and our software & services businesses.

In our primary outsourced portal business, we generally enter into contracts primarily with state and local governments to design, build, and operate Internet-based enterprise-wide portals on their behalf. We typically enter into multi-year contracts and manage operations for each government partner through separate local subsidiaries that operate as decentralized businesses with a high degree of autonomy. Our portals consist of websites and applications that we build, which allow businesses and citizens to access government information through multiple online channels, including mobile, and complete secure transactions, including applying for a permit, retrieving government records, or filing a government-mandated form or report. We help increase our government partners’ revenues by expanding the distribution of their information assets and increasing the number of financial transactions conducted with governments. We do this by marketing portal services and soliciting users to complete government-based transactions and to enter into subscriber contracts that permit users to access the portal and the government information contained therein in exchange for transactional and/or subscription user fees. We are typically responsible for funding up-front investment and ongoing operations and maintenance costs of the government portals. Our unique self-funded business model allows us to generate revenues by sharing in the fees collected from eGovernment transactions. Our partners benefit because they reduce their financial and technology risks, increase their operational efficiencies, and gain a centralized, customer-focused presence on the Internet, while businesses and citizens gain a faster, more convenient, and more cost-effective means to interact with governments.

On behalf of our government partners, we enter into separate agreements with various agencies and divisions of the government to provide specific services and to conduct specific transactions. These agreements preliminarily establish the pricing of the electronic transactions and data access services we provide and the division of revenues between the Company and the government agency. The government oversight authority must approve prices and revenue sharing agreements. We have limited control over the level of fees we are permitted to retain. Any changes made to the amount or percentage of fees retained by us, or to the amounts charged for the services offered, could materially affect the profitability of the respective contract to us. We typically own all the intellectual property in connection with the applications developed under these contracts. After completion of a defined contract term, the government partner typically receives a perpetual, royalty-free license to use the software only in its own portal. However, certain customer management, billing and payment processing software applications that we have developed and standardized centrally and that are utilized by our portal businesses, are being provided to an increasing number of our government partners on a software-as-a-service, or “SaaS,” basis, and thus would not be included in any royalty-free license. If our contract was not renewed after a defined term or if our contract was terminated by our government partner for cause, the government agency would be entitled to take over the portal in place with no future obligation of the Company, except as otherwise provided in the contract and except for the services we provide on a SaaS basis, which would be available to our partners on a fee-for-service basis. We also provide certain payment processing services on a SaaS basis to a few private sector companies and non-NIC portal state agencies, and may continue to market these services to other entities in the future. Historically, revenues from these services have not been significant, but have been steadily growing in recent years. In some cases, we enter into contracts to provide consulting, application development and portal management services to governments in exchange for an agreed-upon fee.
 
 
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Any renewal of the outsourced portal contracts beyond the initial term is optional and a government may terminate its contract prior to the expiration date if we breach a material contractual obligation and fail to cure such breach within a specified period or upon the occurrence of other events or circumstances specified in the contract. In addition, 17 contracts under which we provide outsourced state portal services can be terminated without cause on a specified period of notice. Collectively, revenues generated from these contracts represented 59% and 58%, respectively, of our total consolidated revenues for the current quarter and year-to-date periods. In the event that any of these contracts is terminated without cause, the terms of the respective contract may require the government to pay a fee to us in order to continue to use our software in its portal. In addition, the loss of one or more of our larger state portal partners, such as Alabama, Arkansas, Colorado, Indiana, Montana, New Jersey, Pennsylvania, Tennessee, Texas, or Utah, as a result of the expiration, termination or failure to renew the respective contract, if such partner is not replaced, could significantly reduce our revenues and profitability. See the discussion below regarding the expiration of certain contracts with the Commonwealth of Virginia and the states of Arizona and Delaware.

In our software & services businesses, the majority of our revenues are generated from a contract with the Federal Motor Carrier Safety Administration (“FMCSA”), to provide outsourced services through our NIC Technologies, LLC (“NIC Technologies”) subsidiary. The contract with the FMCSA to develop and manage the FMCSA’s Pre-Employment Screening Program (“PSP”) for motor carriers nationwide uses the self-funded, transaction-based business model. During the first quarter of 2014, the FMCSA exercised the fourth of its four one-year contract renewal options, extending the term through February 16, 2015. During the third quarter of 2014, we received a six-month contract extension with the FMCSA, extending the term through August 16, 2015. NIC Technologies also designs and develops online campaign expenditure and ethics compliance systems for the state of Michigan. During the first quarter of 2014, we were awarded a new five-year contract by the state of Michigan, which includes renewal options for the government to extend the contract up to an additional five years.

Any renewal of these software & services contracts beyond the initial term is optional and a government agency may terminate its contract prior to the expiration date if we breach a material contractual obligation and fail to cure such breach within a specified period or upon the occurrence of other events or circumstances specified in the contract. The contract with the FMCSA expires on August 16, 2015 and can be terminated by the other party without cause prior to expiration on a specified period of notice. The loss of the contract with the FMCSA, as a result of the expiration, termination or failure to renew the contract, if not replaced, could significantly reduce our revenues and profitability. In addition, we have limited control over the level of fees we are permitted to retain under the contract with the FMCSA. Any changes made to the amount or percentage of fees retained by us, or to the amounts charged for the services offered, could materially affect the profitability of this contract to us.

As of June 30, 2014, there were 12 contracts under which we provide outsourced portal services or software development and services that have expiration dates within the 12-month period following June 30, 2014. Collectively, revenues generated from these contracts represented 32% and 31% of our total consolidated revenues for the current quarter and year-to-date periods. As described above, if a contract is not renewed after a defined term, the government partner would be entitled to take over the portal in place with no future obligation on our part, except as otherwise provided in the contract and except for the services we provide on a SaaS basis, which would be available to the government agency on a fee-for-service basis.

The contract under which our subsidiary, Virginia Interactive, LLC (“VI”), provided outsourced portal services to agencies of the Commonwealth of Virginia, expired on August 31, 2012. As more fully disclosed in a Form 8-K filed by us with the SEC on April 18, 2012, VI chose not to agree to terms mandated by the Commonwealth of Virginia for a new contract. VI provided transition services as required by the contract through August 31, 2013. We continue to provide eGovernment services to certain agencies of the Commonwealth of Virginia, as further discussed in Note 2 in the Notes to Unaudited Consolidated Financial Statements included in this Form 10-Q. Revenues from operations in Virginia for the current quarter and year-to-date periods were approximately $0.7 million and $1.3 million, respectively, compared to approximately $1.6 million and $3.1 million, respectively, in the corresponding prior year periods.
 
 
15

 
 
During the first quarter of 2013, our subsidiary, NICUSA, Inc. (“NICUSA”), chose not to respond to a request for proposal issued by the state of Arizona for a new contract. NICUSA provided transition services as required by the contract through March 26, 2014. The costs incurred in transitioning out of NICUSA’s contract with the state of Arizona, including employee retention bonuses, operating lease termination costs, and fixed asset impairment, did not have a material impact on our consolidated results of operations, cash flows, or financial condition. Revenues from our legacy Arizona portal contract for the current quarter and year-to-date periods were $0 and approximately $0.8 million, respectively, compared to approximately $1.1 million and $2.0 million, respectively, in the corresponding prior year periods.

Our subsidiary, Delaware Interactive, LLC (“DI”), has a contract with the state of Delaware to manage the state's official government portal through September 30, 2014. Currently, the primary revenue source for DI under the contract is an annual portal management fee of approximately $2.2 million paid to DI by the state. During the second quarter of 2014, the state informed DI, that due to fiscal constraints, it does not intend to renew its contract with DI when the current contract term expires. We do not believe the expiration of our contract with the state of Delaware will have a material impact on our consolidated results of operations, cash flows or financial condition.

REVENUE RECOGNITION

We classify our revenues and cost of revenues into two categories: (1) portal and (2) software & services. The portal category includes revenues and cost of revenues primarily from our subsidiaries operating state and local government portals on an enterprise-wide outsourced basis. The software & services category primarily includes revenues and cost of revenues from our subsidiaries that provide software development and services, other than enterprise-wide outsourced portal services, to state and local governments as well as federal agencies. We currently earn revenues from three main sources: transaction-based fees, time and materials-based fees for application development, and fixed fees for portal management services. Each of these revenue types and the corresponding business models are further described below.

Our outsourced portal businesses

We categorize our portal revenues according to the underlying source of revenue. A brief description of each category follows:

IGS transaction-based : these are transaction fees from sources other than electronic access to motor vehicle driver history records, for transactions conducted by business users and consumer users through our portals referred to as IGS or Interactive Government Services (previously referred to as non-DMV), and are generally recurring. For a representative listing of the IGS transactions we currently offer through our portals, refer to Part I, Item 1 in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on February 27, 2014.

DHR transaction-based : these are transaction fees for providing electronic access to motor vehicle driver history records, referred to as DHR (previously referred to as DMV), from our state portals to data resellers, insurance companies, and other pre-authorized customers on behalf of our state partners, and are generally recurring.

Portal software development : these are revenues from the performance of application development projects and other time and materials services for our government partners. While we actively market these services, they do not have the same degree of predictability as our transaction-based or portal management revenues. As a result, these revenues are excluded from our recurring portal revenue percentage.
 
Portal management : these are revenues from the performance of fixed fee portal management services for our government partners in the states of Indiana, Delaware and Arizona and are generally recurring. As further discussed above, the Arizona portal contract expired on March 26, 2014 and the Delaware contract will expire on September 30, 2014.
 
  Our software & services businesses

NIC Technologies currently earns a significant portion of its revenues from its contract with the FMCSA to develop and manage the PSP for motor carriers nationwide, using a self-funded, transaction-based business model. NIC Technologies recognizes revenues from this contract (primarily transaction-based information access fees) when the services are provided. NIC Technologies also earns a portion of its revenues from fixed fee and time and materials application development and outsourced maintenance contracts with other government agencies and recognizes revenues as services are provided.

CRITICAL ACCOUNTING POLICIES

There have been no material changes in our critical accounting policies from the information provided under “Critical Accounting Policies” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on February 27, 2014.
 
 
16

 

RESULTS OF OPERATIONS

The following discussion summarizes the significant factors affecting operating results for the three- and six-month periods ended June 30, 2014 and 2013. This discussion and analysis should be read in conjunction with our Unaudited Consolidated Financial Statements and the related Notes included in this Form 10-Q.

Due to the expiration of VI’s legacy contract with the Commonwealth of Virginia on August 31, 2013 and the expiration of NICUSA’s contract with the state of Arizona on March 26, 2014, the operating results for our legacy Virginia and Arizona portals have been removed from the same state category for the three and six months ended June 30, 2014 as the portals no longer meet the definition of a same state portal (portals in operation and generating self-funded revenues for two full periods). Furthermore, the Company’s newer portal contracts with the states of Pennsylvania, Wisconsin and Connecticut have been excluded from the same state category for the three and six months ended June 30, 2014, because they had not generated self-funded revenues for two full periods.
 
