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EVTC > SEC Filings for EVTC > Form 10-Q on 8-May-2014All Recent SEC Filings

Show all filings for EVERTEC, INC.

Form 10-Q for EVERTEC, INC.


8-May-2014

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 months ended March 31, 2014 and 2013, respectively; and (ii) the financial condition as of March 31, 2014. 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, 2013, included in the Company's annual report on Form 10-K (the "2013 Form 10-K") 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.

Except as otherwise indicated or unless the context otherwise requires, (a) the terms "EVERTEC," "we," "us," "our," "our company" and "the Company" refer to EVERTEC, Inc. and its subsidiaries on a consolidated basis, (b) the term "Holdings" refers to EVERTEC Intermediate Holdings, LLC, but not any of its subsidiaries and (c) the term "EVERTEC Group" refers to EVERTEC Group, LLC and its predecessor entities and their subsidiaries on a consolidated basis, including the operations of its predecessor entities prior to the Merger (as defined below). EVERTEC Inc.'s subsidiaries include Holdings, EVERTEC Group, EVERTEC Dominicana, SAS, EVERTEC Panamá, S.A., EVERTEC Costa Rica, S.A. ("EVERTEC CR"), EVERTEC Guatemala, S.A. and EVERTEC México Servicios de Procesamiento, S.A. de C.V. Neither EVERTEC nor Holdings conducts any operations other than with respect to its indirect or direct ownership of EVERTEC Group.

Executive Summary

EVERTEC is the leading full-service transaction processing business in Latin America, providing a broad range of merchant acquiring, payment processing and business process management services. According to the July 2013 Nilson Report, we are the largest merchant acquirer in the Caribbean and Central America and the seventh largest in Latin America, based on total number of transactions. We serve 19 countries in the region from our base in Puerto Rico. We manage a system of electronic payment networks that process more than 2.1 billion transactions annually, and offer a comprehensive suite of services for core bank processing, cash processing and technology outsourcing. In addition, we own and operate the ATH network, one of the leading personal identification number ("PIN") debit networks in Latin America. We serve a diversified customer base of leading financial institutions, merchants, corporations and government agencies with "mission-critical" technology solutions that enable them to issue, process and accept transactions securely. We believe 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 that 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 provide in one package a range of services that traditionally had 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 and use that data 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 just one portion of the transaction-processing value chain (such as only merchant acquiring or payment processing).

Our broad suite of services spans the entire transaction-processing value chain and includes a range of front-end customer-facing solutions such as the electronic capture and authorization of transactions at the point-of-sale, as well as back-end support services such as the clearing and settlement of transactions and account reconciliation for card issuers. These include:
(i) merchant acquiring services, which enable point of sales ("POS") and e-commerce merchants to accept and process electronic methods of payment such as debit, credit, prepaid and electronic benefit 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, automated teller machines ("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 IT outsourcing and cash management services to financial institutions, corporations and governments. We provide these services through a highly scalable, end-to-end technology platform that we manage and operate in-house and that generates significant operating efficiencies that enable us to maximize profitability.


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We sell and distribute our services mainly through a proprietary direct sales force with strong customer relationships. We are also building a variety of indirect sales channels that enable us to leverage the distribution capabilities of partners in adjacent markets, including value-added resellers. Also, we continue to pursue joint ventures and merchant acquiring alliances.

We benefit from an attractive business model, the hallmarks of which are recurring revenue, scalability, 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 business model enables us to continue to grow our business organically without significant additional capital expenditures.

Corporate Background

Our main operating subsidiary, EVERTEC Group, LLC (formerly known as EVERTEC, LLC and EVERTEC, Inc., hereinafter "EVERTEC Group"), was organized in Puerto Rico in 1988. EVERTEC Group was formerly a wholly-owned subsidiary of Popular. On September 30, 2010, pursuant to an Agreement and Plan of Merger (as amended, the "Merger Agreement"), AP Carib Holdings, Ltd. ("Apollo") acquired a 51% indirect ownership interest in EVERTEC Group as part of a merger (the "Merger") and EVERTEC Group became a wholly-owned subsidiary of EVERTEC Intermediate Holdings, LLC (formerly known as Carib Holdings, LLC and Carib Holdings, Inc., hereinafter "Holdings").

