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GAXC > SEC Filings for GAXC > Form 10-K on 1-Apr-2013All Recent SEC Filings

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Form 10-K for GLOBAL AXCESS CORP


1-Apr-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

In addition to historical information, this Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially. Factors that might cause or contribute to such differences include, but are not limited to, those discussed below. You should carefully review the risks described in other documents we file from time to time with the SEC, including the Quarterly Reports on Form 10-Q to be filed in 2013. When used in this report, the words "expects," "anticipates," "intends," "plans," "believes," "seeks," "targets," "estimates," "looks for," "looks to," and similar expressions are generally intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.

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 $0.14 to $0.70 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.

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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 the 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 ("fiscal 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 grocery stores. 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. Typically, the DVD rental price is a flat fee plus tax for one night and if the consumer chooses to keep the DVD for additional nights, they are automatically charged for the additional fee. We generate revenue primarily through fees charged to rent or purchase a DVD, and pay our retail partners a percentage of our revenue. See Financial Statement Footnote #26 "Subsequent Events" for an update on the Company's contract with its major DVD customer.

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Results of Operations

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

                                                  For the year ended       For the year ended       For the year ended
                                                   December 31, 2012        December 31, 2011        December 31, 2010

Revenues                                                        100.0 %                  100.0 %                  100.0 %
Cost of revenues                                                 71.4 %                   62.1 %                   58.7 %
Gross profit                                                     28.6 %                   37.9 %                   41.3 %
Operating expenses
Depreciation expense                                              8.1 %                    7.0 %                    7.0 %
Amortization of intangible merchant contracts                     4.2 %                    3.8 %                    3.8 %
Impairment of assets and long-lived assets                       21.4 %                    3.7 %                    2.1 %
Selling, general and administrative                              20.1 %                   23.3 %                   29.3 %
Restructuring charges                                             0.2 %                    3.0 %                    0.0 %
Stock compensation expense                                        0.3 %                    0.3 %                    0.9 %
Total operating expenses                                         54.3 %                   41.1 %                   43.3 %
Operating loss from operations before items
shown below                                                     (25.8 )%                  (3.2 )%                  (1.9 )%

Interest expense, net                                            (5.2 )%                  (2.3 )%                  (2.3 )%
Debt restructuring charges                                       (1.7 )%                   0.0 %                    0.0 %
Gain on sale of assets                                            0.2 %                    0.3 %                    0.0 %
Other non-operating expense, net                                 (0.0 )%                  (0.4 )%                   0.0 %
Loss on early extinguishment of debt                              0.0 %                    0.0 %                   (0.4 )%
Income tax expense                                               (6.4 )%                  (0.2 )%                   0.9 %
Net loss                                                        (38.8 )%                  (5.9 )%                  (3.8 )%
EBITDA (1)                                                      (15.0 )%                   7.5 %                    8.4 %

(1) See "-EBITDA" section in "Comparison of Results of Operations for the Fiscal Years Ended December 31, 2012, 2011 and 2010".

Comparison of Results of Operations for the Fiscal Years Ended December 31, 2012 and 2011

Revenues

The Company reported total revenue from operations of $31,193,987 for the fiscal year ended December 31, 2012 ("fiscal 2012") compared to $31,941,134 for the fiscal year ended December 31, 2011 ("fiscal 2011"), a decrease of 2.4% year over year.

Revenue from our ATM services business was up approximately 8.2% from fiscal 2011. We ended fiscal 2012 with approximately 600 fewer ATMs than we ended with in fiscal 2011 and processed 5.9% more surcharge transactions in fiscal 2012 as compared to fiscal 2011. During fiscal 2012, we benefited from having ATM transactions from ATM portfolios acquired in the fourth quarter of 2011. Additionally, we raised surcharge fees during the first quarter of 2011 which helped grow our ATM surcharge revenue by 16.1% year over year as fiscal 2012 benefitted from a full year of this increase. We earned approximately $237,000 less interchange fees during fiscal 2012 than we earned during fiscal 2011 due to a reduction in interchange paid to us by card networks. Revenue from our DVD services business decreased approximately $2,807,000 for fiscal 2012, compared to fiscal 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 Footnote #23 "Impairment of Assets and Long-Lived Assets" for more on the impact of this cancellation.

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Cost of Revenues

Our total cost of revenues from operations increased from $19,835,298 in fiscal 2011 to $22,278,241 in fiscal 2012. $4,728,202 of the increase in cost of revenues related to our ATM business, partially offset by a decrease of $2,285,259 from our DVD business.

