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GAXC > SEC Filings for GAXC > Form 10-Q on 19-Nov-2012All Recent SEC Filings

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Form 10-Q for GLOBAL AXCESS CORP


19-Nov-2012

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto.

Overview

Global Axcess Corp, through its wholly owned subsidiaries, owns or leases, operates or manages Automated Teller Machines ("ATM"s) and DVD kiosks with locations primarily in the eastern and southwestern United States of America.

ATM Business Services

Our revenues are principally derived from two types of fees, which we charge for processing transactions on our ATM network. We receive an interchange fee from the issuer of the credit or debit card for processing a transaction when a cardholder uses an ATM in our network. In addition, in most cases we receive a surcharge/convenience fee from the cardholder when the cardholder makes a cash withdrawal from an ATM in our network.

Interchange fees are processing fees that are paid by the issuer of the credit or debit card used in a transaction. Interchange fees vary for cash withdrawals, balance inquiries, account transfers or uncompleted transactions, which are the primary types of transactions that are currently processed on ATMs in our network. The maximum amount of the interchange fees is established by the national and regional card organizations and credit card issuers with whom we have a relationship. We receive interchange fees for transactions on ATMs that we own, but sometimes we rebate a portion of the fee to the owner of the ATM location under the applicable lease for the ATM site. We also receive the interchange fee for transactions on ATMs owned by third party vendors included within our network, but we rebate all or a portion of each fee to the third party vendor based upon negotiations between us. The interchange fees received by us vary from network to network and, to some extent, from issuer to issuer, but generally range from $0.15 to $0.55 per cash withdrawal. Interchange fees for balance inquiries, account transfers and denied transactions are generally substantially less than fees for cash withdrawals. The interchange fees received by us from the card issuer are independent of the service fees charged by the card issuer to the cardholder in connection with ATM transactions. Service fees charged by card issuers to cardholders in connection with transactions through our network range from zero to $2.50 per transaction. We do not receive any portion of these service fees.

In most markets we impose a surcharge/convenience fee for cash withdrawals. Surcharge/convenience fees are a substantial additional source of revenue for us and other ATM network operators. The surcharge/convenience fee for most of the ATMs in our network ranges between $1.50 and $2.95 per withdrawal. The surcharge/convenience fee for other ATMs in our network ranges between $0.50 and $7.50 per withdrawal. We receive the full surcharge/convenience fee for cash withdrawal transactions on ATMs that we own, but often we rebate a portion of the fee to the owner of the ATM location under the applicable lease for the ATM site. We also receive the full surcharge/convenience fee for cash withdrawal transactions on ATMs owned by third party vendors included within our network, but we rebate all or a portion of each fee to the third party vendor based upon a variety of factors, including transaction volume and the party responsible for supplying vault cash to the ATM and only record earned revenues based upon the Company's contracts with the third party vendors.

In addition to revenues derived from interchange and surcharge/convenience fees, we also derive revenues from providing network management services to third parties owning ATMs included in our ATM network. These services include 24 hour transaction processing, monitoring and notification of ATM status and cash condition, notification of ATM service interruptions, in some cases dispatch of field service personnel for necessary service calls and cash settlement and reporting services. The fees for these services are paid by the owners of the ATMs.

Interchange fees are credited to us by networks and credit card issuers on a monthly basis and are paid to us in the following month between the 5th and 15th business day. Surcharge/convenience fees are charged to the cardholder and credited to us by networks and credit card issuers on a daily basis. We rebate a portion of these fees to ATM owners and owners of ATM locations as commission payments as per their contractual terms. Fees for network management services are generally paid to us on a monthly basis.

We compete in a fragmented industry; in which no one firm has a significant market share and can strongly influence the industry outcome. Our industry is populated by a large number of financial institutions and ISOs which deploy ATMs. Our industry is also characterized by essentially undifferentiated services.

There are underlying economic causes as to why our industry is fragmented. For example:

Low overall entry barriers;

Absence of national economies of scale;

Seasonal and geographic volume fluctuations;

The need for local presence in some market segments; and

The need for low overhead.

Additionally, our industry is showing increasing signs of being an industry in decline. Reasons for this market decline include:

Emergence of debit cards, "pay pass" machines and RFID as substitutes for cash in making purchases;

Increasing acceptance of debit cards by younger demographics; and

Market saturation of prime ATM locations in the United States.

