Everi Holdings Inc. - Quarter Report: 2012 September (Form 10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark one)

 

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2012

 

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 no 001 — 32622

 

GLOBAL CASH ACCESS HOLDINGS, INC.

(Exact name of Registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(800) 833-7110

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Sections 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 x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x 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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

As of October 29, 2012 there were 66,596,777 shares of the Registrant’s $0.001 par value per share common stock outstanding.

 

 

 

TABLE OF CONTENTS

 

	Page
Part I: Financial Information	3
Item 1: Unaudited Condensed Consolidated Financial Statements	3
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011	3
Unaudited Condensed Consolidated Statements of Income and Comprehensive Income for the three and nine months ended September 30, 2012 and 2011	4
Unaudited Condensed Consolidated Statements of Cash Flows for nine months ended September 30, 2012 and 2011	5
Notes to Unaudited Condensed Consolidated Financial Statements	6
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3: Quantitative and Qualitative Disclosures about Market Risk	23
Item 4: Controls and Procedures	23
Part II: Other Information	24
Item 1: Legal Proceedings	24
Item 1A: Risk Factors	24
Item 2:  Unregistered Sales of Equity Securities and Use of Proceeds	25
Item 5: Other Information	25
Item 6: Exhibits	26
Signatures	27

 

2

 

PART I: FINANCIAL INFORMATION

 

ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

GLOBAL CASH ACCESS HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except par value)

(unaudited)

 

		September 30,			December 31,
		2012			2011
ASSETS
Cash and cash equivalents		$	46,940		$	55,535
Restricted cash and cash equivalents		200			455
Settlement receivables		113,989			80,246
Other receivables, net		10,076			16,885
Inventory		7,266			7,087
Prepaid expenses and other assets		16,564			15,406
Property, equipment and leasehold improvements, net		14,357			15,577
Goodwill, net		180,152			180,122
Other intangible assets, net		33,327			38,216
Deferred income taxes, net		106,484			119,538
Total assets		$	529,355		$	529,067
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Settlement liabilities		$	158,438		$	141,827
Accounts payable		34,809			32,223
Accrued expenses		18,608			21,159
Borrowings		126,500			174,000
Total liabilities		338,355			369,209
COMMITMENTS AND CONTINGENCIES (Note 5)
Stockholders’ Equity:
Common stock, $0.001 par value, 500,000 shares authorized and 87,375 and 85,651 shares issued at September 30, 2012 and December 31, 2011, respectively		87			86
Convertible preferred stock, $0.001 par value, 50,000 shares authorized and 0 shares outstanding at September 30, 2012 and December 31, 2011, respectively		-			-
Additional paid-in capital		214,612			204,735
Retained earnings		119,216			97,925
Accumulated other comprehensive income		2,504			2,340
Treasury stock, at cost, 20,714 and 20,686 shares at September 30, 2012 and December 31, 2011, respectively		(145,419)			(145,228)
Total stockholders’ equity		191,000			159,858
Total liabilities and stockholders’ equity		$	529,355		$	529,067

 

See notes to unaudited condensed consolidated financial statements.

 

3

 

GLOBAL CASH ACCESS HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(amounts in thousands, except per share)

(unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2012			2011			2012			2011
Revenues
Cash advance		$	57,520		$	50,913		$	172,557		$	152,036
ATM		76,411			71,044			233,361			213,450
Check services		6,611			6,479			19,731			19,813
Other revenues		9,282			8,452			22,705			21,031
Total revenues		149,824			136,888			448,354			406,330
Cost of revenues		111,373			106,953			333,566			317,900
Operating expenses		19,463			18,529			55,910			51,922
Amortization		2,650			1,929			7,317			6,250
Depreciation		1,695			1,867			5,260			6,201
Operating income		14,643			7,610			46,301			24,057
Interest expense, net of interest income		3,586			4,414			12,133			14,167
Loss on early extinguishment of debt		-			-			-			943
Interest expense, net		3,586			4,414			12,133			15,110
Income before income tax provision		11,057			3,196			34,168			8,947
Income tax provision		3,977			1,356			12,878			4,356
Net income		7,080			1,840			21,290			4,591
Foreign currency translation		236			(218)			164			(191)
Comprehensive income		$	7,316		$	1,622		$	21,454		$	4,400
Basic earnings per share:
Net income per share - basic		$	0.11		$	0.03		$	0.32		$	0.07
Diluted earnings per share:
Net income per share - diluted		$	0.10		$	0.03		$	0.32		$	0.07
Weighted average number of common shares outstanding:
Basic		66,108			64,712			65,673			64,597
Diluted		67,601			64,751			67,031			64,708

 

See notes to unaudited condensed consolidated financial statements.

