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Cardtronics, Inc. (NASDAQ:CATM)

Q1 2010 Earnings Call Transcript

April 29, 2010 5:00 pm ET

Executives

Melissa Schultz – IR

Steve Rathgaber – CEO

Rick Updyke – President, Global Development

Mike Clinard – President, Global Services

Chris Brewster – CFO

Analysts

Andrew Jeffrey – SunTrust

Chris Mammone – Deutsche Bank

Bob Napoli – Piper Jaffray

Jeremy Frazer – William Blair

Reggie Smith – JPMorgan

Josh Elving – Feltl & Company

Operator

Good day, ladies and gentlemen, and thank you for standing by. And welcome to the Cardtronics first quarter earnings conference call. Currently, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions for audio questions will be given at that time. (Operator instructions) And now I’d like to turn the program over to our presenter, Melissa Schultz. Ma’am, please go ahead.

Melissa Schultz

Thank you, operator. Good afternoon, everyone, and welcome to Cardtronics first quarter conference call. On the call today are Steve Rathgaber, our Chief Executive Officer; Mike Clinard, our President of Global Services; Rick Updyke, our President of Global Development; and Chris Brewster, our Chief Financial Officer. Our prepared remarks is scheduled to run for about 25 to 30 minutes, at which point we’ll open the call up for any questions that you may have.

Before we get started, I’d like to make the following cautionary statement regarding forward-looking information. During the course of this call, we will make certain forward-looking statements regarding future events, results, or performance. Any forward-looking statements made on this call are subject to risks and uncertainties, including but not limited to those outlined in our reports filed with the SEC. Actual events, results, or performance may differ materially. Any forward-looking statements are based on current information only and we assume no obligation to update those statements.

In addition, during the course of the call, we will reference certain non-GAAP financial performance measures. Our opinion regarding the usefulness of those measures together with a reconciliation of such measures is included in the press release issued this afternoon.

I’d now like to turn the call over to Steve Rathgaber, our CEO.

Steve Rathgaber

Thank you, Melissa. And let me add my welcome to all of you to the call. I first spoke to you as Cardtronics’ CEO back on February 11. At that time, I shared with you the reasons I joined the company. You may or may not recall that one of the key reasons of my enthusiastically joining the company was my sense that Cardtronics was a one-of-a-kind asset in the payment space and that it was poised to deliver on a significant potential.

Well, after almost 90 days of deep dive into the company, I’m extremely confident that my initial impressions were well founded. I believe the results of the first quarter are clear demonstration of the value of this unique ATM network franchise. One of the opportunities I was confronted with upon my arrival was the desire on the part of our two longstanding private equity partners to complete a secondary offering for a portion of their shareholdings.

In addition to the opportunity to accumulate a large amount of frequent flyer airline miles and see America from coast-to-coast, two wonderful benefits of any secondary road show, there was more importantly a great value enforcing a quick digestion of the Cardtronics story. The research for the road show was extremely productive for identifying our key strengths for detailing our unique business model and for crafting the near-term plans for driving revenue and an earnings growth, thereby creating additional shareholder value through meaningful leverage of our existing ATM networks.

The preparation yielded the story Chris and I told on a secondary road show in March, we identified six distinct tracks for rolling Cardtronics that we are driving to each day. These include, number one, to grow revenue from our existing premium locations at our key and generally exclusive national retailer relationships from both additional ATM placements and appropriately managed convenient fee increases.

Number two, to grow revenue by adding to our portfolio of premium merchants who provide the locations where folks do their daily shopping and living. Number three, to grow revenue and transactions at our ATMs by providing financial institutions the opportunity to place their brand on selected portions of our high-quality ATM fleet so that they can provide more convenient access for their customers and create more value for their own brand.

Number four, to grow participation in our Allpoint surcharge-free network by helping financial institutions of all sizes to compete with banks that have large ATM footprints. Number five, to grow revenues by providing managed services to fleets of ATMs that we typically do not own, thereby avoiding capital expenditures and deriving a fixed monthly revenue per ATM without concerns of transaction volume. And number six, to grow revenue to our international footprint by effective expansion of our current ATM at states in the UK and in Mexico.

So in summary, our near-term execution focus is to drive transactions to our ATM fleet through a portfolio of service offerings that accommodate the needs of essentially all card issuers at the locations we have the cardholders, the consumers that carry pinned ATM cards routinely go. We will continue our focus on providing value to the three constituencies that we serve; the retailer, the financial institution, and ultimately the consumer.

I am pleased to report that the secondary offering was greater than 400% over-subscribed. 28 million shares were requested for the 6 million that were part of the original offer at a price above the share price on a daily launch fee effort. In all, 98 institutions bought stock in the offering. We were told that it was the fifth best performing secondary measured in stock price before and after out of the last 1,000 offerings of this type. Well, I would love to take credit for the success. It is obvious to me and I suspect that all of you who are interested buyers that the credit goes to the asset that the team at Cardtronics has created.

And now, to fill you in on the details and highlights of our first quarter performance, I will turn it over to that team, starting with Rick Updyke, our President of Global Development.

