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EVTC > SEC Filings for EVTC > Form 10-Q on 14-Aug-2013All Recent SEC Filings

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Form 10-Q for EVERTEC, INC.


14-Aug-2013

Quarterly Report


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

The following Management's Discussion and Analysis ("MD&A") covers: (i) the results of operations for the three and six months ended June 30, 2013 and 2012, respectively; and (ii) the financial condition as of June 30, 2013. You should read the following discussion and analysis in conjunction with the Audited Consolidated Financial Statements and related notes for the fiscal year ended December 31, 2012, included in the Registration Statement and with the Unaudited Consolidated Financial statements and related notes appearing elsewhere herein. This MD&A contains forward-looking statements that involve risks and uncertainties. Our actual results may differ from those indicated in the forward-looking statements. See "Forward-Looking Statements" for a discussion of the risks, uncertainties and assumptions associated with these statements.

Overview

EVERTEC, Inc. and its subsidiaries (collectively the "Company," "EVERTEC," "we," "us," or "our") is the leading full-service transaction processing business in Latin America and the Caribbean. We are based in Puerto Rico and provide a broad range of merchant acquiring, payment processing and business process management services across 19 countries in the region. We process over 1.8 billion transactions annually, and manage the electronic payment network for over 4,100 automated teller machines ("ATM") and over 104,000 point-of-sale ("POS") payment terminals. According to the July 2012 Nilson Report, we are the largest merchant acquirer in the Caribbean and Central America and the sixth largest in Latin America based on total number of transactions. We own and operate the ATH network, one of the leading ATM and personal identification number debit networks in Latin America. In addition, we provide a comprehensive suite of services for core bank processing, cash processing and technology outsourcing in the regions we serve. We serve a broad and diversified customer base of leading financial institutions, merchants, corporations and government agencies with 'mission critical' technology solutions that are essential to their operations, enabling them to issue, process and accept transactions securely, and we believe that our business is well positioned to continue to expand across the fast growing Latin American region.

We are differentiated, in part, by our diversified business model, which enables us to provide our varied customer base with a broad range of transaction processing services from a single source across numerous channels and geographic markets. We believe this single source capability provides several competitive advantages which will enable us to continue to penetrate our existing customer base with new, complementary services, win new customers, develop new sales channels and enter new markets. We believe these competitive advantages include:

Our ability to package and provide a range of services across our customers' business that often need to be sourced from different vendors;

Our ability to serve customers with disparate operations in several geographies with a single integrated technology solution that enables them to manage their business as one enterprise; and

Our ability to capture and analyze data across the transaction processing value chain to provide value-added services that are differentiated from those offered by 'pure-play' vendors that only have the technology, capabilities and products to serve one portion of the transaction processing value chain (such as only merchant acquiring or payment processing).

Our broad suite of services span the entire transaction processing value chain and include a range of front-end customer facing solutions as well as back-end support services. These include: (i) merchant acquiring services, which enable POS and e-commerce merchants to accept and process electronic methods of payment such as debit, credit, prepaid and electronic benefits transfer ("EBT") cards;
(ii) payment processing services, which enable financial institutions and other issuers to manage, support and facilitate the processing for credit, debit, prepaid, ATM and EBT card programs; and (iii) business process management solutions, which provide 'mission critical' technology solutions such as core bank processing, as well as information technology ("IT") outsourcing and cash management services to financial institutions, enterprises and governments. We provide these services through a highly scalable, end-to-end technology platform that we manage and operate in-house. Our end-to-end technology platform includes solutions that encompass the entire transaction processing value chain. This enables us to provide 'front-end' processing services, such as the electronic capture and authorization of transactions at the point-of-sale, and 'back-end' services, such as the clearing and settlement of transactions and account reconciliation for card issuers. Our platform provides us with the broad range of capabilities, flexibility and operating leverage that enable us to innovate and develop new services, differentiate ourselves in the marketplace and generate significant operating efficiencies to continue to maximize profitability.

