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Euronet Worldwide, Inc. (NASDAQ:EEFT)

Q1 2008 Earnings Call Transcript

April 30, 2008 9:00 am ET

Executives

Jeff Newman – EVP and General Counsel

Rick Weller – EVP and CFO

Mike Brown – Chairman and CEO

Kevin Caponecchi – President

Analysts

Anurag Rana – KeyBanc Capital Markets

Franco Turrinelli – William Blair

Tim Willi – Avondale Partners

Robert Dodd – Morgan Keegan & Co.

Robert Napoli – Piper Jaffray & Co.

Jason [ph] – Raymond James & Associates

David Parker – Merrill Lynch

Operator

Greetings and welcome to the Euronet Worldwide first quarter 2008 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. (Operator instructions) As a reminder, this conference is being recorded.

It's now my pleasure to introduce your host, Mr. Jeff Newman, Executive Vice President and General Counsel for Euronet Worldwide. Thank you. Mr. Newman, you may begin.

Jeff Newman

Thank you. Good morning and welcome everyone to Euronet Worldwide's quarterly results conference call. We'll be presenting our results for the first quarter 2008 on this call. We have Mike Brown, our CEO; Kevin Caponecchi, our President; and Rick Weller, our CFO, with us today.

Before we begin, I need to make a disclaimer concerning forward looking statements. During this conference call, representatives of Euronet Worldwide will make statements concerning the company's or management's intentions, expectations, or predictions for future performance including selected financial guidance concerning the company's results. These statements are forward looking statements.

Euronet's actual results may vary materially from those predicted or anticipated in such forward looking statements as a result of a number of factors, including competition, technological development affecting the markets for the company's products and services, foreign exchange fluctuations, and changes in laws and regulations affecting Euronet's business. Additional explanation of these factors and other factors affecting the company's results are set forth from time to time in Euronet's periodic reports filed with the U.S. Securities and Exchange Commission, including but not limited to its Form 10-K for the period ended December 31, 2007. Copies of those filings and our other public filings with the SEC may be obtained by contacting the company or the SEC. Euronet does not intend to update these forward looking statements and undertakes no duty to any person to provide any such update.

Now, I'll turn the call over to Rick Weller, our CFO.

Rick Weller

Thank you, Jeff, and welcome everyone. For the first quarter 2008, the company delivered revenue of $247.1 million, operating income of $12.1 million, adjusted EBITDA of $29.5 million, and cash earnings per share of $0.29. The increase in revenue and adjusted EBITDA year-over-year was largely the result of last year's acquisition of RIA in early April. Operating income benefited as well from the acquisition but also included significant intangible amortization charges as required by GAAP.

Moreover, you may have read in our earnings press release, and as we mentioned in our call on the year end results, we wrote down our investment in MoneyGram shares as well as the acquisition related expenses. To this end, you see the investment write-down of $17.5 million as a separate line item in the income statement and a deal related fees of $3 million are included in the SG&A expenses. Cash EPS came in at $0.29 and does include the effects of MoneyGram charges I just mentioned.

I'll also point out that due to the GAAP net loss for the quarter, resulting from the MoneyGram investment write-down, approximately $4.2 million shares related to the 1.625% coupon convertibles were not included in the weighted average diluted shares, because doing so would have been accretive. However, in calculating the cash EPS, the $4.2 million shares were included because in that calculation, they were dilutive.

We now move to slide number six, here on slide six, you can see the last two years of revenues of the first quarter and how the trend of yearly improvements continue, again recognizing that the addition subsequent to the first quarter last year of RIA made a significant contribution to this year's first quarter revenues.

Let's move now to slide seven. On slide seven, we illustrate quarter over quarter transaction growth. The 24% increase in transactions year over year has been consistent with revenue growth that I discussed on the previous slide. We continue to see transaction growth in all segments of the business.

Now, the slide eight. In the first quarter, RIA processed 3.8 million transfers. This represents transaction growth of approximately 10% year over year. You can also see in the chart how the business continues to grow through transactions sent to countries other than Mexico. I think this clearly illustrates the continued mixed shift to markets other than Mexico which are growing faster and more profitably.

Let's turn to slide nine. Slide nine includes a review of our segment's first quarter results compared to last year. The EFT segment grew year over year by 20% and op income grew by 30%. It's important here to point out that in the first quarter last year, the EFT segment's op income included a charge of $1.2 million related to the settlement of a prior year bank sponsorship agreement. Excluding that charge from last year's first quarter results, op income and adjusted EBITDA would have improved by 11% and 16% respectively.

The lighter expansion of these profit totals was largely the result of volume driven rate reductions as discussed throughout 2007 of an outsourcing customer, market expansion efforts in Eastern Europe, and the deployment of cross-border products to meet the emerging opportunities resulting from the new single European Payments Area. I'll also point out that the International Card Fraud matter that we discussed in our fourth quarter call was resolved in the first quarter and the related losses were not significant.

In the prepaid segment, we grow our revenues year over year by 13% and op income increased by 8%. The expansion of the operating income on a year over year basis was impacted by the addition of the acquired UK processor, which had more operating margins and the expansion cost of entering the Indian and Italian prepaid market.

Our money transfer segment grew quarterly revenue year over year by 18%. This is presented on a pro-forma basis to help you better understand the fundamental business developments. You can see in the operating margins and EBITDA margins that the business benefits nicely from volume expansions. The 18% revenue growth was the result of 10% overall transaction growth, which reflected a 60% plus growth in non-U.S. originated transactions, but a decline of 9% in transactions to Mexico.

Despite the decline in Mexico transactions, gross profit that is revenue less payout commission costs on transactions to Mexico improved by a few percent as a result of RIA's decision to not chase certain irrational unprofitable transactions. Mike will comment more about this in his remarks.

