UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
For the quarterly period ended March 31, 2014
or
For the transition period from to
COMMISSION FILE NUMBER 001-35872
EVERTEC, Inc.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. employer
identification number)
Cupey Center Building, Road 176, Kilometer 1.3,
San Juan, Puerto Rico
(787) 759-9999
(Registrant’s telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
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 x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in rule 12b-2 of the Exchange Act).
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
At May 1, 2014, there were 78,381,126 outstanding shares of common stock of EVERTEC, Inc.
TABLE OF CONTENTS
Item 1.
Item 2.
Item 3.
Item 4.
Part II. OTHER INFORMATION
Item 1A.
Item 5.
Item 6.
SIGNATURES
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of, and subject to the protection of, the Private Securities Litigation Reform Act of 1995. Such statements can be identified by the use of forward-looking terminology such as “believes,” “expects,” “may,” “estimates,” “will,” “should,” “plans” or “anticipates” or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and may involve significant risks and uncertainties, and that actual results may vary materially from those in the forward-looking statements as a result of various factors. Among the factors that significantly impact our business and could impact our business in the future are:
These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. The Company does not undertake, and specifically disclaims any obligation, to update any of the “forward-looking statements” to reflect occurrences or unanticipated events or circumstances after the date of such statements except as required by the federal securities laws.
Investors should refer to the Company’s Form 10-K for the year ended December 31, 2013 (the “2013 Form 10-K”) for a discussion of factors that could cause events to differ from those suggested by the forward-looking statements, including factors set forth in the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”
EVERTEC, Inc. (Unaudited) Consolidated Balance Sheets
(Dollar amounts in thousands, except for share information)
Assets
Current Assets:
Cash
Restricted cash
Accounts receivable, net
Deferred tax asset
Prepaid expenses and other assets
Total current assets
Investment in equity investee
Property and equipment, net
Goodwill
Other intangible assets, net
Other long-term assets
Total assets
Liabilities and Stockholders’ equity
Current Liabilities:
Accrued liabilities
Accounts payable
Unearned income
Income tax payable
Current portion of long-term debt
Short-term borrowings
Deferred tax liability, net
Total current liabilities
Long-term debt
Long-term deferred tax liability, net
Other long-term liabilities
Total liabilities
Commitments and contingencies (Note 10)
Stockholders’ equity
Preferred Stock, par value $0.01; 2,000,000 shares authorized, none issued
Common Stock, par value $0.01; 206,000,000 shares authorized; 78,381,126 shares issued and outstanding at March 31, 2014 (December 31, 2013 - 78,286,465)
Additional paid-in capital
Accumulated earnings
Accumulated other comprehensive (loss) income, net of tax
Total stockholders’ equity
Total liabilities and stockholders’ equity
The accompanying notes are an integral part of these unaudited consolidated financial statements.
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EVERTEC, Inc. (Unaudited) Consolidated Statements of Income and Comprehensive Income
(Dollar amounts in thousands, except per share information)
Revenues
Merchant Acquiring, net
Payment Processing (from affiliates: $7,104 and $7,210)
Business Solutions (from affiliates: $33,358 and $34,445)
Total revenues
Operating costs and expenses
Cost of revenues, exclusive of depreciation and amortization shown below
Selling, general and administrative expenses
Depreciation and amortization
Total operating costs and expenses
Income from operations
Non-operating (expenses) income
Interest income
Interest expense
Earnings of equity method investment
Other income
Total non-operating (expenses) income
Income before income taxes
Income tax expense
Net income
Other comprehensive (loss) income, net of income tax expense of $6 and $6
Foreign currency translation adjustments
Total comprehensive income
Net income per common share - basic
Net income per common share - diluted
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EVERTEC, Inc. (Unaudited) Consolidated Statement of Changes in Stockholders’ Equity
(Dollar amounts in thousands, except share information)
Balance at December 31, 2013
Share-based compensation recognized
Tax windfall benefit on exercises of stock options and vesting of restricted stock
Stock options exercised, net of cashless exercise
Cash dividends paid on common stock
Other comprehensive (loss) income
Balance at March 31, 2014
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EVERTEC, Inc. (Unaudited) Consolidated Statements of Cash Flows
(Dollar amounts in thousands)
Cash flows from operating activities
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of debt issue costs and premium and accretion of discount
Provision for doubtful accounts and sundry losses
Deferred tax benefit
Share-based compensation
Unrealized loss (gain) of indemnification assets
Loss on disposition of property and equipment and other intangibles
Decrease (increase) in assets:
(Decrease) increase in liabilities:
Accounts payable and accrued liabilities
Total adjustments
Net cash provided by operating activities
Cash flows from investing activities
Net decrease in restricted cash
Intangible assets acquired
Property and equipment acquired
Proceeds from sales of property and equipment
Net cash used in investing activities
Cash flows from financing activities
Net decrease in short-term borrowing
Repayment of short-term borrowing for purchase of equipment
Repayment of long-term debt
Repayment of other financing agreement