Rick Updyke

Thanks, Steve. Well, as you can clearly see, we had a great first quarter. Our adjusted EBITDA totaled $29.3 million, which represents an increase of over 30% when compared to the first quarter of 2009. From the top-line perspective, our revenues were up roughly 11%. But when you take out the impact of favorable foreign currency exchange rate movement, that growth rate was about 9%.

In terms of our core revenues, which include our domestic and international company-owned ATM placement business as well as our Allpoint network and bank branding businesses, the growth rates were 13% and 11% respectively. These growth rates are quite impressive and are clearly higher than the growth rate we saw throughout 2009. So that begs the question, why? Well, there are really three key reasons behind the improved performance, all of which tie into the revenue growth strategy that Steve just outlined.

Those reasons include growth from existing domestic merchants through continued strong transaction and revenue trends, growth in our bank branding and surcharge-free offerings primarily through the continued expansion of Allpoint, and growth through international expansion primarily through the deployment of additional units in the UK, Mexico and the Caribbean.

Let me talk briefly to each of these factors. In terms of growth with our existing merchant customers here in the US, what we saw was really a continuation of the strong transaction trends that we experienced in 2009. However, on top of that, we also experienced some nice gains resulting from higher revenues per transaction as a result of some surcharge rate increases that we’ve recently put in place. As you know, we have the strategy for both, the surcharge-free or fee-avoiding market and the surcharging or convenience fee accepting market.

With respect to the latter, the cost of that convenience has been steadily raising over the past few years, as evidenced by the large domestic banks raising their convenience fees to $3, if not more. I should point out that we are not looking to go straight to $3 across the board. But we do believe that the demonstrated value of our convenient locations and strong brand should bring us closer over-time to the surcharge rates that the large banks charge.

So if you take a look at our domestic surcharge revenue, they were actually up year-over-year, which compares to the flattish to slightly declining trend that we’ve seen over the past couple of years. Now, while we are pleased with the results that we’ve seen from these recent surcharge rate changes, it’s important to point out that it’s still very early on in the process. As a result, we will continue to closely monitor the impact these increases have on our long-term transaction trends. However, the early turns do appear to suggest that the trade-off between price and volume has been beneficial to us.

Regarding our existing merchant customers, we were informed during the quarter that one of our regional petroleum retail customers with about 470 locations will not be renewing their contract, which expires this month. Instead, they chose a banking partner with whom they have had a longstanding relationship. Based on its size and the fact that it doesn’t impact our national footprint, this won’t have any material impact on us moving forward, as you will see from Chris’s discussion regarding our future guidance.

In terms of our bank branding and surcharge-free revenue growth, we continued to see some very nice year-over-year revenue gains in that aspect of our business, much of which came from Allpoint. To give you a feel for the growth that we’ve seen in that business, the number of Allpoint transactions conducted on our network of ATMs increased 72% from the first quarter last year to the first quarter this year. But I think it’s clear why we are optimistic about the growth prospects for that aspect of our business.

On the bank branding front, we’ve recently come to agreement with two existing branding customers to brand an additional 350 currently installed ATMs and we continue to add new prospects to a promising pipeline of potential new deals. However, to be perfectly clear, the decision process is still slower than what we’d like to see at this point. Regardless, we are continuing to work on getting the additional 7,000 or so unbranded company-owned locations in the US branded and look forward to having more positive updates for you in that regard in the future.

Internationally, we saw some very nice year-over-year revenue growth, primarily in the form of higher surcharge revenues from positive units in transaction growth in Mexico and higher interchange revenues in the UK, primarily due to an increase in the number of deployed free-to-use ATMs in that market.

On the topic of interchange revenues, one of the global network brands recently decided to reduce the interchange rate it pays to domestic ATM deployers. The decrease, which will result in a net reduction of about 25% in the interchange fees earned by us for transactions were added to this particular network, became effective in April and did not impact our first quarter results.

Looking ahead, we estimate that this could reduce our EBITDA by about $1.5 million over the last three quarters of 2010. We view this as business as usual and are accustomed to these types of changes. Consequently, we allowed for this in our previous guidance and of course in our current guidance.

Finally, we did recently announce a couple of new managed services deals, including one with Travelex, which I’d like to touch on briefly. Under the terms of that agreement, we will be providing comprehensive ATM management services for 85 domestic Travelex ATMs, including transaction processing, cash management, cash replenishment, monitoring, and maintenance.

The ATMs themselves will continue to be owned by Travelex and include both dollar dispensing and foreign currency dispensing ATMs, which are located in high-traffic locations, including over a dozen major international airports in a variety of high profile, retail and business centers. While the Travelex deal in itself isn’t particularly large, it is with a very well known internationally recognized brand, which we believe will help further validate the managed services concept.

Our international – our managed services offering represents a great opportunity for us to leverage our core competencies and to diversify our revenue sources. As such, I expect you will be hearing more about these kinds of deals throughout the year as we continue to grow this aspect of our business and expand our network of managed ATMs and financial services kiosk.

So in wrapping up, we are quite pleased with the progress we’ve made to date. Clearly, we have more work ahead of us to ensure that we are leveraging our existing network and expertise to maximize to the extent possible in order to drive future revenue growth. That’s clearly our focus and one we will be updating you on throughout the course of the year.

