UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2004March 31, 2005
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number: 000-22167
EURONET WORLDWIDE, INC.
(Exact name of the registrant as specified in its charter)
Delaware | 74-2806888 | |
(State or other jurisdiction incorporation or organization) | (I.R.S. employer
|
4601 COLLEGE BOULEVARD, SUITE 300
LEAWOOD, KANSAS 66211
(Address of principal executive offices)
(913) 327-4200
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES Yesx No¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yesx No¨
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of October 31, 2004,April 30, 2005, the Company had 32,128,84635,066,342 common shares outstanding.
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3 | ||||
ITEM 1. | 3 | |||
ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 15 | ||
ITEM 3. | 39 | |||
ITEM 4. | 40 | |||
40 | ||||
ITEM 1. | 40 | |||
ITEM 2. | 40 | |||
ITEM 6. | 41 |
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ITEM 1. FINANCIAL STATEMENTS
ITEM 1. | FINANCIAL STATEMENTS |
EURONET WORLDWIDE, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share and per share data)
As of | As of | |||||||||||||||
September 30, 2004 (unaudited) | December 31, 2003 | March 31, 2005 (unaudited) | December 31, 2004 | |||||||||||||
ASSETS | ||||||||||||||||
Current assets: | ||||||||||||||||
Cash and cash equivalents | $ | 36,892 | $ | 19,245 | $ | 72,984 | $ | 124,198 | ||||||||
Restricted cash | 57,650 | 58,280 | 107,896 | 69,300 | ||||||||||||
Trade accounts receivable, net of allowances for doubtful accounts of $1,803 at September 30, 2004 and $1,047 at December 31, 2003 | 83,373 | 75,648 | ||||||||||||||
Earnings in excess of billings on software installation contracts | 293 | 729 | ||||||||||||||
Deferred income tax | 1,830 | 2,543 | ||||||||||||||
Inventory - PINs and other | 18,224 | 18,949 | ||||||||||||||
Trade accounts receivable, net of allowances for doubtful accounts of $1,254 at March 31, 2005 and $1,373 at December 31, 2004 | 114,276 | 110,306 | ||||||||||||||
Earnings in excess of billings | 5,703 | 7,206 | ||||||||||||||
Deferred income tax assets | 2,905 | 1,637 | ||||||||||||||
Prepaid expenses and other current assets | 27,057 | 11,509 | 19,741 | 13,170 | ||||||||||||
Total current assets | 207,095 | 167,954 | 341,729 | 344,766 | ||||||||||||
Property, plant and equipment, net of accumulated depreciation of $52,181 at September 30, 2004 and $45,817 at December 31, 2003 | 34,367 | 20,658 | ||||||||||||||
Goodwill, net | 116,222 | 88,512 | ||||||||||||||
Acquired intangible assets, net of accumulated amortization of $4,385 at September 30, 2004 and $1,704 at December 31, 2003 | 25,277 | 22,772 | ||||||||||||||
Deferred income taxes | 326 | 279 | ||||||||||||||
Other assets, net of accumulated amortization of $4,896 at September 30, 2004 and $2,380 at December 31, 2003 | 6,574 | 3,598 | ||||||||||||||
Property, plant and equipment, net of accumulated depreciation of $61,088 at March 31, 2005 and $61,384 at December 31, 2004 | 42,007 | 39,907 | ||||||||||||||
Goodwill | 245,624 | 183,668 | ||||||||||||||
Acquired intangible assets, net of accumulated amortization of $6,887 at March 31, 2005 and $5,363 at December 31, 2004 | 40,579 | 28,930 | ||||||||||||||
Deferred income tax assets | 9,112 | 8,494 | ||||||||||||||
Other assets, net of accumulated amortization of $6,068 at March 31, 2005 and $5,430 at December 31, 2004 | 9,476 | 12,710 | ||||||||||||||
Total assets | $ | 389,861 | $ | 303,773 | $ | 688,527 | $ | 618,475 | ||||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||||||||
Current liabilities: | ||||||||||||||||
Trade accounts payable | $ | 115,668 | $ | 97,188 | $ | 205,020 | $ | 155,079 | ||||||||
Accrued expenses and other current liabilities | 49,248 | 39,277 | 84,567 | 107,580 | ||||||||||||
Debt obligations | 25,598 | 5,930 | ||||||||||||||
Accrued interest on notes payable | 958 | 381 | ||||||||||||||
Current installments on obligations under capital leases | 4,855 | 4,403 | ||||||||||||||
Short-term obligations | 4,233 | 4,862 | ||||||||||||||
Income taxes payable | 7,245 | 3,316 | 10,479 | 9,446 | ||||||||||||
Deferred income taxes | 1,558 | 1,374 | ||||||||||||||
Other | 5,278 | 4,460 | ||||||||||||||
Deferred income tax liabilities | 4,024 | 1,864 | ||||||||||||||
Deferred revenue | 9,350 | 9,949 | ||||||||||||||
Total current liabilities | 205,553 | 151,926 | 322,528 | 293,183 | ||||||||||||
Debt obligations | 45,090 | 59,032 | 140,000 | 140,000 | ||||||||||||
Deferred income tax | 8,271 | 7,828 | ||||||||||||||
Obligations under capital leases, excluding current installments | 15,450 | 16,894 | ||||||||||||||
Deferred income tax liabilities | 22,762 | 17,520 | ||||||||||||||
Other long-term liabilities | 2,332 | 3,118 | 2,314 | 3,093 | ||||||||||||
Minority interest | 6,341 | 5,871 | ||||||||||||||
Total liabilities | 261,246 | 221,904 | 509,395 | 476,561 | ||||||||||||
Stockholders’ equity: | ||||||||||||||||
Common Stock, $0.02 par value. Authorized 60,000,000 shares; issued and outstanding 31,713,573 shares at September 30, 2004 and 29,525,554 at December 31, 2003 | 634 | 590 | ||||||||||||||
Common stock, $0.02 par value; 60,000,000 shares authorized; 34,870,941 and 33,126,038 shares issued and outstanding at March 31, 2005 and December 31, 2004, respectively | 698 | 663 | ||||||||||||||
Additional paid-in-capital | 230,571 | 198,377 | 270,025 | 235,559 | ||||||||||||
Treasury stock | (185 | ) | (145 | ) | (149 | ) | (149 | ) | ||||||||
Employee loans for stock | (94 | ) | (427 | ) | (47 | ) | (47 | ) | ||||||||
Subscriptions receivable | 25 | 26 | (328 | ) | (180 | ) | ||||||||||
Accumulated deficit | (104,242 | ) | (117,871 | ) | (94,618 | ) | (99,444 | ) | ||||||||
Restricted reserve | 776 | 777 | 774 | 774 | ||||||||||||
Accumulated other comprehensive income | 1,130 | 542 | 2,777 | 4,738 | ||||||||||||
Total stockholders’ equity | 128,615 | 81,869 | 179,132 | 141,914 | ||||||||||||
Total liabilities and stockholders’ equity | $ | 389,861 | $ | 303,773 | $ | 688,527 | $ | 618,475 | ||||||||
See accompanying notes to the consolidated financial statements.
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EURONET WORLDWIDE, INC. AND SUBSIDIARIES
Consolidated Statements OfStatement of Operations Andand Comprehensive Income
(Unaudited, in thousands, except share and per share data)
Three months ended September 30, | Nine months ended September 30, | Three Months Ended March 31, | ||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | 2005 | 2004 | |||||||||||||||||||
Revenues: | ||||||||||||||||||||||||
EFT processing segment | $ | 20,930 | $ | 12,925 | $ | 53,872 | $ | 36,983 | ||||||||||||||||
Prepaid processing segment | 75,359 | 36,532 | 203,912 | 86,096 | ||||||||||||||||||||
Software segment | 3,635 | 3,604 | 10,217 | 11,223 | ||||||||||||||||||||
EFT Processing Segment | $ | 23,889 | $ | 14,940 | ||||||||||||||||||||
Prepaid Processing Segment | 89,381 | 62,919 | ||||||||||||||||||||||
Software Solutions Segment | 3,936 | 3,196 | ||||||||||||||||||||||
Total revenues | 99,924 | 53,061 | 268,001 | 134,302 | 117,206 | 81,055 | ||||||||||||||||||
Operating expenses: | ||||||||||||||||||||||||
Direct operating costs | 69,192 | 34,224 | 186,337 | 85,938 | 82,372 | 56,645 | ||||||||||||||||||
Salaries and benefits | 10,810 | 7,694 | 30,296 | 20,846 | 11,949 | 9,454 | ||||||||||||||||||
Selling, general and administrative | 5,733 | 4,386 | 16,313 | 10,974 | 6,138 | 4,889 | ||||||||||||||||||
Depreciation and amortization | 4,215 | 3,067 | 11,202 | 8,919 | 5,025 | 3,554 | ||||||||||||||||||
Total operating expenses | 89,950 | 49,371 | 244,148 | 126,677 | 105,484 | 74,542 | ||||||||||||||||||
Operating income | 9,974 | 3,690 | 23,853 | 7,625 | 11,722 | 6,513 | ||||||||||||||||||
Other income (expenses): | ||||||||||||||||||||||||
Interest income | 864 | 300 | 2,050 | 926 | 1,207 | 571 | ||||||||||||||||||
Interest expense | (1,769 | ) | (1,837 | ) | (5,277 | ) | (5,358 | ) | (1,588 | ) | (1,836 | ) | ||||||||||||
Gain on sale of U.K. subsidiary | — | — | — | 18,001 | ||||||||||||||||||||
Equity in income from unconsolidated subsidiaries | 164 | 246 | 268 | 380 | ||||||||||||||||||||
Income (loss) from unconsolidated affiliates | 245 | (21 | ) | |||||||||||||||||||||
Loss on early retirement of debt | (32 | ) | — | (126 | ) | — | — | (71 | ) | |||||||||||||||
Foreign exchange gain (loss), net | 419 | (234 | ) | 912 | (5,193 | ) | (2,842 | ) | 235 | |||||||||||||||
Total other income (expense) | (354 | ) | (1,525 | ) | (2,173 | ) | 8,756 | |||||||||||||||||
Total other expense | (2,978 | ) | (1,122 | ) | ||||||||||||||||||||
Income from continuing operations before income taxes | 9,620 | 2,165 | 21,680 | 16,381 | ||||||||||||||||||||
Income from continuing operations before income taxes and minority interest | 8,744 | 5,391 | ||||||||||||||||||||||
Income tax expense | (3,657 | ) | (740 | ) | (8,051 | ) | (2,310 | ) | (3,830 | ) | (2,105 | ) | ||||||||||||
Income from continuing operations | 5,963 | 1,425 | 13,629 | 14,071 | ||||||||||||||||||||
Loss from discontinued operations | — | (49 | ) | — | (51 | ) | ||||||||||||||||||
Minority interest | (88 | ) | — | |||||||||||||||||||||
Net income | 5,963 | 1,376 | 13,629 | 14,020 | 4,826 | 3,286 | ||||||||||||||||||
Translation adjustment | 521 | (361 | ) | 588 | 696 | |||||||||||||||||||
Translation adjustment, net | (1,961 | ) | (205 | ) | ||||||||||||||||||||
Comprehensive income | $ | 6,484 | $ | 1,015 | $ | 14,217 | $ | 14,716 | $ | 2,865 | $ | 3,081 | ||||||||||||
Income per share - basic: | ||||||||||||||||||||||||
Income from continuing operations per share | $ | 0.19 | $ | 0.05 | $ | 0.44 | $ | 0.54 | ||||||||||||||||
Income from discontinued operations per share | — | — | — | — | ||||||||||||||||||||
Net income per share - basic: | ||||||||||||||||||||||||
Net income per share | $ | 0.19 | $ | 0.05 | $ | 0.44 | $ | 0.54 | $ | 0.14 | $ | 0.11 | ||||||||||||
Basic weighted average shares outstanding | 31,623,233 | 26,700,521 | 30,903,488 | 26,158,391 | 33,883,451 | 30,120,295 | ||||||||||||||||||
Income per share - diluted: | ||||||||||||||||||||||||
Income from continuing operations per share | $ | 0.17 | $ | 0.05 | $ | 0.40 | $ | 0.49 | ||||||||||||||||
Income from discontinued operations per share | — | — | — | — | ||||||||||||||||||||
Net income per share - diluted: | ||||||||||||||||||||||||
Net income per share | $ | 0.17 | $ | 0.05 | $ | 0.40 | $ | 0.49 | $ | 0.13 | $ | 0.10 | ||||||||||||
Diluted weighted average shares outstanding | 34,698,436 | 29,232,003 | 34,018,812 | 28,431,142 | 36,528,742 | 33,351,456 | ||||||||||||||||||
See accompanying notes to the unaudited consolidated financial statements.
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EURONET WORLDWIDE, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited, in thousands)
Nine months ended September 30, | Three Months Ended March 31, | |||||||||||||||
2004 | 2003 | 2005 | 2004 | |||||||||||||
Net income | $ | 13,629 | $ | 14,020 | $ | 4,826 | $ | 3,286 | ||||||||
Adjustments to reconcile net income to net cash used in operating activities: | ||||||||||||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||||||
Depreciation and amortization | 11,202 | 8,919 | 5,025 | 3,554 | ||||||||||||
Unrealized foreign exchange (gain) loss | (388 | ) | 5,145 | 2,724 | (672 | ) | ||||||||||
Gain on sale of U.K. subsidiary | — | (18,001 | ) | |||||||||||||
Gain on on disposal of fixed assets | — | (931 | ) | |||||||||||||
Deferred income tax (benefit) expense | (662 | ) | 2,933 | |||||||||||||
Change in operating assets and liabilities, net of effects of acquisitions: | ||||||||||||||||
Gain on disposal of fixed assets | (92 | ) | — | |||||||||||||
Deferred income tax expense | 333 | 1,563 | ||||||||||||||
Income assigned to minority interest | 88 | — | ||||||||||||||
Accretion of discount on notes payable | — | 31 | ||||||||||||||
Amortization of debt obligations issuance expense | 223 | — | ||||||||||||||
Changes in working capital, net of amounts acquired: | ||||||||||||||||
Increase in income taxes payable, net | 779 | 1,561 | ||||||||||||||
Decrease (increase) in restricted cash | 630 | (13,380 | ) | (38,596 | ) | 20,667 | ||||||||||
Decrease (increase) in inventory | 725 | (2,864 | ) | |||||||||||||
Decrease (increase) in trade accounts receivable | (5,450 | ) | 6,205 | (2,773 | ) | 414 | ||||||||||
Increase in prepaid expenses and other current assets | (8,007 | ) | (2,534 | ) | ||||||||||||
Decrease in trade accounts payable | 7,831 | 4,581 | ||||||||||||||
Increase in accrued expenses and other liabilities | 13,778 | 5,203 | ||||||||||||||
Decrease (increase) in accrued income | 1,503 | (1,712 | ) | |||||||||||||
Decrease (increase) in prepaid expenses and other current assets | (6,801 | ) | 3,293 | |||||||||||||
Increase (decrease) in trade accounts payable | 33,968 | (2,962 | ) | |||||||||||||
Decrease in deferred revenue | (1,378 | ) | (1,325 | ) | ||||||||||||
Increase (decrease) in accrued expenses and other liabilities | 7,741 | (14,025 | ) | |||||||||||||
Other, net | 2,040 | (1,292 | ) | 1,604 | (1,402 | ) | ||||||||||
Total adjustments and changes in working capital | 5,073 | 6,121 | ||||||||||||||
Net cash provided by operating activities | 34,603 | 10,868 | 9,899 | 9,407 | ||||||||||||
Cash flows from investing activities: | ||||||||||||||||
Acquisitions, net of cash acquired | (3,684 | ) | (28,712 | ) | (55,969 | ) | (2,600 | ) | ||||||||
Sale of U.K. subsidiary | — | 24,418 | ||||||||||||||
Proceeds from sale of fixed assets | 164 | — | ||||||||||||||
Fixed asset purchases | (6,047 | ) | (2,713 | ) | (3,041 | ) | (2,000 | ) | ||||||||
Proceeds from sale of fixed assets | — | 2,910 | ||||||||||||||
Other, net | (1,828 | ) | (966 | ) | ||||||||||||
Purchase of intangible and other long term assets | (465 | ) | (65 | ) | ||||||||||||
Net cash used in investing activities | (11,559 | ) | (5,063 | ) | (59,311 | ) | (4,665 | ) | ||||||||
Cash flows from financing activities: | ||||||||||||||||
Proceeds from issuance of shares and other capital contributions | 5,495 | 3,022 | 3,369 | 1,769 | ||||||||||||
Debt obligation repayments | (15,790 | ) | (4,806 | ) | ||||||||||||
Debt issuances | 5,067 | — | ||||||||||||||
Repayment of obligations under capital leases | (2,048 | ) | (6,550 | ) | ||||||||||||
Net repayments on short-term borrowings | (236 | ) | — | |||||||||||||
Other, net | (309 | ) | (3,077 | ) | — | (2 | ) | |||||||||
Net cash used in financing activities | (5,537 | ) | (4,861 | ) | ||||||||||||
Net cash provided by (used in) financing activities | 1,085 | (4,783 | ) | |||||||||||||
Effect of exchange differences on cash | 140 | (114 | ) | (2,887 | ) | 64 | ||||||||||
Net increase in cash and cash equivalents | 17,647 | 830 | ||||||||||||||
Net increase (decrease) in cash and cash equivalents | (51,214 | ) | 23 | |||||||||||||
Cash and cash equivalents at beginning of period | 19,245 | 12,021 | 124,198 | 19,245 | ||||||||||||
Cash and cash equivalents at end of period | $ | 36,892 | $ | 12,851 | $ | 72,984 | $ | 19,268 | ||||||||
Interest paid during the period | $ | 4,615 | $ | 3,612 | $ | 624 | $ | 1,069 | ||||||||
Income taxes paid during the period | $ | 2,980 | $ | 274 | 2,937 | 998 |
See accompanying notes to the unaudited consolidated financial statements.
See Note 4 for details of significant non-cash transactions.
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EURONET WORLDWIDE, INC. AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1—(1) GENERAL
Basis of Presentation
The accompanying unaudited consolidated financial statements of Euronet Worldwide, Inc. and Subsidiaries (Euronet(“Euronet” or the Company)“Company”) have been prepared from the records of the Company, in conformity with accounting principles generally accepted accounting principles ofin the United States of America and pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, such unaudited consolidated financial statements includecontain all adjustments (consisting only of normal recurring accruals)interim closing procedures) necessary to present fairly the financial position of the Company at September 30, 2004,March 31, 2005 and the results of its operations for the three- and nine-month periods ended September 30, 2004 and 2003, and cash flows for the nine-monththree-month periods ended September 30, 2004March 31, 2005 and 2003.2004.
Balance sheet amounts as of December 31, 2003 were derived from the Company’s audited financial statements for the year ended December 31, 2003. The unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements of Euronet for the year ended December 31, 2003,2004, including the notes thereto, set forth in the Company’s Form 10-K filed with the Securities and Exchange Commission (SEC).10-K.
Reclassifications – Certain prior year amounts have been reclassified to conform to the current year consolidated financial statement presentation.
TheDuring the third quarter 2004, the Company changed the manner in which it reports EFT Processing Segment direct costs, salaries and benefits and sales, general and administrative (SG&A) expenses in the third quarter of 2004.expenses. In prior periods, processing center costs were charged and then allocated from SG&A to direct costs on the basis of a standard rate per transaction. Management has evaluated the method and believes that the specific assignment of processing center salaries and related costs, together with other costs directly attributable to the center, is a preferred method and more appropriately reflects the variable and non-variable nature of the Company’s operating expenses. Prior periodsPeriods prior to the third quarter 2004 have been conformed to ensure consistent presentation. This change in presentation does not impact consolidated operating income or net income for any period presented.
The results of operations for the three- and nine-month periodsthree-month period ended September 30, 2004March 31, 2005 are not necessarily indicative of the results to be expected for the full year.
NOTE 2—(2) SIGNIFICANT ACCOUNTING POLICIES AND RECENTLY ADOPTED ACCOUNTING STANDARDSPRACTICES
For a description of the accounting policies of the Company, see Note 3 to the audited consolidated financial statementsAudited Consolidated Financial Statements as of and for the year ended December 31, 20032004 set forth in the Company’s Form 10-K.
NOTE 3—EARNINGS(3) NET INCOME PER SHARE—BASIC AND DILUTEDSHARE
Basic earnings per share havehas been computed by dividing net income by the weighted average number of common shares outstanding. DilutiveDiluted earnings per share reflect the potential dilution that could occur if dilutive stock options and warrants were exercised using the treasury stock method, where applicable. The following table provides a reconciliation of the weighted average number of common shares outstanding to the fully diluted weighted average number of common shares outstanding:
Three months ended September 30, | Nine months ended September 30, | |||||||
2004 | 2003 | 2004 | 2003 | |||||
Basic weighted average shares outstanding | 31,623,233 | 26,700,521 | 30,903,488 | 26,158,391 | ||||
Convertible warrants outstanding | 201,250 | 146,065 | 202,616 | 129,597 | ||||
Stock options outstanding* | 2,873,953 | 2,385,417 | 2,912,708 | 2,143,154 | ||||
Potentially diluted weighted average shares outstanding | 34,698,436 | 29,232,003 | 34,018,812 | 28,431,142 | ||||
Three Months Ended March 31, | ||||
2005 | 2004 | |||
Basic weighted average shares outstanding | 33,883,451 | 30,120,295 | ||
Additional shares from assumed conversion of warrants | — | 196,572 | ||
Incremental shares from assumed conversion of stock options | 2,645,291 | 3,034,589 | ||
Potentially diluted weighted average shares outstanding | 36,528,742 | 33,351,456 | ||
5
The table aboveincludes options with strike prices below the average fair market value of Euronet common shares during the period. The table does not reflect 125,000 options of 774,000 and 697,000 for the three and nine months ended September 30, 2004, respectively, that have an exercise price in excess of the average market price of Euronet common shares during the period. These options may have an additional dilutive effect in the future if the average market value of Euronet common shares rises above the exercise price of the options. In December 2004, the Company issued convertible senior debentures that if converted in the future, would have a potentially dilutive effect on the Company’s stock. The debentures are convertible into 4.2 million shares of Common Stock, subject to adjustment. As required by Emerging Issues Task Force (EITF) Issue No. 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings per Share,” the dilutive impact of the contingently issuable shares must be included in the calculation of diluted net income per share under the “if-converted” method, regardless of whether the conditions upon which the debentures would be convertible into shares of the Company’s Common Stock have been met. Since the assumed conversion of the debentures under the if-converted method is anti-dilutive for the three-months ended March 31, 2005, the impact has been excluded from the calculation of diluted net income per share.
NOTE 4—BUSINESS COMBINATIONS AND PURCHASES- 6 -
Investments Accounted for Using the Cost Method
Under the cost method of accounting, there is no recognition of an investee company’s periodic income or loss from operations in the Consolidated Statement of Operations and Comprehensive Income of Euronet. If additional ownership interest is acquired and Euronet obtains a position of significant influence or a control position, equity in the unconsolidated subsidiary will be recognized or the operating results will be consolidated under the equity or consolidation method of accounting, depending on the ownership percentage. Income is recorded if any dividends are received and management monitors its cost method investments for impairment.
Acquisition of 10% Ownership Shares in ATX Software Ltd.
In May 2004, Euronet purchased 10% of the shares of ATX Software Ltd. (ATX), a provider of electronic prepaid voucher solutions headquartered in the U.K. The purchase price was approximately $2.8 million. The Company issued 125,000 shares of Euronet Common Stock for the ATX shares. Euronet was granted an option to purchase an additional 41% of the shares of ATX at any time prior to April 1, 2005.
ATX offers software or outsourcing solutions for prepaid processing to existing scratch card distributors willing to switch to electronic top-up solutions. ATX’s network and transaction processing centers in London and Paris support approximately 20,000 devices using secure protocols and processes over 2.5 million transactions a month. ATX works directly with scratch card distributors, who in turn contract with individual retailers. ATX has customers in more than 25 countries, including Belgium, Switzerland, Spain, Holland, Greece, Romania, Tunisia, Nigeria, Gabon, Ghana, Senegal, Cameroon, China, French West Indies, Denmark, Morocco, Mali, South Africa, Burkina Faso, Bahamas, Jamaica, Luxembourg, Pakistan, Reunion, Puerto Rico, Fiji and Israel.
In June 2004, Euronet filed a registration statement with the SEC to enable the public resale of the Common Stock received by the former shareholders of ATX. The Common Stock issued at the closing of the transaction may be transferred by the holders upon receipt of such shares (subject to the escrow provision described above) as of the effective date of the SEC registration statement, which occurred in July 2004.
Acquisitions Accounted for Under the Consolidation Method of Accounting and SFAS 141(4) ACQUISITIONS
In accordance with SFASStatement of Financial Accounting Standards (SFAS) No. 141, “Business Combinations,” the Company allocates the purchase price of its acquisitions to the tangible assets, liabilities and intangible assets acquired based on their estimated fair values. The excess purchase price over those fair values is recorded as goodwill. The fair value assigned to intangible assets acquired is supported by valuations using estimates and assumptions provided by management. For larger acquisitions management engagesengaged an appraiser to assist in the evaluation.
2005 Acquisitions:
Acquisition of Dynamic Telecom, Inc.
In March 2005, Payspot (a wholly-owned subsidiary of Euronet) purchased substantially all of the assets of Dynamic Telecom, Inc. (“Dynamic”), a company based in Iowa. Dynamic distributes several types of prepaid products including wireless, long distance and gift cards via point of sale (POS) terminals in convenience store chains throughout the U.S. The purchase price of $11.1 million consisted of 434,116 shares of Euronet Common Stock, valued at $10.8 million, and $0.3 million in cash. Of the 434,116 shares of Common Stock, 206,547 shares will be held in escrow and released, subject to certain performance criteria and indemnification claims. There are also additional earn-out payments to be calculated based on certain performance criteria for the second and fourth quarter 2005, as specified in the purchase agreement. The total of these payments is currently estimated to be between $7 million and $10 million, which will be recorded as additional goodwill when determined beyond a reasonable doubt. The Company has the option of paying the earn-out in Euronet Common Stock or a combination of cash and Euronet Common Stock.
The following table summarizes the allocation of the purchase price to the fair values of the acquired tangible and intangible assets at the acquisition date. The Company’s allocation of the purchase price to the fair values of acquired tangible and intangible assets remains preliminary while management completes its evaluation of the fair value of the net assets acquired.
Description (all dollar amounts in thousands) | Estimated Life | Amount | ||||
Current assets | $ | 87 | ||||
Property, plant & equipment | various | 679 | ||||
Customer relationships | 8 years | 3,488 | ||||
Goodwill | Indefinite | 8,098 | ||||
Assets acquired | 12,352 | |||||
Deferred income tax | (1,300 | ) | ||||
Net assets acquired | $ | 11,052 | ||||
Acquisition of Telerecarga S.L.
In March 2005, Euronet purchased 100% of the assets of Telerecarga. S.L. (“Telerecarga”), a Spanish company that distributes prepaid wireless airtime and other prepaid products via POS terminals throughout Spain. The purchase price of €38.0 million (approximately $50.8 million) was settled through the assumption of €23.0 million (approximately $30.7 million) in liabilities together with, in the second quarter 2005, a cash payment of €12.6 million (approximately $16.8 million) and the assumption of €2.4 million (approximately $3.3 million) in liabilities; the second quarter cash payment and liability assumption are subject to certain performance conditions, which Euronet expects will be met. Accordingly, the Company has recorded an accrued purchase price liability of $20.1 million as of March 31, 2005, which is included in “Accrued expenses and other current liabilities” in the Company’s consolidated balance sheet.
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The following table summarizes the allocation of the purchase price to the fair values of the acquired tangible and intangible assets at the acquisition date. The Company’s allocation of the purchase price to the fair values of acquired tangible and intangible assets remains preliminary while management completes its evaluation of the fair value of the net assets acquired.
Description (all dollar amounts in thousands) | Estimated Life | Amount | ||||
Property, plant & equipment | various | $ | 2,139 | |||
Customer relationships | 8 years | 7,246 | ||||
Goodwill | Indefinite | 43,957 | ||||
Assets acquired | 53,342 | |||||
Deferred income tax | (2,536 | ) | ||||
Net assets acquired | $ | 50,806 | ||||
Increase in ownership of ATX Software, Ltd.
In March 2005, the Company exercised its option to acquire an additional 41% of the shares of ATX Software Ltd. (“ATX”) and increased its investment in ATX to 51% for a purchase price of €8.0 million, which was settled through a cash payment of €4.0 million (approximately $5.3 million) and the issuance of 215,644 shares of Euronet Common Stock with an estimated fair value of $5.6 million at the date of issuance. Of the purchase price, €1.0 million (approximately $1.3 million) is being held in escrow to be released quarterly through March 31, 2006, subject to the collection of certain trade accounts receivable. The acquisition was accounted for at fair value as a step acquisition in accordance with SFAS No. 141. Euronet’s $0.1 million share of dividends declared prior to acquiring control of ATX was recognized as income from unconsolidated affiliates during the first quarter 2005. As described below under “2004 Acquisitions,” Euronet originally acquired a 10% investment in ATX in May 2004. With our increase in ownership from 10% to 51%, we are now required to consolidate ATX’s financial position and results of operations.
The following table summarizes the allocation of the purchase price to the fair values of Euronet’s 51% share of the acquired tangible and intangible assets at the acquisition date. The Company’s allocation of the purchase price to the fair values of acquired tangible and intangible assets remains preliminary while management completes its evaluation of the fair value of the net assets acquired.
Description (all dollar amounts in thousands) | Estimated Life | Amount | ||||
Net assets | various | $ | 369 | |||
Customer relationships | 8 years | 781 | ||||
Software | 5 years | 338 | ||||
Goodwill | Indefinite | 12,729 | ||||
Assets acquired | 14,217 | |||||
Deferred income tax | (419 | ) | ||||
Net assets acquired | $ | 13,798 | ||||
2004 Acquisitions:
Acquisition of Prepaid Concepts, Inc.