Dividends paid
Tax windfall benefits on exercise of stock options
Statutory minimum withholding taxes paid on cashless exercise of stock options
Net cash used in financing activities
Net increase in cash
Cash at beginning of the period
Cash at end of the period
Supplemental disclosure of non-cash activities:
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Notes to Unaudited Consolidated Financial Statements
Note 1 – The Company and Basis of Presentation
Note 2 – Recent Accounting Pronouncements
Note 3 – Property and Equipment, net
Note 4 – Goodwill and Other Intangible Assets
Note 5 – Debt and Short-Term Borrowings
Note 6 – Financial Instruments and Fair Value Measurements
Note 7 – Share-based Compensation
Note 8 – Income Tax
Note 9 – Net Income Per Common Share
Note 10 – Commitments and Contingencies
Note 11 – Related Party Transactions
Note 12 – Segment Information
Note 13 – Subsequent Events
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EVERTEC, Inc. Notes to Unaudited Consolidated Financial Statements
The Company
EVERTEC, Inc. (formerly known as Carib Latam Holdings, Inc.) and its subsidiaries (collectively the “Company,” or “EVERTEC”) is the leading full-service transaction processing business in Latin America and the Caribbean. The Company is based in Puerto Rico and provides a broad range of merchant acquiring, payment processing and business process management services across 19 countries in the region. EVERTEC owns and operates the ATH network, one of the leading automated teller machine (“ATM”) and personal identification number (“PIN”) debit networks in Latin America. In addition, EVERTEC provides a comprehensive suite of services for core bank processing, cash processing and technology outsourcing in the regions the Company serves. EVERTEC serves 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 Management believes that the Company’s business is well positioned to continue to expand across the fast growing Latin American region.
On April 13, 2012, EVERTEC was formed in order to act as the new parent company of EVERTEC Intermediate Holdings, LLC (formerly known as Carib Holdings, LLC and Carib Holdings, Inc., hereinafter “Holdings”) and its subsidiaries, including EVERTEC Group, LLC (formerly known as EVERTEC, LLC and EVERTEC, Inc., hereinafter “EVERTEC Group”). The Company’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.
Basis of Presentation
The unaudited consolidated financial statements of EVERTEC and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted from these statements pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and, accordingly, these financial statements should be read in conjunction with the Audited Consolidated Financial Statements of the Company for the year ended December 31, 2013, included in the Company’s 2013 Form 10-K. All adjustments (consisting only of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the statement of financial position, results of operations and cash flows for the interim periods have been reflected. All significant intercompany accounts and transactions have been eliminated in consolidation.
Certain reclassifications have been made to certain prior period notes to the unaudited consolidated financial statements to conform with the presentation in 2014.
In March 2013, the Financial Accounting Standard Board (“FASB”) issued new guidance clarifying the accounting for the release of a cumulative translation adjustment into net income when a parent entity either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or a business within a foreign entity. The amendments in this Update are effective prospectively for fiscal years, and interim reporting periods within those years, beginning after December 15, 2013. The Company adopted this guidance with no impact on the financial statements.
In July 2013, the FASB issued a new accounting standard that will require the presentation of certain unrecognized tax benefits as reductions to deferred tax assets rather than as liabilities in the consolidated balance sheets when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The amendments are effective for public entities with fiscal periods beginning after December 15, 2013. Early adoption is permitted. The Company adopted this guidance with no impact on the financial statements given that as of March 31, 2014, there are no unrecognized tax benefits.
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Property and equipment, net consists of the following:
Buildings
Data processing equipment
Furniture and equipment
Leasehold improvements
Less - accumulated depreciation and amortization
Depreciable assets, net
Land
Depreciation and amortization expense related to property and equipment amounted to $3.9 million and $4.0 million for the three months ended March 31, 2014 and 2013, respectively.
The changes in the carrying amount of goodwill, allocated by reportable segments, were as follows (See Note 12):
Goodwill is tested for impairment at least annually, or more often if events or circumstances indicate there may be impairment, using the qualitative assessment option or step zero process. Using this process, the Company first assesses whether it is “more likely than not” that the fair value of a reporting unit is less than its carrying amount.
During 2013, the Company completed the qualitative assessment, as described above, and determined that there are no impairment losses to be recognized during the period. There were no triggering events or changes in circumstances that subsequent to the impairment test would have required an additional impairment evaluation. As part of the Company’s qualitative assessment, EVERTEC considered the results for the 2011 impairment test (which indicated that the fair value of each reporting unit was in excess of 30% of its carrying amount) as well as current market conditions and changes in the carrying amount of the Company’s reporting units that occurred subsequent to the 2011 impairment test.