Finally, corporate and other included $3 million in charges related to the abandoned MoneyGram transaction. Increased FAS 123R expenses of $1.1 million per share based compensation which was driven by the overall larger size of the business and charges incurred with regard to certain senior level termination. Mike will make additional comments with regard to all segments in a few minutes.

Since the 2007 year end, this is slide ten sorry, since the 2007 year end close, our balance sheet changed in one key area, in the repayment of debt. You can see that debt was reduced by about $60 million. $10 million of that was on the term loan and the balance for the revolver. We will continue to look to reducing our total debt.

On this slide, you can see that we present a couple of debt ratios on a last quarter annualized basis. The increase over the fourth quarter stats reflect the higher seasonal results of the fourth quarter together with the lower seasonal results of the first quarter. As I mentioned, our leverage continues to reduce and we expect to see similar trends in future quarters. There were no other significant changes from December 31 in the balance sheet. Net-net, our balance sheet continues to strengthen.

Now, to Mike, next slide please.

Mike Brown

Slide number eleven, thanks Rick. In our previous call, there's a lot of interest in our bid to acquire MoneyGram and we spent a significant amount of time on last quarter's call discussing our rationale, the synergies and the risk reward profile of combining Euronet and MoneyGram. Despite the circumstances, we felt the opportunity was simply too compelling to pass up without first exploring the possibility.

Ultimately, the turmoil in the credit markets and the damage to MoneyGram's investment portfolio were too significant to yield a combination that we felt would be financially attractive to our shareholders. Our initial decision to pursue MoneyGram was based upon the best information publicly available at the time. We were confident that the combination of our two businesses could mutually benefit our shareholders under appropriate – assuming they were under appropriate terms.

In hindsight, given what has been disclosed regarding the severity of MoneyGram's portfolio problems, we would not have pursued the acquisition had we known then what we know now. We will continue to look for unique opportunities that benefit our shareholders albeit in all livelihood not on the scale of the MoneyGram opportunity. But rest assured that we have learned from this experience and have listened to the advice of our shareholders.

As Rick mentioned, we delivered on our first quarter 2008 earnings guidance and I'm proud of our management team that remained focused and committed to our core business during the MoneyGram endeavor. This quarter, in addition to reviewing our current quarter business highlights, we are going to change our presentation format slightly so that we can discuss some of the opportunities we continue to see in each of our primary businesses and also to discuss some of the near-term realities we need to overcome. Also, in order to accommodate more questions from our shareholders, we have reduced the length of this presentation to allow more time for Q&A.

On the slide 12, we'll start with our EFT processing segment. As you know this kind of a review of our business, we'll do in the next three slides, will cover our three business lines. As you know, we are pioneers in ATM outsourcing concept in emerging markets. We have built a great clientele of banks including 18 multinational banks and 80 individual bank contracts for ATM and POS outsourcing.

In our markets of Central and Eastern Europe and Asia Pacific, including India and China, we continue to see exponential growth in new ATM deployments and the use of debit and credit cards. We provide emerging market banks with a complete suite of payment products while our outsourcing solutions minimize their capital investments and allow them to focus on their core banking business.

While there will always be internal resistance to outsourcing, the growth in our business over the last seven to ten years is a testament to the compelling business proposition. As well, the migration to and consolidation of multinational banks in emerging markets is creating opportunities for us to expand our operations alongside the regional and multinational banks. Our number one focus is to sign new ATM outsourcing agreements. Our pipeline here is more robust than ever. Additionally, we have made significant progress and investments in the development of our SEPA compliant cross border solution for multi country markets.

Now, onto the next slide please, slide number 13, and I'll talk about prepaid debt. As we continue to expand our prepaid payments business, we're seeing a growing preference for prepaid payment products such as prepaid debit and gift cards as well as prepaid cellular. Our ability to add a wide range of products on a same terminal is benefiting our retail partners. At the same time, we can help our product partners to expand internationally faster and more efficiently due to our global cash collection effort.

Additionally, we are working on offsetting the lower growth rate challenges we face in the mature prepaid markets by extending into promising new prepaid markets. Most recently, we successfully leveraged our e-Pay technical platform and EFT operations to expand our prepaid operations in India, Italy, and Romania at a relatively low entry cost. Our prepaid teams continue to track prepaid market trends and are working hard to diversify our products and market portfolio to create profit centers beyond prepaid mobile airtime.

On to slide number 14 about money transfer, the trends in global migration which fuel our business are unabated. For instance, Europe's disappearing internal boarders are resulting in large scale movement from the former Eastern Bloc to Western Europe. Our consumer focused money transfer product is a compelling product opportunity for our EFT bank and prepaid retail customers. Our success in expanding our money transfer network in international markets since acquiring RIA has enabled us to maintain the growth momentum we are experiencing in these international markets.

In the near term, our U.S. and Mexico business is experiencing pressure from the prevailing U.S. immigration policies and general weakness in the U.S. economy, as well we have seen some of our competitors in the Mexico market exhibit rather irrational pricing. RIA's thoughtful development of excellent payout in Mexico over the prior years and in Latin America as well, gave us the ability to make more money despite these self destructive smaller competitors. We are hopeful that we will see an uplift in the Mexican corridor soon, but we cannot be sure of the timing. Meanwhile, we continue to benefit from the phenomenal growth in our international market.

Please go on to slide number 16 and we will talk more specifically about the quarter. In slide number 16, you can see Rick presented the numbers earlier, so I will not repeat them here. I do have or I want to talk a little bit about SEPA and our SEPA compliant cross-border initiatives. These investments started last year and continue in 2008. We estimate about $5 million a year in operating costs for this endeavor. This new product is costing us a bit more than we expected of what the rollout of OMV and process combined with very strong pipeline of other multinational retailers, we believe that this investment will be a good one.

We have initiated rollout in our first country for OMV. Our pipeline for implementation includes the rollout of four to five contracted countries planned in conjunction with the costumer over the next few quarters. On (inaudible) that are not for our investments in this cross border endeavor, our first quarter operating income would have expanded slightly faster than our revenue growth of 20% year-over-year.