In January 2004, PaySpot purchased all of the share capital of Prepaid Concepts, Inc. (Precept), a company based in California that distributes prepaid services via POS terminals throughout the U.S. The purchase price of $17.8 million was settled through the issuance of 527,180 shares of Euronet Common Stock, payment of $4.0 million in cash and issuance of $4.0 million in promissory notes bearing interest at an annual rate of 7%. Of the issued shares of Common Stock, 160,000 shares were held in escrow and a portion was released in March 2005, with the remaining shares, valued at $1.4 million, retained in escrow until August 2005, subject to any indemnification claims. The promissory notes, including accrued interest, were repaid in cash during 2004.
Acquisition of Electronic Payment Solutions
In May 2004, PaySpot purchased all of the net assets of Electronic Payment Solutions (EPS), a company based in Texas that distributes prepaid services via POS terminals throughout the U.S. The purchase price of $2.2 million was settled through the issuance of 107,911 shares of Euronet Common Stock. Of the issued shares of Common Stock, 50% of the shares will be held in escrow, with 25% being released in May 2005 and the final 25% being released in May 2006, subject to certain performance
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criteria. The Company also agreed to deliver cash in consideration for the net current assets acquired. Additionally, subject to certain performance criteria, there is a potential earn-out payment payable in Common Stock, currently estimated to be approximately $0.8 million, which will be paid during the second quarter 2005 in Euronet Common Stock. The shares issued related to the earn-out payment will be held in escrow until May 2006. Goodwill will be increased by the amount of additional consideration, if any. The Company’s allocation of the purchase price to the fair values of acquired tangible and intangible assets remain preliminary while management completes its evaluation of the fair value of the net assets acquired.
Initial investment in ATX Software, Ltd.
In May 2004, Euronet purchased 10% of the shares of ATX, a provider of electronic prepaid voucher solutions incorporated in the U.K. ATX offers software or outsourcing solutions for prepaid processing to existing scratch card distributors willing to switch to electronic top-up solutions. ATX has customers in more than 25 countries and works directly with scratch card distributors, who in turn contract with the mobile operators individual retailers. The purchase price of $2.9 million, including professional fees, was settled through the issuance of 125,590 shares of Euronet Common Stock for the ATX shares. Euronet was also granted an option to purchase an additional 41% of the shares of ATX at any time prior to April 1, 2005, which, as discussed above, Euronet exercised in March 2005.
Acquisition of Call Processing, Inc.
In July 2004, EuronetPaySpot purchased all of the share capital of Call Processing, Inc. (CPI), a company based in Texas withthat provides prepaid wireless processing and other services to convenience store chains throughout the U.S. CPI provides these services through a network of retail locations, all of which have electronic distribution of prepaid services via POS terminals. CPI provides several types of prepaid products, including prepaid wireless, prepaid long distance, prepaid gift cards, age verification and other services. The purchase price of $6.6 million was settled through a cash payment of $0.7 million and issuance of 281,916 shares of Euronet Common Stock, valued at approximately $5.9 million, to the former share holdersshareholders of CPI. Of the issued shares of Common Stock, 65,104 shares will be held in escrow and released on July 1, 2005 and 60,690 shares will be held in escrow and released on June 30, 2006, subject to certain performance criteria. If the average share price of the Company’s Common Stock is less than $22.66 on the 20 trading days prior to the date the shares are released from escrow, the Company will pay the aggregate difference between $22.66 and that average share price in either cash or through the issuance of additional shares of Common Stock, at the Company’s discretion. In addition, there iswas a potential earn-out payment payable in Common Stock, currently estimated to be up to $1.8 million due in March 2005.
CPI isStock. In February 2005, the Company fully settled this earn-out obligation with a providercash payment of prepaid wireless processing and other services to convenience store chains throughout the U.S. through a network of retail locations, all of which have electronic distribution of prepaid services via point-of-sale (POS) terminals. CPI provides several types of prepaid products, including prepaid wireless, prepaid long distance, prepaid gift cards, age verification and other services. Euronet will use CPI’s resources to enhance the$0.3 million. Goodwill was increased for this additional consideration paid. The Company’s U.S. prepaid business, called PaySpot, which enables customers to purchase airtime and long-distance calling plans from POS terminals across the country.
The following table summarizes the total cost of the acquisition of CPI. Note that all amounts are included asallocation of the purchase price date. Certain minor changes to these amounts may be made due to final purchase price allocations and adjustments to acquisition costs (unaudited, in thousands except shares):
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Consideration paid – estimated fair value of Euronet Common Stock (281,916 shares) | $ | 6,444 | |
Cash | 697 | ||
Transaction costs and share registration fees | 18 | ||
Total purchase price | $ | 7,159 | |
Under the purchase method of accounting, management has made a preliminary allocation of the total purchase price to the fair values of acquired tangible and intangible assets based on an estimateremain preliminary while management completes its evaluation of their fair values at the acquisition date. The purchase price was allocated as follows (unaudited, in thousands):
Description | Estimated Life | Amount | ||||
Net tangible assets acquired | various | $ | 710 | |||
Customer relationships | 8 years | 670 | ||||
Software | 5 years | 525 | ||||
Goodwill | N/A | 5,660 | ||||
Less: Deferred income tax | (406 | ) | ||||
Total value assigned to tangible and intangible assets | $ | 7,159 | ||||
Goodwill represents the excess of the purchase price of an acquired business over the fair value of the underlying net tangible and intangible assets.
In August 2004, Euronet filed a registration statement with the SEC to enable the public resale of the Common Stock received by the former shareholders of CPI. The Common Stock issued at the closing of the transaction may be transferred by the holders upon receipt of such shares (subject to certain escrow provisions) as of the effective date of the SEC registration statement, which occurred in August 2004.assets acquired.
Acquisition of Electronic Payment SolutionsMovilcarga
In MayNovember 2004, Euronet purchased all of theindirectly acquired certain prepaid mobile phone top-up assets and assumed alla network of POS terminals through which mobile phone time is distributed, contracts with retailers that operate the liabilities of Electronic Payment Solutions (EPS)POS terminals, certain employees, and various operating contracts from Grupo Meflur Corporacion (Meflur), a Spanish telecommunications distribution company (“Movilcarga Assets”). With this acquisition Euronet entered into a service agreement with Meflur to provide certain administrative and support functions necessary to operate the Movilcarga Assets, a lease agreement for office space and a license agreement for technology used to process transactions. To implement the acquisition, Euronet purchased 80% of a non-operating Spanish subsidiary (“Movilcarga”) that acquired the Movilcarga Assets. Meflur owns the remaining 20%. Euronet purchased the Movilcarga Assets for €18.0 million (approximately $23.1 million) in two installments: €8.0 million in cash at closing and €10.0 million in cash paid in January 2005 that was subject to certain revenue targets and adjustments. The revenue targets were met as of December 31, 2004; therefore, €10.0 million (approximately $13.0 million) was recorded as a purchase price payable, and included in the asset allocation, as of December 31, 2004. Additional payments may be due during the first quarters of 2007 and 2008, subject to the fulfillment of certain financial conditions. The Company estimates that, based on information from Meflur, these additional payments will total approximately €7.0 million to €10.0 million (approximately $9.0 million to $12.9 million). The additional payments may be made, at the option of Euronet, in Texas, through the issuanceeither cash or a combination of 107,911 shares ofcash and Euronet Common Stock. Of the issued shares of Common Stock, 55,000 sharesGoodwill will be held in escrow, with 27,500 being released in 12 months and 27,500 being released in 24 months, subject to certain performance criteria. The Seller also agreed to deliver cash of $0.1 million in consideration for the net current liabilities assumedincreased by the Company. In addition, there isamount of additional consideration, if any, when determined beyond a potential earn-out payment payable in Common Stock, currently estimated to be approximately $1.0 million, one-half of which will be paid in March 2005, subject to certain performance criteria. One-half of the shares of Common Stock issued as part of the earn-out payment will be held in escrow for 12 months from the date of issuance.
EPS distributes prepaid services via POS terminals. Euronet will use EPS’s resources to enhance the PaySpot business.
reasonable doubt. The following table summarizes the total cost of the acquisition of EPS. Certain minor changes are ongoing due to final purchase price allocations and adjustments to acquisition costs (unaudited, in thousands except shares):
Consideration paid – estimated fair value of Euronet Common Stock (107,911 shares) | $ | 2,211 | ||
Reimbursement for liabilities assumed | (110 | ) | ||
Total purchase price | $ | 2,101 | ||
Under the purchase method of accounting, management has made a preliminaryCompany’s allocation of the total purchase price to the fair values of acquired tangible and intangible assets based on an estimateremain preliminary while management completes its evaluation of their fair values at the acquisition date. The purchase price was allocated as follows (unaudited, in thousands):
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Description | Estimated Life | Amount | |||
Net tangible assets acquired | various | $ | 458 | ||
Customer relationships | 8 years | 450 | |||
Software | 5 years | 50 | |||
Goodwill | N/A | 1,143 | |||
Total value assigned to tangible and intangible assets | $ | 2,101 | |||
Goodwill represents the excess of the purchase price of an acquired business over the fair value of the underlying net tangible and intangible assets.
In June 2004, Euronet filed a registration statement with the SEC to enable the public resale of the Common Stock received by the former shareholders of EPS. The registration statement became effective in July 2004. The Common Stock issued at the closing of the transaction may be transferred by the holders upon the effective date of registration of such shares (subject to the escrow provision described above).
Acquisition of Prepaid Concepts, Inc.
In January 2004, Euronet purchased all of the share capital of Prepaid Concepts, Inc. (Precept), a company based in California in consideration of the issuance of 527,180 shares of Euronet Common Stock, $4.0 million in cash and $4.0 million in promissory notes. Of the issued shares of Common Stock, 160,000 shares will be held in escrow and released on February 25, 2005 subject to certain performance criteria. Of the $4.0 million in promissory notes, $2.0 million are convertible into shares of Euronet Common Stock as described more fully below. The principal terms of the promissory notes issued in this transaction are as follows:
Precept distributes prepaid services via POS terminals. Euronet will use Precept’s resources to enhance the PaySpot business.
The following table summarizes the total cost of the acquisition of Precept. Certain minor changes to these amounts may be made due to final purchase price allocations and adjustments to acquisition costs (unaudited, in thousands except shares):
Cash paid at closing | $ | 4,000 | |
Notes payable | 4,000 | ||
Estimated fair value of Euronet Common Stock (527,180 shares) | 9,801 | ||
Transaction costs and share registration fees | 28 | ||
Total purchase price | $ | 17,829 | |
Under the purchase method of accounting, management has made a preliminary allocation of the total purchase price to the acquired tangible and intangible assets based on an estimate of their fair values at the acquisition date. The purchase price was allocated as follows (unaudited, in thousands):
Description | Estimated Life | Amount | |||
Net tangible assets acquired | various | $ | 313 | ||
Customer relationships | 8 years | 3,367 | |||
Software | 5 years | 118 | |||
Goodwill | N/A | 15,216 |
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Less: Deferred income tax | (1,185 | ) | ||
Total value assigned to tangible and intangible assets | $ | 17,829 | ||
Goodwill represents the excess of the purchase price of an acquired business over the fair value of the underlying net tangible and intangible assets.
In February 2004, Euronet filed with the SEC a registration statement to enable the public resale of the Common Stock received by the former shareholders of Precept. The registration statement became effective in February 2004. The Common Stock issued at the closing of the transaction and issuable upon conversion of the convertible notes may be transferred by the holders upon the effective date of registration of such shares (subject to the escrow provision described above).
Acquisitions of e-pay, AIM and transact
In February 2003, the Company purchased 100% of the shares of e-pay Limited (“e-pay”), an electronic payments processor of prepaid mobile phone airtime top-up services in the U.K. and Australia. Subsequent to the acquisition, e-pay added service in Ireland, Poland and New Zealand. Substantially all of the purchase price was allocated to intangible assets including goodwill. The assets acquired include tangible long-term assets, such as computer equipment and other fixed assets, working capital, and intangible assets, such as software, trademarks and trade names, customer relationships, and goodwill.
In September 2003, the Company acquired the assets of Austin International Marketing and Investments, Inc. (AIM), a U.S.-based company that distributed prepaid services via POS terminals in 36 states. The assets of AIM were initially purchased on an “earn-out” basis over two years based upon defined financial results of the network purchased, with maximum total consideration of $7.5 million. Of the purchase price, $2.0 million was paid at closing in cash and Euronet stock, and the remainder was to be paid 30% in cash and 70% in Euronet Common Stock valued at market prices at time of payment. In September 2004, the purchase agreement was modified to pay the remaining consideration through the issuance of 283,976 shares of Euronet Common Stock. Of the issued shares of Common Stock, 168,068 will be held in escrow; 110,114 shares will be released on September 30, 2005 and are not subject to any performance criteria, and 57,954 will be released on December 31, 2006 subject to certain performance criteria. The value of the shares above is reflected as an adjustment to the purchase price as of September 30, 2004.
In November 2003, the Company purchased 100% of the shares of transact Elektronische Zahlungssysteme GmbH, which it refers to as “transact,” a company based in Germany. The transfer of the transact shares to the Company is staged, with 96% of the transact shares transferred at closing and the remaining 4% transferred upon payment by the Company on January 14, 2005 of the “earn-out” payment described below. The Company paid approximately $17.8 million in cash and issued 643,048 shares of Common Stock for the transact shares. Based upon the financial performance of transact over the three-month period ended September 30, 2004, the future payment is estimated to be between $20.0 million and $30.0 million. No amounts have been recorded at September 30, 2004 for this contingent obligation because the final payment amount could not be estimated beyond reasonable doubt. Based upon the estimated payout range, the Company could issue between 666,667 and 1,000,000 additional shares of Common Stock to transact selling stockholders on January 14, 2005. However, because the shares issued and issuable pursuant to the transact and Fletcher (discussed below) transactions may be considered to be part of the same transaction for purposes of the Nasdaq Marketplace Rules, the Company has agreed not to issue more than approximately 705,500 shares of Common Stock to pay the earn-out payment without prior stockholder approval. The Company is required to pay in cash any amount of the earn-out payment that is not paid in shares of Euronet Common Stock.
To finance the transact acquisition, Euronet privately placed 1,131,363 shares of Common Stock with Fletcher International, Ltd. (Fletcher), an accredited institutional investor, and received proceeds of $20.0 million. The per share purchase price of approximately $17.68 was based on the volume-weighted average price for shares of Common Stock on November 19, 2003, plus $2.00 per share. In addition, Euronet granted Fletcher certain “additional investment rights” entitling Fletcher to purchase up to an additional $16.0 million in value of Euronet Common Stock. The shares of Common Stock subject to the additional investment rights may be purchased at a per share price equal to either (i) the prevailing price at the time of exercise of the additional investment rights (based on a volume-weighted average formula) or (ii) if the prevailing price is less than $17.68, the prevailing price minus $2.00 per share. The additional investment rights were exercisable by Fletcher on one or more occasions commencing March 19, 2004, and for the 15-month period thereafter, which period could be extended under certain circumstances. The additional investment rights, under certain circumstances, could be exercised on a “net settlement basis,” under which Fletcher was not required to purchase shares, but received a number of shares of Common Stock that corresponded to any discount between the price Fletcher was to pay for the stock and the then-current market price of the Common Stock that Fletcher could have purchased from Euronet.
In April 2004, Fletcher exercised 50% of its additional investment rights in accordance with its agreement with Euronet, resulting in a net share settlement to Fletcher of 233,451 shares. In May 2004, Fletcher delivered a notice of exercise of the remaining 50% of their
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additional investment rights, which would result in a net share settlement to Fletcher of 190,248 shares; however, Fletcher has suspended such exercise pending discussions regarding an alternative investment in Euronet.acquired.
Pro Forma Resultsforma results
The following unaudited pro forma financial information presents the condensed combined results of operations of Euronet for the three and nine months ended September 30, 2003March 31, 2005 and 2004 as if the acquisitions of e-pay, AIM, transact, Precept, EPS and CPIdescribed above had occurred as of January 1, 2003. All acquisitions were included in the reported figures for the three months ended September 30, 2004, and accordingly, pro forma results are not required. A pro forma results table is included for the nine months ended September 30, 2004 because the EPS and CPI acquisitions were not included in the reported results for the entire nine months.2004. An adjustment was made to the combined results of operations, reflecting amortization of purchased intangible assets, net of tax, which would have been recorded if the acquisition had occurred at the beginning of the periods presented. The unaudited pro forma financial information is not intended to represent or be indicative of the consolidated results of operations or financial condition of Euronet
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that would have been reported had the acquisitions been completed as of the beginning of the periods presented, and should not be taken as representative of the future consolidated results of operations or financial condition of Euronet.
EURONET WORLDWIDE INC. AND SUBSIDIARIES
Consolidated Condensed Statement of Revenues, Income from Continuing Operations and Net Income
(In thousands, except per share data)
Three months ended September 30, 2003 | |||||||||
As reported | Prepaid Processing Acquisitions | Pro forma | |||||||
Revenues | $ | 53,061 | $ | 7,732 | $ | 60,793 | |||
Income from continuing operations | 1,425 | 569 | 1,994 | ||||||
Net income | 1,376 | 569 | 1,945 | ||||||
Income per share-basic: | |||||||||
Income from continuing operations | $ | 0.05 | $ | 0.07 | |||||
Net income | $ | 0.05 | $ | 0.07 | |||||
Income per share-diluted: | |||||||||
Income from continuing operations | $ | 0.05 | $ | 0.06 | |||||
Net income | $ | 0.05 | $ | 0.06 | |||||
Nine months ended September 30, 2003 | |||||||||
As reported | Prepaid Processing Acquisitions | Pro forma | |||||||
Revenues | $ | 134,302 | $ | 28,869 | $ | 163,171 | |||
Income from continuing operations | 14,071 | 1,962 | 16,033 | ||||||
Net income | 14,020 | 1,962 | 15,982 | ||||||
Income per share-basic: | |||||||||
Income from continuing operations | $ | 0.54 | $ | 0.56 | |||||
Net income | $ | 0.54 | $ | 0.56 | |||||
Income per share-diluted: | |||||||||
Income from continuing operations | $ | 0.49 | $ | 0.52 | |||||
Net income | $ | 0.49 | $ | 0.52 |
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EURONET WORLDWIDE INC. AND SUBSIDIARIES
Consolidated Condensed Statement of Revenues, Income from Continuing Operations and Net Income
(In thousands, except per share data)
Nine months ended September 30, 2004 | |||||||||
As reported | Prepaid Processing Acquisitions | Pro forma | |||||||
Revenues | $ | 268,001 | $ | 3,169 | $ | 271,170 | |||
Income from continuing operations | 13,629 | 444 | 14,073 | ||||||
Net income | 13,629 | 444 | 14,073 | ||||||
Income per share-basic: | |||||||||
Income from continuing operations | $ | 0.44 | $ | 0.45 | |||||
Net income | $ | 0.44 | $ | 0.45 | |||||
Income per share-diluted: | |||||||||
Income from continuing operations | $ | 0.40 | $ | 0.41 | |||||
Net income | $ | 0.40 | $ | 0.41 |
Pro Forma for the Three Months Ended March 31, | ||||||
(in thousands, except per share data) | 2005 | 2004 | ||||
Revenues | $ | 125,773 | $ | 95,922 | ||
Operating income | $ | 12,714 | $ | 8,523 | ||
Net income | $ | 5,342 | $ | 4,443 | ||
Per share data: | ||||||
Net Income per share-basic | $ | 0.15 | $ | 0.14 | ||
Net Income per share-diluted | $ | 0.14 | $ | 0.13 |
NOTE 5—SALE OF SUBSIDIARY
GAIN ON DISPOSITION OF U.K. ATM NETWORK
In January 2003, the Company sold 100% of the shares in its U.K. subsidiary, Euronet Services (U.K.) Ltd. (Euronet U.K.) to Bridgepoint Capital Limited for approximately $29.4 million in cash, subject to certain working capital adjustments. A gain of $18.0 million was reported on the sale for the three months ended March 31, 2003. The Acquisition Agreement includes certain representations, warranties and indemnification obligations of Euronet concerning Euronet U.K., which are customary in transactions of this nature in the U.K., including a “Tax Deed” providing for the indemnification of Bridgepoint by Euronet against tax liabilities of Euronet U.K. that relate to periods prior to January 1, 2003 but arise after the sale.
Simultaneously with this transaction, Euronet and Bank Machine Limited (which is the new name of Euronet U.K. following the acquisition) signed a five-year ATM Outsourcing and Gateway Services Agreement under which Euronet will provide services that are substantially identical to the services provided to Euronet U.K. prior to its sale to Bridgepoint. Management has allocated $4.5 million of the total sale proceeds to the Services Agreement, which will be accrued to revenues on a straight-line basis over the five-year contract term that began January 1, 2003, representing approximately $0.9 million annually. The results of operations for the 12 months ended December 31, 2002 of Euronet U.K. continue to be included in operations due to the ongoing revenues generated under the Services Agreement.
NOTE 6—BUSINESS SEGMENT INFORMATION
The Company operates in three principal business segments:
i) In the EFT Processing Segment, the Company processes transactions for a network of 5,404 automated teller machines (ATMs) across Europe, Africa and India. The Company provides comprehensive electronic payment solutions consisting of ATM network participation, outsourced ATM management solutions, outsourced POS EFT (electronic financial transactions) solutions, outsourced card solutions and electronic top-up services (for prepaid mobile airtime purchases via ATM or directly from the handset).
ii) Through the Prepaid Processing Segment, the Company provides prepaid processing, or top-up services, for prepaid mobile airtime and other prepaid products. The Company operates a network of more than 168,000 POS terminals providing electronic processing of prepaid mobile phone airtime (top-up) services in the U.K., Australia, Poland, Ireland, New Zealand, Germany, Spain, the U.S., Malaysia and Indonesia.
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iii) Through the Software Solutions Segment, the Company offers a suite of integrated EFT software solutions for electronic payment and transaction delivery systems.
The Company also has a “Corporate Services Segment” that provides the three business segments with corporate and other administrative services that are not directly identifiable to a specific segment.
As discussed in the Note 1, management refined the definition of direct costs for the EFT Processing Segment. Changes to direct costs had corresponding changes within the salaries and benefits and the selling, general and administrative categories. Operating income was not impacted. All periods presented reflect the change to promote comparability.
The following tables present the segment results of the Company’s operations for the three- and nine-month periods ended September 30, 2004 and 2003 (unaudited, in thousands):
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Three months ended September 30, 2004 | |||||||||||||||||||||||
EFT Processing | Prepaid Processing | Software Solutions | Corporate Services | Eliminations | Consolidated | ||||||||||||||||||
Total revenues | $ | 20,930 | $ | 75,359 | $ | 3,635 | $ | — | $ | — | $ | 99,924 | |||||||||||
Operating expenses: | |||||||||||||||||||||||
Direct operating costs | 9,290 | 59,744 | 158 | — | — | 69,192 | |||||||||||||||||
Salaries and benefits | 3,590 | 3,925 | 2,081 | 1,214 | — | 10,810 | |||||||||||||||||
Selling, general and administrative | 1,572 | 2,392 | 514 | 1,247 | 8 | 5,733 | |||||||||||||||||
Depreciation and amortization | 2,280 | 1,637 | 256 | 50 | (8 | ) | 4,215 | ||||||||||||||||
Total operating expenses | 16,732 | 67,698 | 3,009 | 2,511 | — | 89,950 | |||||||||||||||||
Operating income (loss) | 4,198 | 7,661 | 626 | (2,511 | ) | — | 9,974 | ||||||||||||||||
Other income (expense): | |||||||||||||||||||||||
Interest income | 62 | 762 | — | 40 | — | 864 | |||||||||||||||||
Interest expense | (434 | ) | (37 | ) | — | (1,298 | ) | — | (1,769 | ) | |||||||||||||
Equity in unconsolidated subsidiaries | — | 164 | — | — | — | 164 | |||||||||||||||||
Loss on early retirement of debt | — | — | — | (32 | ) | — | (32 | ) | |||||||||||||||
Foreign exchange gain, net | — | — | — | 419 | — | 419 | |||||||||||||||||
Total other income (expense) | (372 | ) | 889 | — | (871 | ) | — | (354 | ) | ||||||||||||||
Income (loss) from continuing operations before income taxes | $ | 3,826 | $ | 8,550 | $ | 626 | $ | (3,382 | ) | $ | — | $ | 9,620 | ||||||||||
Segment assets as of September 30, 2004 | $ | 66,752 | $ | 308,125 | $ | 5,997 | $ | 8,987 | $ | — | $ | 389,861 | |||||||||||
Fixed assets as of September 30, 2004 | $ | 28,141 | $ | 5,437 | $ | 744 | $ | 45 | $ | — | $ | 34,367 | |||||||||||
Three months ended September 30, 2003 | |||||||||||||||||||||||
EFT Processing | Prepaid Processing | Software Solutions | Corporate Services | Eliminations | Consolidated | ||||||||||||||||||
Total revenues | $ | 12,925 | $ | 36,532 | $ | 3,659 | $ | — | $ | (55 | ) | $ | 53,061 | ||||||||||
Operating expenses: | |||||||||||||||||||||||
Direct operating costs | 4,433 | 29,583 | 207 | — | 1 | 34,224 | |||||||||||||||||
Salaries and benefits | 2,891 | 1,954 | 2,152 | 696 | 1 | 7,694 | |||||||||||||||||
Selling, general and administrative | 1,470 | 1,116 | 640 | 1,211 | (51 | ) | 4,386 | ||||||||||||||||
Depreciation and amortization | 1,834 | 922 | 296 | 20 | (5 | ) | 3,067 | ||||||||||||||||
Total operating expenses | 10,628 | 33,575 | 3,295 | 1,927 | (54 | ) | 49,371 | ||||||||||||||||
Operating income (loss) | 2,297 | 2,957 | 364 | (1,927 | ) | (1 | ) | 3,690 | |||||||||||||||
Other income (expense): | |||||||||||||||||||||||
Interest income | 6 | 276 | — | 18 | — | 300 | |||||||||||||||||
Interest expense | (144 | ) | (4 | ) | — | (1,689 | ) | — | (1,837 | ) | |||||||||||||
Equity in unconsolidated subsidiaries | — | 292 | — | (46 | ) | — | 246 | ||||||||||||||||
Loss on early retirement of debt | — | — | — | — | — | — | |||||||||||||||||
Foreign exchange gain, net | — | — | — | (240 | ) | 6 | (234 | ) | |||||||||||||||
Total other income (expense) | (138 | ) | 564 | — | (1,957 | ) | 6 | (1,525 | ) | ||||||||||||||
Income (loss) from continuing operations before income taxes | $ | 2,159 | $ | 3,521 | $ | 364 | $ | (3,884 | ) | $ | 5 | $ | 2,165 | ||||||||||
Segment assets as of December 31, 2003 | $ | 46,488 | $ | 236,950 | $ | 8,155 | $ | 12,180 | $ | — | $ | 303,773 | |||||||||||
Fixed assets as of December 31, 2003 | $ | 17,095 | $ | 2,908 | $ | 798 | $ | (116 | ) | $ | (27 | ) | $ | 20,658 |
13
Nine months ended September 30, 2004 | ||||||||||||||||||||||||
EFT Processing | Prepaid Processing | Software Solutions | Corporate Services | Eliminations | Consolidated | |||||||||||||||||||
Total revenues | $ | 53,872 | $ | 203,912 | $ | 10,217 | $ | — | $ | — | $ | 268,001 | ||||||||||||
Operating expenses: | ||||||||||||||||||||||||
Direct operating costs | 24,332 | 161,568 | 438 | — | (1 | ) | 186,337 | |||||||||||||||||
Salaries and benefits | 9,791 | 10,761 | 6,397 | 3,346 | 1 | 30,296 | ||||||||||||||||||
Selling, general and administrative | 4,531 | 6,748 | 1,489 | 3,543 | 2 | 16,313 | ||||||||||||||||||
Depreciation and amortization | 5,929 | 4,463 | 712 | 105 | (7 | ) | 11,202 | |||||||||||||||||
Total operating expenses | 44,583 | 183,540 | 9,036 | 6,994 | (5 | ) | 244,148 | |||||||||||||||||
Operating income (loss) | 9,289 | 20,372 | 1,181 | (6,994 | ) | 5 | 23,853 | |||||||||||||||||
Other income (expense): | ||||||||||||||||||||||||
Interest income | 99 | 1,896 | 1 | 53 | 1 | 2,050 | ||||||||||||||||||
Interest expense | (908 | ) | (80 | ) | (2 | ) | (4,288 | ) | 1 | (5,277 | ) | |||||||||||||
Equity in unconsolidated subsidiaries | — | 289 | — | (21 | ) | — | 268 | |||||||||||||||||
Loss on early retirement of debt | — | — | — | (126 | ) | — | (126 | ) | ||||||||||||||||
Foreign exchange gain, net | — | — | — | 912 | — | 912 | ||||||||||||||||||
Total other income (expense) | (809 | ) | 2,105 | (1 | ) | (3,470 | ) | 2 | (2,173 | ) | ||||||||||||||
Income (loss) from continuing operations before income taxes | $ | 8,480 | $ | 22,477 | $ | 1,180 | $ | (10,464 | ) | $ | 7 | $ | 21,680 | |||||||||||
Segment assets as of September 30, 2004 | $ | 66,752 | $ | 308,125 | $ | 5,997 | $ | 8,987 | $ | — | $ | 389,861 | ||||||||||||
Fixed assets as of September 30, 2004 | $ | 28,141 | $ | 5,437 | $ | 744 | $ | 45 | $ | — | $ | 34,367 | ||||||||||||
Nine months ended September 30, 2003 | ||||||||||||||||||||||||
EFT Processing | Prepaid Processing | Software Solutions | Corporate Services | Eliminations | Consolidated | |||||||||||||||||||
Total revenues | $ | 37,129 | $ | 86,096 | $ | 11,403 | $ | — | $ | (326 | ) | $ | 134,302 | |||||||||||
Operating expenses: | ||||||||||||||||||||||||
Direct operating costs | 15,677 | 69,668 | 715 | — | (122 | ) | 85,938 | |||||||||||||||||
Salaries and benefits | 7,765 | 4,261 | 6,868 | 1,951 | 1 | 20,846 | ||||||||||||||||||
Selling, general and administrative | 3,811 | 2,490 | 2,005 | 2,834 | (166 | ) | 10,974 | |||||||||||||||||
Depreciation and amortization | 5,554 | 2,480 | 837 | 63 | (15 | ) | 8,919 | |||||||||||||||||
Total operating expenses | 32,807 | 78,899 | 10,425 | 4,848 | (302 | ) | 126,677 | |||||||||||||||||
Operating income (loss) | 4,322 | 7,197 | 978 | (4,848 | ) | (24 | ) | 7,625 | ||||||||||||||||
Other income (expense): | ||||||||||||||||||||||||
Interest income | 20 | 748 | 4 | 154 | — | 926 | ||||||||||||||||||
Interest expense | (502 | ) | (8 | ) | — | (4,848 | ) | — | (5,358 | ) | ||||||||||||||
Gain on sale of U.K. subsidiary | — | — | — | 18,001 | — | 18,001 | ||||||||||||||||||
Loss on early retirement of debt | (1 | ) | 461 | — | (80 | ) | — | 380 | ||||||||||||||||
Foreign exchange gain, net | — | — | — | (5,231 | ) | 38 | (5,193 | ) | ||||||||||||||||
Total other income (expense) | (483 | ) | 1,201 | 4 | 7,996 | 38 | 8,756 | |||||||||||||||||
Income from continuing operations before income taxes | $ | 3,839 | $ | 8,398 | $ | 982 | $ | 3,148 | $ | 14 | $ | 16,381 | ||||||||||||
Segment assets as of December 31, 2003 | $ | 46,488 | $ | 236,950 | $ | 8,155 | $ | 12,180 | $ | — | $ | 303,773 | ||||||||||||
Fixed assets as of December 31, 2003 | $ | 17,095 | $ | 2,908 | $ | 798 | $ | (116 | ) | $ | (27 | ) | $ | 20,658 |
14
Total revenues for the nine-month periods ended September 30, 2004 and September 30, 2003, and long-lived assets as of September 30, 2004 and December 31, 2003 for the Company, summarized by geographical location, are as follows (unaudited, in thousands):
Revenues for the nine months ended September 30, | Long-lived assets as of | |||||||||||
2004 | 2003 | September 30, 2004 | December 31, 2003 | |||||||||
U.K. | $ | 123,864 | $ | 62,526 | $ | 1,551 | $ | 1,141 | ||||
Australia | 43,806 | 24,864 | 488 | 470 | ||||||||
United States | 30,073 | 11,546 | 2,399 | 804 | ||||||||
Germany | 24,742 | 10,102 | 7,059 | 3,788 | ||||||||
Poland | 20,893 | 12,077 | 14,911 | 6,509 | ||||||||
Other | 16,168 | 4,788 | 1,159 | 937 | ||||||||
Hungary | 6,233 | 5,406 | 4,904 | 5,049 | ||||||||
Czech Republic | 2,222 | 2,993 | 1,896 | 1,960 | ||||||||
Total | $ | 268,001 | $ | 134,302 | $ | 34,367 | $ | 20,658 | ||||
Total revenues are attributed to countries based on location of customer for the EFT Processing and Prepaid Processing Segments. All revenues generated by Software Solutions Segment activities are attributed to the U.S. Long-lived assets consist of property, plant and equipment, net of accumulated depreciation.