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 $4,674,817 increase was mainly due to increased commissions (or revenue share) due to higher revenues and new terms in certain customer renewal agreements along with increases in first line and second line maintenance costs. The higher revenues were mostly due to a full year of transactions from our acquisitions of Rocky Mountain ATM portfolios in the fourth quarter of 2011.

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, decreased DVD title purchases, and reduced processing costs. The contract cancellation was the result of the customer's bankruptcy proceedings. (See Financial Statement Footnote #23 "Impairment of Assets and Long-Lived Assets" for more on the impact of this cancellation).

Gross Profit

Gross profit from operations as a percentage of revenue for fiscal 2012 and 2011 was approximately 28.6%, or $8,915,746 and approximately 37.9%, or $12,105,835, respectively. The decreased gross profit for fiscal 2012 versus fiscal 2011 was mainly attributable to the increased revenue share and other cost of sales for the ATM services business, along with the decreased rental revenue from DVD services discussed above.

Gross profit percentage in the ATM services business for fiscal 2012 was 29.4%, which is lower than the 42.4% gross profit for fiscal 2011. The decrease in gross profit in the ATM services business was attributable to the increased cost of revenues discussed above.

Gross profit percentage in the DVD services business for fiscal 2012 was 23.4%, which is in line with the 21.4% gross profit for the same period in 2011.

Operating Expenses

Our total operating expenses increased to $16,952,338, or approximately 54.3% of revenues, in fiscal 2012 from $13,135,153, or approximately 41.1% of revenues in fiscal 2011. This was mostly due to impairment and restructuring charges of $6,730,487 in 2012 compared to $2,132,001 in 2011. These impairment and restructuring charges were partially offset by a year over year reduction in SG&A expenses of $1,174,770. The principal components of operating expenses are selling, 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, restructuring charges 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:

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                                                 For the year ended       For the year ended      2012 to 2011      2012 to 2011
                                                 December 31, 2012        December 31, 2011         $ Change          % Change

Depreciation expense                            $          2,533,440     $          2,233,721     $     299,718              13.4 %
Amortization of intangible merchant contracts              1,301,036                1,210,213            90,823               7.5 %
Impairment of assets and long-lived assets                 6,679,742                1,182,694         5,497,048             464.8 %
Selling, general and administrative                        6,280,287                7,455,057        (1,174,770 )           (15.8 )%
Restructuring charges                                         50,745                  949,307          (898,562 )           (94.7 )%
Stock compensation expense                                   107,088                  104,161             2,928               2.8 %
Total operating expenses                        $         16,952,338     $         13,135,153     $   3,817,185              29.1 %

See explanation of operating expenses below:

Depreciation Expense

Depreciation expense increased in fiscal 2012 to $2,533,440 from $2,233,721 in fiscal 2011. This increase in depreciation expense was mainly due to depreciation expenses relating to our DVD services business.

Depreciation expense in the ATM services business increased slightly in fiscal 2012 as compared to fiscal 2011, going from $1.4 million in fiscal 2011 to $1.5 million in fiscal 2012.

Depreciation expense in the DVD services business increased from approximately $876,000 in fiscal 2011 to approximately $1,031,000 in fiscal 2012.

Amortization of Intangible Merchant Contracts

Amortization of intangible merchant contracts increased in fiscal 2012 to $1,301,036 from $1,210,213 in fiscal 2011. The increase from 2011 was due to the amortization of contracts in the ATM services business acquired during fiscal 2011.

See Financial Statement Footnotes #2 "Summary of Significant Accounting Policies" and #8 "Intangible Assets and Merchant Contracts," regarding the amortization of intangible merchant contracts.

Impairment of Assets and Long-Lived assets

During 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 #12 "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 $4,030,360.

Additionally, the Company identified a group of ATM's that were no longer useful to the Company. These ATM's were sold during fiscal 2012. Accordingly, these ATM's were written down to their fair market value based on proceeds realized. The impairment charge was $91,235.

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During fiscal 2012, we also determined that sufficient indicators of potential impairment existed to require an impairment analysis for the DVD business. Based on our analyses, we recorded an impairment charge of $1,023,610 on our merchant contracts and a $1,534,537 impairment charge on our DVD kiosks.

During fiscal 2011, the Company removed all of its DVD kiosks from store locations owned by its major DVD customer. This was done to remove unprofitable DVD kiosks from site locations. The largest wave of de-installs relating to these kiosks occurred during the third quarter, consisting of approximately 115 kiosks removed from store locations and placed into the Company's warehouse to prepare for redeployment to other locations. Along with these idle kiosks in the warehouse, were the DVD titles associated with these machines.