 

4

 

GLOBAL CASH ACCESS HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

(amounts in thousands)

(unaudited)

 

		Nine Months Ended September 30,
		2012				2011
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	21,290			$	4,591
Adjustments to reconcile net income to cash provided by operating activities:
Amortization of financing costs		1,081				988
Amortization of intangibles		7,317				6,250
Depreciation		5,260				6,201
Loss on sale or disposal of assets		112				216
Provision for bad debts		2,586				4,016
Loss on early extinguishment of debt		-				943
Stock-based compensation		3,951				5,238
Changes in operating assets and liabilities:
Settlement receivables		(33,676		)		10,266
Other receivables, net		5,682				(829		)
Inventory		(6		)		(2,575		)
Prepaid and other assets		(1,329		)		(3,477		)
Deferred income taxes		12,556				4,092
Settlement liabilities		16,509				(12,221		)
Accounts payable		2,582				505
Accrued expenses		(2,496		)		(4,030		)
Net cash provided by operating activities		41,419				20,174
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, equipment, leasehold improvements and other intangibles		(7,353		)		(6,227		)
Proceeds from sale of fixed assets		448				-
Changes in restricted cash and cash equivalents		255				(14		)
Net cash used in investing activities		(6,650		)		(6,241		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments against old credit facility		-				(208,750		)
Securing of new credit facility		-				214,000
Issuance costs of new credit facility		(676		)		(7,099		)
Repayments against new credit facility		(47,500		)		(35,000		)
Proceeds from exercise of stock options		5,946				591
Purchase of treasury stock		(191		)		(156		)
Net cash used in financing activities		(42,421		)		(36,414		)
NET EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		(943		)		191
NET DECREASE IN CASH AND CASH EQUIVALENTS		(8,595		)		(22,290		)
CASH AND CASH EQUIVALENTS - Beginning of Period		55,535				60,636
CASH AND CASH EQUIVALENTS - End of Period		$	46,940			$	38,346
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest		$	11,402			$	15,202
Cash paid for taxes, net of refunds		$	267			$	336

 

See notes to unaudited condensed consolidated financial statements.

 

5

 

GLOBAL CASH ACCESS HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

1.         BUSINESS AND BASIS OF PRESENTATION

 

Overview

 

Global Cash Access Holdings, Inc. (“Holdings”) is a holding company, the principal asset of which is the capital stock of Global Cash Access, Inc. (“GCA”).  Unless otherwise indicated, the terms “the Company,” “Holdings,” “we,” “us” and “our” refer to Holdings together with its consolidated subsidiaries. Holdings was formed on February 4, 2004 for the purpose of holding all of the outstanding capital stock of GCA and to guarantee the obligations under our senior secured credit facilities.

 

We are a global provider of cash access and data intelligence services and solutions to the gaming industry.  Our services and solutions provide gaming establishment patrons access to cash through a variety of methods, including automated teller machine (“ATM”) cash withdrawals, credit card cash access transactions, point-of-sale (“POS”) debit card transactions, check verification and warranty services and money transfers.  In addition, we also provide products and services that improve credit decision-making, automate cashier operations and enhance patron marketing activities for gaming establishments.  We also sell and service cash access devices such as slot machine ticket redemption and jackpot kiosks to the gaming industry.

 

The Company owns and operates a credit reporting agency for the gaming industry through a wholly-owned subsidiary, Central Credit, LLC (“Central Credit”), which provides credit information services and credit reporting history on gaming patrons to various gaming establishments. Central Credit operates in both international and domestic gaming markets.  The results of operations of Central Credit have been reflected in other revenues.  The Company also owns Western Money Systems (“Western Money”), a manufacturer of redemption kiosk devices.  The results of operations of Western Money have been reflected in other revenues.

 

In November 2011, we acquired substantially all of the assets of MCA Processing LLC (“MCA”), a provider of ATM, debit card and credit card cash access services to gaming establishments and also a manufacturer, seller, licensor and servicer of redemption kiosk devices.

 

Basis of Presentation

 

The unaudited condensed consolidated financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Some of the information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. In the opinion of management, all adjustments (which include normal recurring adjustments) necessary for a fair presentation of results for the interim periods have been made. The results for the three and nine months ended September 30, 2012 are not necessarily indicative of results to be expected for the full fiscal year.

 

These unaudited condensed consolidated financial statements should be read in conjunction with the annual consolidated financial statements and notes thereto included within the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 (the “2011 10-K”).

 

Use of Estimates

 

The Company has made estimates and judgments affecting the amounts reported in these financial statements and the accompanying notes. The actual results may differ from these estimates. These accounting estimates incorporated into the Company’s consolidated financial statements include, but are not limited to:

 

·                  the estimated reserve for warranty expense associated with our check warranty receivables;

 

·                  the valuation and recognition of share-based compensation;

 

·                  the valuation allowance on our deferred income tax assets; and

 

·                  the estimated cash flows in assessing the recoverability of long-lived assets.

 

6

 

2.         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Principles of Consolidation

 

The unaudited condensed consolidated interim financial statements presented include the accounts of Holdings and its subsidiaries.  All significant intercompany transactions and balances have been eliminated in consolidation.

 

Earnings Applicable to Common Stock

 

Basic earnings per share are calculated by dividing net income by the weighted-average number of common shares outstanding for the period.  Diluted earnings per share reflect the dilutive effect of potential common stock resulting from equity grants.

 

The weighted-average number of common shares outstanding used in the computation of basic and diluted earnings per share is as follows (in thousands):

 

		Three Months Ended September 30,				Nine Months Ended September 30,
		2012		2011		2012		2011
Weighted average number of common shares outstanding - basic(1)		66,108		64,712		65,673		64,597
Potential dilution from equity grants(2)		1,493		39		1,358		111
Weighted average number of common shares outstanding - diluted		67,601		64,751		67,031		64,708

 

(1)         Included in the calculation of weighted average common shares outstanding — basic are 70 and 40 and 16 and 44 unvested shares of restricted common stock of Holdings granted in share-based payment transactions for the three and nine months ended September 30, 2012 and 2011, respectively, that are participating securities because such shares have voting rights as well as the right to participate in dividend distributions made by the Company to its common stockholders.