NOTE 7—RESTRICTED CASH
As of September 30, 2004, the Company had $57.7 million of restricted cash, of which $56.9 million is related to the administration of customer collection and vendor remittance activities in the Prepaid Processing Segment. The Company is responsible for the collection of cash receipts from the retailer for subsequent remittance to the telecommunication provider. Cash is collected on behalf of others and held in designated trust accounts or other restricted accounts that are not available for operating business activities. The remaining $0.8 million is deposits held by vendors.
NOTE 8—STOCK-BASED EMPLOYEE COMPENSATION
The Company accounts for its stock-based employee compensation plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the fair market value of the Company’s shares at the date of the grant over the exercise price.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” as amended by Statement of Financial Accounting Standards (SFAS) No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure,” to stock-based employee compensation (in thousands, except per share data):
15
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||
Net income, as reported | $ | 5,963 | $ | 1,376 | $ | 13,629 | $ | 14,020 | ||||||||
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | (1,112 | ) | (886 | ) | (3,158 | ) | (3,085 | ) | ||||||||
Pro forma net income | $ | 4,851 | $ | 490 | $ | 10,471 | $ | 10,935 | ||||||||
Earnings per share: | ||||||||||||||||
Basic-as reported | $ | 0.19 | $ | 0.05 | $ | 0.44 | $ | 0.54 | ||||||||
Basic-pro forma | $ | 0.15 | $ | 0.02 | $ | 0.34 | $ | 0.42 | ||||||||
Diluted-as reported | $ | 0.17 | $ | 0.05 | $ | 0.40 | $ | 0.49 | ||||||||
Diluted-as reported | $ | 0.14 | $ | 0.02 | $ | 0.31 | $ | 0.38 |
The board of directors approved restricted share award agreements that provide restricted shares of Company stock as compensation for certain key executives. The restricted stock awards will be accounted for as “fixed” compensation expense as prescribed within ABP 25. The total number of shares of restricted stock to be granted is 70,696. Under the terms of the agreements, the restricted shares granted will be earned by December 31, 2004, provided each individual is a director, officer, employee or consultant of the Company. As of September 30, 2004 the Company had expensed approximately $0.9 million in recognition of awards under these plans.
NOTE 9—NOTES PAYABLE AND CREDIT FACILITIES
A summary of the activity for the nine months ended September 30, 2004 for all debt obligations is presented below:
Debt Obligations Balances and activity for the nine months ended September 30, 2004 (unaudited, in thousands) | |||||||||||||||||||||||||||
12 3/8% Senior Discount Notes | Acquisition Indebtedness | Operating and asset based indebtedness | Lines of credit | Capital leases | Total | ||||||||||||||||||||||
e-pay notes due Feb. 2005 | Precept notes due Jan. 2005 | ||||||||||||||||||||||||||
Balance at January 1, 2004 | $ | 43,521 | $ | 12,271 | $ | — | $ | 2,005 | $ | 1,974 | $ | 5,191 | $ | 64,962 | |||||||||||||
Add: Additional debt | — | — | 4,000 | 564 | 5,317 | 16,321 | 26,202 | ||||||||||||||||||||
Less: Payments | (14,187 | ) | — | (1,603 | ) | (248 | ) | (250 | ) | (4,406 | ) | (20,694 | ) | ||||||||||||||
Adjust: Foreign exchange loss (gain) | (800 | ) | 146 | — | — | — | 870 | 216 | |||||||||||||||||||
Balance at September 30, 2004 | $ | 28,534 | $ | 12,417 | $ | 2,397 | $ | 2,321 | $ | 7,041 | $ | 17,976 | $ | 70,686 | |||||||||||||
In February 2004, we entered into a two-year unsecured revolving credit agreement providing a facility of up to $10 million with a U.S.-based financial institution. The proceeds from the facility can be used for working capital needs, acquisitions, and other corporate purposes. Interest accrues on any balances outstanding at a prime-based floating rate or LIBOR-based rates for 90-day periods. Certain financial performance covenants must be maintained under the agreement, and the $10 million is subject to certain advance rate restrictions. As of September 30, 2004, the Company was in compliance with these covenants, and the maximum amount allowable to borrow under the advance rate limitation was approximately $9.0 million. As of September 30, 2004, $5.0 million was borrowed under this bank agreement and $2.9 million was utilized to secure stand by letters of credit, leaving approximately $1.1 million available for future borrowings.
As more fully described in Note 13 – Subsequent Events, after September 30, 2004, we expanded and restructured the $10.0 million revolving credit agreement to $40.0 million, repurchased an additional $17.0 million of the 12 3/8% Senior Discount Notes, called the remaining $11.5 million of 12 3/8% Senior Discount Notes and extended the maturity date on $11.2 million of the e-pay acquisition notes to August 2005 with the right to further extend the maturity to February 2006.
NOTE 10—RELATED PARTY TRANSACTIONS
See Note 4 – Business Combinations and Purchases and Note 13 – Subsequent Events for a description of notes payable, deferred payment and additional equity issued and contingently issuable to the historic business owners (now Euronet shareowners and certain employees) in connection with the acquisitions of various Prepaid Processing businesses.
16
NOTE 11—(5) GOODWILL AND INTANGIBLE ASSETS
Intangible assets and goodwill are carried at amortized cost and evaluated for impairment annually or more frequently if there is an indication of impairment. As disclosed in Note 4 – Business Combinations and Purchases,Acquisitions, additions during the ninethree months ended September 30, 2004March 31, 2005 include $5.2$11.9 million in allocatedassigned to acquired amortizable intangible assets and $27.7$64.8 million inassigned to goodwill. Goodwill represents the excess of the purchase price of the acquired businessbusinesses over the fair value of the underlying net tangible and intangible assets.assets acquired. A summary of activity in intangible assets and goodwill for the ninethree months ended September 30, 2004March 31, 2005 is presented below (unaudited, in thousands):below:
Goodwill and Intangible Assets activity for the nine months ended September 30, 2004 | |||||||||||||||
Balance at December 31, 2003 | Additions (Primarily Precept, EPS and CPI Acquisitions) | Reductions (Amortization Expense) | Balance at September 30, 2004 | ||||||||||||
Goodwill | $ | 88,512 | $ | 27,710 | $ | — | $ | 116,222 | |||||||
Amortizable intangibles | 24,476 | 5,186 | — | 29,662 | |||||||||||
Accumulated amortization | (1,704 | ) | — | (2,681 | ) | (4,385 | ) | ||||||||
Total | $ | 111,284 | $ | 32,896 | $ | (2,681 | ) | $ | 141,499 | ||||||
Goodwill and Intangible Assets Activity for Three Months Ended March 31, 2005 | ||||||||||||
(in thousands) | Amortizable Intangible Assets | Goodwill | Total Intangible Assets | |||||||||
Balance as of December 31, 2004 | $ | 28,930 | $ | 183,668 | $ | 212,598 | ||||||
Additions: | ||||||||||||
Acquisition of Dynamic | 3,488 | 8,098 | 11,586 | |||||||||
Acquisition of Telerecarga | 7,246 | 43,957 | 51,203 | |||||||||
Acquisition of ATX | 1,123 | 12,729 | 13,852 | |||||||||
Adjustment to Transact | 1,789 | (1,121 | ) | 668 | ||||||||
Amortization | (1,182 | ) | — | (1,182 | ) | |||||||
Other (primarily changes in foreign currency exchange rates) | (815 | ) | (1,707 | ) | (2,522 | ) | ||||||
Balance as of March 31, 2005 | $ | 40,579 | $ | 245,624 | $ | 286,203 | ||||||
Three months ended 2004 | Estimated annual intangible asset amortization expense | |||||||||||||||||
2005 | 2006 | 2007 | 2008 | 2009 | ||||||||||||||
Customer relationships | $ | 712 | $ | 2,848 | $ | 2,848 | $ | 2,848 | $ | 2,849 | $ | 2,848 | ||||||
Software | 112 | 449 | 449 | 449 | 231 | 56 | ||||||||||||
Trademarks | 58 | 232 | 232 | 232 | 232 | 232 | ||||||||||||
Total | $ | 882 | $ | 3,529 | $ | 3,529 | $ | 3,529 | $ | 3,312 | $ | 3,136 | ||||||
The additions above include adjustments to the purchase price allocations of the Company’s previous acquisitions. The purchase price allocation for Transact, a Prepaid Processing Segment subsidiary based in Germany, was adjusted based on an independent appraisal of the value of Transact as of the date of acquisition finalized during the first quarter 2005. The adjustment resulted in a reclassification of the initial purchase price from goodwill to amortizable intangible assets, primarily customer relationships, of $1.8 million. The related deferred income tax liabilities related to the increase in intangible assets increased by $0.7 million, which also increased goodwill related to Transact. The impact of this reclassification on the Company’s net income is an increase to amortization expense, net of the related income tax impact, of less than $0.2 million per year beginning in the first quarter 2005.
Estimated amortization expense on intangible assets, before income taxes, as of March 31, 2005 with finite lives is expected to total $5.5 million for 2005, $5.7 million for 2006, $5.7 million for 2007, $5.5 million for 2008, $5.3 million for 2009 and $5.2 million for 2010.
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(6) DEBT OBLIGATIONS
A summary of the activity for the three months ended March 31, 2005 for all debt obligations is presented below:
(in thousands) | Short-Term Obligations | Capital Leases | 1.625% Convertible Debentures Due Dec. 2024 | Total | |||||||||||
Balance at December 31, 2004 | $ | 4,862 | $ | 21,297 | $ | 140,000 | $ | 166,159 | |||||||
Indebtedness incurred | — | 2,086 | — | 2,086 | |||||||||||
Repayments | (518 | ) | (2,048 | ) | — | (2,566 | ) | ||||||||
Foreign exchange gain | (111 | ) | (1,030 | ) | — | (1,141 | ) | ||||||||
Balance at March 31, 2005 | 4,233 | 20,305 | 140,000 | 164,538 | |||||||||||
Less - current maturities | (4,233 | ) | (4,855 | ) | — | (9,088 | ) | ||||||||
Balance at March 31, 2005 | $ | — | $ | 15,450 | $ | 140,000 | $ | 155,450 | |||||||
As of March 31, 2005, there were no amounts outstanding against the Company’s $40 million revolving credit facilities, but there were stand by letters of credit outstanding against these facilities totaling $2.2 million.
NOTE 12—(7) STOCK-BASED EMPLOYEE COMPENSATION
The Company accounts for stock-based employee compensation plans under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations. Accordingly, compensation cost for stock options or restricted stock is measured as the excess, if any, of the fair market value of the Company’s shares at the date of the grant over the exercise or purchase price. Such compensation cost is charged to expense on a straight-line basis over the vesting period of the respective options or restricted stock. If vesting may be accelerated as a result of achieving certain milestones, and those milestones are believed to be reasonably achievable, the compensation is recognized on a straight-line basis over the shorter accelerated vesting period.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment.” SFAS No. 123R supersedes APB Opinion No. 25, which requires recognition of compensation expense when stock-based incentives are awarded for services provided. SFAS No. 123R requires the determination of the fair value of the share-based compensation at the grant date and the recognition of the related expense over the period in which the share-based compensation vests. SFAS No. 123R permits a prospective or two modified versions of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by the original SFAS No. 123, “Accounting for Stock-Based Compensation.” After amendment of the compliance date by the United States Securities and Exchange Commission during April 2005, the Company is required to adopt the provisions of SFAS No. 123R on or before January 1, 2006. Upon adoption, the Company will begin recognizing an expense for unvested share-based compensation that has been issued or will be issued after that date. Under the retroactive options, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The Company has not yet finalized its decision concerning the date of adoption, the transition option it will utilize to adopt SFAS No. 123R, or completed its analysis of the estimated impact that its adoption will have on its financial position and results from operations. However, the impact on net income is likely to be material. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of the original SFAS No. 123 as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure,” to stock-based employee compensation:
Three Months Ended March 31, | ||||||||
(in thousands, except per share data) | 2005 | 2004 | ||||||
Net income, as reported | $ | 4,826 | $ | 3,286 | ||||
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards | (1,722 | ) | (930 | ) | ||||
Pro forma net income | $ | 3,104 | $ | 2,356 | ||||
Earnings per share: | ||||||||
Basic-as reported | $ | 0.14 | $ | 0.11 | ||||
Basic-pro forma | $ | 0.09 | $ | 0.08 | ||||
Diluted-as reported | $ | 0.13 | $ | 0.10 | ||||
Diluted-pro forma | $ | 0.08 | $ | 0.07 |
- 11 -
Due to the Company’s United States corporate income tax position, the Company currently provides a valuation allowance over its entire U.S. net deferred tax position. Therefore, no tax benefits have been attributed to stock-based compensation expense in the above table because management has not determined that it is more likely than not that such benefit would be realized.
(8) BUSINESS SEGMENT INFORMATION
The Company operates in three principal business segments:
1) | In the EFT Processing Segment, the Company processes transactions for a network of automated teller machines (ATMs) and point of sale (POS) terminals across Europe, the Middle East, Africa and India. The Company provides comprehensive electronic payment solutions consisting of ATM network participation, outsourced ATM and POS management solutions, and electronic recharge services (for prepaid mobile airtime purchases via ATM or directly from the handset). |
2) | Through the Prepaid Processing Segment, the Company provides prepaid processing, or top-up services, for prepaid mobile airtime and other prepaid products. The Company operates a network of POS terminals providing electronic processing of prepaid mobile phone airtime top-up services in the U.S., Europe and Asia Pacific. |
3) | Through the Software Solutions Segment, the Company offers a suite of integrated electronic financial transaction (EFT) software solutions for electronic payment and transaction delivery systems. |
The Company also has a “Corporate Services Segment” that provides the three business segments with corporate and other administrative services. These services are not directly identifiable with the Company’s business segments. There are no significant inter-segment transactions.
- 12 -
The following tables present the segment results of the Company’s operations for the three-month periods ended March 31, 2005 and 2004:
For the Three Months Ended March 31, 2005 | |||||||||||||||||||
(in thousands) | EFT Processing | Prepaid Processing | Software Solutions | Corporate Services and Other | Consolidated | ||||||||||||||
Total revenues | $ | 23,889 | $ | 89,381 | $ | 3,936 | $ | — | $ | 117,206 | |||||||||
Operating expenses: | |||||||||||||||||||
Direct operating costs | 10,834 | 71,279 | 259 | — | 82,372 | ||||||||||||||
Salaries and benefits | 3,703 | 4,903 | 2,127 | 1,216 | 11,949 | ||||||||||||||
Selling, general and administrative | 1,308 | 3,120 | 390 | 1,320 | 6,138 | ||||||||||||||
Depreciation and amortization | 2,465 | 2,243 | 282 | 35 | 5,025 | ||||||||||||||
Total operating expenses | 18,310 | 81,545 | 3,058 | 2,571 | 105,484 | ||||||||||||||
Operating income (loss) | 5,579 | 7,836 | 878 | (2,571 | ) | 11,722 | |||||||||||||
Other income (expense): | |||||||||||||||||||
Interest income | 46 | 909 | — | 252 | 1,207 | ||||||||||||||
Interest expense | (569 | ) | (154 | ) | — | (865 | ) | (1,588 | ) | ||||||||||
Income from unconsolidated affiliates | — | 113 | — | 132 | 245 | ||||||||||||||
Foreign exchange loss, net | — | — | — | (2,842 | ) | (2,842 | ) | ||||||||||||
Total other income (expense) | (523 | ) | 868 | — | (3,323 | ) | (2,978 | ) | |||||||||||
Income (loss) from continuing operations before income taxes and minority interest | $ | 5,056 | $ | 8,704 | $ | 878 | $ | (5,894 | ) | $ | 8,744 | ||||||||
Segment assets as of March 31, 2005 | $ | 90,875 | $ | 548,091 | $ | 6,247 | $ | 43,314 | $ | 688,527 | |||||||||
For the Three Months Ended March 31, 2004 | ||||||||||||||||||||
(in thousands) | EFT Processing | Prepaid Processing | Software Solutions | Corporate Services and Other | Consolidated | |||||||||||||||
Total revenues | $ | 14,940 | $ | 62,919 | $ | 3,196 | $ | — | $ | 81,055 | ||||||||||
Operating expenses: | ||||||||||||||||||||
Direct operating costs | 6,855 | 49,712 | 78 | — | 56,645 | |||||||||||||||
Salaries and benefits | 2,889 | 3,370 | 2,161 | 1,034 | 9,454 | |||||||||||||||
Selling, general and administrative | 1,371 | 1,992 | 529 | 997 | 4,889 | |||||||||||||||
Depreciation and amortization | 1,835 | 1,466 | 221 | 32 | 3,554 | |||||||||||||||
Total operating expenses | 12,950 | 56,540 | 2,989 | 2,063 | 74,542 | |||||||||||||||
Operating income (loss) | 1,990 | 6,379 | 207 | (2,063 | ) | 6,513 | ||||||||||||||
Other income (expense): | ||||||||||||||||||||
Interest income | 14 | 544 | 1 | 12 | 571 | |||||||||||||||
Interest expense | (176 | ) | (23 | ) | (1 | ) | (1,636 | ) | (1,836 | ) | ||||||||||
Loss from unconsolidated affiliates | — | — | — | (21 | ) | (21 | ) | |||||||||||||
Loss on early retirement of debt | — | — | — | (71 | ) | (71 | ) | |||||||||||||
Foreign exchange gain, net | — | — | — | 235 | 235 | |||||||||||||||
Total other income (expense) | (162 | ) | 521 | — | (1,481 | ) | (1,122 | ) | ||||||||||||
Income (loss) from continuing operations before income taxes | $ | 1,828 | $ | 6,900 | $ | 207 | $ | (3,544 | ) | $ | 5,391 | |||||||||
Segment assets as of December 31, 2004 | $ | 92,238 | $ | 429,850 | $ | 6,605 | $ | 89,782 | $ | 618,475 | ||||||||||
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(9) RELATED PARTY TRANSACTIONS
See Note 4 - Acquisitions for a description of notes payable, deferred payment and additional equity issued and contingently issuable to the former business owners (now Euronet shareholders) in connection with various acquisitions.
Under the terms of certain debt agreements entered into in connection with the acquisitions of e-pay, the Company paid approximately $0.6 million in interest in the first quarter 2004 to former e-pay shareholders who now serve as a director and officers of the Company. This indebtedness was repaid in full during December 2004, accordingly, there was no interest incurred for this indebtedness during the first quarter 2005.
(10) LEGAL PROCEEDINGS
The Company is from time to time a party to litigation arising in the ordinary course of its business. Currently, there are no legal proceedings that management believes, either individually or in the aggregate, would have a material adverse effect upon the consolidated results of operations or financial condition of the CompanyCompany.
NOTE 13—SUBSEQUENT EVENTS(11) GUARANTEES
AcquisitionAs of MovilcargaMarch 31, 2005, the Company has $4.2 million of bank guarantees issued on its behalf, the majority of which are collateralized by cash deposits held by the respective issuing banks.
In November 2004, Euronet acquiredregularly grants guarantees of certain unrecorded obligations of its wholly-owned subsidiaries. As of March 31, 2005, the assetsCompany had granted guarantees in the following amounts:
From time to time, Euronet enters into agreements with unaffiliated parties that purchasedcontain indemnification provisions, the Movilcarga assets for €18.0 million (approximately $22.9 million)terms of which may vary depending on the negotiated terms of each respective agreement. The amount of such obligations is not stated in two installments: €8.0 million in cash at closing and €10.0 million in cash tothe agreements. The liability under such indemnification provision may be paid in March 2005, subject to time and materiality limitations, monetary caps and other conditions and defenses. Such indemnity obligations include the following:
New Credit Agreement
During October 2004To date, the Company is not aware of any significant claims made by the indemnified parties or parties to guarantee agreements with the Company and, certainaccordingly, no liabilities were recorded as of its subsidiaries renegotiatedMarch 31, 2005 and expanded the Company’s $10 million credit facility (as more fully discussed in Note 9 – Notes Payable and Credit Facilities) for two new revolving credit agreements with a U.S.-based bank. The total of the two agreements provides the Company a two-year facility to borrow $40 million with certain provisions to increase the total borrowed amount up to $43 million as a result of foreign exchange rate fluctuations.December 31, 2004.
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The first agreement is a $10 million revolving credit agreement among the Company and its U.S. subsidiaries, PaySpot, Euronet USA, Precept and CPI (collectively, the U.S. Borrowers), and the bank. This agreement provides the U.S. Borrowers with a $10 million revolving line of credit that terminates on October 25, 2006. The U.S. Borrowers may use the line of credit to repay existing debt, for working capital needs, to make acquisitions and for other corporate purposes. Borrowings under the U.S. Credit Agreement bear interest at either a Prime Rate plus an applicable margin specified in the U.S. Credit Agreement or a rate fixed for up to 30- to 90-day periods equal to the LIBOR (the London Interbank Offered Rate), rate plus an applicable margin as set forth in the agreement and varies based on a consolidated funded debt to EBITDA (earning before interest, tax, depreciation and amortization as defined in the credit agreement) ratio. This agreement contains customary events of default and covenants related to limitations on indebtedness and the maintenance of certain financial ratios.
The second agreement is a $30 million revolving credit agreement among the Company and its European subsidiaries, e-pay Holdings Limited and Delta Euronet GmbH (collectively, the European Borrowers), and the bank. This agreement provides the European Borrowers with a $30 million revolving line of credit that terminates on October 25, 2006; this $30 million may be increased to $33 million as a result of certain foreign exchange rate fluctuations. The European Borrowers may use the line of credit to repay existing debt, for working capital needs, to make acquisitions and for other corporate purposes. Funds may be drawn in U.S. dollars, euros, and/or British Pounds Sterling (GBP). Borrowings in U.S. dollars bear interest at rates similar to the U.S. Credit Agreement; borrowings in either euro or GBP bear interest at a rate fixed for up to 30- to 90-day periods equal to the EURIBOR (the Euro Interbank Offered Rate) or the LIBOR rate plus a margin that varies based on a consolidated funded debt to EBITDA ratio plus an ancillary cost. The agreement contains customary events of default and covenants related to limitations on indebtedness and the maintenance of certain financial ratios.
Subsequent to the signing of the revolving credit agreements, the Company terminated the $10 million credit agreement as described in Note 9 – Notes Payable and Credit Facilities, and then the Company borrowed approximately $28 million ($5.0 million to replace amounts borrowed under the $10 million credit agreement plus an additional $23 million) under the two lines of credit, including $2.9 million to cover stand by letters of credit, leaving $12 million available for future borrowings.
Extension of e-pay Acquisition Notes
In November 2004, the Company extended the maturity date on $11.2 million of the $12.4 million e-pay unsecured acquisition notes from February 2005 to August 2005 with the right to further extend the maturity date to February 2006. In addition, the interest rate was increased on the extended notes effective February 2005 from 8% per annum to 10% per annum, payable quarterly.
Additional Repayment of 12 3/8% Senior Discount Notes
At September 30, 2004 the outstanding balance of the 12 3/8% Senior Debt Notes was approximately $28.5 million. During November 2004, the Company repurchased approximately $17.0 million of its 12 3/8% Senior Discount Notes. After the November repurchase, approximately $11.5 million remained outstanding (excluding effects of foreign exchange fluctuations subsequent to September 30, 2004). The Company has given notice to redeem the remaining $11.5 million outstanding on December 4, 2004. As a result of the repurchase and redemption, in the fourth quarter 2004, the Company will record approximately $0.9 million as a loss on the early retirement of debt due to the combination of redemption premiums and the elimination of capitalized debt issuance costs.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
OVERVIEW
Company OverviewCOMPANY OVERVIEW
Euronet Worldwide, offers EFTInc. (“Euronet” or the “Company”) is a leading electronic transaction processor, offering ATM and POS outsourcing services, integrated EFTelectronic financial transaction (EFT) software, and related consulting services, network gateways, and electronic prepaid top-up services to financial institutions, mobile operators and retailers. We operate and service the largest independent pan-European group of ATMsATM network and operate the largest national shared ATM network in India, and we are one of the largest providers of prepaid processing, or top-up services, for prepaid mobile airtime. We have processing centers in the U.S., Europe and Asia, Pacific, and process electronic top-up transactions at more than 168,000 POS205,000 point of sale (POS) terminals across over 79,000 retailers. Withmore than 94,000 retailers with corporate headquarters in Leawood, Kansas, USA,U.S.A., and 17we have 21 offices worldwide, Euronet servesserving clients in more than 6570 countries.
Economic Factors, Industry Factors and RisksECONOMIC AND INDUSTRY FACTORS AND RISKS
Our companyCompany faces certain economic and industry-wide factors that could materially affect our business. AsWe are an international company, and face economic, political, technology infrastructure and legal issues in every country in which we operate that could have a positive or negative impact, and therefore are also considered risks.impact. Some of the more significant risk factors that our management is focused on include the following:
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These risks and other risks are described at the end of Item 2 to this Form 10-Q.
Lines of Business, Geographic Locations and Principal Products and ServicesLINES OF BUSINESS, GEOGRAPHIC LOCATIONS AND PRINCIPAL PRODUCTS AND SERVICES
We operate in three principal business segments:
As of September 30, 2004,March 31, 2005, we had 1014 principal offices in Europe, four in the Asia-Pacific region, two in the U.S. and one in Africa.Egypt. Our executive offices are located in Leawood, Kansas, U.S.A.USA.
Sources of Revenues and Cash FlowSOURCES OF REVENUES AND CASH FLOW
Euronet earns revenues and income based on ATM management fees, transaction fees, processing fees, professional services, software licensing fees and software maintenance agreements. Each business segment’s sources of revenue are described further below.
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EFT Processing Segment—SegmentOf total segment revenue, approximately 33% was - Our revenues in the EFT Processing Segment are derived from fees charged for transactions effected by cardholders on our proprietary network of ATMs, as well as fixed management fees and transaction fees we owned (excluding those leased by us in connection with outsourcing agreements). We believe our strategycharge to shift from a largely proprietary, Euronet-owned ATM network to a greater focus onbanks for operating their ATMs operated under outsourcing agreements will provide higher marginal returns on investments. agreements.
On our proprietary network, we generally charge fees for four types of ATM transactions that are processed on our ATMs:
Transaction feesFor the quarter ended March 31, 2005 approximately 30% of total segment revenue was derived from ATMs we owned (excluding those leased by us in connection with outsourcing agreements) and the remainder was derived from ATMs that we operate for cash withdrawals varybanks on an outsourced basis. The percentage of revenues we generate from marketour proprietary network of ATMs has fallen significantly over the past two years. We believe this shift from a largely proprietary, Euronet-owned ATM network, to market buta greater focus on ATMs operated under outsourcing agreements will provide higher marginal returns on investment. This is because we bear all costs of owning and operating ATMs on our proprietary network, including the capital investment represented by the cost of the ATMs themselves, whereas customer-owned ATMs operated under outsource service agreements require a nominal up-front capital investment because we do not purchase the ATMs. Additionally, in many instances operating costs are the responsibility of the owner and, therefore, recurring operating expenses per ATM are lower. In connection with certain long-term outsourcing agreements, we lease many of our ATMs under capital lease arrangements where, generally, rangewe purchase a bank’s ATMs and simultaneously sell the ATMs to an entity related to the bank and lease back the ATMs for purposes of fulfilling the ATM outsourcing agreement with the bank. We fully recover the related lease costs from approximately $0.10 to $2.70 per transaction. Transaction fees for the other three types of transactions are generally substantially less. bank under the outsourcing agreements.
