Cardtronics, plc.
CARDTRONICS INC (Form: 10-Q, Received: 11/13/2008 06:04:14)
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2008
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-33864
 
CARDTRONICS, INC.
(Exact name of registrant as specified in its charter)
     
Delaware   76-0681190
(State or other jurisdiction of   (I.R.S. Employer Identification No.)
incorporation or organization)    
     
3110 Hayes Road, Suite 300   77082
Houston, TX   (Zip Code)
(Address of principal executive offices)    
Registrant’s telephone number, including area code: (281) 596-9988
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer’’ and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer o   Accelerated filer o   Non-accelerated filer þ   Smaller reporting company o
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
Common Stock, par value: $0.0001 per share. Shares outstanding on November 7, 2008: 40,624,033
 
 

 

 


 

CARDTRONICS, INC.
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  Exhibit 31.1
  Exhibit 31.2
  Exhibit 32.1
When we refer to “us,” “we,” “our,” “ours” or “the Company,” we are describing Cardtronics, Inc. and/or our subsidiaries.

 

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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CARDTRONICS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
                 
    September 30, 2008     December 31, 2007  
    (Unaudited)        
ASSETS
               
Current assets:
               
Cash and cash equivalents
  $ 1,205     $ 13,439  
Accounts and notes receivable, net of allowance of $431 and $560 as of September 30, 2008 and December 31, 2007, respectively
    26,098       23,248  
Inventory
    2,425       2,355  
Restricted cash, short-term
    2,958       5,900  
Deferred tax asset, net
    195       216  
Prepaid expenses, deferred costs, and other current assets
    16,218       11,627  
 
           
Total current assets
    49,099       56,785  
Restricted cash
    324       317  
Property and equipment, net
    170,477       163,912  
Intangible assets, net
    116,125       130,901  
Goodwill
    227,139       235,185  
Prepaid expenses and other assets
    4,583       4,185  
 
           
Total assets
  $ 567,747     $ 591,285  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Current portion of long-term debt
  $ 1,512     $ 882  
Current portion of capital lease obligations
    818       1,147  
Current portion of other long-term liabilities
    18,170       16,201  
Accounts payable
    24,981       34,385  
Accrued liabilities
    51,026       70,524  
 
           
Total current liabilities
    96,507       123,139  
Long-term liabilities:
               
Long-term debt, net of current portion and related discounts
    341,985       307,733  
Capital lease obligations, net of current portion
    411       982  
Deferred tax liability, net
    11,740       11,480  
Asset retirement obligations
    19,103       17,448  
Other long-term liabilities
    14,950       23,392  
 
           
Total liabilities
    484,696       484,174  
 
               
Commitments and contingencies
               
 
               
Stockholders’ equity:
               
Common stock, $0.0001 par value; 125,000,000 shares authorized; 45,633,582 and 43,571,956 shares issued as of September 30, 2008 and December 31, 2007, respectively; 40,627,833 and 38,566,207 shares outstanding as of September 30, 2008 and December 31, 2007, respectively
    4       4  
Subscriptions receivable (at face value)
    (128 )     (229 )
Additional paid-in capital
    192,755       190,508  
Accumulated other comprehensive loss, net
    (18,779 )     (4,518 )
Accumulated deficit
    (42,580 )     (30,433 )
Treasury stock; 5,005,749 shares at cost
    (48,221 )     (48,221 )
 
           
Total stockholders’ equity
    83,051       107,111  
 
           
Total liabilities and stockholders’ equity
  $ 567,747     $ 591,285  
 
           
See accompanying notes to consolidated financial statements.

 

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CARDTRONICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
(Unaudited)
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     2008     2007  
Revenues:
                               
ATM operating revenues
  $ 121,192     $ 106,234     $ 357,759     $ 251,854  
Vcom operating revenues
    1,416       685       4,014       685  
ATM product sales and other revenues
    4,651       3,668       13,036       9,805  
 
                       
Total revenues
    127,259       110,587       374,809       262,344  
Cost of revenues:
                               
Cost of ATM operating revenues (excludes depreciation, accretion, and amortization shown separately below. See Note 1 )
    91,434       79,966       270,128       191,046  
Cost of Vcom operating revenues
    1,469       2,644       5,477       2,644  
Cost of ATM product sales and other revenues
    4,064       3,111       11,890       9,196  
 
                       
Total cost of revenues
    96,967       85,721       287,495       202,886  
Gross profit
    30,292       24,866       87,314       59,458  
Operating expenses:
                               
Selling, general, and administrative expenses
    10,387       7,621       28,738       20,985  
Depreciation and accretion expense
    10,048       6,961       29,169       18,541  
Amortization expense
    4,657       9,204       13,661       14,062  
 
                       
Total operating expenses
    25,092       23,786       71,568       53,588  
Income from operations
    5,200       1,080       15,746       5,870  
Other expense (income):
                               
Interest expense, net
    7,913       8,545       23,267       20,437  
Amortization of deferred financing costs and bond discounts
    531       439       1,569       1,155  
Minority interest in subsidiary
    (814 )     (174 )     (814 )     (286 )
Other
    1,274       678       3,377       1,037  
 
                       
Total other expense
    8,904       9,488       27,399       22,343  
Loss before income taxes
    (3,704 )     (8,408 )     (11,653 )     (16,473 )
Income tax expense
    469       2,275       494       3,212  
 
                       
Net loss
    (4,173 )     (10,683 )     (12,147 )     (19,685 )
Preferred stock accretion expense
          67             200  
 
                       
Net loss available to common stockholders
  $ (4,173 )   $ (10,750 )   $ (12,147 )   $ (19,885 )
 
                       
 
                               
Net loss per common share — basic and diluted
  $ (0.11 )   $ (0.77 )   $ (0.31 )   $ (1.42 )
 
                       
 
                               
Weighted average shares outstanding — basic and diluted
    38,920,887       14,026,960       38,749,233       14,006,822  
 
                       
See accompanying notes to consolidated financial statements.

 

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CARDTRONICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
                 
    Nine Months Ended September 30,  
    2008     2007  
Cash flows from operating activities:
               
Net loss
  $ (12,147 )   $ (19,685 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Depreciation, accretion, and amortization expense
    42,830       32,603  
Amortization of deferred financing costs and bond discounts
    1,569       1,155  
Stock-based compensation expense
    2,167       768  
Deferred income taxes
    388       3,053  
Gain on sale of Winn-Dixie equity securities
          (569 )
Minority interest
    (814 )     (286 )
Loss on disposal of assets
    3,350       1,672  
Other reserves and non-cash items
    (5,481 )     (840 )
Changes in assets and liabilities, net of acquisitions:
               
Increase in accounts and notes receivable, net
    (3,378 )     (1,607 )
(Increase) decrease in prepaid, deferred costs, and other current assets
    (4,096 )     2,855  
Decrease in inventory
    362       3,231  
(Increase) decrease in other assets
    674       (5,193 )
Increase (decrease) in accounts payable and accrued liabilities
    (10,927 )     19,393  
Decrease in other liabilities
    (2,724 )     (1,010 )
 
           
Net cash provided by operating activities
    11,773       35,540  
 
           
 
               
Cash flows from investing activities:
               
Additions to property and equipment
    (53,585 )     (43,957 )
Proceeds from sale of property and equipment
          3  
Payments for exclusive license agreements and site acquisition costs
    (895 )     (1,381 )
Additions to equipment to be leased to customers
          (412 )
Principal payments received under direct financing leases
    17       22  
Acquisition, net of cash acquired
    (350 )     (137,694 )
Proceeds from sale of Winn-Dixie equity securities
          3,950  
 
           
Net cash used in investing activities
    (54,813 )     (179,469 )
 
           
 
               
Cash flows from financing activities:
               
Proceeds from issuance of long-term debt
    103,336       170,264  
Repayments of long-term debt and capital leases
    (69,753 )     (22,363 )
Repayments of borrowings under bank overdraft facility, net
    (2,961 )     54  
Payments received on subscriptions receivable
    101        
Proceeds from exercises of stock options
    362       46  
Minority interest stockholder capital contribution
    1,662       174  
Equity offering costs
    (1,489 )     (150 )
Debt issuance and modification costs
    (195 )     (677 )
 
           
Net cash provided by financing activities
    31,063       147,348  
 
           
 
               
Effect of exchange rate changes on cash
    (257 )     (19 )
 
           
Net increase (decrease) in cash and cash equivalents
    (12,234 )     3,400  
 
               
Cash and cash equivalents at beginning of period
    13,439       2,718  
 
           
Cash and cash equivalents at end of period
  $ 1,205     $ 6,118  
 
           
 
               
Supplemental disclosure of cash flow information:
               
Cash paid for interest, including interest on capital leases
  $ 31,025     $ 22,872  
Cash paid for income taxes
    220       27  
Fixed assets financed with direct debt
          3,125  
See accompanying notes to consolidated financial statements.

 

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CARDTRONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) General and Basis of Presentation
General
Cardtronics, Inc., along with its wholly- and majority-owned subsidiaries (collectively, the “Company”) owns and operates approximately 28,600 automated teller machines (“ATM”) located in all 50 states of the United States, 2,500 ATMs located throughout the United Kingdom, and 2,000 ATMs located throughout Mexico. The Company provides ATM management and equipment-related services (typically under multi-year contracts) to large, nationally-known retail merchants as well as smaller retailers and operators of facilities such as shopping malls and airports. Additionally, the Company operates the largest surcharge-free network of ATMs within the United States (based on the number of participating ATMs) and works with financial institutions to place their logos on the Company’s ATM machines, thus providing convenient surcharge-free access to the financial institutions’ customers.
Basis of Presentation
This Quarterly Report on Form 10-Q (this “Form 10-Q”) has been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) applicable to interim financial information. Because this is an interim period filing presented using a condensed format, it does not include all of the disclosures required by accounting principles generally accepted in the United States (“U.S. GAAP”), although the Company believes that the disclosures are adequate to make the information not misleading. You should read this Form 10-Q along with the Company’s Annual Report on Form 10-K for the year ended December 31, 2007 (“2007 Form 10-K”), which includes a summary of the Company’s significant accounting policies and other disclosures.
The financial statements as of September 30, 2008 and for the three and nine month periods ended September 30, 2008 and 2007 are unaudited. The Consolidated Balance Sheet as of December 31, 2007 was derived from the audited balance sheet filed in the Company’s 2007 Form 10-K. In management’s opinion, all adjustments (consisting of only normal recurring adjustments) necessary for a fair presentation of the Company’s interim period results have been made. The results of operations for the three and nine month periods ended September 30, 2008 and 2007 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year. Additionally, the financial statements for prior periods include reclassifications that were made to conform to the current period presentation. Those reclassifications did not impact the Company’s reported net loss or stockholders’ equity.
The unaudited interim consolidated financial statements include the accounts of Cardtronics, Inc. and its wholly- and majority-owned subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation. Because the Company owns a majority (51.0%) interest in and absorbs a majority of the losses or returns of Cardtronics Mexico, S.A. de C.V. (“Cardtronics Mexico”), this entity is reflected as a consolidated subsidiary in the accompanying consolidated financial statements, with the remaining ownership interest not held by the Company being reflected as a minority interest. See Note 10 for additional information on minority interest stockholder activity during 2008.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates, and these differences could be material to the financial statements.

 

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Cost of ATM Operating Revenues and Gross Profit Presentation
The Company presents “Cost of ATM operating revenues” and “Gross profit” within its Consolidated Statements of Operations exclusive of depreciation, accretion, and amortization expenses related to ATMs and ATM-related assets. The following table sets forth the amounts excluded from cost of ATM operating revenues and gross profit:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2008     2007     2008     2007  
    (In thousands)  
Depreciation and accretion expenses related to ATMs and ATM-related assets
  $ 8,719     $ 6,479     $ 25,415     $ 17,257  
Amortization expense
    4,657       9,204       13,661       14,062  
 
                       
Total depreciation, accretion, and amortization expenses excluded from cost of ATM operating revenues and gross profit
  $ 13,376     $ 15,683     $ 39,076     $ 31,319  
 
                       
(2) Acquisitions
Acquisition of 7-Eleven Financial Services Business. On July 20, 2007, the Company acquired substantially all of the assets of the financial services business of 7-Eleven, Inc. (the “7-Eleven Financial Services Business”) for approximately $137.3 million in cash (the “7-Eleven ATM Transaction”). The 7-Eleven ATM Transaction included approximately 5,500 ATMs located in 7-Eleven, Inc. (“7-Eleven”) stores throughout the United States, of which approximately 2,000 were advanced-functionality financial self-service kiosks, referred to as “Vcom” terminals, that are capable of providing more sophisticated financial services, such as check-cashing, remote deposit capture (which is deposit-taking at ATMs not located on a bank’s premises using electronic imaging), money transfer, bill payment services, and other kiosk-based financial services (collectively, the “Vcom Services”).
The Company accounted for the 7-Eleven ATM Transaction pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations . Accordingly, the Company allocated the total purchase consideration to the assets acquired and liabilities assumed based on their respective fair values as of the acquisition date. The purchase price allocation resulted in goodwill of approximately $62.2 million, which is deductible for tax purposes.
Pro Forma Results of Operations. The Company’s Consolidated Statements of Operations for the three and nine month periods ended September 30, 2008 includes the results of operations of the 7-Eleven Financial Services Business. The following table presents the unaudited pro forma combined results of operations of the Company and the acquired 7-Eleven Financial Services Business, after giving effect to certain pro forma adjustments, including the effects of the issuance of the Series B Notes (as defined in Note 8 ) and additional borrowings under its revolving credit facility, as amended, for the three and nine month periods ended September 30, 2007. The unaudited pro forma financial results assume that the 7-Eleven ATM Transaction and the related financing transactions occurred on January 1, 2007.
                 
    Three Months     Nine Months  
    Ended     Ended  
    September 30, 2007     September 30, 2007  
    (In thousands, excluding per share amounts)  
Revenues
  $ 118,514     $ 349,854  
Income from operations
    867       10,953  
Net loss
    (12,295 )     (22,249 )
Net loss available to common stockholders
    (12,362 )     (22,449 )
Net loss per share — basic and diluted
  $ (0.88 )   $ (1.60 )
This pro forma information is presented for illustrative purposes only and is not necessarily indicative of the actual results that would have occurred had those transactions been consummated on January 1, 2007. Additionally, the pro forma results for the nine months ended September 30, 2007 include approximately $4.2 million of placement fee revenues associated with the Vcom operations of the 7-Eleven Financial Services Business, which are not expected to recur in future periods. Furthermore, the pro forma results are not necessarily indicative of the future results to be expected for the Company’s consolidated operations.

 

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Acquisition of Deposit Solutions, Inc. On September 3, 2008, the Company acquired all of the assets of Deposit Solutions, Inc., a small, privately-held company specializing in kiosk-based image deposit solutions. The acquisition included the hiring of the former president of Deposit Solutions, who understands the complexities of both the software and hardware components of image deposit solutions, as well as the assumption of miscellaneous permits, trademarks, and trade names. The Company believes this technology solution will provide an additional image deposit capability that could enhance the roll out of image deposit as well as provide an add-on capability to certain existing locations. The total consideration paid for the acquisition was $0.4 million in cash, the full amount of which was preliminarily allocated to a non-compete agreement with the former president of Deposit Solutions.
(3) Stock-Based Compensation
The Company accounts for stock-based compensation arrangements under SFAS No. 123 (revised 2004), Share-Based Payment, which requires a company to record the grant date fair value of stock-based compensation arrangements, net of estimated forfeitures, as compensation expense on a straight-line basis over the underlying service periods of the related awards. The following table reflects the total stock-based compensation expense amounts included in the accompanying Consolidated Statements of Operations:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2008     2007     2008     2007  
    (In thousands)  
Cost of ATM operating revenues
  $ 227     $ 16     $ 424     $ 47  
Selling, general, and administrative expenses
    1,129       297       1,743       721  
 
                       
Total stock-based compensation expense
  $ 1,356     $ 313     $ 2,167     $ 768  
 
                       
The increase in stock-based compensation expense during the three and nine month periods ended September 30, 2008 was due to the Company’s issuance of 1,670,250 shares of restricted stock and 228,000 stock options to certain of its employees during 2008. Both the restricted shares and the stock options were granted under the Company’s 2007 Stock Incentive Plan.
Restricted Shares. A summary of the Company’s outstanding restricted shares as of September 30, 2008 and changes during the nine months ended September 30, 2008 are presented below:
         
    Number  
    of Shares  
Restricted shares outstanding as of January 1, 2008
     
Granted
    1,670,250  
Vested
    (3,500 )
 
     
Restricted shares outstanding as of September 30, 2008
    1,666,750  
 
     
During the second and third quarters of 2008, the Company granted 1,640,250 and 30,000 restricted shares, respectively, to certain employees. These shares, the majority of which represent shares that will vest ratably over a four-year service period, had a total grant-date fair value of $14.4 million, or $8.62 per share. Compensation expense associated with the restricted stock grants totaled approximately $949,000 and $1.1 million during the three and nine month periods ended September 30, 2008, respectively, and, based upon our estimates of forfeitures, there was approximately $12.8 million of unrecognized compensation cost associated with these shares as of September 30, 2008, which will be recognized over the remaining vesting period.

 

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Options. A summary of the Company’s outstanding stock options as of September 30, 2008 and changes during the nine months ended September 30, 2008 are presented below:
                 
            Weighted  
    Number     Average  
    of Shares     Exercise Price  
Options outstanding as of January 1, 2008
    4,960,041     $ 7.78  
Granted
    228,000     $ 8.57  
Exercised
    (391,376 )   $ 0.92  
Forfeited
    (130,156 )   $ 11.22  
Cancelled
    (406,367 )   $ 11.40  
 
             
Options outstanding as of September 30, 2008
    4,260,142     $ 8.00  
 
             
 
               
Options vested and exercisable as of September 30, 2008
    2,935,251     $ 6.66  
The options granted in 2008 had a total grant-date fair value of $801,000, or $3.51 per share.
(4) Earnings per Share
The Company reports its earnings per share in accordance with SFAS No. 128, Earnings per Share . Potentially dilutive securities are excluded from the calculation of diluted earnings per share (as well as their related income statement impacts) when their impact on net income (loss) available to common stockholders is anti-dilutive. For the three and nine month periods ended September 30, 2008 and 2007, the Company incurred net losses and, accordingly, excluded all potentially dilutive securities from the calculation of diluted earnings per share as their impact on the net loss available to common stockholders was anti-dilutive. The anti-dilutive securities included all outstanding stock options, all shares of restricted stock, and, for periods prior to their conversion in December 2007, the Company’s Series B redeemable convertible preferred stock.
(5) Comprehensive Income (Loss)
SFAS No. 130, Reporting Comprehensive Income , establishes standards for reporting comprehensive income (loss) and its components in the financial statements. Total comprehensive loss consisted of the following:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2008     2007     2008     2007  
    (In thousands)  
Net loss
  $ (4,173 )   $ (10,683 )   $ (12,147 )   $ (19,685 )
Unrealized gains (losses) on interest rate hedges
    (4,314 )     (7,155 )     642       (6,961 )
Foreign currency translation adjustments
    (13,657 )     1,878       (14,903 )     4,378  
Reclassifications of unrealized gains on available-for-sale securities, net of taxes
                      (498 )
 
                       
Total comprehensive loss
  $ (22,144 )   $ (15,960 )   $ (26,408 )   $ (22,766 )
 
                       
The significant increase in the total comprehensive loss figure for the three and nine month periods ended September 30, 2008 was primarily due to changes in foreign currency exchange rates. As of September 30, 2008, the exchange rate between the United States dollar and the British pound was 1.81:1, compared to 1.99:1 as of June 30, 2008 and 2.01:1 as of December 31, 2007.

