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Cardtronics Incorporated (NASDAQ:CATM)

Q2 2010 Earnings Call

August 4, 2010 5:04 pm

Executives

Melissa Schultz - Investor Relations

Steve Rathgaber - Chief Executive Officer

Mike Clinard - President of Global Services

Rick Updyke - President of Global Development

Chris Brewster - Chief Financial Officer

Analysts

Andrew Jeffrey - SunTrust

Chris Mammone - Deutsche Bank

Chris Shutler - William Blair

Jason Kupferberg - UBS

Bob Napoli - Piper Jaffray

Reginald Smith - JPMorgan

Gary Prestopino - Barrington Research

Operator

Good day, ladies and gentlemen, and welcome to Cardtronics Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will be given at that time. (Operator instructions). As a reminder, this conference call is being recorded. I would now like to turn the conference over to Ms. Melissa Schultz. Ma'am, you may begin.

Melissa Schultz - Investor Relations

Thank you, operator. Good afternoon everyone and welcome to Cardtronics Second Quarter Conference Call. On the call today are Steve Rathgaber, 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 are scheduled to run for about 25 to 30 minutes at which point we'll open up the call for any questions you might 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. Additionally, 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 this call we will reference certain non-GAAP financial performance measures. Our opinion regarding the usefulness of this measures together with the reconciliation of these measures is included in the press release issued this afternoon.

Now, I would like to turn the call over to Steve Rathgaber, our CEO.

Steve Rathgaber

Thank you, Melissa. Thanks to all of you on the line for joining us today. I think it is appropriate to start at the end of the quarter that is and acknowledge that we had a good quarter which helped the results in most components our business. I am proud of the results and of the team that continues to produce them.

The quarter was clearly defined by solid performance at Cardtronics, but outside of Cardtronics the quarter was defined by turbulence in the industry due to regulatory activity. When environments get complicated I always find it useful to go back to basics and then to reassess opportunity and risk.

So, let’s start with the basis of Cardtronics. I continue to be bullish on Cardtronics for the simple reason that it remains a unique and critical asset in the current financial ecosystem. A looked back on the quarter underscores this point. We enjoyed solid organic growth, closed on several new and substantial opportunities, renewed several large clients, saw a significant improvement year-over-year in our Allpoint surcharge-free network and continued progress with prepaid cards at our ATMs.

We expanded key branding relationships further validating this component of our revenue model. We enjoyed record operational availability in the US. We achieved record transaction volumes and also our best ever operational quality performance in the UK business.

Importantly, our sales pipeline is stronger than when I arrive back in February and in fact is the strongest at anytime in our history. So, I find this a relatively sturdy position from which to catch one's business breathe and reflect on the industry turbulence.

First, let’s focus on a subject which may surprise you was increasingly in our control, network interchange fees. In the last quarter call, we reported that one of the global payments networks lowered the interchange they paid ATM acquirers including all banks and Cardtronics for a portion of the transactions and increased the acquirer fees that they charged for network access. Interchanges an important component of our revenue model, about 28% domestically, and historically a revenue component largely outside of our control. It has been viewed as under the control of the various debit network because they set the rate that an issuer will pay to an ATM owner.

We are both a network and a valuable ATM portfolio. We have an asset that our customers want and actually in many cases need to complement their own ATM network. Our network persona allows us to set in control a material amount of interchange because we in the market are solely responsible for Allpoint interchange.

Importantly, we are also able to contract directly with card portfolios for access to our ATMs in a variety of ways that allows us to lock in a predetermined price for interchange unrelated to third-party network interchange pricing. The critical effect of our ability to contract directly for fair value exchange is that we now have multiple contracts that lock in the rate on 39% of what historically would be termed US domestic interchange. This is up from 23% two years ago and we should exit next year near or above 50%.

This continues to diminish the impact any third-party can have on our revenues via interchange fee moves. Management is committed to controlling this additional element of our revenue. The more we succeed at this objective, the more stable and certain this component of the revenue base. We look forward to continued progress on this key objective.

During this quarter, we were buffeted like everyone else in this space by the uncertainty of swirling regulatory winds that at various times felt by both headwinds and tailwinds. Financial reform legislations spawned the Harkin Amendment, the Durbin Amendment and the Consumer Financial Protection Bureau. These legislative events was supplemented with additional activities in Mexico, which Mike Clinard will discuss.

My crystal ball is no clearer than anyone else's with respect to potential outcomes of this legislative pokerie [ph]. I believe certain observations and potential conclusions are worthy of consideration. The Harkin Amendment which targeted convenience fees otherwise known as a surcharge is dead as a legislative event. The reform bill has passed and the Harkin Amendment is not in it. We believe that the industry performed well in educating congress about the important impact on the economy, employment, ATM manufacturing and perhaps most importantly consumer choice, convenience, and safety. We are not naïve enough to believe this type of legislation is permanently behind us, but we are pleased with the reception we’ve received in our outreach efforts during the process.

Our course of action here is simply to continue to educate all interested parties in the value of the services provided by organizations like Cardtronics. The Financial Reform Act broadly, and the Durbin Amendment specifically, may actually provide opportunity for Cardtronics. A reasonable speculation on outcomes is that debit cards will get more expensive for financial institutions and consumers, incentives for using cards are likely to come under pressure and be reduced perhaps dramatically.

I would point out that when interchange was lowered in Australia several years back, bank profitability came under material pressure resulting in impacts like I mentioned above. Additionally, discount for purchases made with cash may be offered at merchant locations and debit cards may not be accepted for some smaller ticket purchases. I believe that these outcomes would be good for cash and cash is good for Cardtronics.

In response to potential revenue shrinkage for financial institutions, banks may charge higher fees for everything they legally can including higher surcharges for non-bank customers at their ATMs, one of the few fees they can raise without harming their own depositor. These outcomes could make our franchise more valuable. They could create a higher ceiling for surcharge increases as the largest fleet owners raise rates and as a byproduct may go a point even more valuable, as they surcharge free networks.