Should the signs of industry decline come to fruition, it could negatively impact our results of operations by decreasing revenues and placing downward pressure on earnings. It could also make the availability of capital resources more difficult to obtain and could negatively impact our ability to more aggressively pay down debt, both of which could affect our results of operations.

The demand for our ATM services is primarily a function of population growth and new business creation to serve that population growth. New opportunities may exist:

As our competitors seek to exit the business;

As our competitors encounter financial and regulatory difficulties; and

As financial institutions seek to reduce their costs of managing an ATM channel during a period of decreasing ATM usage.

Opportunities may also exist to leverage our existing customer base by selling additional products and services to them.

DVD Business Services

Nationwide Ntertainment Services, Inc., a wholly owned subsidiary of the Company formed during the fiscal year ended December 31, 2009, is engaged in the business of operating a network of DVD rental kiosks. We offer self-service DVD rentals through kiosks where consumers can rent or purchase movies or games. Our current DVD kiosks are installed primarily at military bases within the United States. Our DVD kiosks, through our brand InstaFlix, serve as a mini video rental store and occupy an area of less than ten square feet. Consumers use a touch screen to select their DVD, swipe a valid credit or debit card, and rent movies or games in some kiosks. The process is designed to be fast, efficient and fully automated with no upfront or membership fees.

Results of Operations

The following tables set forth certain consolidated statement of operations data as a percentage of revenues for the periods indicated. Percentages may not add due to rounding.

                                                     For the Three Months Ended
                                                September 30,          September 30,
                                                     2012                   2011

Revenues                                                 100.0 %                100.0 %
Cost of revenues                                          73.2 %                 61.5 %
Gross profit                                              26.8 %                 38.5 %
Operating expenses
Depreciation expense                                       8.4 %                  6.3 %
Amortization of intangible merchant contracts              4.1 %                  3.7 %
Impairment of assets and long-lived assets                42.2 %                 13.4 %
Selling, general and administrative                       19.2 %                 24.0 %
Restructuring charges                                      0.0 %                  5.2 %
Stock compensation expense                                 0.4 %                  0.4 %
Total operating expenses                                  74.4 %                 53.2 %
Operating loss from operations
 before items shown below                                (47.5 %)               (14.6 %)

Interest expense, net                                     (6.5 %)                (2.4 %)
Debt restructuring charges                                (5.0 %)                 0.0 %
Gain on sale of assets                                     0.2 %                  0.0 %
Income tax expense                                        (0.3 %)                (0.3 %)
Net loss                                                 (59.1 %)               (17.3 %)
EBITDA (1)                                               (39.8 %)                (4.5 %)




                                                      For the Nine Months Ended
                                                September 30,          September 30,
                                                     2012                   2011

Revenues                                                 100.0 %                100.0 %
Cost of revenues                                          70.5 %                 62.0 %
Gross profit                                              29.5 %                 38.0 %
Operating expenses
Depreciation expense                                       8.0 %                  6.8 %
Amortization of intangible merchant contracts              4.0 %                  3.6 %
Impairment of assets and long-lived assets                13.7 %                  4.4 %
Selling, general and administrative                       19.9 %                 23.5 %
Restructuring charges                                      0.2 %                  3.8 %
Stock compensation expense                                 0.3 %                  0.3 %
Total operating expenses                                  46.1 %                 42.5 %
Operating loss from operations
 before items shown below                                (16.6 %)                (4.5 %)

Interest expense, net                                     (4.4 %)                (2.2 %)
Debt restructuring charges                                (1.6 %)                 0.0 %
Gain on sale of assets                                     0.1 %                  0.3 %
Other non-operating expense, net                          (0.0 %)                (0.5 %)
Income tax expense                                        (0.3 %)                (0.3 %)
Net loss                                                 (22.8 %)                (7.2 %)
EBITDA (1)                                                (6.0 %)                 5.7 %

(1) See "-EBITDA" sections in: "Comparison of Results of Operations for the Three and Nine Months Ended September 30, 2012 and 2011".

Comparison of Results of Operations for the Three Months Ended September 30, 2012 and 2011:

Revenues

The Company reported total operating revenue from operations of $7,909,112 for the three-month period ended September 30, 2012 as compared to $8,055,922 for the three-month period ended September 30, 2011, a decrease of 1.8% year over year.

