Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Cardtronics Inc. (NASDAQ:CATM)

Q2 2008 Earnings Call

August 12, 2008 8:30 am ET

Executives

Melissa Schultz - Investor Relations

Jack Antonini - Chief Executive Officer, Director

J. Chris Brewster - Chief Financial Officer

Michael H. Clinard - President - Global Services

Analysts

Robert P. Napoli - Piper Jaffray

Christopher Mammone - Deutsche Bank Securities

Franco Turrinelli - William Blair & Company

Reginald L. Smith - JPMorgan Securities

Operator

Welcome to today’s Cardtronics second quarter 2008 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Melissa Schultz of Cardtronics.

Melissa Schultz

Participating on the call today are Jack Antonini our Chief Executive Officer, Chris Brewster our Chief Financial Officer, and Mike Clinard our President of Global Services. Today’s call will follow our traditional format. First, Jack will discuss this quarter’s financial results and key highlights. Mike will then provide an overview of our operations and an update on some of our operational initiatives. And finally, Chris will provide additional information on our financial results as well as an update on our expectations for 2008. Prepared remarks are scheduled to run for about 20 minutes at which point we’ll open the call up for any questions that the listeners may have.

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

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

I’d like to now turn the call over to Jack Antonini our Chief Executive Officer.

Jack M. Antonini

For the second quarter our adjusted EBITDA which is earnings before interest, taxes, depreciation and amortization adjusted for certain non-cash and non-recurring items totaled $22.5 million. This represents an increase of 82% over the $12.4 million of adjusted EBITDA that we reported in the second quarter of 2007. The majority of this increase is attributable to our acquisition of the ATM and self-service advanced functionality kiosk business of 7-Eleven that we completed in July of last year. Adjusted net income which is adjusted EBITDA less interest, depreciation and normalized taxes totaled $3.1 million or $0.08 per diluted share for the quarter. As usual Chris Brewster our CFO will discuss our financial results in more detail in just a few minutes as well as our expectations for the remainder of 2008.

As we noted in our press release this morning the second quarter was a solid one for Cardtronics. We made significant progress on many of our key initiatives including our bank branding and surcharge free offerings and our growth plans in the United Kingdom and Mexico. We also continued to make progress in reducing the losses related to our advanced functionality offerings. And finally, we’ve had continued success with our conversion efforts related to our electronic funds transfer or EFT processing operations.

On the bank branding front, we currently have approximately 10,000 ATMs with bank brands on them. While we didn’t have much in the way of announcements this quarter related to our branding efforts, there continues to be significant activity going on behind the scenes. In the second quarter alone we signed agreements to brand over 230 additional ATMs, the majority of which will be branded by one of our existing branding partners. This continued interest by existing partners is truly a testament not only to the competence these major financial institutions have in us but also to the value we provide to our branding arrangements. We have also recently signed a branding arrangement for over 300 locations with a new branding partner, the details of which will be announced at a later date.

Along those lines I think it’s important to point out that while we continue to see strong interest in our branding offerings from financial institutions, we’re starting to experience longer sales cycles in this aspect of our business. From what we’ve been told, this is clearly a result of the economic and credit related issues that are currently impacting many of these banks. So while we believe the compelling economics of our branding offerings will result in continued growth for this portion of our business, we’re likely to see longer sales cycles at least for the time being as our existing and potential branding partners work through these issues.

Turning to our surcharge-free network offerings we continued to welcome new financial institution members to our Allpoint network during the quarter including Chevron Federal Credit Union and Technology Credit Union. Combined these two credit unions have over 130,000 members and over $2 billion in assets. With the most recently quarterly additions, Allpoint now has over 1,150 member institutions and continues to be the industry leader in terms of the number of surcharge-free ATMs available to its customers. In addition, in June Credit Union 24 the largest credit union owned point of sale network in the United States extended its relationship for the Allpoint network for another two years out through February 2011 further demonstrating the significant value of the Allpoint network to smaller financial institutions and to their customers.

In terms of our international growth efforts, we continued to make good progress on this front during the second quarter as a result of additional deployments. Our average number of transacting ATMs in the UK increased over 2,400 during the second quarter representing a 7% increase over the first quarter and a 52% increase over the second quarter of last year. And we continue to be excited about our growth opportunities in the UK.

With respect to Mexico, our average number of transacting ATMS now exceeds 1,500 which represents an increase of over 11% compared to the prior quarter and an increase of over 150% when compared to the second quarter of last year. We continue to be very encouraged by the growth opportunities in this still-developing market and we’re pleased with the improvement and the financial results that we’ve seen in this segment of our business this year.