Also in the third quarter of 2011, the Company received notice from the same customer that it would have to remove all remaining kiosks in the fourth quarter of 2011, due to a cancellation of the Company's contract with the customer. This cancellation was a result of the customer's bankruptcy proceedings.

As such, during fiscal 2011, the Company wrote down $1,085,194 of impaired DVD inventory and $97,500 of capitalized installation costs related to the DVD kiosks. This impaired DVD inventory consisted of both DVD titles that were not being utilized due to the removal of the DVD kiosks from store locations, as well as a mark-to-market reduction in value of the DVDs located in the kiosks that were removed during the fourth quarter of 2011, pursuant to the cancellation of the customer contract. The machine installation costs could no longer be considered attached to the machine as the machines were idle in the warehouse, and therefore, were written off accordingly..

See Financial Statement Footnote #23 "Impairment of Assets and Long-Lived Assets" regarding the details of these charges.

Selling, General and Administrative (SG&A) Expenses

Our total SG&A expenses from operations decreased to $6,280,287 in fiscal 2012 from $7,455,055 in fiscal 2011. SG&A expenses represented 20.1% of revenues for the year ended December 31, 2012 as compared to 23.3% of revenues for the year ended December 31, 2011. The decrease in SG&A expenses was mainly due to approximately $300,000 of decreased headcount, salary related, and director's fees expenses as well as $850,000 of reduced SG&A expenses related to the cost savings pursuant to the removal of DVD kiosks in 2011 and reduction in the Company's DVD business, including headcount-related expenses, travel, and other miscellaneous items.

Restructuring Charges

During fiscal 2012, the Company incurred restructuring expenses due to headcount reductions of $50,745.

On February 28, 2011, the Company and George McQuain, the Company's Chief Executive Officer, agreed to a mutual separation of Mr. McQuain's employment. As of February 28, 2011, Mr. McQuain was no longer employed as Chief Executive Officer, Director or in any other capacity, by the Company or any of its subsidiaries. As of December 31, 2012, the Company had paid its severance obligation in full to Mr. McQuain. During February 2011 through September 2011 several other headcounts were reduced as part of a corporate restructuring.

For fiscal 2011, the Company recorded restructuring charges of $547,936 for severance-related expenses. As of December 31, 2011, the Company had accrued $237,391 for severance obligations included in accounts payable and accrued liabilities on the consolidated balance sheet.

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 incurred approximate $100,000 of costs associated with the de-installation of these additional kiosks as well as the cost of redeploying kiosks during the fourth quarter of 2011. Additionally, the Company wrote off $175,102 of un-amortized costs intangible costs relating to its cancelled contract with this customer.

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The following table summarizes the restructuring charges recorded during the fiscal years 2012 and 2011:

                                    For the year ended       For the year ended
                                    December 31, 2012        December 31, 2011

Deinstallation Charges             $                  -     $            226,269
Unamortized Intangible Write Off                      -                  175,102
Severance Related Charges                        50,745                  547,936
Total                              $             50,745     $            949,307

Stock Compensation Expense

In fiscal 2012, we recorded stock compensation expense of $107,088 mainly relating to executive and director stock option grants (see Financial Footnote #2 "Summary of Significant Accounting Policies" and #20 "Stock-Based Compensation") during fiscal years 2007 through 2012. During the fiscal year ended December 31, 2011 we recorded stock compensation expense of $104,161.

Interest Expense

Interest expense, net, increased to $1,608,548 from $742,407 for fiscal 2012 and 2011 respectively. The increase was mainly due to increased overall all debt balances and interest rates, along with approximately $144,000 of reclassification due to our two cash flow hedges becoming effective during the third quarter of 2012. See Financial Footnote #12 "Senior Lenders' Notes Payable" regarding the details of the debt balances.

Debt Restructuring Charges

During fiscal 2012, we recorded $543,648 of costs related to the process of restructuring our debt with Fifth Third Bank. Included in the $543,648 of expenses were $250,000 of bank waiver fees and fees associated with the hiring of consultants mandated by our amendments and Forbearance Agreement with Fifth Third Bank. See Financial Footnote #12 "Senior Lenders' Notes Payable" for further detail.

Gain on Sale of Assets

The Company recorded a gain on sale of assets during fiscal 2012, of $75,194. The two largest components of this variance were a bulk sale of fully amortized DVD titles for approximately $20,000 along with a sale of fully depreciated ATM equipment for approximately $37,000.

During fiscal 2011, the Company sold certain DVD machines and ATM assets for a net gain on sale of $82,685.

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