Moving on to our first quarter EFT business highlights. We expanded our ATM network by 30% year over year. Currently, we have almost 12,000 ATMs under management and this includes approximately 2,400 bank machine ATMs that were no longer be in our network beginning in the second quarter of 2008.

As most of you are aware, in conjunction with the sale of our UK ATM network in 2003, we signed a five-year ATM outsourcing agreement with Bank Machine Limited. This agreement concluded in Q1 2008 was not renewed based upon the customer's decision to take their processing in-house to their parent company. We have a strong backlog of approximately 1,500 ATMs which are under contract but not yet installed and we continue to market our ATM outsourcing services to multinational and local banks across Europe and Asian Pacific.

In Poland, we signed Polbank to set up a host-to-host connection to handle customized payment card functionalities on ATM. In China, we expanded our agreement with China Post Bank to deploy 90 additionally ATMs to the 700 or so now contracted in three new provinces. This is our third agreement with China Post. We plan to roll out up to 200 ATMs in China prior to the Olympic blackout period starting in May and ending in August.

We continue to strengthen our relationship with multinational bank customers. In Europe, we renewed our (inaudible) agreement for ATM and POS driving and debit card management services. While in Asia Pac, we have implemented outsourcing services in eight countries with Standard Chartered Bank within a year of signing that agreement.

Moving on to slide 18, here you can see some of the observations I made a couple of slides back, but I won't really repeat them, but I will close off EFT by observing that in the software area, we signed two credit card solution agreements with banks in Egypt and Lebanon. This brings us to the end of our EFT discussion and we will now move on now to prepaid.

So please jump at slide number 20. Here we see our prepaid financial highlights for the first quarter of 2008. Our prepaid revenues of $144.3 million in Q1 2008 increased by 13% over the same quarter last year. Our operating income of $10.3 million and adjusted EBITDA of $14.5 million increased by 8% and 7% respectively for the same period.

Our operating income was tempered this quarter by cost to expand Italy. Italy is an important market for us, it is Europe's largest prepaid market. Within just a year of entering this market, we have made significant progress and I will follow up with more details on this in next slide. This is indicative of our disciplined approach to launching new markets. We scope out new markets and leverage our technical expertise, people and successes in established markets to recreate our winning strategy.

A lighter growth in operating income reflects our investments of approximately $400,000 to launch our prepaid operations in Italy. If you exclude this new market investment cost, our operating income for Q1 2008 would have increased at the same rate as revenues reflecting the strong growth from the rest of the prepaid business in another countries.

Slide number 21. We've now signed all four Italian mobile operators. We are currently the only company in Italy capable of processing or disturbing all mobile operator products at large retailer locations. This is a significant achievement in the new market the size of Italy and despite the presence of long established competitors. Great work, to our team in Italy.

Move on to other prepaid business highlights for the quarter. Our transaction processing capabilities which make us the number one prepaid processor or distributor of choice for large retailers in any channel is evidenced by our wins this quarter. We signed Aral, the largest operator of petrol chains in Germany, taking the largest German customer from our competition. We signed Clinton Cards, the leading greeting card retailer in the UK, and another Germany and Denmark chain of discount supermarkets. We've now rolled out five countries for media market, world's largest retailer of consumer electronics, and finally we have completed a full rollout of up to 1,300 stores for Carrefour the largest mass retailer in France.

Slide number 22, in line with our product diversification strategy, we are focusing on adding other popular prepaid products on our global cash collections network. We signed an exclusive partnership with a leading licensed football merchandising company in Italy to launch gift cards.

As you can read on this slide, we have continued to grow our prepaid position by adding several new products in multiple markets. We've also expanded our network in the independent and multiple retail channels by signing 300 independent petrol chains and 250 newspaper stands for prepaid top-ups to Spain. And we've completed full prepaid rollout to Vodafone Core store network and the BP buying group in Australia.

I would also point out that for the first time in several years, we're seeing a competitive landscape change, almost I would say, a good change significantly to benefit our prepaid segment. We're seeing that our competitors in several markets are having some significant challenges. So, overall, a strong quarter with good progress in Italy, our most recent market.

We'll now move on to money transfer and a discussion on slide number 23, actually 24. On a pro-forma basis, our money transfer revenues of $52.3 million in Q1 '08 increased by 18% over the same quarter last year on a 10% increase in transactions. I want to repeat that. Our revenues increased 18% on 10% increase in transactions. Our operating income in Q1 2008 was $2 million and our adjusted EBITDA was $6.8 million, which increased 74% over the same quarter last year. As Rick mentioned earlier, the 60% plus increase in transactions from non-U.S. locations was instrumental to the segment's revenue and adjusted EBITDA growth for the first quarter of '08.

Slide number 25. The continued growth from non-U.S. markets was instrumental to our results this quarter. Revenues from non-U.S. markets increased by 85% while money transfer transactions increased by 51% year over year showing strong margin expansion. Currently, our non-U.S. markets represent 30% of the total money transfer transactions up from 20% a year ago.

A few slides ago I discussed at length our near-term challenges on the prevailing U.S. immigration policies and economic issues impacting transactions to Mexico. But, as I mentioned before, our prudent approach working with high quality agents and not competing with illogical pricing has seen our product margin expand year over year despite a 9% decline in transactions to Mexico over the same period.

We continue to expand our money transfer distribution network. This quarter we've signed new correspondents in 16 countries for more than 400 locations. We also have approximately 4,000 payout locations in the pipeline pending implementation in the next few quarters. This Mexican issue is really challenging to us. I hope you could see that we try to balance good growth with good profit. We've been challenged in Mexico, we focused our efforts at more favorable markets and as you can see, we've expanded our revenue and profits in doing so. I feel encouraged to have an 18% revenue growth with the Mexican pressure we have.