We include transactionin the EFT Processing Segment revenues from transaction-based fees earned under the electronicpayable for mobile phone recharge solutionstime that we distribute through our ATMs in EFT Processing Segment revenues.ATMs. Fees for recharge transactions vary significantly from market to market and are based on the specific prepaid solution and the denomination of prepaid usage purchased. Generally, transaction fees vary from approximately $0.30 to $3.00 per prepaid mobile recharge purchase and are shared with the financial institution and the mobile operator. Any or all of these fees may come under pricing pressure in the future.
Customer-owned ATMs operated under service agreements require a minimal, if any, up-front capital investment by us because we do not purchase the ATMs. We typically, but not necessarily in all cases, charge a per ATM management fee and a transaction fee for
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each ATM managed under our outsourcing agreements. Additionally, in many instances, operating costs are the responsibility of the owner and, therefore, recurring operating expenses per ATM are lower.
Prepaid Processing Segment—SegmentThe significant growth - Revenue in the revenue and operating income in our Prepaid Processing Segment is the result of the acquisitions of e-pay, transact, AIM, Precept, EPS and CPI (see discussion below and Note 4 to the unaudited consolidated financial statements) together with the significant growth rates experienced at each of these businesses. During 2003 and 2004, e-pay was still establishing contractual relationships with many large and small retailers to distribute mobile top-up services through POS terminals. Revenues have grown rapidly each quarter as the level of business at the retailers concerned has ramped up to full realization. Growth in the business is also attributable to the conversion by mobile operators from prepaid top-up using scratch card solutions to electronic processing solutions. We do not expect these growth rate levels to continue.
Revenue is recognized based on commissions or processing fees received from mobile and other telecommunication operators or from distributors of prepaid wireless products for the distribution and/or processing of prepaid mobile airtime and other telecommunication products. Due to certain provisions of thein our mobile phone operator agreements, mobile phonethe operators have the ability to reduce the overall processing feecommission paid on each top-up transaction. However, by virtue of ourthe Company’s contracts with retailers in certain markets, not all of these reductions are absorbed by us as commission rates paidEuronet. In those markets, when mobile phone operators reduce overall commissions, the effect is to reduce revenues and reduce our retailersdirect operating costs resulting in only a small impact, if any, on gross margin and distributors may also decline.operating income. In Australia, certain retailers negotiate directly with the mobile phone operators for their own commission rates. Our maintenance of agreements with mobile operators is important to the success of our business, because these agreements permit us to distribute top-up to the mobile operators’ customers.
Growth in our prepaid business The loss of any agreements with mobile operators in any given market is driven by a number of factors, including the extent to which conversion from scratch cards to electronic distribution solutions in occurring or has been completed, the pace of growth in the prepaid mobile telephone market generally,could materially and adversely affect our own share of the retail distribution capacity in the market, and the level of commission or margin that is paid to the various intermediaries in the process of distribution of prepaid mobile phone time. In mature markets, such as the U.K, Australia and Ireland, the conversion from scratch cards to electronic forms of distribution is either complete or nearing completion, so this factor will cease to provide the organic increases in the number of transactions per terminal that we have been experiencing. Also in mature markets, competition among prepaid distributors results in reduction of commissions and margins by mobile operators as well as retailer churn to alternative providers. In other markets in which we operate, such as Poland, Germany and the U.S., many of the factors that may contribute to rapid growth (conversion from scratch cards to electronic distribution, growth in the prepaid market and rapid roll out of our network of retailers) are still present.results.
Software Solutions Segment—Segment - The revenues from the Software Solutions Segment are derivedrecognizes revenue from licensing, professional services and maintenance fees for software and sales of related hardware. Software license fees professional serviceare the initial fees we charge to license our proprietary application software to customers. Professional fees consist of charges for providing customization, installation and consulting services to our customers,customers. Software maintenance revenue represents the ongoing fees charged for maintenance and support for customers’ software maintenance fees and hardwareproducts. Hardware sales revenues.are derived from the sale of computer equipment necessary for the respective software solution.
Opportunities, Challenges and RisksOPPORTUNITIES, CHALLENGES AND RISKS
Our expansion plans and opportunities are focused on three primary areas:areas within our three business segments: (i) outsourced ATM POS and card management contracts; (ii) our prepaid mobile phone airtime top-up processing services; and (iii) transactions processed on our network of owned and operated ATMs.
EFT Processing Segment - The continued expansion and development of our ATM business will depend on various factors including but not limited to, the following:
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We carefully monitor the revenue and transactional growth of our ATM networks in each of our markets, and we adjust our plans depending on local market conditions, such as variations in the transaction fees we receive, competition, overall trends in ATM-transaction levels and performance of individual ATMs.
We consistently evaluate and add prospects to our list of potential ATM outsource customers. However, we cannot predict the increase or decrease in the number of ATMs we manage under outsourcing agreements, because this depends largely on the
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willingness of banks to enter into outsourcing contracts with us. Banks are very deliberateDue to the thorough internal reviews and extensive negotiations conducted by existing and prospective banking customers in negotiating these agreements. Thechoosing outsource vendors, the process of negotiating and entering into or renewing outsourcing agreements typically takes ninecan take approximately six months to 12 months or longer. Banks evaluate a wide range of matters when deciding to choose an outsource vender. Generally, this decision is subject to extensive management analysis and approvals. In addition, themore than one year. The process is further complicated by the legal and regulatory considerations of local countries as well as local language complexities. These agreements tend to cover large numbers of ATMs, so significant increases and decreases in our pool of managed ATMs could result from signature or termination of these management contracts. In this regard,Therefore, the timing of both current and new contract revenues is uncertain and unpredictable.
Prepaid Processing Segment - We currently offer prepaid mobile phone top-up services in the U.S., Europe and Asia Pacific We plan to expand our prepaid mobile phone top-up business which is currently focused on the U.K., Germany, the U.S., Ireland, Poland, Spain, New Zealandin these and Australia, into our other markets by taking advantage of our existing expertise together with existing relationships with mobile phone operators and retailers.
This expansion will depend on various factors, including, but not necessarily limited to, the following:
Growth in our prepaid business in any given market is driven by a number of factors, including the availability of financing for expansion; and
In addition, our continued expansion may involve acquisitions that could divert our resources and management time and require integration of new assets with our existing networks and services. Our ability to effectively manage effectively our rapid expansion maywill require us eventually to expand our operating systems and employee base.base in 2005, particularly at the management level, which may reduce our operating income. An inability to do this could have a material adverse affecteffect on our business, growth, financial condition or results of operations. Inadequate technology and resources would impair our ability to maintain current processing technology and efficiencies as well as deliver new and innovative services to compete in the marketplace.
Software Solutions Segment - Software products are an integral part of our product lines, and our investment in research, development, delivery and customer support reflects our ongoing commitment to an expanded customer base. We have been able to enter into agreements under which we use our software in lieu of cash as our initial capital contributions to new transaction processing joint ventures. Such contribution sometimes permits us to enter new markets without significant cash outlay. Therefore, although revenues from our Software Solutions Segment are not currently growing significantly, we view it as a valuable element
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of our overall business strategy. The competitive factors in the Software Solutions business include price, technology development and the ability of software systems to interact with other leading products. Our success is dependent on our ability to design and implement software applications. Technical disruptions or errors in these systems would adversely impact our revenue and financial results.
Seasonality- Our business is significantly impacted by seasonality, as our revenues for the first quarter are generally lower than those of the last quarter of each year. We have estimated that, absent unusual circumstances (such as the impact of new acquisitions or unusually high levels of growth due to market factors), the overall revenue realized from our three business segments is likely to be approximately 5% to 10% lower during the first quarter of each year than in the last quarter of the year. The impact of this seasonality has been masked for the last two years due to significant growth rates resulting from the addition of large retailer customers in mid-fourth quarter, continued shifts from scratch cards to electronic top-up and acquisitions made in the first quarter of each year. There can be no assurance that this will be the case for future years.
Significant events in the first nine months of 2004:quarter 2005:
To assist the reader in understanding and locating certain important information in this Management’s Discussion and Analysis, we have summarized the more significant events of the nine months ended September 30, 2004 below:
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SEGMENT SUMMARY RESULTS OF OPERATIONS (unaudited, in thousands)
Revenues for the Three Months Ended March 31, | Year-over-Year Change | ||||||||||
(dollar amounts in thousands) | 2005 | 2004 | Increase (Decrease) Amount | Increase (Decrease) Percent | |||||||
EFT Processing | $ | 23,889 | $ | 14,940 | $ | 8,949 | 60% | ||||
Prepaid Processing | 89,381 | 62,919 | 26,462 | 42% | |||||||
Software Solutions | 3,936 | 3,196 | 740 | 23% | |||||||
Total | $ | 117,206 | $ | 81,055 | $ | 36,151 | 45% | ||||
Operating Income for the Three Months Ended March 31, | Year-over-Year Change | |||||||||||||
(dollar amounts in thousands) | 2005 | 2004 | Increase (Decrease) Amount | Increase (Decrease) Percent | ||||||||||
EFT Processing | $ | 5,579 | $ | 1,990 | $ | 3,589 | 180% | |||||||
Prepaid Processing | 7,836 | 6,379 | 1,457 | 23% | ||||||||||
Software Solutions | 878 | 207 | 671 | 324% | ||||||||||
Total | 14,293 | 8,576 | 5,717 | 67% | ||||||||||
Corporate Services and Other | (2,571 | ) | (2,063 | ) | (508 | ) | 25% | |||||||
Total | $ | 11,722 | $ | 6,513 | $ | 5,209 | 80% | |||||||
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COMPARISON OF OPERATING RESULTS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30,MARCH 31, 2005 AND 2004 AND SEPTEMBER 30, 2003
Three months ended September 30, | |||||||||||||||
Revenues | Operating Income | ||||||||||||||
2004 | 2003 | 2004 | 2003 | ||||||||||||
EFT Processing | $ | 20,930 | $ | 12,925 | $ | 4,198 | $ | 2,297 | |||||||
Prepaid Processing | 75,359 | 36,532 | 7,661 | 2,957 | |||||||||||
Software Solutions | 3,635 | 3,659 | 626 | 364 | |||||||||||
Corporate Services | — | — | (2,511 | ) | (1,927 | ) | |||||||||
Total | 99,924 | 53,116 | 9,974 | 3,691 | |||||||||||
Inter-Segment Eliminations | — | (55 | ) | — | (1 | ) | |||||||||
Total | $ | 99,924 | $ | 53,061 | $ | 9,974 | $ | 3,690 | |||||||
Nine months ended September 30, | |||||||||||||||
Revenues | Operating Income | ||||||||||||||
2004 | 2003 | 2004 | 2003 | ||||||||||||
EFT Processing | $ | 53,872 | $ | 37,129 | $ | 9,289 | $ | 4,322 | |||||||
Prepaid Processing | 203,912 | 86,096 | 20,372 | 7,197 | |||||||||||
Software Solutions | 10,217 | 11,403 | 1,181 | 978 | |||||||||||
Corporate Services | — | — | (6,994 | ) | (4,848 | ) | |||||||||
Total | 268,001 | 134,628 | 23,848 | 7,649 | |||||||||||
Inter-Segment Eliminations | — | (326 | ) | 5 | (24 | ) | |||||||||
Total | $ | 268,001 | $ | 134,302 | $ | 23,853 | $ | 7,625 | |||||||
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EFT PROCESSING SEGMENT
The following table presents the results of operations for the three and nine months ended September 30,March 31, 2005 and 2004 and 2003 for our EFT Processing Segment:
EFT Processing
Three months ended September 30, (unaudited, in thousands) | Results for the Three Months Ended March 31, | Year-over-Year Change | ||||||||||||||||
2004 | 2003 | |||||||||||||||||
(dollar amounts in thousands) | 2005 | 2004 | Increase (Decrease) Amount | Increase (Decrease) Percent | ||||||||||||||
Total revenues | $ | 20,930 | $ | 12,925 | $ | 23,889 | $ | 14,940 | $ | 8,949 | 60% | |||||||
Operating expenses: | ||||||||||||||||||
Direct operating cost | 9,290 | 4,433 | ||||||||||||||||
Operating expense: | ||||||||||||||||||
Direct operating costs | 10,834 | 6,855 | 3,979 | 58% | ||||||||||||||
Salaries and benefits | 3,590 | 2,891 | 3,703 | 2,889 | 814 | 28% | ||||||||||||
Selling, general and administrative | 1,572 | 1,470 | 1,308 | 1,371 | (63 | ) | (5%) | |||||||||||
Depreciation and amortization | 2,280 | 1,834 | 2,465 | 1,835 | 630 | 34% | ||||||||||||
Total operating expenses | 16,732 | 10,628 | 18,310 | 12,950 | 5,360 | 41% | ||||||||||||
Operating income | $ | 4,198 | $ | 2,297 | $ | 5,579 | $ | 1,990 | $ | 3,589 | 180% | |||||||
Nine months ended September 30, (unaudited, in thousands) | ||||||||||||||||||
2004 | 2003 | |||||||||||||||||
Total revenues | $ | 53,872 | $ | 37,129 | ||||||||||||||
Operating expenses: | ||||||||||||||||||
Direct operating cost | 24,332 | 15,677 | ||||||||||||||||
Salaries and benefits | 9,791 | 7,765 | ||||||||||||||||
Selling, general and administrative | 4,531 | 3,811 | ||||||||||||||||
Depreciation and amortization | 5,929 | 5,554 | ||||||||||||||||
Total operating expenses | 44,583 | 32,807 | ||||||||||||||||
Operating income | $ | 9,289 | $ | 4,322 | ||||||||||||||
Transactions processed (millions) | 77.3 | 34.9 | 42.4 | 121% | ||||||||||||||
ATMs as of March 31 | 6,201 | 3,870 | 2,331 | 60% | ||||||||||||||
Average ATMs | 6,042 | 3,610 | 2,432 | 67% |
Revenues
We generally charge fees for four types of ATM transactions that are currently processed on our ATMs:
TotalThe increase in EFT Processing Segment revenues increased 62%, or $8.0 million, to $20.9 million for the three months ended September 30,first quarter 2005 is a result of the increase in number of ATMs operated and the number of transactions processed compared to the first quarter 2004, primarily derived from $12.9 millionATM management agreements in Poland, Romania and India. Revenue per average ATM was $3,954 for the three months ended September 30, 2003, and revenues increased 45%, or $16.7 million,first quarter 2005, compared to $53.9 million$4,139 for the nine months ended September 30, 2004 from $37.1 millionsame period a year ago, or a 4% decrease. Revenue per transaction decreased 28% to $0.31 for the nine months ended September 30, 2003.first quarter 2005 from $0.43 for the first quarter 2004. Generally, these decreases are the result of a continued shift from Euronet proprietarily owned ATMs to ATMs managed under outsourcing agreements. Under outsourcing agreements, the Company primarily earns revenue based on a fixed recurring monthly management fee, with less dependence on transaction-based fees because incremental transactions have little impact on the fixed or variable costs of managing ATMs. The more significant decrease in revenue per transaction is due to an overall increase in the number of transactions on ATMs that are managed under outsourcing agreements. Since revenue from these arrangements is derived primarily from a fixed monthly recurring management fee, an increase in the number of transactions processed does not generate commensurate increases in related revenue. As of September 30, 2004, weMarch 31, 2005, the Company owned 15% of the ATMs operated 5,404 ATMs, an increase of 2,150, or 66%, over 3,254 ATMs as of September 30, 2003. At September 30, 2004, we owned 16% of these ATMs (excluding those leased by us in connection with outsourcing agreements), whileoperated 30% under capital lease and management outsourcing agreements and operated the remaining 84% were operated55% under management outsourcing agreements. Transactions on machines owned or operated by us increased 39.1 million, or 126%agreements only. This compares to 22%, to 70.1 million for the third quarter 2004 from 31.0 million transactions for the third quarter 2003,27% and 51%, respectively, as of March 31, 2004.
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and they increased 77.6 million, or 95%, to 159.1 million for the nine months ended September 30, 2004 from 81.5 million transactions for the nine months ended September 30, 2003. The increase in transaction growth is greater than the increase in ATMs operated and revenue growth due to an increase in ATMs that we operate under ATM management outsourcing agreements relative to ATMs we owned during this period. The revenues generated from ATM management agreements often have a substantial monthly recurring fee as compared to a per transaction fee for our owned ATMs. This recurring fee generates both fixed and variable revenue components. As a result, transactions on these machines generally increase faster than the revenues. Substantially all of the additional 2,150 ATMs from September 30, 2003 to September 30, 2004 were from ATM management agreements in Central Europe and India.
Revenue per ATM decreased 2.6% to $3,932 for the third quarter 2004 from $4,035 for third quarter 2003 and increased less than 1% to $12,045 for the nine months ended September 30, 2004 from $12,029 for the nine months ended September 30, 2003. Revenue per transaction decreased to $0.30 for the third quarter of 2004 from $0.42 for the third quarter 2003 and decreased to $0.34 for the nine months ended September 30, 2004, from $0.46 for the nine months ended September 30, 2003. These changes in revenue per transaction are primarily due to a general increase in transaction levels on ATMs, increases in transactions under network participation agreements, the full period effect of new outsourcing agreements installed throughout 2003 and the partial period effect of outsourcing agreements installed in the nine months ended September 30, 2004. Certain new outsourcing agreements have fixed monthly or periodic fees and other professional fees during the roll out period. Although network participation agreements have transaction fees that are lower than our average fees, they produce increased transaction levels on currently existing ATMs. Our revenue from mobile phone top-ups at our ATM sites also continued to increase. The decline in revenue per ATM for the third quarter 2004 compared to the third quarter of 2003 is the result of the continuing movement to ATM management outsourcing agreements that have a substantial monthly recurring fee as compared to a per transaction fee. Of total segment revenue, for the first quarter 2005, approximately 33% is30% was from ATMs we owned (excluding those leased by us in connection with outsourcing agreements), approximately 26% was from ATMs operated under capital lease and management outsourcing arrangements, while the remaining 44% was from other sources, primarily management outsourcing agreements. This compares to 47%, 13% and 40%, respectively, for the nine months ended September 30, 2004 compared to 54% for the nine months ended September 30, 2003.same period last year. We believe ourthis shift from a largely proprietary, Euronet-owned ATM network to operating ATMs under outsourcing arrangements is a positive development in the long run and will provide higher marginal returns on investments.investment because costs of purchasing and operating each ATM is lower for outsourced ATMs as compared to owned ATMs. Customer-owned ATMs operated under service agreements require minimal, if any, up fronta nominal up-front capital investment because we do not purchase the ATMs.ATMs, nor do we incur the start-up costs typically incurred in the early life cycle of Euronet-owned ATM. Additionally, in many instances operating costs are the responsibility of the owner and, therefore, recurring operating expenses per ATM are lower.
Operating ExpensesDirect operating costs
Direct cost consistsoperating costs consist primarily of site rental fees, cash delivery costs, cash supply costs, maintenance, insurance, telecommunications and the cost of data center operations-related personnel, as well as the processing center’s facility-relatedfacility related costs and other processing center related expenses. As discussed in the Note 1 – General, to the unaudited consolidated financial statements, management has refinedUnaudited Consolidated Financial
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Statements, Euronet changed the definition of direct costs for themanner in which it reports EFT Processing Segment. Reclassification toSegment direct costs, had corresponding changes within the salaries and benefits and the selling,sales, general and administrative categories. Operating income was not impacted. All periods presented reflect the reclassification to promote comparability.
Total segment operating(SG&A) expenses increased 57%, or $6.1 million, to $16.7 million induring the third quarter 2004. In prior periods, processing center costs were charged to and then allocated from SG&A to direct costs on the basis of 2004 from $10.6 million ina standard rate per transaction. We have evaluated this approach and believe that the third quarterspecific assignment of 2003,processing center salaries and they increased 36%, or $11.8 million,related costs together with other costs directly attributable to $44.6 million for the nine months ended September 30, 2004 from $32.8 million forcenter is a preferred method and more appropriately reflects the nine months ended September 30, 2003. These increases are primarily due tovariable and non-variable nature of our operating costs supporting revenue increases driven by additional ATMs under management, salaries to support our operational growth during the period, including an increase in incentive accruals based on performance, and operating expenses to support the Asia Pacific markets; the increases in 2004 expenses wouldexpenses. Prior periods have been less significant if not for a non-recurring gain recognized in the third quarter of 2003 relatedreclassified to conform to the sale of Hungarian ATMs.current year presentation. This change does not impact consolidated operating income or net income for any period presented.
Total segment operating expenses as a percentage of revenues decreased to 80% for the third quarter of 2004 from 82% for the third quarter of 2003 and decreased to 83% for the nine months ended September 30, 2004 from 88% for the nine months ended September 30, 2003. The net decrease in expense as a percentage of revenue reflects expense management efforts and the impact of scale insomuch as revenue and transactional growth does not necessarily drive commensurate percentage increases in operating expenses. The increase in outsourced ATMs with lowerdirect operating costs also contributedcost for the first quarter 2005, compared to the expense decrease in relation to revenues. The improvement in segment operating expenses as a percentage of revenue is more significant when considering that the thirdfirst quarter 2003 included a gain on the sale of Hungarian ATMs.
Direct operating costs increased 110%, or $4.9 million, to $9.3 million for the third quarter of 2004 from $4.4 million for the third quarter of 2003, and they increased 55%, or $8.7 million, to $24.3 million for the nine months ended September 30, 2004 from $15.7 million for the nine months ended September 30, 2003. These increases are primarily due to the increased cost of operating approximately 66% more ATMs in the third quarter of 2004 over 2003 and 39% more ATMs for the nine months ended September 30, 2004 over 2003, together with variable costs related to prepaid telecommunications recharge transactions. Direct operating costs decreased in relation to revenue when considering that the third quarter of 2003 included a non-recurring gain on the sale of Hungarian ATMs and the benefit of certain non-recurring expense recoveries.
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Direct operating costs as a percentage of revenues increased to 44% in the third quarter of 2004 from 34% in the third quarter of 2003 and increased to 45% of revenues for the nine months ended September 30, 2004 from 42% for the nine months ended September 30, 2003. The increase is attributed to the gain on the sale of Hungarian ATMs recordedincrease in the third quarternumber of 2003. Direct operating costs in 2004 as a percentage of revenue remained relatively unchanged from 2003 after adjusting for the non-recurring gain on the third quarter 2003 sale of Hungarian ATMs.
ATMs under operation. Direct operating costs per ATM increasedhave decreased to $1,745 in$1,793 for the thirdfirst quarter of 20042005 from $1,384 in$1,899 for the thirdfirst quarter of 2003 and2004. Direct operating costs per transaction have decreased to $5,442 in$0.14 per transaction for the nine months ended September 30, 2004first quarter 2005 from $5,079 in$0.20 per transaction during the nine months ended September 30, 2003. Excluding the gain on the sale of Hungariansame period last year. These improvements resulted from installing outsourced ATMs, the comparablewhose direct costs per ATM for the three and nine months ended September 30, 2004 would have remained largely flat compared to the three and nine months ended September 30, 2003.
Direct operating coston an average per transaction fell 7% to $0.13basis were lower than the existing installed base of ATMs. As discussed in the third quarter of 2004 from $0.14 in the third quarter of 2003 and fell 20% to $0.15 in the nine months ended September 30, 2004 from $0.19 in the nine months ended September 30, 2003. Excluding the gain on the sale of Hungarian ATMs, direct cost per transaction would have decrease even more substantially.
Overall, excluding the non-recurring gain on the sale of Hungarian ATMs from the third quarter of 2003, costs per transaction decreased because incremental increases in transaction volumes on existing sites drive little or no additional fixed direct operating expense. In addition,“Revenues” section above, the number of ATMs that we operate under ATM management outsourcing agreements has increased as compared to ATMs that we own and network sharing arrangements increased. Theseoperate. Outsourced ATMs generally have lower direct operating expenses (telecommunications, cash delivery, security, maintenance and site rental) because, depending on the customer, our ATM management agreements cause usthe customer retains the responsibility for certain operational costs.
Gross margin
Gross margin, which is revenue less direct operating costs, increased by $5.0 million, or 61% to bear some, but not necessarily all, expenses required$13.1 million for the first quarter 2005 compared to operate$8.1 million for the ATM. Further, during 2003 andfirst quarter 2004 we renegotiated certain maintenance, telecommunication, sponsorship and cash supply agreements with vendorsdue to reduce feesincreases in revenues that exceeded the corresponding increase in direct operating costs. Gross margin per ATM was $2,161 and gross margin per transaction.
As a resulttransaction was $0.17 for the three months ended March 31, 2005, decreasing from $2,240 and $0.23 for the three months ended March 31, 2004. These decreases are primarily due to the addition of the factors mentioned above,more ATMs added under outsourcing agreements where we generate less gross margin per ATM, (revenue less direct operating costs) decreased 18% to $2,186but we do not have any capital investment at risk like we do for ATMs we own.
Salaries and benefits
The increase in salaries and benefits for the thirdfirst quarter of 2004 from $2,651 for the third quarter 2003 and decreased 5% to $6,603 for the nine months ended September 30, 2004 from $6,950 for the nine months ended September 30, 2003. Excluding the non-recurring gain on the sale of Hungarian ATMs, gross margin per ATM decreased marginally from the third quarter of 2003 and remained mostly flat2005 compared to the nine months ended September 30, 2003.
Gross margin per transaction decreased to $0.17 for the thirdfirst quarter 2004 from $0.27 for the third quarter 2003 and decreased to $0.19 for the nine months ended September 30, 2004 from $0.26 for the nine months ended September 30, 2003. The decline in gross margin per transaction is the result of the continuing movement to ATM management agreements that have a substantial fixed monthly recurring revenue fee as compared to a per transaction fee. We believe our shift from a largely proprietary, Euronet-owned ATM network to operating ATMs under outsourcing arrangements is a positive development and will provide higher marginal returns on investments.
Salaries and benefits increased 24%, or $0.7 million, to $3.6 million in the third quarter of 2004 from $2.9 million in the third quarter of 2003 and increased 26%, or $2.0 million, to $9.8 million for the nine months ended September 30, 2004 from $7.8 million for the nine months ended September 30, 2003. These increases are primarily due to ourEuronet’s growing Asiabusinesses in Indian and Romanian markets, staffing costs to expand in emerging markets and certain incentive payments earned based on meeting or exceeding performance plans.general merit increases awarded to employees. Certain staffing increases were also necessary due to the increasinglarger number of ATMs under operation and transactions processed in connection with additional outsourcing agreements signed in late 2003. Salaries and benefits decreasedprocessed. These expenses as a percentage of revenue, however, continued to 17%trend downward during the first quarter 2005 decreasing to 16%, compared to 19% for the same period in 2004. This decrease as a percentage of revenue reflects the third quarterbenefits from our investment of 2004 from 22%resources in India and Romania, as well as the third quarter of 2003leverage and to 18%scalability associated with increases in the nine months ended September 30, 2004 from 21%revenues in the nine months ended September 30, 2003, reflecting the scalability of human resource utilizationour other markets without commensurate increases in the EFT Processing Segment.salaries and benefits expense.
Selling, general and administrative
Selling, general and administrative costsexpenses for the nine months ended September 30, 2004 were $1.6 million and increased $0.1 million overfirst quarter 2005 remained relatively flat compared to the same periodquarter in 2003. The increases2004. However, these costs were reduced by $0.5 million for an insurance recovery related to a loss recorded in transactional volumes, ATMs and revenue has had little impactthe fourth quarter of 2003 on ourcertain ATM disbursements resulting from a card association’s change in their data exchange format. Adjusting for this benefit, selling, general and administrative expense as we leverage these expenses acrossincreased by approximately 34% due to increases in tax consulting fees, primarily in Poland, and software consulting fees in our network of ATMs.growing India business.
Depreciation and amortization increased to approximately $2.3 million
The increase in depreciation and $5.9 million foramortization expense during the three and nine months ended September 30, 2004, respectively,first quarter 2005 compared to approximately $1.8 million and $5.5 million for the three and nine months ended September 30, 2003, respectively. The increasefirst quarter 2004 is partially attributeddue to additional depreciation on more than 700 ATMs under capital lease arrangements related to an outsourcing agreement in Poland implemented induring the first half ofsecond quarter 2004, together with technologicaladditional processing center computer equipment necessary to handle increased transaction volumes and technology upgrades to certain of our owned ATMs we own.during the last half of 2004.
Operating Incomeincome
The EFT Processing Segmentincrease in operating income increased by $1.9 million to $4.2 million, or 20% of revenues, infor the third quarter 2004 from $2.3 million, or 18% of revenues, in the third quarter 2003, and it increased by $5.0 million to $9.3 million, or 17% of revenues, in the nine months ended September 30, 2004 from $4.3 million, or 12% of revenues, in the nine months ended September
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30, 2003. This increasesegment is generally the result of revenue increases of 62% during the third quarter and 45% during the nine months ended September 30, 2004 compared to the same periods in 2003. The increases are even more significant when considering the non-recurring ATM gain recognized in the third quarter of 2003. Newfrom new ATM outsourcing and network participation agreements have allowed uscombined with leveraging certain management cost structures. Operating income as a percentage of revenue was 23% and 13% for the three months ended March 31, 2005 and 2004, respectively. Operating income per transaction was $0.07 and per ATM was $923 during the first quarter 2005, compared to leverage our cost structure$0.06 and reduce certain per-ATM and per-transaction supply contracts.