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The carrying amount of other intangible assets for the three months ended March 31, 2014 and the year ended December 31, 2013 consisted of the following:
Customer relationships
Trademark
Software packages
Non-compete agreement
For the three months ended March 31, 2014 and 2013, the Company recorded amortization expense related to other intangibles of $12.7 million and $13.6 million, respectively.
The estimated amortization expense of the balances outstanding at March 31, 2014 for the next five years is as follows:
2014
2015
2016
2017
2018
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Total debt as of March 31, 2014 and December 31, 2013 was as follows:
Senior Secured Credit Facility (Term A) due on April 17, 2018 paying interest at a variable interest rate (LIBOR plus applicable margin (1)(3))
Senior Secured Credit Facility (Term B) due on April 17, 2020 paying interest at a variable interest rate (LIBOR plus applicable margin (2)(3))
Senior Secured Revolving Credit Facility expiring on April 17, 2018 paying interest at a variable interest rate
Other short-term borrowing
Total debt
Term A Loan
As of March 31, 2014, the unpaid principal balance of the Term A Loan was $288.8 million. The Term A Loan requires principal payments on the last business day of each quarter equal to (a) 1.250% of the original principal amount commencing on September 30, 2013 through June 30, 2016; (b) 1.875% of the original principal amount from September 30, 2016 through June 30, 2017; (c) 2.50% of the original principal amount from September 30, 2017 through March 31, 2018; and (d) the remaining outstanding principal amount on the maturity of the Term A Loan on April 17, 2018. Interest is based on EVERTEC Group’s first lien secured net leverage ratio and payable at a rate equal to, at the Company’s option, either (a) LIBOR plus an applicable margin ranging from 2.00% to 2.50%, or (b) base rate, as defined in the credit agreement, plus an applicable margin ranging from 1.00% to 1.50%. Term A Loan has no LIBOR or Base Rate minimum or floor.
Term B Loan
As of March 31, 2014, the unpaid principal balance of the Term B Loan was $397.0 million. The Term B Loan requires principal payments on the last business day of each quarter equal to 0.250% of the original principal amount commencing on September 30, 2013 and the remaining outstanding principal amount on the maturity of the Term B Loan on April 17, 2020. Interest is based on EVERTEC Group’s first lien secured net leverage ratio and payable at a rate equal to, at the Company’s option, either (a) LIBOR plus an applicable margin ranging from 2.50% to 2.75%, or (b) base rate plus an applicable margin ranging from 1.50% to 1.75%. The LIBOR and Base Rate are subject to floors of 0.75% and 1.75%, respectively.
Revolving Credit Facility
The revolving credit facility has an available balance up to $100.0 million, with an interest rate on loans calculated the same as the applicable Term A Loan rate. The facility matures on April 17, 2018 and has a “commitment fee” payable one business day after the last business day of each quarter calculated based on the daily unused commitment during the preceding quarter. The commitment fee for the unused portion of this facility ranges from 0.125% to 0.375% and is based on EVERTEC Group’s first lien secured net leverage ratio. As of March 31, 2014, the revolving credit facility had an outstanding balance of $40.0 million.
The senior secured credit facilities contain various restrictive covenants. The Term A Loan and the revolving credit facility (subject to certain exceptions) require EVERTEC Group to maintain on a quarterly basis a specified maximum senior secured leverage ratio of up to 6.60 to 1.00 as defined in the 2013 Credit Agreement (total first lien secured debt to adjusted EBITDA). In addition, the 2013 Credit Agreement, among other things: (a) limits EVERTEC Group’s ability and the ability of the Company’s subsidiaries to incur additional indebtedness, incur liens, pay dividends or make certain other restricted payments and enter into certain transactions with affiliates; (b) restricts EVERTEC’s ability to enter into agreements that would limit the ability of the Company’s subsidiaries to pay dividends or make certain payments to EVERTEC; and (c) places restrictions on the Company’s ability and the ability of its subsidiaries to merge or consolidate with any other person or sell, assign, transfer, convey or otherwise dispose of all or substantially all of the Company’s assets. As of March 31, 2014, the Company was in compliance with the applicable restrictive covenants under the 2013 Credit Agreement.
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Recurring Fair Value Measurements
Fair value measurement provisions establish a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. These provisions describe three levels of input that may be used to measure fair value:
Level 1: Inputs are unadjusted, quoted prices for identical assets or liabilities in active markets at the measurement date.
Level 2: Inputs, other than quoted prices included in Level 1, that are observable for the asset or liability through corroboration with market data at the measurement date.
Level 3: Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.