On April 17, 2012, EVERTEC Group was converted from a Puerto Rico corporation to a Puerto Rico limited liability company (the "Conversion") for the purpose of improving its consolidated tax efficiency by taking advantage of recent changes to the Puerto Rico Internal Revenue Code, as amended (the "PR Code"), that permit limited liability companies to be treated as partnerships that are pass-through entities for Puerto Rico tax purposes. Concurrent with the Conversion, Holdings, which is our direct subsidiary, was also converted from a Puerto Rico corporation to a Puerto Rico limited liability company. Prior to these conversions, EVERTEC, Inc. (formerly known as Carib Latam Holdings, Inc.) was formed in order to act as the new parent company of Holdings and its subsidiaries, including EVERTEC Group. The transactions described above in this paragraph are collectively referred to as the "Reorganization."

Separation From and Key Relationship with Popular

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. After the consummation of the Merger, Popular retained an indirect ownership interest in EVERTEC Group and is our largest customer. In connection with, and upon consummation of the Merger, EVERTEC Group entered into a 15-year Master Services Agreement, and several related agreements with Popular. Under the terms of the Master Services Agreement, Popular agreed to continue to use EVERTEC services on an ongoing exclusive basis, for the duration of the agreement, on commercial terms consistent with those of our historical relationship. Additionally, Popular granted us a right of first refusal on the development of certain new financial technology products and services for the duration of the Master Services Agreement.

Factors and Trends Affecting 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. We believe that the penetration of electronic payments in the markets in which we 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 region is lower relative to the more 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. We also benefit from the trend for financial institutions and government agencies to outsource technology systems and processes. Many medium- and small-size institutions in the Latin American markets in which we operate have outdated computer systems and updating these IT legacy systems is financially and logistically challenging. We believe that our technology and business outsourcing solutions cater to the evolving needs of the financial institution customer base we target, providing integrated, open, flexible, customer-centric and efficient IT products and services.

Our results of operations may be affected by regulatory changes that will occur as the payments industry has come under increased scrutiny from lawmakers and regulators.

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


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Overview of Results of Operations

The following briefly describes the components of revenue and expenses as presented in the unaudited consolidated statements of income and comprehensive income. Descriptions of the revenue recognition policies are detailed in Note 1 of the Notes to the Audited Consolidated Financial Statements included in our 2013 Form 10-K.

Merchant Acquiring, net. Merchant Acquiring revenue consist of income 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, revenue includes a discount fee (generally a percentage of the sales amount of a credit or debit card transaction value) 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.

Our Merchant Acquiring business accounted for $19.3 million or 22.1% of total revenue for the three months ended March 31, 2014, compared with $17.5 million, or 20.0%, for the same period in 2013; and $8.4 million, or 24.3%, of total segment income from operations for the three month period ended March 31, 2014 compared with $9.2 million, or 28.4%, for the same period in 2013.

Payment Processing. Payment Processing revenue comprises income related to providing financial institutions access to the ATH network and other card networks, including related services such as authorization, processing, management and recording of ATM and POS transactions, and ATM management and monitoring. Payment Processing revenue also includes income from card processing services for debit or credit issuers, such as credit and debit card processing, authorization and settlement and fraud monitoring and control services; payment processing services such as payment and billing products for merchants, businesses and financial institutions and EBT; which principally consists 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, revenue is mainly driven by the number of transactions processed. Revenue is derived mainly from network fees, transaction switching and processing fees, and leasing of POS devices. For card issuer processing, revenue is dependent mostly upon the number of cardholder accounts on file, transactions and authorizations processed, the number of cards embossed and other processing services. For EBT services, revenue is derived mainly from the number of beneficiaries on file.