   
Three months ended
 
Six months ended
   
June 30,
 
June 30,
Key Financial Metrics
 
2014
 
2013
 
2014
 
2013
Revenue growth - outsourced portals
    8 %     27 %     7 %     27 %
Same state revenue growth - outsourced portals
    8 %     19 %     7 %     18 %
Recurring portal revenue as a % of total portal revenues
    95 %     94 %     95 %     95 %
Gross profit % - outsourced portals
    42 %     44 %     42 %     44 %
Revenue growth - software & services
    13 %     31 %     18 %     18 %
Gross profit % - software & services
    72 %     69 %     74 %     67 %
Selling & administrative expenses as a % of total revenues
    15 %     15 %     16 %     15 %
Operating income margin % (operating income as a % of total revenues)
    26 %     27 %     25 %     26 %

PORTAL REVENUES. In the analysis below, we have categorized our portal revenues according to the underlying source of revenue (in thousands), with the corresponding percentage increase or decrease from the prior year period.
 
   
Three months ended June 30,
 
Six months ended June 30,
Portal Revenue Analysis
 
2014
 
% Change
 
2013
 
2014
 
% Change
 
2013
IGS transaction-based (formerly, Non-DMV)
   36,684        8    34,005      69,053        8    64,175  
DHR transaction-based (formerly, DMV)
     25,017        14      22,030        48,493        8      44,792  
Portal software development
    3,288       (6 %)     3,494       6,315       5 %     6,039  
Portal management
    1,820       (29 %)     2,565       4,430       (14 %)     5,130  
Total
  $ 66,809       8 %   $ 62,094     $ 128,291       7 %   $ 120,136  

Portal revenues in the current quarter increased 8%, or approximately $4.7 million, over the prior year quarter, due mainly to an increase in same state portal revenues (portals in operation and generating self-funded revenues for two full periods). The increase in revenues from our newer portals in Connecticut, which began generating revenues in April 2014, Wisconsin, which began generating revenues in September 2013, and Pennsylvania, which began generating revenues under the self-funded model in October 2013, totaling approximately $2.2 million, was mostly offset by a decrease in revenues totaling approximately $2.0 million from our legacy Virginia and Arizona portals due to contract expirations, as further discussed above. Our 8% portal revenue growth in the current quarter was lower than the 27% portal revenue growth we achieved in the prior year quarter primarily due to IGS revenues from the motor vehicle inspection service with the Texas Department of Public Safety (“DPS”) in the prior year quarter and a full quarter of DHR revenues from our newer portals in Pennsylvania, Maryland and Oregon in the prior year quarter, all of which were included in both the current and prior year quarter results. Revenues from the motor vehicle inspection service for the Texas DPS and Pennsylvania portal were not included in our results for the second quarter of 2012 as the Texas DPS service launched in September 2012 and our Pennsylvania portal began to generate revenues in January 2013. Furthermore, only a partial quarter of DHR revenues from our newer portals in Maryland and Oregon were included in the second quarter of 2012 as our Maryland portal began to generate revenues in May 2012 and our Oregon portal began to generate revenues in June 2012.
 
Same state portal revenues in the current quarter increased 8% over the prior year quarter primarily due to higher revenues across several portals. Our same state revenue growth in the current quarter was lower than the 19% revenue growth we achieved in the prior year quarter due mainly to lower growth in same state IGS transaction-based revenues in the current quarter. Same state IGS transaction-based revenues increased 8% in the current quarter due mainly to higher revenues from our Arkansas, Texas and Colorado portals, which were driven by several key services, including payment processing in Arkansas, professional license renewals and motor vehicle registrations in Texas and motor vehicle registrations and court record searches in Colorado. Same state IGS transaction-based revenue growth was 40% in the prior year quarter due mainly to the motor vehicle inspection service with the Texas DPS, as further discussed above, and to a lesser extent the deployment and increased adoption of key revenue generating services in other state portals. Same state DHR revenues grew 9% in the current quarter compared to 5% in the prior year quarter. The increase in same state DHR revenues in the current quarter was mainly due to a price increase in one state portal in the third quarter of 2013 and price increases in two other state portals in the second quarter of 2014, and to a lesser extent, higher transaction volumes across various portals. Our same state portal software development revenues decreased 30% in the prior year quarter, primarily due to the expiration of certain Master Work Order projects in Texas on August 31, 2012, as previously disclosed.
 
 
17

 
 
Portal revenues for the six-month period ended June 30, 2014 increased 7%, or approximately $8.2 million, over the prior year period, mainly due to an increase in same state portal revenues. The increase in self-funded revenues from our newer portals in Connecticut, Wisconsin and Pennsylvania totaling approximately $3.1 million was mostly offset by a decrease in revenues from our legacy Virginia and Arizona portals totaling approximately $3.0 million due to contract expirations, as further discussed above.

Same state portal revenues in the current year-to-date period increased 7% over the prior year period, primarily due to higher revenues across several portals. Our same state revenue growth in the current year-to-date period was lower than the 18% revenue growth we achieved in the prior year period due mainly to lower growth in same state IGS transaction-based revenues in the current year-to-date period. Same state IGS transaction-based revenues increased 8% in the current year-to-date period due mainly to higher revenues from our Colorado, Arkansas and Hawaii portals, which were driven by several key services, including court record searches and motor vehicle registrations in Colorado, payment processing in Arkansas and tax filings and professional license renewals in Hawaii. Same state IGS transaction-based revenue growth was 37% in the prior year-to-date period due mainly to the motor vehicle inspection service with the Texas DPS, as further discussed above, and to a lesser extent the deployment and increased adoption of key revenue generating services in other state portals. Same state DHR revenues grew 6% in the current year-to-date period compared to 4% in the prior year-to-date period. The increase in same state DHR revenues in the current year-to-date period was mainly due to a price increase in one state portal that became effective in the third quarter of 2013, price increases at two other state portals that became effective in the second quarter of 2014, and to a lesser extent higher transaction volumes across various portals. Our same state portal software development revenues increased 10% in the current year-to-date period due to higher project-based revenues from our Indiana, Arkansas and Hawaii portals, among others. Our same state portal software development revenues decreased 30% in the prior year-to-date period, primarily due to the expiration of certain Master Work Order projects in Texas, as discussed above.

COST OF PORTAL REVENUES. In the analysis below, we have categorized our cost of portal revenues between fixed and variable costs (in thousands), with the corresponding percentage increase or decrease from the prior year period. Fixed costs include costs such as employee compensation (including stock-based compensation), subcontractor labor costs, telecommunications, and all other costs associated with the provision of dedicated client service such as dedicated facilities. Variable costs consist of costs that vary with our level of portal revenues and primarily include bank fees required to process credit/debit card and automated clearinghouse transactions and, to a lesser extent, costs associated with revenue share arrangements with our state partners.
 
   
Three months ended June 30,
 
Six months ended June 30,
Cost of Portal Revenue Analysis 2014  
% Change
 
2013
 
2014
 
% Change
 
2013
Fixed costs
  $ 23,747       7 %   $ 22,195     $ 47,549       10 %   $ 43,055  
Variable costs
    14,786       16 %     12,704       27,381       11 %     24,606  
Total
  $ 38,533       10 %   $ 34,899     $ 74,930       11 %   $ 67,661  
 
Cost of portal revenues in the current quarter increased 10%, or approximately $3.6 million, over the prior year quarter. Of this increase, (i) approximately $2.8 million was attributable to an increase in same state cost of portal revenues; and (ii) approximately $0.8 million was attributable to increases from our newer portals in Connecticut, Wisconsin and Pennsylvania (collectively, $1.7 million) that were partially offset by a $0.9 million decrease in cost of portal revenues from our legacy Virginia and Arizona portals due to contract expirations, as further discussed above.

The increase in same state cost of portal revenues in the current quarter was partially attributable to higher employee compensation and benefit costs, as well as software maintenance costs across various portals, in addition to higher variable fees to process credit/debit card transactions due to a change in the mix of payment card types for certain services in our Texas portal and higher IGS transaction volumes across several other portals. A significant percentage of our IGS transaction-based revenues are generated from online applications whereby users pay for information or transactions via credit/debit cards. We typically earn a percentage of the credit/debit card transaction amount, but also must pay an associated interchange fee to the bank that processes the credit/debit card transaction. We earn a lower incremental gross profit percentage on these transactions as compared to our DHR and other IGS transactions. However, we plan to continue to implement these services as they contribute favorably to our operating income growth.

Our portal gross profit percentage was 42% in the current quarter, down from 44% in the prior year quarter, due mainly to (i) lower gross profits from our Texas portal, as further discussed above; and (ii) a $2.0 million decrease in revenues in the current quarter from our legacy Virginia and Arizona portal contracts due to contract expirations, as further discussed above. We carefully monitor our portal gross profit percentage to strike the balance between generating a solid return for our stockholders and delivering value to our government partners through reinvestment in our portal operations (which we believe also benefits our stockholders).

Cost of portal revenues for the current year-to-date period increased 11%, or approximately $7.3 million, over the prior year-to-date period. Of this increase, (i) approximately $4.8 million was attributable to an increase in same state cost of portal revenues; and (ii) approximately $2.5 million was attributable to increases at our newer portals in Connecticut, Wisconsin and Pennsylvania (collectively, $3.9 million) that were partially offset by a $1.4 million decrease in cost of portal revenues at our legacy Virginia and Arizona portals due to contract expirations, as further discussed above.
 
 
18

 
 
The increase in same state cost of portal revenues in the current year-to-date period was partially attributable to higher employee compensation and benefit costs, as well as software maintenance costs across various portals, in addition to higher variable fees to process credit/debit card transactions due to a change in the mix of payment card types for certain services in our Texas portal and higher IGS transaction volumes across several other portals, as further discussed above.

Our portal gross profit percentage was 42% for the current year-to-date period, down from 44% in the prior year period, due mainly to (i) lower gross profits from our Texas portal, as further discussed above; (ii) a $3.0 million decrease in revenues in the current year-to-date period from our legacy Virginia and Arizona portal contracts, as further discussed above; and (iii) higher employee compensation and other costs in the current year-to-date period totaling approximately $1.1 million related to our Pennsylvania portal, which started to significantly ramp up its cost structure midway through the second quarter of 2013.

SOFTWARE & SERVICES REVENUES. In the analysis below, we have categorized our software & services revenues by business (in thousands), with the corresponding percentage increase or decrease from the prior year period.
 