 

(2)         The potential dilution excludes the weighted average effect of stock options to acquire 5.5 million and 6.9 million and 9.0 million and 8.2 million shares of common stock of Holdings for the three and nine months ended September 30, 2012 and 2011, respectively, because the application of the treasury stock method, as required, makes them anti-dilutive.

 

Warranty Receivables

 

In the check services transactions provided by Central Credit, Central Credit warrants check cashing transactions performed at gaming establishments.  If a gaming establishment chooses to have a check warranted, it sends a request to a check warranty service provider asking whether it will warrant the check.  Upon approval, the gaming establishment then pays the patron the check amount and deposits the check.  If the check is dishonored by the patron’s bank, the gaming establishment invokes the warranty and the check warranty service provider purchases the check from the gaming establishment for the full check amount and then pursues collection activities on its own. All amounts paid out to the gaming establishment related to these items result in a warranty receivable from the patron.  This amount is recorded in other receivables, net on the condensed consolidated balance sheets.  On a monthly basis, Central Credit evaluates the collectability of the outstanding balances and establishes a reserve for the face amount of the expected losses on these receivables.  The warranty expense associated with this reserve is included within cost of revenues (exclusive of depreciation and amortization) in the condensed consolidated statements of income.  The Company writes off substantially all warranty receivables that are generally older than one year in age.

 

7

 

A summary of the activity for the check warranty reserve for the nine months ended September 30, 2012, is as follows (amounts in thousands):

 

		Amount
Balance, December 31, 2011		$	6,756
Warranty expense provision		2,633
Charge offs against reserve		(3,896		)
Balance, September 30, 2012		$	5,493

 

Fair Values of Financial Instruments

 

The fair value of a financial instrument represents the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are made at a specific point in time, based upon relevant market information about the financial instrument.

 

The carrying amount of cash and cash equivalents, restricted cash and cash equivalents, other receivables, net, settlement receivables, settlement liabilities, accounts payable and accrued expenses approximates fair value due to the short-term maturities of these instruments. The fair value of GCA’s borrowings are estimated based on quoted market prices for the same issue. The fair values of all other financial instruments, including amounts outstanding under the ATM funding agreements approximate their book values as the instruments are short-term in nature or contain market rates of interest.

 

GCA uses the market approach when measuring the fair value of an asset or liability for recurring and nonrecurring fair value measurements categorized within Levels 1 and 2 of the fair value hierarchy.  Level 1 inputs are quoted market prices in active markets for identical assets or liabilities. Level 2 inputs are inputs other than quoted market prices that are directly or indirectly observable for the asset or liability.  The market approach uses prices and other relevant information from market transactions involving identical or comparable assets or liabilities to measure fair value.  Level 3 inputs indicate that the fair value is determined using pricing inputs that are unobservable for the investment and include situations where there is little, if any, market activity for the investment.  Significant management estimates and judgment are used in the determination of the fair value of Level 3 pricing inputs.

 

Interest Rate Cap

 

In conjunction with the terms and conditions of the New Senior Credit Facility, as described in Note 6, GCA purchased a $150.0 million notional amount interest rate cap with an effective date of January 5, 2012 and a term of three years. GCA purchased this interest rate cap to partially reduce the Company’s exposure to increases in the London Interbank Offer Rate (“LIBOR’) above 1.5% during the term of the interest rate cap with respect to its variable rate debt obligations under the New Senior Credit Facility and its obligations under the Contract Cash Solutions Agreement with Wells Fargo.  This interest rate cap is recorded in other assets in the balance sheet, and is marked-to-market based on a quoted market price with the effects offset in the income statement.  The interest rate cap carrying value and fair value approximate each other and these values are considered insignificant as of September 30, 2012.

 

The following table presents the fair value and carrying value of GCA’s borrowings (amounts in thousands):

 

		Level of Hierarchy		Fair Value			Carrying Value
September 30, 2012
New senior secured credit facility		1		$	128,398		$	126,500
December 31, 2011
New senior secured credit facility		1		$	173,565		$	174,000

 

8

 

Inventory

 

Inventory consists primarily of finished goods such as redemption kiosk devices, and includes work-in-progress and parts. The cost of inventory includes cost of materials, labor, overhead and freight. Inventory is stated at lower of cost or market accounted for using the average cost method.

 

Statement of Cash Flows Correction

 

Subsequent to the issuance of our Interim Quarterly report filed on Form 10-Q for the period ended September 30, 2011, we determined that our Unaudited Condensed Consolidated Statement of Cash Flows for this period should have reported a use of cash for the purchase of fixed assets, an investing activity, rather than a use of cash as inventory purchases, an operating activity. As a result, net cash provided by operating activities and net cash used in investing activities in the Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2011 were adjusted from amounts previously reported, as indicated in the table below.

 

Management has determined that adjusting amounts previously reported for net cash provided by operating activities and net cash used in investing activities in 2011 are not material corrections of the interim financial statements.  These amounts were presented correctly in our 2011 Annual Report on Form 10-K filed on March 12, 2012.