At this point, I’d like to turn the call over to Mike Clinard.

Mike Clinard

Thanks, Rick. During the first quarter, we continued to show nice gains in many of our key operating metrics when compared to last year. You can find these statistics on the Key Operating Metrics page of this afternoon’s press release. In all, we had another greater quarter. Our total withdrawal transactions were up nearly 6% and our company-owned ATM count was up 3%. The 6% year-over-year growth is down slightly from what we saw in 2009, but we think that’s primarily due to surcharge fee increases we’ve put in place and the fact that weather in the first quarter, especially in the UK and here in the US, was much worse this year.

From a margin standpoint, our per-ATM operating gross profit per month increased over 25% from $316 in 2009 to nearly $400, or $396 to be exact, in 2010. As Rick discussed, much of the margin growth was due to strong year-over-year revenue growth we experienced. However, we also continue to enjoy benefits of some of the cost-savings we’ve secured in 2009, including the savings from the lower maintenance and armor grades that we negotiated here in the US last year.

We also continue to benefit from lower market interest rates, especially as it relates to our vault cash rental costs. However, as we’ve discussed on our last conference call, we did see an increase in those costs during the first quarter as a result of certain fixed rate hedges that we’ve put in place in the UK, beginning in January.

Domestically, we did have some incremental operating costs during the quarter related to the closure of one of our third-party armored service providers. As we’ve reported in our recent 10-K filing, in February, federal authorities seized the operations of one of our armor providers in the Northeast and arrested its founder and principle owner on fraud charges.

We had slightly more than $16 million of vault cash in their possession at the time of the seizure. It’s probable that some of that vault cash will be recovered from the cash seized by the federal authorities, and for any remaining shortfalls, we carry insurance to cover situations like this, and therefore we expect that this event will not have a material impact. We did incur roughly $400,000 in costs during the first quarter to transition the impact of ATMs to a new armor provider.

Turning now to some of our operational initiatives, we made very good progress on a number of critical projects during the first quarter. For example, we’ve made significant progress on converting the remaining 3,700 ATMs to our in-house ATM management and processing platform, all of which are 7-Eleven ATMs that were subject to a third-party managed services agreement assumed in that acquisition. Today, we’ve converted nearly 1,400 of these ATMs, and the remaining 2,300 should be fully converted by the end of August.

Internationally, we continued to make very good strides as well during the quarter. In the UK, for example, we continued to make progress on setting up our second armored cash depot and are still on track to have that depot become operational during the third quarter of this year. In Mexico, we’ve continued to see the benefits of scale as we deployed more ATMs on our existing platform there. We deployed over 270 ATMs in that market during the first quarter. And that was on top of 350 ATMs that we deployed in that market during the fourth quarter of last year. As a result, Mexico contributed significantly to our year-over-year increase in surcharge revenues.

Now looking ahead, we will continue to focus on our key operating initiatives, all of which are geared towards three primary objectives. First, we will continue to grow our number of devices, increase the size of our network. Secondly, we will continue to invest in our technology and infrastructure so that we can offer more services to financial institutions and retailers. And finally, we will continue to work on optimizing the efficiency of our existing platform to ensure that we remain one of the lowest cost and highest quality providers in the industry.

I’d like to now turn the call over to Chris Brewster, our CFO, who will provide some additional details on our financial results for the quarter and our expectations for the remainder of 2010.

Chris Brewster

Thanks, Mike. With regard to the quarter, our revenues for the quarter were at about $128 million. That was up roughly 11% from the $115 million that we generated in the same period last year. Gross margins were also up nicely again coming in at just over 31% compared to about 27% last year. If you take out the impact of favorable year-over-year foreign currency exchange rate changes, revenues would have been up about 9% as opposed to the 11% actually reported.

Much like last year, the growth we saw during the first quarter continued to come from the higher margin components of our business, namely the large US company-owned ATM and branding business as well as our international operations. In fact, these operations in the quarter represented about 85% of total revenues, and they generated gross margins of over 34%.

As I said, gross margins did increase by about 4 percentage points year-over-year. Now that rate of margin expansion is somewhat smaller than the 8 percentage points of margin growth that we saw during the second half of 2009. But I think that’s to be expected, as we are beginning to cycle on some of the substantial margin increases that we saw last year. If you look at this over time, gross margins were 22.6% in the March quarter of 2008. They grew by 4.5 percentage points to 27% in the March quarter of 2009 and that had grown by another 4 percentage points to 31% in the March quarter of 2010.

So to give you a little perspective around that 4 percentage point year-over-year gain in the current quarter, I believe that the major moving parts on that would include the following. First, we’ve got about 2 percentage points of benefit from lower maintenance and armored car costs, and most of that relates to vendor contracts that we renegotiated in the second quarter last year. Some is also related, I should say, though, to the outstanding job that our US cash management team using a new computer-based tool has been doing in the management of our domestic cash supply operations.

By going in the other direction, as Mike said, we did have a negative effect and it was worth about 100 basis points or 1% percentage point that arose from vault cash costs, arising largely from the fact that as for the first time we’ve put interest rate swaps in place to hedge about 75% of our vault cash cost in the UK.