Revenue from our ATM services business was up approximately 9.0% from the third quarter of 2011. We ended September 30, 2012 with 34 fewer ATMs than we ended with on September 30, 2011, and processed 7.0% more surcharge transactions in the third quarter of 2012 as compared to the third quarter of 2011.

During the third quarter of 2012, we benefited from having ATM transactions from ATM portfolios acquired subsequent to third quarter 2011. For the third quarter of 2012, we earned approximately $79,000 less interchange fees than we earned in the third quarter of 2011. This was due to an interchange reduction implemented by network sponsors during the second quarter of 2012. This interchange reduction was mostly offset by higher transactions per machine. Revenue from our DVD services business decreased approximately $720,000 from the third quarter of 2011. The decrease in DVD services revenue was due primarily to cancellation of a contract with a major customer resulting in removal of our DVD kiosks from this customer's sites in December of 2011. This cancellation was the result of the customer's bankruptcy proceedings. (See Financial Statement Footnotes #24 and #25 "Impairment of Long-Lived Assets" and "Impairment of Assets" included in our Annual Report on Form 10-K for the year ended December 31, 2011 for more on the impact of this cancellation).

Cost of Revenues

Our total cost of revenues from operations increased from $4,952,102 to $5,785,763 for the three-month period ended September 30, 2011 to the three-month period ended September 30, 2012. The increase was the result of approximately $1,377,000 of increased cost of revenues related to our ATM business. This increase was partially offset by approximately $543,000 of decreased cost of revenues related to our DVD business. Cost of revenues in our ATM services business increased primarily due to increased revenues, increased commission share resulting from renewals of new customer contracts, as well as an increase in ATM maintenance costs. The decrease in cost of revenues from our DVD services business was a function of decreased DVD rental revenue from a significantly lower deployed machine count, and other reductions in cost of sales discussed below.

The principal components of cost of revenues in the ATM services business are retailer, merchant and distributor commissions (or revenue share), cost of cash, cash replenishment, ATM vault cash insurance, field maintenance, transaction processing charges, telecommunication costs and equipment costs on related equipment sales. The $1,377,000 increase was mainly due to increased commissions (or revenue share) due to higher revenues, new terms in certain customer renewal agreements, and increased first line and second line maintenance costs.

The principal components of cost of revenues in the DVD services business are retailer and merchant commissions (or revenue share), amortization of our DVD library, DVD replenishment, field maintenance, credit card processing charges and telecommunication costs. The decrease in DVD services cost of sales was a function of decreased DVD rental revenue due primarily to cancellation of a contract with a major customer, which resulted in removal of our DVD kiosks from customer sites in December of 2011. Additionally, the Company reduced DVD library amortization due to the impairment of DVD titles in the September 30, 2011 of 2011, decreased DVD title purchases, and reduced processing costs. The contract cancellation was the result of the customer's bankruptcy proceedings. (See Financial Statement Footnotes #24 and #25 "Impairment of Long-Lived Assets" and "Impairment of Assets" included in our Annual Report on Form 10-K for the year ended December 31, 2011 for more on the impact of this cancellation).

Gross Profit

Gross profit from operations as a percentage of revenue for the three-month periods ended September 30, 2012 and 2011 were approximately 26.8% or $2,123,349, and approximately 38.5%, or $3,103,820, respectively. The decreased gross profit for the third quarter of 2012 versus the same period in 2011 was mainly attributable to the increased cost of sales for the ATM services business and the decreased rental revenue from DVD services discussed above.

Gross profit percentage in the ATM services business for the third quarter of 2012 was 28.0%, which is lower than the 43.1% gross profit for the same period in 2011. The decrease in gross profit percentage for the ATM services business was attributable to the increased cost of revenues discussed above.

Gross profit percentage in the DVD services business for the third quarter of 2012 was 18.7%, which is lower than the 21.2% gross profit for the same period in 2011. The decrease in gross profit percentage for the DVD services business was attributable to the decreased revenues discussed above.

Operating Expenses

Our total operating expenses for the three months ended September 30, 2012 and 2011 were $5,881,219 and $4,282,602 respectively. The principal components of operating expenses are general and administrative expenses such as professional and legal fees, administrative salaries and benefits, consulting and audit fees, occupancy costs, sales and marketing expenses and administrative expenses. Operating expenses also include depreciation, amortization of intangible merchant contracts, Impairment of assets and long lived assets and stock compensation expenses.