Now, to a few summary comments on the quarter and then we'll take questions. In summary, we were within the range of our guidance cash EPS of $0.29 this year at Q1 2008. Our primary businesses continue to expand on opportunity. We signed prepaid agreements with several large retailers in the supermarket, convenience and petrol chains across Europe, several from our competitors.

Our progress in Italy to date is commendable. We are currently the only company in Italy capable of offering all four mobile operator products in large retailer locations. In EFT, we focused on signing and implementing outsourcing agreements for multinational and local banks across Europe and Asia Pacific. We will continue to make significant investments to build our cross border merchant acquiring platform. We've initiated the roll out of our first country for OMV and the rollout of additional contracted countries has been planned in conjunction with the customer.

We continue to post strong growth in the money transfer transactions from non-U.S. locations, our non-U.S. volume increasing by 61% year-over-year. And finally, we expect our second quarter 2008 cash earnings per share to be about $0.32. The reasons for the $0.32 was a little bit below where we might have expected it two quarters ago, and it's for three reasons. Number one is the interest rates have come down and that's both on our invested income and also our float.

Second is Mexico continues to be weak for us, and the third is we are investing more in our cross-border initiative than we might have anticipated two or three quarters ago. But $0.32 is where we're looking at it for Q2.

This concludes our presentation portion of the call. We'll be glad to take questions, and operator, will you please assist here?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question today comes from the line of Anurag Rana. Please proceed with your question.

Anurag Rana – KeyBanc Capital Markets

Good morning everyone. Just wanted to understand one thing. Your ATMs at quarter end were very strong compared to last quarter; the year-over-year growth rate was down 30%. Yet your average monthly revenue per ATM I think declined about 7% compared to last year. Is this because of the mix of ATMs and should we expect this kind of revenue per ATM going forward as well?

Mike Brown

Good observation. Let me just try to clear that up for you. There are probably two big reasons why you can see the dip. When we move from Q4 to Q1, the numbers of transactions fall off absolutely significantly due to the Christmas seasonality; fall off from Q4 to Q1. And then we also couple that with brand new ATMs in our nascent market China. So this is nothing to be concerned about. In our mind, it's very seasonal. You are one of our more recent analysts, but if you kind of look back over last five to seven years, you'll see a similar trend in Q1 as compared to Q4 prior quarter. We also saw a little bit of a margin squeeze from Bank Machine in the quarter, about $225,000 worth there.

Rick Weller

That deferred revenue of five years ago, when we signed that agreement, had fully completed its cycle. And so, that came out as revenue. So it really wasn't a pricing issue. It's just that that part of the contract terminated.

Mike Brown

Yes. Just to put some perspective on here, one of our second largest most profitable country is Germany. A lot of that is generated out of our own network of ATMs in that market and we do – probably 40% of the transactions that we do in the entire year, we probably do in the last six weeks of the year in Germany and those transactions are at about $4 deferred [ph]. You can see how that just, when that falls off to Q1, it certainly affects our bottom line.

Anurag Rana – KeyBanc Capital Markets

And what should we expect this number to be in what range going forward in the second and third quarter?

Rick Weller

Well, it would actually lift a little bit going forward because as the Bank Machine ATMs that Mike referred to in his comment come out of the mix. Those machines on average brought lighter revenue per machine. So, we would expect to see that number go up a little bit. And that's balanced a little bit with the continued rollout in China where those machines are newer machines and so we'll be seeing the transactions come up on those.

Anurag Rana – KeyBanc Capital Markets

And then just to follow up, this is more just to reconcile the way we calculate the cash EPS. In your reconciliation at the back, you are taking out $5 million of foreign exchange gain in the back and in the income statement, I looked at foreign exchange gain net as to be about $13 million. Could you just help me reconcile the two numbers as to why we are only taking partial FX gains over there in the reconciliation?

Mike Brown

What we're taking out is the net-of-tax effect, because in our GAAP numbers, we calculate some tax expense on that and the numbers end up being not necessarily equal to an effective tax rate because those FX gains are largely – they are largely on inter-company loans and they are all in different countries and so in some countries, you would technically get a deduction or not get a deduction or include or not include that in income and so that's just the net of tax effect on those FX gains or losses in our P&L.

Anurag Rana – KeyBanc Capital Markets

Okay, thank you so much.

Operator

Our next question is coming from the line of Franco Turrinelli with William Blair. Please proceed with your question.

Franco Turrinelli – William Blair

Hey Mike, hey Rick.

Rick Weller

Hello Franco.

Franco Turrinelli – William Blair

Can we go back for a second to the EFT processing business and then understand little bit about what is going on with the OMV contract on cross border, and maybe I am not sure we were scribbling it as we were writing, Mike, I am not sure I really understand the $5 million in operating costs versus the $400,000 in the quarter. So can you just kind of go back over that for me?

Mike Brown

Rick, why don't you answer that then I will add a little bit to it.

Rick Weller

Yes, Franco, it was $400,000 in terms of a delta difference over the prior year in this first quarter here and then that number will increase as we go throughout the year. In total for the year, it will be about $5 million in operating cost in the business. We will start to generate some revenue, it will be a smaller amount towards the end of the year, but for the most part, it will be about $5 million in net operating cost to our business this year. So it will gain, the amount will increase as we go throughout the year.

Franco Turrinelli – William Blair

Okay. That seems really high, I guess I am surprised, is this something that was in the plan or is this something that's increased as we have – actually comment on (inaudible) complexity of rolling this out?

Mike Brown

Yes, Franco I think in the past what we shared with everyone is that in this card arena that we were spending about $2 million-ish a year in cost to do this endeavor. In essence, what we are now expecting is that it's probably going to be about $5 million-ish, so it's gone up. But, and again, we generally share that it's in that kind of $2 million, $2.5 million range historically. So I guess I would say it's certainly an increase, but not – shouldn't be a surprise that we are spending a fair bit of money in this product.