We sell and distribute our services primarily through a proprietary direct sales force with strong customer relationships. We are also increasingly building a variety of indirect sales channels which enable us to leverage the distribution capabilities of partners in adjacent markets, including value-added resellers, joint ventures and merchant acquiring alliances. Given our breadth across the transaction processing value chain, our customer base is highly diversified by size, type and geographic footprint.


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We benefit from an attractive business model, which is characterized by recurring revenue, significant operating margins and low capital expenditure requirements. Our revenue is recurring in nature because of the mission-critical and embedded nature of the services we provide, the high switching costs associated with these services and the multi-year contracts we negotiate with our customers. Our scalable business model creates significant operating efficiencies. In addition, our business model enables us to continue to grow our business organically without significant additional capital expenditures.

Separation from and Key Relationship with Popular

We have a 25 year operating history in the transaction processing industry. Prior to the Merger on September 30, 2010, EVERTEC Group was 100% owned by Popular, the largest financial institution in the Caribbean, and operated substantially as an independent entity within Popular. In September 2010, Apollo Global Management, LLC, a leading private equity investor, acquired a 51% interest in EVERTEC Group and shortly thereafter, we began the transition to a separate, stand-alone entity. As a stand-alone company, we have made substantial investments in our technology and infrastructure, recruited various senior executives with significant transaction processing experience in Latin America, enhanced our profitability through targeted productivity and cost savings actions and broadened our footprint beyond the markets historically served.

We continue to benefit from our relationship with Popular. Popular is our largest customer, acts as one of our largest merchant referral partners and sponsors us with the card associations (such as Visa or MasterCard), enabling merchants to accept these card associations' credit card transactions. Popular also provides merchant sponsorship as one of the participants of the ATH network, enabling merchants to connect to the ATH network and accept ATH debit card transactions. We provide a number of critical products and services to Popular, which are governed by a 15-year Amended and Restated Master Services Agreement that runs through 2025.

Factors and Trends Impacting the Results of Our Operations

The ongoing migration from cash and paper methods of payment to electronic payments continues to benefit the transaction processing industry globally. The increased penetration of electronic payments has been a driver for many merchants to offer acceptance of such methods in order to increase customer traffic and drive sales. We believe that the penetration of electronic payments in the markets where we principally operate is significantly lower relative to the U.S. market and that this ongoing shift will continue to generate substantial growth opportunities for our business. For example, currently the adoption of banking products, including electronic payments, in the Latin American and Caribbean region is lower relative to the mature U.S. and European markets. We believe that the unbanked and underbanked population in our markets will continue to shrink, and therefore drive incremental penetration and growth of electronic payments in Puerto Rico and other Latin American regions.

In addition, our revenue is also impacted by the trend in outsourcing of in-house technology systems and processes. The medium and small size institutions in the Latin American markets in which we operate currently face challenges in updating and renewing their IT legacy computer systems, which we believe will continue the trend to outsource in-house technology systems and processes. We believe that our technology and business outsourcing solutions cater to the evolving needs of the financial institution customer base we target, by providing integrated, open, flexible, customer-centric and efficient IT products and services.

We also expect our results of operations to be impacted by regulatory changes which occur as the payments industry has come under increased scrutiny from lawmakers and regulators. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 signed into law in July 2010 is an example of such scrutiny and of changes in laws and regulations that could impact our operating results and financial condition.

In addition, our financial condition and results of operations are, in part, dependent on the economic and general conditions of the geographies in which we operate.

Recent Accounting Pronouncements

For a description of recent accounting standards, see Note 2 of the Notes to Unaudited Consolidated Financial Statements appearing elsewhere in this Quarterly Report on Form 10-Q.

Overview of Results of Operations

The following briefly describes the components of revenues and expenses as presented in the unaudited consolidated statements of (loss) income and comprehensive (loss) income. Descriptions of the revenue recognition policies are detailed in Note 1 of the Notes to Audited Consolidated Financial Statements included in our Registration Statement.