The Company uses observable inputs when available. Fair value is based upon quoted market prices when available. If market prices are not available, the Company may employ internally-developed models that mostly use market-based inputs including yield curves, interest rates, volatilities, and credit curves, among others. The Company limits valuation adjustments to those deemed necessary to ensure that the financial instrument’s fair value adequately represents the price that would be received or paid in the marketplace. Valuation adjustments may include consideration of counterparty credit quality and liquidity as well as other criteria. The estimated fair value amounts are subjective in nature and may involve uncertainties and matters of significant judgment for certain financial instruments. Changes in the underlying assumptions used in estimating fair value could affect the results. The fair value measurement levels are not indicative of risk of investment.
The following table summarizes fair value measurements by level at March 31, 2014 and December 31, 2013 for assets measured at fair value on a recurring basis:
March 31, 2014
Financial assets:
Indemnification assets:
Software cost reimbursement
December 31, 2013
The fair value of financial instruments is the amount at which an asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced liquidation sale. Fair value estimates are made at a specific point in time based on the type of financial instrument and relevant market information. Many of these estimates involve various assumptions and may vary significantly from amounts that could be realized in actual transactions.
For those financial instruments with no quoted market prices available, fair values have been estimated using present value calculations or other valuation techniques, as well as management’s best judgment with respect to current economic conditions, including discount rates and estimates of future cash flows.
Indemnification assets include the present value of the expected future cash flows of certain expense reimbursement agreements with Popular. These contracts have termination dates up to September 2015 and were entered into in connection with the merger transaction completed on September 30, 2010 (“the Merger”). Management prepared estimates of the expected reimbursements to be received from Popular until the termination of the contracts, discounted the estimated future cash flows and recorded the indemnification assets
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as of the Merger closing date. Payments received during the quarters reduced the indemnification asset balance. The remaining balance was adjusted to reflect its fair value as of March 31, 2014, resulting in a net unrealized loss of approximately $0.2 million for the three months ended March 31, 2014 and an unrealized gain of $16,000 for the three months ended March 31, 2013, which are reflected within the other income caption in the unaudited consolidated statements of income and comprehensive income. The current portion of the indemnification assets is included within accounts receivable, net, and the other long-term portion is included within Other long-term assets in the accompanying unaudited consolidated balance sheets.
The unobservable inputs related to the Company’s indemnification assets as of March 31, 2014 using the discounted cash flow model include the discount rate of 5.33% and the projected cash flows of $3.0 million.
For indemnification assets a significant increase or decrease in market rates or cash flows could result in a significant change to the fair value. Also, the credit rating and/or the non-performance credit risk of Popular, which is subjective in nature, also could increase or decrease the sensitivity of the fair value of these assets.
The following table presents the carrying value, as applicable, and estimated fair values for financial instruments at March 31, 2014 and December 31, 2013:
Financial liabilities:
Senior secured term loan A
Senior secured term loan B
The fair value of the senior secured term loan and the senior notes at March 31, 2014 and December 31, 2013 were obtained using prices supplied by third party service providers. Their pricing is based on various inputs such as: market quotes, recent trading activity in a non-active market or imputed prices. The pricing inputs also may include the use of an algorithm that could take into account movement in the general high-yield market, among other variants.
The senior secured term loan and senior notes, which are not measured at fair value in the balance sheets, could be categorized as Level 3 in the fair value hierarchy.
The following table provides a summary of the change in fair value of the Company’s Level 3 assets:
Beginning balance
Payments received
Unrealized (loss) gain recognized in other income (expenses)
Ending balance
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The following table summarizes stock options activity for the three months ended March 31, 2014:
Outstanding at December 31, 2013
Granted
Forfeited
Exercised
Outstanding at March 31, 2014
Exercisable at March 31, 2014
Management uses the fair value method of recording stock-based compensation as described in the guidance for stock compensation in ASC topic 718.
The following table summarizes nonvested restricted shares activity for the three months ended March 31, 2014:
Nonvested restricted shares
Nonvested at December 31, 2013
Nonvested at March 31, 2014
For the three months ended March 31, 2014 and March 31, 2013, the Company recognized $0.4 million and $0.3 million of share-based compensation expense, respectively. As of March 31, 2014, there was $2.5 million of total unrecognized compensation cost related to stock options, which is expected to be recognized over the next 2.5 years. In addition, for the same period, there was $81,000 of total unrecognized compensation cost related to nonvested shares of restricted stock. That cost is expected to be fully recognized during 2014.
The components of income tax expense for the three months ended March 31, 2014 and 2013 consisted of the following:
Current tax provision
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The Company conducts operations in Puerto Rico and certain countries in Latin America. As a result, the income tax expense includes the effect of taxes paid to the Puerto Rico government as well as foreign jurisdictions. The following table presents the components of income tax expense for the three months ended March 31, 2014 and 2013 and its breakdown based on location of operations:
Puerto Rico
United States
Foreign countries
Total currrent tax provision
Deferred tax (benefit) expense
Total deferred tax benefit
Taxes payable to foreign countries by EVERTEC’s subsidiaries will be paid by such subsidiary and the corresponding liability and expense will be presented in EVERTEC’s consolidated financial statements.