Additionally, in this scenario, banks of all sizes may respond with an appetite for a larger free ATM footprint as a competitive differentiator in a fee hungry world which could conceivably strengthen our branding opportunities as well.

All of this will take some amount of time and at least one election to sort through. At Cardtronics, we will observe, anticipate, plan and, when necessary, react from the view afforded by the strength of our franchise.

I will now turn it over to Rick, Mike, and Chris for additional color on our performance and return after Chris to offer some closing thoughts.

Rick Updyke

Thanks Steve. Well, as you can see we had another very strong quarter. Our adjusted EBITDA totaled $33.9 million which represents an increase of nearly 22% when compared to the second quarter of 2009. From a top line perspective, our revenues were up roughly 7%, but 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 business, the growth rate was over 10%.

So, with that let me give you some color on the quarter, our pipeline of new business and some recent sales wins. First on new sales. Earlier this week, we announced a signing of an ATM managed services deal with Kroger, one of the largest retailers in the US with almost 2,500 grocery stores and 800 convenience stores operating under the banners of Kroger, Ralphs, King Soopers, Kwik Shop and Loaf 'N Jug to name a few. The long term deal will initially cover about 800 of these locations and provide us an opportunity to add more locations with Kroger over time.

The deal is also a strong validation of our ATM managed services offering and provides us with additional momentum for this new aspect of our business as we head into the second half of the year. Furthermore, the signing with Kroger means that we now have eight of the top 10 retailers with ATM fleets in the US under contract. Given the size of the Kroger deal and the operational logistics involved, we won’t begin recognizing any of the related revenues until the fourth quarter of this year. As such, it won’t really have much of an impact on our 2010 revenues, but will certainly provide us with an nice boost in 2011 and beyond.

In addition to the Kroger deal, the pipeline of retail opportunities through 2011 is very robust with a larger number of competitive portfolios totaling as many as 8,000 locations becoming available in the market due to contract expiration. Based on some of the recent successes we’ve had, we feel pretty positive about our chances of landing of these new deals over the next 12 to 18 months. Conversely, we have an insignificant number of retail locations with contracts expiring during the same time period.

On the bank branding front, we continue to see growth in that area of our business. In fact, we’ve recently increased our number of branded ATMs through arrangements with SunTrust and PNC. SunTrust expanded their relationship with us by branding an additional 100 CVS locations in Florida, bringing the total number of our branded ATMs with their brand on them to 439. PNC in turn signed a new agreement to brand 230 Hess and Hess select locations throughout Florida.

Furthermore, we continue to see a growing pipeline of branding opportunities both with current and new branding partners. I’m confident that we will be reporting additional progress in this area in the near future because we have current and active discussions with almost half of the top 15 banks among others.

On the surcharge-free front, we continue to see very nice growth in our Allpoint Network and frankly see no reason why that trend won't continue as it is coming from both increasing adoptions in our existing base as well as from expansion from new financial institutions. Additionally, we have some efforts underway to try and further leverage the growth we have seen in prepaid card transactions on our network through Allpoint and should have some favorable updates for you in that regard during our next quarterly conference call.

Internationally, our UK operations has had a number of positive events of late that are worth noting. First, we signed an ATM placement agreement with WRVS, an owner-operator of around 400 shops located in hospitals around the UK and we expect to install at least ATMs in their store locations over the next 12 months. Additionally, we've been running a test with two free to use ATMs in London that expense only £5 notes. Since making that change cash withdrawals and more importantly interchange have more than doubled. As a result, we expect to convert an additional 50 ATMs to £5 notes only. I point this out only because it represents another creative example of the leverage we have at our disposal to increase transaction volumes.

Finally, while we did lose a potential contract renewal earlier this year, as we discussed on our conference call, it is important to note that we have successfully renewed or extended 17 placements and branding arrangements over the last 18 months covering thousands of ATMs. So, we you can see why we view that speed bump as a true anomaly.

So, in summary, we have strong book of potential new business with new retail partners as well as with new and existing financial institutions that give us a pretty good line of sight to our targeted annual revenue growth rate of 7% to 9% this year and beyond. Of course, it's up to us to close deals, but as I noted earlier, we feel pretty good about our chances in that regard.

At this point, I’d like to turn the call over to Mike Clinard, our President of Global Services.

Mike Clinard

Thanks Rick. During the second quarter, we continue 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 metric stage of this afternoon’s press release. For the quarter, our total withdrawal transactions were up over 5.5% and our company owned ATM count was up over 4.5%. The year-over-year growth withdrawal is in line with what we saw during the first quarter.

From a margin standpoint, our per ATM operating gross profit per month increased over 12% from $378 in 2009 to $425 in 2010. The strong margin growth was due to a combination of solid year-over-year revenue growth and continued benefits realized from the operational cost savings we secured in 2009, which include savings from lower maintenance and our armor grades that we negotiated here in US.

Now, should be point it out that while those savings are expected to continue, we will begin cycling on most of those savings during the third quarter, so the year-over-year gains we've seen in terms of margin expansion will be less pronounced in the back half of the year. We also continue to benefit from low vault cash rental rates. However, as we discussed during the first quarter, we did see a year-over-year increase in those costs during the quarter as a result of certain fixed rate hedges that we put in place in UK beginning in January.

Turning now to some of our operational initiatives, we made very good progress on a number of critical projects during the second quarter. First, we made significant progress on converting the remaining 3,700 ATMs to our in-house processing platform all of which are 711 ATMs were subject to a third-party managed services agreement that we assumed in that acquisition.