 

		Nine months ended September 30, 2011
		As previously reported			As corrected
Operating activities:
Changes in inventory		$	(5,307)		$	(2,575	)
Net cash provided by operating activities		$	17,442		$	20,174
Investing activities:
Purchase of property, equipment, leasehold improvements and other intangibles		$	(3,495)		$	(6,227	)
Net cash used in investing activities		$	(3,509)		$	(6,241	)

 

Recently Issued Accounting Pronouncements

 

In July 2012, the FASB issued ASU 2012-02, which provides amendments stating that an entity has the option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired.  If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action.  However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification 350 - Goodwill and Other.  An entity also has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test.  An entity will be able to resume performing the qualitative assessment in any subsequent period.  These amendments are intended to reduce cost and complexity by providing an entity with the option to make a qualitative assessment about the likelihood that an indefinite-lived intangible asset is impaired to determine whether it should perform a quantitative test.  The amendments also enhance the consistency of impairment testing guidance among long-lived asset categories by permitting an entity to assess qualitative factors to determine whether it is necessary to calculate the asset’s fair value when testing an indefinite-lived intangible asset for impairment, which is equivalent to the impairment testing requirements for other long-lived assets.  We will assess the impairment of our intangible assets and determine the most appropriate form of action, whether to perform a qualitative assessment to ascertain the validity of a quantitative measure or to bypass the qualitative assessment and conduct a quantitative impairment test.  Adoption of this amended guidance is not expected to have an impact on the Company’s financial position, results of operations or cash flows.

 

3.         ATM FUNDING AGREEMENTS

 

The Company’s Contract Cash Solutions Agreement with Wells Fargo allows for the Company to utilize funds owned by Wells Fargo to provide the currency needed for normal operating requirements for the Company’s ATMs. For the use of these funds, the Company pays Wells Fargo a cash usage fee on the average daily balance of funds utilized multiplied by a contractually defined cash usage rate.

 

9

 

Under this agreement, all currency supplied by Wells Fargo remains the sole property of Wells Fargo at all times until it is dispensed, at which time Wells Fargo obtains an interest in the corresponding settlement receivable.  As the cash is never an asset of ours, supplied cash is not reflected on our balance sheet.

 

In June 2012, the Company and Wells Fargo amended the Contract Cash Solutions Agreement to increase the maximum amount of cash to be provided to GCA from $400.0 million to $500.0 million, and the initial term of the Contract Cash Solutions Agreement was extended from November 30, 2013 until November 30, 2014.

 

As of September 30, 2012 and December 31, 2011, the outstanding balances of ATM cash utilized by GCA from Wells Fargo were $327.2 million and $467.8 million, respectively.  For the three and nine months ended September 30, 2012 and 2011, the cash usage fees incurred by the Company were $0.7 million and $2.5 million and $0.6 million and $1.9 million, respectively, and are reflected as interest expense within the condensed consolidated statements of income.

 

The Company is responsible for any losses of cash in the ATMs under its agreement with Wells Fargo.  The Company is self-insured related to this risk.  For the nine months ended September 30, 2012 and 2011, the Company incurred no material losses related to this self-insurance.

 

Site Funded ATMs

 

The Company operates ATMs at certain customer gaming establishments where the gaming establishment provides the cash required for the ATM operational needs. GCA is required to reimburse the customer for the amount of cash dispensed from these Site-Funded ATMs. The Site-Funded ATM liability is included within settlement liabilities in the accompanying condensed consolidated balance sheets and was $96.7 million and $85.9 million as of September 30, 2012 and December 31, 2011, respectively.

 

4.         BENEFIT PLANS

 

In January 2005, the Company adopted the 2005 Stock Incentive Plan (the “2005 Plan”) to attract and retain the best available personnel, to provide additional incentives to employees, directors and consultants and to promote the success of the Company’s business. The 2005 Plan is administered by the Board of Directors but may be administered by our Compensation Committee. The administrator of the 2005 Plan has the authority to select individuals who are to receive options or other equity incentive awards under the 2005 Plan and to specify the terms and conditions of grants of options or other equity incentive awards, the vesting provisions, the term and the exercise price.

 

Generally, stock options and restricted stock granted under the 2005 Plan (other than those granted to non-employee directors) will vest at a rate of 25% of the shares underlying the option after one year and the remaining shares vest in equal portions over the following 36 months, such that all shares are vested after four years. Unless otherwise provided by the administrator, an option granted under the 2005 Plan generally expires ten years from the date of grant. Stock options are issued at the closing market price on the date of grant.

 

A summary of stock option award activity under the 2005 Plan as of September 30, 2012 and changes during the nine months ended is as follows:

 

		Number of Common Shares		Weighted Average Exercise Price (Per Share)			Weighted Average Life Remaining (Years)		Aggregate Intrinsic Value
									(in thousands)
Balance outstanding - December 31, 2011		9,227,541		$	6.87		6.9		$	5,186
Granted		2,260,000
Exercised		(1,464,507)
Canceled or forfeited		(340,761)
Balance outstanding - September 30, 2012		9,682,273		$	7.07		6.8		$	19,602
Balance exercisable - September 30, 2012		5,662,015		$	8.49		5.4		$	7,578

 

10

 

The fair value of options was determined as of the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions for the nine months ended September 30, 2012 and 2011, respectively.