In addition to our existing international operations we continued to make solid progress in our international expansion efforts during this most recent quarter, and in fact in June we reorganized our business to help us to focus on our strategic priorities. We promoted Mike Clinard our former Chief Operating Officer to the role of President - Global Services where Mike will focus on leveraging our operating scale and efficiencies as well as our technology platform in each of our markets and lead the expansion of our EFT processing business. Rick Updyke our former Chief Strategy and Development Officer has been promoted to the role of President - Global Development. In addition to our sales and marketing group we’ve pulled our acquisitions team, our international expansion team and our business development teams together under Rick’s leadership to facilitate our international expansion clearly demonstrating our commitment to international development as a top priority of our future growth plans.

In terms of potential international expansion opportunities we’ve had an increased level of interest and activity with respect to opportunities in both the Europe/Middle East/Africa region and the Asia Pacific region during the first half of this year. As a result we’re in the process of bringing on additional staff for the extensive ATM and payments processing experience to assist us in our international growth efforts in these regions. As a result I feel confident we’ll have some tangible progress to report to you in this aspect of our business over the next several months.

Finally turning to our advanced functionality offerings, in May of 2008 we launched our remote deposit capture program with Co-op the nation’s largest surcharge-free network for credit unions. This allows card holders of financial institutions that participate in the Co-op network to make deposits at any of our Vcom units. We’re also working with a number of other financial institutions to implement similar programs for their card holders, one of which we anticipate will be implemented in the fourth quarter of this year. In addition, we’re currently working with potential new partners on additional service offerings for consumers that will result in incremental revenues as well as service for future periods.

During the second quarter we generated a small operating loss around $600,000 related to our advanced functionality offerings. This is a significant improvement compared to the $1.3 million losses that were generated in the first quarter and the $10 million loss run rate that we had at the time that we acquired the business. At this point we still expect to turn a small profit on these offerings during the first quarter or second quarter possibly of 2009 which is consistent with what we communicated during our last conference call. Along those lines it’s important to remember that the Vcom machines themselves which are machines that perform traditional ATM services as well as the advanced functionality services such as image deposit and money transfer and check cashing are actually quite profitable already. So as we continue to improve the results from the advanced functionality offerings, the Vcom units will become even more profitable.

In closing, I think we made solid progress during the second quarter and have put ourselves in a great position to achieve the goals that we set out to achieve at the beginning of the year.

At this point I’ll turn the call over to Mike Clinard our President of Global Services who will provide you with some additional detail on our operations during the most recent quarter.

Michael H. Clinard

As we noted in the press release, during the second quarter of 2008 a number of our key operating metrics demonstrated significant improvement over the second quarter of 2007. You can find these statistics on the key operating metrics page of the press release. As you’ll see, the average number of transacting machines, overall transaction levels, and per ATM per month metrics were substantially higher during the second quarter when compared to the same period last year. The majority of the growth can be attributed to the 7-Eleven acquisition and growth in our international operations. In addition our legacy domestic operations also delivered a solid performance during the quarter primarily due to our bank branding and surcharge-free offerings.

Turning now to one of our key operating initiatives which is the expansion of our processing operation, during the second quarter we converted roughly 3,000 existing ATMs to our internal processing platform. The additional conversions bring the total number of ATMs on our processing platform to 23,000 as of the second quarter of 2008. We expect to transition our remaining ATMs including Mexico by the end of this year. However, I should point out that there are about 3,500 ATMs from the 7-Eleven acquisition that cannot be converted until the end of 2009 when our agreement with a third party processor expires. Expanding our processing operation is a key strategy for us here at Cardtronics which we believe will provide us with additional domestic and international growth opportunities.

And finally, it’s interesting to note that despite the difficult economic environment here in the US our domestic legacy business has continued to perform quite well this year. For the first time in years we’ve seen a noticeable decline in the amount of cash dispensed per withdrawal transaction which allows us to maintain lower cash balances in our company-owned ATMs and thus reduces our overall operating costs. We’re not sure if this is due to the current economic environment or if it represents a trend that will continue in the future. What we do know is that our domestic ATM business has exceeded our expectations so far this year.

I’d like to now turn the call over to Chris Brewster our CFO who will provide some details on our financial results for the quarter.