Rick Weller

And one thing that kind of caught us a little bit, Franco, is the offsetting revenues are put back about six months when we originally contracted with a customer. We thought we could go live with this in November. We are only really rolling it out right now. We have passed pilot and we are in full rollout now, and that's due to – as we get closer and closer to November, the customer wasn't quite ready and we had that kind of the seasonal lockdown, so they were unable to kind of move forward. We'll both move forward together now at full pace, so are – where we thought we could keep our, I mean, our net investment down at $2.5 million, the cost of investment has gone up a little bit plus the offsetting revenues are about six months behind the curve there.

Kevin Caponecchi

Hey Franco, this is Kevin. On a positive side, we are finding – we are seeing a lot of interest from multi-national merchants on this. Domestic acquiring is a commodity gain but this potential solution where we are often acquiring across multiple countries, it's turning out to be a pretty unique value proposition and our sales pipeline for this offering is rapidly growing. So, we are pretty bullish about the opportunities on a go-forward basis.

Franco Turrinelli – William Blair

One other question on the EFT processing, if I may, and then I'll let other people jump back on. We are familiar with the plans for the Bank Machine rollouts, but not a surprise, but can you just help us collectively without getting into too much details, I know you don't want to, but just help us a little bit to understand the impact here. EFT is primarily ATM processing, but not exclusively and then I'm trying to – and my point is I don't think we should reduce our revenue forecast by 20% because we got 2500 ATMs rolling off. Can you help us scope it out a little bit better?

Rick Weller

Franco, as Mike mentioned earlier in the average ATM numbers, we have about 225,000 in the first quarter that came out of the math and that number will increase another 550,000 to 600,000 in revenue and profit in the second quarter. So, we will have a total of about 800 or so thousand per quarter come out from Bank Machine and revenue largely equals profit in that or operating income, because we have very little cost. That was just really a driving agreement. There weren't any other ancillary services with it. So, you can do the math there at that roughly $800,000 per quarter level on both the top and op income line.

Franco Turrinelli – William Blair

Thank you, Rick, that's very helpful.

Rick Weller

And that is obviously pre-tax on the op income line.

Franco Turrinelli – William Blair

Okay. Thank you, Rick. Thanks, Mike.

Operator

Our next question is coming from the line of Tim Willi with Avondale Partners. Please proceed with your question.

Tim Willi – Avondale Partners

Thanks good morning. Couple of questions here. Just staying on the ATM and the POS topic first, could you talk about I guess – you have sunk a lot of money into OMV or intend to over the course of the year. Is there scalability for the money that you are spending here as you talk about these strong pipelines or is this truly a very customized solution?

Kevin Caponecchi

This is Kevin. It is about 85% reusable, so we expect about 15% customization with particular interfaces with new merchants and tweaks for the solution. But the short answer to your question is that it's highly scalable, highly repeatable.

Mike Brown

It's also given us a leg up as we fit this to other petrol chains, because they can see that the product is ready to rock and roll and could be installed with them rather quickly and it's working right.

Kevin Caponecchi

So, on a petrol – the next petrol customer will probably be higher, probably over 90% reusable. If we did a merchant like in (inaudible) or something else, it will be probably 85% reusable.

Tim Willi – Avondale Partners

Yes, okay great. Is there any way to just sort of give us some color for the additional call it $2 million to $2.5 million that you have articulated you have to spend here, what sort of drove that incremental risk and spending associated with OMV?

Rick Weller

Well, it's kind of a variety of things that it – I wouldn't tell you that there is any one thing in there. SEPA is a new requirement and also we are working through as Kevin mentioned in this petro application and it's just making sure that you understand all of the specific nuances and requirements of this new kind of emerging practice and then probably the other thing is Mike pointed out that is as significant as anything to it is the delays in accommodating the fourth quarter high seasonal traffic patterns where OMV wanted us to be – to delay that. We were a little slow in getting a couple of things done, and so it is not one particular thing, it's just kind of a number of things that kind of gets – expands a bit when your revenue delays a bit.

Kevin Caponecchi

This is Kevin again. In summary, we think we have our arms around it. It's not something that we believe is a risk going forward, something that we understand and is captured and we are 100% confident we can deliver.

Rick Weller

And we are delivering. I mean that's the point, I mean it took us a little bit longer to get here and the run rate to continue to deliver this in multiple markets. It's higher than we anticipated a few quarters ago, but the fact of the matter is, this is not an R&D project that's incomplete. We launched our pilot about six to eight weeks ago. It was very successful. We are in the full rollout mode in our first country, which is Czech Republic, and we have got a number of other countries now slated for the coming quarters. So, it's kind of like the risk is out of the equation, now we just have to get down to work, finish rolling this out for OMV and other markets and that becomes an excellent sales tool for these other petro chains and so forth who want to save probably on average about 1% of sales by utilizing this kind of solution, the multiple solutions that they have had to live within multiple markets. So, it's a value proposition they can't get away from and we are kind of the only guys with the offer on the table and we are certainly the only guys doing a deal like this.

Tim Willi – Avondale Partners

And then just a second question, Mexico, obviously you've laid out the case and the numbers seem to prove it, very strong international growth is overriding the issues with the Mexican market. Can you give us any thoughts around deliberate managing of that market down where you are at in terms of thinking through, trying to maximize profitability, be rational about pricing, agent commissions, just trying to get a sense for what you are thinking along those lines, how much more we have here in terms of restructuring, so to speak, in that operation?

Mike Brown

I don't think we have got much restructuring but what we did do is we decided not to play an unhealthy game and the nice thing is RIA in prior years has developed a network that's par excellence as far as payout goes in Mexico and Latin America. So, because we have got – our network is no worse than and probably no better than the top two guys, so all three of us have equal payout. But, as you go below us, payout starts to get more spotty, and so we have been able to take advantage of our good reputation, our excellent payouts and solidify our pricing and basically stick to it. And a few transactions did fall off but our net profit ended up a few percentage points higher. So, I think we have kind of done our – we are going to just continue what we are doing, it seems to work well and we are continuing to grow our profits and we will do that even in a tough market.