Now the good news from that is we have taken this amount of exposure to floating interest rates and its related volatility out of our P&L, but this does come with the cost, as we are now priced on a three-year rate as opposed to a three-month rate, or in other words, as a matter of conservatism and risk management, we have moved out of ways on an upwardly sloping yield curve.

The remaining 300 basis points of margin increase can be attributed really to a combination of factors that are difficult to separate out discretely and specifically to revenue mix shifts, which is simply saying that we are seeing faster growth out of our higher margin revenue categories, some from the benefits of driving more transactions across a network with relatively low variable cost, commonly known as operating leverage. And we also have some benefit in margins from the surcharge price increases that we’ve put in place.

Moving down the P&L to SG&A costs, we did show a small year-over-year increase. A couple – some detail around that. In the first quarter of last year, we had about $1.2 million in expenses related to the departure of our former CEO. In the first quarter of this year, we had about $600,000 in additional costs that related to the legal accounting, printing and other costs related to the secondary stock offering that we’ve just concluded. If you strip out both of those items and you also take out stock comp expenses, SG&A increased about $450,000 year-over-year by about 5%.

So the net of all of those moving parts was a 30% year-over-year increase in adjusted EBITDA from about $22.5 million last year to $29.3 million this year. We’ve generated adjusted net income of $7.6 million or $0.19 a share for the quarter this year compared with $3.4 million or $0.09 a fully diluted share in the same period last year. One thing you may have noticed in the press release is that depreciation expense was up slightly year-over-year.

We made some changes effective the 1st of January in some of our asset lives and the effect of those will be to cause slightly higher depreciation expense in the quarter we just ended and on a go-forward basis. We modified the lives the ATMs and the related installation costs such that our ATMs will now be written off over eight years instead of seven, and the related installation costs will now be written off over five years instead of seven.

The rationale behind this was fairly simple. We found that our ATMs were lasting longer, in some cases considerably longer than we had originally estimated. However, we also found that in recent years we’ve de-installed ATMs and moved them to new locations with some frequency. As a result, we from time to time had the related installation costs to write off those write-offs, ran through P&L as losses on disposal of assets in the other income/expense line.

Under this new policy, while our total depreciation expense will be up somewhat because of the shorter lives for these installed costs, our overall P&L will be more predictable since we will essentially eliminate these one-time charges for gain and loss on disposal of assets in most cases. That has created some noise in the P&L in recent years.

Now, we could have some losses on disposals from time to time if we had, say, in a short period of time a significant number of de-installs. However, absent that, our P&L with somewhat higher depreciation and on a constant basis and fewer sporadic charges should be a steadier reflection of the basic reality for the business.

Turning to the balance sheet, debt at the end of March stood at $307 million. That was unchanged from year-end. That consisted of $297 million net of discount for our senior sub-notes, and about $10 million of debt under our Mexico equipment financing lines. We ended the quarter with no bank debt and about $10 million in cash on hand, which is essentially unchanged from year-end.

Since we generated almost $50 million in free cash flow last year, this begs a question of why was there no free cash flow in the first quarter of 2010. And the reason is that there is significant seasonality in our working capital situation in this business. During the quarter, we earned about $29 million in adjusted EBITDA; we paid about $14 million in cash in semi-annual bond interest payments that come due in the first and third quarters; and we paid about $6 million in seasonal working capital payments, including employee incentive pay-outs that are only paid in the first quarter.

So if you chart those payments out for the year, they total about $20 million in the first quarter, zero in the second quarter, $14 million in the third quarter, and zero in the fourth quarter. Consequently, we tend not to flow cash in the first quarter; we flow a lot of cash in the second and fourth quarters; and we flow some cash in the third quarter.

In short, there should be no concern over our not generating cash in the first quarter. This is quite normal given our working capital seasonality. I would expect to build cash balances in a meaningful way over the rest of the year. And in fact, we are already seeing this happen with cash balances today hovering around the $26 million mark.

From a liquidity standpoint, as you might imagine, we are in excellent shape. Our $175 million credit facility is still in place. It’s good until May of 2012. The only outstandings under it are about $4.5 million of letters of credit. So we’ve got about $171 million in available committed funding under that facility at this point in time.

So now turning to guidance. Based on the quarterly outperformance we saw in the first quarter, we thought it was appropriate to modify our guidance to some extent for the full year 2010. Our revenue guidance remains unchanged at $520 million to $530 million. We did increase guidance on percentage gross margins by 1 percentage point, now at a range of 31% to 31.5%. Adjusted EBITDA guidance was increased from a range of $118 million to $123 million to a range of $120 million to $125 million. In other words, up by $2 million on both ends of the range.

Depreciation and accretion expense was increased to $42 million, up from a range of $40 million to $41 million communicated on the last call, primarily due to the accounting change that I mentioned earlier. Cash interest expense is the same at $29.5 million. Guidance on adjusted net income at $0.75 to $0.85 per fully diluted share is unchanged, still based on approximately 41.5 million diluted shares outstanding. And capital expenditure at $45 million is unchanged. This guidance assumes exchange rates of $1.50 per UK pound and 12.5 Mexican pesos to the US dollar, which are somewhat different and down from the rates used at the beginning of the year, but more in line with today’s rates.