 

		Nine Months Ended September 30,
		2012		2011
Risk-free interest rate		1.0%		2.5%
Expected life of options (in years)		6.3		6.3
Expected volatility		62.2%		62.9%
Expected dividend yield		0.0%		0.0%

 

As of September 30, 2012, there was $10.2 million in unrecognized compensation expense related to options expected to vest.  This cost is expected to be recognized on a straight-line basis over a weighted average period of 2.7 years.  During the nine months ended September 30, 2012, the Company granted options to acquire approximately 2.3 million shares of common stock, received $5.9 million in proceeds from the exercise of options and recorded $3.7 million in non-cash compensation expense related to options granted that are expected to vest.  There were no options granted during the three months ended September 30, 2012.  The weighted average grant date fair value of options granted during the nine months ended September 30, 2012 was $3.31.  The total intrinsic value of options exercised during the three and nine months ended September 30, 2012 were $2.9 million and $5.1 million, respectively.

 

As of September 30, 2011, there was $8.2 million in unrecognized compensation expense related to options expected to vest.  This cost was expected to be recognized on a straight-line basis over a weighted average period of 0.9 years.  During the nine months ended September 30, 2011, the Company granted options to acquire approximately 2.1 million shares of common stock, received $0.6 million in proceeds from the exercise of options and recorded $5.4 million in non-cash compensation expense related to options granted that are expected to vest.

 

Restricted Stock

 

The Company began issuing restricted stock to employees in the first quarter of 2006. The vesting provisions are similar to those applicable to stock options. Because these restricted shares are issued primarily to employees of the Company, many of the shares issued will be withheld by the Company to satisfy the statutory withholding requirements applicable to the restricted stock grants. Therefore, as these awards vest the actual number of shares outstanding as a result of the restricted stock awards is reduced. These shares will vest over a period of four years. There are certain restricted stock shares that have rights to the dividends declared and voting rights, and, therefore, the shares are considered issued and outstanding prior to vesting.

 

A summary of all non-vested awards for the Company’s time-based restricted stock awards as of September 30, 2012 is as follows:

 

		Shares Outstanding		Weighted Average Grant Date Fair Value (Per Share)
Balance outstanding - December 31, 2011		198,279		$	2.20
Granted		65,000
Vested		(126,332)
Forfeited		(3,509)
Balance outstanding - September 30, 2012		133,438		$	4.35

 

As of September 30, 2012, there was $0.5 million in unrecognized compensation expense related to shares of time-based restricted shares expected to vest.  This cost is expected to be recognized on a straight-line basis over a weighted average period of 2.6 years.  During the nine months ended September 30, 2012, there were 126,332 shares of time-based restricted shares vested, and we recorded $0.3 million in non-cash compensation expense related to restricted stock granted that is expected to vest.  The total fair value of shares vested during the three and nine months ended September 30, 2012 were $0.3 million and $1.0 million, respectively.

 

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As of September 30, 2011, there was $0.6 million in unrecognized compensation expense related to shares of time-based restricted shares expected to vest.  This cost was expected to be recognized on a straight-line basis over a weighted average period of 0.5 years.  During the nine months ended September 30, 2011, there were 201,991 shares of time-based restricted shares vested, and we recorded a credit of $0.1 million in non-cash compensation expense related to the restricted stock granted that is expected to vest.

 

5.         COMMITMENTS AND CONTINGENCIES

 

Litigation Claims and Assessments

 

Automated Systems America, Inc.

 

On July 7, 2010, an action was commenced by Automated Systems America, Inc. in the United States District Court, Central District of California, against Holdings, GCA and certain current employees of GCA. The complaint seeks a declaratory judgment of invalidity, unenforceability and non-infringement of certain patents owned by the Company and alleges antitrust violations of Section 2 of the Sherman Act, unfair competition violations under the Lanham Act and tortuous interference and defamation per se. The plaintiff seeks damages in excess of $2.0 million, punitive damages, and a trebling of damages associated with the allegations under Section 2 of the Sherman Act. On March 3, 2011, the Company filed a motion to dismiss this action. In February 2012, the District Court entered an order granting the Company’s motion to dismiss this action without prejudice, allowing the plaintiff to file a new complaint if it elected to do so. The plaintiff subsequently filed an amended complaint alleging substantially similar claims to those contained in the original complaint, and the Company has filed a motion to dismiss the amended complaint. The Company has not accrued any amounts related to this matter as the Company does not believe it is probable that a loss has been incurred and has meritorious defenses and will vigorously defend this action.

 

We are also subject to a variety of other claims and suits that arise from time to time in the ordinary course of our business. We do not believe the liabilities, if any, which may ultimately result from the outcome of such matters, individually or in the aggregate, will have a material adverse impact on our financial position, liquidity or results of operations.

 

6.         BORROWINGS

 

On March 1, 2011, GCA, together with its sole stockholder, Holdings entered into a Credit Agreement (“the Credit Agreement”) with certain lenders, Deutsche Bank Trust Company Americas, as Administrative Agent and Wells Fargo Securities, LLC, as Syndication Agent. The Credit Agreement provides for a $210.0 million term loan facility and a $35.0 million revolving credit facility (the “New Senior Credit Facility”). The revolving credit facility includes provisions for the issuance of up to $10.0 million of letters of credit and up to $5.0 million in swing-line loans. We used the proceeds from the New Senior Credit Facility to repay all outstanding indebtedness under our existing senior secured credit facility under the Second Amended and Restated Credit Agreement and to defease our senior subordinated notes.