Tim Willi – Avondale Partners

Thanks a lot.

Operator

(Operator instructions) Our next question today is coming from the line of Robert Dodd with Morgan Keegan & Co. Please proceed with your question.

Robert Dodd – Morgan Keegan & Co.

Hi guys, a couple of housekeeping ones first and then a couple more complicated ones, corporate expense what’s the run rate going to be? Once we take out the $3 million for the MoneyGram issue, how much was related to normal occurring severance or catch up versus what’s the run-rate number for that second?

Kevin Caponecchi

Right at 800,000 to 900,000 in non-recurring charges that's kind of split between stock-based comp and SG&A – it's probably salary and stock-based comp and there was even a little bit of SG&A in there. So it's $800,000 to $900,000 in that total category, Robert.

Robert Dodd – Morgan Keegan & Co.

Okay, got it. Going back to the OMV issue, I mean you have been sending money on this product, this product development over a year and not going to generate revenues to another six months. How do you feel on the IRR of this investment and in particular, I mean how many OMVs or Ikea [ph] to use one of your own names, do you need to turn this product into a profit center in the near term and to justify the IRR in the long-term?

Kevin Caponecchi

We would estimate that it will take between two and three, certainly as you get into your third merchant you are start to print money.

Mike Brown

We can make money on the – but it takes time with the transaction growth. Our goal is to accelerate that payback period by bridging on two to three new customers, so that we can start to have positive results next year.

Rick Weller

But Robert, to get to our targeted internal ROIs on it, as Mike said, we would be making money at two to three, we need to probably be between three and four to get our achieved ROI. So you can tell from that that this isn't an insurmountable kind of a challenge to try to pick up customers and with the sea change in this payment processing area across Europe and as Kevin mentioned, what we are seeing in the pipeline opportunities, it certainly looks like a reasonable goal to achieve in that three to four to get to our desired ROI. And this is the kind of product that if we start going above that, we could be doing a lot better than our ROI there.

Kevin Caponecchi

And also, I know there is a lot of focus here on OMV and this is the investment quarter, so let's not forget the rest of our EFT business. I mean the rest of our EFT business grew its revenues handsomely and ex the investments in OMV, profit margins went commensurate with that, actually slightly higher. So we are not – you don't see us (inaudible) worry about margin pressure and this last quarter's results, do not fair [ph] that out. We are seeing just lots of growth in these emerging markets for just the old-fashioned ATM POS outsourcing. That's going to continue to be so, especially with these new contracts that we are getting in Asia and pipeline that we see really across the board, so we are pretty excited. Actually, the pipeline right now as you see from a qualitative position, is unbelievable. I have never seen a pipeline of real-life deals that could close in next year, even half this big is what we are looking at today. The numbers are kind of off the chart. I think we have finally become absolutely the industry leader in these markets. Everybody acknowledges that and we are just seeing kind of strength pushing strength. So we hope that will continue to grow while we are growing our cross-border initiatives.

Robert Dodd – Morgan Keegan & Co.

Okay thanks. And one last one on, going back to the tax issue, 51% effective tax for the first quarter, is that kind of level going to continue in the second quarter? Is that one of the things that's affecting the earning guidance as well? And if I can make a recommendation, I think it would be helpful for all of us analysts if you could give maybe a somewhat disciplined reconciliation account for EPS, maybe starting from the pre-tax numbers and then potentially even using a long-term tax rate to figure out a cash EPS number, because the volatility in the effective tax like quarter-to-quarter and the adjustments that we have to factor in make projecting that cash EPS even more difficult that it normally is.

Rick Weller

Yes, Robert, I sympathize with you. I also wish it wasn't that way for the purposes of our auditor's tax bill, but what we pay in fees for our accounts. But, anyway to me, the 51% is largely driven by that large gain on foreign exchange. We don't project what that number maybe. It's kind of hard to outguess that number there, but to make it a little bit more simple on, let's call it, on a cash EPS basis, we were just under kind of 30% on an effective tax rate for our cash EPS. We have assumed as we go throughout the year that we will be a little bit higher on the tax rate because we are seeing great production in transaction growth out of our RIA international businesses in the lights of the Italy's, the France's, the Spain's and markets like that where there are higher tax rates. But, nonetheless, kind of to get a little bit more simple, in that 30% zip code for cash effective tax rate.

Robert Dodd – Morgan Keegan & Co.

Okay, thank you.

Operator

Our next question is coming from the line of Robert Napoli with Piper Jaffray & Co. Please proceed with your questions.

Robert Napoli – Piper Jaffray & Co.

Thank you and good morning. Couple of questions, I guess. One suggestion, I think you guys got to focus a lot more time and effort getting more contracts like the Bank Machine contract with 100% margins. That would mitigate the need for a lot of the other –

Mike Brown

And the reality is, our next contract whatever that is in ATMs, which is why I'm excited about the pipeline of potential deals, if we're in any of our current countries, it is a deal like that. It is 85%, 90% kind of flow-through. So, that's the magic of our business. That's why when these contracts are a challenge to close because nobody likes to outsource. Outsourcing is a bad word in all languages. But, once you get them, they are very highly productive with very high flow-throughs.

Rick Weller

I would add just one maybe alternative comment to that and they are very – in this Bank Machine, it is a very high flow-through but this is our only contract where we really only do driving only. One of our real values and I think one of the real stickiness to a lot of our other contracts is that we provide end to end in most of these other contracts, kind of an end-to-end ATM outsourcing solution which is not just the IT outsourcing part, but it includes the cash fill, the maintenance, the placement of the machine, the managing of even the retailer relationships and things like that. And that makes it incredibly more difficult for someone just to decide to want to in-source something like they did in this situation here. So I appreciate what you're saying, clearly revenues all dropping to the bottom line are great for us, but when you have a customer relationship where you have fewer elements of that decision, that manage service delivery, it's just a little easier for them to move. So, we would rather see those customers that we sign up have full end-to -end agreements where it's just very hard for them to want to in-source that thing.