 

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Accumulated other comprehensive loss is displayed as a separate component of stockholders’ equity in the accompanying Consolidated Balance Sheets and consisted of the following:
                 
    September 30, 2008     December 31, 2007  
    (In thousands)  
Unrealized losses on interest rate hedges
  $ (13,002 )   $ (13,644 )
Foreign currency translation adjustments
    (5,777 )     9,126  
 
           
Total accumulated other comprehensive loss
  $ (18,779 )   $ (4,518 )
 
           
The Company currently believes that the unremitted earnings of its foreign subsidiaries will be reinvested in the foreign countries in which those subsidiaries operate for an indefinite period of time. Accordingly, no deferred taxes have been provided for the differences between the Company’s book basis and underlying tax basis in those subsidiaries or the foreign currency translation adjustment amounts reflected in the tables above. As a result of the Company’s overall net loss position for tax purposes, the Company has not recorded deferred tax benefits on the loss amounts related to these interest rate swaps as of September 30, 2008 or December 31, 2007, as management does not currently believe the Company will be able to realize the benefits associated with its net deferred tax asset positions.
(6) Intangible Assets
Intangible Assets with Indefinite Lives
The following table presents the net carrying amount of the Company’s intangible assets with indefinite lives as of September 30, 2008 and December 31, 2007, as well as the changes in the net carrying amounts for the nine months ended September 30, 2008, by geographic segment:
                                                 
    Goodwill     Trade Name        
    U.S.     U.K.     Mexico     U.S.     U.K.     Total  
    (In thousands)  
Balance as of December 31, 2007
  $ 150,445     $ 84,050     $ 690     $ 200     $ 4,015     $ 239,400  
Purchase price adjustments
    6                               6  
Foreign currency translation adjustments
          (8,052 )                 (395 )     (8,447 )
 
                                   
Balance as of September 30, 2008
  $ 150,451     $ 75,998     $ 690     $ 200     $ 3,620     $ 230,959  
 
                                   
Intangible Assets with Definite Lives
The following is a summary of the Company’s intangible assets that are subject to amortization as of September 30, 2008:
                         
    Gross             Net  
    Carrying     Accumulated     Carrying  
    Amount     Amortization     Amount  
    (In thousands)  
Customer and branding contracts/relationships
  $ 162,327     $ (62,154 )   $ 100,173  
Deferred financing costs
    14,080       (5,422 )     8,658  
Exclusive license agreements
    5,420       (2,322 )     3,098  
Non-compete agreements
    448       (72 )     376  
 
                 
Total
  $ 182,275     $ (69,970 )   $ 112,305  
 
                 

 

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(7) Accrued Liabilities
Accrued liabilities consisted of the following:
                 
    September 30, 2008     December 31, 2007  
    (In thousands)  
Accrued merchant fees
  $ 10,511     $ 9,933  
Accrued armored fees
    6,771       5,879  
Accrued cash management fees
    4,766       5,574  
Accrued maintenance fees
    4,617       6,970  
Accrued merchant settlement amounts
    4,018       5,807  
Accrued interest
    3,742       11,257  
Accrued compensation
    3,109       3,832  
Accrued processing costs
    1,584       1,477  
Accrued purchases
    1,497       6,098  
Accrued ATM telecommunications costs
    1,495       1,424  
Accrued property and sales taxes
    1,283       446  
Accrued interest rate swap payments
    1,014       147  
Other accrued expenses
    6,619       11,680  
 
           
Total
  $ 51,026     $ 70,524  
 
           
The decrease in accrued liabilities from December 31, 2007 to September 30, 2008 was primarily the result of the timing of interest payments associated with our $300.0 million of senior subordinated notes, which are due in February and August of each year (see Note 8 ), and the timing of the receipt and payment of invoices for purchases, including capital expenditures.
(8) Long-Term Debt
The Company’s long-term debt consisted of the following:
                 
    September 30, 2008     December 31, 2007  
    (In thousands)  
Revolving credit facility
  $ 39,100     $ 4,000  
Senior subordinated notes due August 2013 (net of unamortized discounts of $3.5 million as of September 30, 2008 and $3.9 million as of December 31, 2007)
    296,494       296,088  
Other
    7,903       8,527  
 
           
Total
    343,497       308,615  
Less current portion
    1,512       882  
 
           
Total excluding current portion
  $ 341,985     $ 307,733  
 
           
Revolving Credit Facility
As of September 30, 2008, $39.1 million of borrowings were outstanding under the Company’s $175.0 million revolving credit facility. Additionally, $6.1 million in letters of credit had been posted under the facility in favor of the lessors under the ATM equipment leases that the Company assumed in connection with the 7-Eleven ATM Transaction. These letters of credit, which the lessors may draw upon in the event the Company fails to make payments under the leases, further reduced the Company’s borrowing capacity under the facility. As of September 30, 2008, the Company’s available borrowing capacity under the amended facility, as determined under the earnings before interest expense, income taxes, depreciation and accretion expense, and amortization expense (“EBITDA”) and interest expense covenants contained in the agreement, totaled approximately $129.8 million. As of September 30, 2008, the Company was in compliance with all applicable covenants and ratios under the facility.

 

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Senior Subordinated Notes
On July 20, 2007, the Company issued $100.0 million of 9.25% senior subordinated notes due 2013 — Series B (the “Series B Notes”) pursuant to Rule 144A of the Securities Act of 1933, as amended. In conjunction with this issuance, the Company entered into a registration rights agreement with the bondholders, pursuant to which the Company was required to either (1) register the Series B Notes with the SEC on or before July 14, 2008 (the “Effectiveness Target Date”) and successfully complete an exchange offer with respect to the Series B Notes within 30 days following the Effectiveness Target Date or (2) be subject to higher interest rates on the Series B Notes in subsequent periods. On June 10, 2008, the Series B Notes were successfully registered with the SEC, and on July 18, 2008, the Company successfully completed its exchange offer. The form and terms of the Series B Notes are the same as the form and terms of the Company’s $200.0 million senior subordinated notes due 2013 (the “Series A Notes”).
As of September 30, 2008, the Company was in compliance with all applicable covenants required under both the $200.0 million Series A Notes and the $100.0 million Series B Notes.
Other
As of September 30, 2008, “Other” consists of six separate equipment financing agreements entered into by Cardtronics Mexico. Such agreements, which are denominated in Mexican pesos and bear interest at an average fixed rate of 10.96%, were utilized for the purchase of additional ATMs to support the Company’s Mexico operations. Pursuant to the terms of the loan agreement, the Company has issued a guaranty for 51.0% of the obligations under this agreement (consistent with its ownership percentage in Cardtronics Mexico.) As of September 30 2008, the total amount of the guaranty was $44.1 million pesos ($4.0 million U.S.).
(9) Asset Retirement Obligations
The Company accounts for asset retirement obligations in accordance with SFAS No. 143, Asset Retirement Obligations. Asset retirement obligations consist primarily of deinstallation costs of the ATM and the costs to restore the ATM site to its original condition. In most cases, the Company is legally required to perform this deinstallation and restoration work. In accordance with SFAS No. 143, for each group of ATMs, the Company has recognized the fair value of a liability for an asset retirement obligation and capitalized that cost as part of the cost basis of the related asset. The related assets are being depreciated on a straight-line basis over the estimated useful lives of the underlying ATMs, and the related liabilities are being accreted to their full value over the same period of time.
The following table is a summary of the changes in Company’s asset retirement obligation liability for the nine months ended September 30, 2008 (in thousands) :
         
Asset retirement obligation as of January 1, 2008
  $ 17,448  
Additional obligations
    3,694  
Accretion expense
    1,233  
Payments
    (2,538 )
Change in estimates
    (265 )
Foreign currency translation adjustments
    (469 )
 
     
Asset retirement obligation as of September 30, 2008
  $ 19,103  
 
     
The change in estimates during the nine months ended September 30, 2008 represents the write-off of residual liability amounts during the first quarter of 2008 associated with a portfolio of ATMs previously installed at one of the Company’s merchant customers’ locations. As the entire portfolio of machines was deinstalled in conjunction with the Company’s Triple-DES security upgrade efforts in 2007 and 2008, the Company no longer has any further deinstallation obligations associated with the previously-installed ATMs. The amount shown as a change in estimates represents the difference in the costs that the Company originally estimated it would incur to deinstall the ATMs and the actual costs incurred on the deinstallations.

 

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(10) Other Liabilities
Other liabilities consisted of the following:
                 
    September 30, 2008     December 31, 2007  
    (In thousands)  
Current Portion of Other Long-Term Liabilities:
               
Obligations associated with acquired unfavorable contracts
  $ 7,990     $ 8,158  
Interest rate swaps
    6,888       4,489  
Deferred revenue
    1,674       1,789  
Other
    1,618       1,765  
 
           
Total
  $ 18,170     $ 16,201  
 
           
 
               
Other Long-Term Liabilities:
               
Interest rate swaps
  $ 6,384     $ 9,155  
Obligations associated with acquired unfavorable contracts
    1,636       7,626  
Deferred revenue
    3,539       3,380  
Minority interest
    848        
Other long-term liabilities
    2,543       3,231  
 
           
Total
  $ 14,950     $ 23,392  
 
           
The decline in other long-term liabilities was primarily the result of the amortization of the unfavorable contracts acquired in the 7-Eleven ATM Transaction. These obligations are being amortized on a monthly basis over the remaining life of the contracts, the majority of which terminate by the end of 2009.
Minority Interest Liability. As of December 31, 2007, the cumulative losses generated by Cardtronics Mexico and allocable to the minority interest stockholders exceeded the underlying equity amounts of the minority interest stockholders. As Cardtronics is the entity that consolidates Cardtronics Mexico, all losses generated by Cardtronics Mexico were being allocated 100.0% to Cardtronics until such time that Cardtronics Mexico generates a cumulative amount of earnings sufficient to cover all excess losses allocable to the Company, or until such time that the minority interest stockholders contribute additional equity to Cardtronics Mexico in an amount sufficient to cover the losses. In the third quarter of 2008, both Cardtronics, Inc. and the minority interest stockholders in Cardtronics Mexico made additional capital contributions in the amount of $1.8 million and $1.7 million, respectively. As the contribution made by the minority interest stockholders exceeded the excess losses that had been absorbed by Cardtronics, Inc., the Company now has a minority interest payable on its books for the excess of the contribution over the previously absorbed losses.
(11) Commitments and Contingencies
Legal and Other Regulatory Matters
In June 2006, Duane Reade, Inc. (“Customer”), one of the Company’s merchant customers, filed a complaint in the New York State Supreme Court alleging that the Company had breached its ATM operating agreement with the Customer by failing to pay the Customer the proper amount of fees under the agreement. The Customer is claiming that it is owed no less than $600,000 in lost revenues, exclusive of interest and costs, and projects that additional damages will accrue to it at a rate of approximately $100,000 per month, exclusive of interest and costs. As the term of the Company’s operating agreement with the Customer extends to December 2014, the Customer’s claims could exceed $12.0 million. In response to a motion for summary judgment filed by the Customer and a cross-motion filed by the Company, the New York State Supreme Court ruled in September 2007 that the Company’s interpretation of the ATM operating agreement was the appropriate interpretation and expressly rejected the Customer’s proposed interpretations. The Customer appealed this ruling, and on August 5, 2008, the New York State Court of Appeals remanded the case back to the New York State Supreme Court for trial on the merits. Notwithstanding that decision, the Company believes that the ultimate resolution of this dispute will not have a material adverse impact on its financial condition or results of operations.

 

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In the second quarter of 2008, the Company was made aware of a security incident affecting a previous third-party service provider which, in turn, potentially affected certain of the Company’s ATMs located in the stores of one of the Company’s merchant customers in the United States. In May 2008, the Company received a notification from a financial institution indicating that it believes approximately $3.0 million in fraudulent cash withdrawals occurred on that financial institution’s network of ATMs as a result of the security incident. The Company also understands that approximately $1.7 million in cash has been recovered and that some or all of these recovered funds may be applied to the financial institution’s losses. In any event, based on information received to date, the Company does not believe that the security incident referred to above caused any cardholder personal identification numbers (“PINs”) to be compromised and thus does not believe that the fraudulent cash withdrawals were associated with the security incident. The Company is working closely with the financial institution to try to identify the source of the financial institution’s recent PIN-based losses. To the extent additional notifications are received by, or loss claims are made against, the Company related to this security incident, the Company intends to work through its normal process with its insurance carrier and its partners to determine the appropriate means of addressing those notifications or claims. In the event the Company is unsuccessful in its efforts to effectively address any such notifications or claims, and it is determined that the Company is liable for any losses that are deemed to have resulted from the security incident, the Company’s financial results could be negatively impacted.
In October 2008, the Company became aware of a lawsuit filed in the Superior Court of California, County of Los Angeles, against Cardtronics, Inc.; Citibank, N.A.; 7-Eleven, Inc.; American State Bank; and Unionbancal Corporation. This lawsuit is a putative class-action lawsuit, on behalf of consumers in California, alleging that the companies’ ATMs violated state laws by not disclosing the possibility that consumers’ financial institutions would impose surcharges for balance inquiry transactions conducted through the companies’ ATMs. Cardtronics denies that it has violated any laws relating to the operation of its ATMs in the state of California. Although the Company has not yet been officially served with notice of the lawsuit, if and when such service is completed, management will defend vigorously against the allegations made in this lawsuit. At this time, the Company does not believe the outcome of this lawsuit will have a material adverse impact on its financial condition or results of operations.
In addition to the above items, the Company is subject to various legal proceedings and claims arising in the ordinary course of its business. The Company has provided reserves where necessary for all claims and the Company’s management does not expect the outcome in any of these legal proceedings, individually or collectively, to have a material adverse effect on the Company’s financial condition or results of operations.
Capital and Operating Leases
Capital Lease Obligations. As a result of the 7-Eleven ATM Transaction, the Company assumed responsibility for certain capital lease contracts that expire at various times through June 2010. Upon the fulfillment of certain payment obligations related to the capital leases, ownership of the ATMs transfers to the Company. As of September 30, 2008, approximately $1.2 million of capital lease obligations were included within the Company’s Consolidated Balance Sheet.
Operating Lease Obligations. In addition to the capital leases assumed in connection with the 7-Eleven ATM Transaction, the Company also assumed certain operating leases. In conjunction with its purchase price allocation related to the 7-Eleven ATM Transaction, the Company recorded approximately $8.7 million of other liabilities (current and long-term) to value certain unfavorable equipment operating leases assumed as part of the acquisition. These liabilities are being amortized over the remaining terms of the underlying leases, the majority of which expire in late 2009, and serve to reduce ATM operating lease expense amounts to the fair value of these services as of the date of the acquisition. During the three and nine month periods ended September 30, 2008, the Company recognized approximately $0.9 million and $2.7 million, respectively, in lease expense reductions associated with the amortization of these liabilities, and the remaining balance as of September 30, 2008 was $4.3 million. Upon the expiration of the operating leases, the Company will be required to renew the lease contracts, enter into new lease contracts or purchase new or used ATMs to replace the leased equipment.

 

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Related Letters of Credit. Additionally, in connection with the 7-Eleven ATM Transaction, the Company posted $7.5 million in letters of credit related to the operating and capital leases described above upon which the lessors can draw in the event the Company fails to make scheduled payments under the leases. These letters of credit, which are reduced periodically as payments are made under the leases, will be released upon the expiration of the leases. As of September 30, 2008, the total outstanding balance under these letters of credit was $6.1 million.
Other Commitments
Asset Retirement Obligations. The Company’s asset retirement obligations consist primarily of deinstallation costs of the ATM and the costs to restore the ATM site to its original condition. In most cases, the Company is legally required to perform this deinstallation and restoration work. The Company had $19.1 million accrued for these liabilities as of September 30, 2008. For additional information on the Company’s asset retirement obligations, see Note 9 .
(12) Derivative Financial Instruments
As a result of its variable-rate debt and ATM cash management activities, the Company is exposed to changes in interest rates (the London Interbank Offered Rate (“LIBOR”) and the federal funds effective rate in the United States, LIBOR in the United Kingdom, and the Mexican Interbank Rate in Mexico). It is the Company’s policy to limit the variability of a portion of its expected future interest payments as a result of changes in the underlying rates by utilizing certain types of derivative financial instruments.
To meet the above objective, the Company has entered into several LIBOR-based and federal funds effective rate-based interest rate swaps to fix the interest rate paid on $550.0 million of the Company’s current and anticipated outstanding ATM cash balances in the United States. The swaps in place as of September 30, 2008 serve to fix the interest rate paid on the following notional amounts for the periods identified:
                 
        Weighted Average      
Notional Amount     Fixed Rate     Period
(In thousands)          
$ 550,000       4.61 %  
October 1, 2008 – December 31, 2008
$ 550,000       4.30 %  
January 1, 2009 – December 31, 2009
$ 550,000       4.11 %  
January 1, 2010 – December 31, 2010
$ 400,000       3.72 %  
January 1, 2011 – December 31, 2011
$ 200,000       3.96 %  
January 1, 2012 – December 31, 2012
As of September 30, 2008 and December 31, 2007, the Company had a net liability of $13.0 million and $13.6 million, respectively, recorded in its Consolidated Balance Sheets related to the above interest rate swaps, which represented the fair value of the agreements based on third-party quotes for similar instruments with the same terms and conditions, as the instruments are required to be carried at fair value. These swaps have been accounted for as cash flow hedges pursuant to SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. Accordingly, changes in the fair values of the swaps have been reported in accumulated other comprehensive loss in the accompanying Consolidated Balance Sheets. As a result of the Company’s overall net loss position for tax purposes, the Company has not recorded deferred tax benefits on the loss amounts related to these interest rate swaps as of September 30, 2008 or December 31, 2007, as management does not currently believe that the Company will be able to realize the benefits associated with its net deferred tax asset positions.
Net amounts paid or received under the swaps are recorded as adjustments to the Company’s “Cost of ATM operating revenues” in the accompanying Consolidated Statements of Operations, as the interest rate swaps are utilized by the Company to economically hedge exposure to variable interest rates charged on outstanding vault cash balances, a cost of revenue activity. During the three and nine month periods ended September 30, 2008 and 2007, gains or losses incurred as a result of ineffectiveness associated with the Company’s interest rate swaps were immaterial.
As of September 30, 2008, the Company has not entered into any derivative financial instruments to hedge its variable interest rate exposure in the United Kingdom or Mexico.