As of March 31, 2014, the gross deferred tax asset amounted to $12.7 million and the gross deferred tax liability amounted to $29.8 million, compared with $13.5 million and $31.7 million as of December 31, 2013. At March 31, 2014 the recorded value of the Company’s net operating loss (“NOL”) carryforwards was $10.2 million. The recorded value of the NOL carryforwards is approximately $7.0 million lower than the total NOL carryforwards available because of a windfall tax benefit. The windfall tax benefit is available to offset future taxable income and is considered an off-balance sheet item until the deduction reduces taxes payable. This windfall tax benefit results from tax deductions that were in excess of previously recorded compensation expense because the fair value of stock options at the time they were granted differed from their fair value when they were exercised. The total gross NOL carryforwards available, including the windfall benefit, amount to $72.8 million as of March 31, 2014.
There are no open tax uncertain positions as of March 31, 2014.
The reconciliation of the numerator and denominator of the earnings per common share is as follows:
Weighted average common shares outstanding
Weighted average potential dilutive common shares (1)
Weighted average common shares outstanding - assuming dilution
On February 12, 2014, our Board declared a quarterly cash dividend of $0.10 per share of common stock, which was paid on March 14, 2014 to stockholders of record as of February 25, 2014.
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Certain lease agreements contain provisions for future rent increases. The total amount of rental payments due over the lease term is being charged to rent expense on the straight-line method over the term of the lease. The difference between rent expense recorded and the amount paid is recorded as a deferred rent obligation. Total deferred rent obligation as of March 31, 2014 amounted to $0.2 million, and $0.3 million as of December 31, 2013, and is included within the Accounts receivable, net caption in the accompanying unaudited consolidated balance sheets.
Rent expense for office facilities and real estate for both the three months ended March 31, 2014 and 2013 amounted to $2.0 million. Rent expense for telecommunications and other equipment for the three months ended March 31, 2014 and 2013 amounted to $1.5 million and $1.7 million, respectively.
In the ordinary course of business, the Company may enter into commercial commitments. As of March 31, 2014, EVERTEC has an outstanding letter of credit of $1.1 million with a maturity of less than three months.
EVERTEC is a defendant in a number of legal proceedings arising in the ordinary course of business. Based on the opinion of legal counsel and other factors, management believes that the final disposition of these matters will not have a material adverse effect on the business, results of operations or financial condition of the Company. The Company has identified certain claims as a result of which a loss may be incurred, but in the aggregate the loss would be minimal. For other claims regarding which proceedings are in an initial phase, the Company is unable to estimate the range of possible loss but at this time believes that any loss related to such claims will not be material.
The following table presents the Company’s transactions with related parties for the quarters ended March 31, 2014 and 2013:
Total revenues (1)(2)
Cost of Revenues
Rent and other fees (3)
Interest earned from and charged by affiliate
Interest expense(4)
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At March 31, 2014 and December 31, 2013, EVERTEC had the following balances arising from transactions with related parties:
Cash and restricted cash deposits in affiliated bank
Indemnification assets from Popular reimbursement (1)
Accounts receivable
Other due to/from affiliate
Accounts payable(2)
Other long-term liabilities (2)
At March 31, 2014 and December 31, 2013, EVERTEC Group has a credit facility with Popular for $3.6 million, on behalf of EVERTEC CR, under which a letter of credit of a similar amount was issued.
The Company operates in three business segments: Merchant Acquiring, Payment Processing and Business Solutions.
The Merchant Acquiring segment consists of revenue from services that allow merchants to accept electronic methods of payment. In the Merchant Acquiring segment, revenue includes a discount fee (generally a percentage of the transaction value) and membership fees charged to merchants, debit network fees and rental fees from point of sales (“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.
Payment Processing segment 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 electronic benefit transfer (“EBT”), which principally consists of services to the government of Puerto Rico for the delivery of benefits to participants.
For ATH network and processing services, revenue is driven mainly by the number of transactions processed. Revenue is derived mainly from network fees, transaction switching and processing fees, and the leasing of POS devices. For card issuer processing, revenue is mostly 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, revenue is derived mainly from the number of beneficiaries on file.
The Business Solutions segment consists of revenue from a full suite of business process management solutions in various product areas, such as core bank processing, network hosting and management, IT professional services, business process outsourcing, item processing, cash processing, and fulfillment. Core bank processing and network services revenues are derived in part from a recurrent fee and from fees based on the number of accounts on file (i.e.; savings or checking accounts, loans, etc.) or computer resources utilized. Revenue from other processing services within the Business Solutions segment is generally volume-based and depend on factors such as the number of accounts processed. In addition, EVERTEC is a reseller of hardware and software products and these resale transactions are generally one-time transactions.