To aid in the understanding of our discussion and analysis of our operating expenses, the following table summarizes the amount and percentage change in the amounts from the previous year for certain operating expense line items:

                         For the Three Months Ended         2012 to 2011       2012 to 2011
                       September 30,       September
                           2012             30, 2011          $ Change           % Change

Depreciation expense   $     663,844      $    508,697     $      155,147               30.5 %
Amortization of
intangible merchant
contracts                    325,421           299,872             25,549                8.5 %
Impairment of assets
and long-lived
assets                     3,338,732         1,085,194          2,253,538              207.7 %
Selling, general and
administrative             1,521,649         1,933,074           (411,425 )            (21.3 %)
Restructuring
charges                            -           421,046           (421,046 )           (100.0 %)
Stock compensation
expense                       31,573            34,719             (3,146 )             (9.1 %)
Total operating
expenses               $   5,881,219      $  4,282,602     $    1,598,617               37.3 %

See explanation of operating expenses below:

Depreciation Expense

Depreciation expense from operations increased for the three-month period ended September 30, 2012 to $663,844 from $508,697 for the same period in 2011. This increase in depreciation expense was mainly due to an increase of Company owned kiosks, as well as re-introduction of previously suspended DVD kiosk depreciation to coincide with re-deployment of warehoused machines. The warehousing of these machines was the result of cancellation of a contract with a major customer. (See Financial Statement Footnotes #24 and #25 "Impairment of Long-Lived Assets" and "Impairment of Assets" included in our Annual Report on Form 10-K for the year ended December 31, 2011 for more on the impact of this cancellation).

Amortization of Intangible Merchant Contracts

Amortization of intangible merchant contracts from operations increased for the three-month period ended September 30, 2012 to $325,421 from $299,872 for the same period in 2011. The increase from 2011 was due to the amortization of contracts in the ATM services business acquired subsequent to the third quarter of 2011.

Impairment of Assets and Long-lived Assets

During the third quarter of fiscal 2012, we determined that sufficient indicators of potential impairment existed to require a goodwill impairment analysis for the ATM business. These indicators included a recent forbearance agreement signed with Fifth Third bank (See Financial Footnote #4 "Senior Lenders' Notes Payable" regarding the details of the agreement), as well as the recent trading values of the company's stock coupled with decreases in the Company's profit margin.

We estimated the fair value of the ATM business utilizing a combination of market multiple valuation metrics used in our industry and the present value of discounted cash flows. Cash flow projections are based on management's estimates of revenue growth rates and operating margins, taking into consideration industry and market conditions. The market approach estimates fair value based on market multiples of revenue and earnings derived from comparable companies with similar operating and investment characteristics as the reporting unit.

Based on our analyses, the implied fair value of goodwill was lower than the carrying value of goodwill for the ATM business unit. As a result, we recorded an impairment charge of $3,247,497.

Additionally, the company identified a group of ATM's that were no longer useful to the company. These ATM's were sold subsequent to September 30, 2012. During the quarter, these ATM's were written down to their fair market value based on future proceeds to be realized. The impairment charge was $91,235.

Selling, General and Administrative ("SG&A") Expenses

Our total SG&A expenses from operations decreased to $1,521,649, or 19.2% of revenue for the three-month period ended September 30, 2012 from $1,933,074 or 24% of revenue for the three-month period ended September 30, 2011. The decrease in SG&A expenses was mainly due to approximately $300,000 of decreased headcount, salary related, and director's fees expense, as well as another $100,000 reduction in other miscellaneous SG&A expenses.

Restructuring Charges

During the third quarter of 2011, the Company removed approximately 115 of its DVD rental kiosks from store locations of a major customer, and placed them into storage at a Company warehouse. While some of these kiosks were redeployed to other locations in the field, the majority remained in the warehouse at the end of the third quarter. The Company incurred $126,269 of costs associated with the de-installation and storage of the kiosks. Additionally, the Company received notice from the same customer in the third quarter that it would have to remove all remaining kiosks in the fourth quarter of 2011. This came as a result of cancellation of the Company's contract with the customer pursuant to the customer's bankruptcy proceedings. The Company accrued $100,000 total for the de-installation of these kiosks as well as the cost of redeploying other kiosks in the third quarter of 2011. The company wrote off $175,103 of un-amortized costs intangible costs relating to its contract with this customer. The company also had severance related charges of $19,674 for the three months ended September 30, 2011.