 

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(13) Income Taxes
Income tax expense based on the Company’s loss before income taxes was as follows:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2008     2007     2008     2007  
    (In thousands)     (In thousands)  
Income tax expense
  $ 469     $ 2,275     $ 494     $ 3,212  
Effective tax rate
    (12.7 )%     (27.1 )%     (4.2 )%     (19.5 )%
The Company computes its quarterly income tax provision amounts under the effective tax rate method based on applying an anticipated effective tax rate in each major tax jurisdiction, if and when applicable, to the pre-tax book income or loss amounts generated in the jurisdictions. During the three and nine month periods ended September 30, 2008, the Company increased its valuation allowance by approximately $0.9 million and $2.8 million, respectively. The increases were due to the Company’s determination that it is more likely than not that it will not be able to realize the benefit associated with the net deferred tax asset balance related to its domestic operations. The negative effective tax rates reflected above were due to the domestic valuation allowance discussed above, the relative mix of pre-tax loss amounts in the Company’s foreign and domestic jurisdictions, and the fact that the Company is not currently recognizing any tax benefits associated with its Mexico operations. Furthermore, the Company was in a taxable income position with respect to its domestic state income taxes but in a taxable loss position with respect to its domestic federal income taxes, which also contributed to the overall negative effective tax rates for certain periods reflected above. Finally, the Company recorded a contingent tax liability totaling $0.4 million during the three month period ended September 30, 2008 related to our United Kingdom operations, further contributing to the overall negative effective tax rate.
The Company is currently not recording any valuation allowances related to the deferred tax assets associated with its United Kingdom operations as the Company currently believes it is more likely than not that it will have sufficient taxable income in future periods, including the reversal of existing deferred tax liabilities, to utilize those assets. However, the Company’s United Kingdom operations have generated significant pre-tax book losses during the nine months ended September 30, 2008. If these losses continue through the remainder of 2008 and into 2009, the Company may be required to establish a valuation allowance for a portion, if not all, of any net deferred tax asset balance associated with these operations.
(14) Segment Information
As of September 30, 2008, the Company’s operations consisted of its United States, United Kingdom, Mexico, and Advanced Functionality segments. While each of these segments provides similar ATM-related services, each segment is managed separately, as they require different marketing and business strategies. Furthermore, the Company previously determined that the advanced-functionality services provided through the acquired Vcom units exhibited different economic characteristics than the traditional ATM services provided by its other three segments, in large part due to the anticipated losses associated with providing advanced-functionality services and the fact that these operations will be managed separately until they can achieve break-even status.

 

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Management uses earnings before interest expense, income taxes, depreciation and accretion expense, and amortization expense to assess the operating results and effectiveness of its business segments. Management believes EBITDA is useful because it allows them to more effectively evaluate the Company’s and its business segments’ operating performance and compare the results of its operations from period to period without regard to its financing methods or capital structure. Additionally, the Company excludes depreciation, accretion, and amortization expense as these amounts can vary substantially from company to company within its industry depending upon accounting methods and book values of assets, capital structures and the method by which the assets were acquired. EBITDA, as defined by the Company, may not be comparable to similarly titled measures employed by other companies and is not a measure of performance calculated in accordance with U.S. GAAP. Therefore, EBITDA should not be considered in isolation or as a substitute for operating income, net income, cash flows from operating, investing, and financing activities or other income or cash flow statement data prepared in accordance with GAAP. Below is a reconciliation of EBITDA to net loss:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2008     2007     2008     2007  
    (In thousands)     (In thousands)  
EBITDA
  $ 19,445     $ 16,741     $ 56,013     $ 37,722  
Depreciation and accretion expense
    10,048       6,961       29,169       18,541  
Amortization expense
    4,657       9,204       13,661       14,062  
Interest expense, net, including amortization of deferred financing costs and bond discounts
    8,444       8,984       24,836       21,592  
Income tax expense
    469       2,275       494       3,212  
 
                       
Net loss
  $ (4,173 )   $ (10,683 )   $ (12,147 )   $ (19,685 )
 
                       
The following tables reflect certain financial information for each of the Company’s reporting segments. All intercompany transactions between the Company’s reporting segments have been eliminated.
                                                 
    For the Three Months Ended September 30, 2008  
    United     United           Advanced              
    States     Kingdom   Mexico     Functionality     Eliminations   Total  
    (In thousands)  
Revenue from external customers
  $ 101,068     $ 20,132     $ 4,643     $ 1,416     $     $ 127,259  
Intersegment revenues
    536                         (536 )      
Cost of revenues
    75,665       16,396       3,824       1,618       (536 )     96,967  
Selling, general, and administrative expenses
    8,788       1,204       270       125             10,387  
 
                                               
EBITDA
    16,984       1,577       397       (327 )     814       19,445  
 
                                               
Depreciation and accretion expense
    6,521       3,062       471             (6 )     10,048  
Amortization expense
    4,112       532       13                   4,657  
Interest expense, net
    6,786       1,448       210                   8,444  
 
                                               
Capital expenditures, excluding acquisitions (2)(3)
    3,106       6,071       1,585       131             10,893  
 
                                               
    For the Three Months Ended September 30, 2007  
    United     United           Advanced              
    States   (1)     Kingdom     Mexico     Functionality   (1)     Eliminations     Total  
    (In thousands)  
Revenue from external customers
  $ 91,259     $ 17,192     $ 1,451     $ 685     $     $ 110,587  
Cost of revenues
    69,586       12,339       1,152       2,644             85,721  
Selling, general, and administrative expenses
    6,091       1,116       344       121       (51 )     7,621  
 
                                               
EBITDA
    15,036       3,611       (50 )     (2,080 )     224       16,741  
 
                                               
Depreciation and accretion expense
    4,862       1,997       93             9       6,961  
Amortization expense
    8,743       449       12                   9,204  
Interest expense, net
    7,778       1,124       82                   8,984  
 
                                               
Capital expenditures, excluding acquisitions (2)(3)
    9,685       9,833       865       226             20,609  
Additions to equipment to be leased to customers
                (10 )                 (10 )

 

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    For the Nine Months Ended September 30, 2008  
    United     United             Advanced              
    States     Kingdom     Mexico     Functionality     Eliminations     Total  
    (In thousands)  
Revenue from external customers
  $ 302,874     $ 57,473     $ 10,448     $ 4,014     $     $ 374,809  
Intersegment revenues
    1,256                         (1,256 )      
Cost of revenues
    225,685       48,329 (4)     8,756       5,981       (1,256 )     287,495  
Selling, general, and administrative expenses
    23,908       3,670       845       315             28,738  
 
EBITDA
    53,249       3,659 (4)     573       (2,282 )     814       56,013  
 
Depreciation and accretion expense
    19,217       8,799       1,186             (33 )     29,169  
Amortization expense
    12,017       1,606       38                   13,661  
Interest expense, net
    19,896       4,336       604                   24,836  
 
Capital expenditures, excluding acquisitions (2) (3)
    24,824       24,937       4,348       371             54,480  
 
                                               
    For the Nine Months Ended September 30, 2007  
    United     United             Advanced              
    States   (1)     Kingdom     Mexico     Functionality   (1)     Eliminations     Total  
    (In thousands)  
Revenue from external customers
  $ 213,186     $ 45,533     $ 2,940     $ 685     $     $ 262,344  
Intersegment revenues
    82                         (82 )      
Cost of revenues
    165,188       32,650 (4)     2,454       2,644       (50 )     202,886  
Selling, general, and administrative expenses
    16,735       3,152       961       121       16       20,985  
 
                                               
EBITDA
    30,773       9,394 (4)     (491 )     (2,080 )     126       37,722  
 
                                               
Depreciation and accretion expense
    13,392       5,007       162             (20 )     18,541  
Amortization expense
    12,747       1,278       37                   14,062  
Interest expense, net
    18,262       3,156       174                   21,592  
 
                                               
Capital expenditures, excluding acquisitions (2) (3)
    21,795       21,058       2,259       226             45,338  
Additions to equipment to be leased to customers
                412                   412  
 
     
(1)   The Company consummated the 7-Eleven ATM Transaction on July 20, 2007. As a result, the Company’s results of operations for the three and nine months ended September 30, 2007 only include the acquired operations for 70 days. The acquired ATM operations are included in the United States segment results, and the acquired Vcom operations are included in the Advanced Functionality segment results.
 
(2)   Capital expenditure amounts include payments made for exclusive license agreements and site acquisition costs.
 
(3)   Capital expenditure amounts for Mexico are reflected gross of any minority interest amounts.
 
(4)   During the second quarter of 2008, the Company experienced a significant increase in transactions conducted on its ATMs in the United Kingdom with counterfeit credit cards. Due to a delay in the completion of its Europay MasterCard Visa (“EMV”) security standard certification with the network whose brand was on those cards, the Company was liable under the network’s rules for the resulting claims, which the Company now estimates could total $1.2 million. As a result, cost of revenues and EBITDA were negatively impacted by the $1.2 million charge during the nine month period ended September 30, 2008. Additionally, a similar charge in the amount of $0.4 million was incurred during the second quarter of 2007, which negatively impacted the United Kingdom segment’s costs of revenues and EBITDA for the nine month period ended September 30, 2007. However, during the third quarter of 2008, the Company successfully achieved EMV certification with this particular network, and thus, it does not expect to incur additional charges related to this issue in the future.
Identifiable Assets:
                 
    September 30, 2008     December 31, 2007  
    (In thousands)  
United States
  $ 386,000     $ 409,120  
United Kingdom
    156,570       163,464  
Mexico
    14,585       12,337  
Advanced Functionality
    10,592       6,364  
 
           
Total
  $ 567,747     $ 591,285  
 
           

 

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(15) New Accounting Pronouncements
Adopted
Fair Value Measurements. In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurements, which provides guidance on measuring the fair value of assets and liabilities in the financial statements. In summary, SFAS No. 157 does the following:
    Defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date and establishes a framework for measuring fair value;
    Establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date;
    Eliminates large position discounts for financial instruments quoted in active markets and requires consideration of the Company’s creditworthiness when valuing liabilities; and
    Expands disclosures about instruments measured at fair value.
In addition, SFAS No. 157 establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows:
    “Level 1” inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
    “Level 2” inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.
    “Level 3” inputs are unobservable inputs based on assumptions used to measure assets and liabilities at fair value.
A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
Subsequent to the issuance of SFAS No. 157, the FASB issued FSP No. 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13 , and FSP No. 157-2, Effective Date of FASB Statement No. 157 . FSP No. 157-1 amends SFAS No. 157 to exclude SFAS No. 13, Accounting for Leases , and its related interpretive accounting pronouncements that address leasing transactions, while FSP No. 157-2 delays the effective date of the application of SFAS No. 157 to fiscal years beginning after November 15, 2008 for all non-financial assets and non-financial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis.
The Company adopted SFAS No. 157 as of January 1, 2008, with the exception of the application of the statement to nonrecurring non-financial assets and non-financial liabilities. Nonrecurring non-financial assets and non-financial liabilities for which the Company has not applied the provisions of SFAS No. 157 include those measured at fair value for impairment testing, including goodwill, other intangible assets, and property and equipment. As a result of the adoption of SFAS No. 157, the Company recorded a $1.6 million reduction of the unrealized loss associated with its interest rate swaps, which served to decrease the Company’s liability associated with the interest rate swaps and reduce its other comprehensive loss. This adjustment reflected the consideration of nonperformance risk by the Company for interest rate swaps that were in a net liability position and the nonperformance risk of the Company’s counterparties for interest rate swaps that were in a net asset position, as measured by the use of applicable credit default spreads, as of the date of adoption.

 

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The following table provides the liabilities carried at fair value measured on a recurring basis as of September 30, 2008:
                                 
    Fair Value Measurements  
    Total Carrying                    
    Value     Level 1     Level 2     Level 3  
    (In thousands)  
Interest rate swaps
  $ 13,002     $     $ 13,002     $  
The following is a description of the Company’s valuation methodology for assets and liabilities measured at fair value:
C ash and cash equivalents, accounts and notes receivable, net of the allowance for doubtful accounts, other current assets, accounts payable, accrued expenses, and other current liabilities. These financial instruments are not carried at fair value, but are carried at amounts that approximate fair value due to their short-term nature and generally negligible credit risk.
Interest rate swaps. These financial instruments are carried at fair value, calculated as the present value of amounts estimated to be received or paid to a marketplace participant in a selling transaction. These derivatives are valued using pricing models based on significant other observable inputs (Level 2 inputs), while taking into account the nonperformance risk of the party that is in the liability position with respect to each trade.
The methods described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
Fair Value Option. In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities , which provides companies the option to measure certain financial instruments and other items at fair value. The Company has elected not to adopt the fair value option provisions of this statement for any currently recognized assets or liabilities.
Issued but Not Yet Adopted
As of September 30, 2008, the Company had not adopted the following accounting standards and interpretations:
Business Combinations. In December 2007, the FASB issued SFAS No. 141R, Business Combinations , which provides revised guidance on the accounting for acquisitions of businesses. This standard changes the current guidance to require that all acquired assets, liabilities, minority interest, and certain contingencies, including contingent consideration, be measured at fair value, and certain other acquisition-related costs, including costs of a plan to exit an activity or terminate and relocate employees, be expensed rather than capitalized. SFAS No. 141R will apply to acquisitions that are effective after December 31, 2008, and application of the standard to acquisitions prior to that date is not permitted. The Company will adopt the provisions of SFAS No. 141R effective January 1, 2009 and apply the requirements of the statement to business combinations that occur subsequent to its adoption. The impact of the Company’s adoption of SFAS No. 141R will depend upon the nature and terms of business combinations, if any, that the Company consummates on or after January 1, 2009.
Noncontrolling Interests. In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51 , which provides guidance on the presentation of minority interest in the financial statements and the accounting for and reporting of transactions between the reporting entity and the holders of the noncontrolling interest. This standard requires that minority interest be presented as a separate component of equity rather than as a “mezzanine” item between liabilities and equity and requires that minority interest be presented as a separate caption in the income statement. In addition, this standard requires all transactions with minority interest holders, including the issuance and repurchase of minority interests, be accounted for as equity transactions unless a change in control of the subsidiary occurs. The provisions of SFAS No. 160 are to be applied prospectively with the exception of reclassifying noncontrolling interests to equity and recasting consolidated net income (loss) to include net income (loss) attributable to both the controlling and noncontrolling interests, which are required to be adopted retrospectively. The Company will adopt the provisions of SFAS No. 160 on January 1, 2009 and is currently assessing the impact its adoption will have on the Company’s financial position and results of operations.

 

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Disclosures about Derivatives and Hedging Activities. In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivatives and Hedging Activities — an amendment of SFAS No. 133, which changes the disclosure requirements for derivative instruments and hedging activities. This standard requires a company to provide enhanced disclosures about (1) how and why the company uses derivative instruments, (2) how derivative instruments and related hedged items are accounted for under SFAS No. 133, and (3) how derivative instruments and related hedged items affect the company’s financial position, financial performance, and cash flows. The Company will adopt the provisions of SFAS No. 161 on January 1, 2009 and apply the disclosure requirements to disclosures made subsequent to its adoption. The Company is currently evaluating the impact that the adoption of SFAS No. 161 will have on its financial statement disclosures.
Useful Life of Intangible Assets. In April 2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of Intangible Assets, which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). The intent of FSP FAS 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141R (discussed above) and other applicable accounting literature. The Company will adopt the provisions of FSP FAS 142-3 on January 1, 2009 and is currently assessing its impact the adoption will have on the Company’s financial position and results of operations.
(16) Supplemental Guarantor Financial Information
The Company’s Series A Notes and Series B Notes are guaranteed on a full and unconditional basis by all of the Company’s domestic subsidiaries. The following information sets forth the condensed consolidating statements of operations and cash flows for the three and nine month periods ended September 30, 2008 and 2007 and the condensed consolidating balance sheets as of September 30, 2008 and December 31, 2007 of (1) Cardtronics, Inc., the parent company and issuer of the senior subordinated notes (“Parent”); (2) the Company’s domestic subsidiaries on a combined basis (collectively, the “Guarantors”); and (3) the Company’s international subsidiaries on a combined basis (collectively, the “Non-Guarantors”):
Condensed Consolidating Statements of Operations
                                         
    Three Months Ended September 30, 2008  
                    Non-              
    Parent     Guarantors     Guarantors     Eliminations     Total  
    (In thousands)  
Revenues
  $     $ 102,870     $ 24,775     $ (386 )   $ 127,259  
Operating costs and expenses
    1,451       95,228       25,772       (392 )     122,059  
 
                             
Operating (loss) income
    (1,451 )     7,642       (997 )     6       5,200  
Interest expense, net, including amortization of deferred financing costs and bond discounts
    236       6,550       1,658             8,444  
Equity in losses of subsidiaries
    2,414                   (2,414 )      
Other (income) expense, net
    (116 )     283       1,107       (814 )     460  
 
                             
(Loss) income before income taxes
    (3,985 )     809       (3,762 )     3,234       (3,704 )
Income tax expense (benefit)
    1,008       (30 )     (509 )           469  
 
                             
Net (loss) income available to common stockholders
  $ (4,993 )   $ 839     $ (3,253 )   $ 3,234     $ (4,173 )
 
                             

 

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Condensed Consolidating Statements of Operations — Continued
                                         
    Three Months Ended September 30, 2007  
                    Non-              
    Parent     Guarantors     Guarantors     Eliminations     Total  
    (In thousands)  
Revenues
  $     $ 91,944     $ 18,643     $     $ 110,587  
Operating costs and expenses
    320       91,727       17,502       (42 )     109,507  
 
                             
Operating (loss) income
    (320 )     217       1,141       42       1,080  
Interest expense, net, including amortization of deferred financing costs and bond discounts
    2,142       5,636       1,206             8,984  
Equity in losses of subsidiaries
    6,005                   (6,005 )      
Other (income) expense, net
          547       131       (174 )     504  
 
                             
Loss before income taxes
    (8,467 )     (5,966 )     (196 )     6,221       (8,408 )
Income tax expense (benefit)
    2,432       53       (210 )           2,275  
 
                             
Net (loss) income
    (10,899 )     (6,019 )     14       6,221       (10,683 )
Preferred stock accretion expense
    67                         67  
 
                             
Net (loss) income available to common stockholders
  $ (10,966 )   $ (6,019 )   $ 14     $ 6,221     $ (10,750 )
 
                             
                                         
    Nine Months Ended September 30, 2008  
                    Non-              
    Parent     Guarantors     Guarantors     Eliminations     Total  
    (In thousands)  
Revenues
  $     $ 307,639     $ 67,921     $ (751 )   $ 374,809  
Operating costs and expenses
    2,141       284,477       73,229       (784 )     359,063  
 
                             
Operating (loss) income
    (2,141 )     23,162       (5,308 )     33       15,746  
Interest expense, net
    319       19,577       4,940             24,836  
Equity in losses of subsidiaries
    7,798                   (7,798 )      
Other (income) expense, net
    (288 )     1,576       2,089       (814 )     2,563  
 
                             
(Loss) income before income taxes
    (9,970 )     2,009       (12,337 )     8,645       (11,653 )
Income tax expense (benefit)
    3,024       106       (2,636 )           494  
 
                             
Net (loss) income available to common stockholders
  $ (12,994 )   $ 1,903     $ (9,701 )   $ 8,645     $ (12,147 )
 
                             
                                         
    Nine Months Ended September 30, 2007  
                    Non-              
    Parent     Guarantors     Guarantors     Eliminations     Total  
    (In thousands)  
Revenues
  $     $ 213,953     $ 48,473     $ (82 )   $ 262,344  
Operating costs and expenses
    909       209,918       45,701       (54 )     256,474  
 
                             
Operating (loss) income
    (909 )     4,035       2,772       (28 )     5,870  
Interest expense, net
    6,502       11,760       3,330             21,592  
Equity in losses of subsidiaries
    9,240                   (9,240 )      
Other (income) expense, net
    (112 )     684       353       (174 )     751  
 