Mike Brown

And if I might add too, this is the first contract loss we've had in 14 years. And it's for the reason that Rick mentioned.

Robert Napoli – Piper Jaffray & Co.

Interesting. Thank you for that answer. It's very helpful. To a question (inaudible) a question on the Italian prepaid market and I just wondered if you could try to quantify, size up the opportunity and try to quantify when you would expect, when you hope to see results that could be material through the P&L?

Mike Brown

We're rolling out in this quarter and so, when you say material, I would say towards the end of this year because we've got to roll them out, we've got to get this and transactions have to grow and that kind of thing. But I would say, for sure, by the fourth quarter this year – third, fourth quarter.

Robert Napoli – Piper Jaffray & Co.

Can you kind of size up where you feel like the revenue opportunity is for you in that market over the next several years?

Mike Brown

Well, I think that we'll – let me just kind of paint for you the Italian position. It's very interesting. There's one player out there right now, virtually has all the electronic top-up and their company is Lotomatic [ph] and they are a lottery company there. They do all the transactions that, kind of small convenience stores, tobacco shops and so forth. They do about 70% of all the top-up in the Italian market. The other 30% is still (inaudible) at the large retailers. The mobile operators there in Italy did not feel like it was in their best interest to give Lotomatic virtually 100% of the business, so they've locked them out of the large retailers. So we've kind of swooped in here; we actually are – the guy who used to run Lotomatic, its prepaid business, now works for us. He's a very talented individual and he's gone into these large retailers to sell our services and he's been very successful. He's got all the mobile operators, he selling these deals and we are starting to roll them out now. So, I guess you could say that we've got all the large retailers who are dying for an electronic solution but don't have one, we probably got a 30% market share potential. But, our experience in the UK and Germany showed that the large retailers actually have larger potential and you'll see a shift from the little guys to the big guys. There are 50 million prepaid users in Italy alone, the largest prepaid market in all of Europe, and 90% of them, 90% of all the users in that market are prepaid as opposed post-paid. So it's the market to win in. And with the large retailers that we are starting to sign up, it's very exciting for us.

Robert Napoli – Piper Jaffray & Co.

Do you have any idea what revenue Lotomatic generates from prepaid in Italy?

Mike Brown

We have looked at that revenue under non-disclosure in the past, so I'm not at liberty.

Robert Napoli – Piper Jaffray & Co.

Okay. Just the question on the segment trends and I understand the seasonality in the first quarter. But looking back through fourth quarter-first quarter, '05-'06, '06-'07 and then '07-'08, it does look like we had slower sequential growth. And I'm not sure, I know there is some little acquisitions sprinkled in here and there in EFT and prepaid in particular – but I just wondered. Why it seems that way? Also currency changes could diminish the effectiveness of that analysis. I would put it – is there some slower market growth? Is there some economic effects?

Mike Brown

We see this on ATM transactions. We can see a very similar thing in prepaid as well. But you're right, from December to January, transactions will fall off 15%, maybe even 20%. And then you will see them come back to where they were going down about – they might come back 5% but they're still 10% or 15% off of December in February and by March you start to get your feet back under you.

The reality is people don't even go to the ATM in January because they know they have no money there. So, it's that kind of seasonality. And when you're doing – on prepaid business, lots of people buy new phones for their kids and their siblings and their wives, whoever it is, in the fourth quarter and with that they give them a prepaid card. They buy 50 pounds or 50 euros worth of prepaid top-up. They burn through this through January and it is February before they start topping up again. So, those are the reasons, the kind of a qualitative reason behind the seasonality and it all makes sense.

And when it comes to money transfer, which is new to us and you can't really look three to four, five years back because it doesn't make sense. But, the reality is much of the demograph labor used for farming and construction and it just doesn't happen in the cold months.

Robert Napoli – Piper Jaffray & Co.

Okay. Just on the money transfer business. While the acquisition of MoneyGram didn't go well and maybe you wouldn't do it if you knew what you know today. The logic behind it does seem to hold. Western Union talking about U.S. and Mexico, they also pointed out that Canada and Mexico was up 70% year-over-year. So people were still immigrating. They just moved further north.

Mike Brown

They're a little bit more well treated up there.

Robert Napoli – Piper Jaffray & Co.

Yes, they are.

Mike Brown

Down here, let's face it, we've got guys trying to shoot them at the border. It just doesn't make them feel real comfy.

Rick Weller

You still have to get (inaudible).

Mike Brown

It doesn't make them wanted. And that's the one thing about the Mexican immigrants. We picture them like coming over the border and staying here. It's a very fluid populace. They all go back and forth multiple times in a year, stay there during the winter months, go back for the holidays, that kind of thing. So it's a more fluid group than say the thousands Central Americans where they're just, it's just a longer trek.

Robert Napoli – Piper Jaffray & Co.

Yes, I understand that. But my point strategically is, are there other opportunities to expand countries? Because having, being in more countries as immigration shift around is a major advantage…

Mike Brown

Absolutely. If Juan was here – Juan Bianchi runs our money transfer unit – he'll tell you how excited he is about the growth in Canada. It's more of our burgeoning market as an example. We're following Western Union's trends if they have one.