   
Three months ended June 30,
 
Six months ended June 30,
Software & Services Revenue Analysis   2014  
% Change
 
2013
 
2014
 
% Change
 
2013
NIC Technologies
  $ 2,797       (3 %)   $ 2,897     $ 5,458       (3 %)   $ 5,623  
Other
    1,549       64 %     947       2,803       100 %     1,403  
Total
  $ 4,346       13 %   $ 3,844     $ 8,261       18 %   $ 7,026  

Software & services revenues in the current quarter and year-to-date periods increased 13% and 18%, or approximately $0.5 million and $1.2 million, respectively, over the corresponding prior year periods. The increases were primarily due to (i) higher revenues in the current quarter and year-to-date periods from our contract with the FMCSA ($0.3 million and $0.5 million, respectively), as a result of increased adoption of the PSP; and (ii) higher revenues in the current quarter and year-to-date periods from various other software & services businesses, including the North Carolina construction lien service that commenced in April 2013 (revenues from this service were flat compared to the prior year quarter and increased $0.4 million over the prior year-to-date period).

COST OF SOFTWARE & SERVICES REVENUES. Our software & services gross profit percentage in the current quarter and year-to-date periods was 72% and 74%, respectively, compared to 69% and 67%, respectively, in the corresponding prior year periods. The increase in the gross profit percentage in the current quarter and year-to-date periods was primarily due to higher revenues from the PSP and North Carolina construction lien service, as further discussed above, as cost of software & services revenues in the current year periods were relatively flat compared to the prior year periods.

SELLING & ADMINISTRATIVE. Selling & administrative expenses in both the current quarter and year-to-date periods increased 8%, or approximately $0.8 million and $1.5 million, respectively, over the corresponding prior year periods mainly due to higher personnel and software maintenance costs to support and enhance corporate-wide information technology, security and portal operations, partially offset by lower net costs related to the SEC matter, which was successfully concluded in December 2013, as further discussed in Item 3, Legal Proceedings, and Note 7 in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on February 27, 2014. In the prior year quarter and year-to-date periods, we incurred approximately $1.9 million and $3.7 million, respectively, in legal fees and other third-party costs related to the SEC matter. These expenses were reduced by approximately $1.5 million and $2.9 million, respectively, of reimbursement from our directors’ and officers’ liability insurance carrier, resulting in a net expense of approximately $0.4 million and $0.8 million related to the SEC matter in the prior year periods. We did not incur any costs related to the SEC matter in the current quarter or year-to-date periods, and we do not currently expect to incur any additional costs related to the SEC matter going forward. As a percentage of total consolidated revenues, selling & administrative expenses were 15% and 16%, respectively, for the current quarter and year-to-date periods, compared to 15% in both of the prior year periods.

DEPRECIATION & AMORTIZATION. Depreciation & amortization expense in both the current quarter and year-to-date periods increased 11%, or approximately $0.2 million and $0.5 million, respectively, over the prior year periods. These increases were primarily attributable to (i) capital expenditures for our centralized hosting environment to support and enhance corporate-wide information technology and security infrastructure; and (ii) capital expenditures for new services across various portals, including our newer portals in Connecticut, Wisconsin and Pennsylvania. As a percentage of total consolidated revenues, depreciation & amortization was 3% for all periods presented.

INCOME TAXES. Our effective tax rate for the current quarter and year-to-date periods was approximately 40% and 39%, respectively, compared to 39% and 38%, respectively, in the prior year periods. Our effective tax rate in the current quarter and year-to-date periods was higher than in the prior year periods mainly due to the expiration of the federal research and development tax credit on December 31, 2013. In the prior year quarter and year-to-date periods, we recognized a favorable benefit related to the federal research and development tax credit totaling approximately $0.1 million and $0.6 million, respectively. Legislation extending the research and development tax credit beyond December 31, 2013 has not been enacted.
 
 
19

 
 
Liquidity and Capital Resources

Operating Activities

Net cash provided by operating activities was approximately $22.7 million in the current year-to-date period as compared to $19.7 million in the prior year-to-date period. The increase in cash flow from operations in the current period was primarily the result of (i) a smaller increase in accounts receivable in the current period, due to lower revenue growth in the current period compared to the prior year period and to the timing of accounts receivable collections; and (ii) an increase in accounts payable in the current period due to the timing of payments to our government partners. These increases were partially offset by a decrease in accrued expenses in the current period, mainly due to higher payments for executive and non-executive management incentive compensation as well as 401(k) match contributions for all employees.

Investing Activities
 
Net cash used in investing activities was approximately $3.3 million and $3.0 million, respectively, in the current and prior year-to-date periods. Investing activities in the current and prior year periods primarily reflect $2.7 million and $2.3 million, respectively, of capital expenditures, which were for fixed asset additions in our outsourced portal businesses including additional capital expenditures in our new state portals and in our centralized hosting environment to support and enhance corporate-wide information technology and security infrastructure, including Web servers, purchased software and office equipment. Furthermore, in both the current and prior year-to-date periods, we capitalized approximately $0.7 million of internal-use software development costs primarily related to the standardization of centralized customer management, billing and payment processing systems that support our portal operations and accounting systems.
 
Financing Activities
 
Net cash provided by financing activities was approximately $2.0 million and $1.6 million, respectively, in the current and prior year-to-date periods, primarily reflecting the receipt of approximately $1.1 million and $0.9 million, respectively, in proceeds from our employee stock purchase program and tax deductions of approximately $0.9 million and $0.7 million, respectively, related to stock-based compensation.

Liquidity

We recognize revenues primarily from providing outsourced government portal services net of the transaction fees due to the government when the services are provided. We recognize accounts receivable at the time these services are provided, and also accrue the related fees that we must remit to the government as accounts payable at such time. As a result, trade accounts receivable and accounts payable reflect the gross amounts outstanding at the balance sheet dates. Gross billings for the three-months ended June 30, 2014 and December 31, 2013 were approximately $1.1 billion and $833.4 million, respectively. We calculate days sales outstanding by dividing trade accounts receivable at the balance sheet date by gross billings for the period and multiplying the resulting quotient by the number of days in that period. Days sales outstanding for the three-month periods ended June 30, 2014 and December 31, 2013 were five days and six days, respectively.

We believe our working capital and current ratio are important measures of our short-term liquidity. Working capital, defined as current assets minus current liabilities, increased to $103.8 million at June 30, 2014, from $79.4 million at December 31, 2013. The increase in our working capital is primarily due to an increase in cash flows from operating activities, as further described above. Our current ratio, defined as current assets divided by current liabilities, was 2.6 and 2.0 at June 30, 2014 and December 31, 2013, respectively.

At June 30, 2014, our unrestricted cash balance was $95.7 million compared to $74.2 million at December 31, 2013. We believe that our currently available liquid resources and cash generated from operations will be sufficient to meet our operating requirements, capital expenditure requirements, current growth initiatives, and dividend payments (if any) for at least the next 12 months without the need of additional capital. We have a $10.0 million unsecured revolving credit facility with a bank that is available to finance working capital, issue letters of credit and finance general corporate purposes. We can obtain letters of credit in an aggregate amount of $5.0 million, which reduces the maximum amount available for borrowing under the facility. In total, we had $3.6 million in available capacity to issue additional letters of credit and $8.6 million of unused borrowing capacity at June 30, 2014 under the facility. We were in compliance with all of the financial covenants under the revolving credit facility at June 30, 2014.

We issue letters of credit as collateral for certain office leases, and to a lesser extent, as collateral for performance on certain of our outsourced government portal contracts. These irrevocable letters of credit are generally in force for one year. Letters of credit may have an expiration date of up to one year beyond the expiration date of the credit agreement. We had unused outstanding letters of credit totaling approximately $1.4 million at June 30, 2014. We are not currently required to cash collateralize these letters of credit. As further discussed in Note 7 in the Notes to Unaudited Consolidated Financial Statements in this Form 10-Q, on August 6, 2014, we entered into an amendment to extend our credit facility to May 1, 2016.
 
 
20

 
 
At June 30, 2014, we were bound by performance bond commitments totaling approximately $6.6 million on certain outsourced government portal contracts. We have never had any defaults resulting in draws on performance bonds. Had we been required to post 100% cash collateral at June 30, 2014 for the face value of all performance bonds, letters of credit, and our line of credit in conjunction with a corporate credit card agreement, unrestricted cash would have decreased by approximately $9.0 million and would have been classified as restricted cash.
 
We currently expect our capital expenditures to be approximately $6.5 million to $7.0 million in fiscal 2014, which we intend to fund from our cash flows from operations and existing cash reserves. This estimate includes capital expenditures for normal fixed asset additions in our outsourced portal businesses and in our centralized hosting environment to support and enhance corporate-wide information technology and security infrastructure, including Web servers, purchased software, and office equipment.

On October 28, 2013, we declared a $0.35 per share special cash dividend totaling approximately $23.0 million that was paid out of our available cash on January 2, 2014. We do not believe that this dividend will have a significant effect on our future liquidity.

We may need to raise additional capital within the next 12 months to further:
 
fund operations if unforeseen costs arise;
 
support our expansion into other states and government agencies beyond what is contemplated if unforeseen opportunities arise;
 
expand our product and service offerings beyond what is contemplated if unforeseen opportunities arise;
 
respond to unforeseen competitive pressures; and
 
acquire technologies beyond what is contemplated.
 
Any projections of future earnings and cash flows are subject to substantial uncertainty. If our cash generated from operations and the unused portion of our line of credit are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity securities or issue debt securities. The sale of additional equity securities could result in dilution to our stockholders. There can be no assurance that financing will be available in amounts or on terms acceptable to us, if at all.

Off-Balance Sheet Arrangements and Contractual Obligations

We do not have off-balance sheet arrangements that are not recorded or disclosed in our financial statements. As of June 30, 2014, there have been no material changes outside the ordinary course of business from the disclosures relating to contractual obligations contained under “Off-Balance Sheet Arrangements and Contractual Obligations” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on February 27, 2014. While we have significant operating lease commitments for office space, except for our headquarters, those commitments are generally tied to the period of performance under related portal contracts. We have income tax uncertainties of approximately $2.2 million at June 30, 2014. These obligations are classified as non-current on our consolidated balance sheet, as resolution is expected to take more than a year. We estimate that these matters could be resolved in one to three years. However, the ultimate timing of resolution is uncertain.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
INTEREST RATE RISK. Our cash is held entirely in domestic non-interest bearing transaction accounts.
 
We currently have no principal amounts of indebtedness outstanding under our line of credit. Borrowings under our line of credit bear interest at a floating rate. Interest on amounts borrowed is payable at a base rate equal to the higher of the Federal Funds Rate plus 0.5% or the bank’s prime rate.
 
We do not use derivative financial instruments.
 