Merchant acquiring, net. Merchant acquiring revenues consist of revenues from services that allow merchants to accept electronic methods of payment. Our standard merchant contract has an initial term of one or three years, with automatic one-year renewal periods. In the merchant acquiring segment, revenues include a discount fee and membership fees charged to merchants, debit network fees and rental income from POS devices and other equipment, net of credit card interchange and assessment fees charged by credit cards associations (such as VISA or MasterCard) or payment networks. The discount fee is generally a percentage of the sales amount of a credit or debit card transaction value. We also charge merchants for other services that are unrelated to the number of transactions or the transaction value.


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Our merchant acquiring business accounted for $18.2 million, or 20.4%, of total revenues and $8.2 million, or 28.5%, of total segment income from operations for the three months ended June 30, 2013, and $35.6 million, or 20.2%, of total revenues and $17.4 million, or 28.0%, of total segment income from operations for the six months ended June 30, 2013.

Payment processing. Payment processing revenues are comprised of revenues related to providing access to the ATH network and other card networks to financial institutions, including related services such as authorization, processing, management and recording of ATM and POS transactions, and ATM management and monitoring. Payment processing revenues also include revenues from card processing services (such as credit and debit card processing, authorization and settlement and fraud monitoring and control to debit or credit issuers), payment processing services (such as payment and billing products for merchants, businesses and financial institutions) and EBT (which principally consist of services to the Puerto Rico government for the delivery of government benefits to participants). Our payment products include electronic check processing, automated clearing house ("ACH"), lockbox, interactive voice response and web-based payments through personalized websites, among others.

We generally enter into one to five year contracts with our private payment processing clients and one year contracts with our government payment processing clients. For ATH network and processing services, revenues are primarily driven by the number of transactions processed. Revenues are derived primarily from network fees, transaction switching and processing fees, and leasing of POS devices. For card issuer processing, revenues are primarily dependent upon the number of cardholder accounts on file, transactions and authorizations processed, the number of cards embossed and other processing services. For EBT services, revenues are primarily derived from the number of beneficiaries on file.

Our payment processing business accounted for $24.3 million, or 27.2%, of total revenues and $11.7 million, or 40.9%, of total segment income from operations for the three months ended June 30, 2013, and $48.4 million, or 27.4%, of total revenues and $25.3 million, or 40.8%, of total segment income from operations for the six months ended June 30, 2013.

Business solutions. Business solutions revenues consist of revenues from a full suite of business process management solutions including specifically core bank processing, network hosting and management, IT consulting services, business process outsourcing, item and cash processing, and fulfillment. We generally enter into one to five year contracts with our private business solutions clients and one year contracts with our government business solutions clients.

In addition, we are a reseller of hardware and software products and these resale transactions are generally one-time transactions. Revenues from sales of hardware or software products are recognized once the following four criteria are met: (i) evidence of an agreement exists, (ii) delivery and acceptance has occurred or services have been rendered, (iii) the selling price is fixed or determinable, and (iv) collection of the selling price is reasonably assured.

Our business solutions business accounted for $46.7 million, or 52.4%, of total revenues and $8.8 million, or 30.6%, of total segment income from operations for the three months ended June 30, 2013, and $92.5 million, or 52.4%, of total revenues and $19.3 million, or 31.2%, of total segment income from operations for the six months ended June 30, 2013.

Cost of revenues. This caption includes the costs directly associated with providing services to customers as well as product and software sales, including software licensing and maintenance costs, telecommunications costs, personnel and infrastructure costs to develop and maintain applications, operate computer networks and provide associated customer support, and other operating expenses.

Selling, general and administrative. This caption primarily consists of salaries, wages and related expenses paid to sales personnel, administrative employees and management, advertising and promotional costs, audit and legal fees, and other selling expenses.

Depreciation and amortization. This caption consists of our depreciation and amortization expense. Following the completion of the Merger, our depreciation and amortization expense increased as a result of the purchase price allocation adjustments to reflect the fair value and revised useful life assigned to property and equipment and intangible assets in connection with the Merger.