 

The Credit Agreement also contains an increase option permitting GCA to arrange with existing lenders and/or new lenders for them to provide up to an aggregate of $50.0 million in additional term loan commitments. All $210.0 million of available borrowings under the term loan facility were borrowed concurrent with the establishment of the New Senior Credit Facility. Once repaid, no amounts under the term loan facility may be re-borrowed. In addition, $4.0 million of available borrowings under the revolving credit facility were borrowed concurrent with the establishment of the New Senior Credit Facility. Once repaid, amounts under the revolving credit facility may be re-borrowed.

 

The term loan requires principal repayments of one quarter of 1% of the aggregate initial principal amount of term loans, adjusted for any non-mandatory prepayments per quarter, as well as annual mandatory prepayment provisions based on an excess cash flow sweep equal to a fixed percentage of excess cash flow (as defined in the Credit Agreement). The remaining principal is due on the maturity date, March 1, 2016. GCA may prepay the loans and terminate the commitments at any time after the first year, without premium or penalty, subject to certain qualifications set forth in the Credit Agreement. Furthermore, the Credit Agreement contains mandatory prepayment provisions which, under certain circumstances, such as asset or equity sales, obligate GCA to apply defined portions of its cash flow to prepayment of the New Senior Credit Facility.

 

Borrowings under the New Senior Credit Facility bear interest at either (x) a specified base rate plus a 4.50% margin, or (y) LIBOR plus a 5.50% margin.  The base rate minimum is 2.50% and the LIBOR minimum is 1.50%.  Interest in respect of base rate loans is payable quarterly in arrears and interest in respect of LIBOR loans is payable in arrears at the end of the applicable interest period and every three months in the case of interest periods in excess of three months. Interest is also payable at the time of repayment of any loans and at maturity.  As of September 30, 2012, we had $126.5 million of outstanding indebtedness under the New Senior Credit Facility, all of which is outstanding under the term loan facility.

 

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The weighted average interest rate, inclusive of the applicable margin of 550 basis points, was 7.0%.  We also had no amounts outstanding under our letter of credit sub facility that is part of our revolving credit facility as of September 30, 2012.  The New Senior Credit Facility is unconditionally guaranteed by Holdings and each direct and indirect domestic subsidiary of GCA.  All amounts owing under the New Senior Credit Facility are secured by a first priority perfected security interest in all stock (but only 65% of the stock of foreign subsidiaries), other equity interests and promissory notes owned by GCA and a first priority perfected security interest in all other tangible and intangible assets owned by GCA and the guarantors.

 

On September 24, 2012, the Company entered into an amendment to its Credit Agreement.  The amendment modifies certain financial covenants contained in the Credit Agreement with respect to the Company’s ability to make capital expenditures, dividends and stock repurchases. Specifically, the Company, together with its subsidiaries, may make an additional $15.0 million of capital expenditures, as such term is defined in the Credit Agreement, during the remainder of the term of the Credit Agreement, which amount is in addition to any other permitted capital expenditures under the Credit Agreement. In addition, the Credit Agreement provided that the Company could make certain dividends or stock repurchases if, among other things, the Company’s total leverage ratio (as calculated under the Credit Agreement) was less than 2.0 to 1. The amendment provides that the Company may now make certain dividends and stock repurchases if, among other things, its total leverage ratio is less than 2.5 to 1.

 

The Credit Agreement contains customary affirmative and negative covenants, financial covenants, representations and warranties and events of defaults.  As of September 30, 2012, the Company is in compliance with the required covenants.

 

7.         RELATED PARTY TRANSACTIONS

 

Michael Rumbolz, who serves as a member of our Board of Directors, also serves as a member of the board of directors of Affinity Gaming LLC (“Affinity Gaming”). The Company provides various cash access products and services to Affinity Gaming that are insignificant to the Company’s net income.  Mr. Rumbolz receives both cash and equity compensation from Affinity Gaming in consideration for serving on the board of directors of Affinity Gaming, however, none of this consideration is tied in any manner to the Company’s performance or obligations under its cash access agreements with Affinity Gaming. In addition, Mr. Rumbolz was not involved in the negotiation of the Company’s cash access agreements with Affinity Gaming.

 

In October 2012, the Company entered into a long-term lease agreement related to office space for its corporate headquarters.  Voit Real Estate Services (“Voit”) acted as the Company’s broker in connection with this transaction.  Kevin J. Higgins is an Executive Vice President of Voit, and is the brother of Mary E. Higgins, our Chief Financial Officer.  The total estimated rental payments owing by the Company under the lease agreement total $11.8 million and Voit is entitled to receive approximately $0.4 million as compensation for acting as the Company’s broker.

 

8.         INCOME TAX

 

The Company’s effective income tax rate for the three and nine months ended September 30, 2012 was 36.0% and 37.7% respectively, both of which were greater than the statutory federal rate of 35.0% due in part to state taxes and the non-deductible, non-cash compensation expenses related to incentive stock options.  The Company’s effective income tax rate for the three and nine months ended September 30, 2011 was 42.4% and 48.7% respectively, both of which were greater than the statutory federal rate of 35.0% due in part to state taxes, the non-deductible, non-cash compensation expenses related to incentive stock options and the cancellation or forfeiture of non-qualified stock options.

 

The Company accounts for uncertain tax positions in accordance with the applicable accounting guidance.  As of September 30, 2012, there has been no material change to the balance of unrecognized tax benefits reported at December 31, 2011.