                             
Loss before income taxes
    (16,539 )     (8,409 )     (911 )     9,386       (16,473 )
Income tax expense (benefit)
    3,292       158       (238 )           3,212  
 
                             
Net loss
    (19,831 )     (8,567 )     (673 )     9,386       (19,685 )
Preferred stock accretion expense
    200                         200  
 
                             
Net loss available to common stockholders
  $ (20,031 )   $ (8,567 )   $ (673 )   $ 9,386     $ (19,885 )
 
                             

 

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Condensed Consolidating Balance Sheets
                                         
    As of September 30, 2008  
                    Non-              
    Parent     Guarantors     Guarantors     Eliminations     Total  
    (In thousands)  
Assets:
                                       
Cash and cash equivalents
  $ 25     $ 425     $ 755     $     $ 1,205  
Receivables, net
    935       22,473       4,049       (1,359 )     26,098  
Other current assets
    2,469       10,935       10,365       (1,973 )     21,796  
 
                             
Total current assets
    3,429       33,833       15,169       (3,332 )     49,099  
Property and equipment, net
          100,299       70,358       (180 )     170,477  
Intangible assets, net
    7,961       95,049       13,115             116,125  
Goodwill
          150,451       76,688             227,139  
Investments in and advances to subsidiaries
    39,762                   (39,762 )      
Intercompany receivable (payable)
    (2,751 )     8,647       (5,896 )            
Prepaid expenses and other assets
    384,575       3,186       1,721       (384,575 )     4,907  
 
                             
Total assets
  $ 432,976     $ 391,465     $ 171,155     $ (427,849 )   $ 567,747  
 
                             
 
                                       
Liabilities and Stockholders’ Equity:
                                       
Current portion of long-term debt
  $     $     $ 1,512     $     $ 1,512  
Current portion of capital lease obligations
          818                   818  
Current portion of other long-term liabilities
          18,170                   18,170  
Accounts payable and accrued liabilities
    3,921       53,077       22,335       (3,326 )     76,007  
 
                             
Total current liabilities
    3,921       72,065       23,847       (3,326 )     96,507  
Long-term debt, net of current portion
    335,594       267,447       123,519       (384,575 )     341,985  
Capital lease obligations, net of current portion
          411                   411  
Deferred tax liability
    10,410       981       349             11,740  
Asset retirement obligations
          13,089       6,014             19,103  
Other non-current liabilities
          14,084       18       848       14,950  
 
                             
Total liabilities
    349,925       368,077       153,747       (387,053 )     484,696  
Stockholders’ equity
    83,051       23,388       17,408       (40,796 )     83,051  
 
                             
Total liabilities and stockholders’ equity
  $ 432,976     $ 391,465     $ 171,155     $ (427,849 )   $ 567,747  
 
                             

 

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Condensed Consolidating Balance Sheets — Continued
                                         
    As of December 31, 2007  
                    Non-              
    Parent     Guarantors     Guarantors     Eliminations     Total  
    (In thousands)  
Assets:
                                       
Cash and cash equivalents
  $ 76     $ 11,576     $ 1,787     $     $ 13,439  
Receivables, net
    (292 )     20,894       2,713       (67 )     23,248  
Other current assets
    1,031       8,781       10,876       (590 )     20,098  
 
                             
Total current assets
    815       41,251       15,376       (657 )     56,785  
Property and equipment, net
          99,764       64,360       (212 )     163,912  
Intangible assets, net
    8,768       106,808       15,325             130,901  
Goodwill
          150,445       84,740             235,185  
Investments in and advances to subsidiaries
    50,249                   (50,249 )      
Intercompany receivable (payable)
    (863 )     6,395       (5,532 )            
Prepaid expenses and other assets
    368,424       2,970       1,532       (368,424 )     4,502  
 
                             
Total assets
  $ 427,393     $ 407,633     $ 175,801     $ (419,542 )   $ 591,285  
 
                             
 
                                       
Liabilities and Stockholders’ Equity:
                                       
Current portion of long-term debt
  $     $     $ 882     $     $ 882  
Current portion of capital lease obligations
          1,147                   1,147  
Current portion of other long-term liabilities
          16,032       169             16,201  
Accounts payable and accrued liabilities
    12,808       66,726       26,027       (652 )     104,909  
 
                             
Total current liabilities
    12,808       83,905       27,078       (652 )     123,139  
Long-term debt, net of current portion
    300,088       265,725       110,343       (368,423 )     307,733  
Capital lease obligations, net of current portion
          982                   982  
Deferred tax liability
    7,386       980       3,114             11,480  
Asset retirement obligations
          12,332       5,116             17,448  
Other non-current liabilities
          22,868       524             23,392  
 
                             
Total liabilities
    320,282       386,792       146,175       (369,075 )     484,174  
Stockholders’ equity
    107,111       20,841       29,626       (50,467 )     107,111  
 
                             
Total liabilities and stockholders’ equity
  $ 427,393     $ 407,633     $ 175,801     $ (419,542 )   $ 591,285  
 
                             
Condensed Consolidating Statements of Cash Flows
                                         
    Nine Months Ended September 30, 2008  
                    Non-              
    Parent     Guarantors     Guarantors     Eliminations     Total  
    (In thousands)  
Net cash (used in) provided by operating activities
  $ (10,354 )   $ 13,571     $ 8,556     $     $ 11,773  
 
                             
Additions to property and equipment
          (25,144 )     (28,441 )           (53,585 )
Payments for exclusive license agreements and site acquisition costs
          (50 )     (845 )           (895 )
Principal payments received under direct financing leases
                17             17  
Acquisitions
          (350 )                 (350 )
 
                             
Net cash used in investing activities
          (25,544 )     (29,269 )           (54,813 )
 
                             
Proceeds from issuance of long-term debt
    103,500       53,899       19,853       (73,916 )     103,336  
Repayments of long-term debt
    (68,400 )     (53,077 )     (453 )     52,177       (69,753 )
Issuance of long-term notes receivable
    (73,916 )                 73,916        
Payments received on long-term notes receivable
    52,177                       (52,177 )      
Repayments of borrowings under bank overdraft facility, net
                (2,961 )           (2,961 )
Proceeds from exercises of stock options
    362                         362  
Other financing activities
    (3,420 )           3,499             79  
 
                             
Net cash provided by financing activities
    10,303       822       19,938             31,063  
 
                             
Effect of exchange rate changes on cash
                (257 )           (257 )
 
                             
Net decrease in cash and cash equivalents
    (51 )     (11,151 )     (1,032 )           (12,234 )
 
                                     
Cash and cash equivalents at beginning of period
    76       11,576       1,787             13,439  
 
                             
Cash and cash equivalents at end of period
  $ 25     $ 425     $ 755     $     $ 1,205  
 
                             

 

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Condensed Consolidating Statements of Cash Flows — Continued
                                         
    Nine Months Ended September 30, 2007  
                    Non-              
    Parent     Guarantors     Guarantors     Eliminations     Total  
    (In thousands)  
Net cash (used in) provided by operating activities
  $ (4,114 )   $ 25,335     $ 14,319     $     $ 35,540  
 
                             
Additions to property and equipment, net of proceeds from sale of property and equipment
          (21,711 )     (22,243 )           (43,954 )
Payments for exclusive license agreements and site acquisition costs
          (307 )     (1,074 )           (1,381 )
Additions to equipment to be leased to customers, net of principal payments received under direct financing leases
                (390 )           (390 )
Acquisition, net of cash acquired
          (137,694 )                 (137,694 )
Proceeds from sale of Winn-Dixie equity securities
          3,950                   3,950  
 
                             
Net cash used in investing activities
          (155,762 )     (23,707 )           (179,469 )
 
                             
Proceeds from issuance of long-term debt
    169,434       155,935       8,877       (163,982 )     170,264  
Repayments of long-term debt
    (22,000 )     (21,610 )     (113 )     21,360       (22,363 )
Issuance of long-term notes receivable
    (163,982 )                 163,982        
Payments received on long-term notes receivable
    21,360                   (21,360 )      
Repayments of borrowings under bank overdraft facility, net
                54             54  
Other financing activities
    (781 )     (189 )     363             (607 )
 
                             
Net cash provided by financing activities
    4,031       134,136       9,181             147,348  
 
                             
Effect of exchange rate changes on cash
                (19 )           (19 )
 
                             
Net increase (decrease) in cash and cash equivalents
    (83 )     3,709       (226 )           3,400  
Cash and cash equivalents at beginning of period
    97       1,818       803             2,718  
 
                             
Cash and cash equivalents at end of period
  $ 14     $ 5,527     $ 577     $     $ 6,118  
 
                             

 

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Cautionary Statement Regarding Forward-Looking Statements
Certain statements and information in this Quarterly Report on Form 10-Q (this “Form 10-Q”) may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Act of 1995. The words “believe,” “expect,” “anticipate,” “plan,” “intend,” “foresee,” “should,” “would,” “could” or other similar expressions are intended to identify forward-looking statements, which are generally not historical in nature. These forward-looking statements are based on our current expectations and beliefs concerning future developments and their potential effect on us. While management believes that these forward-looking statements are reasonable as and when made, there can be no assurance that future developments affecting us will be those that we anticipate. All comments concerning our expectations for future revenues and operating results are based on our forecasts for our existing operations and do not include the potential impact of any future acquisitions. Our forward-looking statements involve significant risks and uncertainties (some of which are beyond our control) and assumptions that could cause actual results to differ materially from our historical experience and our present expectations or projections. Important factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to, those summarized below:
    our financial outlook and the financial outlook of the ATM industry;
    our ability to compete successfully with our competitors;
    our cash needs, including liquidity issues with our vault cash providers;
    the implementation of our corporate strategy;
    our financial performance;
    our ability to expand our bank branding and surcharge-free service offerings;
    our ability to provide new ATM solutions to financial institutions;
    our ability to pursue and successfully integrate acquisitions;
    our ability to implement new services on our advanced-functionality Vcom units;
    our ability to strengthen existing customer relationships and reach new customers;
    our ability to expand internationally;
    our ability to meet the service levels required by our service level agreements with our customers;
    our ability prevent security breaches;
    the additional risks we are exposed to in our armored transport business;
    the consolidation of several of our existing branding customers; and
    our ability to cope with and develop business strategies dealing with the deterioration experienced in global credit markets.
Other factors that could cause our actual results to differ from our projected results are described in (1) Part II, Item 1A. Risk Factors and elsewhere in this Form 10-Q , (2) our Annual Report on Form 10-K for the fiscal year ended December 31, 2007 (“2007 Form 10-K”), (3) our reports and registration statements filed from time to time with the Securities and Exchange Commission (“SEC”) and (4) other announcements we make from time to time.
Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statements after the date they are made, whether as a result of new information, future events or otherwise.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Cardtronics, Inc. operates the world’s largest network of automated teller machines (“ATM”). As of September 30, 2008, our network included approximately 33,100 ATMs throughout the United States, the United Kingdom, and Mexico, primarily at national and regional merchant locations. We provide ATM management and equipment-related services and electronic funds transfer (“EFT”) transaction processing services to our network of ATMs as well as ATMs owned and operated by third parties. For a more detailed discussion of our operations and the manners in which we derive revenues, please refer to our 2007 Form 10-K.
Economic and Strategic Outlook
Over the past three years, we have made significant capital investments, including (1) our acquisition of our United Kingdom operations in 2005, (2) our expansion into Mexico in 2006, (3) our acquisition of the ATM and advanced-functionality kiosk business of 7-Eleven, Inc. (“7-Eleven”) in 2007, and (4) the launch of our in-house EFT processing platform. Additionally, during this same period of time, we continued to deploy ATMs in high-traffic locations under our contracts with large, well-known retailers, which has led to the development of relationships with large financial institutions through bank branding opportunities and enhanced the value of our wholly-owned surcharge-free network, Allpoint. While we describe certain adverse developments below, it remains unclear what impact the current and continuing adverse general economic conditions will ultimately have on us. We believe that as a result of past strategic actions and what we believe to be the relatively conservative use of capital during this time, the current economic downturn may be mitigated by the following characteristics of our business:
Stable earnings and consistent cash flows . The investments made and the relationships built over the last several years have provided us with an operating platform that we believe will continue to generate relatively stable earnings and cash flows without having to expend significant amounts of new capital. As a result, we currently expect that our 2009 capital expenditures will be substantially lower than 2007 and 2008 levels, which in turn should lead to the generation of higher net cash flows in 2009.
Strong liquidity position . We believe that we have a sufficient amount of liquidity to meet our anticipated operating needs for the foreseeable future. Our $175.0 million revolving credit facility does not expire until May 2012 and is led by a syndicate of banks, which we believe to be comparatively well-positioned to weather current overall capital constraints, including BNP Paribas, Bank of America, N.A., BBVA Compass, JPMorgan Chase, and Wells Fargo, N.A. As of September 30, 2008, we had $39.1 million of debt outstanding under this facility and $6.1 million in letters of credit posted under the facility, leaving us $129.8 million in available, committed funding. Given that, absent acquisitions, we expect to generate higher net cash flow amounts during 2009 as a result of decreased capital spending, we currently expect to pay down a significant portion of our outstanding borrowings under this facility, leaving us a majority of the $175.0 million available for future borrowings, if needed. Furthermore, our remaining indebtedness, absent $1.2 million of capital leases in the United States and $7.9 million of equipment loans in Mexico, consists of $300.0 million in senior subordinated notes. These fixed rate notes, which mature in August 2013, contain limited incurrence covenants and require semi-annual interest payments prior to their maturity date.
Product diversification . Over the past few years, we have consciously worked to diversify our product and service offerings beyond the traditional ATM surcharging model, which should provide for future growth opportunities that we do not expect to require significant amounts of new capital. Examples of such growth opportunities include (1) adding more third parties to our ATM transaction processing platform, similar to the arrangement we currently have in place to process transactions for roughly 700 third-party owned and operated ATMs in Circle K Stores across the United States; (2) continued expansion and improvement in the types of services that we currently offer on our advanced-functionality Vcom units located in 7-Eleven convenience stores across the United States; and (3) continued growth in our branding and surcharge-free offerings. With respect to our surcharge-free offerings, we continue to engage in active sales cycles with smaller financial institutions, namely through our Allpoint surcharge-free network. We believe that smaller regional banks and credit unions may benefit in terms of increased customer deposits as a result of the issues currently being experienced by the nation’s larger financial institutions. This, in turn, could result in additional demand for this aspect of our business.

 

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Although we believe that the characteristics described above should benefit us given current market conditions, we do expect the current issues that are negatively impacting the economy and many of the nation’s largest banks to have an adverse impact on our ongoing operations. For example, we have recently seen a decrease in the demand for new bank branding deals, which we believe is directly attributable to the distractions that many of the nation’s large financial institutions are currently facing. While we believe that our bank branding solution offers a compelling value proposition for financial institutions of varying sizes and scale, we currently do not expect any meaningful growth in this aspect of our business until we begin to see a sustained improvement within the credit markets. In addition, the consolidation currently occurring within the banking industry has, and is expected to continue to have, an impact on our branding relationships as existing branding customers are acquired by other, more stable financial institutions, some of which may or may not be existing branding customers of ours. Although we currently believe that our branding contracts will remain fully enforceable in light of these transactions, there can be no assurance that such contracts will remain unaffected by the increased consolidation currently occurring within the United States banking industry.
In addition to the above, the strengthening of the United States dollar relative to the British pound and Mexican peso negatively impacted our third quarter results in terms of translating those foreign earnings into United States dollars. We expect that our financial results will continue to be negatively impacted during the remainder of 2008 as the British pound has continued to weaken significantly relative to the United States dollar during the fourth quarter. Despite the negative impact on our revenues and gross profits, we do not expect this trend to have a negative impact on our cash flows as we do not currently rely on cash generated in our United Kingdom and Mexico markets to fund our domestic operating needs. Additionally, given the fact that we continue to explore potential growth opportunities in the two international markets in which we currently operate, the strengthening of the United States dollar could enhance our ability to invest in those markets at favorable exchange rates.
Finally, we are closely monitoring our ATM operations to determine if the expected downturn in consumer spending will have an impact on our ATM transaction levels in any of our key markets. While it is still too early to detect any discernable trends in this regard, we do not currently expect (based on past experience) to see a significant drop-off in the level of transactions conducted on our ATMs. Regardless, we are taking certain actions to ensure that we are operating each of our businesses as efficiently as possible in light of current deteriorating economic conditions. These actions include, but are not limited to, an 8% reduction in headcount of our United States and United Kingdom operations during the fourth quarter of this year, significantly reduced capital spending in 2009 (absent any acquisitions), and tighter cost controls in all areas of our business. With respect to the headcount reductions, we currently expect to record a pre-tax charge of approximately $0.3 million during the fourth quarter of 2008 in connection with severance payments made to the impacted employees and anticipate that our headcount reductions and other cost reduction efforts will allow us to save between $4.5 million and $5.0 million on an annual basis.
While we are continuing to monitor current economic conditions and cannot at this point accurately predict their impact, as a result of the factors discussed above, we currently believe that our revenue growth rate in 2009 will be considerably lower than the growth rates achieved during 2007 and 2008. However, while we have not yet finalized our 2009 budgeting efforts, we currently expect that the reduction in our revenue growth rate will be mitigated, at least in part, by the cost reduction measures that we recently put in place. Furthermore, because of our decision to significantly reduce our level of capital expenditures in 2009, we currently expect to generate incremental operating cash flow amounts that can be utilized to pay down a significant portion of the outstanding borrowings under our revolving credit facility, further enhancing our overall liquidity position.
Factors Impacting Comparability
7-Eleven ATM Transaction. In July 2007, we acquired the financial services business of 7-Eleven (the “7-Eleven Financial Services Business”) for approximately $137.3 million in cash. The acquisition (the “7-Eleven ATM Transaction”) included approximately 5,500 ATMs located in 7-Eleven stores throughout the United States, of which approximately 2,000 were advanced-functionality kiosks branded as “Vcom” terminals that are capable of providing more sophisticated financial services, such as check cashing, money transfer, remote deposit capture, and bill payment services (collectively, the “Vcom Services”). Additionally, in connection with the 7-Eleven ATM Transaction, we entered into a placement agreement that provides us with, subject to certain conditions, a 10-year exclusive right to operate all ATMs and Vcom units in 7-Eleven locations throughout the United States, including any new stores opened or acquired by 7-Eleven.

 

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The operating results of our United States segment now include the results of the traditional ATM operations of the 7-Eleven Financial Services Business, including the traditional ATM activities conducted on the Vcom units. Because of the significance of this acquisition, our operating results for the nine month period ended September 30, 2008 will not be comparable to our historical results for the nine month period ended September 30, 2007. In particular, our revenues and gross profits will be substantially higher, but these increased revenue and gross profit amounts will initially be substantially offset by higher operating expense amounts, including higher selling, general, and administrative expenses associated with running the combined operations. In addition, depreciation, accretion, and amortization expense amounts are significantly higher as a result of the tangible and intangible assets recorded as part of the acquisition. Additionally, as a result of the different functionality provided by the Vcom units, and the operating losses that were expected at the time of our acquisition associated with providing the Vcom Services, the operations have been identified as a separate reporting segment, Advanced Functionality. However, we expect to see continued improvements in the performance of our advanced-functionality operations in 2009 and expect these operations to achieve breakeven results in the near future, at which point we will consider whether these operations should be combined into our United States segment.