In summary, we produced$551, respectively, for the same period in 2004. The continuing increases in operating income as a percentage of revenue, per transaction and per ATM of $789is due to significant growth in the third quarter of 2004 compared to $717revenues and transactions without commensurate increases in the third quarter of 2003,operating expenses, as well as the continuing migration toward operating income per ATMATMs under management through outsourcing agreements rather than ownership arrangements. In addition, in 2004 our EFT operations in India began managing a number of ATMs under outsourcing agreements sufficient to $2,077produce positive operating results in the nine months ended September 30,latter part of 2004. For the first quarter 2005, the Indian operations recorded operating profit of $0.1 million, compared to an operating loss for the first quarter 2004 from $1,400 in the nine months ended September 30, 2003. We do not expect these operating income metrics per ATMof $0.2 million. Management expects to continue to grow at these rates. Operating profit increases are subject to our ability to continue to sign and implement new outsourcing and network sharing agreementsproduce operating income in Central Europe, India and other developing markets.this market during 2005.
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PREPAID PROCESSING SEGMENT
Acquisitions of Prepaid Processing Companies
In 2003, we acquired e-pay, transact and AIM, and in 2004, we acquired Precept, EPS and CPI. These companies are in the business of electronic payment processing of prepaid mobile phone airtime top-up services throughout Europe, Asia Pacific and the U.S. The transactions are more fully described in Note 4 to the unaudited consolidated financial statements.
The following table presentstables present the results of operations for the nine-month periodthree months ended September 30, 2004March 31, 2005 and third quarter of 2004, including pro forma“pro forma” results for the nine-month period ended September 30, 2004 and 2003 and third quarter of 2003those periods as if all Prepaid Processing Segment acquired businesses were included in our consolidated results of operations as of January 1, 2003; all2004. Since the acquisitions of Telerecarga, Dynamic and ATX occurred near the end of the first quarter 2005, their contributions to the operations of the segment were included for the full period in the third quarter of 2004 and, accordingly, it is not necessary to present pro forma results (unaudited, in thousands):material.
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Prepaid Processing
Results for the Three Months Ended March 31, | Year-over-Year Change | ||||||||||
(dollar amounts in thousands) | 2005 | 2004 | Increase (Decrease) Amount | Increase (Decrease) Percent | |||||||
Total revenues | $ | 89,381 | $ | 62,919 | $ | 26,462 | 42% | ||||
Operating expense: | |||||||||||
Direct operating costs | 71,279 | 49,712 | 21,567 | 43% | |||||||
Salaries and benefits | 4,903 | 3,370 | 1,533 | 45% | |||||||
Selling, general and administrative | 3,120 | 1,992 | 1,128 | 57% | |||||||
Depreciation and amortization | 2,243 | 1,466 | 777 | 53% | |||||||
Total operating expenses | 81,545 | 56,540 | 25,005 | 44% | |||||||
Operating income | $ | 7,836 | $ | 6,379 | $ | 1,457 | 23% | ||||
Transactions processed (millions) | 67.2 | 48.5 | 18.7 | 39% |
Actual three months ended September 30, 2004 | Actual three months ended September 30, 2003 | Pro forma ended September 30, 2003 | |||||||
Total revenues | $ | 75,359 | $ | 36,532 | $ | 44,264 | |||
Operating expenses: | |||||||||
Direct operating cost | 59,744 | 29,583 | 34,514 | ||||||
Salaries and benefits | 3,925 | 1,954 | 2,925 | ||||||
Selling, general and administrative | 2,392 | 1,116 | 1,991 | ||||||
Depreciation and amortization | 1,637 | 922 | 1,313 | ||||||
Total operating expenses | 67,698 | 33,575 | 40,743 | ||||||
Operating income | $ | 7,661 | $ | 2,957 | $ | 3,521 | |||
Nine months ended September 30, 2004 | Pro forma nine months ended September 30, 2004 (all acquisitions) | Actual nine months ended September 30, 2003 | Pro forma nine months ended September 30, 2003 (all acquisitions) | |||||||||
Total revenues | $ | 203,912 | $ | 207,081 | $ | 86,096 | $ | 114,965 | ||||
Operating expenses: | ||||||||||||
Direct operating cost | 161,568 | 163,452 | 69,668 | 89,507 | ||||||||
Salaries and benefits | 10,761 | 10,910 | 4,261 | 7,146 | ||||||||
Selling, general and administrative | 6,748 | 7,265 | 2,490 | 5,057 | ||||||||
Depreciation and amortization | 4,463 | 4,638 | 2,480 | 3,946 | ||||||||
Total operating expenses | 183,540 | 186,265 | 78,899 | 105,656 | ||||||||
Operating income | $ | 20,372 | $ | 20,816 | $ | 7,197 | $ | 9,309 | ||||
Pro Forma | |||||||||||
Results for the Three Months Ended March 31, | Year-over-Year Change | ||||||||||
(dollar amounts in thousands) | 2005 | 2004 | Increase (Decrease) Amount | Increase (Decrease) Percent | |||||||
Total revenues | $ | 97,948 | $ | 77,786 | $ | 20,162 | 26% | ||||
Operating expense: | |||||||||||
Direct operating costs | 76,999 | 59,642 | 17,357 | 29% | |||||||
Salaries and benefits | 5,562 | 4,249 | 1,313 | 31% | |||||||
Selling, general and administrative | 3,728 | 2,860 | 868 | 30% | |||||||
Depreciation and amortization | 2,831 | 2,646 | 185 | 7% | |||||||
Total operating expenses | 89,120 | 69,397 | 19,723 | 28% | |||||||
Operating income | $ | 8,828 | $ | 8,389 | $ | 439 | 5% | ||||
Summary
The three and nine months ended September 30, 2004 results compared to the three and nine months ended September 30, 2003 actual and pro forma results for the Prepaid Processing Segment reflect significant growth. The three and nine months ended September 30, 2004 growth was predominately from e-pay in the U.K., Ireland, Australia, Poland and New Zealand, as well as from our German and U.S. prepaid markets. The U.K. and Australian mobile operators were among the first to aggressively promote the use of electronic top-up products over scratch-card products, and e-pay was able to benefit significantly from their actions in this regard. Moreover, e-pay benefited from strong sales growth in both 2004 and 2003, during which time it was successful in signing e-top-up distribution agreements with several major U.K. and Australian retailers. The entire Prepaid Processing Segment benefited in 2004 by the full period effects of retailer agreements signed and implemented throughout 2003. In addition, the significant growth in revenue and operating income for the three and nine months ended September 30, 2004 over comparable periods in 2003 is the result of the start-up of each of our acquired prepaid businesses complemented by the conversion of mobile operators from prepaid top-up using scratch card solutions to electronic processing solutions such as those provided by e-pay.
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Revenues
The increase in Prepaid Processing Segment’s third quarter 2004 revenues increased 106% to $75.4 million from $36.5 million in third quarter 2003. The segment’s revenues for the nine months ended September 30,first quarter 2005 compared to the first quarter 2004 increased 137%was primarily attributable to $203.9 millionthe increase in total transactions processed. This transaction growth reflects growth from $86.0 million inexisting operations and the nine months ended September 30, 2003.full year effects of our 2004 acquisitions. On a pro forma basis, these increases were 70% and 80% forfirst quarter 2005 revenues increased by 26% over the three and nine months ended September 30,first quarter 2004 respectively. This significant growth is theas a result of adding new pointthe addition of sale devicesPOS terminals throughout all of our markets, together with theand increased volumes driven by mobile operators shifting from scratch card distribution to electronic distribution. The three and nine months ended September 30, 2004 actual year-over-year revenue improvements included $5.4 million and $9.3 million, respectively, from the November 2003 acquisition of transact, and $4.2 million and $10.9 million, respectively, from our U.S. prepaid operations, which were initiated in September 2003 with the acquisition of AIM, followed with the January 2004 acquisition of Precept, the May 2004 acquisitionacquisitions of EPS, CPI and Movilcarga contributed revenues of $6.6 million for the July 2004 acquisition of CPI. The nine months ended September 30, 2004first quarter 2005. Additionally, revenues included e-pay for all months rather than only eight months inhave grown from the nine months ended September 30, 2003. The full quarter effects of large retailer agreements implemented in 2003, as well as the launch of prepaid business operations in New Zealand, Ireland, Poland and Spain subsequent to the first quarter 2003, have resulted in additional growth.during 2004. We do not expect these growth rates at these significant levels to continue. Incontinue and, in certain markets, we have noticedfelt the competitive effects of lower pricing and margins driven by certain mobile operators as well as certainand retailers.
Total transactions processed by the Prepaid Processing Segment in the three and nine months ended September 30, 2004 were 59.8 million and 162.9 million, respectively, compared to 26.3 million and 61.1 million in the three and nine months ended September 30, 2003, respectively. The nine months ended September 30, 2003 included only eight months of transactions due to the February 2003 acquisition of e-pay as compared to a full nine months ended September 30, 2004. Moreover, the nine months ended September 30, 2004 included transactions from our acquired companies transact, AIM, Precept, EPS and CPI. Transaction growth in the U.K., Spain and Australia is expected to slow as a result of our current association with nearly all of the larger retail merchants and as the conversion to electronic top-up from scratch-card vouchers begins to slow. New markets in Germany, Poland and the U.S. are expected to experience higher transaction growth rates than the U.K. and Australia as the conversion to electronic top-up from scratch-card vouchers accelerates.
Revenue per transaction decreasedincreased slightly to $1.26$1.33 for the thirdfirst quarter 2004 compared to $1.392005 from $1.30 for the thirdfirst quarter 2004. Revenue growth in mature markets, such as the U.K. and Australia, has flattened substantially as conversion from scratch cards to electronic top-up approaches completion. We expect most of 2003,our growth from 2005 and gross margin performance per transaction of $0.26 remained constant with the same period last year. Additionally, revenue and gross margin per transaction declinedbeyond to $1.25 and $0.26, respectively, for the nine months ended September 30, 2004, compared to $1.41 and $0.27 for the nine months ended September 30, 2003, respectively. The year-over-year revenue per transaction decrease was largely attributable to a decreasebe derived from developing markets or markets in which there is organic growth in the U.K. commissionsprepaid sector, overall, or continued conversion from the mobile operators in mid 2003; this decrease in commission has minimal impact on margins because it was passed throughscratch cards to retailers. Gross margin as a percent of revenue increased slightly in both the three- and nine-month periods of 2004 over 2003. These increases were driven by the commission reduction from the mobile operators that were passed onto the retailers together with the addition to the segment of transact whose transaction-based revenues have minimal direct cost. Although margin as a percent of revenue increased, margin per transaction was consistent period over period.electronic top-up.
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Operating ExpensesDirect operating costs
Direct operating expenses in the Prepaid Processing Segment include the distribution feecommissions we pay to retail merchants. These expenditures vary directly with processed transactions. Communicationmerchants for the distribution and sale of prepaid mobile airtime and other prepaid products, as well as communication and paper expenses required to operate terminalsPOS terminals. These expenditures vary directly with revenues and the cost of terminals sold are also included.processed transactions.
DirectThe increase in direct operating expense generally grew at rates slightly lower than revenue growth.costs for the first quarter 2005 compared to the first quarter 2004 was principally due to corresponding increases in revenues and transactions processed. Direct operating expenses per transaction were $59.7$1.06 and $1.03 for the quarters ended March 31, 2005 and 2004, respectively.
Gross margin
Gross margin, which represents revenue less direct costs, grew by approximately $4.9 million, or 37%, to $18.1 million for the thirdfirst quarter 2005 compared to $13.2 million for the first quarter 2004 and $161.6 for the nine months ended September 30, 2004, or 79% of revenuedue to increases in transactions processed. Gross margin per transaction remained relatively flat at $0.27 for both periods, while decreasing slightly as a percentage of revenue to 20% for the first quarter 2005, from 21% for the first quarter 2004. This slight decrease in gross margin as a percentage of revenues is largely a result of a slight shift in the mix toward transactions processed by major retailers, where our margins are lower, from independent retailers.
Salaries and benefits
The increase in segment salaries and benefits for the first quarter 2005 compared to $29.6 million for the thirdfirst quarter of 2003 and $69.6 million for the nine months ended September 30, 2003, or 81% of revenues for both periods. Higher transaction volumes and2004 was primarily related commission expense directly attributable to increase in revenue were the primary reasons for the increase in the amountsrevenues and transactions processed, as well as annual merit increases for employees. As a percentage of direct operating expenses. Direct operating expense per transaction decreased to $1.00 in the third quarter and to $0.99 in the nine months ended September 30, 2004 from $1.12 and $1.14 per transaction in the three and nine months ended September 30, 2003, respectively. This decrease was generally due to two items: (i) mobile operator rate decreases in the U.K., which were passed through to the retailers, and (ii) the addition of transact to the Prepaid Processing Segment in the nine months ended September 30, 2004. Moreover, in the third quarter 2004, the Prepaid Processing Segment had stronger than average sales of POS terminals from transact, which provided approximately $0.7 million in additional gross margin. The majority of the transactions currently processed by transact earn revenues based on a transactional fee structure with minimal or no related direct costs. We expect transact’s proportion of the total prepaid business to continue to expand. However, we have no ability to estimate whether the mobile operators will change their commission structures nor can we accurately predict whether we will continue to be able to pass any such reduced commissions, if any, through to the retailers.
Segmentrevenue, salaries and benefits remained relatively flat at 5% of revenue5.5% and 5.4% for the three and nine months ended September 30,March 31, 2005 and 2004, and 2003. In absolute amounts, salaries and benefits increased 101% and 152% for the three and nine months ended September 30, 2004, respectively, over 2003 to $3.9 million and $10.7 million, respectively. These increases were generally due to the inclusion of salaries for a full nine month
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periodSelling, general and administrative expense for e-paythe first quarter 2005 compared to the first quarter 2004 increased slightly as a percentage of revenue to 3.5% from 3.2% as we continue to focus resources on expanding our operations in the nine months ended September 30, 2004 versus eight months in the nine months ended September 30, 2003 together with the acquisitions of transact, AIM, Precept, EPSU.S., Poland and CPI. The expansion of prepaid in the Polish, U.S. and New Zealand markets also contributed to these increases in the 2004 periods.Australia.
Depreciation and amortization
The increase in depreciation and amortization expense, increased by $2.0 million to $4.5 million for the nine months ended September 30, 2004 compared to $2.5 million for nine months ended September 30, 2003. This increase was primarily driven bymost of which represents amortization of acquired intangibles, which increased to $2.7 million for the nine months ended September 30, 2004first quarter 2005 compared to $1.1 million for the nine months ended September 30, 2003first quarter 2004 was due to the inclusion of a full nine months of amortization in 2004 for e-pay compared to eight months in 2003 and due to the inclusion in 2004quarter impact of amortization of the intangible assets acquired in 2004. Depreciation and amortization as a percentage of revenue increased slightly to 2.5% from 2.3% for the transact, AIM, Precept, EPSthree months ended March 31, 2005 and CPI acquisitions.2004, respectively. This increase is due to higher depreciation and amortization expense as a percentage of revenue related to the Movilcarga and Telerecarga acquisitions because each of these entities owns a majority of its POS terminals. Additionally, we recorded higher amortization expense for our Transact subsidiary for the first quarter 2005, as compared to the first quarter 2004 as a result of the adjustment to our purchase price allocation increasing amortizable intangibles, such as customer relationships, and decreasing goodwill, which is not amortized. See Note 5 – Goodwill and Intangible Assets, to the Unaudited Consolidated Financial Statements for further discussion of this adjustment.
Operating Incomeincome
The Prepaid Processing Segment’simprovement in operating income increased to $7.7 million, or 10% of revenues, for the thirdfirst quarter 2005 compared to 2004 was due to the significant growth in revenues and transactions processed together with contributions from $3.0 million, or 8%the acquisition of revenues, forEPS, CPI and Movilcarga after the thirdfirst quarter 2003 and, on a pro forma basis, from $4.3 million, or 7% of revenues, in the third quarter of 2003. Additionally, the Prepaid Processing Segment’s operating income increased to $20.4 million, or 10% of revenues, for the nine months ended September 30, 2004 from $7.2 million, or 8% of revenues, for the nine months ended September 30, 2003 and, on a pro-forma basis, from $9.7 million, or 6% of revenues, in the nine months ended September 30, 2003. This annualized rate of increase in operating revenues is not expected to continue. The increasing trend in operating2004. Operating income as a percentage of revenue isrevenues decreased to 9% for the first quarter 2005 from 10% for the first quarter 2004, mainly due to our focus on expanding operations in the comparatively low capital expenditures, depreciationU.S., Poland and selling, generalAustralia, together with a mix shift from independent retailers to major retailers. On a pro forma basis, operating income for the first quarter 2005 improved slightly over the same period last year as a result of the acquired entities’ continued growth over the past year. The decrease in the pro forma operating margin percentage to 9% for the first quarter 2005 from 11% for the first quarter 2004 is a result of the inclusion of our acquisitions in the U.S. and administrative expenditures growth when measured against revenue growth. Operating income per transaction remained relatively constant between $0.11 to $0.13Spain in the pro forma results for both the threefirst quarter 2004. The pro forma results for the first quarter 2004 in these markets include the positive impact on operating margin of margin-rich opportunistic, short-lived wholesale arrangements that are not necessarily ongoing in nature. Additionally, our businesses have added several large customers, thereby increasing total revenues and nine months ended September 30, 2004 and 2003.total operating profits, while slightly lowering overall operating margin as a percentage of revenues.
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SOFTWARE SOLUTIONS SEGMENT
The following table presents the results of operations for the three and the nine months ended September 30,March 31, 2005 and 2004 and 2003 for our Software Solutions Segment:
Software Solutions
(unaudited, in thousands)
Three months ended September 30, | Nine months ended September 30, | Results for the Three Months Ended March 31, | Year-over-Year Change | |||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||||||||||
(dollar amounts in thousands) | 2005 | 2004 | Increase (Decrease) Amount | Increase (Decrease) Percent | ||||||||||||||||||||
Total revenues | $ | 3,635 | $ | 3,659 | $ | 10,217 | $ | 11,403 | $ | 3,936 | $ | 3,196 | $ | 740 | 23% | |||||||||
Operating expense: | ||||||||||||||||||||||||
Direct operating cost | 158 | 207 | 438 | 715 | ||||||||||||||||||||
Direct operating costs | 259 | 78 | 181 | 232% | ||||||||||||||||||||
Salaries and benefits | 2,081 | 2,152 | 6,397 | 6,868 | 2,127 | 2,161 | (34 | ) | (2%) | |||||||||||||||
Selling, general and administrative | 514 | 640 | 1,489 | 2,005 | 390 | 529 | (139 | ) | (26%) | |||||||||||||||
Depreciation and amortization | 256 | 296 | 712 | 837 | 282 | 221 | 61 | 28% | ||||||||||||||||
Total operating expenses | 3,009 | 3,295 | 9,036 | 10,425 | 3,058 | 2,989 | 69 | 2% | ||||||||||||||||
Operating income | $ | 626 | $ | 364 | $ | 1,181 | $ | 978 | $ | 878 | $ | 207 | $ | 671 | 324% | |||||||||
Revenues, operating expenses and Operating Expensesoperating income
The Software Solutions Segment’s revenues consist of fees from licensing, professional services and maintenance of software and sales of hardware. Software license fees are the initial fees we charge to license our proprietary application software to customers. We charge professional service fees for providing customization, installation and consulting services to our customers. Software maintenance fees are the ongoing fees we charge for maintenance of our customers’ software products. Hardware sales revenues are derived from the sale of computer products.
Software revenues increased in the thirdfirst quarter of 2004 were flat as2005 by $0.7 million compared to the thirdfirst quarter 2004. This increase is due to the addition of 2003new contracts and decreased by $1.2 millionthe efficient implementation of several upgrades for existing customers during the nine-month period ended September 30, 2004first quarter 2005 compared to the nine-month period ended September 30, 2003. Fewer billable hours in
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professional services as well as fewer license contracts and maintenance contract fees accounted for the decreasefirst quarter 2004. Direct operating costs increased in the nine-month period ended September 30, 2004. Operatingfirst quarter 2005 from the first quarter 2004, however, other costs decreased, resulting in overall operating expenses also decreased by $0.3remaining flat. The combination of increased revenues, without corresponding increases in associated total operating costs resulted in an increase to operating income during the first quarter 2005 of $0.7 million in the third quarter of 2004 compared to third quarter of 2003 and by $1.4 million for the nine-month period ended September 30, 2004 compared to the same nine-month period of 2003. Operating income increased due to the fact that the operating expense decrease was greater than decrease in revenue.a year ago.
Software Sales Backlog
We define “software sales backlog” as fees specified in contracts thatwhich we have executed and for which we expect recognition of the related revenue within one year. At September 30, 2004,As of March 31, 2005, the revenue backlog was $5.0$4.1 million compared to $4.5 million as compared to $5.5 million at September 30, 2003.of March 31, 2004. We cannot give assurances that the contracts included in backlog will actually generate the specified revenues or that the revenues will be generated within the one-year period.
CORPORATE SERVICES SEGMENTAND NON-OPERATING RESULTS
The following table presents the results of operationsoperating expenses for the third quarterthree months ended March 31, 2005 and the nine-month period ended September 30, 2004 and 2003 for ourthe Corporate Services Segment:
Corporate Services
(unaudited, in thousands)
Three months ended September 30, | Nine months ended September 30, | Results for the Three Months Ended March 31, | Year-over-Year Change | ||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | ||||||||||||||||||||
(dollar amounts in thousands) | 2005 | 2004 | Increase (Decrease) Amount | Increase (Decrease) Percent | |||||||||||||||||||
Salaries and benefits | $ | 1,214 | $ | 696 | $ | 3,346 | $ | 1,951 | $ | 1,216 | $ | 1,034 | $ | 182 | 18% | ||||||||
Selling, general and administrative | 1,247 | 1,211 | 3,543 | 2,834 | 1,320 | 997 | 323 | 32% | |||||||||||||||
Depreciation and amortization | 50 | 20 | 105 | 63 | 35 | 32 | 3 | 9% | |||||||||||||||
Total operating expenses | $ | 2,511 | $ | 1,927 | $ | 6,994 | $ | 4,848 | $ | 2,571 | $ | 2,063 | $ | 508 | 25% | ||||||||
Corporate Operating Expenses
OperatingThe increase in total operating expenses for the Corporate Services Segment increased by $0.6 millionis primarily attributable to $2.5 million for the third quarter 2004 from $1.9 million for the third quarter 2003, and they increased by $2.1 million to $7.0 million for the nine months ended September 30, 2004 from $4.8 for the same period of 2003, primarily due to increases in professional fees insurance and salary expense resulting fromstaffing levels required to manage overall companyCompany growth annual compensation increases and incentive compensation. Professional fee increases include accruals for control documentation and testing required byto continue fulfilling the requirements of the Sarbanes-Oxley regulations.Act of 2002.
NON-OPERATING RESULTS- 23 -
Interest Income
Interest income increased to $0.9was $1.2 million for the thirdfirst quarter 2004 and2005, compared to $2.1$0.6 million for the nine months ended September 30,first quarter 2004, compared to $0.3 million for the third quarter 2003 and $0.9 million for the nine months ended September 30, 2003. These increases were due to small increases in the interest rates earned in 2004 over 2003 and to a significant increase in the average balance on temporary cash depositsinvestments held in trust in the growing Prepaid Processing Segment.Segment and interest earned on the net proceeds from the December 2004 issuance of $140 million in convertible debentures.
Interest Expense
Interest expense remained constant at $1.8 million for the third quarter 2004 compared to the third quarter 2003 and decreased to $5.3 million for the nine months ended September 30, 2004 from $5.4 for the nine months ended September 30, 2003. The slight change in the interest expense is due to foreign exchange fluctuations and partial repayment of 12 3/8% Senior Discount Notes, offset by capitalized leases and borrowings on our line of credit at lower interest rates.
Gain on Sale of Subsidiary
The gain on the sale of subsidiary of $18.0was $1.6 million for the first quarter 2003 relates2005 compared to $1.8 million for the first quarter 2004. Although we had a larger amount of interest bearing debt outstanding during the first quarter 2005 compared to the salefirst quarter 2004, the weighted average interest rate was 4% for the first quarter 2005 compared to 12% for the first quarter 2004. The decrease was primarily due to the 1.625% interest rate on our convertible debentures, which were outstanding for the first quarter 2005 and the retirement of our U.K. subsidiary in January 2003. This sale is more fully described in Note 5 to
12 3/8% Senior Discount Notes and 8% acquisition notes, which were outstanding during the unaudited consolidated financial statements.first quarter 2004.
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Foreign Exchange Gain (Loss)
We had net foreign exchange gains of $0.4 million and $0.9 million for the three and the nine months ended September 30, 2004, respectively, compared to net foreign exchange losses of $0.2 million and $5.2 million for the three and the nine months ended September 30, 2003, respectively. These improvements are primarily due to the strengthening of the U.S. dollar, particularly relative to the euro and British pound sterling (GBP) during 2004 compared to the same periods in 2003 when we experienced a significant weakening of the U.S. dollar against those currencies. Exchange gains and losses that result from re-measurement of some of our assets and liabilities are recorded in determining net gain or loss. A portion of our assets and liabilities are denominated in euros, GBP and other currencies, including certain capital lease obligations, Senior Discount Notes, acquisition debt and cash and cash equivalents. It is our policy to attempt to reasonably match local currency receivables and payables. Foreign currency denominated assets and liabilities give rise to foreign exchange gains and losses as a result of U.S. dollar to local currency exchange movements. We recorded a net foreign exchange loss of $2.8 million for the first quarter 2005, compared to a gain of $0.2 million for the first quarter 2004. Exchange gains and losses that result from re-measurement of certain assets and liabilities are recorded in determining net income. Due to our global exposure, a significant portion of our assets and liabilities are denominated in currencies other than the U.S. dollar, including capital lease obligations, short-term obligations, cash and cash equivalents and investments.
Income Tax Expense
Tax expense on income from continuing operations was $3.7$3.8 million for the three months and $8.1first quarter 2005 compared to $2.1 million for the nine months ended September 30, 2004, respectively, comparedfirst quarter 2004. Tax expense continues to $0.7 for the three months and $2.3 for the nine months ended September 30, 2003, respectively. The increase in tax expense isgrow due to the growing profitability of individual companies in the Prepaid Processing and EFT Processing Segments, particularly in Western Europe and Australia, together with the inclusion of e-pay for nine months in the nine months ended September 30, 2004 compared to eight months in the nine months ended September 30, 2003 and the inclusion of transact in the nine months ended September 30, 2004.
Australia. The effective tax rate for the thirdfirst quarter 20042005 was approximately 38% and for the nine months ended September 30, 2004 was approximately 37% compared to 34% for the third quarter 2003 and 14% for the nine months ended September 30, 2003. The effective tax rate for the nine months ended September 30, 2003 included a non-taxable gain on the sale of the U.K. ATM network in the first quarter of 2003 and, accordingly, resulted in a low effective tax rate. If this gain were not included in the prior year, the effective tax rate for the nine months ended September 30, 2003 would have been significantly higher—higher than the effective tax rate for the nine months ended September 30, 2004. Accordingly, excluding the gain in 2003 from the effective tax rate calculation, the effective tax rate for the nine months ended September 30, 2004 would have decreased significantly over the prior period. This improvement was largely the result of improving operating profits in countries with low tax rates or countries where net operating losses have not been fully utilized.44%.
Net Income
In summary, net income was $6.0of $4.8 million for the thirdfirst quarter 2004 and $13.62005 represents a $1.5 million increase over the $3.3 million recorded for the nine months ended September 30, 2004 compared to a net income of $1.4 million for the thirdfirst quarter 2003 and net income of $14.0 million for the nine months ended September 30, 2003.2004. The nine months ended September 30, 2004 decrease of $0.4 millionincrease was primarily due to:
$1.7 million.
LIQUIDITY AND CAPITAL RESOURCES
LiquidityWorking Capital
AsOur balance of September 30, 2004, the Company had unrestricted cash and cash equivalents was $73.0 million and the balance of $36.9restricted cash was $107.9 million an increaseas of $17.7 million fromMarch 31, 2005. At March 31, 2005, we had working capital of approximately $19.2 million compared to working capital of approximately $51.6 million at December 31, 2004. The ratio of current assets to current liabilities decreased to 1.06 at March 31, 2005 from 1.18 at December 31, 2004. The decrease in working capital and the ratio of current assets to current liabilities was mainly due to cash payments for the acquisition of Movilcarga, Telerecarga and ATX and the earn-out payment to the former owners of Transact. For a detailed explanation of these items and the variances from such amounts as of December 31, 2003. 2004, see “Balance Sheet Items” below.
Operating cash flows
Cash flow from operations contributed approximately $34.6flows provided by operating activities increased slightly to $9.9 million infor the nine months ended September 30, 2004, including approximately $4.2first quarter 2005 compared to $9.4 million thatfor the first quarter 2004. The increase was freed upprimarily due to the release of restricted cash held as collateral on standby letters of credit. The release of restricted cash occurredincrease in connectionnet income, combined with execution of a $10 million unsecured revolving line of credit entered intoincreases in February 2004, see “Debtdepreciation and Capital Resources” for more information. Previously stand-by letters of credit were secured by cash depositsamortization and as of September 30, 2004, were secured by the bank line of credit. New debt issuances contributed $5.1 million in cash during the nine months ended September 30, 2004. Additionally, employee stock option exercises,unrealized foreign exchange loss, which represent non-cash expenses.
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employee stock purchasesCash flows used in investing activities were $59.3 million and warrant exercises resulted in $5.5 million in cash. Debt repayments reduced unrestricted cash by approximately $15.8 million during the first nine months of 2004. Capital expenditures consumed approximately $6.0 million of cash during the nine months ended September 30, 2004. Net tax payments were approximately $3.0$4.7 million for the ninethree months ended September 30, 2004.March 31, 2005 and 2004, respectively. The balanceamount for the first quarter 2005 includes cash paid related to the acquisitions in the amounts of the net uses$14.7 million for Telerecarga, $13.0 million for Movilcarga and $3.5 million (net of cash duringacquired of $1.9 million) for ATX, as well as the ninecash earn-out payment of $24.5 million to the former owners of Transact. Additionally, our fixed asset purchased for the first quarter 2005 totaled $3.0 million. The amount for 2004 was primarily comprised of $2.6 million for the acquisition of Precept and $2.0 million for fixed asset purchases.