 

9.         SEGMENT INFORMATION

 

Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision-making group consists of the Chief Executive Officer, President and Chief Financial Officer. The operating segments are reviewed separately because each represents products or services that can be, and often are, marketed and sold separately to our customers.

 

The Company operates in three distinct business segments: (1) cash advance, (2) ATM and (3) check services. These segments are monitored separately by management for performance against its internal forecast and are consistent with the Company’s internal management reporting. Other lines of business, none of which exceed the quantitative thresholds for segment reporting, include Western Money, credit reporting services and Casino Marketing Services, among others.

 

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The Company does not allocate depreciation and amortization expenses to the business segments.  Certain corporate overhead expenses have been allocated to the segments for identifiable items related to such segments or based on a reasonable methodology.

 

The Company’s business is predominantly domestic, with no specific regional concentrations and no significant assets in foreign locations.

 

Major Customers

 

For the three and nine months ended September 30, 2012, none of our customers had combined revenues from all segments equal to or exceeding 10.0%.  For the three and nine months ended September 30, 2012 and 2011, our five largest customers accounted for approximately 32.8% and 31.9% and 29.1% and 29.1%, respectively, of our total revenue.

 

The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies.

 

The tables below present the results of operations by operating segment for the three and nine months ended September 30, 2012 and 2011, respectively (amounts in thousands):

 

		Cash						Check
		Advance			ATM			Services			Other			Corporate			Total
Three Months Ended September 30, 2012
Revenues		$	57,520		$	76,411		$	6,611		$	9,282		$	-		$	149,824
Operating income		15,785			7,951			3,822			4,673			(17,588)			14,643
Three Months Ended September 30, 2011
Revenues		$	50,913		$	71,044		$	6,479		$	8,452		$	-		$	136,888
Operating income		7,789			8,659			3,579			4,393			(16,810)			7,610
Nine Months Ended September 30, 2012
Revenues		$	172,557		$	233,361		$	19,731		$	22,705		$	-		$	448,354
Operating income		48,388			25,620			11,017			11,563			(50,287)			46,301
Nine Months Ended September 30, 2011
Revenues		$	152,036		$	213,450		$	19,813		$	21,031		$	-		$	406,330
Operating income		23,375			27,157			11,168			10,029			(47,672)			24,057

 

The table below presents total assets by operating segment as of September 30, 2012 and December 31, 2011, respectively (amounts in thousands):

 

		September 30, 2012			December 31, 2011
Cash Advance		$	169,133		$	164,515
ATM		117,925			98,418
Check services		33,842			37,231
Other		35,231			39,570
Corporate		173,224			189,333
Total Assets		$	529,355		$	529,067

 

10.  SUBSEQUENT EVENTS

 

The Board of Directors of the Company has authorized and approved a new share repurchase program granting the Company the authority to repurchase up to $40.0 million of outstanding Company common stock over a two year period, which is expected to commence in the first quarter of 2013.   The Company intends to finance the share repurchases with cash on hand.  The repurchase program authorizes the Company to buy its common stock from time to time through open market, privately negotiated or other transactions, including pursuant to trading plans established in accordance with Rules 10b5-1 and 10b-18 of the Securities Exchange Act of 1934, as amended, or by a combination of such methods.  The share repurchase program is subject to prevailing market conditions and other considerations and may be suspended or discontinued at any time, and supersedes all other outstanding share repurchase programs of the Company.

 

In October 2012, the Company entered into a long-term lease agreement related to office space for its corporate headquarters.  The total estimated rental payments owing by the Company under the lease agreement total $11.8 million.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Our Management’s Discussion and Analysis of our Financial Condition and Results of Operations (“MD&A”) begins with an overview of our business which includes our business goals, certain trends, risks and challenges.  We then discuss our results of operations for the three and nine months ended September 30, 2012 as compared to the same period for 2011, respectively, including any recently issued accounting pronouncements, if applicable. This is followed by a description of our liquidity and capital resources, including discussions about sources and uses of cash, our borrowings, deferred tax asset, other liquidity needs and off-balance sheet arrangements. We conclude with a discussion of critical accounting policies and their impact on our unaudited condensed consolidated financial statements.

 

You should read the following discussion together with our condensed consolidated financial statements and the notes to those financial statements included in this Quarterly Report on Form 10-Q and our 2011 Annual Report on Form 10-K (our “2011 10-K”). When reviewing our MD&A, you should also refer to the description of our Critical Accounting Policies and Estimates in our 2011 10-K because understanding these policies and estimates is important in order to fully understand our reported financial results and our business outlook for future periods. In addition to historical information, this discussion contains “forward-looking statements” as defined in the U.S. Private Securities Litigation Reform Act of 1995. In this context, forward-looking statements often address our expected future business and financial performance, and often contain words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” or “will.”  These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected or assumed, including, but not limited to, the following: the timing and the extent of a recovery in the gaming industry, if any; gaming establishment and patron preferences; national and international economic conditions; changes in gaming regulatory, card association and statutory requirements; regulatory and licensing difficulties; competitive pressures; operational limitations; gaming market contraction; changes to tax laws; uncertainty of litigation outcomes; interest rate fluctuations; inaccuracies in underlying operating assumptions; unanticipated expenses or capital needs; technological obsolescence; and employee turnover. If any of these assumptions prove to be incorrect, the results contemplated by the forward-looking statements regarding our future results of operations are unlikely to be realized. Additional factors that could cause actual results to differ materially are included under the heading “Risk Factors.” These factors include, but are not limited to, those set forth in our press releases, reports and other filings made with the SEC. These cautionary statements qualify all of our forward-looking statements, and you are cautioned not to place undue reliance on these forward-looking statements. All forward-looking statements are subject to various risks and uncertainties that could cause our actual future results to differ materially from those presently anticipated due to a variety of factors, including those discussed in Item 1A of our 2011 10-K.