The Company’s business segments are organized based on the nature of products and services. The Chief Operating Decision Maker (“CODM”) reviews their individual financial information to assess performance and to allocate resources.
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The following tables set forth information about the Company’s operations by its three business segments for the periods indicated:
Three months ended March 31, 2014
Three months ended March 31, 2013
The reconciliation of income from operations to consolidated net income for the three months ended March 31, 2014 and 2013 is as follows:
Segment income from operations
Merchant Acquiring
Payment Processing
Business Solutions
Total segment income from operations
Merger related depreciation and amortization and other unallocated expenses(1)
Interest expense, net
Other income (expenses)
On May 7, 2014, the Company’s Board of Directors declared a regular quarterly cash dividend of $0.10 per share on the Company’s outstanding shares of common stock. The Board anticipates declaring this dividend in future quarters on a regular basis; however future declarations of dividends are subject to Board approval and may be adjusted as business needs or market conditions change. The cash dividend of $0.10 per share will be paid on June 6, 2014 to stockholders of record as of the close of business on May 19, 2014.
The Company performed an evaluation of all other events occurring subsequent to March 31, 2014; management has determined that there are no additional events occurring in this period that require disclosure in or adjustment to the accompanying unaudited financial statements.
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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 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
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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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.
The following table presents income from operations by reportable segments.
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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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 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.
Cash provided by operating activities
Cash used in investing activities
Cash used in financing activities
Increase in cash
Net cash provided by operating activities for the three months ended March 31, 2014 was $30.0 million compared with $33.8 million for the corresponding 2013 period. The decrease was mostly attributable to cash used to pay down accounts payable and accrued liabilities. The decrease was partially offset by an increase in income from operations mainly due to a decrease in operating costs and expenses.
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Net cash used in investing activities for the three months ended March 31, 2014 was $2.3 million compared with $4.3 million for the corresponding period in 2013. The decrease is mainly attributable to lower purchases of property and equipment.
Net cash used in financing activities for the three months ended March 31, 2014 and 2013 amounted to $23.0 million and $21.0 million, respectively. The increase in cash used in financing activities was driven by dividend payments made during the first quarter of 2014 of $7.8 million, while none were made during the comparable period in 2013. This increase was partially offset by a $5.6 million decrease in debt repayment during the first quarter of 2014 when compared to repayments made in the first quarter of 2013.
Capital Resources
Our principal capital expenditures are for hardware and computer software (purchased and internally developed) and additions to property and equipment. We invested approximately $2.5 million and $4.5 million for the three months ended March 31, 2014 and 2013, respectively. Capital expenditures are expected to be funded by cash flow from operations and, if necessary, borrowings under our revolving credit facility.
Dividend Payments
We currently have a policy under which we pay a regular quarterly dividend on our common stock, subject to the declaration thereof by our Board each quarter. On February 12, 2014, our Board declared a quarterly cash dividend of $0.10 per share of common stock, which was paid on March 14, 2014 to stockholders of record as of February 25, 2014.
On May 7, 2014, our Board declared a quarterly cash dividend of $0.10 per share of common stock. The cash dividend of $0.10 per share will be paid on June 6, 2014 to stockholders of record as of close of business on May 19, 2014.
Financial Obligations
Senior Secured Credit Facilities
As of March 31, 2014, the unpaid principal balance of the Term A Loan was $288.8 million. The Term A Loan requires principal payments on the last business day of each quarter equal to (a) 1.250% of the original principal amount commencing on September 30, 2013 through June 30, 2016; (b) 1.875% of the original principal amount from September 30, 2016 through June 30, 2017; (c) 2.50% of the original principal amount from September 30, 2017 through March 31, 2018; and (d) the remaining outstanding principal amount on the maturity of the Term A Loan on April 17, 2018. For the three months ended March 31, 2014, the Company made principal payments amounting to $3.8 million on the Term A Loan. Interest is based on EVERTEC Group’s first lien secured net leverage ratio and payable at a rate equal to, at the Company’s option, either (a) LIBOR plus an applicable margin ranging from 2.00% to 2.50% or (b) base rate, as defined in our 2013 Credit Agreement, plus an applicable margin ranging from 1.00% to 1.50%. The Term A Loan has no LIBOR or Base Rate minimum or floor.
As of March 31, 2014, the unpaid principal balance of the Term B Loan was $397.0 million. The Term B Loan requires principal payments on the last business day of each quarter equal to 0.250% of the original principal amount commencing on September 30, 2013 and the remaining outstanding principal amount on the maturity of the Term B Loan on April 17, 2020. For the three months ended March 31, 2014, the Company made principal payments amounting to $1.0 million on the Term B Loan. Interest is based on EVERTEC Group’s first lien secured net leverage ratio and payable at a rate equal to, at the Company’s option, either (a) LIBOR plus an applicable margin ranging from 2.50% to 2.75%, or (b) base rate plus an applicable margin ranging from 1.50% to 1.75%. The LIBOR and Base Rate are subject to floors of 0.75% and 1.75%, respectively.