 
21

 
 
ITEM 4. CONTROLS AND PROCEDURES
 
a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
 
The Company maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that material information required to be disclosed in its filings under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of such date.
     
b) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
 
There have been no changes in our internal control over financial reporting that occurred during our second quarter of 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Share Repurchases

During the second quarter of 2014, we acquired and cancelled shares of common stock surrendered by employees to pay income taxes due upon the vesting of restricted stock as follows:
 
Period
 
Total Number of
Shares Purchased
 
Average Price
Paid per share
 
Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs
 
Maximum Number (or
Approximate Dollar Value)
of Shares that May Yet Be
Purchased Under the Plans
or Programs
May 1, 2014
    832     $ 18.52       N/A       N/A  
May 3, 2014
    1,353       18.64       N/A       N/A  
May 4, 2014
    1,415       18.64       N/A       N/A  
May 7, 2014
    59       17.66       N/A       N/A  

ITEM 5.  OTHER INFORMATION
 
On August 6, 2014, the Company entered into an amendment to extend its $10 million unsecured revolving credit agreement with Bank of America, N.A. to May 1, 2016. See Note 7 in the Notes to Unaudited Consolidated Financial Statements in this Form 10-Q for a description of the amendment to extend our credit facility to May 1, 2016, which is incorporated herein by this reference.

ITEM 6. EXHIBITS
     
 
10.1
NIC Inc. 2014 Amended and Restated Stock Compensation Plan ** (incorporated by reference from Exhibit 10.1 to the Form 8-K filed with the SEC on May 8, 2014)
     
 
10.2
Amended Credit Agreement Dated as of August 6, 2014 between NIC Inc., as Borrower, and Bank of America, N.A., as Lender and L/C Issuer
     
 
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
 
31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
 
32.1
Section 906 Certifications of Chief Executive Officer and Chief Financial Officer
     
 
101
The following financial information from NIC’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, formatted in XBRL (Extensible Business Reporting Language) includes (i) Unaudited Consolidated Balance Sheets at June 30, 2014 and December 31, 2013, (ii) Unaudited Consolidated Statements of Income for the three and six months ended June 30, 2014 and 2013, (iii) Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the six months ended June 30, 2014, (iv) Unaudited Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013, and (v) the Notes to Unaudited Consolidated Financial Statements (submitted electronically herewith).
 
 
** 
Management contract and compensatory plan and arrangement required to be filed as an Exhibit pursuant to Item 6 of this report.
 
 
22

 
 
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
NIC INC.
   
Dated:  August 7, 2014
/s/ Stephen M. Kovzan
 
Stephen M. Kovzan
 
Chief Financial Officer
 
 
 

 
 
NIC Inc.
EXHIBIT INDEX

Exhibit
Number
 
Description of Exhibit
10.1
 
 
NIC Inc. 2014 Amended and Restated Stock Compensation Plan ** (incorporated by reference from Exhibit 10.1 to the Form 8-K filed with the SEC on May 8, 2014)
     
10.2
 
Amended Credit Agreement Dated as of August 6, 2014 between NIC Inc., as Borrower, and Bank of America, N.A., as Lender and L/C Issuer
     
31.1
 
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
31.2
 
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
32.1
 
Section 906 Certifications of Chief Executive Officer and Chief Financial Officer
     
101
 
The following financial information from NIC’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, formatted in XBRL (Extensible Business Reporting Language) includes (i) Unaudited Consolidated Balance Sheets at June 30, 2014 and December 31, 2013, (ii) Unaudited Consolidated Statements of Income for the three and six months ended June 30, 2014 and 2013, (iii) Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the six months ended June 30, 2014, (iv) Unaudited Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013, and (v) the Notes to Unaudited Consolidated Financial Statements (submitted electronically herewith).
     
**
Management contract and compensatory plan and arrangement required to be filed as an Exhibit pursuant to Item 6 of this report.
 
Exhibit 10.2
 

 




 
 
 
AMENDED AND RESTATED
 
CREDIT AGREEMENT
 
Dated as of August 6, 2014
 
between
 
NIC INC.,
 
as Borrower, and
 
BANK OF AMERICA, N.A.,
 
as Bank and Letter of Credit Issuer
 

 
 



 
 

 
 
TABLE OF CONTENTS
 
 
Section
 
Page
       
ARTICLE I
DEFINITIONS AND ACCOUNTING TERMS
1
 
1.01
Defined Terms
1
       
ARTICLE II
LINE OF CREDIT AMOUNT AND TERMS
11
 
2.01
Line of Credit
11
 
2.02
Availability Period
13
 
2.03
Repayment Terms
13
 
2.04
Interest Rate(s)
14
 
2.05
Increase in Commitments
14
  2.06  Letters of Credit   15
       
ARTICLE III
LOAN ADMINISTRATION AND FEES
16
 
3.01
Fees
16
 
3.02
Collection of Payments
17
 
3.03
Borrower’s Instructions
17
 
3.04
Direct Debit
17
 
3.05
Interest Calculation
17
 
3.06
Illegality
17
 
3.07
Inability to Determine Rates
18
 
3.08
Increased Costs
18
 
3.09
Compensation for Losses
19
 
i
 

 
 
TABLE OF CONTENTS
 
(continued)
 
ARTICLE IV
CONDITIONS
20
 
4.01
Authorizations
20
 
4.02
Governing Documents
20
 
4.03
Good Standing
20
 
4.04
Secretary Certificate
20
 
4.05
Guaranties
20
 
4.06
Payment of Fees
20
 
4.07
Legal Opinion
20
 
4.08
Insurance
20
 
4.09
Other Required Documentation
20
 
4.10
Conditions to Each Extension of Credit under the Line of Credit
21
       
ARTICLE V
REPRESENTATIONS AND WARRANTIES
21
 
5.01
Formation
21
 
5.02
Authorization
21
 
5.03
Enforceable Agreement
21
 
5.04
Good Standing
21
 
5.05
No Conflicts
22
 
5.06
Financial Information
22
 
5.07
Lawsuits
22
 
5.08
Permits, Franchises
22
 
5.09
Other Obligations
22
 
5.10
Tax Matters
22
 
5.11
No Event of Default
22
 
5.12
Insurance
22
 
5.13
ERISA Plans
23
 
5.14
Subsidiaries
23
 
5.15
Margin Regulations; Investment Company Act; Public Utility Holding Company Act
23
 
5.16
Disclosure
24
 
5.17
Compliance with Laws
24
 
5.18
Intellectual Property; Licenses, Etc
24
 
5.19
Government Sanctions
24
 
ii
 

 
 
TABLE OF CONTENTS
 
(continued)
 
ARTICLE VI
COVENANTS
25
 
6.01
Use of Proceeds
25
 
6.02
Financial and Other Information
25
 
6.03
Tangible Net Worth
27
 
6.04
Maximum Leverage Ratio
27
 
6.05
Notices to Bank
27
 
6.06
Maintenance of Assets
28
 
6.07
Insurance
28
 
6.08
Compliance with Laws
28
 
6.09
Books and Records
28
 
6.10
Audits
28
 
6.11
Cooperation
28
 
6.12
Additional Guarantors
28
 
6.13
Bank as Principal Depository
29
 
6.14
Payment of Obligations
29
 
6.15
Preservation of Existence
29
 
6.16
Restricted Payments
30
 
6.17
Liens
30
 
6.18
Indebtedness
31
 
6.19
Dispositions
32
 
6.20
Investments
33
 
6.21
Loans
34
 
6.22
Change in Nature of Business
34
 
6.23
Transactions with Affiliates
34
 
6.24
Burdensome Agreements
34
 
6.25
Change of Ownership
35
 
6.26
Additional Negative Covenants
35
 
6.27
Acquisitions
35
 
iii
 

 
 
TABLE OF CONTENTS
 
(continued)
 
ARTICLE VII
DEFAULT AND REMEDIES
36
 
7.01
Remedies Upon Default
36
 
7.02
Failure to Pay
37
 
7.03
Specific Covenants
37
 
7.04
Other Covenants
37
 
7.05
Representations and Warranties
37
 
7.06
Other Bank Agreements
37
 
7.07
Cross-default
37
 
7.08
Bankruptcy/Receivers
38
 
7.09
Inability to Pay Debts; Attachment
38
 
7.10
ERISA Plans
38
 
7.11
Judgments
38
 
7.12
Invalidity of Loan Documents
38
 
7.13
Change of Control
38
 
7.14
Material Adverse Effect
39
 
7.15
Government Action
39
       
ARTICLE VIII
ENFORCING THIS AGREEMENT; MISCELLANEOUS
39
 
8.01
GAAP
39
 
8.02
Governing Law
39
 
8.03
Venue and Jurisdiction
39
 
8.04
Successors and Assigns
40
 
8.05
Dispute Resolution Provision
40
 
8.06
Severability; Waivers
45
 
8.07
Expenses
45
 
8.08
Set-Off
46
 
8.09
One Agreement
46
 
8.10
Notices
46
 
8.11
Headings
46
 
8.12
Counterparts
46
 
8.13
Customary Advertising Material
47
 
8.14
Amendment and Restatement of Prior Agreement
47
 
8.15
Amendments
47
  8.16  Treatment of Certain Information; Confidentiality   47

iv
 

 
 
AMENDED AND RESTATED CREDIT AGREEMENT
 

 
This Amended and Restated Credit Agreement dated as of August 6, 2014 (the “ Agreement ”), is between Bank of America, N.A. (the “ Bank ”) and NIC INC. , a Delaware corporation (the “ Borrower ”).
 
Borrower has requested that Bank provide a revolving credit facility, and the Bank is willing to do so on the terms and conditions set forth in this Agreement.
 
In consideration of the mutual covenants and agreements contained in this Agreement, the parties agree as follows:
 
ARTICLE I
DEFINITIONS AND ACCOUNTING TERMS
 
1.01   Defined Terms.   As used in this Agreement, the following terms shall have the meanings set forth below:
 
AAA ” has the meaning set forth in Section 8.05(c)(ii).
 
Acquisition ”  means any transaction or series of related transactions for the purpose of or resulting, directly or indirectly, in (a) the  acquisition by  a Loan Party of all or substantially all of the assets of a Person, or of any line of business or division of a Person, or (b) the acquisition by a Loan Party of more than 50% of the Equity Interests of any Person (other  than a Person that is already a Subsidiary of such Loan Party), or otherwise causing any Person to become a Subsidiary of such Loan Party, or (c) a merger or consolidation or any other combination by a Loan Party with another Person (other than a Person that is a Loan Party); provided that (i) the Loan Party is the surviving entity or (ii) after giving effect to such merger or consolidation, such other Person has become a Loan Party; provided further that in no event shall the formation or establishment of a Subsidiary that becomes a Loan Party or the capitalization of or transfer to such Subsidiary that becomes a Loan Party of any existing assets or business of any Loan Party constitute an Acquisition.
 
Act ” has the meaning set forth in Section 8.05(c)(i).
 
Affiliate ” means, with respect to any Person, another Person that directly or indirectly, through one or more intermediaries, Controls or is Controlled by or is under common Control with the Person specified.
 
 
1

 
 
Applicable Rate ” means, from time to time, the following percentages per annum, based upon the Leverage Ratio, as set forth in the most recent Compliance Certificate received by the Bank as required in Article VI.
 