J. Chris Brewster

As you can see in the numbers we did show solid sequential year-over-year revenue and EBITDA growth during the second quarter and while a significant portion of the increases were due to the 7-Eleven acquisition, our legacy domestic operations that we owned prior to the acquisition continued to show strong financial performance due to the domestic bank and network branding efforts that we have underway and the recent transaction strengths that Mike just discussed. Our international operations also showed strong organic revenue growth during the most recent quarter.

Digging into the numbers a little bit, revenues were $127 million in the second quarter of 2008. That’s up 64% from the $77 million reported in the second quarter of 2007. Most of that growth was due to the 7-Eleven acquisition in July of last year; however, we did achieve organic growth at the rate of 10.8% that is organic non-acquisition revenue growth in the second quarter versus last year. And that was achieved through a 6% organic increase in machine count coupled with higher revenues per machine.

Adjusted EBITDA margins in the quarter were 17.7% this year versus 16.1% last year. That increase was driven by good margins in the 7-Eleven acquired business and the continuing addition of high-margin branding and surcharge-free revenues. Margins in our legacy US operations were up a little over 50 basis points.

Consolidated adjusted EBITDA for the quarter totaled $22.5 million slightly ahead of what we had expected. However, the mix of our consolidated results was somewhat different than what we expected in particular revenues and margins in the UK business continued to be under some pressure and came in somewhat lower than we had anticipated early in the year while revenues and margins in the US business were higher than what we originally anticipated.

Digging into the UK business another level, we continued to be negatively impacted by the armored and cash management service issues that were caused by the merger of two of the major UK armored car service providers that occurred during the latter part of 2007. While we believe that the worst of this is behind us, our second quarter results continued to be negatively impacted by these service disruptions as we continued to experience missed cash fills resulting in ATMs without cash. This costs us in two ways. It costs us transaction revenue when those machines can’t operate because they’re out of cash, and it also runs our expenses up because it forces us to maintain higher cash levels in those ATMs when we could get them filled thus resulting in higher vault cash rental costs. One positive aspect of this issue is that we are still on track to formally commence our in-house armored car operations in the UK during the third quarter of this year. As of the end of this year we expect to be servicing about 300 of our UK locations and we expect to be moving up to about 900 by the end of the first quarter of 2009, again all in the UK.

We noted in our earnings release that we distributed early this morning that our UK results for the quarter were negatively impacted by a $1.3 million pre-tax charge related to delays experienced in our EMV certification process. While this charge is a non-recurring event and thus didn’t negatively impact our adjusted EBITDA for the quarter, it did negatively impact our GAAP results and related margins and we thought we owed you some explanation of this.

In the UK the major networks including Europay MasterCard and Visa, and that’s where the acronym EMV comes from, require that ATM operators and merchant acquirers get certified under the new EMV security standards. All of our ATMs in the UK are EMV or chip and pin as they call it compliant and we have successfully completed our certification of all of our machines in the network for EMV compliance with Link which is the dominant UK network through whom we clear more than 95% of our transactions and on one of the two major international networks.

However we have not yet been able to complete the EMV certification process with the second major international network. This is despite some considerable efforts on our part. These certification efforts have been delayed due to a number of reasons including difficulties encountered in scheduling certification reviews with the network, the fact that we changed our sponsoring bank back in 2006, and the conversion of our ATMs to our in-house EFT processing platform that occurred in the early part of 2008.

So I guess the question is “How did this delay in certification result in us having to take a $1.3 million charge during the quarter?” By contrast, under the US EFT rules generally speaking any authorized transaction that later proves to be from a counterfeit card is the responsibility of the bank that authorized the transaction. That is, it’s not the responsibility of the card holder and it’s not the responsibility of the acquirer, the person standing in our shoes. However under the network rules promulgated by the major international networks in the UK, certain transactions from counterfeit cards can be charged back to the acquirer, that is us, if the acquirer has not achieved EMV certification.

During the second quarter we had transactions conducted at our UK ATMs with counterfeit cards because we had not completed our EMV certification with the network whose brand was on those cards in one case. We’re liable under the network’s rules for the resulting claims which we estimate would total approximately $1.3 million and we took a charge for that amount in the second quarter. I should also point out that our being EMV certified on this network would not have prevented these counterfeit cards from being used. EMV certification would only shift the risk of loss away from us to the card-issuing bank.

It’s important to point out that as soon as we identify the counterfeits we immediately disabled on our network all cards associated with the network brand with which we had not achieved EMV compliance. None of those cards will work in our UK ATMs now and we will continue to block those cards until such time as we gain EMV certification from that network which we think will happen late this year. So I can tell you that we absolutely don’t expect these types of charges to recur.