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Financing activity cash flows
Cash flows provided by financing activities were $1.1 million for the three months ended September 30, 2004 cameMarch 31, 2005, compared to the amount used in financing activities of $4.8 million for the first quarter 2004. These amounts include proceeds from net changes in non-current assets, largely related to acquisitions.
We had restricted cashthe exercise of $57.6 million asstock options and employee share purchases and repayments of September 30, 2004, including $56.9 million of cash held in trust and/or cash held on behalf of others in connection with the collection and disbursement activities in the Prepaid Processing Segment. Restricted cash decreased by approximately $0.6 million during the nine months ended September 30, 2004. The net increase resulted from a release of $4.2 million in cash collateral that supported the letters of credit described above; the reduction was more than offset by higher balances driven by increased processing of prepaid transactions.obligations under capital leases.
We reduced the amountOther Sources of our 12 3/8% Senior Discount Notes outstanding by $15.0 million to $28.5 million at September 30, 2004, from $43.5 million at December 31, 2003, resulting from $14.2 million in cash repurchases together with a $0.8 million benefit in foreign exchange rates due to the strengthening of the dollar against the euro during the nine months ended September 30, 2004. Subsequent to September 30, 2004, we repurchased an additional $17.0 million of our 12 3/8% Senior Discount Notes, reducing the September 30, 2004 balance of $28.5 million to $11.5 million (excluding the effects of any foreign exchange fluctuations since that date). Additionally, the company called the remaining outstanding $11.5 million, which will be fully redeemed in December 2004. As of September 30, 2004 we had sufficient cash to fully repurchase these bonds.Capital
Debt and Capital Resources
In February 2004, we entered into a two-year unsecured revolving credit agreement providing a facility of up to $10 million with a U.S.-based financial institution. The proceeds from the facility can be used for working capital needs, acquisitions and other corporate purposes. Interest accrues on borrowings outstanding at a prime-based floating rate or LIBOR-based rates for 90-day periods. Certain financial performance covenants must be maintained under the agreement, and the $10 million is subject to certain advance rate restrictions.Credit agreements – As of September 30, 2004,March 31, 2005, we were in compliance with these covenants, and the maximum amount allowable to borrow under the advance rate limitation is approximately $9.0 million. As of September 30, 2004, we borrowed $5.0 million under this bank agreement and utilized $2.9 million to securehad stand by letters of credit.
In October 2004, we renegotiated and expanded the $10credit totaling $2.2 million outstanding against our $40 million revolving credit agreement to a two-year $40agreements; the remaining $37.8 million commitment.was available for borrowing. The expanded $40 million revolving credit agreement consisting of two credit agreements, will allow us to borrow up tocomprises a $10 million throughfacility among our holding company, Euronet Worldwide, Inc. and certain U.S. subsidiaries and a U.S. subsidiary agreement and up to $30 million through afacility among certain European subsidiary agreement. Each agreement hassubsidiaries. The revolving credit facilities have been, and can be, used to repay existing debt, for working capital needs, to make acquisitions or for other corporate purposes. These agreements expire during October 2006 and contain customary financial performanceevents of default and covenants related to limitations on indebtedness and is secured with the securitiesmaintenance of certain financial ratios. We were in compliance with all covenants as of March 31, 2005. For more information regarding these facilities see our subsidiaries. Borrowings under our U.S. subsidiary agreement bear interest (at our option) at either the U.S. Prime rate or a 30- to 90-day fixed rate equal to the LIBOR Rate plus a margin basedAnnual Report on our consolidated funded debt to EBITDA ratio. Borrowings under our European subsidiary agreement bear interest (at our option) at either a 30- to 90-day rate equal to the EURIBOR rate or the LIBOR rate plus a margin on our consolidated funded debt to EBITDA ratio plus certain ancillary costs. At the endForm 10-K, Item 7 – “Management’s Discussion and Analysis of October 2004, the averageFinancial Condition and Results of the annualized rates under these agreements was approximately 6%. As of November 8, 2004, we had borrowed $25 million against these agreements (including amounts borrowed under the prior $10 million agreement)Operations – Liquidity and utilized $2.9 million to secure stand by letters of credit, leaving approximately $12 million available to borrow. At the current draw level, and the current interest rates, we will be required to make approximately $0.4 million in quarterly interest payments related to our revolving credit agreements.Capital Resources.”
OurOverdraft facility – In 2004, our Czech Republic officesubsidiary entered into an overdraft facility with a bank for up to approximately $2.0$3.0 million in order to support additional ATM network cash needs. As of September 30, 2004,March 31, 2005, the balance outstanding is approximately $2.0 million.
Infull amount of the EFT Processing Segment, we lease many of our ATMs and certain computer equipment under capital lease arrangements that expire between 2003 and 2008. The leases bear interest between 2.4% and 12% per year. As of September 30, 2004, we owed $18.0 million under these capital lease arrangements. We expect that our capital requirements will continue in the future, although our strategy to focus on ATM outsourcing opportunities rather than ATM ownership and deployment as well as redeployment of under-performing ATMs will reduce capital requirements.
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There can be no assurance that we will be able to meet the debt obligations upon maturity as disclosed above or to obtain favorable terms for refinancing of any of our debt as it matures.facility was outstanding.
Employee Stock PlansConvertible debt – On December 15, 2004, we closed the sale of $140 million in principal amount of 1.625% Contingent Convertible Senior Debentures Due 2024 (“Convertible Debentures”). The net proceeds, after fees totaling $4.5 million, were $135.5 million. The $4.4 million in fees has been deferred and is being amortized over five years, the term of the initial put option by the holders of the Convertible Debentures. We have used, and plan to use the proceeds of the Convertible Debentures for debt repayment, acquisitions and other corporate purposes.
Effective July 1, 2001, we implemented our 2001Proceeds from issuance of shares and other capital contributions – In February 2003, the Company established a new qualified Employee Stock Purchase Plan or ESPP,(“ESPP”) and reserved 500,000 shares of Common Stock for purchase under whichthe plan by employees have the opportunity to purchase Common Stock through payroll deductions according to specific eligibility and participation requirements. This plan qualifies as an “employee stock purchase plan” under section 423 of the Internal Revenue Code of 1986. We completed a series of offerings of three months duration with new offerings commencing on January 1, April 1, July 1, and October 1Offerings commence at the beginning of each year.quarter and expire at the end of the quarter. Under the plan, participating employees are granted options, which immediately vest and are automatically exercised on the final date of the respective offering period. The exercise price of Common Stock options purchased is the lesser of 85% of the “fair market value” (as defined in the ESPP) of the shares on the first day of each offering or the last dateday of each offering. The options are funded by participating employees’ payroll deductions or cash payments.
Under the provisions of the 2001 ESPP, we reserved 500,000 shares of Common Stock all of which we had issued as of December 31, 2002. In February 2003, we adopted a new ESPP and reserved 500,000 shares of Common Stock for issuance under that plan. During the three quarterly periodsmonths ended September 30, 2004,March 31, 2005, we issued a total of 33,08810,907 shares at pricesan average price of $15.79, $16.11 and $15.90$21.50 per share, resulting in proceeds to us of approximately $0.5$0.2 million.
In January 2004, we made matching contributions of 11,482 shares of stock in conjunction with our 401(k) employee benefits plan for the plan year 2003. Under the terms of this plan, employer-matching contributions consist of two parts, referred to as “basic” and “discretionary.” The basic matching contribution is equal to 50% of eligible employee elective salary deferrals between 4% and 6% of participating employee salaries for the plan year. The discretionary matching contribution is determined by our Board of Directors for a plan year and is allocated in proportion to employee elective deferrals. As of September 30, 2004, total employer matching contributions since inception of the plan has consisted of 81,693 shares.
Acquisitions and RelatedOther Uses of Capital Requirements
In February 2003,Payment obligations related to acquisitions – As provided in our share purchase agreement with the selling shareholders of Transact, during the first quarter 2005, we acquired e-paypaid an “earn-out” totaling $39.1 million. This payment was settled through the issuance of 598,302 shares of Company Common Stock, valued at approximately $14.6 million, and incurred indebtedness comprised€18.7 million (approximately $24.5 million) in cash. We also recorded approximately $13.0 million as of three separate elements totaling approximately $27 million. In JanuaryDecember 31, 2004 for the second payment in connection with the acquisition of the Movilcarga assets. These payments were accrued as current liabilities as of December 31, 2004.
As of March 31, 2005, we acquired Precept and incurred indebtedness of $4.0 million. The terms of this new indebtedness are more fully described in Note 4recorded an obligation to the unaudited consolidated financial statements. All but $12.4former shareholders of Telerecarga for €15.0 million (approximately $20.1 million) to be settled during the second quarter 2005 through a combination of cash and assumption of liabilities. This settlement is subject to certain performance conditions, which Euronet expects will be met. We also have other potential earn-out obligations to the former owners of the e-pay indebtedness was repaid or converted to sharesnet assets of EPS, Movilcarga and Dynamic. These obligations, certain of which may be settled through the issuance of our Common Stock, prior to December 21, 2003. We repaid $1.6 million ofhave not been recorded in the Precept acquisition indebtedness duringaccompanying unaudited consolidated financial statements because the nine months ended September 30, 2004. In November, we extended the maturity date on $11.2 million of the $12.4 million e-pay notes from February 2005 to August 2005 with the right tofinal amounts cannot be estimated beyond a reasonable doubt. These potential obligations are discussed further extend the maturity to February 2006. The $1.2 not extended with be paid upon maturity in February 2005 from operating cash flows. Moreover, the interest rate on the e-pay acquisition debt was increased on the extended notes effective February 2005 from 8% per annum to 10% per annum, payable quarterly. The remaining element of the e-pay acquisition debt of $12.4 million and $2.4 million in Precept acquisition debt is due within twelve months and, accordingly, is classified as current in our balance sheet as of September 30, 2004. With respectNote 4 – Acquisitions to the $2.4 million Precept acquisition debt, we have the option to settle $2.0 millionUnaudited Consolidated Financial Statements and in Item 2 – Management’s Discussion and Analysis of the obligation with cash or our Common Stock valued at a 10% discount to the average market price 20 trading days prior to the maturity dateFinancial Condition and Results of February 25, 2005. At the current level of this acquisition debt, we will be required to make quarterly interest payments of approximately $0.4 million. We intend to repay this indebtedness from cash flows from operations or up to $2.0 million in our Common Stock.Operations – Contractual Obligations and Off Balance Sheet Items below.
ATM Leases – In the eventEFT Processing Segment, we are not able to repay the debt through cash flows, we will attempt to refinance this debt.
In September 2004, the AIM purchase agreement was modified to pay the remaining consideration through the issuancelease many of 283,976 shares of Euronet Common Stock, 168,068 will be held in escrow; 110,114 shares will be released on September 30,our ATMs under capital lease arrangements that expire between 2005 and 2011. The leases bear interest between 2.5% and 12% per year. As of March 31, 2005, we owed $20.3 million under these capital lease arrangements. The majority of these lease agreements are not subject to any performance criteria, and 57,954 will be released on December 31, 2006, subject to certain performance criteria. The value of the shares above is reflected as an adjustment to the purchase price as of September 30, 2004.
Additionally, we may be required to issue additional shares of our Common Stock and make additional cash payments under contingent “earn-out” paymentsentered into in connection with our acquisitionslong-term outsourcing
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agreements where, generally, we purchase a bank’s ATMs and simultaneously sell the ATMs to an entity related to the bank and lease back the ATMs for purposes of fulfilling the shares of transact and CPI andATM outsourcing agreement with the assets of EPS. The number of shares issuedbank. We fully recover the related lease costs from the bank under the earn outs will dependoutsourcing agreements. Generally, the leases may be canceled without penalty upon the performance of the businesses acquired and the trading price of our Common Stock at the time we make the earn-out payments. We estimate the earn-out paymentreasonable notice in the transact acquisitionunlikely event the bank or we were to terminate the related outsourcing agreement. We expect that, if terms were acceptable, we would acquire more ATMs from banks under such outsourcing and lease agreements.
Capital expenditures and needs– Total cash capital expenditures for 2005 are estimated to be approximately $20$10 million to $30$12 million, (50% payable in cashof which $3.0 million has been incurred as of March 31, 2005. These capital expenditures are required largely for the upgrade of ATMs to meet EMV requirements and 50% in our Common Stock; this payment is due“micro-chip” card technology, the purchase of terminals for the Prepaid Processing Segment and payable on January 14, 2005),office and in the other acquisitions to be approximately $2.0 million, largely payable in our Common Stock.
Capital expenditures requirementsdata center computer equipment and software.
In the Prepaid Processing Segment, we own approximately 32,00037,500 of the 168,000more than 205,000 POS devices that we operate. Theoperate are Company owned, with the remaining 136,000 representterminals being operated as integrated cash register devices of our major retail customers.customers or owned by the retailers. As the prepaid processing businessour Prepaid Processing Segment expands, we will continue to add terminals in certain independent retail locations at a price of approximately $300 per terminal. We expect the proportion of owned terminals to remain at a similar percent of total terminals operated.operated to remain relatively constant.
CapitalWe are required to maintain ATM hardware for Euronet-owned ATMs and software for all ATMs in our network in accordance with certain regulations and mandates established by local country regulatory and administrative bodies as well as Europay, MasterCard and Visa (EMV). Accordingly, we expect additional capital expenditures over the next few years to maintain compliance with these regulations and/or mandates. However, we expect hardware expenditures to be less each year as we increase the outsourcing aspect of our business and reduce the number of owned ATMs. Upgrades to our ATM software and hardware were required in 2004 and continue into 2005 to meet EMV mandates such as Triple DES (Data Encryption Standard) and “micro–chip” card technology for 2004smart cards. We completed a plan for implementation and delivery of the hardware and software modifications; the remaining capital expenditures necessary to complete these upgrade requirements are estimated to be approximately $20 million. These capital expenditures are largely driven by the second quarter 2004 purchase of 728 ATMs from a bank for approximately $8.5 million under a multi-year ATM outsourcing agreement and an expected $4.0$3.0 million to $6.0 million related the EMV/chip-card upgrades to enable certain “micro-
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chip” card technology for “Smart Cards.” With respect to the purchase of the 728 ATMs, our agreement with the bank provides for a simultaneous ATM sale/leaseback transaction with a leasing entity affiliated with the bank. The cost of the lease will be charged back to the bank customer. Our agreement further provides that in the event we or the bank terminate the ATM outsourcing agreement for any reason, the obligations under the lease agreement will automatically terminate and the ATMs revert back to the affiliated entity with no remaining obligation to us. With respect to the remaining capital expenditures, we anticipate that we will fund their purchases under lease terms acceptable to us or with cash. Capital expenditures, including capitalized leases, for the nine months ended September 30, 2004 were approximately $18.6 million; cash funded capital expenditures was $6.0$4.0 million.
GivenAt current and projected cash flow levels together with cash on-hand and amounts available under our recently signed revolving credit agreements, we anticipate that our cash generated from operations and existing financing will be sufficient to meet our debt, leasing, acquisition earn-out and capital expenditure obligations. If our cash is insufficient to meet these obligations, we will seek to refinance these obligations.our debt under terms acceptable to us. However, therewe can beoffer no assuranceassurances that we will be able to obtain favorable terms for the refinancing of any of the debt or obligations described above.
Subsequent Events
Subsequent to September 30, 2004, Euronet acquired the assets of the Movilcarga Division (Movilcarga) of Grupo Meflur Corporacion (Meflur), a Spanish telecommunications distribution company. Euronet acquired 80% of the shares of an acquisition entity that purchased the Movilcarga assets for €18.0 million (approximately $22.9 million) in two installments: €8.0 million in cash at closing and €10.0 million in cash to be paid in March 2005, subject to certain revenue targets and adjustments. Additional payments may be due in December 2006 and 2007, subject to the fulfillment of certain financial conditions. Based on financial estimates provided by Meflur, we estimate the additional payments to be approximately $7 million to $10 million.
Subsequent to September 30, 2004 we extended the maturity date by six months on $11.2 million of the epay acquisition notes. See discussion of this event under the subcategory “Acquisitions and Related Capital Requirements” included in this same section above.
Subsequent to September 30, 2004, we restructured and expanded our revolving credit agreement. See discussion of this event under the subcategory “Debt and Capital Resources” included in this same section above.
CONTRACTUAL OBLIGATIONS AND OFF-BALANCEOFF BALANCE SHEET ITEMS
The following table summarizes our contractual obligations as of September 30, 2004March 31, 2005 (unaudited, in thousands):
Payments due by period | Payments due by period | |||||||||||||||||||||||||||||
Contractual Obligations | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | |||||||||||||||||||||||||
(amounts in thousands) | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | |||||||||||||||||||||||||
Debt obligations | $ | 51,479 | $ | 19,676 | $ | 31,803 | $ | — | $ | — | $ | 185,500 | $ | 2,275 | $ | 4,550 | $ | 4,550 | $ | 174,125 | ||||||||||
Acquisition obligations | 43,400 | 30,500 | 12,900 | — | — | |||||||||||||||||||||||||
Capital leases | 22,497 | 5,408 | 8,168 | 5,699 | 3,222 | 24,284 | 6,485 | 10,008 | 5,094 | 2,697 | ||||||||||||||||||||
Operating leases | 16,700 | 3,641 | 7,220 | 4,586 | 1,253 | 17,584 | 4,607 | 7,755 | 4,689 | 533 | ||||||||||||||||||||
Lines of credit | 7,041 | 7,041 | — | — | — | |||||||||||||||||||||||||
Operating and asset based indebtedness | 2,321 | 2,321 | — | — | — | |||||||||||||||||||||||||
Short-term obligations | 4,233 | 4,233 | — | — | — | |||||||||||||||||||||||||
Purchase obligations | $ | 16,897 | $ | 5,363 | $ | 5,505 | $ | 4,233 | $ | 1,796 | 16,331 | 6,863 | 6,351 | 2,142 | 975 | |||||||||||||||
Total | $ | 116,935 | $ | 43,450 | $ | 52,696 | $ | 14,518 | $ | 6,271 | $ | 291,332 | $ | 54,963 | $ | 41,564 | $ | 16,475 | $ | 178,330 | ||||||||||
Purchase obligations include contractual amounts for ATM maintenance, cleaning, telecommunication and cash replenishment operating expenses. While contractual payments may be greater or less based on the number of ATMs and transaction levels, purchase obligations listed above are estimated based on current levels of such business activity.
Euronet Worldwide, Inc.We regularly grantsgrant guarantees of the obligations of its wholly ownedour wholly-owned subsidiaries. These obligations include financial obligations of subsidiaries under leases or other agreements (such as cash supply agreements), as well as guarantees of performance of executory commercial agreements entered into between our subsidiaries and our customers. As of September 30, 2004,March 31, 2005, we had granted guarantees inof the following obligations and amounts:
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In certain instances in which we license proprietary systems to customers, we give certain warranties and infringement indemnities to the licensee, the terms of which vary depending on the negotiated terms of each respective license agreement, but which generally warrant that such systems do not infringe on any intellectual property owned by third parties and that they will perform in accordance with their specifications. The amount of such obligations is not stated in the license agreements. Our liability for breach of such warranties may be subject to time and materiality limitations, monetary caps and other conditions and defenses.
From time to time, we enterEuronet enters into agreements with unaffiliated parties containingthat contain indemnification provisions, the terms of which may vary depending on the negotiated terms of each respective agreement. The amount of such obligations is not stated in the agreements. Our liability under such indemnification provisionsprovision may be subject to time and materiality limitations, monetary caps and other conditions and defenses. Such indemnity obligations include the following:
To date, we are obligatednot aware of any significant claims made by the indemnified parties or parties to indemnify the officersguarantee agreements with us and, directorsaccordingly, no liabilities have been recorded as of our company to the maximum extent authorized by Delaware law. The amount of such obligations is not stated in the charter or the resolutions and is subject only to limitations imposed by Delaware law.
At September 30, 2004, we had not accrued any liability on the aforementioned guarantees or indemnifications.
As of September 30, 2004, we have letters of credit of $2.8 million outstanding on the Company’s behalf.March 31, 2005.
BALANCE SHEET ITEMS
Cash and Cash Equivalentscash equivalents
Cash and cash equivalents increased $17.6 milliondecreased to $36.9$73.0 million at September 30, 2004 compared to $19.2March 31, 2005 from $124.2 million at December 31, 20032004 primarily due to the following activity:
Sources of cash:
Uses of cash:
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See the Unaudited Consolidated Statements of Cash Flows for further description of these items.
Restricted Cashcash
Restricted cash decreased $0.6 millionincreased to $57.7$107.9 million at September 30, 2004March 31, 2005 from $58.3$69.3 million at December 31, 20032004, and primarily represents $103.0 million held in trust and/or cash held on behalf of others in connection with the administration of the customer collection
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and vendor remittance activities in the Prepaid Processing Segment. Amounts collected from customers that are due to the release of $4.2 millionmobile operators are deposited into a restricted cash account held as cash collateral on letters of credit, offset by higher balances resulting from increased prepaid transaction sales. At September 30, 2004, our Prepaid Processing Segment companies held approximately $56.9 million on behalf of the mobile operators for which we process transactions. These balances are used in connection with the administration of customer collection and vendor remittance activities. The remainderremaining balances of restricted cash represent primarily ATM deposits and collateral on bank guarantees. The increase from December 31, 2004 is held as security with respect to cash provided by mobile operatorsprimarily related to top-up transactions withinthe timing of the settlement process at our EFT Processing Segmente-pay subsidiaries in the U.K. and other deposits held by vendors.Australia.
Trade Accounts Receivableaccounts receivable, net
Trade accounts receivable, net increased $7.7 million to $83.4$114.3 million at September 30, 2004March 31, 2005 from $75.7$110.3 million at December 31, 2003 primarily due to revenue growth in2004. The primary component of our Prepaid Processing Segment, as well as the acquisitions of Precept, EPS and CPI in our Prepaid Processing Segment. Approximately $71.6 million of the balance at September 30, 2004 represents the trade accounts receivable of our Prepaid Processing Segment, which relates to trust or similar cash arrangementsrepresents amounts to be collected on behalf of mobile operators.operators in connection with the timing of the settlement process for the growing Prepaid Processing Segment. The slight growth over the prior year is due to the acquisitions of Telerecarga, Dynamic and ATX, mostly offset by a decrease related to the timing of the settlement process at our e-pay subsidiary in the U.K.
Prepaid Expensesexpenses and Other Current Assetsother current assets
Prepaid expenses and other current assets increased by $15.6 million to $27.1$19.7 million as of September 30, 2004March 31, 2005 from $11.5$13.2 million atas of December 31, 20032004. The largest component of this balance is amounts recorded for our net Value Added Tax (VAT) receivable related to certain European subsidiaries. The balance of net VAT receivable as of March 31, 2005 was $12.6 million, compared to $7.0 million as of December 31, 2004. This increase of $5.6 million was primarily due to an increase in PIN (prepaid wireless minutes using a personal identification number) inventory inresult of the Prepaid Processing Segment.acquisition of Telerecarga during the first quarter 2005.
Property, Plantplant and Equipmentequipment, net
Net property, plant and equipment increased by $13.7 million to $34.4$42.0 million as of September 30, 2004March 31, 2005 from $20.7$39.9 million at December 31, 2003. This2004. Of this increase, includes approximately $18.6 million in fixed asset purchases, including approximately $8.6 million for ATMs related to a new outsourcing contract in Poland, $3.1 million for German ATM upgrades, $1.0 million for other ATM purchases, $2.4 million for POS terminals, $2.5 million for computer hardware and software, and $1.0 million for leasehold improvements and office equipment. These additions plus $1.0 million for the net book value of assets acquired from Precept, EPS and CPI are substantially offset by $7.6 million in depreciation and amortization. The remaining changes are primarily due to foreign exchange rate movements.
Goodwill and Intangible Assets
Total intangible assets (goodwill of $116.2 million and net amortizable intangible assets of $25.3 million) increased by $30.2 million to $141.5 million at September 30, 2004 from $111.3 million at December 31, 2003 primarily due to the acquisition of Precept in January 2004, EPS in May 2004 and CPI in July 2004 and the earn-out payment of $4.9 million for the purchase of AIM. Of the total purchase price for these entities, $5.2 million has been preliminarily allocated to amortizable intangible assets acquired and $22.0 million has been allocated to goodwill. Goodwill represents the excess of the purchase price of the acquired business over the fair value of the underlying net tangible and intangible assets. The $32.9 million increase was offset by $2.7 million in amortization expense on all amortizable intangible assets. The remaining difference of $0.8 million is due to foreign exchange rate fluctuations and minor purchase price allocation refinements during the nine months ended September 30, 2004. A summary of activity for the nine months ended September 30, 2004 and balances by subsidiary as of September 30, 2004 is presented below.
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Goodwill and Intangible Assets activity for the nine months ended September 30, 2004 (unaudited, in thousands) | |||||||||||||||
Category | Balance at December 31, 2003 | Additions (Primarily Precept, EPS and CPI Acquisitions) | Reductions (Amortization expense) | Balance at September 30, 2004 | |||||||||||
Goodwill | $ | 88,512 | $ | 27,710 | $ | — | $ | 116,222 | |||||||
Amortizable intangibles | 24,476 | 5,186 | — | 29,662 | |||||||||||
Accumulated amortization | (1,704 | ) | — | (2,681 | ) | (4,385 | ) | ||||||||
Total | $ | 111,284 | $ | 32,896 | $ | (2,681 | ) | $ | 141,499 | ||||||
Balance as of September 30, 2004 | |||||||||||||||
Acquisition | Total intangibles, net | Goodwill | Amortizable intangibles | Accumulated amortization | |||||||||||
Germany ATM | $ | 2,158 | $ | 2,158 | $ | — | $ | — | |||||||
e-pay | 75,399 | 61,272 | 17,328 | (3,201 | ) | ||||||||||
transact | 30,348 | 24,484 | 6,556 | (692 | ) | ||||||||||
AIM | 6,803 | 6,289 | 598 | (84 | ) | ||||||||||
Precept | 18,368 | 15,216 | 3,485 | (333 | ) | ||||||||||
EPS | 1,615 | 1,143 | 500 | (28 | ) | ||||||||||
CPI | 6,808 | 5,660 | 1,195 | (47 | ) | ||||||||||
Total | $ | 141,499 | $ | 116,222 | $ | 29,662 | $ | (4,385 | ) | ||||||
Deferred Tax Assets
Current and deferred tax assets decreased to $2.2 million at September 30, 2004 from $2.8 million at December 31, 2003 as a result of utilization of net operating losses and the reduction stemming from a review by the Hungarian tax authorities of other net operating losses.
Other Assets
Other assets increased by $3.0 million to $6.6 million at September 30, 2004 from $3.6 million at December 31, 2003 primarily due to the purchase of 10% of the shares of ATX Software Ltd. for $2.8 million.
Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses increased by $28.5 million to $165.0 million at September 30, 2004 from $136.5 million at December 31, 2003. Approximately $10.8 million of this increase is due to the acquisition of accounts payableTelerecarga and accrued expensesDynamic. Other additions to property, plant and equipment during the first quarter 2005 were offset by depreciation and amortization expense.
Goodwill and intangible assets
Net intangible assets and goodwill increased to $286.2 million at March 31, 2005 from $212.6 million at December 31, 2004 due to the acquisitions of Precept, EPSDynamic Telecom, Telerecarga and CPI atATX during the datefirst quarter 2005. Additionally, the final independent appraisal of acquisition.the Transact purchase price allocation resulted in an increase to the amount recorded for amortizable intangible assets of $1.8 million and a decrease to goodwill of $1.1 million, after the impact of deferred income taxes. Amortization of intangible assets for the three months ended March 31, 2005 was $1.2 million. The remaining $17.7following table summarizes the activity for the three months ended March 31, 2005:
(in thousands) | Amortizable Intangible Assets | Goodwill | Total Intangible Assets | |||||||||
Balance as of December 31, 2004 | $ | 28,930 | $ | 183,668 | $ | 212,598 | ||||||
Additions: | ||||||||||||
Acquisition of Dynamic | 3,488 | 8,098 | 11,586 | |||||||||
Acquisition of Telerecarga | 7,246 | 43,957 | 51,203 | |||||||||
Acquisition of ATX | 1,123 | 12,729 | 13,852 | |||||||||
Adjustment to Transact | 1,789 | (1,121 | ) | 668 | ||||||||
Amortization | (1,182 | ) | — | (1,182 | ) | |||||||
Other (primarily changes in foreign currency exchange rates) | (815 | ) | (1,707 | ) | (2,522 | ) | ||||||
Balance as of March 31, 2005 | $ | 40,579 | $ | 245,624 | $ | 286,203 | ||||||
Deferred tax assets
Current and non-current deferred tax assets totaled $12.0 million and $10.1 million as of March 31, 2005 and December 31, 2004, respectively. The increase in these balances as of March 31, 2005 is due to increasesthe recognition of deferred tax assets generated during the first quarter.
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Other assets
Other assets decreased to $9.5 million at March 31, 2005 from $12.7 million at December 31, 2004 primarily due to the Company exercising the option to purchase an additional 41% interest in ATX. As of December 31, 2004, we used the “cost method” of accounting for our 10% interest in ATX of $2.9 million. With our increase in ownership from 10% to 51%, we are now required to consolidate ATX’s financial position and results of operations.
Accounts payable
Accounts payable increased to $205.0 million at March 31, 2005 from $155.1 million at December 31, 2004. The primary component of our trade accounts payable represents payables to mobile operators in connection with the timing of the settlement process for the growing Prepaid Processing Segment. The increase of $49.9 million is due to the first quarter acquisition of Telerecarga, which has $36.8 million in accounts payable recorded as of March 31, 2005. The remaining increase is due to additional accounts payable recorded in our prepaid business related to the timing of the settlement process, primarily at our e-pay subsidiary in the U.K.