The revolving credit facility has a balance up to $100.0 million, with an interest rate on loans calculated the same as the applicable Term A Loan rate. The facility matures on April 17, 2018 and has a “commitment fee” payable one business day after the last business day of each quarter calculated, based on the daily unused commitment during the preceding quarter. The commitment fee for the unused portion of this facility ranges from 0.125% to 0.375% based on EVERTEC Group’s first lien secured net leverage ratio. As of March 31, 2014, the outstanding balance of the revolving credit facility was $40.0 million. For the three months ended March 31, 2014, the Company made payments amounting to $10.0 million on the revolving credit facility.
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All loans may be prepaid without premium or penalty, except for a 1% premium payable if any of the Term B Loans are refinanced or repriced with syndicated secured term loans having a lower effective interest rate on or prior to April 17, 2014. The new senior secured credit facilities allow EVERTEC Group to obtain, on an uncommitted basis at the sole discretion of participating lenders, an incremental amount of term loan and/or revolving credit facility commitments not to exceed the greater of (i) $200.0 million and (ii) maximum amount of debt that would not cause EVERTEC Group’s pro forma first lien secured net leverage ratio to exceed 4.25 to 1.00.
The senior secured revolving credit facility is available for general corporate purposes and includes borrowing capacity available for letters of credit and for short-term borrowings referred to as swing line borrowings. All obligations under the new senior secured credit facilities are unconditionally guaranteed by Holdings and, subject to certain exceptions, each of EVERTEC Group’s existing and future wholly-owned subsidiaries. All obligations under the new senior secured credit facilities, and the guarantees of those obligations, are secured by substantially all of EVERTEC Group’s assets and the assets of the guarantors, subject to certain exceptions.
See Note 5 of the Notes to Unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for additional information.
Other Short-Term Borrowing
In August 2013, we entered into a financing agreement in the ordinary course of business to purchase certain hardware, software and maintenance and related services in the amount of $1.8 million to be repaid in three installments over a term of eight months. As of March 31, 2014, the outstanding balance of this other short-term borrowing was $0.6 million.
Covenant Compliance
The credit facilities contain various restrictive covenants. The Term A Loan and the revolving facility (subject to certain exceptions) require EVERTEC Group to maintain on a quarterly basis a specified maximum senior secured leverage ratio of up to 6.60 to 1.00 as defined in the 2013 Credit Agreement (total first lien senior secured debt to Adjusted EBITDA). In addition, the 2013 Credit Agreement, among other things: (a) limits EVERTEC Group’s ability and the ability of its subsidiaries to incur additional indebtedness, incur liens, pay dividends or make certain other restricted payments and enter into certain transactions with affiliates; (b) restricts EVERTEC Group’s ability to enter into agreements that would limit the ability of its subsidiaries to pay dividends or make certain payments to its parent company; and (c) places restrictions on EVERTEC Group’s ability and the ability of its subsidiaries to merge or consolidate with any other person or sell, assign, transfer, convey or otherwise dispose of all or substantially all of their assets. However, all of the covenants in these agreements are subject to significant exceptions. As of March 31, 2014, the senior secured leverage ratio was 3.84 to 1.00 and we were in compliance with the applicable restrictive covenants under the 2013 Credit Agreement.
In this Quarterly Report on Form 10-Q, we refer to the term “Adjusted EBITDA” to mean EBITDA as so defined and calculated for purposes of determining compliance with the senior secured leverage ratio based on the financial information for the last twelve months at the end of each quarter.
Net Income Reconciliation to EBITDA, Adjusted EBITDA and Adjusted Net Income
We define “EBITDA” as earnings before interest, taxes, depreciation and amortization. We define “Adjusted EBITDA” as EBITDA further adjusted to exclude unusual items and other adjustments described below. We define “Adjusted Net Income” as net income adjusted to exclude unusual items and other adjustments described below.
We present EBITDA and Adjusted EBITDA because we consider them important supplemental measures of our performance and believe they are frequently used by securities analysts, investors and other interested parties in the evaluation of companies in our industry. In addition, our presentation of Adjusted EBITDA is consistent with the equivalent measurements that are contained in the senior secured credit facilities in testing EVERTEC Group’s compliance with covenants therein, such as the senior secured leverage ratio. We use Adjusted Net Income to measure our overall profitability because it better reflects our cash flows generation by capturing the actual cash taxes paid rather than our tax expense as calculated under GAAP and excludes the impact of the non-cash amortization and depreciation that was created as a result of the Merger. In addition, in evaluating EBITDA, Adjusted EBITDA and Adjusted Net Income, you should be aware that in the future we may incur expenses such as those excluded in calculating them. Further, our presentation of these measures should not be construed as an inference that our future operating results will not be affected by unusual or nonrecurring items.