Pricing Level
Leverage Ratio
LIBOR Rate +
Letter of Credit
Prime Rate +
1
< 1.25:1.00
1.50%
0.0%
2
> 1.25:1.00
1.75%
0.0%
 
The Applicable Rate shall be in effect from the date the most recent Compliance Certificate or financial statement is received by the Bank until the date the next Compliance Certificate or financial statement is received; provided , however , that if the Borrower fails to timely deliver the next Compliance Certificate or financial statement, the Applicable Rate from the date such Compliance Certificate or financial statement was due until the date such Compliance Certificate or financial statement is received by the Bank shall be the highest pricing level set forth above.
 
If, as a result of any restatement of or other adjustment to the financial statements of the Borrower or for any other reason, the Borrower or the Bank determines that (i) the financial test as calculated by the Borrower as of any applicable date was inaccurate and (ii) a proper calculation of the financial test would have resulted in higher pricing for such period, the Borrower shall immediately and retroactively be obligated to pay to the Bank an amount equal to the excess of the amount of interest and fees that should have been paid for such period over the amount of interest and fees actually paid for such period.  The Bank’s acceptance of payment of such amounts will not constitute a waiver of any default under this Agreement.  The Borrower’s obligations under this paragraph shall survive the termination of this Agreement and the repayment of all other obligations.
 
Authorized Individual ” has the meaning set forth in Section 3.03.
 
Availability Period ” means the period from the date of this Agreement until the Maturity Date, or such earlier date as the availability may terminate as provided in this Agreement.
 
Banking Days   mean a day other than a Saturday, Sunday or other day on which commercial banks are authorized to close, or are in fact closed, in the state where the Bank's lending office is located , and, if such day relates to (i) amounts bearing interest at an offshore rate (if any), means any such day on which dealings in dollar deposits are conducted among banks in the offshore dollar interbank market, and (ii) any LIBOR Rate Loan, means any such day that is also a London Banking Day.  All payments and disbursements which would be due or which are received on a day which is not a banking day will be due or applied, as applicable, on the next banking day.
 
 
2

 
 
Change of Control ” means, with respect to any Person, an event or series of events by which:
 
(a)           any “person” or “group” (as such terms are used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, but excluding any employee benefit plan of such person or its subsidiaries, and any person or entity acting in its capacity as trustee, agent or other fiduciary or administrator of any such plan) becomes the “beneficial owner” (as defined in Rules 13d-3 and 13d-5 under the Securities Exchange Act of 1934, except that a person or group shall be deemed to have “beneficial ownership” of all securities that such person or group has the right to acquire, whether such right is exercisable immediately or only after the passage of time (such right, an “option right”)), directly or indirectly, of 50% or more of the equity securities of such Person entitled to vote for members of the board of directors or equivalent governing body of such Person on a fully-diluted basis (and taking into account all such securities that such person or group has the right to acquire pursuant to any option right);
 
(b)           during any period of 24 consecutive months, a majority of the members of the board of directors or other equivalent governing body of such Person cease to be composed of individuals (i) who were members of that board or equivalent governing body on the first day of such period, (ii) whose election or nomination to that board or equivalent governing body was approved by individuals referred to in clause (i) above constituting at the time of such election or nomination at least a majority of that board or equivalent governing body or (iii) whose election or nomination to that board or other equivalent governing body was approved by individuals referred to in clauses (i) and (ii) above constituting at the time of such election or nomination at least a majority of that board or equivalent governing body (excluding, in the case of both clause (ii) and clause (iii), any individual whose initial nomination for, or assumption of office as, a member of that board or equivalent governing body occurs as a result of an actual or threatened solicitation of proxies or consents for the election or removal of one or more directors by any person or group other than a solicitation for the election of one or more directors by or on behalf of the board of directors); or
 
(c)           any individual(s) or entity(s) acting in concert shall have acquired by contract or otherwise, or shall have entered into a contract or arrangement that, upon consummation thereof, will result in its or their acquisition of the power to exercise, directly or indirectly, a controlling influence over the management or policies of such Person, or control over the equity securities of such Person entitled to vote for members of the board of directors or equivalent governing body of such Person on a fully-diluted basis (and taking into account all such securities that such individual(s) or entity(s)  or group has the right to acquire pursuant to any option right) representing 50% or more of the combined voting power of such securities.
 
Claim ” has the meaning set forth in Section 8.05(a).
 
 
3

 
 
Class Action Waiver ” has the meaning set forth in Section 8.05(e).
 
Code ” means the Internal Revenue Code of 1986, as amended.
 
Commitment ” has the meaning set forth in Section 2.01(a).
 
Compliance Certificate ” has the meaning set forth in Section 6.02(f).
 
Control ” means the possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of a Person, whether through the ability to exercise voting power, by contract or otherwise.  “ Controlling ” and “ Controlled ” have meanings correlative thereto.
 
Default ” means any event or condition that constitutes an Event of Default or that, with the giving of notice, the passage of time, or both, would be an Event of Default.
 
Default Rate ” means an interest rate equal to 2.0 percentage point(s) higher than the rate of interest otherwise provided under this Agreement.
 
Designated Account ” has the meaning set forth in Section 3.04.
 
Disposition ” or “ Dispose ” means the sale, transfer, license, lease or other disposition (including any sale and leaseback transaction) of any property by any Person, including any sale, assignment, transfer or other disposal, with or without recourse, of any notes or accounts receivable or any rights and claims associated therewith.
 
EBITDA ” means, for any period, an amount equal to net income (less income or plus loss for such period from discontinued operations and extraordinary items) plus (i) amounts deducted in the computation thereof for (a) income taxes, (b) interest expense, (c) depreciation, depletion or amortization and (d) other non-cash expenses, losses or charges (including, without limitation, non-cash expenses for recognized pursuant to Financial Accounting Standards Board Statement No. 123(R) (Share-Based Payments), but excluding any accounts receivable or inventory write-offs); provided that if any such non-cash expense becomes a cash charge in a future period, EBITDA will be adjusted by the amount of such cash charge, and minus (ii) all non-cash items added in the computation thereof.
 
ERISA ” means the Employee Retirement Income Security Act of 1974, as amended.
 
ERISA Affiliate ” means any trade or business (whether or not incorporated) under common control with the Borrower within the meaning of Section 414(b) or (c) of the Code.
 
Equity Interests ” means, with respect to any Person, all of the shares of capital stock of (or other ownership or profit interests in) such Person, all of the warrants, options or other rights for the purchase or acquisition from such Person of shares of capital stock of (or other ownership or profit interests in) such Person, all of the securities convertible into or exchangeable for shares of capital stock of (or other ownership or profit interests in) such Person or warrants, rights or options for the purchase or acquisition from such Person of such shares (or such other interests), and all of the other ownership or profit interests in such Person (including partnership, member or trust interests therein), whether voting or nonvoting, and whether or not such shares, warrants, options, rights or other interests are outstanding on any date of determination.
 
 
4

 
 
Eurocurrency Liability ” has the meaning set forth in Section 3.08(e).
 
Event of Default ” has the meaning set forth in Section 7.01.
 
GAAP ” means generally accepted accounting principles in the United States set forth in the opinions and pronouncements of the Accounting Principles Board and the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board or such other principles as may be approved by a significant segment of the accounting profession in the United States, that are applicable to the circumstances as of the date of determination, consistently applied.
 
Governing Law State ” has the meaning set forth in Section 8.02.
 
Guarantee ” means, as to any Person, any (a) any obligation, contingent or otherwise, of such Person guaranteeing or having the economic effect of guaranteeing any Indebtedness or other obligation payable or performable by another Person (the “ primary obligor ”) in any manner, whether directly or indirectly, and including any obligation of such Person, direct or indirect, (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such Indebtedness or other obligation, (ii) to purchase or lease property, securities or services for the purpose of assuring the obligee in respect of such Indebtedness or other obligation of the payment or performance of such Indebtedness or other obligation, (iii) to maintain working capital, equity capital or any other financial statement condition or liquidity or level of income or cash flow of the primary obligor so as to enable the primary obligor to pay such Indebtedness or other obligation, or (iv) entered into for the purpose of assuring in any other manner the obligee in respect of such Indebtedness or other obligation of the payment or performance thereof or to protect such obligee against loss in respect thereof (in whole or in part), or (b) any Lien on any assets of such Person securing any Indebtedness or other obligation of any other Person, whether or not such Indebtedness or other obligation is assumed by such Person (or any right, contingent or otherwise, of any holder of such Indebtedness to obtain any such Lien); provided , that Guarantee ” shall not include obligations relating to the endorsement of checks, drafts or other items for collection in the ordinary course of business.  The amount of any Guarantee shall be deemed to be an amount equal to the stated or determinable amount of the related primary obligation, or portion thereof, in respect of which such Guarantee is made or, if not stated or determinable, the maximum reasonably anticipated liability in respect thereof as determined by the guaranteeing Person in good faith.  The term “ Guarantee ” as a verb has a corresponding meaning.
 
 
5

 
 
Guarantor ” means, collectively, (a) the initial Guarantors listed on Schedule 1.01; (b) each Material Subsidiary that hereafter becomes a party to the Guaranty in accordance with Section 6.12; and (c) each Non-Material Subsidiary that now or hereafter elects to become a party to the Guaranty provided that such Non-Material Subsidiary delivers to the Bank any required documents or favorable opinions of counsel to such Non-Material Subsidiary (which shall cover, among other things, the legality, validity, binding effect and enforceability of the Guaranty), all in form, content and scope reasonably satisfactory to the Bank.
 
Guaranty ” means the Guaranty made by the Guarantors in favor of the Bank, in form and substance reasonably satisfactory to the Bank.
 
Increase Effective Date ” has the meaning set forth in Section 2.05.
 
Indebtedness ” means, as to any Person at a particular time, without duplication, all of the following, whether or not included as indebtedness or liabilities in accordance with GAAP:
 
(a)           all obligations of such Person for borrowed money and all obligations of such Person evidenced by bonds (other than performance bonds obtained in the ordinary course of business), debentures, notes, loan agreements or other similar instruments;
 
(b)           all direct or contingent obligations of such Person arising under letters of credit (including standby and commercial), bankers’ acceptances, bank guaranties, surety bonds and similar instruments (other than performance bonds obtained in the ordinary course of business);
 
(c)           all obligations of such Person to pay the deferred purchase price of property or services (other than (i) trade accounts payable in the ordinary course of business and, in each case, not past due for more than 60 days after the due date that was set when such trade payable or account payable was created or (ii) expenses accrued in the ordinary course of business);
 
(d)           indebtedness (excluding prepaid interest thereon) secured by a Lien on property owned or being purchased by such Person (including indebtedness arising under conditional sales or other title retention agreements), whether or not such indebtedness shall have been assumed by such Person or is limited in recourse;
 
(f)           capital leases;
 
(g)           all obligations of such Person to purchase, redeem, retire, defease or otherwise make any payment in respect of any Equity Interest in such Person or any other Person, valued, in the case of a redeemable preferred interest, at the greater of its voluntary or involuntary liquidation preference plus accrued and unpaid dividends; and
 
(h)           all Guarantees of such Person in respect of any of the foregoing.
 