 

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Results of Operations
The following table sets forth our consolidated statements of operations information as a percentage of total revenues for the periods indicated. Percentages may not add due to rounding.
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     2008     2007  
Revenues:
                               
ATM operating revenues
    95.2 %     96.1 %     95.5 %     96.0 %
Vcom operating revenues
    1.1       0.6       1.1       0.3  
ATM product sales and other revenues
    3.7       3.3       3.5       3.7  
 
                       
Total revenues
    100.0       100.0       100.0       100.0  
Cost of revenues:
                               
Cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization, shown separately below) (1)
    71.8       72.3       72.1       72.8  
Cost of Vcom operating revenues
    1.2       2.4       1.5       1.0  
Cost of ATM product sales and other revenues
    3.2       2.8       3.2       3.5  
 
                       
Total cost of revenues
    76.2       77.5       76.7       77.3  
 
                       
Gross profit
    23.8       22.5       23.3       22.7  
Operating expenses:
                               
Selling, general, and administrative expenses
    8.2       6.9       7.7       8.0  
Depreciation and accretion expense
    7.9       6.3       7.8       7.1  
Amortization expense
    3.7       8.3       3.6       5.4  
 
                       
Total operating expenses
    19.7       21.5       19.1       20.4  
 
                       
Income from operations
    4.1       1.0       4.2       2.2  
Other expense (income):
                               
Interest expense, net
    6.6       8.1       6.6       8.2  
Minority interest in subsidiary
    (0.6 )     (0.2 )     (0.2 )     (0.1 )
Other
    1.0       0.6       0.9       0.4  
 
                       
Total other expense
    7.0       8.6       7.3       8.5  
 
                       
Loss before income taxes
    (2.9 )     (7.6 )     (3.1 )     (6.3 )
Income tax expense
    0.4       2.1       0.1       1.2  
 
                       
Net loss
    (3.3 )%     (9.7 )%     (3.2 )%     (7.5 )%
 
                       
 
     
(1)   Excludes effects of depreciation, accretion, and amortization expense of $13.4 million and $15.7 million for the three month periods ended September 30, 2008 and 2007, respectively, and $39.1 million and $31.3 million for the nine month periods ended September 30, 2008 and 2007, respectively. The inclusion of this depreciation, accretion, and amortization expense in “Cost of ATM operating revenues” would have increased our Cost of ATM operating revenues as a percentage of total revenues by 10.5% and 14.2% for the three month periods ended September 30, 2008 and 2007, respectively, and by 10.4% and 12.0% for the nine month periods ended September 30, 2008 and 2007, respectively.

 

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Key Operating Metrics
We rely on certain key measures to gauge our operating performance, including total transactions, total cash withdrawal transactions, ATM operating revenues per ATM per month, and ATM operating gross profit margins. The following table sets forth information regarding certain of these key measures for the periods indicated.
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2008     2007     2008     2007  
Average number of transacting ATMs:
                               
United States: Company-owned
    12,326       11,347       12,288       11,424  
United States: Merchant-owned
    10,641       11,691       10,781       11,811  
United States: 7-Eleven Financial Services Business (1)
    5,716       4,170       5,695       1,668  
United Kingdom
    2,518       1,794       2,389       1,602  
Mexico
    1,905       878       1,645       644  
 
                       
Total average number of transacting ATMs
    33,106       29,880       32,798       27,149  
 
                       
 
                               
Total transactions (in thousands)
    91,853       73,007       264,678       166,183  
Total cash withdrawal transactions (in thousands)
    59,095       49,710       171,694       113,934  
Average monthly cash withdrawal transactions per average transacting ATM
    595       555       582       466  
 
                               
Per ATM per month:
                               
ATM operating revenues
  $ 1,220     $ 1,185     $ 1,212     $ 1,031  
Cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization) (2)
    920       892       915       782  
 
                       
ATM operating gross profit (2) (3)
  $ 300     $ 293     $ 297     $ 249  
 
                       
 
                               
ATM operating gross profit margin (exclusive of depreciation, accretion, and amortization)
    24.6 %     24.7 %     24.5 %     24.2 %
ATM operating gross profit margin (inclusive of depreciation, accretion, and amortization)
    13.5 %     10.0 %     13.6 %     11.7 %
 
     
(1)   The average number of transacting ATMs for the three and nine months ended September 30, 2007 includes the ATM and Vcom units acquired in the 7-Eleven ATM Transaction beginning from the acquisition date (July 20, 2007) and continuing through September 30, 2007. The actual number of transacting ATMs and Vcom units from the acquisition date to September 30, 2007 was 5,560.
 
(2)   Excludes effects of depreciation, accretion, and amortization expense of $13.4 million and $15.7 million for the three month periods ended September 30, 2008 and 2007, respectively, and by $39.1 million and $31.3 million for the nine month periods ended September 30, 2008 and 2007, respectively. The inclusion of this depreciation, accretion, and amortization expense in “Cost of ATM operating revenues” would have increased our cost of ATM operating revenues per ATM per month and decreased our ATM operating gross profit per ATM per month by $135 and $175 for the three month periods ended September 30, 2008 and 2007, respectively, and by $132 and $128 for the nine month periods ended September 30, 2008 and 2007, respectively.
 
(3)   ATM operating gross profit is a measure of profitability that uses only the revenue and expenses that related to operating the ATMs. The revenue and expenses from ATM equipment sales, Vcom Services, and other ATM-related services are not included.

 

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Revenues
                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     % Change     2008     2007     % Change  
    (In thousands)             (In thousands)          
ATM operating revenues
  $ 121,192     $ 106,234       14.1 %   $ 357,759     $ 251,854       42.1 %
Vcom operating revenues
    1,416       685       106.7 %     4,014       685       486.0 %
ATM product sales and other revenues
    4,651       3,668       26.8 %     13,036       9,805       33.0 %
 
                                       
Total revenues
  $ 127,259     $ 110,587       15.1 %   $ 374,809     $ 262,344       42.9 %
 
                                       
Three Months Ended September 30, 2008 Compared to Three Months Ended September 30, 2007
ATM operating revenues. ATM operating revenues generated during the three months ended September 30, 2008 increased $15.0 million over the three months ended September 30, 2007. Below is a detail, by geographic segment, of changes in the various components of ATM operating revenues:
                                 
    Variance: Three Months Ended September 30, 2008  
    to Three Months Ended September 30, 2007  
    U.S.     U.K.     Mexico     Total  
    (In thousands)  
Surcharge revenue
  $ 1,822     $ 252     $ 1,605     $ 3,679  
Interchange revenue
    4,178       2,637       829       7,644  
Branding and surcharge-free network revenue
    4,091                     4,091  
Other
    (456 )                 (456 )
 
                       
Total increase
  $ 9,635     $ 2,889     $ 2,434     $ 14,958  
 
                       
United States . During the three months ended September 30, 2008, our United States operations experienced a $9.6 million, or 11.0%, increase in ATM operating revenues over the same period in 2007. The majority of this increase was attributable to the 7-Eleven ATM Transaction. Specifically, although acquired in the third quarter of 2007, the 7-Eleven Financial Services Business generated $3.5 million of incremental surcharge revenue and $3.7 million of incremental interchange revenue during the third quarter of 2008 compared to the same period in 2007 as a result of the inclusion of the acquired operations for the full third quarter of the current year versus only 70 days in the prior year. Also contributing to the increase in ATM operating revenues were the branding activities of our pre-existing domestic operations, which generated $4.1 million in incremental bank branding and surcharge-free network fees in 2008 when compared to 2007, and our pre-existing Company-owned operations, which generated $1.2 million in incremental interchange revenues during the third quarter of 2008 when compared to the same period in 2007. These incremental revenues were primarily a result of additional branding and surcharge-free network agreements entered into with financial institutions during late 2007 and 2008. Additionally, our pre-existing Company-owned operations generated $0.3 million of incremental surcharge revenue during the three months ended September 30, 2008 as a result of higher surcharge transaction levels during the period on Company-owned machines.
The overall increase in ATM operating revenues discussed above was partially offset by lower revenues generated by our pre-existing merchant-owned operations. Specifically, during the third quarter of 2008, our merchant-owned base experienced a $2.0 million decline in surcharge revenues and a $0.7 million decline in interchange revenues when compared to the same period in 2007. These declines were primarily a result of the decline in the average number of transacting merchant-owned ATMs in the United States, the majority of which was attributable to attrition related to the Triple Data Encryption Standard (“Triple-DES”) mandated by the EFT networks. However, due to our retention efforts and the completion of the Triple-DES security upgrade process earlier this year, we do not expect to see attrition rates continue at this level in the future.
United Kingdom . Our United Kingdom operations also contributed to the higher ATM operating revenues for the three months ended September 30, 2008, as the interchange revenues earned in this segment during 2008 increased by 71.8% over the same period in 2007. These incremental revenues were primarily driven by the increase in the average number of transacting ATMs in the United Kingdom, which increased from 1,794 ATMs during the third quarter of 2007 to 2,518 ATMs during the third quarter of 2008, due to additional ATM deployments. Further contributing to the increase was the fact that, of the machines we have recently deployed, a higher number have been free-to-use ATMs, meaning that we do not charge the cardholder a surcharge fee for the use of the ATM but rather only receive interchange revenue from the cardholder’s financial institution. The increase in interchange revenue is the result of the additional free-to-use ATMs as well as the increase we have recently seen in the number of transactions conducted on our free-to-use ATMs.

 

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Despite the above, the increase in revenues from our United Kingdom operations was lower than originally anticipated due to lower than expected surcharge transaction levels during 2008. We believe that the primary factor contributing to this decline was certain service-related issues associated with one of our third-party armored cash providers. As a result of certain issues stemming from the merger-integration of two of our third-party armored cash providers in late 2007, our ATMs in the United Kingdom have experienced a significantly higher percentage of downtime due to cash outages beginning during the fourth quarter of 2007 and continuing through 2008, which in turn resulted in lost transactions. As a result, we have been forced to maintain higher vault cash balances in those ATMs in an effort to avoid running out of cash, further increasing our operating costs and consequently putting downward pressure on our margins. Although we have recently seen a decline in the number of resulting cash outages during the month of October 2008 from the average of the prior six months and expect that the service-related issues will improve during the fourth quarter of 2008, it is likely that these issues will continue to negatively impact the operating results of our United Kingdom operations in the near term. Additionally, it should be noted that we have taken a number of steps to help mitigate the negative impact of these third-party service issues on our ongoing operations. In particular, we are in the final stages of implementing our own in-house armored courier operation and expect to begin transitioning many of the problem locations to our own service during the fourth quarter of 2008. While this operation is not expected to provide significant initial cost savings, we do anticipate that it will alleviate some of the third-party armored cash service-related issues discussed above, and we expect to see an improvement in the uptime, and consequently profits, of these ATMs in 2009. Finally, also contributing to the lower than expected revenues was the strengthening of the United States dollar relative to the British pound during the third quarter, which negatively impacted our results in terms of translating those foreign earnings into United States dollars. Specifically, changes in exchange rates resulted in a $0.4 million decrease in revenues during the third quarter of 2008 compared to the same period in 2007.
Despite the above factors that are negatively impacting transaction levels of our United Kingdom ATMs, overall transaction-based revenues have increased as transaction levels at recently-deployed ATMs continue to mature and reach consistent monthly transaction levels.
Mexico . Our Mexico operations further contributed to the increase in ATM operating revenues as a result of the increase in the average number of transacting ATMs associated with these operations, which rose from 878 during the third quarter of 2007 to 1,905 during the third quarter of 2008 as a result of additional ATM deployments throughout 2007 and 2008.
Vcom operating revenues. We acquired our Vcom operations as a part of the 7-Eleven ATM Transaction in July 2007. The Vcom operating revenues generated during the three months ended September 30, 2008 and 2007 were primarily comprised of check-cashing fees. The increase in revenues over prior year was primarily the result of our efforts during 2008 to concentrate our advanced-functionality Vcom kiosks into 13 selected markets within the United States, which allowed us to advertise the availability of the advanced-functionality services offered at the Vcom kiosks. Although the revenues generated by these operations during the most recent quarter were nominal, we expect that these revenues will increase in the future as we have fully implemented our image deposit function on the Vcom kiosks for two major financial institutions: (1) the CO-OP Network, the nation’s largest surcharge-free network devoted exclusively to credit unions, and (2) Financial Service Centers Cooperative, Inc., a cooperative service organization providing shared branching services for credit unions. Additionally, we expect to further expand our image deposit function in the first quarter of 2009 as we roll-out this service to customers of Citibank, N.A.
ATM product sales and other revenues. ATM product sales and other revenues for the three months ended September 30, 2008 were higher than those generated during the same period in 2007 due to higher value-added reseller (“VAR”) program sales. Under our VAR program, we primarily sell ATMs to Associate VARs who in turn resell the ATMs to various financial institutions throughout the United States in territories authorized by the equipment manufacturer. The increase in VAR sales during the three months ended September 30, 2008 was primarily due to the additions of two new Associate VARs during the third quarter of 2007 and one new Associate VAR during the first quarter of 2008.

 

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Nine Months Ended September 30, 2008 Compared to Nine Months Ended September 30, 2007
ATM Operating Revenues. ATM operating revenues generated during the nine months ended September 30, 2008 increased $105.9 million over the nine months ended September 30, 2007. Below is a detail, by geographic segment, of changes in the various components of ATM operating revenues:
                                 
    Variance: Nine Months Ended September 30, 2008  
    to Nine Months Ended September 30, 2007  
    U.S.     U.K.     Mexico     Total  
    (In thousands)  
Surcharge revenue
  $ 36,450     $ 3,967     $ 4,033     $ 44,450  
Interchange revenue
    32,365       7,897       2,163       42,425  
Branding and surcharge-free network revenue
    19,423             1       19,424  
Other
    (395 )     1             (394 )
 
                       
Total increase
  $ 87,843     $ 11,865     $ 6,197     $ 105,905  
 
                       
United States. During the nine months ended September 30, 2008, our United States operations experienced an $87.8 million, or 43.1%, increase in ATM operating revenues over the same period in 2007. The majority of this increase was attributable to the traditional ATM operations acquired in the 7-Eleven ATM Transaction. Specifically, our results included $42.8 million of incremental surcharge revenue, $30.0 million of incremental interchange revenue, and $7.7 million of incremental branding and surcharge-free network revenue generated by the acquired operations during 2008 as a result of the inclusion of these operations in our results for the full nine months of 2008 compared to only 70 days in 2007. Also contributing to the increase in ATM operating revenues were the additional branding and surcharge-free network agreements entered into during late 2007 and 2008, which resulted in $11.7 million in incremental bank branding and surcharge-free network fees from our pre-existing domestic operations and $3.5 million of incremental interchange revenues from our pre-existing Company-owned domestic operations in 2008 when compared to 2007.
The overall increase in ATM operating revenues described above was partially offset by lower surcharge and interchange revenues associated with our domestic merchant-owned operations. As a result of declines in the average number of transacting ATMs, surcharge revenues and interchange revenues generated by our merchant-owned base were $6.1 million and $1.1 million, respectively, less during the first nine months of 2008 than during the same period in 2007. These declines were primarily a result of the decline in the average number of transacting merchant-owned ATMs in the United States. Additionally, surcharge revenues from our Company-owned base slightly declined during the first nine months of 2008, primarily as a result of a shift in revenues from surcharge-based fees to surcharge-free branding and network fees due to the additional branding and surcharge-free network arrangements entered into with financial institutions during 2007.
United Kingdom. Our United Kingdom operations further contributed to the higher ATM operating revenues during the nine months ended September 30, 2008, as surcharge revenues and interchange revenues increased by 11.0% and 85.6%, respectively, over the same period in 2007 due to the additional ATM deployments that occurred during 2007 and 2008. Specifically, the average number of transacting ATMs in the United Kingdom increased from 1,602 ATMs during the first nine months of 2007 to 2,389 ATMs during the first nine months of 2008 due to additional deployments. Additionally, the higher number of free-to-use ATMs also contributed to the increase in the amount of interchange revenues earned during 2008. However, the increase in revenues was lower than originally anticipated due to lower than expected surcharge transaction levels during 2008, which we believe are primarily due to the service-related issues associated with one of our third-party armored cash providers that resulted in a higher percentage of downtime at our ATMs. Although we have seen a slight reduction in the number of cash outages during the month of October 2008 from the average of the prior six months, it is likely that these issues will continue to somewhat negatively impact the operating results of our United Kingdom operations until such time as the service provider achieves acceptable service levels or we complete the establishment of our own in-house armored courier operation, which we expect will formally commence operations in the fourth quarter of 2008. In addition to the service issues that we have experienced in 2008 with respect to our third-party armored cash provider, we believe that the lower than expected surcharge transaction levels can also be attributed, in part, to (1) increased competition resulting from a higher number of free-to-use ATMs in the United Kingdom during 2008, (2) additional fee signage required for pay-to-use ATMs, and (3) changes in consumer behavior resulting from a smoking ban that was implemented in the United Kingdom in 2007.