Kevin Caponecchi

I think I'd just add to that is, as we take a look at the growth that we are seeing in the non-U.S. markets, that's where we are focused on with the RIA business. We are seeing good success coming out of our European originations and a lot of that traffic is because, what Mike said, immigration patterns moving from the eastern side to the western side of Europe. There's virtually no restrictions on many of those country movements there. And we have continued to build out those payout networks going into those Eastern European countries. We, in addition, are working on other payout corridors, and enhancing those corridors whether it's to the Northern African kind of markets or to the Indian markets or our other Asian Pacific type of markets where you as well see a fairly strong immigration patterns. So we're not just focused on North American activity. We benefited as well from improvements in the Canadian traffic, as Mike said. But we've got our eyes set on many on these other non-Mexican markets that are equally as big. If you take a look at the statistics, Eastern European transactions are about the same size as U.S. to Mexico. India and China are each again about the size of Mexico. So there are four big markets out there: Mexico, China, India and Eastern Europe. We're looking at all of them.

Mike Brown

And we get kind of myopic being Americans here, sitting here. The reality is there are more immigrants in Western Europe than there are in America. So we don't have, right now, theoretically if we got our fair share, or our big competitor's got their fair share, we would all be doing over half our business in Europe. That's why we bought RIA because we have that great European presence and we continue to leverage that and grow our business. So it would not surprise me that in the future, we'll do more transactions Europe, non-U.S. originated, than we will U.S. originated.

Robert Napoli – Piper Jaffray & Co.

Thank you.

Operator

Our next question is coming from the line of Wayne Johnson of Raymond James and Associates. Please proceed with your question.

Jason – Raymond James & Associates

Good morning. Jason [ph] for Wayne. How are you?

Mike Brown

Hi, Jason.

Jason – Raymond James & Associates

Hi, my questions are in regard to prepaid segment. Looks like the retail locations were quite sequentially (inaudible) were actually down. Was there any reason for this?

Mike Brown

Yes. That's a good observation. We wondered which one of you guys is going to be awake enough to notice that. In our computer systems, the way we work is we get a count of the POS terminals that are actually doing business in a given quarter. And when we sign up these large retailers, as I mentioned before, the reality is in Q4 in the Christmas season, people like Tesco and Wal-Mart and so forth, just open up more lanes. So that POS, that ID number on that lane lights up in our computer systems. So, it's just the Q4 seasonality of having more lanes opened across basically the same number of retailers.

Jason – Raymond James & Associates

Okay. That's helpful. Also, were there any negative impacts from pricing in prepaid or is it the usual…?

Mike Brown

There's no – there's nothing of any instance at all.

Jason – Raymond James & Associates

Okay. That's great. Thank you.

Mike Brown

You saw actually ex little Italian investment, we had strong powers in prepaid both margin – we didn't see compressions in margin. Do you have one more question?

Jason – Raymond James & Associates

Did you quantify the Italian investment?

Mike Brown

Yes. $400,000 in this quarter.

Jason – Raymond James & Associates

Great.

Mike Brown

And we've got time I think now, operator, for one more question.

Operator

That is correct, sir. Our next question will be coming from the line of David Parker with Merrill Lynch. Please proceed with your question.

David Parker – Merrill Lynch

Good morning everyone.

Mike Brown

Good morning, David.

David Parker – Merrill Lynch

Could you just remind us of the 1,500 ATMs in the pipeline. How many belong to the China post banks (inaudible)? Also just talk about the timing of the rollout beyond the 200 ATMs that are coming out soon. Then just provide some color around the blackout period that you mentioned.

Kevin Caponecchi

China post bank might have about 700 per China post because we added a new contract just last quarter. And you asked about the blackout in China. Basically China, Inc. – the government says no construction, don't mess with the system May through August. And so, we are – end of May I guess through August. We're trying like the devil to get it in a couple of hundred ATMs this quarter before the curtain falls on it. And then it opens up again after the Olympics are over.

David Parker – Merrill Lynch

Can you just get in those final 500 rolled out by the end of the year? Between August and the end of the year?

Mike Brown

I'd say we've got a pretty good shot at that.

Kevin Caponecchi

That's our goal, certainly.

David Parker – Merrill Lynch

Okay. Can you talk about your unrestricted cash position? You mentioned one of the reasons why 2Q was a little bit lower was because of rising – or interest rates coming down. Is that any impetus for you to put that cash to work?

Mike Brown

Well, I'll let Rick answer some of it. There's no way we're going to put the – when you say 'cash to work', there's only two places we can do it and that's some kind of an acquisition or paying down debt.

David Parker – Merrill Lynch

Yes.

Mike Brown

I would say, with the interest rates lower, there might be a little bit more impetus to pay down debt quicker. But, as far as acquisitions, we can't time – if it's a good, accretive – very accretive acquisition, we'll do it when it's there, but I can't time those.

Rick Weller

Yes. The only other thing I would add to that David is from time to time, I'm asked whether we would consider or have considered repurchasing our shares, especially at the current price level. And the short answer is, you bet, yes, we would. The difficult answer is, under our bank agreements, the bankers want to get all their debt paid off before we would acquire any kind of shares. So unfortunately, we have limitations – not limitation, an outright restriction, on repurchasing our shares or we would consider doing something like that. So, as Mike said, it's either good, accretive opportunities or whether we want to put more down to take down debt.

David Parker – Merrill Lynch

Okay. Then just final question is First Data announced the acquisition of your largest competitor in the U.S. prepaid business, InComm. Any comments on that or any thoughts?

Mike Brown

We would expect probably no change, similar environments to what we see right now. The U.S. is the only market where we don't have a pretty dominant position. But we still continue to make good money here because we're focusing on different market segments than they are. And now, actually that First Data is taking it over, which has a penchant for larger margins, hard processing and so forth, they may actually stay out of our sandbox a little bit more than they have in the past. So we'll see what happens. I would say, in general, I don't expect much to change there.

David Parker – Merrill Lynch

Okay. Thanks guys.

Mike Brown

I want to thank everybody for taking your time with us today. And we'll look forward to talking to everybody next quarter.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Euronet Worldwide, Inc. Q1 2008 Earnings Call Transcript
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