For all purposes hereof, the Indebtedness of any Person shall include the Indebtedness of any partnership or joint venture (other than a joint venture that is itself a corporation or limited liability company) in which such Person is a general partner or a joint venturer, unless such Indebtedness is expressly made non-recourse to such Person.
 
 
6

 
 
Interest Payment Date ” means, (a) as to any LIBOR Rate Loan, the last day of each Interest Period applicable to such Loan and the Maturity Date; and (b) as to any Prime Rate Loan, the last Business Day of each March, June, September and December and the Maturity Date.
 
Interest Period ” has the meaning set forth in Section 2.01(e).
 
Investment ” means, as to any Person, any direct or indirect acquisition or investment by such Person, whether by means of (a) the purchase or other acquisition of capital stock or other securities of another Person, (b) a loan, advance or capital contribution to, Guarantee or assumption of debt of, or purchase or other acquisition of any other debt or equity participation or interest in, another Person, including any partnership or joint venture interest in such other Person and any arrangement pursuant to which the investor Guarantees Indebtedness of such other Person, or (c) the purchase or other acquisition (in one transaction or a series of transactions) of assets of another Person that constitute a business unit.  For purposes of covenant compliance, the amount of any Investment shall be the amount actually invested, without adjustment for subsequent increases or decreases in the value of such Investment.
 
LIBOR ” means, for any applicable Interest Period, the rate per annum equal to the London Interbank Offered Rate (or a comparable or successor rate which is approved by the Bank), as published by Bloomberg (or other commercially available source providing quotations of such rate as selected by the Bank from time to time) at approximately 11:00 a.m. London time two (2) London Banking Days before the commencement of the Interest Period, for U.S. Dollar deposits (for delivery on the first day of such Interest Period) with a term equivalent to such Interest Period.  If such rate is not available at such time for any reason, then the rate for that Interest Period will be determined by such alternate method as reasonably selected by the Bank.
 
LIBOR Rate ” means the interest rate determined by the following formula (all amounts in the calculation will be determined by the Bank as of the first day of the Interest Period):
 

 
LIBOR
(1.00 - Reserve Percentage)
 
LIBOR Rate Loan ” means a Loan that bears interest at the LIBOR Rate.
 
Letter of Credit ” has the meaning set forth in Section 2.05.
 
Leverage Ratio ” means, as of any date of determination, the ratio of (a) Total Funded Debt as of such date to (b) EBITDA for the period of the 12 months then ended.
 
 
7

 
 
Lien ” means any mortgage, pledge, hypothecation, assignment, deposit arrangement, encumbrance, lien (statutory or other), charge, or preference, priority or other security interest or preferential arrangement in the nature of a security interest of any kind or nature whatsoever (including any conditional sale or other title retention agreement, any easement, right of way or other encumbrance on title to real property, and any financing lease having substantially the same economic effect as any of the foregoing).
 
Line of Credit ” has the meaning set forth in Section 2.01(a).
 
Loan ” means any extension of credit under the Line of Credit, regardless of its Type.
 
Loan Documents ” means this Agreement, the Guaranty and any other documents or other agreements executed or required by this Agreement.
 
Loan Notice ” has the meaning set forth in Section 2.01(c).
 
Loan Parties ” means, collectively, Borrower and each Person (other than the Bank) executing a Loan Document including, without limitation, each Guarantor.
 
London Banking Day ” means a day on which banks in London are open for business and dealing in offshore dollars.
 
Material Adverse Effect ” means (a) a material adverse change in, or a material adverse effect upon, the operations, business, properties, liabilities (actual or contingent) or condition (financial or otherwise) or prospects of Borrower and its Subsidiaries taken as a whole; (b) a material impairment of the ability of the Borrower or any Material Subsidiary to perform its obligations under any Loan Document to which it is a party; or (c) a material adverse effect upon the legality, validity, binding effect or enforceability against any Loan Party of any Loan Document to which it is a party.
 
Material Subsidiary ” means a Subsidiary other than a Non-Material Subsidiary.
 
Maturity Date ” means May 1, 2016; provided , however , that if such date is not a Business Day, the Maturity Date shall be the next preceding Business Day.
 
Non-Material Subsidiary ” means a Subsidiary that (a) at no time during the then current fiscal year or the two then preceding fiscal years of the Borrower, constituted more than three percent (3%) of consolidated total assets (as shown on the Borrower's consolidated balance sheet) or (b) accounted for no more than three percent (3%) of the gross revenues of the Borrower and its Subsidiaries, determined on a consolidated basis, in respect of any one or more of the then preceding twelve (12) fiscal quarters of the Borrower or (c) accounted for no more than three percent (3%) of the EBITDA of the Borrower and its Subsidiaries, determined on a consolidated basis, in respect of any one or more of the then preceding twelve (12) fiscal quarters of the Borrower or (d) accounted for no more than three percent (3%) of the net income of the Borrower and its Subsidiaries, determined on a consolidated basis, in respect of any one or more of the then preceding twelve (12) fiscal quarters of the Borrower.
 
 
8

 
 
Obligations ” means all advances to, and debts, liabilities, obligations, covenants and duties of, any Loan Party arising under any Loan Document or otherwise with respect to any Loan or Letter of Credit, whether direct or indirect (including those acquired by assumption), absolute or contingent, due or to become due, now existing or hereafter arising and including interest and fees that accrue after the commencement by or against any Loan Party or any Affiliate thereof of any proceeding under any debtor relief laws naming such Person as the debtor in such proceeding, regardless of whether such interest and fees are allowed claims in such proceeding.
 
Party ” has the meaning set forth in Section 8.05(a).
 
Permitted Acquisition ” means an Acquisition by the Borrower or any other Loan Party of Persons and/ or assets where (i) no Default or Event of Default exists either before or after the proposed Permitted Acquisition, and (ii) the Persons or assets to be acquired are in (or used in) a business substantially related or incidental to those lines of business conducted by the Borrower and its Subsidiaries and the prior, effective written consent or approval of such Acquisition by the board of directors, executive committee or equivalent governing body, or the stockholders, as appropriate, of the other party or parties has been obtained, and would not be perceived by the Person or assets to be acquired as hostile in nature; provided , that , without the prior written consent of the Bank, the purchase price of any Acquisition (including assumed liabilities in connection with such Acquisition) will not exceed $3,000,000, and the aggregate purchase price of all Acquisitions until the Maturity Date (including assumed liabilities in connection with such Acquisitions) will not exceed $10,000,000.
 
Person ” means any natural person, corporation, limited liability company, trust, joint venture, association, company, partnership, governmental authority or other entity.
 
Plan ” means a plan within the meaning of Section 3(2) of ERISA maintained or contributed to by the Borrower or any ERISA Affiliate, including any multiemployer plan within the meaning of Section 4001(a)(3) of ERISA.
 
Prime Rate ” means the rate of interest publicly announced from time to time by the Bank as its Prime Rate.  The Prime Rate is set by the Bank based on various factors, including the Bank’s costs and desired return, general economic conditions and other factors, and is used as a reference point for pricing some loans.  The Bank may price loans to its customers at, above, or below the Prime Rate.  Any change in the Prime Rate shall take effect at the opening of business on the day specified in the public announcement of a change in the Bank's Prime Rate.
 
Prime Rate Loan ” means a Loan that bears interest at the Prime Rate.
 
Renewal Notice ” has the meaning set forth in Section 2.02.
 
 
9

 
 
Reserve Percentage ” means the total of the maximum reserve percentages for determining the reserves to be maintained by member banks of the Federal Reserve System for Eurocurrency Liabilities, as defined in Federal Reserve Board Regulation D, rounded upward to the nearest 1/100 of one percent.  The percentage will be expressed as a decimal, and will include, but not be limited to, marginal, emergency, supplemental, special, and other reserve percentages.
 
Restricted Payment ” means any dividend or other distribution (whether in cash, securities or other property) with respect to any capital stock or other Equity Interest of Borrower or any Subsidiary, or any payment (whether in cash, securities or other property), including any sinking fund or similar deposit, on account of the purchase, redemption, retirement, acquisition, cancellation or termination of any such capital stock or other Equity Interest or on account of any return of capital to Borrower’s stockholders, partners or members (or the equivalent Person thereof).
 
Restricted Subsidiary ” means a Subsidiary that is not a Guarantor.
 
Sanctions ” has the meaning set forth in Section 5.19.
 
Subordinated Liabilities ” means liabilities subordinated to the Borrower’s obligations to the Bank in a manner reasonably acceptable to the Bank.
 
Subsidiary ” of a Person means a corporation, partnership, joint venture, limited liability company, series of a limited liability company or other business entity of which a majority of the shares of securities or other interests having ordinary voting power for the election of directors or other governing body (other than securities or interests having such power only by reason of the happening of a contingency) are at the time beneficially owned, or the management of which is otherwise controlled, directly, or indirectly through one or more intermediaries, or both, by such Person.  Unless otherwise specified, all references herein to a “ Subsidiary ” or to “ Subsidiaries ” shall refer to a Subsidiary or Subsidiaries of Borrower.
 
Tangible Net Worth ” means the value of total assets (including leaseholds and leasehold improvements and reserves against assets but excluding goodwill, patents, trademarks, trade names, organization expense, unamortized debt discount and expense, capitalized or deferred research and development costs, deferred marketing expenses, and other like intangibles, and monies due from affiliates, officers, directors, employees, shareholders, members or managers) less total liabilities, including but not limited to accrued and deferred income taxes, but excluding the non-current portion of Subordinated Liabilities.
 
Threshold Amount ” means $1,000,000.00.
 
Total Funded Debt ” means all outstanding Indebtedness.
 
Type ” means, with respect to a Loan, its character as a LIBOR Rate Loan or a Prime Rate Loan.
 
 
10

 
 
ARTICLE II
LINE OF CREDIT AMOUNT AND TERMS
 
2.01   Line of Credit.
 
(a)   During the Availability Period, the Bank will provide a line of credit to the Borrower (the “ Line of Credit ”).  The amount of the Line of Credit (the “ Commitment ”) is Ten Million Dollars ($10,000,000.00).
 
(b)   This is a revolving line of credit. During the availability period, the Borrower may repay principal amounts and reborrow them.  The Borrower agrees not to permit the principal balance outstanding to exceed the Commitment.  If the Borrower exceeds this limit, the Borrower will immediately pay the excess to the Bank upon the Bank's demand.  Loans may be either LIBOR Rate Loans or Prime Rate Loans, as further provided herein.
 