 

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Mexico . Our Mexico operations further contributed to the increase in ATM operating revenues during the nine months ended September 30, 2008 as a result of the deployment of additional ATMs during 2007 and 2008. Specifically, the average number of transacting ATMs associated with these operations increased from 644 during the first nine months of 2007 to 1,645 during the first nine months of 2008.
Vcom operating revenues. The Vcom operating revenues generated during 2008 and 2007 were primarily comprised of check cashing fees. The increase over prior year is primarily result of the inclusion of the result of the acquired operations for the full nine months versus only 70 days during 2007. As we have now completed our Vcom kiosk relocation project and have implemented image deposit functionality on the Vcom kiosks for two financial institutions, with a third expected to be implemented in the first quarter of 2009, we expect to see an increase in the number of advanced-functionality transactions being conducted on those machines.
ATM product sales and other revenues. ATM product sales and other revenues for the nine months ended September 30, 2008 were higher than those generated during the same period in 2007 due to higher VAR program sales, which resulted from the additions of two new Associate VARs during the third quarter of 2007 and one new Associate VAR during the first quarter of 2008.
Cost of Revenues
                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     % Change     2008     2007     % Change  
    (In thousands)           (In thousands)        
Cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization)
  $ 91,434     $ 79,966       14.3 %   $ 270,128     $ 191,046       41.4 %
Cost of Vcom operating revenues
    1,469       2,644       (44.4 )%     5,477       2,644       107.1 %
Cost of ATM product sales and other revenues
    4,064       3,111       30.6 %     11,890       9,196       29.3 %
 
                                       
Total cost of revenues (exclusive of depreciation, accretion, and amortization)
  $ 96,967     $ 85,721       13.1 %   $ 287,495     $ 202,886       41.7 %
 
                                       
Three Months Ended September 30, 2008 Compared to Three Months Ended September 30, 2007
Cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization). The cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization) incurred during the three months ended September 30, 2008 increased $11.5 million over the same period in 2007. Below is a detail, by geographic segment, of changes in the various components of the cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization):
                                 
    Variance: Three Months Ended September 30, 2008  
    to Three Months Ended September 30, 2007  
    U.S.     U.K.     Mexico     Total  
    Increase (decrease)  
    (In thousands)  
Merchant commissions
  $ 1,224     $ 2,045     $ 618     $ 3,887  
Cost of cash
    1,490       1,107       684       3,281  
Repairs and maintenance
    1,549       406       202       2,157  
Direct operations
    543       160       153       856  
Communications
    450       120       146       716  
Charges related to EMV certification
          (179 )           (179 )
Processing and other expenses
    24       396       330       750  
 
                       
Total increase in cost of ATM operating revenues
  $ 5,280     $ 4,055     $ 2,133     $ 11,468  
 
                       

 

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United States . During the three months ended September 30, 2008, the cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization) incurred by our United States operations increased $5.3 million over the cost incurred during the same period in 2007. This increase was primarily the result of the 7-Eleven ATM Transaction, as the ATM operations of the acquired 7-Eleven Financial Services Business incurred $2.5 million of incremental merchant fees, $0.9 million of higher maintenance and repairs expense, $0.7 million of incremental cost of cash, $0.3 million of incremental communications expense, and $0.7 million of incremental processing and other expenses during the three months ended September 30, 2008 compared to the same period in 2007. These increases were primarily the result of the inclusion of the acquired operations in our results for the full third quarter of 2008 versus only 70 days during the third quarter of 2007. Our pre-existing United States operations also contributed to the higher cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization), incurring (1) $0.8 million of higher costs of cash, primarily due to higher armored courier costs as a result of the increase in the number of Company-owned machines; (2) $0.8 million of additional costs directly allocable to our pre-existing domestic operations, primarily as a result of our decision to hire additional personnel during 2007 to focus on our strategic initiatives at that time; and (3) $0.6 million of higher maintenance costs. Partially offsetting these increases in costs were merchant fees associated with our pre-existing domestic operations, which decreased $1.3 million when compared to the same period in 2007, primarily due to the year-over-year decline in the number of domestic merchant-owned ATMs, as discussed above, and the related surcharge revenues, and lower processing and other costs, which decreased $0.7 million as a result of the conversion of a higher number of our ATMs over to our in-house EFT processing platform.
United Kingdom . During the three months ended September 30, 2008, our United Kingdom operations contributed to the increase in the cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization) with those costs increasing $4.1 million over the same period in 2007. These increases were primarily due to higher merchant commissions and costs of cash, which resulted from the increased number of ATMs operating in the United Kingdom during the third quarter of 2008 compared to the same period in 2007. With respect to merchant commissions, although we saw a decline in surcharge revenues, as discussed above, we did not see a corresponding decline in merchant fees due to the fact that certain merchant contracts contain fixed yearly rentals. As a result, surcharge revenues in certain of these merchant locations declined without a similar decline in the related merchant fees. Additionally, due to the third-party armored cash service-related issues discussed above, we maintained higher cash balances in our ATMs within the United Kingdom during the third quarter of 2008 in an effort to minimize the amount of downtime caused by the service disruptions, thus contributing to the overall year-over-year increase in our cost of cash amounts. Finally, contributing to the increase were the costs incurred related to the establishment of our own in-house armored courier operation, which we expect will formally commence operations in the fourth quarter of 2008. This operation will initially service the cash needs of approximately 300 of our ATMs located throughout the London metropolitan area. While this operation is not expected to provide significant initial cost savings, we do anticipate that it will alleviate some of the third-party armored cash service-related issues discussed above.
Mexico . Our Mexico operations contributed to the increase in the cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization) as a result of the increase in the average number of transacting ATMs associated with our Mexico operations and the increased number of transactions conducted on our machines during the third quarter of 2008 compared to the third quarter of 2007.
Cost of Vcom operating revenues. The cost of Vcom operating revenues incurred during the third quarter of 2008 was primarily related to communication expense, maintenance costs, and costs of cash related to the provision of the Vcom Services. The decrease in the cost of Vcom operating revenues during the third quarter of 2008 compared to the same quarter of 2007 was primarily the result of certain cost-reduction efforts that we completed in late 2007, primarily through a combination of contract renegotiations and by bringing a number of previously-outsourced functions in-house.
Cost of ATM product sales and other revenues. Consistent with the increase in “ — ATM product sales and other revenues” discussed above, the cost of ATM product sales and other revenues increased during the three months ended September 30, 2008 compared to the same period in 2007 due to a higher number of Associate VARs, which resulted in higher VAR program sales during the three months ended September 30, 2008 compared to the same period in 2007.

 

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Nine Months Ended September 30, 2008 Compared to Nine Months Ended September 30, 2007
Cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization). The cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization) incurred during the nine months ended September 30, 2008 increased $79.1 million over the same period in 2007. Below is a detail, by geographic segment, of changes in the various components of the cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization):
                                 
    Variance: Nine Months Ended September 30, 2008  
    to Nine Months Ended September 30, 2007  
    U.S.     U.K.     Mexico     Total  
    (In thousands)  
Merchant commissions
  $ 24,195     $ 6,327     $ 1,732     $ 32,254  
Cost of cash
    16,076       5,201       1,594       22,871  
Repairs and maintenance
    8,703       508       534       9,745  
Direct operations
    4,301       737       408       5,446  
Communications
    2,987       828       298       4,113  
Charges related to EMV certification
          793             793  
Processing and other expenses
    1,765       1,259       836       3,860  
 
                       
Total increase in cost of ATM operating revenues
  $ 58,027     $ 15,653     $ 5,402     $ 79,082  
 
                       
United States . During the nine months ended September 30, 2008, the cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization) incurred by our United States operations increased $58.0 million over the cost incurred during the same period in 2007. This increase was primarily the result of the 7-Eleven ATM Transaction, as the ATM operations of the acquired 7-Eleven Financial Services Business incurred $57.0 million of incremental expenses during the first nine months of 2008, including $29.0 million of merchant fees, $14.0 million in costs of cash, $7.0 million of repairs and maintenance costs, $2.6 million in communication costs, and $4.0 million of processing and other fees. The $57.0 million of incremental expenses generated by the ATM operations of the acquired 7-Eleven Financial Services Business is net of $6.1 million of amortization expense related to the liabilities we recorded in connection with the acquisition to value certain unfavorable operating leases and an operating contract assumed as a part of the 7-Eleven ATM Transaction.
Our pre-existing United States operations also contributed to the higher cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization), including (1) $4.0 million of additional costs directly allocable to our pre-existing domestic operations, primarily as a result of our decision to hire additional personnel during 2007 to focus on our strategic initiatives at that time; (2) $2.1 million of higher costs of cash due to higher armored courier costs as a result of the increase in the number of Company-owned machines; and (3) $1.7 million of higher maintenance costs. Offsetting these increases in costs was a $4.8 million reduction in merchant fees associated with our pre-existing domestic operations, comprised of a $5.7 million decrease attributable to the year-over-year decline in the number of domestic merchant-owned ATMs and the related surcharge revenues that was partially offset by a $0.9 million increase in merchant fees associated with the increased number of ATMs under domestic Company-owned arrangements. Also offsetting these increases was a $2.2 million decrease in processing and other costs as a result of the conversion of a higher number of our ATMs over to our in-house EFT processing platform.
United Kingdom . During the nine months ended September 30, 2008, our United Kingdom operations contributed to the increase in the cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization) with those costs increasing $15.7 million over the same period in 2007. These increases were primarily due to higher merchant commissions and higher costs of cash, which resulted from the increased number of ATMs operating in the United Kingdom during 2008 compared to 2007, as well as the other factors described above for the three month period year-over-year increase. Also contributing to the higher costs of cash was our maintaining higher cash balances in our ATMs within the United Kingdom during the 2008 in an effort to control the amount of downtime caused by service disruptions caused by the merger-related issues of one of our service providers.

 

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Additionally, we incurred $1.2 million of charges associated with transactions conducted with counterfeit cards that resulted from a delay in our Europay MasterCard Visa (“EMV”) certification process. During the nine months ended September 30, 2007, we incurred a similar charge in the amount of $0.4 million. In the United Kingdom, the major international networks require ATM operators and merchant acquirers be certified under the EMV security standard. The EMV security standard provides for the security and processing of information contained on microchips imbedded in certain debit and credit cards, known as “smart cards.” All of our ATMs in the United Kingdom are EMV compliant, and through the second quarter of this year, we had successfully certified our machines and network for EMV compliance with Link, the dominant network in the United Kingdom through whom we clear over 95% of our transactions, as well as one of the other two major international networks. However, during the second quarter of 2008, we experienced a significant increase in transactions conducted on our United Kingdom ATMs with counterfeit credit cards containing the brand of the network with whom we had not yet achieved EMV certification. Because we had not yet completed our EMV certification with this network at that time, we are liable for the resulting claims, which we now estimate to be $1.2 million. However, during the third quarter of 2008, we successfully achieved EMV certification with this particular network, and thus, we do not expect to incur additional charges related to this issue in the future.
Mexico . Our Mexico operations contributed to the increase in the cost of ATM operating revenues (exclusive of depreciation, accretion, and amortization) as a result of the increase in the average number of transacting ATMs associated with our Mexico operations and the increased number of transactions conducted on our machines during 2008 compared to 2007.
Cost of Vcom operating revenues. The cost of Vcom operating revenues increased during the nine month period ended September 30, 2008 as a result of the inclusion of the operations in our results for the full year. Expenses incurred during 2008 were primarily related to the direct marketing expenses to increase awareness of the Vcom Services, costs of cash, communication expense, and maintenance costs related to the Vcom Services.
Cost of ATM product sales and other revenues. The cost of ATM product sales and other revenues increased by $2.7 million during the nine months ended September 30, 2008 compared to the same period in 2007. This 29.3% increase is comparable to the 33.0% increase in ATM product sales and other revenues during the period, the majority of which was attributable to the higher number of Associate VARs, which resulted in higher VAR program sales during the first nine months of 2008 compared to the same period in 2007.
Gross Profit Margin
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2008     2007     2008     2007  
ATM operating gross profit margin:
                               
Exclusive of depreciation, accretion, and amortization
    24.6 %     24.7 %     24.5 %     24.1 %
Inclusive of depreciation, accretion, and amortization
    13.5 %     10.0 %     13.6 %     11.7 %
Vcom operating gross profit margin
    (3.7 )%     (286.0 )%     (36.4 )%     (286.0 )%
ATM product sales and other revenues gross profit margin
    12.6 %     15.2 %     8.8 %     6.2 %
Total gross profit margin:
                               
Exclusive of depreciation, accretion, and amortization
    23.8 %     22.5 %     23.3 %     22.7 %
Inclusive of depreciation, accretion, and amortization
    13.3 %     8.3 %     12.9 %     10.7 %
ATM operating gross profit margin . For the three months ended September 30, 2008, ATM operating gross profit margin exclusive of depreciation, accretion, and amortization was essentially flat when compared to the same period in 2007 as higher margins earned by our United States operations were partially offset by lower margins earned by our United Kingdom operations (further discussed below). However, our ATM operating gross margin exclusive of depreciation, accretion, and amortization increased 0.4% during the nine months ended September 30, 2008 and operating margins inclusive of depreciation, accretion, and amortization increased 3.5% and 1.9% during the three and nine month periods ended September 30, 2008, respectively. These increases were primarily due to our pre-existing domestic operations, which generated significantly higher margins during 2008 due to higher bank branding and our surcharge-free network offerings. Partially offsetting the positive impact from our domestic operations were our United Kingdom operations, which experienced reduced gross margins resulting from lower than anticipated surcharge transactions without a corresponding decline in merchant fees, as well as higher costs of cash resulting from the previously discussed third-party armored cash service related issues. However, we expect the service-related issues to diminish during the fourth quarter of 2008 as we begin to implement our own in-house armored courier operation. Finally, with respect to the merchant fee issue described above, we are currently in the process of deinstalling underperforming or unprofitable ATMs or, absent that, working with the related merchants to restructure the underlying merchant fee payment terms. While these efforts are expected to result in improved operating margins in the United Kingdom, improvements are not likely to materialize until 2009.

 

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ATM product sales and other revenues gross profit margin. For the three months ended September 30, 2008, our ATM product sales and other revenues gross profit margin decreased by 2.6%, primarily as a result of lower margins achieved on equipment sales during the quarter. For the nine months ended September 30, 2008, ATM product sales and other revenues gross profit margin increased by 2.6%, primarily as a result of the completion of our Triple-DES upgrade efforts. Because all ATMs operating on the domestic EFT networks were required to be Triple-DES compliant by the end of 2007 and early 2008, we saw an increase during 2007 in the number of ATM sales associated with the Triple-DES upgrade process. However, in certain circumstances, we sold the machines at little or, in some cases, negative margins in exchange for renewals of the underlying ATM operating agreements. As a result, gross margins associated with our ATM product sales and other activities were negatively impacted during 2007 and the early part of 2008. However, we expect those margins to stabilize now that the Triple-DES compliance upgrade process has been completed.
Vcom operating gross profit margin . Our Vcom operations generated negative gross profit margins during the three and nine months ended September 30, 2008. For the three months ended September 30, 2008, the negative margin was primarily attributable to the increased direct marketing expenses incurred during the period to increase awareness of the Vcom Services. For the nine months ended September 30, 2008, the negative margin was partially attributable to the increased direct marketing expenses and the fact that the number of transactions conducted on the machines had not yet reached the level necessary to cover the fixed costs associated with operating the Vcom machines. However, as we did in the second and third quarters of 2008, we expect to see continued improvements in the performance of our advanced-functionality operations and expect these operations to achieve breakeven results in the near future.
Selling, General, and Administrative Expenses
                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     % Change     2008     2007     % Change  
    (In thousands)             (In thousands)          
Selling, general, and administrative expenses, excluding stock-based compensation
  $ 9,258     $ 7,324       26.4 %   $ 26,995     $ 20,264       33.2 %
Stock-based compensation
    1,129       297       280.1 %     1,743       721       141.7 %
 
                                       
Total selling, general, and administrative expenses
  $ 10,387     $ 7,621       36.3 %   $ 28,738     $ 20,985       36.9 %
 
                                       
 
                                               
Percentage of total revenues:
                                               
Selling, general, and administrative expenses, excluding stock-based compensation
    7.3 %     6.6 %             7.2 %     7.7 %        
Stock-based compensation
    0.9 %     0.3 %             0.5 %     0.3 %        
Total selling, general, and administrative expenses
    8.2 %     6.9 %             7.7 %     8.0 %        
Selling, general, and administrative expenses (“SG&A expenses”), excluding stock-based compensation. For the three and nine months ended September 30, 2008, SG&A expenses, excluding stock-based compensation, increased $1.9 million and $6.7 million, respectively, over the same periods in 2007. These increases were primarily attributable to our United States operations, which experienced an increase in SG&A expenses of $1.9 million, or 32.7%, during the third quarter of 2008 and $6.3 million, or 39.2%, during the nine months ended September 30, 2008. The majority of these increases were attributable to incremental employee-related costs totaling $0.4 million and $3.2 million during the three and nine month periods ended 2008, respectively. The costs were primarily associated with the sales and marketing side of our business and the employees assumed in connection with the 7-Eleven ATM Transaction. Also contributing to the increase during the three and nine months ended September 30, 2008 were $0.5 million and $1.5 million, respectively, of incremental costs associated with accounting and professional services, the majority of which were associated with our Sarbanes-Oxley compliance efforts, and $0.4 million and $0.6 million, respectively, of acquisition costs that we wrote-off as a result of our decision not to pursue selected international acquisitions.

 

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Stock-based compensation. The increase in stock-based compensation during the three and nine months ended September 30, 2008 was due to the issuance of additional shares of restricted stock and stock options during the second and third quarters of 2008. For additional details on these stock and option grants, see Note 3 to our consolidated financial statements.
Based on the headcount and other cost reduction efforts that we began implementing during the fourth quarter of 2008, we expect that our SG&A costs, as a percentage of our total revenues, will decline slightly beginning in 2009.
Depreciation and Accretion Expense
                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     % Change     2008     2007     % Change  
    (In thousands)             (In thousands)          
Depreciation expense
  $ 9,641     $ 6,600       46.1 %   $ 27,936     $ 17,710       57.7 %
Accretion expense
    407       361       12.7 %     1,233       831       48.4 %
 
                                       
Depreciation and accretion expense
  $ 10,048     $ 6,961       44.3 %   $ 29,169     $ 18,541       57.3 %
 
                                       
 
                                               
Percentage of total revenues:
                                               
Depreciation expense
    7.6 %     6.0 %             7.5 %     6.8 %        
Accretion expense
    0.3 %     0.3 %             0.3 %     0.3 %        
Total depreciation and accretion expense
    7.9 %     6.3 %             7.8 %     7.1 %        
Depreciation expense. The increase in depreciation expense during the three and nine month periods ended September 30, 2008 was primarily due to the higher number of machines deployed under Company-owned arrangements compared to 2007. Specifically, our international operations recognized $1.4 million and $4.6 million of additional depreciation during the three and nine months ended September 30, 2008, respectively. Additionally, our pre-existing domestic operations recognized $1.0 million and $1.7 million of higher depreciation during same periods, respectively. Also contributing to the increase was the inclusion of the operations acquired in the 7-Eleven ATM Transaction for a full year in 2008 versus only 70 days in 2007, which resulted in the recognition of $0.6 million and $3.9 million of incremental depreciation during the three and nine month periods ended September 30, 2008, respectively.
Accretion expense. We account for our asset retirement obligations in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 143, Accounting for Asset Retirement Obligations , which requires that we estimate the fair value of future retirement obligations associated with our ATMs, including the anticipated costs to deinstall, and in some cases refurbish, certain merchant locations. Accretion expense represents the increase of this liability from the original discounted net present value to the amount we ultimately expect to incur. The increase in accretion expense during the three and nine months ended September 30, 2008 was primarily attributable to the 7-Eleven ATM Transaction.
In the future, we expect that our depreciation and accretion expense will continue to grow in proportion to the increase in the number of ATMs we own and deploy throughout our Company-owned portfolio.
Amortization Expense
                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     % Change     2008     2007     % Change  
    (In thousands)             (In thousands)          
Amortization expense
  $ 4,657     $ 9,204       (49.4 )%   $ 13,661     $ 14,062       (2.9 )%
Percentage of total revenues
    3.7 %     8.3 %             3.6 %     5.4 %        
Amortization expense, which is primarily comprised of amortization of intangible merchant and branding contracts/relationships associated with our past acquisitions, decreased by 49.4% and 2.9% when compared to the three and nine month periods ended September 30, 2007, respectively. The higher amortization expense recognized in 2007 was primarily the result of a $5.1 million impairment charge recorded during the three months ended September 30, 2007 to write-off of the remaining unamortized intangible asset value associated with a single merchant contract acquired in 2004. This $5.1 million decline from 2007 to 2008 was partially offset by higher amortization recorded in 2008 associated with the intangible assets recorded in conjunction with the 7-Eleven ATM Transaction. Specifically, during the three and nine month periods ended September 30, 2008, we recognized incremental amortization of $0.4 million and $4.5 million, respectively, related to these assets, as the 7-Eleven ATM Transaction occurred on July 20, 2007 and, therefore, 2007 only included 70 days worth of amortization.