The following table summarizes the restructuring charges recorded during the three-month periods ended September 30, 2012 and September 30, 2011:

                                                 For the Three Months        For the Three
                                                        Ended                Months Ended
                                                  September 30, 2012      September 30, 2011

Deinstallation Charges                           $                  -     $           226,269
Unamortized Intangible Write Off                                    -                 175,103
Severance related Charges                                           -                  19,674
Total                                            $                  -     $           421,046

Stock Compensation Expense

For the three months ended September 30, 2012, we recorded stock compensation expense of $31,573, mainly relating to executive and director stock option grants during fiscal years 2007 through 2012. For the three months ended September 30, 2011, we recorded stock compensation expense of $34,719.

Interest Expense, Net

Interest expense, net, increased for the three-month period ended September 30, 2012 to $515,417 from $194,052 for the three-month period ended September 30, 2011. The increase was mainly due to portions of our two cash flow hedges becoming effective during the third quarter of 2012 and increased debt balances year over year. (See Financial Footnote #4 "Senior Lenders' Notes Payable" regarding the details of the debt balances).

Debt Restructuring Charges

During the nine-month period ended September 30, 2012, the Company incurred debt restructuring expenses of $395,000. These expenses include bank fees, legal expenses occurred by the bank in relation to these amendments, as well as fees for consultants the company was required to hire as a condition of these amendments.

Gain (Loss) on Sale of Assets

During the three-month periods ended September 30, 2012 and September 30, 2011 the Company recorded a gain on the sale of assets of $12,917 and $4,000 respectively.

EBITDA

EBITDA (a non-GAAP measure) is defined as earnings before net interest, taxes, depreciation and amortization. EBITDA has some inherent limitations in measuring operating performance due to the exclusion of certain financial elements such as depreciation and is not necessarily comparable to other similarly titled captions of other companies due to potential inconsistencies in the method of calculation. Furthermore, EBITDA is not intended to be a substitute for cash flows from operating activities, as a measure of liquidity, or an alternative to net income in determining our operating performance in accordance with GAAP. Our use of EBITDA should be considered within the following context:

We acknowledge that our depreciable assets are necessary to earn revenue based on our current business.

Our use of EBITDA as a measure of operating performance is not based on our belief about the reasonableness of excluding depreciation when measuring financial performance.

Our use of EBITDA is supported by the importance of EBITDA to the following key stakeholders:

Analysts - who estimate our projected EBITDA and other EBITDA-based metrics in their independently developed financial models for investors;

Creditors- who evaluate our operating performance based on compliance with certain EBITDA-based debt covenants;

Investment Bankers - who use EBITDA and other EBITDA-based metrics in their written evaluations and comparisons of companies within our industry; and

Board of Directors and Executive Management - who use EBITDA as an essential metric for evaluating management performance relative to our operating budget and bank covenant compliance, as well as our ability to service debt and raise capital for growth opportunities which are a critical component to our strategy.

The following table sets forth a reconciliation of net loss to EBITDA from operations for the three months ended September 30, 2012 and 2011:

                                                   For the Three Months Ended
                                                September 30,      September 30,
                                                     2012              2011

Net income (loss)                               $   (4,677,870 )   $  (1,390,834 )
Income tax expense                                      22,500            22,000
Interest expense, net                                  515,417           194,052
Depreciation expense                                   663,844           508,697
Amortization of intangible merchant contracts          325,421           299,872
EBITDA from operations                          $   (3,150,688 )   $    (366,213 )

Our EBITDA from operations decreased to $(3,150,688) for the third quarter of fiscal 2012 from $(366,213) for the third quarter of fiscal 2011. The decrease was primarily due to an impairment of goodwill in the amount of $3,247,497.

The following table sets forth a reconciliation of net income (loss) to EBITDA from operations before impairment of assets and long-lived assets, restructuring charges, debt restructuring charges stock compensation expense, and (gain) loss on sale of assets ("Adjusted EBITDA") for the three months ended September 30, 2012 and 2011:

. . .

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