Taxes PayableAccrued expenses and other current liabilities
Accrued expenses and other current liabilities decreased to $84.6 million at March 31, 2005 from $107.6 million at December 31, 2004. This $23.0 million decrease is due to the settlement of the $39.1 million and $13.0 million purchase price liabilities for the Transact earn-out and Movilcarga acquisition, respectively, that were accrued as of December 31, 2004. This decrease was partially offset by the accrued purchase price liability related to the acquisition of Telerecarga of $20.1 million as of March 31, 2005 and an increase in the accrued liabilities recorded in our prepaid segment related to the timing of the settlement and invoicing process.
Income taxes payable
Income taxes payable increased $3.9 million to $7.2$10.5 million at September 30, 2004March 31, 2005 from $3.3$9.4 million at December 31, 20032004 primarily due to $7.7 million in incremental current tax expense related to our growing and profitable Australian and western European operations,recorded for first quarter earnings, partially offset by $3.8 million in payments.tax payments made during the same period.
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Capital LeasesDebt obligations and Notes Payablecapital leases
As of September 30, 2004, our acquisitionMarch 31, 2005, total indebtedness for Precept was classified as a current obligation because the total current debt obligations, including leases,decreased to $164.5 million from $166.2 million as of September 30, 2004 were $25.6 million.
December 31, 2004. A summary of the activity in our debt obligations for the quarter ended September 30, 2004March 31, 2005 is presented below:as follows:
Debt Obligations Balances and activity for the nine months ended September 30, 2004 (unaudited, in thousands) | |||||||||||||||||||||||||||
12 3/8% Senior Discount Notes | Acquisition Indebtedness | Operating and asset based | Lines of credit | Capital leases | Total | ||||||||||||||||||||||
e-pay notes due Feb. 2005 | Precept notes due Jan. 2005 | ||||||||||||||||||||||||||
Balance at January 1, 2004 | $ | 43,521 | $ | 12,271 | $ | — | $ | 2,005 | $ | 1,974 | $ | 5,191 | $ | 64,962 | |||||||||||||
Add: Additional debt | — | — | 4,000 | 564 | 5,317 | 16,321 | 26,202 | ||||||||||||||||||||
Less: Payments | (14,187 | ) | — | (1,603 | ) | (248 | ) | (250 | ) | (4,406 | ) | (20,694 | ) | ||||||||||||||
Adjust: Foreign exchange loss (gain) | (800 | ) | 146 | — | — | — | 870 | 216 | |||||||||||||||||||
Balance at September 30, 2004 | $ | 28,534 | $ | 12,417 | $ | 2,397 | $ | 2,321 | $ | 7,041 | $ | 17,976 | $ | 70,686 | |||||||||||||
As more fully described in Note 13—Subsequent Events, after September 30, 2004, we expanded and restructured the $10.0 million revolving credit agreement to $40.0 million, repurchased an additional $17.0 million of the 12 3/8% Senior Discount Notes, called the remaining $11.5 million of $12 3/8% Senior Discount Notes and extended the maturity date on $11.2 million of the e-pay acquisition notes to August 2005 with the right to further extend the maturity to February 2006.
(in thousands) | Short-Term Obligations | Capital Leases | 1.625% Convertible Debentures Due Dec. 2024 | Total | |||||||||||
Balance at December 31, 2004 | $ | 4,862 | $ | 21,297 | $ | 140,000 | $ | 166,159 | |||||||
Indebtedness incurred | — | 2,086 | — | 2,086 | |||||||||||
Repayments | (518 | ) | (2,048 | ) | — | (2,566 | ) | ||||||||
Foreign exchange gain | (111 | ) | (1,030 | ) | — | (1,141 | ) | ||||||||
Balance at March 31, 2005 | 4,233 | 20,305 | 140,000 | 164,538 | |||||||||||
Less - current maturities | (4,233 | ) | (4,855 | ) | — | (9,088 | ) | ||||||||
Balance at March 31, 2005 | $ | — | $ | 15,450 | $ | 140,000 | $ | 155,450 | |||||||
Deferred Income Taxesincome tax liabilities
Current and non-current deferred tax liabilities increased marginally to $1.6totaled $26.8 million at September 30, 2004 from $1.4and $19.4 million atas of March 31, 2005 and December 31, 2003, and long-term deferred tax liabilities increased by $0.42004, respectively. The increase of $7.4 million to $8.3 million at September 30, 2004 from $7.8 million at Decemberas of March 31, 2003. In combination, the $0.6 million increase is primarily2005 was due to approximately $1.6$4.3 million of additions to deferred tax liabilities in connection with the amortizable intangible assets acquired with PreceptCompany’s first quarter acquisitions of Dynamic, Telerecarga and CPIATX, reduced by the amortization of all acquisition related deferred taxes of approximately $0.8 million.$0.3 million, an addition of $0.7 million related to an adjustment of the value of the transact amortizable intangible assets and the recognition of other deferred tax liabilities generated during the first quarter.
Total Stockholders’ Equitystockholders’ equity
Total stockholders’ equity increased to $128.6$179.1 million at September 30, 2004March 31, 2005 from $81.9$141.9 million at December 31, 2003.2004. This $46.7$37.2 million increase is primarily the result of:
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Operating Cash Flows
Net cash providedoffset by operations increased by $9.7 million to $20.6 million for the nine-month period ended September 30, 2004, excluding $14.0 million in additions in restricted cash. The 2004 increase was primarily due to additional operating cash flows from the Prepaid Processing and EFT Processing Segments. e-pay operations were included for a full nine months in 2004 versus eight months in 2003 and AIM, transact, and Precept were included for the full nine months in 2004 and not included in the nine months ended September 30, 2003 prior to their acquisition. Approximately $2.0 million of the decrease was due to a decreaseincrease in cash provided by operating assets and liability changes in the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003. We expect continued increases in cash flow from operations as our business grows; while we believe the business will continue to grow, we cannot predict the level or sustainability of the growth.
Investing Activity Cash Flow
Cash used in investing activities was increased by $6.5 million to approximately $11.6 million in the nine months ended September 30, 2004 compared to $5.1 million in the nine months ended September 30, 2003. The nine months ended September 30, 2004
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required approximately $3.7 million in cash to fund acquisitions and approximately $6.0 million to fund fixed asset purchases, $0.8 million long-term deposit in India for ATM sites. In the nine months ended September 30, 2003, the acquisition of e-pay required approximately $28.7 million in cash, offset by the sale of the U.K. ATM network providing $24.4 million in net cash proceeds.
Financing Activity Cash Flows
Cash used in financing activities increased by $0.7 million to $5.5 million for the nine months ended September 30, 2004 compared to $4.8 million for the nine months ended September 30, 2003. The 2004 uses were primarily $15.8 million in debt obligation repayments, including a $14.2 million for the repurchase of our 12 3/8% Senior Discount Notes, offset by approximately $5.5 million in proceeds from employee stock purchases and stock option and warrant exercises and $5.1 million in proceeds from the issuance of additional debt. In the nine months ended September 30, 2003, debt obligation repayments were substantially less at $4.8 million. We expect to continue to reduce our debt as cash flow permits.
Financing and investing sources and uses of cash in the future are primarily dependent on our acquisition of new businesses and the related financing needs.
FORWARD-LOOKING STATEMENTS
This document contains statements that constitute forward-looking statements within the meaning of section 27A of the Securities Act and section 21E of the U.S. Securities Exchange Act of 1934. All statements other than statements of historical facts included in this document are forward-looking statements, including statements regarding the following:
Although we believe that the expectations reflected in these forward-looking statements are reasonable, we can give no assurance that these expectations will prove to be correct. Forward-looking statements are typically identified by the words believe, expect, anticipated, intend, estimate and similar expressions.
Investors are cautioned that any forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Actual results may materially differ from those in the forward-looking statements as a result of various factors, including, but not limited to, the following:
These risks and other risks are more fully described below.
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RISK FACTORS
You should consider carefullyThis Quarterly Report contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the following riskforward-looking statements as a result of factors including the ones described below and elsewhere in evaluating us, our business and an investment in our securities. Any of the following risks, as well as otherthis Quarterly Report. The risks and uncertainties could harm our business and financial results and cause the value of our securities to decline, which in turn could cause you to lose alldescribed below or a part of your investment. The risks belowelsewhere herein are not the only ones facing our company. Additional risks and uncertainties not currentlypresently known to us or that we currently deem immaterial may also may impair our business.business operations.
Although we have reported net income in recent periods, we have incurred net losses forIf any of the majorityfollowing risks actually occurs, our business, financial condition or results of operations could be materially adversely affected. In that case, the trading price of our operating history. We give no assurance that we will continue to report net incomeCommon Stock could decline substantially. Thus, you should carefully consider these risks before investing in future periods, and we may generate net losses while we concentrate on expansion of our business.securities.
For the quarter ended September- 30 2004, we had net income of approximately $6.0 million. For the nine months ended September 30, 2004, we had net income of approximately $13.6 million. For the years ended December 31, 2001 and 2003, we had net income of approximately $0.7 million and $11.8 million, respectively. However, for the years ended December 31, 2000 and 2002, we had net losses of approximately $49.6 million and $6.5 million, respectively. Excluding the $18.0 million gain in 2003, this results in an aggregate net loss of approximately $53.9 million for the period January 1, 2000 through September 30, 2004. We may experience operating losses again while we continue-
Risks Related to concentrate on expansion of our business and increasing our market share. If we cannot sustain operating profitability or positive cash flow from operations, we may not be able to meet our debt service or working capital requirements.
We have substantial indebtedness, and we will need a substantial increase in cash flows to continue to be able to meet our debt service obligations.Our Business
We have a substantial amount of debt and other contractual commitments, and the cost of servicing those obligations could adversely affect our business and hinder our ability to make payments on the Debentures, and such risk could increase if we incur more debt.
We have a substantial amount of indebtedness. As of September 30, 2004March 31, 2005, our total liabilities were approximately $261$509.4 million and our total assets were $389approximately $688.5 million. ForIn addition, we will have to pay approximately $43.4 million during the years ended December 31, 20032005 through 2008 as deferred consideration in connection with the CPI, Movilcarga, Telerecarga and 2002, our total liabilities were approximately $221.9 millionDynamic Telecom acquisitions. A portion of these obligations may be paid in stock. While we expect to satisfy any payment obligations from available cash and $60.4 million, respectively, and our total assets were approximately $303.8 million and $66.7 million, respectively. We incurred $28.5 million of this indebtedness in partoperating cash flows, we may not have sufficient funds to satisfy all such obligations as a result of our issuancea variety of certain 12 3/8% Senior Discount Notes that fall due on July 1, 2006. Interest payments under these notes became due beginning on January 1, 2003. Acquisition indebtednessfactors, some of $14.8 million remains payable with regard to the acquisitions. Moreover, between $20 million and $30 million remains payable in connection with the purchase of transact and will be payable on January 14, 2005, half in cash and half in Euronet Common Stock. Finally, in connection with the acquisitions of EPS and CPI, there are certain obligations, currently estimated to be approximately $3 million thatwhich may be required to be made if certain financial and other performance targets are met; atbeyond our option, these obligations can be settled with Euronet Common Stock. At this time, there is no assurance that these targets will be met and we offer no assurance that these amounts, if due, can be paid on a timely basis through cash flow from operations or through refinancing.
We may be required to refinance a portion of our debt to ensure that we are able to repay such debt on a timely basis. In addition, ifcontrol. If the opportunity of a strategic acquisition arises or if we enter into new contracts that require the installation or servicing of ATM machines on a faster pace than anticipated, we may requirebe required to incur additional financingdebt for these purposes and to fund our working capital needs. This additional financingneeds, which we may not be in the form of additional indebtedness that would increase our overall leverage.able to obtain.
The level of our indebtedness could have important consequences to investors, including the following:
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In addition, ifIf we fail to make required debt payments, or if we fail to comply with other covenants in our debt service agreements, we would be in default under the terms of these agreements. This default would permit the holders of the indebtedness to accelerate repayment of this debt and could cause defaults under other indebtedness that we have.
Although we have reported net income in recent periods, our concentration on expansion of our business in the future may significantly impact our ability to continue to report net income.
Prior to January 1, 2003, we reported a net loss in every fiscal year, primarily attributable to our investments for the expansion of our business. We believe these investments have recently started to produce positive results for us, as evidenced by our reporting of net income of $18.4 million for the year ended December 31, 2004 and a net income for the first quarter 2005 of approximately $4.8 million. We may experience operating losses again in the future while we continue to concentrate on the expansion of our business and increasing our market share.
Restrictive covenants in our credit facilities may adversely affect us.
Our credit facilities contain a variety of restrictive covenants that limit our ability to incur debt, make investments, pay dividends and sell assets. In addition, these facilities require us to maintain specified financial ratios, including Debt to EBITDA and EBITDAR to fixed charges, and satisfy other financial condition tests, including a minimum EBITDA test. See “Description of Credit Facility.” Our ability to meet those financial ratios and tests can be affected by events beyond our control, and we cannot assure you that we will meet those tests. A breach of any of these covenants could result in a default under our credit facilities. Upon the occurrence of an event of default under our credit facilities, the lenders could elect to declare all amounts outstanding under the credit facilities to be immediately due and payable and terminate all commitments to extend further credit. If we were unable to repay those amounts, the lenders could proceed against the collateral granted to them to secure that indebtedness. We have pledged a substantial portion of our assets as security under the credit facilities. If the lenders under either credit facility accelerate the repayment of borrowings, we cannot assure you that we will have sufficient assets to repay our credit facilities and our other indebtedness, including the notes.
The Debt to EBITDA ratio contained in the credit facilities limits our “funded debt” to not more than two times our “EBITDA” for the last four quarters, in each case as defined in the credit facilities. “EBITDA” includes the historical pro forma effect of any acquisitions to the extent agreed to by the lenders. “Funded debt” is defined as certain debt minus proceeds of this offering so long
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as such proceeds are deposited in designated accounts. We will deposit a substantial portion of the proceeds into such accounts in order to comply with such covenant. Following this offering, we will only be able to utilize the proceeds of this offering or incur additional debt to the extent that, after giving effect to such utilization, our debt (less the remaining amount of proceeds in such account) is less than two times our EBITDA, including historical pro forma effect of any acquisitions. Accordingly, our ability to use the proceeds of this offering or incur additional debt for purposes other than debt repayment or for acquisitions that increase our “EBITDA,” will be limited until such time as our EBITDA increases.
Our business may suffer from risks related to our recent acquisitions and potential future acquisitions.
A substantial portion of our recent growth is due to acquisitions, and we continue to evaluate potential acquisition opportunities. We cannot assure you that we will be able to successfully to integrate, or otherwise realize anticipated benefits from, our recent acquisitions including the e-pay, transact, Precept, EPS and CPI, or any future acquisitions, which could averselyadversely impact our long-term competitiveness and profitability. The integration of our recent acquisitions and any future acquisitions will involve a number of risks that could harm our financial condition, results of operations and competitive position. In particular:
Future acquisitions may be affected through the issuance of our Common Stock, or securities convertible into our Common Stock, which could substantially dilute the ownership percentage of our current stockholders. In addition, shares issued in connection with future acquisitions could be publicly tradable, which could result in a material decrease in the market price of our Common Stock.
A lack of business opportunities or financial resources may impede our ability to continue to expand at desired levels, and our failure to expand operations could have an adverse impact on our financial condition.
Our expansion plans and opportunities are focused on three separate areas: (i) our network of owned and operated ATMs; (ii) outsourced ATM management contracts; and (iii) our prepaid mobile phone airtime services.
The continued expansion and development of our ATM business will depend on various factors including the following:
We carefully monitor the growth of our ATM networks in each of our markets, and we accelerate or delay our expansion plans depending on local market conditions, such as variations in the transaction fees we receive, competition, overall trends in ATM-transactionATM transaction levels and performance of individual ATMs.
We cannot predict the increase or decrease in the number of ATMs we manage under outsourcing agreements, because this depends largely on the willingness of banks to enter into outsourcing contracts with us. Banks are very deliberate in negotiating these agreements and the process of negotiating and signing outsourcing agreements typically takes six to 12 months or longer. Moreover, banks evaluate a wide range of matters when deciding to choose an outsource vendor and generally this decision is
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subject to extensive management analysis and approvals. The process is exacerbated by the legal and regulatory considerations of local countries, as well as local language complexities. These agreements tend to cover large numbers of ATMs, so significant increases and decreases
41
in our pool of managed ATMs could result from signature or termination of these management contracts. In this regard, the timing of both current and new contract revenues is uncertain and unpredictable.
We currently offer prepaid mobile phone top-up services in the U.K.U.S., Australia, New Zealand, Ireland, Poland, Spain, the U.S.Europe and Germany.Asia Pacific We plan to expand our top-up business in these and other markets by taking advantage of our existing relationships with mobile phone operators and retailers. This expansion will depend on various factors, including the following:
In addition, our continued expansion may involve acquisitions that could divert our resources and management time and require integration of new assets with our existing networks and services.services and could require financing that we may not be able to obtain. Our ability to manage our rapid expansion effectively will require us eventually to expand our operating systems and employee base. An inability to do this could have a material adverse affecteffect on our business, growth, financial condition or results of operations.
We are subject to business cycles and other outside factors that may negatively affect mobile phone operators, retailers and our customers.
A recessionary economic environment or other outside factors could have a negative impact on mobile phone operators, retailers and our customers and could reduce the level of transactions, which could, in turn, negatively impact our financial results. If mobile phone operators experience decreased demand for their prepaid products and services (including due to increasing usage of postpaid services) or if the retail locations where we provide POS top-up services decrease in number, we will process fewer transactions, resulting in lower revenue. In addition, a recessionary economic environment could result in a higher rate of bankruptcy filings by mobile phone operators, retailers and our customers and could reduce the level of ATM transactions, which will have a negative impact on our business.
The growth of our prepaid business is dependent on certain factors that are variable from market to market but may reduce or eliminate growth in fully mature markets.
Growth in our prepaid business in any given market is driven by a number of factors, including the extent to which conversion from scratch cards to electronic distribution solutions is occurring or has been completed, the overall pace of growth in the prepaid mobile telephone market, our market share of the retail distribution capacity and the level of commission that is paid to the various intermediaries in the prepaid mobile airtime distribution chain. In mature markets, such as the U.K., Australia and Ireland, the conversion of scratch cards from mobile operators to electronic forms of distribution is either complete or nearing completion. Therefore, these factors will cease to provide the organic increases in the number of transactions per terminal that we have experienced historically. Also in mature markets, competition among prepaid distributors results in the reduction of commissions and margins by mobile operators as well as retailer churn. The combined impact of these factors in fully mature markets is a flattening of growth in the revenues and profits that we earn. These factors could adversely impact our financial results as the markets in which we conduct the prepaid business mature.
Our prepaid mobile airtime top-up business may be susceptible to fraud occurring at the retailer level.
WeIn our Prepaid Processing Segment, we contract with retailers that accept payment on our behalf, which we then transfer to a trust or other operating account for payment to mobile phone operators. In the event a retailer does not transfer to us payments that it receives for mobile phone airtime, we are responsible to the mobile phone operator for the cost of the airtime credited to the customer’s mobile phone. Although, in certain circumstances, we maintain credit enhancement insurance polices and take other precautions to mitigate this risk, we can provide no assurance that retailer fraud will not increase in the future or that any proceeds we receive under our insurance policies will be adequate to cover losses resulting from retailer fraud, which could have a material adverse affecteffect on our business, financial condition and results of operations.
Because we typically enter into short-term contracts with mobile phone operators and retailers, our top-up business is subject to the risk of non-renewal of those contracts.
Our contracts with mobile phone operators to process prepaid mobile phone airtime recharge services typically have terms of two to three years or less. Many of those contracts may be canceled by either party upon three months’ notice. Our contracts with mobile phone operators are not exclusive, so these operators may enter into top-up contracts with other service providers. In addition, our top-up service contracts with major retailers typically have terms of one to two years and our contracts with smaller retailers typically may be cancelledcanceled by either party upon three months’ notice. The cancellation or non-renewal of one or more of our significant mobile phone operator or retail contracts, or of a large enough group of our contracts with smaller retailers, could have a material adverse affecteffect on our business, financial condition and results of operations. In addition, our contracts generally permit operators to reduce our fees at any time. Commission revenue or fee reductions by any of the mobile phone operators could also have a material adverse affecteffect on our business, financial condition or results of operations.
In the U.S. and certain other countries, processes we employ may be subject to patent protection by other parties.
We have commenced prepaid processing operations in the U.S. The contribution of these operations to our financial results is currently insignificant, but we hope to expand this business rapidly. In the U.S., patent protection legislation permits the protection of processes. We employ certain processes in the U.S. that have been used in the industry by other parties for many years, and which we and other companies using the same or similar processes consider to be in the public domain. However, we are aware that certain parties believe they hold patents that cover some of the processes employed in the prepaid processing industry in the
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U.S. The question whether a process is in the public domain is a legal determination, and if this issue is litigated we cannot be certain of the outcome of any such litigation. If a person were to assert that it holds a patent covering any of the processes we use, we would be required to defend ourselves against such claim and if unsuccessful, would be required to either modify our processes or pay license
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fees for the use of such processes. This could materially and adversely affect our U.S. prepaid processing business and could result in our reconsidering the rate of expansion of this business in the U.S.
The level of transactions on our ATM and prepaid processing networks is subject to substantial seasonal variation, which may cause our quarterly results to fluctuate materially and create volatility in the price of our shares.
Our experience is that the level of transactions on our networks is subject to substantial seasonal variation. Transaction levels have consistently been much higher in the last quarter of the year due to increased use of ATMs and prepaid top-ups during the holiday season. The level of transactions drops in the first quarter, during which transaction levels are generally the lowest we experience during the year. Since revenues of the EFT Processing and Prepaid Processing Segments are primarily transaction-based, these segments are directly affected by this seasonality. As a result of these seasonal variations, our quarterly operating results may fluctuate materially and could lead to volatility in the price of our shares.
The stability and growth of our ATM business depend on maintaining our current card acceptance and ATM management agreements with banks and international card organizations, and on securing new arrangements for card acceptance and ATM management.
The stability and future growth of our ATM business depend in part on our ability to sign card acceptance and ATM management agreements with banks and international card organizations. Card acceptance agreements allow our ATMs to accept credit and debit cards issued by banks and international card organizations. ATM management agreements generate service income from our management of ATMs for banks. These agreements are the primary source of our ATM business.
These agreements have expiration dates and banks and international card organizations are generally not obligated to renew them. In some cases, banks may terminate their contracts prior to the expiration of their terms. We cannot assure you that we will be able to continue to sign or maintain these agreements on terms and conditions acceptable to us or that international card organizations will continue to permit our ATMs to accept their credit and debit cards. The inability to continue to sign or maintain these agreements, or to continue to accept the credit and debit cards of local banks and international card organizations at our ATMs in the future, could have a material adverse affecteffect on our business, growth, financial condition or results of operations.
Retaining the founders of our company, and of e-pay and transact,companies that we acquire, and finding and retaining qualified personnel in Europe are essentialmay be important to our continued success.
Our strategy and its implementation depend in large part on the founders of our company, in particular Michael Brown and Daniel Henry, and their continued involvement in Euronet in the future. In addition, the success of the expansion of e-pay’s and transact’s businesses dependsthat we acquire may depend in large part upon the retention of e-pay’s and transact’s founders.the founders of those businesses. Our success also depends in part on our ability to hire and retain highly skilled and qualified management, operating, marketing, financial and technical personnel. The competition for qualified personnel in Central Europe and the other markets where we conduct our business is intense and, accordingly, we cannot assure you that we will be able to continue to hire or retain the required personnel.
Our officers and some of our key personnel have entered into service or employment agreements containing non-competition, non-disclosure and non-solicitation covenants and providing for the granting of incentive stock options with long-term vesting requirements. However, most of these contracts do not guarantee that these individuals will continue their employment with us. The loss of our key personnel could have a material adverse affecteffect on our business, growth, financial condition or results of operations.
Our operating results depend in part on the volume of transactions on ATMs in our network and the fees we can collect from processing these transactions.
Transaction fees from banks and international card organizations for transactions processed on our ATMs have historically accounted for a substantial majority of our revenues. These fees are set by agreement among all banks in a particular market. Although we are less dependent on these fees due to our Prepaid Processing Segment, the future operating results of our ATM business depend on the following factors:
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Although we believe that the volume of transactions in developing countries will tend to increase due to growth in the number of cards being issued by banks in these markets, we anticipate that transaction levels on any given ATM in developing markets will not increase significantly. We can improve the levels of transactions on our ATM network overall by acquiring good sites for our ATMs,
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eliminating poor locations, entering new less-developed markets and adding new transactions to the sets of transactions that are available on our ATMs. However, we may not be successful in materially increasing transaction levels through these measures. Per-transaction fees have declined in certain markets in recent years. If we cannot continue to increase our transaction levels and per-transaction fees generally decline, our results would be adversely affected.
Our operating results depend in part on the volume of transactions for prepaid phone services and the commissions we receive for these services.
Our Prepaid Processing Segment derives revenues based on processing fees from mobile and other telecommunication operators or distributors of prepaid wireless products. Generally, these operators have the right to reduce the overall fee paid for each transaction, although a portion of such reductions can be passed along to retailers. In the last year, processing fees per transaction have been declining in most markets, and we expect that trend to continue. We have been able to improve our results despite that trend due to substantial growth in transactions, driven by acquisitions and organic growth. We do not expect to continue this rate of growth. If we cannot continue to increase our transaction levels and per-transaction fees continue to decline, our results would be adversely affected.
Developments in electronic financial transactions, such as the increased use of debit cards by customers and pass-through of ATM transaction fees by banks to customers or developments in the mobile phone industry, could materially reduce ATM transaction levels and our revenues.
Certain developments in the field of electronic financial transactions may reduce the amount of cash that individuals need on a daily basis, including the promotion by international card organizations and banks of the use of bank debit cards for transactions of small amounts. These developments may reduce the transaction levels that we experience on our ATMs in the markets where they occur. Banks also could elect to pass through to their customers all, or a large part of, the fees we charge for transactions on our ATMs. This would increase the cost of using our ATM machines to the banks’ customers, which may cause a decline in the use of our ATM machines and, thus, have an adverse affecteffect on our revenues. If transaction levels over our existing ATM network do not increase, growth in our revenues from the ATMs we own will depend primarily on rolling out ATMs at new sites and developing new markets, which requires capital investment and resources and reduces the margin we realize from our revenues.
The mobile phone industry is a rapidly evolving area, in which technological developments, in particular the development of new methods or services, may affect the demand for other services in a dramatic way. The development of any new technology that reduces the need or demand for prepaid mobile phone time could materially and adversely affect our business.
We generally have little control over the ATM transaction fees established in the markets where we operate;operate, and therefore cannot control any potential reductions in these fees.
The amount of fees we receive per transaction is set in various ways in the markets in which we do business. We have card acceptance agreements or ATM management agreements with some banks under which fees are set. However, we derive the bulk of our revenues in most markets from “interchange fees” that are set by the central ATM processing switch. The banks that participate in these switches set the interchange fee, and we are not in a position in any market to greatly influence greatly these fees, which may increase or decrease over time. A significant decrease in the interchange fee in any market could adversely affect our results in that market.
In some cases, we are dependent upon international card organizations and national transaction processing switches to provide assistance in obtaining settlement from card issuers of funds relating to transactions on our ATMs.
Our ATMs dispense cash relating to transactions on credit and debit cards issued by banks. We have in place arrangements for the settlement to us of all of those transactions, but in some cases we do not have a direct relationship with the card-issuing bank and rely for settlement on the application of rules that are administered by international card associations (such as Visa or MasterCard) or national transaction processing switches.switching networks. If a bankbankcard association fails to settle transactions in accordance with those rules, we are dependent upon cooperation from such organizations or switchesswitching networks to enforce our right of settlement against such banks.banks or card associations. Failure by such organizations or switches to provide the required cooperation could result in our inability to obtain settlement of funds relating to transactions and adversely affect our business.
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We derive a significant amount of revenue in our business from service contracts signed with financial institutions to own and/or operate their ATM machines.
Certain contracts have been and, in the future, may be terminated by our clientthe financial institutionsinstitution resulting in a substantial reduction in revenue. Contract termination payments, if any, may be inadequate to replace revenues and operating income associated with these contracts.
Because our business is highly dependent on the proper operation of our computer network and telecommunications connections, significant technical disruptions to these systems would adversely affect our revenues and financial results.
Our business involves the operation and maintenance of a sophisticated computer network and telecommunications connections with banks, financial institutions, mobile operators and retailers. This, in turn, requires the maintenance of computer equipment and infrastructure, including telecommunications and electrical systems, and the integration and enhancement of complex software applications. Our ATM segment also uses a satellite-based system that is susceptible to the risk of satellite failure. There are operational risks inherent in this type of business that can result in the temporary shutdown of part or all of our processing systems, such as failure of electrical supply, failure of computer hardware and software errors. Excluding our German ATMs, we operate all of our ATMs through our processing centers in Budapest, Hungary and Mumbai, India, and any operational problem in these centers may have a significant adverse impact on the operation of our network generally. In addition, we operate all of our top-up services through our processing centers in the U.K., Germany, Spain and the U.S., and any operational problem there could have a significant adverse impact on the operation of our top-up network.
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We employ experienced operations and computer development staff and have created redundancies and procedures in our processing centers to decrease these risks. However, these risks cannot be eliminated entirely. Any technical failure that prevents operation of our systems for a significant period of time will prevent us from processing transactions during that period of time and will directly and adversely affect our revenues and financial results.
We have the risk of liability for fraudulent bankcard and other card transactions involving a breach in our security systems, as well as for ATM theft and vandalism.
We capture, transmit, handle and store sensitive information in conducting and managing electronic, financial and mobile transactions, such as card information and PIN numbers. These businesses involve certain inherent security risks, in particular the risk of electronic interception and theft of the information for use in fraudulent or other card transactions.transactions, by persons outside the Company or by our own employees. We incorporate industry-standard encryption technology and processing methodology into our systems and software, and maintain controls and procedures regarding access to our computer systems by employees and others, to maintain high levels of security. Although this technology and methodology decrease security risks, they cannot be eliminated entirely, as criminal elements apply increasingly sophisticated technology to attempt to obtain unauthorized access to the information handled by ATM and electronic financial transaction networks.