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Some of the limitations of EBITDA, Adjusted EBITDA and Adjusted Net Income are as follows:
EBITDA, Adjusted EBITDA, Adjusted Net Income and Adjusted Net Income per common share are not measurements of liquidity or financial performance under GAAP. You should not consider EBITDA, Adjusted EBITDA, Adjusted Net Income and Adjusted Net Income per common share as alternatives to cash flows from operating activities or any other performance measures determined in accordance with GAAP, as an indicator of cash flows, as a measure of liquidity or as an alternative to operating or net income determined in accordance with GAAP.
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A reconciliation of net income to EBITDA, Adjusted EBITDA and Adjusted Net Income is provided below:
Net income (loss)
EBITDA
Software maintenance reimbursement and other costs (1)
Equity income (2)
Compensation and benefits (3)
Pro forma cost reduction adjustments (4)
Transaction, refinancing and other non-recurring fees (5)
Management fees (6)
Purchase accounting (7)
Adjusted EBITDA
Pro forma cost reduction adjustments (8)
Operating depreciation and amortization (9)
Cash interest income (expense) (10)
Cash income taxes (11)
Adjusted Net Income
Adjusted Net Income per common share
Basic
Diluted
Shares used in computing Adjusted Net Income per common share
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Off Balance Sheet Arrangements
In the ordinary course of business the Company may enter into commercial commitments. As of March 31, 2014, we had an outstanding letter of credit of $1.1 million with a maturity of less than three months. Also, as of March 31, 2014 we had an off balance sheet item of $55.4 million related to the unused amount of the windfall that is available to offset future taxable income.
See Note 8 of the Unaudited Consolidated Financial Statements within Item I of this Quarterly Report on Form 10-Q for additional information related to this off balance sheet item.
Seasonality
Our payment businesses generally experiences increased activity during the traditional holiday shopping periods and around other nationally recognized holidays.
Effect of Inflation
While inflationary increases in certain input costs, such as occupancy, labor and benefits, and general administrative costs, have an impact on our operating results, inflation has had minimal net effect on our operating results during the last three years as overall inflation has been offset by increased selling process and cost reduction actions. We cannot assure you, however, that we will not be affected by general inflation in the future.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to market risks arising from our normal business activities. These market risks principally involve the possibility of change in interest rates that will adversely affect the value of our financial assets and liabilities or future cash flows and earnings. Market risk is the potential loss arising from adverse changes in market rates and prices.
Interest rate risks
We issued floating-rate debt which is subject to fluctuations in interest rates. Our senior secured credit facilities accrue interest at variable rates and only the Term B Loan is subject to floors or minimum rates. A 100 basis point increase in interest rates over our floor(s) on our debt balances outstanding as of March 31, 2014 under the senior secured credit facilities would increase our annual interest expense by approximately $6.8 million, excluding the revolving credit facility. The impact on future interest expense as a result of future changes in interest rates will depend largely on the gross amount of our borrowings at that time.
Foreign exchange risk
We conduct business in certain countries in Latin America. Some of this business is conducted in the countries’ local currencies. The resulting foreign currency translation adjustments, from operations for which the functional currency is other than the U.S. dollar, are reported in Accumulated other comprehensive income (loss) in the unaudited consolidated balance sheet, except for highly inflationary environments in which the effects would be included in Other operating income in the Consolidated Statements of Income and Comprehensive Income. At March 31, 2014, the Company had $7.3 million in an unfavorable foreign currency translation adjustment as part of Accumulated other comprehensive (loss) income compared with a favorable foreign currency translation adjustment of $0.4 million at December 31, 2013.
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Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company, under the direction of the Chief Executive Officer and the Chief Financial Officer, has established disclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act. Based upon their evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that as of March 31, 2014, the Company’s disclosure controls and procedures are effective at the reasonable assurance level.
Change in Internal Control Over Financial Reporting
There have been no changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended March 31, 2014 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are defendants in various lawsuits or arbitration proceedings arising in the ordinary course of business. Management believes, based on the opinion of legal counsel and other factors, that the aggregated liabilities, if any, arising from such actions will not have a material adverse effect on the financial condition, results of operations and the cash flows of the Company.
Item 1A. Risk Factors
There have been no material changes from the risk factors previously disclosed under Item 1A. of the Company’s 2013 Form 10-K.
The risks described in our 2013 Form 10-K and in this report are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
Item 6. Exhibits
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Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
(Registrant)
Peter Harrington
Chief Executive Officer
Juan J. Román
Chief Financial Officer
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