 

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As a result of the recent economic uncertainties and corresponding decline in our stock price, we continue to closely monitor and assess the recoverability of our goodwill and other intangible asset amounts. In particular, we are closely monitoring our United Kingdom operations as a result of the issues encountered by those operations during 2008. Although we currently believe that the majority of the issues being experienced by our United Kingdom operations are temporary in nature, further clarification on whether these issues are temporary or not should occur during the fourth quarter once we complete our analysis of the issues, including finalizing our 2009 detailed budget. In the event our fourth quarter results and future projections indicate that recoverability issues exist with respect to any of our intangible assets, including our goodwill balances, we may be required to record an impairment charge in our financial statements, the effect of which could be material.
Interest Expense, Net
                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     % Change     2008     2007     % Change  
    (In thousands)           (In thousands)        
Interest expense, net
  $ 7,913     $ 8,545       (7.4 )%   $ 23,267     $ 20,437       13.8 %
Amortization of deferred financing costs and bond discounts
    531       439       21.0 %     1,569       1,155       35.8 %
 
                                       
Total interest expense, net
  $ 8,444     $ 8,984       (6.0 )%   $ 24,836     $ 21,592       15.0 %
 
                                       
 
                                               
Percentage of total revenues
    6.6 %     8.1 %             6.6 %     8.2 %        
Interest expense, net. Interest expense, excluding the amortization of deferred financing costs and bond discounts, decreased by 7.4% during the three month period ended September 30, 2008 when compared to the same period in 2007. The decrease was primarily the result of lower average outstanding balances under our revolving credit facility during 2008 compared to 2007 and an overall decrease in floating interest rates under our revolving credit facility in 2008 compared to 2007.
The 13.8% increase in interest expense during the nine months ended September 30, 2008 was primarily due to our issuance of $100.0 million in Series B Notes in July 2007 to partially finance the 7-Eleven ATM Transaction. This issuance resulted in $6.9 million of additional interest expense during the nine month period ended September 30, 2008, excluding the amortization of the related discount and deferred financing costs. Partially offsetting the incremental interest associated with our Series B Notes were the lower average outstanding balances under our revolving credit facility and the overall decrease in floating interest rates under our revolving credit facility during 2008 compared to 2007.
Amortization of deferred financing costs and bond discounts. The increase in the amortization of deferred financing costs and bond discounts during the three and nine month periods ended 2008 was a result of the additional financing costs incurred in connection with the issuance of the Series B Notes in July 2007 and amendments made to our revolving credit facility in March 2008 to increase the amount of capital expenditures that we can incur on a rolling 12-month basis and in May 2007 to modify the interest rate spreads on outstanding borrowings and other pricing terms and in July 2007 as part of the 7-Eleven ATM Transaction.

 

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Other Expense (Income)
                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     % Change     2008     2007     % Change  
    (In thousands)             (In thousands)          
Minority interest
  $ (814 )   $ (174 )     367.8 %   $ (814 )   $ (286 )     184.6 %
Other expense
    1,274       678       87.9 %     3,377       1,037       225.7 %
 
                                       
Total other expense
  $ 460     $ 504       (8.7 )%   $ 2,563     $ 751       241.3 %
 
                                       
 
                                               
Percentage of total revenues
    0.4 %     0.5 %             0.7 %     0.3 %        
Minority interest. During the three months ended September 30, 2008, we and the minority interest stockholders of Cardtronics Mexico made additional capital contributions to the Cardtronics Mexico. Prior to such time, the portion of Cardtronics Mexico’s cumulative losses allocable to the minority interest stockholders exceeded the stockholders’ underlying equity amounts. As a result, we, as the entity that consolidates Cardtronics Mexico, were being allocated 100% of the losses generated by Cardtronics Mexico and would have continued to have done so until such time as Cardtronics Mexico generated a cumulative amount of earnings sufficient to cover all excess losses allocable to us or the minority interest stockholders contributed additional equity in an amount sufficient to cover the losses. As a result of the contributions made in September 2008, we have now been made whole for the third parties’ losses that we had previously absorbed. Of the $1.7 million contributed by the minority interest stockholders, we recognized $0.8 million as Minority interest income in our Consolidated Statements of Operations for the three month period ended September 30, 2008, which represents the losses previously absorbed on their behalf.
Other expense. The increase in total other expense for the three and nine month periods ended September 30, 2008 and 2007 was due to losses on the disposal of fixed assets that were incurred in conjunction with the deinstallation of ATMs during the periods. For the nine month period ended September 30, 2007, these losses were partially offset by $0.6 million of gains on the sale of the equity securities awarded to us in 2006 pursuant to the bankruptcy plan of reorganization for Winn-Dixie Stores, Inc., one of our merchant customers, and minority interest income, which represents the portion of Cardtronics Mexico’s losses allocable to the minority interest stockholders.
Income Tax Expense (Benefit)
                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     % Change     2008     2007     % Change  
    (In thousands)             (In thousands)          
Income tax expense
  $ 469     $ 2,275       (79.4 )%   $ 494     $ 3,212       (84.6 )%
Effective tax rate
    (12.7 )%     (27.1 )%             (4.2 )%     (19.5 )%        
Our income tax expense decreased by 79.4% and 84.6% during the three and nine month periods ended September 30, 2008, respectively, when compared to the same periods in 2007. These decreases were primarily driven by valuation allowances established for our domestic operations, which resulted in the negative overall effective tax rates reflected in the table above. During the three and nine months ended September 30, 2007, we recorded valuation allowances for our domestic operations totaling $2.5 million and $3.4 million, respectively. Due to the exclusion of certain deferred tax liability amounts from our ongoing analysis of our domestic net deferred tax asset position, we have continued to record additional valuation allowances for our domestic operations during 2008; however, the additional valuation allowances recorded during the three and nine month periods ended September 30, 2008, which totaled approximately $0.9 million and $2.8 million, respectively, were lower than the amounts recorded for the three and nine month periods ended September 30, 2007.
In addition to the above, we recorded a contingent tax liability totaling $0.4 million during the three month period ended September 30, 2008 related to our United Kingdom operations, further contributing to the overall negative effective tax rates reflected above. Additionally, we recorded a $0.2 million deferred tax benefit during the three month period ended September 30, 2007 related to a reduction in the United Kingdom corporate statutory income tax rate from 30% to 28%. The rate reduction, which became effective during the second quarter of 2008, was formally enacted in July 2007.

 

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We are currently not recording any valuation allowances related to the deferred tax assets associated with our United Kingdom operations as we currently believe it is more likely than not that we will have sufficient taxable income in future periods, including the reversal of existing deferred tax liabilities, to utilize those assets. However, our United Kingdom operations have generated significant pre-tax book losses during the nine months ended September 30, 2008. If the losses continue through the remainder of 2008 and into 2009, we may be required to establish a valuation allowance for a portion, if not all, of any net deferred tax asset balance associated with the operations.
Liquidity and Capital Resources
Overview
As of September 30, 2008, we had $1.2 million in cash and cash equivalents on hand and $344.7 million in outstanding long-term debt and capital lease obligations.
Prior to December 2007, we had historically funded our operations primarily through cash flows from operations, borrowings under our credit facilities, private placements of equity securities, and the sale of notes. However, in December 2007, we completed our initial public offering of 12,000,000 shares of our common stock. Furthermore, we have historically used cash to invest in additional operating ATMs, either through the acquisition of ATM networks or through organically generated growth. We have also used cash to fund increases in working capital and to pay interest and principal amounts outstanding under our borrowings. Because we collect a sizable portion of our cash from sales on a daily basis but pay our vendors on 30 day terms and are not required to pay certain of our merchants until 20 days after the end of each calendar month, we are able to utilize the excess upfront cash flow to pay down borrowings made under our revolving credit facility and to fund our ongoing capital expenditure program. Accordingly, we will typically reflect a working capital deficit position and carry a small cash balance on our books.
We believe that our cash on hand and our current bank credit facilities will be sufficient to meet our working capital requirements and contractual commitments for the next 12 months. As a result of the anticipated reduction of capital expenditures in 2009, as discussed in more detail below, we expect to fund our working capital needs with cash flows generated from our operations and, to the extent needed, borrowings under our revolving credit facility.
Operating Activities
Net cash provided by operating activities totaled $11.8 million for the nine months ended September 30, 2008 compared to $35.5 million during the same period in 2007. The year-over-year decrease was primarily attributable to changes in working capital, including the $9.9 million incremental interest payment in February and August 2008 related to our Series B Notes, which were issued in July 2007.
Investing Activities
Net cash used in investing activities totaled $54.8 million for the nine months ended September 30, 2008 compared to $179.5 million for the same period in 2007. The year-over-year decrease was driven by our acquisition of the ATM and advanced-functionality self-service kiosk business of 7-Eleven in July 2007, which was partially offset by the $4.0 million in proceeds from the sale of our Winn-Dixie equity securities in January 2007 and $0.9 million of proceeds out of an escrow account associated with a previous acquisition received during 2007.
Anticipated Future Capital Expenditures. We currently anticipate that the majority of our capital expenditures for the foreseeable future will be driven by organic growth projects, including the purchasing of ATMs for existing as well as new ATM management agreements, as opposed to acquisitions. However, we may continue to pursue selected acquisition opportunities that complement our existing ATM network, some of which could be material.
We currently expect that our capital expenditures for the remaining three months of 2008 will total approximately $6.0 million, net of minority interest, the majority of which will be utilized to purchase additional ATMs for our Company-owned accounts. We expect these expenditures to be funded with cash generated from our operations, supplemented by borrowings under our revolving credit facility. However, looking ahead to 2009, we expect that our capital expenditures, excluding any potential acquisition opportunities, will be substantially lower than the levels incurred during 2007 and 2008 as we look to increase the level of returns required for the allocation of capital funds.

 

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As a result of the 7-Eleven ATM Transaction, we assumed responsibility for certain ATM operating lease contracts that will expire at various times during the next three years, the majority of which will expire in 2009. Accordingly, at that time, we will be required to renew the lease contracts, enter into new lease contracts or purchase new or used ATMs to replace the leased equipment. If we decide to purchase new ATMs and terminate the existing lease contracts at that time, we currently anticipate that we will incur between $13.0 and $16.0 million in related capital expenditures. However, in the event we decide to purchase the leased equipment at the end of the lease term rather than purchasing new ATMs, our expenditures would be substantially less than the above-estimated amounts. Additionally, as of September 30, 2008, we had $6.1 million in letters of credit posted under our revolving credit facility in favor of the lessors under these leases. These letters of credit will expire at the end of the lease terms. See Note 8 to our consolidated financial statements for additional details on these letters of credit.
Financing Activities
Net cash provided by financing activities totaled $31.1 million for the nine months ended September 30, 2008 compared to $147.3 million for the same period in 2007. The year-over-year decrease was primarily due to our issuance of our $100.0 million of Series B Notes and the incremental borrowings under our revolving credit facility to fund the 7-Eleven ATM Transaction during 2007. Although the amount outstanding under our revolving credit facility may fluctuate over the course of the year, we expect that the overall level of our senior debt, absent any acquisitions or unanticipated changes in our working capital and capital expenditure levels, will trend downward over the remainder of the year. Furthermore, because of the anticipated reduction in our level of capital expenditures in 2009, as discussed above, we expect to generate higher net cash flows sufficient to pay off a significant amount of the outstanding borrowings under our revolving credit facility during 2009.
Financing Facilities
As of September 30, 2008, we had $344.7 million in outstanding long-term debt and capital lease obligations, which was comprised of (1) $296.5 million (net of discount of $3.5 million) of our Series A Notes and Series B Notes, (2) $39.1 million in borrowings under our revolving credit facility, (3) $7.9 million in notes payable outstanding under equipment financing lines of our Mexico subsidiary, and (4) $1.2 million in capital lease obligations.
Revolving Credit Facility. Borrowings under our revolving credit facility bear interest at a variable rate based upon the London Interbank Offered Rate (“LIBOR”), or prime rate, at our option. Additionally, we pay a commitment fee of 0.25% per annum on the unused portion of the revolving credit facility. Substantially all of our assets, including the stock of our wholly-owned domestic subsidiaries and 66% of the stock of our foreign subsidiaries, are pledged to secure borrowings made under the revolving credit facility. Furthermore, each of our domestic subsidiaries has guaranteed our obligations under the facility. There are currently no restrictions on the ability of our wholly-owned subsidiaries to declare and pay dividends directly to us.
In March 2008, we amended the facility so that we may incur up to $90.0 million in capital expenditures on a rolling 12-month basis. As a result of this amendment, the primary restrictive covenants within the facility include (1) limitations on the amount of senior debt that we can have outstanding at any given point in time, (2) the maintenance of a set ratio of earnings to fixed charges, as computed on a rolling 12-month basis, (3) limitations on the amounts of restricted payments that can be made in any given year, and (4) limitations on the amount of capital expenditures that we can incur on a rolling 12-month basis. Additionally, we are currently prohibited from making any cash dividends pursuant to the terms of the facility.
As of September 30, 2008, we were in compliance with all covenants contained within the facility and had the ability to borrow an additional $129.8 million under the facility.

 

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Bank Machine Overdraft Facility. In addition to our revolving credit facility, our United Kingdom operation has a £2.0 million unsecured overdraft facility. The facility, which bears interest at 1.75% over the bank’s base rate (currently 3.0%), is utilized for general corporate purposes for our United Kingdom operations. As of September 30, 2008, approximately £0.5 million (or $0.9 million) of this overdraft facility had been utilized to help fund certain working capital commitments. This amount has been reflected in accounts payable in our Consolidated Balance Sheet, as the amount is automatically repaid once cash deposits are made to the underlying bank accounts.
Cardtronics Mexico Equipment Financing Agreements. During 2006 and 2007, Cardtronics Mexico entered into six separate five-year equipment financing agreements with a single lender. The agreements, which are denominated in Mexican pesos and bear interest at an average fixed rate of 10.96%, were utilized for the purchase of additional ATMs to support our Mexico operations. As of September 30, 2008, $86.5 million pesos ($7.9 million U.S.) were outstanding under the agreements in place at the time, with future borrowings to be individually negotiated between the lender and us. Pursuant to the terms of the loan agreements, we have issued a guaranty for 51.0% of the obligations (consistent with our ownership percentage in Cardtronics Mexico.) As of September 30 2008, the total amount of the guaranty was $44.1 million pesos ($4.0 million U.S.).
Lease Agreements. In connection with the 7-Eleven ATM Transaction, we assumed certain capital and operating lease obligations for approximately 2,000 ATMs. As of September 30, 2008, we had $6.1 million in letters of credit posted under our revolving credit facility in favor of the lessors under these assumed equipment leases. These letters of credit reduce the available borrowing capacity under our revolving credit facility. As of September 30, 2008, the principal balance of our capital lease obligations totaled $1.2 million.
New Accounting Standards
For a description of the accounting standards that we have adopted during 2008, as well as details of the accounting standards that have been issued but not yet adopted by us, see Part I. Financial Information, Notes to Consolidated Financial Statements, Note 15 .

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
Vault cash rental expense. Because our ATM cash rental expense is based on market rates of interest, it is sensitive to changes in the general level of interest rates in the United States, the United Kingdom, and Mexico. In the United States, we pay a monthly fee on the average amount of vault cash outstanding under a formula based either on LIBOR or the federal funds effective rate, depending on the vault cash provider. In the United Kingdom, we pay a monthly fee to ALCB in the United Kingdom under a formula based on LIBOR. In Mexico, we pay a monthly fee to our vault cash provider there under a formula based on the Mexican Interbank Rate.
As a result of the significant sensitivity surrounding the vault cash interest expense for our United States operations, we have entered into a number of interest rate swaps to fix the rate of interest we pay on a portion of our current and anticipated outstanding domestic vault cash balances. The swaps in place as of September 30, 2008 serve to fix the interest rate paid on the following notional amounts for the periods identified:
                 
        Weighted Average      
Notional Amount     Fixed Rate     Period
(In thousands)            
$ 550,000       4.61 %  
October 1, 2008 – December 31, 2008
$ 550,000       4.30 %  
January 1, 2009 – December 31, 2009
$ 550,000       4.11 %  
January 1, 2010 – December 31, 2010
$ 400,000       3.72 %  
January 1, 2011 – December 31, 2011
$ 200,000       3.96 %  
January 1, 2012 – December 31, 2012
The following table presents a hypothetical sensitivity analysis of our vault cash interest expense based on our outstanding vault cash balances as of September 30, 2008 and assuming a 100 basis point increase in interest rates:
                                                 
                    Additional Interest Incurred     Additional Interest Incurred  
                    on 100 Basis Point Increase     on 100 Basis Point Increase  
    Vault Cash Balance as of     (Excluding Impact of     (Including Impact of  
    September 30, 2008     Interest Rate Swaps)     Interest Rate Swaps)  
    (Functional currency)     (U.S. dollars)     (Functional currency)     (U.S. dollars)     (Functional currency)     (U.S. dollars)  
    (In millions)     (In millions)     (In millions)  
United States
  $ 748.5     $ 748.5     $ 7.5     $ 7.5     $ 2.0     $ 2.0  
United Kingdom
  £ 80.3       145.3     £ 0.8       1.5     £ 0.8       1.5  
Mexico
  p $ 206.3       18.9     p $ 2.1       0.2     p $ 2.1       0.2  
 
                                         
Total
          $ 912.7             $ 9.2             $ 3.7  
 
                                         
As of September 30, 2008, we had a net liability of $13.0 million recorded in our Consolidated Balance Sheet related to our interest rate swaps, which represented the fair value liability of the agreements based on third-party quotes for similar instruments with the same terms and conditions, as the instruments are required to be carried at fair value. These swaps have been classified as cash flow hedges pursuant to SFAS No. 133. Accordingly, changes in the fair values of the swaps have been reported in accumulated other comprehensive loss in the accompanying Consolidated Balance Sheets. As a result of our overall net loss position for tax purposes, we have not recorded any deferred taxes on the loss amount related to these interest rate hedges, as we do not currently believe that we will be able to realize any benefits.
Net amounts paid or received under the swaps are recorded as adjustments to our cost of ATM operating revenues in the accompanying Consolidated Statements of Operations. During the three and nine month periods ended September 30, 2008 and 2007, the gains or losses as a result of ineffectiveness associated with our existing interest rate swaps were immaterial.
We have not currently entered into any derivative financial instruments to hedge our variable interest rate exposure in the United Kingdom or Mexico.
Interest expense. Our interest expense is also sensitive to changes in the general level of interest rates in the United States, as our borrowings under our domestic revolving credit facility accrue interest at floating rates. Based on the $39.1 million outstanding under the facility as of September 30, 2008, for every interest rate increase of 100 basis points, we would incur an additional $0.4 million of interest expense on an annualized basis.