Given that we beat our estimates in the first quarter, some of you may be wondering why we didn’t dial even more optimism into this guidance. So I would like to give you a little color and flavor around our thinking here at the company. The first thing I’d say is that in the general case, the Street estimates had seasonalized our business a little differently over the four quarters than we would internally. In other words, our actual revenue results in the first quarter, while ahead of Street estimates, were actually quite close to our internal expectations. And our actual EBITDA results did beat our internal expectations, but not by as much as they beat Street estimates.

I think this is simply a reflection of the fact that our winter dip, if you will, the adverse seasonality we have from adverse weather in the wintertime might not be quite as bad in reality as the Street estimates may have anticipated. For the same – put differently, for the same level of full year profits, our internal projections compared to Street estimates might share a little bit more profit in the winter quarter and perhaps little less in the other three.

Second, as we said earlier on the call, we did have two negative events that occurred that were largely anticipated in our earlier guidance, but were not reflected in the first quarter results. But those will affect us from second quarter onwards. And those were the network interchange rate reduction that was discussed and the loss of the regional merchant customer in the US that was discussed. Said in other way, our first quarter profit results would still beat expectations if these had happened as of the beginning of the first quarter, but profits would not have been quite as strong if those events had occurred in the beginning of the quarter.

Third, you may – as I just said, we did change our exchange rate assumptions in the updated guidance. The move from the earlier assumption of $1.60 to the pound to our current assumption of $1.50 to the pound affects our projected annual revenues by over $5 million. Or in other words, absent the FX change, we might have raised our revenue guidance even with the knowledge of the two negative issues that I talked about a minute ago.

Fourth, one of the reasons we beat our profit forecast in Q1 is that we had planned for an increase in floating interest rates in vault cash costs and we have not seen any increase in floating interest rates yet. However, one quarter does not make the year and we are still anticipating that rates could begin to go up, as we get further into the year.

And lastly, I’d say that we do have some nice pieces for new businesses that are well along in our pipeline. But they aren’t signed yet. And we tend to give a lot more weight to what we know will happen as opposed to what we hope will happen when we are doing our forecasting. We’d like to see how this works out over the next few weeks and update you on this on our next call.

So in closing, we are quite encouraged by the good operating results that we saw from the business during the first quarter. We feel good about our ability to continue to deliver strong earnings and cash flow growth in the future. And we certainly hope that will continue to add additional value for our shareholders.

Operator, that concludes our prepared remarks. And we’d now like to take any questions that the callers may have.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) Our first question in queue comes from Andrew Jeffrey with SunTrust. Your line is now open.

Andrew Jeffrey – SunTrust

Hey, guys. Thanks for taking my question. The question is around ATM count. And I think you mentioned a couple of things or one event in particular I guess that affects the go-forward periods. But you kind of had roughly a flattish US company-owned first quarter. Could you address that a little bit as well as some of the trends you'd expect as the year progresses this year in the UK and Mexico?

Rick Updyke

I’ll take a shot at that, Andrew. A couple of things. If we are thinking in terms of year-over-year in that context, we have talked on prior calls about the fact that we terminated the contract with a regional merchant up in the Northeast back in the September quarter. That contract involved about 270 units. And that’s one of the reasons why the year-over-year trend in the US company-owned side of the business might look a little weaker year-over-year than it otherwise would. That’s the key thing that comes to mind.

Andrew Jeffrey – SunTrust

Okay. And then as far as the UK and the Mexico growth rates, should those remain pretty well intact? Mexico obviously had a very good quarter. Was there any pull forward?

Rick Updyke

I think that’s a reasonable assumption. We are on track for solid machine count growth in both of those markets.

Andrew Jeffrey – SunTrust

Okay. And with regard to CapEx, is the ramp as the year goes on here largely a seasonal effect or is there something we should read into that vis-à-vis new ATM rollout plans?

Rick Updyke

They are a little more weighted towards the second half.

Andrew Jeffrey – SunTrust

And that is traditionally the case?

Rick Updyke

And that’s one issue. The second issue, I would say, we did have about $7 million to $8 million of maintenance CapEx dialed into that number, which relates to the replacement of some of the older end of our fleet. And that’s also weighted somewhat later in the year.

Andrew Jeffrey – SunTrust

Okay. And if I may squeeze just one more in here. In light of the changes you're making to surcharges and in light of the Cirrus adjustment to interchange, should we continue to see the revenue mix move more towards surcharge this year on a per cash withdrawal transaction basis? Is that a reasonable assumption?

Rick Updyke

It will probably tend in that direction, although we have a fairly rapidly growing, what we call, free-to-use business over the UK where we basically don’t charge the consumer with the maintenance fee, but we do collect interchange on those transactions as our revenue source. And those machines tend to operate at pretty high volumes. So that will provide some offset in terms of the waiting of that in the consolidated numbers.

Steve Rathgaber

And I would add that we also have the Allpoint network where we set the interchange rate for the transactions, and as reported by Rick earlier, we’ve seen some substantial growth in the volumes there. So that would also mitigate.

Andrew Jeffrey – SunTrust

Okay. So the mix helps you out to some degree in that regard?