 

Overview

 

We are a global provider of cash access and data intelligence services and solutions to the gaming industry. Our services and solutions provide gaming establishment patrons access to cash through a variety of methods, including Automated Teller Machine (“ATM”) cash withdrawals, credit card cash access transactions, point-of-sale (“POS”) debit card transactions, check verification and warranty services and money transfers. In addition, we also provide products and services that improve credit decision-making, automate cashier operations and enhance patron marketing activities for gaming establishments. We also sell and service cash access devices such as slot machine ticket redemption and jackpot kiosks to the gaming industry.

 

Trends

 

Our strategic planning and forecasting processes include the consideration of economic and industry-wide trends that may impact our business. We have identified the more material positive and negative trends affecting our business as the following:

 

·	Although the gaming sector in the United States has experienced revenue declines over the last several years, in 2012, it has stabilized, and modestly improved, as compared to the last several years. Gaming activity continues to expand into more domestic and international markets.
·	The implementation of the Durbin Amendment in October 2011, under the Federal Reserve Board’s Final Rule that imposes caps on the amount of the debit card interchange fees, and the second quarter 2012 implementation by the card associations of a reduction in the interchange fees paid by issuing banks on ATM transactions, continues to have a material impact on our financial performance during 2012. This is due to the decrease in the amount of interchange expense that we are required to pay on both PIN-based and signature-based debit card transactions and the decrease in revenue on our ATM transactions. We believe that more changes are likely to be imposed as the industry continues to respond to these significant changes.
·	There continues to be a migration from the use of traditional paper checks and cash to electronic payments.

 

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·	The Company is facing increased competition from smaller competitors in the gaming cash access market and may face additional competition from gaming equipment manufacturers and systems providers.
·	The cash access industry in the gaming sector has become increasingly competitive and is having an adverse effect on the Company’s operating margins with respect to new customers and existing customers that have renewed their cash access agreements with the Company.
·	There is increasing governmental oversight related to the cost of transaction processing and related fees to the consumer. We expect the financial services and payments industries to respond to these legislative acts by changing other fees and costs, which may negatively impact our business in the future.

 

Results of Operations

 

Three months ended September 30, 2012 compared to three months ended September 30, 2011

 

The following table presents our unaudited condensed consolidated results of operations for the three months ended September 30, 2012 and 2011, respectively (dollars in thousands):

 

		Three Months Ended
		September 30, 2012					September 30, 2011					Sep-12 vs Sep-11
		$			%		$			%		$ Variance			% Var
Revenues
Cash advance		$	57,520		38.4%		$	50,913		37.2%		$	6,607		13%
ATM		76,411			51.0%		71,044			51.9%		5,367			8%
Check services		6,611			4.4%		6,479			4.7%		132			2%
Other revenues		9,282			6.2%		8,452			6.2%		830			10%
Total revenues		149,824			100.0%		136,888			100.0%		12,936			9%
Cost of revenues		111,373			74.3%		106,953			78.1%		4,420			4%
Operating expenses		19,463			13.0%		18,529			13.5%		934			5%
Amortization		2,650			1.8%		1,929			1.4%		721			37%
Depreciation		1,695			1.1%		1,867			1.4%		(172)			(9)%
Operating income		14,643			9.8%		7,610			5.6%		7,033			92%
Net interest expense		3,586			2.4%		4,414			3.2%		(828)			(19)%
Income before income tax provision		11,057			7.4%		3,196			2.4%		7,861			246%
Income tax provision		3,977			2.7%		1,356			1.0%		2,621			193%
Net income		$	7,080		4.7%		$	1,840		1.4%		$	5,240		285%
Other data (unaudited):
Aggregate dollar amount processed (in billions):
Cash advance		$	1.2				$	1.1				$	0.1		9%
ATM		$	3.4				$	3.0				$	0.4		14%
Check warranty		$	0.3				$	0.3				$	-		0%
Number of transactions completed (in millions):
Cash advance		2.3					2.1					0.2			8%
ATM		18.1					17.0					1.1			6%
Check warranty		1.1					1.1					-			0%

 

Total Revenues

 

Total revenues for the three months ended September 30, 2012 were $149.8 million, an increase of $12.9 million, or 9%, as compared to the same period in the prior year.   The primary driver of the increase in revenue was due to the MCA asset acquisition.

 

Cash advance revenues for the three months ended September 30, 2012 were $57.5 million, an increase of $6.6 million, or 13%, as compared to the same period in the prior year.  This was primarily due to the revenues derived from the contracts acquired in the MCA asset acquisition coupled with modest growth in our base businesses.

 

ATM revenues for the three months ended September 30, 2012 were $76.4 million, an increase of $5.4 million, or 8%, as compared to the three months ended September 30, 2011.  The growth in the quarter was primarily due to the revenues derived from the contracts acquired in the MCA asset acquisition and an increase in surcharge revenues.

 

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