Our Payment Processing business accounted for $25.0 million or 28.7% of total revenue for the three months ended March 31, 2014, compared with $24.1 million, or 27.5%, of total revenue for the same period in 2013; and $14.7 million, or 42.6%, of total segment income from operations for the three months ended March 31, 2014, compared with $12.8 million, or 39.2%, of total segment income from operations for the three months ended March 31, 2013.

Business Solutions. Business Solutions revenue consists of income from a full suite of business process management solutions including 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. Revenue from sales of hardware or software products is 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 or probable, as applicable.

Our Business Solutions business accounted for $42.9 million or 49.2% of total revenue for the three months ended March 31, 2014, compared with $45.8 million, or 52.5%, of total revenue for the comparable period in 2013; and $11.4 million, or 33.1%, of total segment income from operations for the three months ended March 31, 2014, compared with $10.5 million, or 32.4%, of total segment income from operations for the three months ended March 31, 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.


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Selling, general and administrative. This caption consists mainly 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 market 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 months ended March 31, 2014 and 2013. 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.

Comparison of the three months ended March 31, 2014 and 2013

The following tables present the components of our unaudited consolidated statements of income and comprehensive income by business segment and the change in those amounts for the three months ended March 31, 2014 and 2013.

Revenue



                                    Three months ended March 31,
 (Dollar amounts in thousands)        2014                 2013               Variance
 Merchant Acquiring, net         $       19,291       $       17,459     $  1,832        10 %
 Payment Processing                      25,002               24,112          890         4 %
 Business Solutions                      42,917               45,768       (2,851 )      -6 %

 Total revenues                  $       87,210       $       87,339     $   (129 )       0 %

Total revenue for the three months ended March 31, 2014 decreased slightly to $87.2 million compared with $87.3 million for the comparable period in 2013. The decrease was driven by a $2.9 million reduction in Business Solutions revenue, which was almost entirely offset by increases in Merchant Acquiring and Payment Processing revenue.

Merchant Acquiring revenue for the three months ended March 31, 2014 increased by $1.8 million or 10% compared with the corresponding 2013 period. The growth was mostly a result of an increase in transaction volumes.

Payment Processing revenue for the three months ended March 31, 2014 increased $0.9 million or 4% compared with the corresponding 2013 period. Revenue growth was driven mainly by an increase in our card products business as a result of higher accounts on file due to new customer additions in our Latin America operations, and by an increase in ATH and POS network and processing transactions. The increase in ATH and POS transactions was largely a result of organic growth from local banks in Puerto Rico, as well as, additional services to certain existing customers. The increase was partially offset by a decrease in a service for a Department of Education program which in the previous year had begun in the first quarter, while in the current year will be commencing during the second quarter.

Business Solutions revenue for the three months ended March 31, 2014 decreased $2.9 million or 6% compared with the corresponding 2013 period. The decrease is almost entirely attributable to a decline in hardware and software sales of $3.5 million, partially offset by increased demand for our core banking products and services.


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Operating costs and expenses

                                                Three months ended March 31,
(Dollar amounts in thousands)                     2014                 2013               Variance
Cost of revenues, exclusive of
depreciation and amortization shown below    $       37,645       $       40,502     $ (2,857 )      -7 %
Selling, general and administrative
expenses                                              8,062                8,863         (801 )      -9 %
Depreciation and amortization                        16,614               17,575         (961 )      -5 %

Total operating costs and expenses           $       62,321       $       66,940     $ (4,619 )      -7 %

Total operating costs and expenses for the three months ended March 31, 2014 decreased $4.6 million or 7% when compared with the same period in 2013.

Cost of revenues for the three months ended March 31, 2014 decreased 7% compared with the corresponding 2013 period. The reduction is mainly due to lower cost of sales incurred as a result of the aforementioned decrease in hardware and software sales.

Selling, general and administrative expenses for the three months ended March 31, 2014 decreased $0.8 million or 9% compared with the corresponding 2013 period. The decline was mainly due to the consulting fees paid to Apollo and Popular during the first quarter of 2013. In connection with our initial public offering during the second quarter of 2013, our consulting agreements with Apollo and Popular were terminated.