I think it is important to point out that we’ve already experienced higher availability on these ATMs resulting in higher revenues and also lower cost as a result of these ATMs being managed in-house. At this point in time slightly more than 100 ATMs remain to be converted, all of which will be completed by the end of this month. So, essentially by the end of this month, 100% of all of our ATMs in all three countries will be processed by our in-house processing platform.

In UK, we continue to make very good process of setting up our second armored cash depot and we’re still on track to have that depot become operational later this month. Given the success that we’ve had on our first cash depot in that market in terms of higher ATM uptime and lower operating cost, we’re very optimistic that we’ll be able to further extent those benefits to the 900 or so ATMs that will ultimately be serviced by the new depot.

In Mexico, new regulatory changes went into affect in May that now required banks and ATM operators to either charge a convenience fee for cash withdrawals or to except an interchange fee from customers, financial institutions, but not both has had been the case in the past. We along with most other ATM operators and financial institutions elected the convenience fee route and raised our fee accordingly to offset the lost interchange revenues.

As a result, there has been consumer confusion in that market resulting in what we expect to be a temporarily slowdown in volume add ATMs including those located at financial institutions throughout the country. We have experienced similar results in our ATMs in Mexico except our resort and tourist locations where transactions are actually up. It is still very early in this new environment and as a result, it’s difficult to gauge exactly what the ultimate impact will be from these changes.

What I can tell you is that we’re actively working on a number of different strategies to overcome these challenges. We have also decided to slowdown the number of ATMs we install for the remainder of the year in Mexico. Furthermore, any revenue headwinds we encounter from this issue for the remainder of the year have already been factored into the guidance that Chris will discuss here shortly.

In closing, I can tell you that nothing has changed in terms of our priorities and we’ll continue to focus on our key operating initiatives all designed to drive margin gain, which include: number one, increasing the volume on our network; number two, investing in our technology and infrastructure so that we can offer more services to financial institutions and retailers like; and number three, optimizing the efficiency of our existing platform to ensure that we remain we’re the lowest cost and highest quality providers in the industry.

I’d like to now turn the call over to Chris Brewster 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. What I’m going to do is tough on our second quarter results for a couple of minutes. I want to update you on a couple of corporate finance matters and then talk about what we’re expecting for the remainder of the year.

With regard to the quarter, consolidated revenues were $133 million, up 7% from the $125 million that we recorded in the same period last year and I'd only say about that that unlike some of our recent quarters the revenues were not significantly impacted year versus year by changes in foreign currency exchange rates, which were relatively stable between the period.

As Mike said, gross margins were up nicely again coming in at approximately 32.5% compared to the 30% last year. That rate of expansion in margins is somewhat smaller than the 400 basis points gain in margin that we saw in the first quarter. The slower rate of margin expansion was expected as we are now beginning, as Mike said, the cycle on some of the cost savings that gave rise to the last year's very substantial margin gains particularly the cost reductions we achieved on our domestic armored cars and costs and maintenance costs which came into effect in the month of May of 2009.

With regard to SG&A costs, we had a decrease of about 3% year-over-year primarily due to the fact that some costs incurred in 2009 related to out corporate office headquarters relocation and certain employer related costs did not recur in 2010. However, even if you factor out the one-time issues in 2009 I think it's notable and should be said that we have been able to maintain a consistent level of SG&A cost even in the light of fairly rapidly growing overall business. I'm pretty happy about that.

From an adjusted EBITDA perspective, we recorded a 22% year-over-year increase from $27.9 million last year to $33.9 million this year again reflecting the solid revenue growth and the successful cost management results that we just spoke about. From a bottom-line perspective we generated adjusted net income $10.9 million or $0.26 per diluted share for the quarter, compared to $6.9 million or $0.17 per diluted share in the same period last year. So, we reported increases of over 50% on those two bottom line metrics.

I should also let you know we corrected, what I'd call, a minor flaw in the way that we've been calculating adjusted earnings per share in the current quarter for the six month numbers that are in the press release and also the prior year figures that are in the press release. This had the effect of increasing those figures very slightly.

As you know, we own 51% of Cardtronics Mexico and we have Mexican partners that own the other 49% of that business. In the past in calculating adjusted EBITDA, we’ve subtracted out of our EBITDA. That amount related to the 49% ownership position that we do not own that our partners own in Cardtronics Mexico and we’ll continue to do that.

As you move down the P&L below the EBITDA line and go to calculated adjusted earnings, what we have been doing was subtracting out all of Mexico’s depreciation and interest, but what we logically should have been doing is subtracting out only our 51% share of those expenses. Consequently, we have been slightly understating adjusted net income and adjusted net income per share. The effect of correcting this is to increase adjusted earnings per share by about $0.01 for all of last year and by about seven tenth of a cent in each quarter of this year.

Turning now to the balance sheet, debt at the end of June stood at just over $307 million, essentially unchanged from the year end. That amount consisted of $298 million of senior subordinated notes, net of the issuance discount, about $9.5 million of debt under our Mexico equipment financing lines also. We started the quarter with 10 million in cash and we ended the quarter with 40 million in cash which really demonstrates the strong cash flow generation capabilities of this business.

In order to productively apply that cash, we initiated a series of actions here recently. We just announced that we’ve entered into a new multi-year revolving credit facility with a syndicate of leading financial institutions. That new facility provides for a $175 million in borrowings and letters of credit, and most importantly it give us the flexibility to repurchase our existing outstanding subordinated notes. At this point in time, we have two issues of public subordinated notes outstanding, one is for $200 million and the other is for $100 million, both of which have a 9.25% interest rate and both of which mature on August 2013. We recently issued a notice of redemption for the entirety of the $100 million issue and we expect to complete that redemption later this month.

The repayment of those notes will be funded with roughly 30 million of cash on hand and 70 million of borrowings under our new credit facility. This activity is intended to achieve really three key objectives. One is to enhance our overall financial flexibility, the second is to reduce our leverage level, and the third is to improve our bottom line results by reducing interest expense.