Any breach in our security systems could result in the perpetration of fraudulent financial transactions for which we may be found liable. We are insured against various risks, including theft and negligence, but our insurance coverage is subject to deductibles, exclusions and limitations that may leave us bearing some or all of any losses arising from security breaches.
In addition to electronic fraud issues, the possible theft and vandalism of ATMs present risks for our ATM business. We install ATMs at high-traffic sites and consequently our ATMs are exposed to theft and vandalism. Although we are insured against these risks, exclusions or limitations in our insurance coverage may leave us bearing some or all of any loss arising from theft or vandalism of ATMs.
We are required under German law and the rules of financial transaction switching networks in all of our markets to have “sponsors” to operate ATMs and switch ATM transactions. Our failure to secure “sponsor” arrangement, or replace existing sponsor agreements with new agreements having similar terms and conditions,arrangements in any market could prevent us from doing business in that market or could adversely impact our future economic performance in that market.
Under German law, only a licensed financial institution may operate ATMs, and we are therefore required to have a “sponsor” bank to conduct our German ATM operations. In addition, in all of our markets, our ATMs are connected to national financial transaction switching networks owned or operated by banks, and to other international financial transaction switching networks operated by organizations such as Citibank, Visa and MasterCard. The rules governing these switching networks require any company sending transactions through these switches to be a bank or a technical service processor that is approved and monitored by a bank. As a result, the operation of our ATM network in all of our markets depends on our ability to secure these “sponsor”-type arrangements with financial institutions.
To date, we have been successful in reaching contractual arrangements that have permitted us to operate in all of our target markets. However, we cannot assure you that we will continue to be successful in reaching these arrangements, and it is possible that our current arrangements will not continue to be renewed.
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Our competition in the EFT Processing Segment and Prepaid Processing Segment include large, well-financedwell financed companies and banks and, in the software market, companies larger than us with earlier entry into the market. As a result, we may lack the financial resources and access needed to capture increased market share.
EFT Processing Segment—Our principal EFT Processing Services Segment competitors include ATM networks owned by banks and national switches consisting of consortiums of local banks that provide outsourcing and transaction services only to banks and independent ATM deployers in that country. Large, well-financed companies that operate ATMs such as First Data Corporation, Global Payments, GTech, SINSYS or MoneyBox may also establishoffer ATM networks or offernetwork and outsourcing services that compete with us in various markets. None of these competitors have dominant market share. Competitive factors in our EFT Processing Services Segment include network availability and response time, price to both the bank and to its customers, ATM location and access to other networks. Our competitors may introduce or expand their ATM networks in the future, which would lead to a decline in the usage of our ATMs.
There are certainCertain independent (non bank-owned) companies providingprovide electronic recharge on ATMs in individual markets in which we provide this service. We are not aware of any individual independent companies providing electronic recharge on ATMs across multiple markets in which we provide this service. In this area, we believe competition will come principally from the banks providing such services on their own ATMs through relationships with mobile operators or from card transaction switching networks that add recharge transaction capabilities to their offerings (as is the case in the U.K. through the LINK network). However, there are relatively few barriers to entry in this business and larger companies that have more financial resources than we do could successfully compete with us based on a number of factors, including price.
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Prepaid Processing Segment— SeveralWe face competition in the prepaid business in all of our markets. A few multinational companies offer electronic recharge services for mobile phone airtime on POS terminalsoperate in several of our markets, and we therefore compete with them in a number of countries. In other markets, our competition is from smaller, local companies. None of these companies is dominant in any of the markets where we do business. These companies include, but are not necessarily limited to, Alphyra, Paypoint, Omega Logic, Barclays Merchant Services and Anpost in the U.K.; On-Q and Ezipin in Australia; Milo, Kolporter and GTech in Poland; TeleCash Kommunikations-Service, GZS, ADT Jalex, ANTHROS and EVS in Germany; and PRE-Solutions, InComm and Everything Prepaid in the U.S.
We believe, however, that we currently have a competitive advantage due to various factors. First, in the U.K., Germany and Australia, our acquired subsidiaries have been in existenceconcentrating on the sale of prepaid airtime for longer than most of our competitors and have significant market share in those markets. We have approximately 40% of the POS recharge market in thisthe U.K., 60%50% in Germany and 47%40% in Australia. In addition, we offer complementary ATM and mobile recharge solutions through our EFT processing centers. We believe this will improve our ability to solicit the use of networks of devices owned by third parties (for example, banks and switching networks) to deliver recharge services. In selected developing markets, we hope to establish a first to market advantage by rolling out terminals rapidly before competition is established. We also have an extremely flexible technical platform that enables us to tailor point of salePOS solutions to individual merchant and mobile operator requirements where appropriate. The GPRS (wireless) technology, designed by our transactTransact subsidiary, will also give us an advantage in remote areas where landline phone lines are of lesser quality or nonexistent.
The principal competitive factors in this area include price (that is, the level of commission charged for each recharge transaction) and up time offered on the system. Major retailers with high volumes are in a position to demand a larger share of the commission, which increases the amount of competition among service providers.
As the volume of transactions increases, we believe the principal factor in competition will be quality and price, as competitors may offer lower commissions to secure business.
In addition to the above competitive factors, it is possible that mobile operators themselves may reduce commissions beyond what is able to be passed on to retailers and distributors and may take over the distribution of their own prepaid mobile phone time. They would be able to terminate our contracts with them, which could have a material adverse impact on our business.
Software Solutions Segment—We believe we are the leading supplier of electronic financial transaction processing software for the IBM iSeries (formerly AS/400) platform.platform in a largely fragmented market, which is made up of competitors that offer a variety of solutions that compete with our products, ranging from single applications to fully integrated electronic financial processing software. Other industry suppliers service the software requirements of large mainframe systems and UNIX based platforms.UNIX-based platforms, and accordingly are not considered competitors. We have specific target customers consisting of financial institutions that operate their back office systems with the IBM iSeries.
The Software Solutions Segment has multiple types of competitors. Competitors of the Software Solutions Segment compete across all EFT software components in the following areas: (i) ATM, network and point-of-salePOS software systems, (ii) Internet banking software systems, (iii) credit card software systems, (iv) wirelessmobile banking software systems, (v) mobile operator solutions, (vi) telephone banking, and (v)(vii) full EFT software, including Applied Communications Inc. (“ACI”), Mosaic Software and Oasis Software International.software.
Competitive factors in the Software Solutions business include price, technology development and the ability of software systems to interact with other leading products.
We conduct a significant portion of our business in Central and Eastern European countries, and we have subsidiaries in the Middle East and Asia, where the risk of continued political, economic and regulatory change that could impact our operating results is greater than in the U.S. or Western Europe.
Certain tax jurisdictions in whichthat we operate in have complex rules regarding the valuation of inter-company services, cross-border payments between affiliated companies and the related effects on income tax, value addedvalue-added tax (VAT), transfer tax and share registration tax. Our foreign subsidiaries frequently undergo VAT reviews, and two of our subsidiaries are currently undergoing comprehensive tax reviews. From time to time, we may be reviewed by tax authorities and be required to make additional tax payments should the review result in different interpretations, allocations or valuations of our services. We obtain legal, tax and regulatory advice as necessary to ensure compliance with tax and regulatory matters but cannot assure that such reviews will not result in additional tax liability.matters.
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We have subsidiaries in Hungary, Poland, the Czech Republic, Romania, Slovakia, Spain, Greece, Croatia, India, Egypt and Indonesia and have operations in other countries in Central Europe, the Middle East and Asia. We sell software in many other markets in the developing world. These countries have undergone significant political, economic and social change in recent years and the risk of new, unforeseen changes in these countries remains greater than in the U.S. or Western Europe. In particular, changes in laws or regulations or in the interpretation of existing laws or regulations, whether caused by a change in government or otherwise, could materially adversely affect our business, growth, financial condition or results of operations.
For example, currently there are no limitations on the repatriation of profits from allany of the countries in which we have subsidiaries (although U.S. tax laws discourage repatriation), but foreign exchange control restrictions, taxes or limitations may be imposed or increased in the future with regard to repatriation of
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earnings and investments from these countries. If exchange control restrictions, taxes or limitations are imposed, our ability to receive dividends or other payments from affected subsidiaries could be reduced, which may have a material adverse affecteffect on us.
In addition, corporate, contract, property, insolvency, competition, securities and other laws and regulations in Hungary, Poland, the Czech Republic, Romania, Slovakia, Croatia and other countries in Central Europe have been, and continue to be, substantially revised during the completion of their transition to market economies. Therefore, the interpretation and procedural safeguards of the new legal and regulatory systems are in the process of being developed and defined, and existing laws and regulations may be applied inconsistently. Also, in some circumstances, it may not be possible to obtain the legal remedies provided for under these laws and regulations in a reasonably timely manner, if at all.
Transmittal of data by electronic means and telecommunications is subject to specific regulation in most Central European countries. Although these regulations have not had a material impact on our business to date, changes in these regulations, including taxation or limitations on transfers of data across national borders, could have a material adverse affecteffect on our business, growth, financial condition or results of operations.
Because we derive our revenue from a multitude of countries with different currencies, our business is affected by local inflation and foreign exchange rates and policies.
We attempt to match any assets denominated in a currency with liabilities denominated in the same currency. Nonetheless, substantially all of our indebtedness is denominated in U.S. dollars, euro and British pound sterling. Additionally,pounds. While a significant amount of our expenditures, including the acquisition of ATMs, executive salaries and certain long-term telecommunication contracts, are made in U.S. dollars.dollars, most of our revenues are denominated in other currencies. The U.S. dollar has recently declined significantly against these currencies. As exchange rates among the U.S. dollar, the euro, and other currencies fluctuate, the translation effect of these fluctuations may have a material adverse affecteffect on our results of operations or financial condition as reported in U.S. dollars. Moreover, exchange rate policies have not always allowed for the free conversion of currencies at the market rate. An increase in the value of the dollar would have an adverse effect on our results.
In recent years, Hungary, Poland and the Czech Republic have experienced high levels of inflation. Consequently, these countries’ currencies have continued to decline in value against the major currencies of the OECDOrganization of Economic Cooperation and Development (“OECD”) countries over this time period. Due to the significant reduction in the inflation rate of these countries in recent years, none of these countries are considered to have a hyper-inflationary economy. Nonetheless, rates of inflation in these countries may continue to fluctuate from time to time. The majority of our subsidiaries’ revenues are denominated in the local currency.
The terms of our certificate of incorporation and bylaws, and of Delaware law generally, may discourage the acquisition of our company and may impede a change in control of our company.
Among other things, the provisions of our certificate of incorporation and bylaws have the following effects:
These provisions could diminish the opportunities for a stockholder to participate in tender offers, including tender offers at a price above the market value of our Common Stock at the time of the offer. The issuance of preferred stock could also adversely affect the voting power of the holders of Common Stock and impede a change in control of our company. In addition, our board of directors recently adopted a stockholder rights plan, which may impede a change in control of our company.
Our directors and officers, together with the entities with which they are associated, owned about 17.0%13% of our Common Stock as of September 30, 2004,March 31, 2005, giving them significant control over decisions related to our company.Company.
This control includes the ability to influence the election of other directors of our companyCompany and to cast a large block of votes with respect to virtually all matters submitted to a vote of our stockholders. This concentration of control may have the effect of delaying or preventing transactions or a potential change of control of our company.Company.
The sale of a substantial amount of our Common Stock in the public market could materially decrease the market price of our Common Stock, and about 34%23% of our outstanding Common Stock, while notcannot currently be traded publicly, couldbut may be publicly traded in blocks in the future.future because we have filed resale registrations statements for a majority of such shares or such shares have been held by non-affiliates for more than two years.
If a substantial amount of our Common Stock were sold in the public market, or even targeted for sale, this could have a material adverse affecteffect on the market price of our Common Stock and our ability to sell Common Stock in the future. As of September 30,
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2004,March 31, 2005, we had approximately 3235 million shares of Common Stock outstanding, of which approximately 10.77.9 million shares (including the shares we issued in the transactTransact acquisition, the Fletcher financing, and the Precept, CPI, Dynamic and the CPIATX acquisitions), or about 34%23%, are notcannot currently be traded on the public market.market without compliance with Rule 144. About 4.64.3 million of these shares are held by persons who may be deemed to be our affiliates and who would be subject to Rule 144 of the general
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rules and regulations of the SEC.Commission. Rule 144 limits the number of shares that affiliates can publicly sell during each 90-day period. However, over the course of time, these 7.9 million shares have the potential to be freely publicly traded, perhaps in large blocks. Moreover, somewe have filed registration statements to permit the resale of these shareholders can require us to register transactions to sell theira substantial portion of such shares, which would permit them to sell shares at any time without regard to the Rule 144 limitations.
An additional 7.610.1 million shares of Common Stock could be added to the total outstanding Common Stock through the exercise of options and warrants or the issuance of additional shares of our Common Stock pursuant to the selling stockholders.existing agreements. This could dilute the ownership percentage of current stockholders. Also, once they are outstanding, these shares of Common Stock could be traded in the future and result in a material decrease in the market price of our Common Stock.
As of January 5, 2004,March 31, 2005, we had an aggregate of 5.74.7 million options outstanding held by our directors, officers and employees, which entitles these holders to acquire an equal number of shares of our Common Stock on exercise. Of this amount, 2.72.0 million options are currently vested, which means they can be exercised at any time. We have 254,010 warrants outstandingApproximately 0.4 million additional shares of our Common Stock are issuable in connection with our issuance of 12 3/8% Senior Discount Notes.employee stock purchase plan. Additionally, we may be required to issue additionalapproximately 0.8 million shares of our Common Stock (based on current prices and estimated earn-out payments) to the former shareholders or owners of transact, AIMEPS, Melfur and EPSDynamic Telecom under contingent “earn-out” payments in connection with our acquisitions of the shares of transact, assets of AIM and shares of EPS.these acquisitions. The number of shares issued under the earn outsearn-outs will depend upon the performance of the businesses acquired and the trading price of our Common Stock at the time we make the earn outearn-out payments. We haveAnother 4.2 million shares of Common Stock could be issued upon conversion of the Company’s Convertible Debentures issued during December 2004. Accordingly, approximately 10.1 million shares (based on current prices and estimated the earn-out payment in the transact acquisition to be approximately $20 million to $30 million (50% payable in cash and 50% in our Common Stock). Therefore, approximately 7.6 million sharespayments) could potentially be added to the total current outstanding Common Stock through the exercise of options and warrants or the issuance of additional shares, to the selling stockholders, and thereby dilute the ownership percentage of the current owners. The actual number of shares issuable could be higher depending upon the actual amounts of the earn-outs and our stock price at the time of payment (more shares could be issuable if our share price declines), which could increase dilution and reduce earnings per share. The indenture will not contain anti-dilution adjustments for such issuances.
Of the 5.74.7 million total options outstanding, an aggregate of 1.91.5 million options are held by persons who may be deemed to be our affiliates and who would be subject to Rule 144. Thus, upon exercise of their options, these affiliates’ shares would be subject to the trading restrictions imposed by Rule 144. For the remainder of the options the warrants and the shares issuable to the selling stockholdersas earn-outs described above, the Common Stock issued on their exercise or conversion would be freely tradable in the public market. Over the course of time, all of the issued shares have the potential to be publicly traded, perhaps in large blocks.
In January 2005, we made matching contributions of 10,273 shares of stock in conjunction with our 401(k) employee benefits plan for the plan year 2004. Under the terms of this plan, employer-matching contributions consist of two parts, referred to as “basic” and “discretionary.” The basic matching contribution is equal to 50% of eligible employee elective salary deferrals between 4% and 6% of participating employee salaries for the plan year. The discretionary matching contribution is determined by our Board of Directors for a plan year and is allocated in proportion to employee elective deferrals. As of March 31, 2005, total employer matching contributions since inception of the plan have consisted of 91,966 shares.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Foreign Exchange Exposureexchange rate risk
InFor the three months ended September 30, 2004, 83%March 31, 2005, 81% of our revenues were generated in Poland, Hungary, Australia, the U.K. and Germany, India or various euro-denominated countries as compared to 78%79% for the three months ended March 31, 2004. This slight increase is due to the fourth quarter 2004 and first quarter 2005 acquisitions in the same period of 2003. In Hungary and Poland, the majority ofSpain, where revenues received are denominated in the Hungarian forint and Polish zloty, respectively. However, manyeuro. Substantially all of our foreign currencyrevenues in these countries are denominated contracts in boththe local currency; however, in countries such as Poland and Hungary, a significant portion of our revenues are also linked to either inflation or the retail price index. In the U.K., Australia and Germany, substantially all of the revenues received are denominated in the British pound, Australian dollar and the euro, respectively.
We estimate that a 10% depreciation in foreign exchange rates of the euro, Australian dollar, Hungarian forint, Polish zloty, and the British pound and the Indian rupee against the U.S. dollar would have the combined effect of a $5.2 million increase in theon reported net income and working capital of a $1.1 million decrease and that a 10% appreciation in foreign exchange rates of the euro, Australian dollar, Hungarian forint, Polish zloty, and the British pound and the Indian rupee against the U.S. dollar would have the combined effect on reported net income and working capital of a $5.2$1.1 million decrease in the reported net income.increase. This effect was estimated by segregating revenues, expenses and expensesworking capital by the U.S. dollar, Hungarian forint, Polish zloty, British pounds,pound, Indian rupee and euro and then applying a 10% currency devaluationdepreciation and appreciation to the non-U.S. dollar amounts. We believe this quantitative measure has inherent limitations. It does not take into account any governmental actions or changes in either customer purchasing patterns or our financing or operating strategies.
As a result of continued European economic convergence, including the increased influence of the euro as opposed to the U.S. dollar on the Central European currencies, we expect that the currencies of the markets where we invest will fluctuate less against the euro than against the dollar. Accordingly, we believe that our euro-denominated debt provides, in the medium- to long-term, for a closer matching of assets and liabilities than would dollar-denominated debt.- 39 -
Debt, Interest Payments and Interest Rate Riskrate risk
We are exposed to various types of market risk in the normal course of business, including the impact of interest rate changes. We may enter into interest rate swaps to manage our exposure to interest rate changes, and we may employ other risk management strategies, including the use of foreign currency forward contracts. Currently, we do not hold any derivative instruments.
As of September 30,In October 2004, we had borrowed $5.0the Company entered into a $40 million under a two-year unsecured revolving credit agreement permitting borrowingswith a bank. The $40 million revolving credit agreement is comprised of upa $10 million facility among the Company and certain U.S. subsidiaries, and a $30 million facility among the Company and certain European subsidiaries. The revolving credit facilities can be used to repay existing debt, for working capital needs, to make acquisitions or for other corporate purposes. Borrowings under the $10 million. We had also utilized $2.8 million offacility bear interest at either a Prime Rate, plus an applicable margin specified in the available credit under this facility to secure stand by letters of credit. These borrowings accrued interest (at our option) atrespective agreement or a prime-based floating rate or fixed LIBOR-based rates for up to 30- to 90-day periods. This variable interest rate debt facility is subject to interest rate risk. We use this facility to meet working capital needs, make
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acquisitions and finance other corporate purposes. These obligations expose the Company to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense also decreases.
Subsequent to the end of our third quarter 2004, we have renegotiated and expanded the $10 million credit facility for a two year credit facility permitting borrowings by a U.S. subsidiary group of up to $10 million and by a European subsidiary group of up to $30 million. As of November 8, 2004, we had borrowed approximately $25.0 million under the new facility (including amounts outstanding under the old facility). Our U.S.-based borrowings accrue interest (at our option) at either the U.S. Prime rate or a 30-to 90-day fixed rateperiods equal to the LIBORLondon Interbank Offered Rate (LIBOR), plus aan applicable margin, as set forth in the respective agreement, and varies based on oura consolidated funded debt to EBITDAearnings before interest, taxes, depreciation and amortization (EBITDA) ratio. Our European-based borrowings
Borrowings under the $30 million facility may be drawn in U.S. dollars, euros, and/or British pounds. Borrowings in U.S. dollars bear interest (at our option)similar to the terms of the $10 million facility. Borrowings in euros or British pounds bear interest at either a 30-torate fixed for up to 30- to 90-day fixed rateperiods equal to the EURIBOR rateEuro Interbank Offered Rate (EURIBOR) or the LIBOR rate plus a margin that varies based on oura consolidated funded debt to EBITDA ratio, plus the U.K. ancillary costs. Based onThe $30 million facility may be expanded to a maximum of $33 million, resulting from certain exchange rate fluctuations. As of March 31, 2005, there were no amounts borrowed against the $40 million revolving credit agreements, however, there were $2.2 million in stand by letters of credit outstanding underagainst these facilities as of March 31, 2005.
On December 15, 2004, the Company does not consider its exposureclosed the sale of $140 million of our private offering 1.625% Contingent Convertible Senior Debentures Due 2024 (“Convertible Debentures”). In addition to the stated annual interest rate riskof 1.625%, payable semi-annually in June and December, and the Company will pay contingent interest, during any six-month period commencing with the period from December 20, 2009 through June 14, 2010, and for each six-month period thereafter from June 15 to December 14 or December 15 to June 14, for which the average trading price of the debentures for the applicable five trading-day period preceding such applicable interest period equals or exceeds 120% of the principal amount of the debentures. Contingent interest will equal 0.30% per annum of the average trading price of a debenture for such five trading-day periods. These terms and other material terms and conditions applicable to the contingent convertible senior debentures are set forth in the indenture governing the debenture. Interest payments of approximately $1.1 million, plus potential contingent interest described above, will be materialdue and estimate that a 1% change in interest rates would have less than a $0.3 million effect on annual net income. For more information regarding this credit facility, See Part I, Item 2 of this quarter report “Management’s Discussionpayable each June 15 and Analysis—Liquidity and Capital Resources—Debt and Capital Resources.”December 15, commencing June 15, 2005 related to these Convertible Debentures.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
ITEM 4. | CONTROLS AND PROCEDURES |
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to our management, including its President and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.
Our executive management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2004.March 31, 2005. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the design and operation of these disclosure controls and procedures were effective as of such date.
CHANGE IN INTERNAL CONTROLS
There has been no change in our internal control over financial reporting during the quarter ended September 30, 2004March 31, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 1. | LEGAL PROCEEDINGS |
ITEM 1. LEGAL PROCEEDINGS
The Company isWe are from time to time a party to litigation arising in the ordinary course of its business. Currently, there are no legal proceedings that management believes, either individually or in the aggregate, would have a material adverse effect upon theour consolidated results of operations or financial condition of the Company.condition.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES
ITEM 2. | CHANGES IN SECURITIES AND USE OF PROCEEDS |
In July and August 2004,March 2005, we issued a total of 281,916215,644 shares of our Common Stock valued at $6.4 million and paid cash(“Euronet Stock”) to a shareholder of $0.7 million to the shareholders of CPIATX Software, Ltd. (“ATX”) in consideration of the exercise of our option to purchase of allan additional 41% of the share capital of CPI,ATX from the shareholders of ATX. The shareholder to whom we issued these shares is a company based in Texas. Based on representations from each former shareholder of CPI that he was an “accredited investor” as contemplated by Regulation D under the Act,non-U.S. citizen and non-resident, and the issuance of
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our Common Stock in this transaction was exempt from registration pursuant to the exemptions provided in Section 4(2) and Regulation DS of the Act. This transaction is described more fully in Note 4 to the unaudited consolidated financial statements.Unaudited Consolidated Financial Statements.
We entered into an amended agreement (the Amendment) with effect as of September 30, 2004 by which we agreed to issue a total of 283,976 shares of our Common Stock to the shareholders of AIM, a company from which we purchased certain prepaid mobile phone top-up assets in September 2003. The Amendment modified the provisions of an Asset Purchase Agreement relating to the purchase of the AIM assets. No common stock has yet been issued under the Amendment. However, based upon representations from each shareholder, the issuance of the Common Stock will be exempt from registration under Section 4.2 of the Act.
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ITEM 6. EXHIBITS
ITEM 6. | EXHIBITS |
a) Exhibits
a) | Exhibits |
The exhibits that are required to be filed herein or incorporated herein by reference are listed on the Exhibit Index below. Exhibits 10.1 to 10.10 are management contracts or compensatory plans or arrangements.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
November 9, 2004May 4, 2005
By: | /s/ MICHAEL J. BROWN | |
Michael J. Brown | ||
Chief Executive Officer | ||
By: | /s/ RICK L. WELLER | |
Rick L. Weller | ||
Chief Financial Officer |
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Exhibit Index
Exhibit | Description | |
2.1 | Agreement for the Purchase of the Entire Issued Share Capital of e-pay | |
2.2 | Share Purchase and Transfer Agreement, dated November 19/20, 2003, among | |
2.3 | Asset Purchase Agreement among Alltel Information Services, Inc., Euronet USA and EFT Network Services LLC (DASH) dated January 4, 2002 relating to the sale of assets of DASH (filed as Exhibit 2.1 to the | |
2.4 | Asset Purchase Agreement among Euronet Worldwide, Inc. and Austin International Marketing and Investments, Inc. and Joseph P. Bodine and David Hawkins dated August 23, 2003 (filed as Exhibit 2.4 to the | |
Certificate of Incorporation of | ||
Bylaws of | ||
Amendment No. 1 to Bylaws of | ||
Amendment No. 2 to Bylaws of | ||
4.1 | Indenture dated as of June 22, 1998 between Euronet Services Inc. and State Street Bank and Trust Company, as Trustee (filed as Exhibit 4.3 to the Registrant’s | |
4.2 | Warrant Agreement dated as of June 22, 1998 between Euronet Services Inc. and State Street Bank and Trust Company, as Warrant Agent (filed as Exhibit 4.4 to the Registrant’s S-1/A filed on June 16, 1998, and incorporated by reference herein) | |
4.3 | Form of Certificate issued to the shareholders of | |
4.4 | Certificate of Additional Investment Rights issued to Fletcher International, Ltd. on November 21, 2003 (filed as Exhibit 4.2 to the | |
4.5 | Rights Agreement, dated as of March 21, 2003, between Euronet Worldwide, Inc. and EquiServe Trust Company, N.A. (filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on March 24, 2003, and incorporated by reference herein) | |
4.6 | First Amendment to Rights Agreement, dated as of November 28, 2003, between Euronet Worldwide, Inc. and EquiServe Trust Company, N.A. (filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on December 4, 2003, and incorporated by reference herein) | |
4.7 | Indenture, dated as of December 15, 2004, between Euronet Worldwide, Inc. and U.S. Bank National Association (filed as exhibit 4.10 to the Company’s Registration Statement on Form S-3/A filed on January 26, 2005 and incorporated by reference herein) | |
4.8 | Purchase Agreement, dated as of December 9, 2004, among Euronet Worldwide, Inc. and Banc of America Securities LLC (filed as exhibit 4.10 to the Company’s Registration Statement on Form S-3/A filed on January 26, 2005 and incorporated by reference herein) | |
4.9 | Registration Rights Agreement, dated as of December 15, 2004, among Euronet Worldwide, Inc. and Banc of America Securities LLC (filed as exhibit 4.11 to the Company’s Registration Statement on Form S-3/A filed on January 26, 2005 and incorporated by reference herein) | |
4.10 | Specimen 1.625% Convertible Senior Debenture due 2024 (Certificated Security) (filed as exhibit 4.14 to the Company’s Registration Statement on Form S-3/A filed on January 26, 2005 and incorporated by reference herein) |
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10.1 | Agreement, dated November 20, 2003, between | |
Employment Agreement executed in October 2003, between |
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| |||
Employment Agreement executed in October 2003, between | |||
10.6 | Services Agreement between e-pay and Paul Althasen, Executive Vice President and Co-Managing Director, e-pay (filed as exhibit 10.5 to the Company’s Annual Report on | ||
10.7 | Services Agreement between e-pay and John Gardiner, Executive Vice President and Co-Managing Director, e-pay (filed as exhibit 10.6 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, and incorporated by reference herein) | ||
10.8 | Employment Agreement executed in June 2003, between Euronet Worldwide, Inc. and Miro Bergman, Executive Vice President & Managing Director, EMEA (filed as exhibit 10.8 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, and incorporated by reference herein) | ||
Employment Agreement executed in October 2003, between | |||
Euronet Worldwide, Inc. Stock Incentive Plan (1998), as amended (filed as | |||
Euronet Worldwide, Inc. 2002 Stock Incentive Plan (Amended and Restated) (incorporated by reference to Appendix B to the | |||
Rules and Procedures for Euronet Matching Stock Option Grant Program (filed as Exhibit 10.3 to Registrant’s Form 10-Q for the quarter ended September 30, 2002 and incorporated by reference herein) | |||
Employment Agreement executed in January 2003, between Euronet Worldwide, Inc. and John Romney, Managing Director, Europe, Middle-East and Africa (EMEA) | |||
10.16 | $10,000,000 U.S. Credit Agreement dated October 25, 2004 among Bank of America, N.A., Euronet Worldwide, Inc., PaySpot, Inc., Euronet USA, Inc., Prepaid Concepts, Inc. and Call Processing, Inc. (incorporated by reference from Exhibit 10.1 to the Current Report on Form 8-K filed | ||
$30,000,000 Euro/GBP Credit Agreement dated October 25, 2004 among Bank of America, N.A., Euronet Worldwide, Inc., e-pay Holdings Limited and Delta Euronet GmbH (incorporated by reference from Exhibit 10.2 to the Current Report on Form 8-K filed | |||
10.18 | Asset Purchase Agreement among Euronet Worldwide, Inc. and Meflur S.L. dated November 3, 2004 (incorporated by reference from Exhibit 10.17 to the Company’s Annual Report on Form 10-K filed on March 15, 2005) | ||
10.19 | Revision to Service Agreement between Euronet Worldwide, Inc. and John Gardiner, dated April 12, 2005 (filed as exhibit 10.1 to the Company’s Current Report on Form 8-K filed on April 15, 2005, and incorporated by reference herein) |
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10.20 | Revision to Service Agreement between Euronet Worldwide, Inc. and Paul Althasen, dated April 12, 2005 (filed as exhibit 10.2 to the Company’s Current Report on Form 8-K filed on April 15, 2005, and incorporated by reference herein) | |
31.1 | Section 302 | |
31.2 | Section 302 | |
32.1 | Section 906 |
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