Results of Operations

The following tables set forth certain consolidated financial information for the three and six months ended June 30, 2013 and 2012. The following tables and discussion should be read in conjunction with the information contained in our Unaudited Consolidated Financial Statements and the notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q.


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Comparison of the three months ended June 30, 2013 and 2012

The following tables present the components of our unaudited consolidated statements of (loss) income and comprehensive (loss) income by business segment and the change in those amounts for the three months ended June 30, 2013 and 2012.

Revenues



                                       Three months ended June 30,
   (Dollar amounts in thousands)        2013                 2012             Variance
   Merchant acquiring, net         $       18,165       $       17,028     $ 1,137       7 %
   Payment processing                      24,285               23,803         482       2 %
   Business solutions                      46,725               43,541       3,184       7 %

   Total revenues                  $       89,175       $       84,372     $ 4,803       6 %

Total revenues for the three months ended June 30, 2013 were $89.2 million, representing an increase of $4.8 million or 6% as compared to the corresponding 2012 period.

Merchant acquiring revenues for the three months ended June 30, 2013 were $18.2 million, representing an increase of $1.1 million or 7% as compared to the corresponding 2012 period. The revenue growth in this quarter was primarily due to an increase in transaction volumes.

Payment processing revenues for the three months ended June 30, 2013 were $24.3 million, representing an increase of $0.5 million or 2% as compared to the corresponding 2012 period. The revenue growth comparison in this quarter is impacted by a non-recurring increase in processing volumes during the quarter ended June 30, 2012 related to certain one-time items. Normalizing for these one-time items, revenues in this segment grew 6% versus the prior year.

Business solutions revenues for the three months ended June 30, 2013 were $46.7 million, representing an increase of $3.2 million or 7% as compared to the corresponding 2012 period. Revenue growth was primarily driven by an increase in sales and higher demand for our services.


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Operating costs and expenses

                                                  Three months ended June 30,
(Dollar amounts in thousands)                      2013                 2012              Variance
Cost of revenues, exclusive of depreciation
and amortization shown below                  $       42,257       $       39,831     $ 2,426        6 %
Selling, general and administrative
expenses                                              12,138                8,477       3,661       43 %
Depreciation and amortization                         17,842               17,830          12        0 %

Total operating costs and expenses            $       72,237       $       66,138     $ 6,099        9 %

Total operating costs and expenses for the three months ended June 30, 2013 were $72.2 million, representing an increase of $6.1 million or 9% as compared to the corresponding 2012 period.

Cost of revenues for the three months ended June 30, 2013 were $42.3 million, representing an increase of $2.4 million or 6% as compared to the corresponding 2012 period. The growth in our cost of revenues was primarily due to a $2.0 million increase in product sales within our business solutions segment and a non-cash compensation expense of $1.8 million related to the vesting of all Tranche B and C stock options, partially offset by a $1.4 million decrease in professional services.

Selling, general and administrative expenses for the three months ended June 30, 2013 were $12.1 million, representing an increase of $3.7 million or 43% as compared to the corresponding 2012 period. The increase in our selling, general and administrative expenses was primarily due to a $3.1 million non-cash charge taken in connection with the vesting of all Tranche B and C stock options.

For additional information regarding the share-based compensation expense during the quarter, refer to Note 7 of the Notes to Unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

Income from operations

The following table presents income from operations by reportable segments.

                                                Three months ended June 30,
(Dollar amounts in thousands)                    2013                 2012                Variance
Segment income from operations
Merchant acquiring, net                      $       8,161        $       7,970      $    191         2 %
Payment processing                                  11,719               12,756        (1,037 )      -8 %
Business solutions                                   8,784                8,870           (86 )      -1 %

Total segment income from operations                28,664               29,596          (932 )      -3 %
Merger related depreciation and
amortization and other unallocated
expenses (1)                                       (11,726 )            (11,362 )        (364 )      -3 %

Income from operations                       $      16,938        $      18,234      $ (1,296 )      -7 %

(1) Primarily represents non-operating depreciation and amortization expenses generated as a result of the Merger and certain non-recurring fees and expenses.