We’ll use 30 million of cash of the balance sheet and today we earn about 50 basis points on that cash and we’re going to be using that to take out $30 million of debt that we’re paying 9.25% on. We use about 70 million of bank debt that will cost us just over 3% to take out 70 million of bonds on which we’re paying 9.25%. Obviously between the two of those factors this generate some fairly considerable interest rate.

Secondly, since we now have 70 million in pre-payable bank debt outstanding, we’ll be able to use our free cash flow on a go forward basis to pay that down further reducing leverage and further reducing interest expense in the future. Assuming no change in floating interest rates, we’d expect to save around or about $8 million next year in pre-tax interest expense which translates into roughly $0.12 per diluted share on a full year annual basis.

Finally, I should point out that as a result of the refinancing of our credit facility and the planned redemption of our Series B, the $100 million in subordinated notes, we will record about $3.6 million one-time pre-tax non cash charge during the third quarter to write-off the remaining discount and the deferred financing cost associated with those notes and with our previous credit facility. We’ll also record a one-time $2.3 million pre-tax cash charge related to the call premium associated with the redemption of those senior subordinated notes. It’s our intent to treat these as one-time non recurring items as that’s what they are and not charge them against our reported adjusted EBITDA or adjusted earnings per share numbers that we report for the third quarter.

So that’s it for the time being on the corporate finance front. Now, turning to guidance, based on the performance that we saw in the second quarter and the refinancing event that we just described, we think it’s appropriate to modify our guidance for the full year 2010 somewhat. We’re leaving our revenue guidance unchanged at 520 to 530 million, and I’ll turn back to that and discuss the logic of that here in a moment. We’re increasing our guidance on gross margin percentages from 31 to 31.5 previous guidance to 31.5 to 32% margins in our new guidance.

We’re also increasing our adjusted EBITDA guidance from a range of $120 million to $125 million to new range of $123 million to $127 million. We’re lowering our depreciation and accretion guidance from $42 million to a range of $40.5 million to $41 million and that arises primarily because of the change I described earlier in the way we’re treating the numbers for our 51% owned Mexican operation and the impact of that on depreciation for the Cardtronics interest in that company.

Cash interest expense is now expected to be in the range between $26.5 million and $27 million down from previous guidance of $29.5 million primarily as a result of the redemption of the $100 million in subordinated notes that I talked about a moment ago. Adjusted net income is now expected to be in a range between $0.87 and $0.93 per diluted share and that’s based on the share count of 41.5 to 42 million shares. That range is up from $0.75 to $0.85 range that we have previously communicated or in other words we have taken the middle of the range up by $0.10 from $0.80 to $0.90.

Capital expenditures are expected to remain at roughly $55 million, that’s net of the non controlling interest. This guidance assumes exchange rate of $1.50 per UK pound and 12.5 Mexican pesos per US dollar which are consistent with the rates communicated on the last conference call and pretty much inline with what our rates are today.

Now returning to the revenue guidance, it may look a little bit conservative, but frankly we believe it’s in the middle of the fairway. To put this in perspective and taking the middle of the range of that full year 2010 revenue guidance of 525 million, that figure would imply revenues of 265 in the second half of 2010 which would represent a 4.5% increase over the revenue that we recorded in the second half of 2009.

Since revenues grew at about 7% in the second quarter of 2010, this begs the question why the lower growth rate in the back half. I’ll start by saying we think that this change in trend is temporary. The bulk of the change is explained by two previously announced contract terminations, one involving ATMs at our Northeastern regional drug store chain that was effective in October of 2009 and the other involving ATMs in a regional gas link convenience retailer that was effective in May of 2010. Without those two events we would expect revenues in the back half to be up around 7% to 8% consistent with first half.

During the third quarter, we will not have cycled on either of those issues. So, I would expect that to be our weakest revenue comparison and in the fourth quarter we will have cycled on one of those events and will also have the benefit of the new Kroger business. So, I would expect that revenue comparison to make it stronger.

Given the company's historical success of renewing contracts we view these two events as anomalies and we continue to believe strongly in our ability to generate organic revenue growth in the 7% to 9% range over time and believe that’s certainly supported by Rick's comments on the new business pipeline that he made earlier.

Now, I tend to think of all of this in the following way. Over the last 18 months, we had a lot of contract renewals to work through. We renewed or extended 17 quite successfully but we lost two and that’s very unusual for us. In both cases, those were under unique circumstances that we have discussed in the past.

Over the next 18 months we have very little in the way of significant renewals of contracts in front of us at Cardtronics. Consequently, we have minimal risk of any material contract losses, and as Rick said, we have a shot at about 8,000 ATM locations that our competitors now have as they go through their renewal cycles.

Moving farther down in the P&L, I would expect our pattern of EBITDA and earnings per share performance for the rest of the year to essentially follow the revenue trend that I described. In other words, I would expect the year-over-year comparison in Q3 to be less strong and in Quarter Four to be somewhat stronger.

To put this all in perspective in a little different way, we increased the center line of our earnings per share guidance for 2010 by $0.10 a share. In my view, about $0.05 of that relates to our performance in the first half against our earlier expectations. An additional $0.025 relates to the full year of the change in the adjusted earnings per share calculation that are related relative to Mexico and about $0.025 relates to the interest expense reduction in the fourth quarter of 2010 brought about by the bond redemption. So, essentially, that accounts for all $0.10 of the increase.

In other words, from where we sit, our guidance for the second half in terms of the operating matters has not changed up or down in any meaningful way. We see the second half in a fairly similar fashion as the way we saw it three months ago or even six months ago.

All in all, the center point of that guidance would imply over the full year 7% year-over-year revenue increase, a 13% increase in EBITDA and a 33% increase in adjusted earnings per share, and I would think such results would look pretty respectable in what's a relatively weak economy.