Steve Rathgaber

You bet.

Andrew Jeffrey – SunTrust

Okay. Thanks a lot.

Rick Updyke

Thank you.

Operator

Thank you, sir. Our next question in queue comes from Chris Mammone with Deutsche Bank. Your line is now open.

Chris Mammone – Deutsche Bank

Thanks. Chris Mammone here. Could you just maybe give us a little more flavor for the types of deals that are in the managed services pipeline? And just to be clear on guidance, are any of those deals contemplated in the 2010 ranges?

Rick Updyke

Yes, Chris. This is Rick. In terms of those deals that are in the pipeline, there are some retail opportunities there and it’s a mix really of retail and financial institution opportunities.

Chris Brewster

I think the way I would answer the question around guidance is whenever we are looking at a forecast, we tend to do a list of what could make it better, what could make it worse. And the reality tends to bring some of those our way over time. And I’d say these items are not explicitly in the forecast, if you will, there on that sort of side list that includes things that could make it better and things that could make it worse.

Chris Mammone – Deutsche Bank

Okay. And I guess, Chris, just maybe drawing on your comments on the floating interest rate assumption, I think that your guidance originally anticipated maybe an adverse $5 million impact from your assumptions on the curve there. Now that it's been extended out, I mean is it still sort of that same $5 million impact or has your thinking changed there for the full year?

Chris Brewster

It’s come down some. I mean, we didn’t see any in the – substantially none in the first quarter. And we continue to be somewhat conservative in that regard, Chris, that I wouldn’t say that we’ve kept – we certainly haven’t kept $5 million of presumption in the back three quarters.

Chris Mammone – Deutsche Bank

Okay. That's helpful. And then maybe just final question. Could you isolate the revenue growth impact from the surcharge increases for the quarter?

Chris Brewster

It’s tough to do. I mean, it’s a – for this – and I really hope you will hopefully believe I’m not trying to dodge your question, but it’s a mixed bag in the sense that we – logic would tell you that if we put in a surcharge price increase, we would probably see some effect on volume. We also have other things that effect volume in surcharge transaction volumes. That is when we sign a new bank branding deal, that’s a certain number of surcharge transactions that we’ll no longer be charging surcharge on or if we sign new Allpoint deal, that may be a certain number of surcharge transactions we no longer charge a surcharge on. So it is difficult for us to really give you a precise number on the impact on surcharge revenue of a pricing move.

Chris Mammone – Deutsche Bank

Okay. Thank you.

Operator

Thank you, sir. Our next question in queue comes from Bob Napoli with Piper Jaffray. Please go ahead.

Bob Napoli – Piper Jaffray

A question on – first on surcharge, when did you tweak up prices in surcharge and do you have a schedule of tweaks that you are going to make to surcharges, certain prices through the year?

Rick Updyke

Bob, this is Rick. We would up in a couple of different merchants early to – mid to latter part of the first quarter. And we don’t have a schedule per se very much as I mentioned, something that we want to proceed cautiously with from measuring the impact on our long-term transaction trends. So there is no set schedule.

Bob Napoli – Piper Jaffray

Okay. Second question, the 450 ATMs that – were they the regional player – were they company-owned or merchant-owned?

Steve Rathgaber

Company-owned, Bob.

Bob Napoli – Piper Jaffray

Okay. So what are you – what is the current game plan? When are you moving those ATMs and where are you moving them to?

Steve Rathgaber

The plan is to – we are transitioning out of those sites in May, de-installing them in May, and then we are going to use that equipment in – we plan on refurbishing that equipment like new and placing them in several other locations.

Bob Napoli – Piper Jaffray

And new 7-Evelen locations or replacing?

Steve Rathgaber

Yes, some new and some replaced.

Bob Napoli – Piper Jaffray

Okay. Let's see. The debt that you have, the $300 million, Chris, of the higher-yield debt with the much improved financial performance of the company and the better financing environment, what are your thoughts about doing some type of a debt refinancing and at what point in time would you do that?

Chris Brewster

Well, I think of that with considerable affection because I do think we have an opportunity to lower our interest expense. And we are thinking of it in terms of this year sort of project.

Bob Napoli – Piper Jaffray

But you don't have any – you don’t have anything included from that in your guidance for this year?

Chris Brewster

No. No, we haven’t, Bob, because – it will – obviously the impact will depend on precise timing and market conditions at that point in time. So the guidance that we have out there assumes that we just continue through the rest of the year with $300 million in fixed rate debt in place as it is today. And as you know, I mean, that represents a certain inefficiency and that effectively we are building cash, which on a good day we might earn 10 basis points on, while on the other side of the balance sheet, we’re paying 9.25% on that debt. So there is some – there is opportunity there.

Bob Napoli – Piper Jaffray

As far as the Allpoint business, revenue was up 72% I think you said in the quarter. What does the pipeline look for Allpoint and how do you expect that to continue growing this year?

Chris Brewster

The statement was transaction counts were up 72%.

Bob Napoli – Piper Jaffray

Okay.

Chris Brewster

And as far as the pipeline expectations – Mike?

Mike Clinard

I’d say it’s still a very healthy pipeline, lot of small and medium sized deals. And we expect to continue to grow our partners there.

Bob Napoli – Piper Jaffray

Okay. And I guess the last question I'll ask is on prepaid. Can you give any updated thoughts on what transactions you're seeing on the prepaid side?

Chris Brewster

Well, we’ve continued to look at the data there. They are continuing to grow, as you would expect in that business. I think it’s – I still feel comfortable with the statement we made earlier that the – the growth in the prepaid side of the business is that represents half or more of our same-store revenue growth. And I don’t see any change in trend there.

Bob Napoli – Piper Jaffray

Thank you.

Chris Brewster

Thanks, Bob.

Operator

Thank you. Our next question in queue comes from Jeremy Frazer with William Blair. Your line is now open.

Jeremy Frazer – William Blair

Good afternoon, guys.

Steve Rathgaber

Hi.

Jeremy Frazer – William Blair

A lot of my questions have been asked already. But you guys talked about trying to grow revenue from your existing merchants. So could you just kind of maybe frame out your penetration of your top 10 or 20 retailers to date and kind of how you plan on increasing that?

Rick Updyke

This is Rick. I think when you look at our retail footprint, there is a couple of ways to grow in that existing footprint. One is with the national growing retailers. Example would be 7-Eleven was typically opened a couple of hundred a year. We naturally grow in that footprint. The other opportunity is in retailers where we have exclusive rights to all or certain portions of their network. And we have up to 5,000 locations that we could go into over a period of time. The issue there is that we are waiting and want to pair that with a branding deal such that the returns are coming much quicker than if we just sort of go in and install an ATM on an unbranded basis today.

Steve Rathgaber

The other thing I would add is, when we think of foot traffic in some of these retail locations where we have the ATMs already placed, we are looking at a foot traffic that utilizes the ATM, the foot traffic from the store. That can range from 0.5% up to 2.0% of the actual foot traffic traveling through the store. And we are looking at instituting a number of programs to help banks think of the ATMs in these locations as essentially their on on-premise network, if you will, and effectively try to drive considerably more of the people in store with ATM cards in their hands to our machines. And we will be looking to do some piling activity in the coming quarters to see if we can affect that kind of penetration and deepen it.

Jeremy Frazer – William Blair

Okay, thanks. Do you guys have any updated thoughts on just geographic expansion and some of the opportunities over the next couple of years?

Steve Rathgaber

Well, what we’ve talked about is the fact that we’ve got a good franchise in the UK and a good franchise in Mexico that we are working to actively expand. And we are taking a look very specifically at the different markets around the globe now and taking our sort of formula for success that has worked so well for us in the United States and seeing which countries are best suited to that formula. So we are starting to look for a number of different attributes ranging from the percentage of cash transactions in that society to the type of retailers that are in that particular country and to whether or not banks by and large roll in off-premise placement or not. And – but I’ve asked the team to do if the catalog by country – developed markets where there is already a fair amount of activity, the markets that would be best suited to our strength. And our intention is to do that cataloging this year and begin to think about how we would enter some of those markets next year, but keep our international activities focused largely on building out the UK, Mexico and the Caribbean where we’ve had success in each of those markets pretty strong.

Jeremy Frazer – William Blair

All right, thanks. Good quarter, guys.

Steve Rathgaber

Thanks.

Operator

Thank you. Our next question in queue comes from Reggie Smith with JPMorgan. Your line is now open.

Reggie Smith – JPMorgan

Hey, guys, thanks for taking my question. I guess if I could, you guys talked a little bit about the pricing increase, if I could dig in a little bit deeper there. So could you talk a little bit about how you approach raising prices? I mean, was it something where you looked at a particular region and thought that – how did you approach it? And then, two, how large was the increase? Did you go from $2.00 to $2.50 versus competitors at $3.00? Like, can you kind of talk about where your pricing is now in those particular regions where you raised prices? And I have a few follow-ups.

Rick Updyke

Sure, Reggie. This is Rick. It’s very much – first of all, it’s very much done in partnership with the retailer where we sit down together and we do competitive surveys in the market and look at trends and basically agree on a market-by-market basis in some cases, how much we are going up, and when we are going up. And the retailer, on their side, is going to look at the impact, if any, on transaction declines. So that’s a factor from their perspective. They are looking to continue to drive more people into their store with cash in their hand. So it’s very much a partnership type of approach that we take. As to the amount of the increases, it varied from – going from $2.00 to $2.25, $2.00 to $2.50, $2.50 to $3.00 in some cases. It was very much all over the board. There were very few big jumps of a dollar, say, from $2 to $3.

Steve Rathgaber

The only thing I’d add to that, Reggie, is the conversation we’ve had around that subject so far on this call would almost tend to indicate as if we just began this in the first quarter of this year. And I don’t want to leave you with that impression. We’ve started doing some testing in this area in the early part of last year and had some pricing increases on a somewhat broader basis as we got later into the year.

Reggie Smith – JPMorgan

Okay. Appreciate that. I guess my next question, MasterCard changed their pricing. This type of stuff is kind of I guess expected in the business. Just kind of looking at the magnitude of the shift, a 20% reduction in interchange is pretty meaningful. What do you think about – or how are you thinking about other brands and whether they would follow suit? Is that something you're concerned about? And if they did, how would you counter that?