(c)   The Borrower shall irrevocably request (i) a LIBOR Rate Loan (or conversion to or continuation of a LIBOR Rate Loan) no later than 12:00 noon central standard time on the London Banking Day preceding the day on which the LIBOR Rate will be set, as specified above, or (ii) a Prime Rate Loan on the requested date of any Prime Rate Loan.  Each telephonic notice by Borrower must be confirmed promptly by delivery to the Bank of a written loan notice (“ Loan Notice ”), appropriately completed and signed by an authorized officer of the Borrower.
 
(d)   Each borrowing of, conversion to or continuation of LIBOR Rate Loans shall be in a principal amount of $1,000,000.00 or a whole multiple of $250,000.00 in excess thereof.  Each borrowing of, conversion to or continuation of Prime Rate Loans shall be in a principal amount of $500,000.00 or a whole multiple of $100,000.00 in excess thereof.
 
(e)   The interest period during which the LIBOR Rate will be in effect will be one, two or three months (the “ Interest Period ”).  The first day of the Interest Period must be a London Banking Day.  The last day of the Interest Period and the actual number of days during the Interest Period will be determined by the Bank using the practices of the London inter-bank market.
 
(f)         Except as otherwise provided herein, a LIBOR Rate Loan may be continued or converted only on the last day of an Interest Period for such LIBOR Rate Loan.
 
(g)   The Bank shall promptly notify the Borrower of the interest rate applicable to any Interest Period for LIBOR Rate Loans upon determination of such interest rate.  At any time that Prime Rate Loans are outstanding, the Bank shall notify the Borrower of any change in Bank’s prime rate used in determining the Prime Rate promptly following the public announcement of such change.
 
 
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(i)   After taking into account all conversions from one Type to the other and all continuations of Loans as the same Type, there shall not be more than 3 Interest Periods in effect at any given time.
 
(h)   Each Loan Notice (whether telephonic or written) shall specify (A) the applicable Type and whether Borrower is requesting a new borrowing, a conversion of Loans from one Type to the other, or a continuation of Loans, as the case may be, (B) the requested date of the borrowing, conversion or continuation, as the case may be (which shall be a Banking Day), (C) the principal amount of Loans to be borrowed, converted or continued, and (D) if applicable, the duration of the Interest Period with respect thereto.  If the Borrower fails to specify a Type of Loan in a Loan Notice or if the Borrower fails to give a timely notice requesting a conversion or continuation, then the applicable Loans shall be made as, or converted to, Prime Rate Loans.  Any such automatic conversion to Prime Rate Loans shall be effective as of the last day of the Interest Period then in effect with respect to the applicable LIBOR Rate Loans.  If any Borrower requests a borrowing of, conversion to, or continuation of LIBOR Rate Loans in any such Loan Notice, but fails to specify an Interest Period, it will be deemed to have specified an Interest Period of one (1) month.
 
(i)   Upon satisfaction of any applicable conditions, the Bank shall make all funds available to the Borrower either by (i) crediting the account of the Borrower on the books of Bank with the amount of such funds or (ii) wire transfer of such funds, in each case in accordance with instructions provided to (and reasonably acceptable to) the Bank by the Borrower; provided , however , that if, on the date a Loan Notice is given by the Borrower, there are any unreimbursed drawings with respect to any Letters of Credit, the proceeds of such Loan, first, shall be applied to the payment in full of any such unreimbursed drawings, and second, shall be made available to the Borrower as provided above.
 
(j)   During the existence of an event of default under this Agreement, the Bank may terminate the availability of optional interest rates for Interest Periods commencing after such event of default occured.  During the existence of an Event of Default, no Loans may be requested as, converted to or continued as LIBOR Rate Loans without the consent of the Bank, and the Bank may demand that any or all of the outstanding LIBOR Rate Loans be converted immediately to Prime Rate Loans.
 
(k)   The Bank will have no obligation to accept an election for a LIBOR Rate Loan if any of the following described events has occurred and is continuing:
 
(i)        Dollar deposits in the principal amount, and for periods equal to the Interest Period, of a LIBOR Rate Loan are not available in the London inter-bank market;
 
(ii)       the LIBOR Rate does not accurately reflect the cost of a LIBOR Rate Loan; or
 
(iii)   adequate and reasonable means do not exist for determining the LIBOR Rate for any requested Interest Period.
 
 
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2.02   Availability Period.   The Availability Period for this Line of Credit will be considered renewed if and only if the Bank has sent to the Borrower a written notice of renewal for the Line of Credit (the “ Renewal Notice ”).  If this Line of Credit is renewed, it will continue to be subject to all the terms and conditions set forth in this Agreement except as modified by the Renewal Notice.  If this Line of Credit is renewed, the term “Maturity Date” shall mean the date set forth in the Renewal Notice as the Maturity Date and the same process for renewal will apply to any subsequent renewal of this Line of Credit .  A renewal fee may be charged at the Bank’s option.  The amount of the renewal fee will be specified in the Renewal Notice.
 
2.03   Repayment Terms.
 
(a)   The Borrower will pay interest on each Interest Payment Date.  No Loan will be converted to a different interest rate during the applicable Interest Period.
 
(b)   The Borrower will repay in full any principal, interest or other charges outstanding under this facility no later than the Maturity Date.
 
(c)   The Borrower may prepay the Loans in full or in part at any time without premium or penalty.  The prepayment will be applied to the most remote payment of principal due under this Agreement. provided that: (A) such notice must be received by the Bank not later than 9:00 a.m. (1) three (3) Banking Days prior to any date of prepayment of LIBOR Rate Loans and (2) on the date of prepayment of Prime Rate Loans; (B) any prepayment of LIBOR Rate Loans shall be in a principal amount of $1,000,000.00 or a whole multiple of $250,000.00 in excess thereof; and (C) any prepayment of Prime Rate Loans shall be in a principal amount of $500,000.00 or a whole multiple of $100,000.00 in excess thereof or, in each case, if less, the entire principal amount thereof then outstanding.  Each such notice shall specify the date and amount of such prepayment and the Type(s) of Loans to be prepaid and, if LIBOR Rate Loans are to be prepaid, the Interest Period(s) of such Loans.  If such notice is given by the Borrower, the Borrower shall make such prepayment and the payment amount specified in such notice shall be due and payable on the date specified therein.  Any prepayment of principal shall be accompanied by all accrued interest on the amount prepaid, together with any additional amounts required pursuant to Section 2.03(d).
 
(d)   The Borrower shall pay to the Bank, immediately upon demand, any losses, costs or expenses, including any loss of anticipated profits and any loss or expense arising from the liquidation or reemployment of funds obtained by it to maintain the Loans or from fees payable to terminate the deposits from which such funds were obtained, incurred by the Bank as a result of:
 
(i)   any continuation, conversion, payment or prepayment of a LIBOR Rate Loan on a day other than the last day of the Interest Period for such Loan (whether voluntary, mandatory, automatic, by reason of acceleration, or otherwise); or
 
 
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(ii)   any failure by the Borrower (for a reason other than the failure of such Lender to make a Loan) to prepay, borrow, continue or convert any LIBOR Rate Loan on the date or in the amount notified by the Borrower.
 
For purposes of calculating amounts payable by the Borrower to the Bank under this Section 2.03(d), the Bank shall be deemed to have funded each LIBOR Rate Loan made by it at the LIBOR Rate for such Loan by a matching deposit or other borrowing in the London interbank eurodollar market for a comparable amount and for a comparable period, whether or not such LIBOR Rate Loan was in fact so funded.  The Bank will deliver to Borrower a certificate setting forth the amount or amounts owed by Borrower to Bank under this Section 2.03(d), including reasonable detail to allow the Borrower to confirm such amount.
 
2.04   Interest Rate(s).
 
(a)   The interest rate is a rate per year equal to (i) the Bank's Prime Rate plus the Applicable Rate with respect to any Prime Rate Loan, or (ii) the LIBOR Rate plus the Applicable Rate with respect to any LIBOR Rate Loan.
 
(b)   Upon the occurrence of any default or after maturity or after judgment has been rendered on any obligation under this Agreement, all amounts outstanding under this Agreement, including any unpaid interest, fees, or costs, will at the option of the Bank bear interest at a Default Rate.  This may result in compounding of interest.  This will not constitute a waiver of any default.
 
2.05   Increase in Commitments.
 
(a)   Request for Increase .  Provided there exists no Default, upon notice to the Bank, the Borrower may from time to time, request an increase in the Commitment by an amount (for all such requests) not exceeding $40,000,000; provided that any such request for an increase shall be in a minimum amount of $5,000,000.  At the time of sending such notice, the Borrower shall specify the time period within which the Bank is requested to respond (which shall in no event be less than ten Business Days from the date of delivery of such notice to the Bank).
 
(b)   Effective Date and Allocations .  If the Commitment is increased in accordance with this Section, the Bank and the Borrower shall determine the effective date (the “ Increase Effective Date ”).
 
(c)   Conditions to Effectiveness of Increase .  As a condition precedent to such increase, the Borrower shall deliver to the Bank such legal opinions as the Bank may reasonably request and a certificate of the Borrower dated as of the Increase Effective Date signed by an authorized officer of the Borrower (x) certifying and attaching the resolutions adopted by the Borrower approving or consenting to such increase, and (y) certifying that, before and after giving effect to such increase, (A) the representations and warranties contained in Article V and the other Loan Documents are true and correct in all material respects on and as of the Increase Effective Date, except to the extent that such representations and warranties specifically refer to an earlier date, in which case they are true and correct as of such earlier date, and except that for purposes of this Section 2.05, the representations and warranties contained in Section 5.06 shall be deemed to refer to the most recent statements furnished pursuant to clauses (a) and (b), respectively, of Section 6.02, and (B) no Default exists.
 
 
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(d)   Conflicting Provisions .  This Section shall supersede any provisions in Section 8.15 to the contrary.
 
2.06   Letters of Credit.
 
(a)   As a subfacility under the Line of Credit, during the Availability Period, the Bank agrees from time to time to issue or cause an affiliate to issue commercial   and   standby letters of credit for the account of the Borrower (each, a “ Letter of Credit ” and collectively, “ Letters of Credit ”); provided however , that the aggregate drawn and undrawn amount of all outstanding Letters of Credit shall not at any time exceed Five Million Dollars ($5,000,000.00).  The form and substance of each Letter of Credit shall be subject to approval by the Bank, in its reasonable discretion. Each Letter of Credit shall be issued for a term not to exceed three hundred sixty-five (365) days, as designated by the Borrower; provided however , that no Letter of Credit shall have an expiration date more than three hundred sixty-five (365) days beyond the Maturity Date.
 
(b)   Standby letters of credit may include a provision providing that their expiry date will automatically be extended each year for an additional one year period unless the Bank delivers written notice to the contrary.
 