The other question that may raise is “If you disabled these cards, how much in the way of transaction count is that going to cost you for revenue?” And the answer is, not much. It appears that we’re blocking transactions that represent less than 1% of our transaction count and most of those transactions are not assessed a surcharge because they’re international transactions. So we don’t expect the temporary loss of that volume to have any significant impact on our ongoing operations.

Turning to US operations, as we said results were better than we had anticipated due to higher-than-expected surcharge transactions and better-than-expected revenue and margin growth in our surcharge-free offerings. As Mike mentioned earlier the domestic ATM operations have been quite resilient during what appears to be a rather challenging economic environment broadly.

Overall gross margin percentage consolidated for the quarter was 23.4% up from 22.8% during the second quarter of 2007 primarily due to the higher margins earned by the 7-Eleven acquired ATM portfolio although our legacy margins in the states were also up year-over-year as I said before. For the quarter our adjusted net income totaled $3.1 million or $0.08 per diluted share which was up from $800,000 or $0.03 per diluted share in the second quarter of 2007. The year-over-year increase in our adjusted net income can be attributed to the incremental profits associated with the 7-Eleven business as well as the other operating growth that we talked about previously. The year-over-year growth in our adjusted net income was somewhat hampered as we said by the armored courier issue in the UK as well as growth in SG&A, depreciation, and interest costs just related to the overall growth of the company.

Turning briefly to the balance sheet, our indebtedness at the end of June stood at just under $344 million that consisted of $296 million of senior subordinated notes net of discount, $8.5 million of debt related to our Mexico operations under equipment financing lines, $37.5 million of senior debt outstanding under our revolver, and $1.5 million of capital leases.

With regard to the senior subordinated notes our publicly traded high yield debt, I’m pleased to announce that we successfully completed the registration of our Series B notes with the Securities and Exchange Commission in June and wrapped up the related exchange offer in July which was in the required timeframe set forth in the indenture.

With respect to our revolving line of credit, the outstanding balance is down slightly from what we showed at the end of the first quarter but even so, the overall amount of debt outstanding under the revolver at quarter end was slightly higher than what we initially anticipated largely due to the timing of certain capital expenditure payments. Despite that fact, overall interest rates were slightly lower than what we’d anticipated so our overall interest expense for the quarter was essentially [inaudible]. Assuming no further acquisitions we expect that that will continue to come down as we move through subsequent quarters.

We continue as we have been to be in a very strong liquidity position with gross availability under our revolving line of credit of $175 million. Of that we were using about $45 million for cash borrowings and letters of credit as of the end of the quarter. Even with the covenant restrictions in place on the facility, we could borrow about an additional $130 million under that facility as of quarter end. So in other words, we have substantial access to liquidity under the facility.

Turning to guidance, as we said in the press release we’re expecting total revenues of $490 million to $505 million for 2008, gross margins of around 24.5%, adjusted EBITDA of $86 million to $90 million, depreciation and accretion expense of $38 million to $39 million, interest expense of $29 million to $30 million, and adjusted net income in a range of $0.30 to $0.35 per fully diluted share and that’s on a share count of approximately 40.5 million fully diluted shares outstanding. In terms of how these numbers compare to the guidance we provided last quarter, everything pretty much stayed on target with the exception of revenues where we increased the bottom end of the range by $10 million to tighten it up a bit and the number of fully diluted shares outstanding which increased slightly over the prior guidance because of a recent stock grant that we made during the second quarter.

In terms of cap ex, we now expect to spend in the neighborhood of $53 million to $55 million in 2008 net of minority interest which is up a little bit from the $48 million to $50 million in guidance that we provided at year end. I’d say that this increase is really more a function of a slight change in the timing of when we expect invoices to be received and paid as opposed to a reflection that we have added additional capital projects. It’s really more of a timing issue than it is an activity issue. You’ll also notice that we didn’t increase our interest expense guidance amounts in spite of the change in cap ex and I’d say that our overall average debt balance may be slightly higher during 2008 than we originally planned, not materially so. Given the fact that the rates are a little lower than what we anticipated, we don’t at this point see any need to change expectations with regard to interest expense.

So I’d say in summary, we’ve been pleased with the progress that we’ve made so far in 2008. Despite some of the challenges we’ve encountered so far this year, we think we’re on track to meet the goals that we set forth at the beginning of the year. The core business remains strong in all of our key markets and we continue to see interesting opportunities to further grow this business both domestically and internationally.