With that, Steve, I will turn it back to you to summarize.

Steve Rathgaber

Thanks Chris. So, that covers a lot of material concerning the state of and the prospects for Cardtronics. My brief summary, it is a good time to be Cardtronics. Revenues are growing well and organically without the benefit of any acquisitions. Revenue growth is driven by a healthy combination of margin expanding services. The contract renewal engine is working well keeping our foundation comfortably intact. Our sales pipeline is robust and broad across our service side and across countries leaving us comfortable with our long-term view of 7% to 9% top line organic growth.

Our UK business is driving to double digit revenue growth and achieving record volumes and performance. We are increasing control over our book of business with active strategies to migrate away from that component of our revenue known as network interchange and we’re negotiating deals directly to protect and lock in interchange amounts. Admittedly, that journey, that’s a long journey, not a sprint, but we’re well on our way to crossing the 50% mark for that.

Prepaid cards are alive and well and we continue to see upside and we are building the muscle to tackle the opportunities to increase foot traffic share that utilizes our ATMs in our major retail partners. There are occasional headwinds and there are certainly uncertainties largely of a regulatory nature to keep an eye on, but the core value of the Cardtronics franchise remains intact, healthy, and growing. As I said, it is a good time to be a Cardtronics. We’re now prepared to take any questions you might have.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) You have a question from Andrew Jeffrey from SunTrust.

Andrew Jeffrey - SunTrust

Couple of things, just big picture for starters. You mentioned more than one occasion sort of the regulatory uncertainty in the quarter and if we look at what limited prepaid data we have for the second quarter versus the first, it looks like it may have been the down sequential quarter for the biggest prepaid guys which is kind of unusual. Do you think that that in anyway affected your business? I’m thinking about the possibility that some of the big prepaid issuers backed off on marketing a bit in light of interchange uncertainty, do you think there is an air pocket at all that is poised to disappear now, we’ve got some clarity on interchange regulation for GPR cards?

Chris Brewster

Andrew, this is Chris, I would answer you this way. Let me tell you what we know and what we don’t know. What we know is basically the prepaid volume that we run on cards from issuers who are Allpoint customers. What we don’t have good visibility of is how much of our volume is on prepaid cards that are not Allpoint customers because we don’t necessarily know the bank identification numbers associated with those cards and it’s hard for us to individually identify those transactions.

So, based on what we do know, we continue to see increases in our prepaid volumes. Now, our prepaid volumes are pretty heavily skewed toward payroll cards and electronic benefit transfer cards, government benefit cards as opposed to the general purpose financial cards. So, we may not be the best source for that sort of information, if you will, for that reason.

Andrew Jeffrey – SunTrust

Okay, all right. So, no change in the growth rates that you can see in your prepaid business or the portion of your businesses generated by prepaid cards.

Chris Brewster

I would say that’s broadly correct. It continues to head north.

Andrew Jeffrey – SunTrust

Okay. Then with regard to surcharge revenue, I know one of the things you talked about in the first quarter is the ability to raise surcharges. It looks like surcharge revenue per cash withdrawal transaction came down this quarter sequentially on year-on-year. Is that a function of the contract loss that you were talking about? Is it mix?

Chris Brewster

It would be more mix related, Andrew. If you think about that for a second, we run a significant portion of our cash withdrawal transactions on which we do not charge a surcharge. That’s particularly true in the UK which runs at this point around 900 or so non-surcharging machines that run very high volumes. So, the average surcharge rate on surcharge transactions in the company did go up somewhat, but you won’t see that in that particular metric because of the mix shift between surcharge and non-surcharge transactions.

Andrew Jeffrey – SunTrust

Okay, and then one last one, I’ll get back in the queue. You mentioned sort of flow through of revenue this year especially with the Kroger deal coming on. Should this be a year in which we might anticipate fourth revenue being inline with or higher than third quarter revenue?

Chris Brewster

It will be. I would say at this point it would be fairly close. I’d almost say it’s too close to call.

Operator

Our next question comes from Chris Mammone from Deutsche Bank

Chris Mammone - Deutsche Bank

Thanks, good afternoon. I guess, congratulations on the Kroger win. It sounds like a good deal. Could you maybe give us some more dynamics on that deal? Will you be picking over already existing ATMs, (inaudible) locations will you be swapping out with your own equipment? Maybe also give some color into what you think are expansion opportunities within Kroger that looks like there or what about three times locations on what you’re starting out with? I know you’re not giving 2011 guidance at this point, but if you can maybe isolate what you think Kroger might add as far as being accretive in 2011? That would be helpful.

Rick Updyke

Hey, Chris, this is Rick. As it relates to the arrangements that we have with Kroger, we will be taking over the ATMs in those locations and essentially outsourcing everything back to Kroger. So, they will be paying us a fixed fee. It’s a managed services arrangement, it’s not a turnkey like a lot of our other arrangements. We do have a tremendous opportunity, as you mentioned. There is 3,300 total locations, we’re going to be in 800 initially and if we perform the way we had historically performed, I would expect us to win more of their business throughout the term of the agreement.

Chris Mammone - Deutsche Bank

That’s a monthly fee, it’s sort of an all-in monthly fee that they’re going to be giving you based on location or based on machine volume?

Rick Updyke

Yes, based on machines, number of machines or per machine.

Chris Mammone - Deutsche Bank

Okay, any thoughts on 2011?

Chris Brewster

Let me maybe speak to the fee situation for just a second and I’m going to be a little oblique here, but give you some framework on which to think about these merchant-owned deals and I’ll speak primarily from the perspective of publicly available information. Our average revenue per ATM is in round numbers about $1,200 a month across Cardtronics, and our average merchant fee that we pay to our merchant host is on average around $400 a month.