Income from operations for the three months ended June 30, 2013 was $16.9 million, representing a decrease of $1.3 million or 7% as compared to the corresponding 2012 period. The decrease in income from operations was the result of the non-recurring $4.9 million non-cash expense related to the vesting of all Tranche B and C stock options. Excluding this expense, income from operations would have increased by $3.6 million or 20%. This increase was driven by the aforementioned factors impacting our revenues and operating costs and expenses.

See Note 12 of the Notes to Unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for additional information on the Company's reportable segments and for a reconciliation of income from operations to net income.


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Non-operating (expenses) income

                                              Three months ended June 30,
(Dollar amounts in thousands)                  2013                 2012                 Variance
Non-operating (expenses) income
Interest income                            $          49        $          77      $     (28 )       -36 %
Interest expense                                  (9,747 )            (13,254 )        3,507          26 %
Earnings of equity method investment                 348                  509           (161 )       -32 %
Other expense                                    (77,535 )             (8,397 )      (69,138 )      -823 %

Total non-operating (expenses) income      $     (86,885 )      $     (21,065 )    $ (65,820 )      -312 %

Total non-operating expenses for the three months ended June 30, 2013 were $86.9 million, representing an increase of $65.8 million as compared to the corresponding 2012 period. The increase in non-operating expenses in 2013 was primarily driven by $58.5 million related to the extinguishment of debt and $16.7 million related to the termination of the consulting agreements with Apollo and Popular, partially offset by a $3.5 million decrease in interest expense as a result of the debt refinancing during the quarter.

For additional information related to the extinguishment of debt and associated loss, see Note 5 of the Notes to Unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

Income tax benefit

Income tax benefit for the three months ended June 30, 2013 amounted to approximately $5.0 million compared to $0.8 million for the corresponding 2012 period. The increase in income tax benefit was attributable to a higher taxable loss as a result of higher non-operating expenses related to the extinguishment of debt, the termination of the consulting agreements and the vesting of all Tranche B and C stock options, as explained above. This increase was partially offset by the effect of the tax grant received in the fourth quarter of 2012 that reduced our marginal corporate tax rates from 30% to 4% on our industrial development income.

See Note 8 of the Notes to Unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for additional information regarding income taxes.

Comparison of the six months ended June 30, 2013 and 2012

The following tables present the components of our unaudited consolidated statements of (loss) income and comprehensive (loss) income by business segment and the change in those amounts for the six months ended June 30, 2013 and 2012.

Revenues



                                       Six months ended June 30,
     (Dollar amounts in thousands)       2013               2012           Variance
     Merchant acquiring, net         $      35,624       $   34,689     $   935       3 %
     Payment processing                     48,397           46,702       1,695       4 %
     Business solutions                     92,493           85,469       7,024       8 %

     Total revenues                  $     176,514       $  166,860     $ 9,654       6 %

Total revenues for the six months ended June 30, 2013 were $176.5 million, representing an increase of $9.7 million or 6% as compared to the corresponding 2012 period.

Merchant acquiring revenues for the six months ended June 30, 2013 were $35.6 million, representing an increase of $0.9 million or 3% as compared to the corresponding 2012 period. The revenue growth for 2013 was primarily due to higher volume, partially offset by certain effects related to the Durbin Amendment which went into effect in the fourth quarter of 2011. Normalizing for the effects related to the Durbin Amendment, revenues in this segment grew 8% versus the prior year.

Payment processing revenues for the six months ended June 30, 2013 were $48.4 million, representing an increase of $1.7 million or 4% as compared to the corresponding 2012 period. The revenue growth comparison is impacted by a non-recurring increase in processing volumes during the quarter ended June 30, 2012 related to certain one-time items. Normalizing for these one-time items, revenues in this segment grew 6% versus the prior year.


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Business solutions revenues for the six months ended June 30, 2013 were $92.5 million, representing an increase of $7.0 million or 8% as compared to the corresponding 2012 period. Revenue growth was primarily driven by an increase in sales and higher demand for our services.

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