That concludes our prepared remarks and we’d now like to open the lines up for any questions that the listeners may have.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Robert P. Napoli - Piper Jaffray.

Robert P. Napoli - Piper Jaffray

On the ATM, the revenue was very strong and transactions were much stronger. I’d like a little more color on where that was coming from, but it did look like the revenue per transaction was a little bit lighter. The margins maybe a little bit softer than we had. So I was hoping you could give a little bit of color around that.

J. Chris Brewster

In terms of the transaction strength, I’d say that largely came from our domestic side of the business. We exceeded our expectations particularly in the Cardtronics legacy business. The primary positives with regard to margins included again that performance in the legacy US business and a good margin performance on the part of the 7-Eleven business and thinking year-over-year certainly the reduced losses in the 7-Eleven Vcom business. Where we had margin pressure was in the UK. As I said, that situation with the armored car providers in the UK has been painful both in terms of revenue performance and cost performance and you’ll see that in the UK margins when you see the segment reporting in the 10Q.

Robert P. Napoli - Piper Jaffray

It seems like you have organized around international growth opportunities with Mike talking a little more firmly about the processing opportunities. I’d like a little more color on that strategy. It seems like its more developed than it was maybe a quarter ago.

Jack M. Antonini

That’s basically from the perspective that as we are now nearing the completion of our conversion and we have a processing arrangement with one outside ATM owner today, we think that we have some unique opportunities there. We see that there’s demand from financial institutions that we talk to for some kind of specialized support there, frankly to have something that’s a little more customizable rather than more the cookie-cutter kind of solutions that typically are provided by the processors and we’re seeing that there are some opportunities for growth in this area. So it’s something that we think we can leverage; it’s a skill we believe we have; we’ve got scale there now. When you look at having 33,000 machines on that platform, that is significant. So we can grow it and leverage that base fairly easily and get a nice return on that growth. So that has become a focus of ours from a strategic perspective and Mike is heading up that part of it. So is there anything you might want to add to that, Mike?

Michael H. Clinard

No, that’s a good summary.

Robert P. Napoli - Piper Jaffray

Is there a pipeline of opportunities that you’re executing on or when would you expect to see some initial results from those efforts?

Jack M. Antonini

It’s hard to say because of the fact that those are things that obviously whatever we’re working on we can’t really talk about till we get it to the point that it’s completed or near to completion, but it’s an area that we think that as we finish this conversion of our machines to the in-house platform we’re seeing some demand from folks that we’re talking to and that’s part of the reason why we’ve organized this way to leverage that and to be able to grow that part of the business. I think we’ll be able to give you more insight on that as we go but at this point I can’t really give you anything more than that.

Operator

Our next question comes from Christopher Mammone - Deutsche Bank Securities.

Christopher Mammone - Deutsche Bank Securities

I noticed you guys calling out the longer sales cycles for some bank branding deals. I’m just wondering if that in any way moderates your longer term expectations beyond this year? Clearly it’s not having an impact on your guidance for this year, but does it change at all how you’re thinking beyond this year? And related to that, given that you cited that that’s a direct result of the tightening credit environment, where else might you be seeing the effects of that environment on your business? Clearly the US business exceeding your expectations, how did that progress through the quarter? Did it exceed your expectations throughout the quarter, did they get better or worse? Could you just address all those topics please?

Jack M. Antonini

I’ll start off relative to the bank branding sales cycle impact. We’re not really seeing that it’s necessarily going to impact us as you pointed out this year. We don’t really expect it’s going to have a negative impact on us next year either honestly. We’re just simply pointing out that it is the one thing that we’re seeing frankly in this economic client that is slowing a bit is that the banks are taking a little bit longer to make a decision, although actually the one that I referenced for 300 ATMs is a new branding partner. They specifically came to us because they realized that in this climate this is a nice way for them to expand to provide enhanced services to their customers and it’s a relatively low cost way for them to be able to do that. I think you’re seeing a little bit of both aspects of this from an impact perspective, but we do see the sales cycles taking a little bit longer. I don’t expect it to have a significant impact on our results. We continue to see good growth there. We also continue to see good growth in the surcharge-free aspects of the business. So between those I think that combined they will continue to put up the kind of numbers that we are expecting. We’re just again in terms of what we’re seeing from the current economic conditions, it’s really a bit of a slow down on the sales cycle on the branding side.