(c)   With respect to any Letters of Credit, the Borrower shall pay the Bank a fee for each Letter of Credit equal to the Applicable Rate times the daily amount available to be drawn under any Letter of Credit.  For purposes of computing the daily amount available to be drawn under any Letter of Credit, the amount of such Letter of Credit shall be determined in accordance with Section 2.05(d).  Letter of Credit fees shall be (i) due and payable on the first Banking Day after the end of each March, June, September and December, commencing with the first such date to occur after the issuance of such Letter of Credit, on the Letter of Credit expiration date and thereafter on demand and (ii) computed on a quarterly basis in arrears.
 
(d)   Unless otherwise specified herein the amount of a Letter of Credit at any time shall be deemed to be the stated amount of such Letter of Credit in effect at such time; provided , however , that with respect to any Letter of Credit that, by its terms provides for one or more automatic increases in the stated amount thereof, the amount of such Letter of Credit shall be deemed to be the maximum stated amount of such Letter of Credit after giving effect to all such increases, whether or not such maximum stated amount is in effect at such time.
 
 
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(e)   The undrawn amount of all Letters of Credit shall be reserved under the Line of Credit and such amount shall not be available for borrowings. Each Letter of Credit shall be subject to the additional terms and conditions of the Letter of Credit agreements, applications and any related documents reasonably required by the Bank in connection with the issuance of Letters of Credit. At the option of the Bank, any drawing paid under a Letter of Credit may be deemed an advance under the Line of Credit and shall be repaid by the Borrower in accordance with the terms and conditions of this Agreement applicable to such advances; provided however , that if advances under the Line of Credit are not available, for any reason, at the time any drawing is paid, then the Borrower shall immediately pay to the Bank the full amount drawn, together with interest from the date such drawing is paid to the date such amount is fully repaid by the Borrower, at the rate of interest applicable to advances under the Line of Credit. In such event the Borrower agrees that the Bank, in its sole discretion, may debit any account maintained by the Borrower with the Bank for the amount of any such drawing. The Borrower agrees to deposit in a cash collateral account with the Bank an amount equal to the aggregate outstanding undrawn face amount of all letters of credit which remain outstanding on the Maturity Date. The Borrower grants a security interest in such cash collateral account to the Bank. Amounts held in such cash collateral account shall be applied by the Bank to the payment of drafts drawn under such letters of credit and to the obligations and liabilities of the Borrower to the Bank, in such order of application as the Bank may in its sole discretion elect.
 
(f)   The following letters of credit are outstanding from the Bank for the account of the Borrower:
 
  Letter of Credit Number   Amount
       
 
PN SLC 00000003089150
$
158,148.00
 
OPN SLC 00000003101786
$
1,203,560.36
 
OPN SLC 00000003116664
$
40,344.00
 
As of the date of this Agreement, these letters of credit shall be deemed to be outstanding under this Agreement, and shall be subject to all the terms and conditions stated in this Agreement.
 
ARTICLE III
LOAN ADMINISTRATION AND FEES
 
3.01   Fees.   The Borrower will pay to the Bank the fees set forth on Schedule 3.01.
 
3.02   Collection of Payments .
 
(a)       Payments will be made by debit to a deposit account, if direct debit is provided for in this Agreement or is otherwise authorized by the Borrower.  For payments not made by direct debit, payments will be made by mail to the address shown on the Borrower’s statement, or by such other method as may be permitted by the Bank.
 
 
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(b)   Each disbursement by the Bank and each payment by the Borrower will be evidenced by records kept by the Bank which will, absent manifest error, be conclusively presumed to be correct and accurate and constitute an account stated between the Borrower and the Bank.
 
3.03   Borrower’s Instructions .    Subject to the terms, conditions and procedures stated elsewhere in this Agreement, the Bank may honor instructions for advances or repayments and any other instructions under this Agreement given by the Borrower (if an individual), or by any one of the individuals the Bank reasonably believes is authorized to sign loan agreements on behalf of the Borrower, or any other individual(s) designated by any one of such authorized signers (each an “Authorized Individual”).  The Bank may honor any such instructions made by any one of the Authorized Individuals, whether such instructions are given in writing or by telephone, telefax or Internet and intranet websites designated by the Bank with respect to separate products or services offered by the Bank.
 
3.04   Direct Debit .  The Borrower agrees that on the due date of any amount due under this Agreement, the Bank will debit the amount due from deposit account number 3473768853 owned by the Borrower, or such other of the Borrower’s accounts with the Bank as designated in writing by the Borrower (the “ Designated Account ”). Should there be insufficient funds in the Designated Account to pay all such sums when due, the full amount of such deficiency shall be immediately due and payable by the Borrower.
 
3.05   Interest Calculation .  Except as otherwise stated in this Agreement, all interest and fees, if any, will be computed on the basis of a 360-day year and the actual number of days elapsed.  This results in more interest or a higher fee than if a 365-day year is used.  Installments of principal which are not paid when due under this Agreement shall continue to bear interest until paid.
 
3.06   Illegality .  If the Bank determines that any law has made it unlawful, or that any governmental authority has asserted that it is unlawful, for the Bank to make, maintain or fund Loans whose interest is determined by reference to the LIBOR Rate, or to determine or charge interest rates based upon the LIBOR Rate, or any governmental authority has imposed material restrictions on the authority of the Bank to purchase or sell, or to take deposits of, U.S. Dollars in the London interbank market, then, on notice to the Borrower, any obligation of the Bank to make or continue LIBOR Rate Loans or to convert Prime Rate Loans to LIBOR Rate Loans shall be suspended until the Bank notifies the Borrower that the circumstances giving rise to such determination no longer exist.  Upon receipt of such notice, the Borrower shall, upon demand from the Bank, prepay or, if applicable, convert all LIBOR Rate Loans to Prime Rate Loans, either on the last day of the Interest Period therefor, if the Bank may lawfully continue to maintain such LIBOR Rate Loans to such day, or immediately, if the Bank may not lawfully continue to maintain such LIBOR Rate Loans until the Bank is advised in writing that it is no longer illegal to determine or charge interest rates based upon the LIBOR Rate.  Upon any such prepayment or conversion, the Borrower shall also pay accrued interest on the amount so prepaid or converted.
 
 
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3.07   Inability to Determine Rates .  If the Bank determines that for any reason in connection with any request for a LIBOR Rate Loan or a conversion to or continuation thereof that (a) U.S. Dollar deposits are not being offered to banks in the London interbank eurodollar market for the applicable amount and Interest Period of such LIBOR Rate Loan, (b) adequate and reasonable means do not exist for determining the LIBOR Rate for any requested Interest Period with respect to a proposed LIBOR Rate Loan, or (c) the LIBOR Rate for any requested Interest Period with respect to a proposed LIBOR Rate Loan does not adequately and fairly reflect the cost to the Bank of funding such Loan, the Bank will promptly so notify the Borrower.  Thereafter, the obligation of the Bank to make or maintain LIBOR Rate Loans shall be suspended until the Bank revokes such notice.  Upon receipt of such notice, the Borrower may revoke any pending request for a borrowing of, conversion to or continuation of LIBOR Rate Loans or, failing that, will be deemed to have converted such request into a request for a borrowing of Prime Rate Loans in the amount specified therein.
 
3.08   Increased Costs .
 
(a)   If any change in law shall: (i) impose, modify or deem applicable any reserve, special deposit, compulsory loan, insurance charge or similar requirement against assets of, deposits with or for the account of, or credit extended by the Bank; (ii) subject the Bank to any taxes on the Loans, any principal balance, Letters of Credit, commitments, or other obligations, or its deposits, reserves, other liabilities or capital attributable thereto; or (iii) impose on the Bank or the London interbank market any other condition, cost or expense affecting this Agreement or LIBOR Rate Loans made by the Bank or any Letter of Credit; and the result of any of the foregoing shall be to increase the cost to the Bank of making, converting to, continuing or maintaining any Loan the interest on which is determined by reference to the LIBOR Rate (or of maintaining its obligation to make any such Loan), or to increase the cost to the Bank of issuing or maintaining any Letter of Credit, or to reduce the amount of any sum received or receivable by the Bank hereunder (whether of principal, interest or any other amount) then, upon request of the Bank, the Borrower will pay the Bank such additional amount or amounts as will compensate the Bank for such additional costs incurred or reduction suffered.
 
(b)   If the Bank determines that any change in law affecting the Bank regarding capital or liquidity requirements has or would have the effect of reducing the rate of return on the Bank’s capital as a consequence of this Agreement, the commitments of such Bank or the Loans made by, or Letters of Credit held or issued by, the Bank, to a level below that which the Bank would have achieved but for such change in law (taking into consideration the Bank’s policies and the policies with respect to capital adequacy), then from time to time the Borrower will pay to the Bank such additional amount or amounts as will compensate the Bank for any such reduction suffered.
 
 
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(c)   A certificate of the Bank setting forth the amount or amounts necessary to compensate the Bank as specified in Subsection (a) or (b) of this Section, including reasonable detail to allow the Borrower to confirm such amount, and delivered to the Borrower shall be conclusive absent manifest error.  The Borrower shall pay the Bank the amount shown as due on any such certificate within ten (10) days after receipt thereof.
 
(d)   Failure or delay on the part of the Bank to demand compensation pursuant to the foregoing provisions of this shall not constitute a waiver of the Bank’s right to demand such compensation, provided that the Borrower shall not be required to compensate the Bank pursuant to the foregoing provisions of this Section for any increased costs incurred or reductions suffered more than nine (9) months prior to the date that the Bank notifies the Borrower of the change in law giving rise to such increased costs or reductions and of the Bank’s intention to claim compensation therefor (except that, if the change in law giving rise to such increased costs or reductions is retroactive, then the nine (9) month period referred to above shall be extended to include the period of retroactive effect thereof).
 
(e)   The Borrower shall pay to the Bank, as long as the Bank shall be required to maintain reserves with respect to liabilities or assets consisting of or including eurodollar funds or deposits (currently known as “ Eurocurrency liabilities ”), additional interest on the unpaid principal amount of each LIBOR Rate Loan equal to the actual costs of such reserves allocated to such Loan by the Bank (as determined by the Bank in good faith, which determination shall be conclusive), which shall be due and payable on each date on which interest is payable on such Loan, provided the Borrower shall have received at least ten (10) days’ prior notice of such additional interest or costs from the Bank.  If the Bank fails to give notice ten (10) days prior to the relevant payment date, such additional interest shall be due and payable ten (10) days from receipt of such notice.
 
3.09   Compensation for Losses .  Upon demand of the Bank, the Borrower shall promptly compensate and hold the Bank harmless from any loss, cost or expense incurred by it as a result of:
 
(a)   any continuation, conversion, payment or prepayment of any Loan other than a Prime Rate Loan on a day other than the last day of the Interest Period for such Loan (whether voluntary, mandatory, automatic, by reason of acceleration, or otherwise); or
 
(b)   any failure by the Borrower to prepay, borrow, continue or convert any Loan other than a Prime Rate Loan on the date or in the amount notified by the Borrower;