 

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Outlook. We anticipate that the recent reductions in short-term interest rates in the United States will serve to reduce the interest expense we incur under our bank credit facilities and our vault cash rental expense. Although we currently hedge a substantial portion of our vault cash interest rate risk through 2010, as noted above, we may not be able to enter into similar arrangements for similar amounts in the future, and any significant increase in interest rates in the future could have an adverse impact on our business, financial condition and results of operations by increasing our operating costs and expenses.
Foreign Currency Exchange Risk
Due to our acquisition of Bank Machine in 2005 and our acquisition of a majority interest in Cardtronics Mexico in 2006, we are exposed to market risk from changes in foreign currency exchange rates, specifically with changes in the United States dollar relative to the British pound and Mexican peso. Our United Kingdom and Mexico subsidiaries are consolidated into our financial results and are subject to risks typical of international businesses including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Furthermore, we are required to translate the financial condition and results of operations of Bank Machine and Cardtronics Mexico into United States dollars, with any corresponding translation gains or losses being recorded in other comprehensive loss in our consolidated financial statements. As of September 30, 2008, this translation loss totaled approximately $5.8 million compared to a translation gain of approximately $9.1 million as of December 31, 2007.
As a result of changes in foreign currency rates, our operating results were somewhat impacted by increases in the value of the British pound relative to the United States dollar during the three months ended September 30, 2008 and for the year ended December 31, 2007. Additionally, as our Mexico operations expand, our future results could be materially impacted by changes in the value of the Mexican peso relative to the United States dollar. A sensitivity analysis indicates that, if the United States dollar uniformly strengthened or weakened 10% against the British pound, the effect upon Bank Machine’s operating income for the nine months ended September 30, 2008 would have been an unfavorable or favorable adjustment, respectively, of approximately $0.6 million. A similar sensitivity analysis would have resulted in a $0.1 million adjustment to Cardtronics Mexico’s financial results for the nine months ended September 30, 2008. Despite the negative impact on our earnings during the most recent quarter, we do not expect the strengthening of the United States dollar to have a negative impact on our cash flows as we do not currently rely on cash generated in our United Kingdom and Mexico markets to fund our domestic operating needs. Additionally, given the fact that we continue to explore potential growth opportunities in these two international markets, the strengthening of the United States dollar could enhance our ability to invest in those markets at favorable exchange rates. At this time, we have not deemed it to be cost effective to engage in a program of hedging the effect of foreign currency fluctuations on our operating results using derivative financial instruments.
We do not hold derivative commodity instruments, and all of our cash and cash equivalents are held in money market and checking funds.

 

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ITEM 4T. CONTROLS AND PROCEDURES
Management’s Quarterly Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Form 10-Q, management performed, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act). Our disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding required disclosures. Based on this evaluation and the existence of the material weaknesses in internal control over financial reporting as disclosed and described in Item 9A(T) of our 2007 Form 10-K, management concluded that, as of September 30, 2008, our disclosure controls and procedures were not effective.
Identification and Remediation of Material Weaknesses
In light of the material weaknesses identified in our evaluation of internal control over financial reporting for the year ended December 31, 2007, we performed additional analyses and other procedures that were designed to provide our management with reasonable assurance regarding the reliability of (1) our financial reporting and (2) the preparation of the consolidated financial statements as of and for the three and nine months ended September 30, 2008, in accordance with U.S. GAAP. Based on these additional procedures, our management has determined that the consolidated financial statements included in this Form 10-Q present fairly, in all material respects, our financial condition, results of operations and cash flows for the periods presented.
Management is committed to achieving effective internal control over financial reporting. Our remediation efforts are described in Item 9A(T) in our 2007 Form 10-K. While these efforts continue, we will rely on additional substantive procedures and other measures as needed to assist us with meeting the objectives otherwise fulfilled by an effective control environment.
Changes in Internal Control over Financial Reporting
Except for the ongoing remediation efforts referenced above, there have been no changes in our internal control over financial reporting during the three months ended September 30, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
For information on our material legal proceedings, see Part II., Item I., Financial Information, Notes to Consolidated Financial Statements, Note 11 .
ITEM 1A. RISK FACTORS
Our business, results of operations and financial condition are subject to a number of risks. Any of the risks discussed below, elsewhere in this Form 10-Q or our other SEC filings could have a material impact on our business, results of operations or financial condition. Some of those risks are set forth in our 2007 Form 10-K. In addition to the risks described in our 2007 Form 10-K, we face risks associated with security breaches, our decision to create an in-house armored transportation operation in the United Kingdom, our reliance on third-party service providers, and the recent deterioration in global credit markets, which could have a material impact on our business, results of operations or financial condition. Outlined below are additional risks we face, as well as modifications to certain risks previously disclosed in our 2007 Form 10-K. These risks should be read in conjunction with the risk factors discussed in Part I, Item 1A. Risk Factors in our 2007 Form 10-K. The risks described in this Form 10-Q and in our 2007 Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, financial condition or future results.
Security breaches could harm our business by compromising customer information and disrupting our ATM transaction processing services, thus damaging our relationships with our merchant customers and exposing us to liability.
As part of our ATM transaction processing services, we electronically process and transmit sensitive cardholder information utilizing our ATMs. In recent years, companies that process and transmit this information have been specifically and increasingly targeted by sophisticated criminal organizations in an effort to obtain the information and utilize it for fraudulent transactions. Unauthorized access to our computer systems, or those of our third-party service providers, could result in the theft or publication of the information or the deletion or modification of sensitive records, and could cause interruptions in our operations. While the security risks outlined above are mitigated by the use of encryption and other techniques, any inability to prevent security breaches could damage our relationships with our merchant customers and expose us to liability.
For example, during the second quarter of 2008, we were made aware of a security incident affecting a previous third-party service provider and, in turn, potentially affecting certain of our ATMs located in the stores of one of our merchant customers in the United States. In May 2008, we received a notification from a financial institution indicating that it believes approximately $3.0 million in fraudulent cash withdrawals have occurred on that financial institution’s network of ATMs as a result of the security incident. We also understand that approximately $1.7 million in cash has been recovered and that some or all of these recovered funds may be applied to the financial institution’s losses. In any event, based on information received to date, we do not believe that the security incident referred to above caused any cardholder personal identification numbers (“PINs”) to be compromised and thus do not believe that the fraudulent cash withdrawals were associated with the security incident. We are working closely with this financial institution to try to identify the source of the financial institution’s recent PIN-based losses. To the extent additional notifications are received by, or loss claims are made against, us related to this security incident, we intend to work through our normal process with our insurance carrier and our partners to determine the appropriate means of addressing those notifications or claims. In the event we are unsuccessful in our efforts to effectively address any such notifications or claims, and it is determined that we are liable for any losses that are deemed to have resulted from the security incident, our financial results could be negatively impacted.

 

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The armored transport business exposes us to additional risks beyond those currently experienced by us in the ownership and operation of ATMs.
The armored transport business exposes us to significant risks, including the potential for cash-in-transit losses, as well as claims for personal injury, wrongful death, worker’s compensation, punitive damages, and general liability. While we will seek to maintain appropriate levels of insurance to adequately protect us from these risks, there can be no assurance that we will avoid significant future claims or adverse publicity related thereto. Furthermore, there can be no assurance that our insurance coverage will be adequate to cover potential liabilities or that insurance coverage will remain available at costs that are acceptable to us. The availability of quality and reliable insurance coverage is an important factor in our ability to successfully operate this aspect of our operations. A successful claim brought against us for which coverage is denied or that is in excess of our insurance coverage could have a material adverse effect on our business, financial condition and results of operations.
If not done properly, the transitioning of armored transport services from third-party service providers to our own internal operations could lead to service interruptions, which would harm our business and our relationships with our merchants.
We have no prior experience in providing armored transport services to the ATM industry. Because this is a new business for us, there is an increased risk that our transition efforts will not be successful, thus resulting in service interruptions for our merchants. Furthermore, if not performed properly, the provisioning of armored transport services to our ATMs could result in the ATMs either running out of cash, thereby resulting in lost transactions and revenues, or having excess cash, thereby unnecessarily increasing our operating costs. Furthermore, if any of these issues were to occur, it could damage our relationships with the affected merchants, thus negatively impacting our business, financial condition and results of operations.

 

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The recent deterioration experienced in global credit markets could have a negative impact on financial institutions that we conduct business with.
We have a significant number of customer and vendor relationships with financial institutions in all of our key markets, including relationships in which those financial institutions pay us for the right to place their brands on our ATMs. Additionally, we rely on a small number of financial institution partners to provide us with the cash that we maintain in our Company-owned ATMs. While we have not experienced any significant changes in our relationships with such financial institutions to date, the continued turmoil seen in the global credit markets may have a negative impact on those financial institutions and our relationships with them. In particular, if the liquidity positions of the financial institutions with whom we conduct business deteriorate significantly, such institutions may be unable to perform under their existing agreements with us. In the case of our financial institution branding partners, we would likely be required to find alternative financial institutions to brand the ATMs negatively impacted by any contractual defaults that may result from a continued deterioration in global credit markets. If such defaults were to occur, we may not be successful in our efforts to identify new branding partners, and the underlying economics of any new branding arrangements may not be consistent with our current branding arrangements. Additionally, we have recently seen a decrease in the demand for new bank branding deals, which we believe is directly attributable to the liquidity issues that many of the United States’ large financial institutions are currently facing, and we currently do not expect any growth in this aspect of our business in the short term. Furthermore, the consolidations currently occurring within the banking industry will impact our branding relationships as existing branding customers are acquired by other, more stable financial institutions, some if which may not be existing branding customers. For example, Washington Mutual, which currently has over 950 ATMs branded with us, recently agreed to be acquired by JPMorgan Chase, which is also an existing branding customer of ours. Additionally, Wachovia, which currently has 15 high-transaction ATMs branded with us, recently agreed to be acquired by Wells Fargo, a bank that currently is not a branding customer of ours. Additionally, Sovereign Bank, which currently has over 1,150 ATMs branded with us, is in the process of being acquired by Banco Santander, one of the largest banks in Europe. Although we currently believe that our branding contracts will remain fully enforceable in light of these transactions, there can be no assurance that such contracts will remain unaffected by the unprecedented amount of consolidation currently unfolding within the United States banking industry.
For the risks associated with our vault cash providers and the potential impact on our business, results of operations or financial condition if some of our financial institution partners were no longer able to meet our ATM vault cash needs, please see the risk factor included in Part I, Item 1A. Risk Factors in our 2007 Form 10-K entitled “We rely on third parties to provide us with the cash we require to operate many of our ATMs. If these third parties were unable or unwilling to provide us with the necessary cash to operate our ATMs, we would need to locate alternative sources of cash to operate our ATMs or we would not be able to operate our business.” For convenience, we have re-included the risk factor from our 2007 Form 10-K below:
We rely on third parties to provide us with the cash we require to operate many of our ATMs. If these third parties were unable or unwilling to provide us with the necessary cash to operate our ATMs, we would need to locate alternative sources of cash to operate our ATMs or we would not be able to operate our business.
In the United States, we rely on agreements with Bank of America, PDNB, and Wells Fargo to provide us with the cash that we use in approximately 18,000 of our domestic ATMs where cash is not provided by the merchant (“vault cash”). In the United Kingdom, we rely on a vault cash agreement with ALCB to provide us with the cash that we use in approximately 2,000 of our U.K. ATMs where cash is not provided by the merchant. Finally, Bansi is our sole vault cash provider in Mexico and provides us with the cash that we use in approximately 900 of our Mexico ATMs. As of December 31, 2007, the balance of vault cash held in our U.S, U.K., and Mexican ATMs was approximately $850.4 million, $196.8 million, and $10.1 million, respectively.
Under our vault cash agreements, we pay a vault cash rental fee based on the total amount of vault cash that we are using at any given time. At all times during this process, legal and equitable title to the cash is held by the cash providers, and we have no access or right to the cash. Each provider has the right to demand the return of all or any portion of its cash at any time upon the occurrence of certain events beyond our control, including certain bankruptcy events of us or our subsidiaries, or a breach of the terms of our cash provider agreements. Our current agreements with Bank of America and Wells Fargo expire in October 2009 and July 2009, respectively. However, Bank of America can terminate its agreement with us upon 360 days prior written notice, and Wells Fargo can terminate its agreement with us upon 180 days prior written notice. Additionally, while our current agreement with ALCB does not expire until January 2009, it contains certain provisions, which, if triggered, may allow ALCB to terminate its agreement with us and demand the return of its cash upon 180 days prior written notice. We are working on extending our agreement with Bansi, which currently expires in March 2009.

 

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If our cash providers were to demand return of their cash or terminate their arrangements with us and remove their cash from our ATMs, or if they were to fail to provide us with cash as and when we need it for our ATM operations, our ability to operate these ATMs would be jeopardized, and we would need to locate alternative sources of cash in order to operate these ATMs.
We depend on ATM transaction fees for substantially all of our revenues, and our revenues would be reduced by a decline in the usage of our ATMs or a decline in the number of ATMs that we operate.
Transaction fees charged to cardholders and their financial institutions for transactions processed on our ATMs, including surcharge and interchange transaction fees, have historically accounted for most of our revenues. We expect that ATM transaction fees, including fees we receive through our bank branding and surcharge-free network offerings, will continue to account for a substantial majority of our revenues for the foreseeable future. Consequently, our future operating results will depend on (i) the continued market acceptance of our services in our target markets, (ii) maintaining the level of transaction fees we receive, (iii) our ability to install, acquire, operate, and retain more ATMs, (iv) continued usage of our ATMs by cardholders, and (v) our ability to continue to expand our surcharge-free offerings. Additionally, it is possible that alternative technologies to our ATM services will be developed and implemented. If such alternatives are successful, we will likely experience a decline in the usage of our ATMs. Moreover, surcharge fees are set by negotiation between us and our merchant partners and could change over time. Further, growth in surcharge-free ATM networks and widespread consumer bias toward such networks could adversely affect our revenues, even though we maintain our own surcharge-free offerings.
We have also recently seen a decline in the average number of ATMs that we operate in the United States. Such decline, which totaled approximately 1.6% during the year ended December 31, 2007, exclusive of ATMs acquired in the 7-Eleven ATM Transaction, is primarily due to customer losses experienced in our merchant-owned ATM business, offset somewhat by new Company-owned ATM locations that were deployed during the year. The decline in ATMs on the merchant-owned side of the business totaled approximately 6.2% during the year ended December 31, 2007, and was due primarily to (i) an internal initiative launched by us to identify and eliminate certain underperforming accounts, (ii) increased competition from local and regional independent ATM service organizations, and (iii) certain network security upgrade requirements.
In addition to the above, many of our ATMs are utilized by consumers that frequent the retail establishments in which our ATMs are located, including convenience stores, malls, grocery stores and other large retailers. If there is a significant slowdown in consumer spending as a result of the current economic downturn, and the number of consumers that frequent the retail establishments in which we operate our ATMs declines significantly, the number of transactions conducted on our ATMs, and the corresponding ATM transaction fees, may also decline.
We cannot assure you that our ATM transaction fees will not decline in the future. Accordingly, a decline in usage of our ATMs by ATM cardholders or in the levels of fees received by us in connection with such usage, or a decline in the number of ATMs that we operate, would have a negative impact on our revenues and would limit our future growth.

 

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ITEM 6. EXHIBITS
Each exhibit identified below is part of this Form 10-Q. Exhibits filed (or furnished in the case of Exhibit 32.1) with this Form 10-Q are designated by an “*”. All exhibits not so designated are incorporated herein by reference to a prior filing as indicated.
         
Exhibit    
Number   Description
       
 
  3.1    
Third Amended and Restated Certificate of Incorporation of Cardtronics, Inc. (incorporated herein by reference to Exhibit 3.1 of the Current Report on Form 8-K filed by Cardtronics, Inc. on December 14, 2007, Registration No. 001-33864).
       
 
  3.2    
Second Amended and Restated Bylaws of Cardtronics, Inc. (incorporated herein by reference to Exhibit 3.2 of the Current Report on Form 8-K filed by Cardtronics, Inc. on December 14, 2007, Registration No. 001-33864).
       
 
  * 31.1    
Certification of the Chief Executive Officer of Cardtronics, Inc. pursuant to Section 13a-14(a) of the Securities Exchange Act of 1934.
       
 
  *31.2    
Certification of the Chief Financial Officer of Cardtronics, Inc. pursuant to Section 13a-14(a) of the Securities Exchange Act of 1934.
       
 
  * 32.1    
Certification of the Chief Executive Officer and Chief Financial Officer of Cardtronics, Inc. pursuant to Section 13a-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.

 

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
  CARDTRONICS, INC.
 
 
November 12, 2008  /s/ Jack Antonini    
  Jack Antonini   
  Chief Executive Officer
(Duly Authorized Officer and
Principal Executive Officer)
 
 
     
November 12, 2008  /s/ J. Chris Brewster    
  J. Chris Brewster   
  Chief Financial Officer
(Duly Authorized Officer and
Principal Financial and Accounting Officer)
 
 

 

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EXHIBIT INDEX
Each exhibit identified below is part of this Form 10-Q. Exhibits filed (or furnished in the case of Exhibit 32.1) with this Form 10-Q are designated by an “*”. All exhibits not so designated are incorporated herein by reference to a prior filing as indicated.
         
Exhibit    
Number   Description
       
 
  3.1    
Third Amended and Restated Certificate of Incorporation of Cardtronics, Inc. (incorporated herein by reference to Exhibit 3.1 of the Current Report on Form 8-K filed by Cardtronics, Inc. on December 14, 2007, Registration No. 001-33864).
       
 
  3.2    
Second Amended and Restated Bylaws of Cardtronics, Inc. (incorporated herein by reference to Exhibit 3.2 of the Current Report on Form 8-K filed by Cardtronics, Inc. on December 14, 2007, Registration No. 001-33864).
       
 
  * 31.1    
Certification of the Chief Executive Officer of Cardtronics, Inc. pursuant to Section 13a-14(a) of the Securities Exchange Act of 1934.
       
 
  *31.2    
Certification of the Chief Financial Officer of Cardtronics, Inc. pursuant to Section 13a-14(a) of the Securities Exchange Act of 1934.
       
 
  * 32.1    
Certification of the Chief Executive Officer and Chief Financial Officer of Cardtronics, Inc. pursuant to Section 13a-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.

 

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Exhibit 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER OF CARDTRONICS, INC.
PURSUANT TO RULE 13a-14(a) UNDER THE
SECURITIES EXCHANGE ACT OF 1934, AS AMENDED,
AS ADOPTED PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002
I, Jack Antonini, Chief Executive Officer of Cardtronics, Inc., certify that:
1.   I have reviewed this Quarterly Report on Form 10-Q (this “report”) of Cardtronics, Inc.;
 
2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4.   The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
  (a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
  (b)   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
  (c)   Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
  (d)   Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
  (a)   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
  (b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
         
Date: November 12, 2008  /s/ Jack Antonini    
  Jack Antonini   
  Chief Executive Officer   

 

 

Exhibit 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER OF CARDTRONICS, INC.
PURSUANT TO RULE 13a-14(a) UNDER THE
SECURITIES EXCHANGE ACT OF 1934, AS AMENDED,
AS ADOPTED PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002
I, J. Chris Brewster, Chief Financial Officer of Cardtronics, Inc., certify that:
1.   I have reviewed this Quarterly Report on Form 10-Q (this “report”) of Cardtronics, Inc.;
 
2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4.   The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
  (a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
  (b)   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
  (c)   Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
  (d)   Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
  (a)   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
  (b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
         
Date: November 12, 2008  /s/ J. Chris Brewster    
  J. Chris Brewster   
  Chief Financial Officer   

 

 

Exhibit 32.1
CERTIFICATION OF
CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report on Form 10-Q of Cardtronics, Inc. (“Cardtronics”) for the period ended September 30, 2008 as filed with the Securities and Exchange Commission (the “SEC”) on the date hereof (the “Report”), the undersigned each hereby certifies, pursuant to 18 U.S.C. §1350 as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002:
(1) The Report fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Cardtronics.
         
Date: November 12, 2008  /s/ Jack Antonini    
  Jack Antonini   
  Chief Executive Officer   
         
Date: November 12, 2008  /s/ J. Chris Brewster    
  J. Chris Brewster   
  Chief Financial Officer