As to the growth, I’ll let Chris speak to that.

J. Chris Brewster

In terms of the second part of your question related to do we see any significant distinctions across the three months of the quarter, April, May or June, I guess an honest answer to that is on a month-to-month basis there’s a certain amount of volatility to our numbers. So looking at year-over-year comparisons I think in the main just revolves around whether the weather was good this year versus bad last year or how many weekends we had in a given month, just those sorts of issues. But having looked through the monthly numbers fairly hard, I can’t spot anything I would call a trend across the three months of either improvement or deterioration. When you sort of filter out the noise, I think it was pretty steady across the quarter.

Christopher Mammone - Deutsche Bank Securities

And any noticeable impact from maybe stimulus checks?

J. Chris Brewster

I don’t know that we have a way to distinguish that frankly. I’m thinking about the timing of precisely when those checks hit and I don’t recall any significant surge in transaction counts.

Jack M. Antonini

No, we still see good growth even going into the third quarter and those stimulus checks are back in May so I don’t really see that they necessarily caused any kind of a change in the overall domestic volumes. We’re continuing to see the same kind of trends as we roll into the third quarter.

Operator

Our next question comes from Franco Turrinelli - William Blair & Company.

Franco Turrinelli - William Blair & Company

Maybe just update us a little bit on surcharge trends and whether or not the current environment is having any impact on surcharge trends, either up or down and whether or not you yourselves are looking at what your currently surcharging customers?

Jack M. Antonini

The market trends Franco as you know have been up with B of A and Wachovia and Chase and US Bank and most of the banks in the country are raising their surcharge to $3.00. We have not really changed our surcharges significantly. We kind of like our position in the market place and we think to a degree that’s part of the reason we’re seeing a pickup in our transactions. We have had a couple of customers ask to increase surcharges. We’re working with them on that doing a test to see whether it’ll have a negative impact on our volumes and all, but we don’t anticipate dramatic changes in our surcharge levels. We’ve not changed them a lot from where we had been. We’ve been holding kind of consistent and we kind of like that position right now. So I don’t anticipate any big changes one way or the other despite the fact that most of the banks in the market place have gone up pretty considerably.

Franco Turrinelli - William Blair & Company

Jack, do you just think of it as literally what maximizes revenue or are there some other more strategic considerations, maybe you care more about volume or something, when you think about surcharges?

Jack M. Antonini

It is a combination of elements Franco because we’re looking at, even in the tests that we’re going to do we want to see what the overall revenue is that we’re going to generate, and partly it’s positioning in the market place. We want to keep the volume good; we want to have the right pricing relative to what our retail partners look for because some of the partners have a real positioning with where our surcharge is in terms of the message that it communicates to their customers in terms of value and things like that. So there are strategic considerations with our retail partners and then there’s overall revenue considerations and we’re really about trying to maximize what our total gross revenues and net revenues are out from the ATMs which is why we’ll test it each way. But again like I say we’re pretty pleased right now with the kind of growth we’re seeing in transactions and growth that we’re seeing in revenues so we don’t’ see a real compelling need to go out and make any significant changes in that regard.

Franco Turrinelli - William Blair & Company

You’re actual ATM counts were just a little bit below what we had forecasted and obviously you don’t guide to ATM counts, so that’s not the question. But I am curious if there’s been any change on your part in the rate at which you’re looking to deploy new ATMs maybe because of the economic environment or because of the issues in the UK and whether or not we should expect a pickup or just a continuation of the current pace in the second half and going into 09?

Michael H. Clinard

I think the install rate in the internationally has been essentially what we anticipated. In the states the primary driver of ATM installs for us in the states is either the winning of a new contract with a merchant or the winning of a new bank branding agreement. And basically we’ve been following form with that installing the new Safeway deal as we came over year end and the pace of installations in drugstores as we’ve come through the first half of the year which is a rate that’s frankly quite close to what we had planned.

Franco Turrinelli - William Blair & Company

The takeaway for us is installations on plan and likely to continue at this kind of rate. Is that a fair statement?

Michael H. Clinard

I think that’s a fair statement.

Operator

Our next question comes from Reginald L. Smith - JPMorgan Securities.

Reginald L. Smith - JPMorgan Securities

On the UK, I believe on the last call you guys said that might have been a 10 point drag to gross margins. I think you said something like it was 28% before and then last quarter it was in the high teens or something to that effect. I’m just curious, is that still the drag and how should we think about that as it flows through the income statement and what impact that might have on EPS? I mean does that drag all profits or are there some offsets there?