Depreciation and amortization expense for the three months ended March 31, 2014 decreased $1.0 million or 5% compared with the corresponding 2013 period. The decrease is related to lower amortization of software packages which became fully depreciated during 2013.

Income from operations

The following table presents income from operations by reportable segments.

                                                 Three months ended March 31,
(Dollar amounts in thousands)                    2014                   2013                Variance
Segment income from operations
Merchant Acquiring, net                      $       8,404         $        9,234      $  (830 )       -9 %
Payment Processing                                  14,717                 12,760        1,957         15 %
Business Solutions                                  11,424                 10,534          890          8 %

Total segment income from operations                34,545                 32,528        2,017          6 %
Merger related depreciation and
amortization and other unallocated
expenses (1)                                        (9,656 )              (12,129 )      2,473        -20 %

Income from operations                       $      24,889         $       20,399      $ 4,490         22 %

(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 March 31, 2014 was $24.9 million, representing an increase of $4.5 million or 22% compared with the corresponding 2013 period. The increase in income from operations was driven by the aforementioned factors impacting our revenue 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 the income from operations to net income.


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Non-operating (expenses) income

                                                Three months ended March 31,
(Dollar amounts in thousands)                   2014                   2013                 Variance
Non-operating (expenses) income
Interest income                             $          75         $           44      $     31          70 %
Interest expense                                   (6,909 )              (15,264 )       8,355         -55 %
Earnings of equity method investment                  321                    277            44          16 %
Other income                                        1,991                     67         1,924       2,872 %

Total non-operating (expenses) income       $      (4,522 )       $      (14,876 )    $ 10,354         (70 )%

The reduction in total non-operating expenses was due to a decrease of $8.4 million in interest expense as a result of the refinancing of our debt, completed in the second quarter of 2013, and the redemption of the senior notes. Additionally, other income increased by $1.0 million as a result of non-recurring gains related to currency translation on an intercompany loan with EVERTEC CR, our Costa Rican subsidiary.

Income tax expense

Income tax expense for the three months ended March 31, 2014 amounted to $2.2 million compared with approximately $51,000 for the corresponding 2013 period, mainly as a result of an increase in taxable 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.

Liquidity and Capital Resources

Our principal source of liquidity is cash generated from operations, and our primary liquidity requirements are the funding of capital expenditures and working capital needs. We also have a $100.0 million revolving credit facility, of which $60.0 million was available as of March 31, 2014.

At March 31, 2014, we had cash of $27.2 million, of which $15.8 million resides in our subsidiaries located outside of Puerto Rico for purposes of (i) funding the respective subsidiary's current business operations and (ii) funding potential future investment outside of Puerto Rico. We intend to indefinitely reinvest these funds outside of Puerto Rico, and based on our liquidity forecast, we will not need to repatriate this cash to fund the Puerto Rico operations or to meet debt-service obligations. However, if in the future we determine that we no longer need to maintain such cash balances within our foreign subsidiaries, we may elect to distribute such cash to the Company in Puerto Rico. Distributions from the foreign subsidiaries to Puerto Rico may be subject to tax withholding and other tax consequences.

Our primary use of cash is for operating expenses, working capital requirements, capital expenditures, dividend payments and debt service.

Based on our current level of operations, we believe our cash flows from operations and the available senior secured revolving credit facility will be adequate to meet our liquidity needs for the next twelve months. However, our ability to fund future operating expenses, dividend payments and capital expenditures and our ability to make scheduled payments of interest, to pay principal on or refinance our indebtedness and to satisfy any other of our present or future debt obligations will depend on our future operating performance, which will be affected by general economic, financial and other factors beyond our control.

                                                Three months ended March 31,
    (Dollar amounts in thousands)                2014                  2013
    Cash provided by operating activities   $       30,014        $       33,831
    Cash used in investing activities               (2,300 )              (4,334 )
    Cash used in financing activities              (22,957 )             (21,003 )

    Increase in cash                        $        4,757        $        8,494

. . .

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