So, what’s the difference between that situation and say, what we’d call a managed services deal? Well, typically in a managed services deal, I mean, we’re not getting the benefit of surcharge and interchange, we’re getting the benefit of a monthly fee. So, you would think that if all else were the same, that is, if we own the assets in a managed services deal and it ran volumes similar to what our corporate averages are in terms of cash withdrawals which are around 600 transactions a month then in order to maintain the same level of profitability, we would be looking for revenues of around $800 a month. That is if we get $1,200 a month of surcharge and interchange and we have to give $400 of that to the merchant in the managed services setting, we’re getting a flat fee. We’re not paying anything out to the merchant. So we’d be sort of in the same place if we were getting 800 bucks a month.

Now, I would tell you in the case of the Kroger situation that broadly speaking we’ve run lower transaction counts in the grocery store class of trade than we do as a corporate average, number one, and number two, I’d say we’re not fully invested in that hardware. That is we are taking over their hardware, but at cost that is a fair distance from new hardware.

So, as you think about what sorts of revenues we might earn on that, I’ll pull throw that out there as a way to think about it and I guess to be a little less oblique, in that sort of context. Unless there were something fairly unusual, I wouldn’t expect to see revenues in excess of $800 a month on one of those deals where we were doing everything including owning new assets. They could well be less than that if we were taking over assets at less than new value or running lower transaction counts or what have you.

Now, none of that speaks to 2011 and I realize that, and frankly we’re not prepared to put out much in the way of guidance relative to 2011 on this call. We will leave that for a little later in the year.

Chris Mammone - Deutsche Bank

Okay, that’s helpful. Then I guess for Steve, thanks for the commentary on sort of some of your early scenario planning around potential impact for the Durbin Amendment. Curious about sort of what you said on perhaps discounts or cash being offered to a greater extent in the post Durbin world. I mean, you put a higher probability on large multi-line retailers adopting those practices. I think we’re all aware that a lot of small, mid size retailers sort of already do it today and so, I don’t think that we’d see much change from this mid-portion of the market, but I guess what would really cause a material change if a lot of larger merchants were to start that, those practices, maybe give us some more color on how you’re thinking about that?

Steve Rathgaber

Sure. I mean, I can opine certainly, that’s certainly about all, but in my experience the retailers, particularly the large multi-line retailers are very creative at extracting value and lowering payment costs. While it doesn’t seem likely that they want to complicate lane traffic. It certainly seems possible that in certain areas, like for example a lot of their self service counters which is increasingly a part of lane traffic for example in grocery stores. You might see encouragement in places like that. Do I think there is going to be a wholesale movement towards that kind of cash discounting broadly across multiple industry segment, now that’s probably not logical. Our business is about baby steps and then just constant steady improvements. At the end of the day, whatever the results are they are likely to be on the upside favorable for us versus the downside.

Operator

Thank you. Our next question comes from Chris Shutler from William Blair.

Chris Shutler - William Blair

Hi, guys, good afternoon. Chris, could you may be talk about the ATM count that you’re expecting in the guidance at the end of the year, obviously I think previously, correct me if I’m wrong, I think you said 600, 700 in the US, maybe 300 to 400 in UK, and a 1,000 in Mexico. Have those changed at least the Mexico number?

Chris Brewster

The Mexico number certainly has. The – Mike, prompt me on how many machines we've installed down there so far this year but I think -- I don’t expect a whole lot of change from where we are here at the end of the second quarter perhaps up by another 100 machines or something like that in Mexico.

Chris Shutler - William Blair

Okay. The US and the UK really no change there, correct?

Chris Brewster

I think pretty steady thoughts on those markets.

Rick Updyke

Yeah, we've installed somewhere around 350 to 450 machines in Mexico to date.

Chris Shutler - William Blair

Then how are you guys feeling these days about outsourcing the banks? I know that that’s one of the things that you’ve talked about in the past and I didn’t catch you mention it in your prepared remarks. Just like to get your take there.

Chris Brewster

I think we continue to see and have active dialogs with banks. You haven’t seen us actually close one of those deals yet but the conversations are continuing to occur and with a little more interest every time we talk. So, we're encouraged.

Chris Shutler - William Blair

Steve, just one last one. In the first quarter and then again this quarter you mentioned I think working on some pilots with the goal of increasing foot traffic to the machines. Maybe you can just talk about to whatever extent you are comfortable with things that you are working on and what kind of success that pilots are having? Thanks.

Chris Brewster

We're still early on on that in the sense of working with some retail partners to understand the things we can do with them and exploring with banks, programs we can do with them. So, I would say that we're still in some formative stages. I would like to be a little bit further along than we are quite frankly. When you get into this there is some complexity and we want to make sure we do this right and do it consistently across the multiple market.

So, I think you’ll see us move a little slower on this, than I’ve might originally anticipated but also with the great deal more expertise being invested in it rather than a quick hit and run. So, I’m looking for that asset, for that foot traffic asset to be a critical piece of our future growth and I want to make sure that we treat that asset with the respect it deserves and begin extracting it very carefully. So, with the wonderful tailwinds that’s provided by the revenue pipeline that is out there and the sales pipeline that’s out there we quite frankly are focused efforts on that as opposed to moving into other stage but I keep an eye on those developments and will be working to tap that.

Operator

Our next question comes from Jason Kupferberg from UBS.

Jason Kupferberg - UBS

Hey thanks. Good afternoon guys. Wanted to start with question on the contracts that you guys going to pursuing on the managed services side. You talk about the potential some competitive takeaways there over the next 12 to 18 months and wanted to get a feel for what you guys feel your competitive advantage will be as you try and go after those. I mean how much of the criteria decision making on the behalf of the customers ends up really being driven by price versus other factors, if you can help us think through that a bit?