J. Chris Brewster

The year-over-year change in margins is similar. It’s about 10 percentage points. There’s really no offset to that. We’ve been as conservative as we can in SG&A but that change in gross margins largely falls through to the bottom line I’m afraid.

Jack M. Antonini

The one thing Reggie that I would add to that is we don’t expect the margins to stay at the depressed levels that they’re at right now. A lot of this is because of what’s happening with the cash issues with the armored carriers in the UK, the higher levels of vault cash that we’ve had to maintain as a result of it. So as we work through these things we expect that the margins will come back up to normal over the next few months.

Reginald L. Smith - JPMorgan Securities

So just to think about that, I guess they did about $17 million in revenues in the first quarter and a 10 point hit on that would be about $1.7 million in profits that was taken out?

J. Chris Brewster

That’s about right.

Reginald L. Smith - JPMorgan Securities

Is it possible to get the regional breakdown for revenues this quarter?

J. Chris Brewster

It’ll be in the segment reporting in the 10Q.

Reginald L. Smith - JPMorgan Securities

On Vcom, expenses were nice. The spread there is narrowing but revenues were a little light of what we were looking for and I guess if you look at how things grew in the first quarter. Is anything going on there? I mean, I know it’s still early in the growth phase and it’s hard to kind of extrapolate trends but just wondering where that sell-out relative to your own expectations on the revenue side specifically for Vcom?

Jack M. Antonini

That’s a good point Reggie. It’s a little light from where we had hoped that we would be predominantly because of the movement that we’re doing in the machine to get them concentrated in 12 to 15 major markets. That took a little bit longer than we were originally planning because of the large Safeway installation that we had to do and then all the completing of the Triple DES requirements by the end of the first quarter. So that slowed down our relocation efforts and slowing down the relocation efforts that then minimized some of the marketing that we were going to do to try to increase the awareness in those major markets, and then of course that resulted in fewer transactions and lower revenue. The other aspect of what we’re doing on the advanced functionality side is we’re engaged in kind of reviewing all of our existing service partner relationships and we’re working through new contracts on those either with existing partners or with new partners and that again is taking a little bit of time and that will result in higher revenues as well. So there’s a combination of things that should start to increase the revenues. It was a little light in the second quarter from where we had originally hoped to be but we do expect to see continued improvement there.

Reginald L. Smith - JPMorgan Securities

I saw you increased your cap ex a little bit. Is that driven by the view that you guys are going to deploy more ATMs this year or something else?

J. Chris Brewster

It’s really a timing issue Reggie. We have not increased our deployment plans. The heart of the issue, you may recall we had a pretty large cap ex number in the first quarter and some of that was due to the fact that we had a lot of projects underway as we came into 2008 and had some payables relative to capital assets that had not yet been paid and consequently had not run through the cap ex line in the cash flow statement. In other words, we had some carry over into the year that related to completion of 2007 projects as opposed to new 2008 projects and we thought that we might see the offsetting effect at the back end of 2008. It does not now look likely that that’ll be the case. Our overall project activity in capital spending in 2008 is going to prove to be somewhat front-end loaded, so we thought it made sense to make the guidance a little bit more conservative in that regard. That’s a windy way of saying that it really doesn’t represent a change in our expected activity levels but is more of a timing issue.

Operator

Our next question comes from Robert P. Napoli - Piper Jaffray.

Robert P. Napoli - Piper Jaffray

A follow-up question on the EMV certification. When do you expect to be fully EMV certified and are there additional costs associated with that and what does it take to get that accomplished?

J. Chris Brewster

There aren’t significant costs of accomplishing that. It’s largely a coordination effort between our technical people and the technical people at the agency sponsored by Europay MasterCard and Visa that does these assessments to get the various tests done. And to some extent we’re at the mercy of their backlog and their scheduling constraints, but based on what we know today we anticipate being through that process relatively early in the fourth quarter.

Robert P. Napoli - Piper Jaffray

Is there any cap ex that’s tied to that Chris?

J. Chris Brewster

No. All of the equipment in the field and all of the equipment in our processing center is fully capable and all the software is fully capable and where it needs to be. It’s really just almost a bureaucratic process that has to be gone through.

Robert P. Napoli - Piper Jaffray

As we look at some of the add-backs and to the operating costs, the $1.3 million related to EMV, would you expect nothing out of that in the third quarter or maybe some straggling costs?