Steve Rathgaber

Reggie, this is Steve. I think a couple of thoughts. One is you are absolutely correct that it’s sort of part of the business model to anticipate some adjustments periodically, and we in fact do that as part of our planning process. So that would be point number one. Point number two is I think that these markets have matured. You will find that there might be an argument that the networks would follow one another less often than they have in the past because their interests are diverging. I mean, one of the things this price adjustment does is put some burden on the ATM side. So if you are lowering interchange and a lot of your bank customers have ATM supplied while you are impacting them even as you are helping them on the issuer side in terms of a lower cost. And some networks might choose to play that angle different than the global network did, and that could result in a benefit or a preservation of the status quo at least for us.

The third thing I would offer is that we operate our own network in Allpoint and we have a strong interchange level there. And I can tell you at least that network has no intention of announcing any decline any time soon. And in fact, as surcharge rates go up, as they have done every year I’ve been in the business, the value of that Allpoint network gets greater even as we maintain our pricing. So I think you’re going to see a blend of activities. I think there will be the occasional bump in the road. This particular bump, we focus on it because it was news in the industry, but it isn’t that material – it isn’t material from a performance perspective to us. And we look forward to surcharges continuing to increase over time even if they do so slowly, and we look forward to having a greater value proposition to offer our customers because of that.

Reggie Smith – JPMorgan

Okay. And if I could sneak two easy ones in. You cut your I guess the British pound assumption. How should we think about those types of changes from an EBITDA perspective? So like a 10-tick move in the pound is worth what in EBITDA? And then the last question, I'm not sure if I missed it, could you talk a little bit about what you are seeing as far as April trends from a transaction perspective? So it looks like the first quarter was a little weaker. You had weather to deal with and some other things. Has that kind of rebounded in April?

Chris Brewster

I’ll take the first one and I’ll let someone else be the weather forecaster. The – for quick and dirty work, if you said what’s the – if you had simply due to an exchange rate change, you had no change in the sterling business, but you had an exchange rate change in the UK that had a $5 million revenue effect. I mean, if you hit that with a 30% margin, you’d be in the ballpark in terms of its EBITDA effect. I’m sorry, Reggie, could you repeat that second part of your question?

Reggie Smith – JPMorgan

Yes. And then I guess this April trends, have withdrawal transaction growth, has it accelerated a little bit, or is it still running about 6%?

Chris Brewster

I know haven’t – obviously we haven’t seen full-month numbers on April. We’ve had a bit of a view of it in terms of a mid-month flash report we do. We trend across the March quarter was – January and March were pretty good. February was kind of weak, and we attribute that to the rather nasty February rather that we had in the US. And I think the sense we have of April so far is it’s kind of like March and looks like pretty much a continuation of the (inaudible) recent trends we’ve seen.

Reggie Smith – JPMorgan

Perfect. Thank you.

Operator

Thank you, sir. (Operator instructions) Our next question in queue comes from Josh Elving with Feltl & Company. Please go ahead.

Josh Elving – Feltl & Company

Good afternoon. Most of my questions have been answered. I guess I had one quick question in the UK business. It looks like the gross margin was down a little bit. And you may have hit on it in some of your prepared remarks that you discussed earlier. But was that lower gross margin in the first quarter driven in part due to the increase in hedging costs associated with that business?

Chris Brewster

I’d say there are two primary effects. One would be the, what you just said, the fact that we’ve put those interest rate swaps in place and which moved us from a starting rate of around 55 or 60 basis points on the – plus a spread on the cost of that cash to a fixed rate more like 3.0% to 3.5% plus the spread on that piece of cash. So that’s part of it. The other part of it really is the fact that in the quarter they were ramping up a very high volume, free-to-use sort of locations for a customer. And if you looked at the pro formas on that piece of business, what would see is basically a business model that anticipates very high transaction volumes, thousands of transactions a month per machine rather than hundreds.

We are working for interchange only, which in the UK would be roughly $0.50 in that range. So higher revenues that our normal machine achieved on very high transaction counts and earn interchange with no surcharge percentage margins that are somewhat similar – somewhat thinner than a normal piece of business, but total dollars of margin that are just fine taken against the capital investment that we’ve made to garner that business. So that’s basically a windy way of saying it’s a higher revenue, somewhat skinnier margin business that we’ve ramped up there. And that will have some negative effect on the reported gross margin percentage.

Josh Elving – Feltl & Company

Okay, great. That’s it for me. Thank you very much.

Chris Brewster

Thank you.

Operator

Thank you. I’m currently showing no further questions in the queue. I’d like to turn the program back over to Chris Brewster for any final remarks.

Chris Brewster

No final remarks from the company, operator, just to say – other than to say thanks to everybody for dialing in and we appreciate your attention and your good questions. And we will look forward to doing this again about three months from now.

Operator

Thank you, sir. Ladies and gentlemen, this does conclude today’s program. Thank you for your participation and have a wonderful day. Attendees, you may now disconnect.

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Source: Cardtronics, Inc. Q1 2010 Earnings Call Transcript
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