Rick Updyke

I think as it relates to the opportunities that I mentioned, those opportunities are likely to be more turnkey than managed services deals. There is mixture there but it’s going to lead more toward the traditional turnkey and clearly the advantages that we have, our scale, our in-house processing, our bank branding program, what we bring with Allpoint can drive customer traffic using that lever in our tool of tricks to help out the retailer.

Jason Kupferberg - UBS

Okay, that’s helpful. How should we think about longer term international opportunities for Cardtronics? I mean, obviously you guys have the footprint in UK, in Mexico, you have some traction there, and what other market longer term do you think offer the most potential and how far along, if at all, are you in terms of actually exploring some other international opportunities?

Steve Rathgaber

This is Steve. I’ll take a swing at that. We are obviously very happy with what’s going on in UK at this point in time, and a little less happy with what’s going on in Mexico at this point in time. From my arrival here, it’s been important for me to make sure that when we expand internationally we are doing it in markets where we feel, we have a better opportunity to control the situation than, quite frankly, be subject to some of the vagaries of large global interchange players changing the rules on us as happened recently I guess the Euronet in Poland, for example. So, we want to be careful about those types of things.

Having said that we think there are opportunities where the countries have the right profile and cash, the right demographics on growth. We are looking, but we are focusing our efforts on demonstrating that our organic engine in the US and in UK and as well in Mexico can deliver on the results that we talked about during our road show this year, while we continue to investigate internationally. So, I wouldn’t expect anything in the very near-term on the international front other than focus on delivering return on assets we’ve invested in. I do think next year that window opens for us and we’ll be looking more closely in opportunities then.

Operator

Our next question comes from Bob Napoli from Piper Jaffray.

Bob Napoli - Piper Jaffray

Chris, the other $200 million, I mean that's 9.25, do you mean that the high yield market is kind of become tougher and become easier, it’s kind of moved around? I mean, what are your thoughts about the other $200 million of high yield debt?

Chris Brewster

Well, you’re quite right. There was a point in time early this year where we might have refinanced that at, say, 8.25% or something like that. That opportunity really flew out the window when you’re began reading about Greek debt and Eurozone problems and so on and so forth so much in the paper and was absent for a while. The high yield markets have sort of come alive again and we’re watching that situation pretty closely.

Bob Napoli - Piper Jaffray

Would you be able to take more of that out with bank debt as opposed to the high yield market? Do you have to take out the whole 200 million or can you take out pieces of it?

Chris Brewster

No, the issue would be this. We can call it in whole or in part. So, I mean literally if we wanted to take out a $10 million piece of it we could do that. Where things start to get interesting, Bob, as we go down that road we are led to believe that the minimum sort of efficient size for a new high yield issue is probably $175 million or so. So, if we took out say half of that last 200 million with bank debt and we have a 100 million remaining to refinance, we probably wouldn’t be able to refinance that in a high yield market, if you will, which is pretty sensitive to trading liquidity and generally doesn’t like issues smaller than about 175 to 200 million. Now, that may be telling you had a build to watch when you just ask me what time it is, but that market has rebounded and we’re watching it very closely for opportunities.

So, we’re in a position where we got three years left to run on existing bonds before they hit final maturity that’s quite bit of time. It’s not obviously in a stage that causes us loss of sleep, but it’s something that we pay a lot of attention to.

Bob Napoli - Piper Jaffray

Okay. With regards to the Kroger deal, are those bank branded ATMs or do you have the opportunity to brand those?

Rick Updyke

They are not bank branded today, and yes we do have the opportunity to brand those.

Bob Napoli - Piper Jaffray

Okay. And just I mean, the pipeline that you do have and maybe give a little more color on the mix of…? I mean the strongest pipeline in history in a pretty strong statement. Is it more turnkey deals or what kind of managed service deals are in there? Maybe give a little more color on how that pipeline is?

Rick Updyke

Bob, it’s more turnkey deals than anything. There maybe a few managed services opportunities in there. It’s a mixed bag of retailers, but it leans heavily toward the sea store kind of opportunities.

Steve Rathgaber

Having said that, we have good activity in branding space in terms of dialog, I think Rick mentioned earlier, back half of the top 15 banks we're in discussions with. We have international opportunities in branding that we are very close on and we have a good surcharge-free network participation announcements that we think are relatively close in the future. So, it is a very broad pipeline and I read that statement eight times before I said it, I wanted to make sure it will hold us to scrutiny, and I fully believe it does at multiple dimensions.

Bob Napoli - Piper Jaffray

Do you have anything branded in UK today?

Rick Updyke

I don’t think we have anything branded today.

Steve Rathgaber

I would ask you to stay tuned.

Bob Napoli - Piper Jaffray

Then just a last question on the surcharges, I mean do you expect continue to gradually increase the surcharge fees? I know we talked about earlier this year that you comfortably below the market, I mean, do you expect to continue to moderately move up surcharges or do you have more room left in that area?

Steve Rathgaber

We absolutely have more room and we absolutely intend to do that on an incremental basis not big waves but save it on an incremental basis. That is absolutely an important arrow in our quiver of things we can leverage and you can look forward to increments next year in that space.

Operator

Our next question comes from Reginald Smith, JP Morgan.

Reginald Smith - JPMorgan

I guess my first question, you guys talked about first no interchange revenue and how you control roughly 39% of what’s you’re receiving. I guess could you kindly explain the types of transaction that fall into the category. Would that be kind of Allpoint and bank branding type stuff or what types of transactions are those?

Steve Rathgaber

What I can comment on there in terms of specific, it is now Allpoint, Allpoint is outside of that control, right in terms of some of the volume.

So, it includes some of Allpoint in terms of all interchange. I stand corrected on that. We are able with a number of partners to who choose to have access and in many cases large partners who choose to have access to components of our portfolio to negotiate fixed rates where we’re saying we will sell you access to our machines at a specific fixed price. By controlling the price, we’re able to basically avoid some of the risk of being exposed movement in interchange. That is essentially controlled by networks like Cirrus and Plus and Star and Pulse and NYCE. So, we’re essentially talking about one of deals that are bilateral arrangements between parties.

Reginald Smith - JPMorgan

Okay. So, I guess would those be bank branded deals then?

Rick Updyke

They would be bank branded deals potentially. They would be a partner deals that might represent a consortium of institutions where we could sell access at a particular service to a particular set of machines. So, it is our business to make sure we’re in control of our pricing and our revenues and we have been quietly building up the strength of that those relationships.

So, it’s a potpourri of things there. It is Allpoint. It is buyers for other types of constituent groups, it is branding deals. It is a variety and we’re interested in all of them and we’re interested in locking them down. We’re in discussions to do more of them.

Reginald Smith - JPMorgan

Okay. That’s good information. I guess my second question, you said ₤5 put some of the ATMs over in UK and then you saw an increase in transactions over there. Just curious, have you guys thought about doing that in US or and do you think we’d have a similar impact for transaction count?

Mike Clinard

Yeah, Reg, this is Mike. We actually did a similar pilot recently and unfortunately saw no impact or really no change in transaction.

Reginald Smith - JPMorgan

This is worth a try. Right, and then if I can sneak one more in. Have you guys ever broken out what percentage if your revenues are Allpoint today and I guess kind of how the gross margin line that compares to the broader company margin?

Chris Brewster

I’m sorry, Reg, could do repeat that for me please?

Reginald Smith - JPMorgan

Yeah. Have you ever broken out which percentage of your revenues are Allpoint driven today and how those margins compare to your corporate average?

Chris Brewster

Well, I guess the straight answer is we haven’t separately broken out Allpoint we do in our in our press release break out what we call our network and branding revenues and in very round numbers you could think of that as roughly half and half between what we would call bank branding and what we call network branding. So that would give you some sense on the revenue side.

In terms of margins, we think of our Allpoint bank branding revenues as being among our highest margin revenue categories, really for couple of reasons. One is because they’re typically largely represent a component of incremental revenues and our incremental cost on an incremental transaction is not that high. In some cases, we don’t pay merchant fees on those transactions. The merchants benefit from that additional activity is more foot traffic in the store and more merchandise sales in the store as opposed to more money from us. So that also helps our margins.

Operator

(Operator instructions). Our next question comes from Gary Prestopino from Barrington Research.

Gary Prestopino - Barrington Research

Hi, good afternoon everyone. Just want to understand the Kroger deal. You do not own those machines, correct.

Chris Brewster

No, we do own the machines. We bought the ones that were in place.

Gary Prestopino - Barrington Research

Okay, so you do own them. Then in terms of the pipeline you talked about something like 8,000 ATMs up for grabs next year, is that one of the years where that probably the largest amount of potential new business that you could get? What percentage of those historically have gone back to the incumbent in terms of, if a contract flat out?

Chris Brewster

I don’t know that I have the answer whether that’s the largest from a historical perspective, but it has to be up there just given those types of numbers.

Steve Rathgaber

Yeah, maybe I can try a swing here as well, Gary. I think a couple of things are true. So, when we talk about pipeline, the 8,000 machine pipeline that Chris mentioned is just one of the components of our business, right. That’s some of the turnkey activity, but there are also branding pipelines, there are also surcharge-free participation pipelines. So, there are variety of activities in place.

In terms of this 8,000 locations though, from what I’ve heard from just talking to folks that seems like a pretty big swathe of stuff to come into the queue. So, I would say it’s probably atypical and probably an exceptionally good year.

In terms of retention, I think that it depends on the mix of players within that portfolio you will find banks who maybe have concluded that they are not in the business of placing ATMs perhaps the better half with the partner to place the ATMs for them and then brand with that partner. Gee, that would be a perfect Cardtronics opportunity, I would say, and you may find other entities that might be have been in the business themselves and they just realized that its just not a sweet spot for them to stay in that business if a particular store location was doing their own thing.

So, it will be a mix. Within that mix, you have different success rates, but we are bullish on penetrating a fair amount of that as we sit here today because all that has been done over the past several years in times of driving our scale, our ability, our performance levels. It’s just hard to think in terms of a competitor that can match what we can do in the side and I think assuming that it’s not just about price we’ll do very well and to the extent, it is just about price. I think you’re looking at the scale party that can be most effective there.

Gary Prestopino - Barrington Research

These contrasts let out are they did on our RFP or a closed bid?

Unidentified Company Representative

Mixed bid, some of them will do that, some of the bigger ones typically will do. If there is an incumbent in there, they might actually be reaching out to us the partner with us and try to put in a preventive bid. So, it’s a mixed bid and it’s a fun bid to be playing with.

Gary Prestopino - Barrington Research

I wish you well and then just getting back to Kroger. So, you own those 800 machines go into your actual count that you will report every quarter then correct?

Chris Brewster

Well, we’re going to end up doing a split count. So, we don’t confuse our statistics. We’ll end up reporting there hasn’t been enough volume in the past of what doing this, but fortunately that we’ve now had in our success in the managed services business where it becomes to remain. I think what you’ll see is doing on a go forward basis is reporting account, what we think, that was our turnkey machines where we are collecting surcharge in interchange revenues and a separate count managed services machines where we don’t typically have an interest in surcharge and interchange revenues but we’re getting paid operating fees. I think the only one we’re all be able to keep the number straight is it we split it out like that.

Gary Prestopino - Barrington Research

So, we’re going to expect that next quarter.

Chris Brewster

Yes.

Operator

I'm showing no further questions at this time.

Steve Rathgaber

Okay, well. We’ve no further questions. We’d like to thank you all for listening in and look forward to talking to you all again next quarter.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes our program for today. You may disconnect and have a wonderful day.

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Source: Cardtronics Incorporated Q2 2010 Earnings Call Transcript
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