J. Chris Brewster

We don’t expect anything out of that in the third quarter. Basically we took our licks for what we knew about in the second quarter and we took our licks for an estimate of what we don’t firmly know about if you will and we think we’ve been conservative, we think we’ve got it covered.

Robert P. Napoli - Piper Jaffray

And in the UK the armored operations, how much investment do you need to do there? How much expense would we expect to come through on that?

J. Chris Brewster

In terms of additional start-up related expenses, it will not make money coming right out of the box. It’s a typical operation where you have a certain level of fixed costs and as you build volume, in this case building the number of machines that we’re servicing, at some point you cross the line and your internal costs are below what your external costs would have been. But we’re not talking about millions of dollars. We may be talking about a couple hundred thousand dollars or something like that say in the fourth quarter.

Robert P. Napoli - Piper Jaffray

And then on the Triple DES and the loss of merchant ATMs related to Triple DES, are we mostly through that at this point?

J. Chris Brewster

I would say definitely, yes. I think we can halfway say that’s now a part of our past.

Operator

Our next question comes from Franco Turrinelli - William Blair & Company.

Franco Turrinelli - William Blair & Company

Going back to the previous question on the merchant-owned portfolio, down about 9% year-over-year, is that decline really all Triple DES or are you still actively managing that portfolio of merchants and reviewing, is that the right euphemism, any ATMs that are not meeting your expectations? In other words, what should we expect from the merchant-owned portfolio going forward?

J. Chris Brewster

If you think of it year-over-year, it’s clearly a mix of all of that because basically if you’re looking year-over-year you’re talking about what occurred between the second quarter of 2007 and the second quarter of 2008 which incorporates just about the entirety of that Triple DES conversion process that essentially finished up in the first quarter of 08. So clearly in that change there’s a Triple DES effect. And there’s also sort of a self-weeding out effect of very low volume merchants just deciding either they don’t want to spend the money on Triple DES or they just don’t want to spend the time and trouble any more to operate an ATM, and probably a little bit of rationalization on our part. I think as you look at the numbers sequentially on a go-forward basis, I think you’ll see that decline in merchant-owned machine counts will mitigate somewhat.

Franco Turrinelli - William Blair & Company

Does the UK experience both on the armored car and on the EMV front change your thinking in any important way about new markets and how you would go to a new market and what you would need to have in place before you were willing to enter a new market?

Jack M. Antonini

The major insight in terms of the two things that you just mentioned, the EMV and the armored car situation, is that the EMV thing basically is as a result of having one network and a shift in the overall security for the entire country basically. That was actually in process at the time that we acquired the business. We knew about it but it was kind of a weird set of circumstances because of the change that happened in our sponsoring bank and the fact that we were also then going through the conversion to our in-house processing system. And that happened to all be around the same time or shortly after the conversion to the EMV security requirements, so we kind of had a confluence of events that we don’t anticipate will happen in other markets but certainly will be something that we’ll keep an eye on as we look at new markets to enter. That’s kind of what happened in the EMV space.

And the armored car situation basically was again something that was unanticipated in terms of two of the three large providers of armored car services deciding to merge and then just frankly botching it so badly. Again the lesson there I guess in terms of what you look for is diversification in a number of alternative providers of those services, so that would clearly again be something that we will keep our eyes on as we look at other markets. We will be reluctant to go into a market where we would be dependent upon a single service provider for example.

So I think that there are kind of lessons learned so to speak from both of these situations and things that we will definitely keep our eye on as we look at other markets. I don’t necessarily expect that we’ll see repeats of these kinds of activities but we will certainly be keeping our eyes open for any kind of potential exposure along those lines.

Franco Turrinelli - William Blair & Company

It sounds Jack as though you haven’t really changed your thinking in terms of the expected costs or appeal of going into a new market. Is that a fair statement?

Jack M. Antonini

I think that’s fair Franco. In most of the markets that we’re looking at we do as we’ve done our basic research multiple service providers. We don’t see transitioning security requirements or other things like that that would potentially trip us up. But again we’re looking at and trying to balance right now multiple markets and the ones that will rise to the top are the ones that are the cleanest and simplest, that don’t have these kinds of other complications. I think your assessment of it is right. We don’t really see this as something that’s going to slow down our ability to expand internationally.

With that, we’d like to thank everyone for joining the call and we look forward to speaking with you in the near future. Thank you very much.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Cardtronics Inc. Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts