EVERTEC, Inc. quarterly report, Q3 FY2018

EVERTEC, Inc. 2018 Q3 Form 10-Q Summary

Business Context and Reporting Period

EVERTEC is a Puerto Rico-based transaction-processing company operating across 26 Latin American and Caribbean countries. Its businesses include payment processing, merchant acquiring, the ATH debit network, core banking and business-process solutions. This unaudited Form 10-Q covers the three and nine months ended September 30, 2018, with comparisons to the corresponding 2017 periods.

Popular, Inc. remained EVERTEC’s largest customer, accounting for approximately 42% of third-quarter revenue and 41% of nine-month revenue. EVERTEC operates under a 15-year master services agreement with Popular.

Financial Performance and Key Metrics

Metric	Q3 2018	Q3 2017	9M 2018	9M 2017
Revenue	$112.0 million	$102.7 million	$335.6 million	$307.5 million
Income from operations	$32.4 million	$8.8 million	$96.6 million	$69.4 million
Net income	$23.1 million	$6.1 million	$66.3 million	$49.5 million
Net income attributable to EVERTEC	$23.0 million	$6.1 million	$66.1 million	$49.2 million
Diluted EPS	$0.31	$0.08	$0.89	$0.67
Adjusted EBITDA	$52.1 million	$41.7 million	$159.8 million	$141.0 million
Operating cash flow	Not separately provided	Not separately provided	$128.4 million	$108.4 million

Q3 revenue increased 9%, while nine-month revenue increased 9%. The reported operating margin was approximately 28.9% in Q3 and 28.8% for the first nine months, compared with approximately 8.6% and 22.6%, respectively, in the prior-year periods. The improvement was substantially influenced by the absence of 2017 charges related to an exited third-party software solution.

Adjusted EBITDA margin was approximately 46.5% in Q3 and 47.6% for the first nine months, compared with 40.6% and 45.9% in the respective 2017 periods. Adjusted EBITDA is a non-GAAP measure and is not a substitute for GAAP operating income, net income or operating cash flow.

• Q3 cost of revenues declined 21% to $49.5 million, primarily because 2017 included $12.8 million of software exit-related charges.
• Nine-month selling, general and administrative expense increased 14% to $45.7 million, driven mainly by higher share-based compensation, PayGroup-related salaries and professional fees.
• Q3 income tax expense was $3.3 million versus a $4.8 million benefit in 2017; the Q3 effective tax rate was 12.5%. The nine-month effective tax rate was 13.5%.
• Capital expenditures and additions to software and property were approximately $25.0 million in the first nine months. Management expected full-year 2018 capital expenditures of $37 million to $42 million.

Liquidity, Debt and Cash Flow

• Cash and cash equivalents were $91.3 million at September 30, 2018, compared with $50.4 million at December 31, 2017. Cash, cash equivalents and restricted cash totaled $104.0 million.
• Operating cash flow increased to $128.4 million from $108.4 million in the prior-year period.
• Investing cash outflows were $25.0 million, versus $67.0 million in 2017, primarily because the prior-year period included the $42.8 million PayGroup acquisition.
• Financing cash outflows were $59.8 million, including $41.4 million of long-term debt repayment and $3.6 million of dividends.
• Total debt was $565.5 million at September 30, 2018, consisting primarily of a $190.0 million 2020 Term A loan and a $375.2 million Term B loan. The $26.1 million 2018 Term A loan was repaid at maturity in April 2018.
• The company had $65.0 million of available revolving credit capacity. The reported senior secured leverage ratio was 2.75 to 1.00, below the applicable covenant threshold, and management reported no default or event of default.
• A $200 million interest-rate swap fixes the related Term B exposure at an effective rate of approximately 4.4225% through April 2020. Management estimated that a 100-basis-point increase in rates would increase annual interest expense by approximately $3.7 million after considering the swap.

Material Changes Versus the Prior Comparable Period

• Revenue and profitability benefited from elevated Puerto Rico and Virgin Islands recovery-related spending following Hurricanes Irma and Maria, including federal relief, insurance proceeds, rebuilding activity, electronic benefit card volumes, government payments and gasoline purchases.
• Q3 operating income increased 267% because of revenue growth, lower amortization and the absence of the prior-year software exit charges and related contractual fee accrual.
• Payment Services–Puerto Rico and Caribbean Q3 revenue increased to $29.0 million from $25.2 million, and Adjusted EBITDA increased to $19.2 million from $15.2 million.
• Payment Services–Latin America Q3 revenue increased to $18.9 million from $17.4 million, partly offset by client migrations. Nine-month results also reflected the PayGroup acquisition completed in 2017.
• Merchant Acquiring Q3 revenue increased to $24.5 million from $21.6 million, driven by higher transaction volumes.
• Business Solutions Q3 revenue increased to $48.8 million from $46.3 million, supported by new services for Popular and the Puerto Rico government.
• The quarterly dividend was reinstated at $0.05 per share in 2018 after being suspended in November 2017. The board declared another $0.05 per share dividend payable December 7, 2018, subject to customary approval and future business conditions.
• Foreign currency translation losses increased accumulated other comprehensive loss to $17.3 million at September 30, 2018, from $11.1 million at year-end 2017.

Guidance, Outlook, Risks and Unusual Items

• Management expected recovery-related spending and related elevated sales volumes to continue through the remainder of 2018 as additional insurance and relief funds were received, but the filing does not provide formal full-year revenue or earnings guidance.
• Management estimated Latin American revenue attrition of approximately $3 million to $6 million in 2019 from previously disclosed client migrations. Timing remains dependent on customer conversion schedules.
• Key risks include dependence on Popular, concentration in Puerto Rico, the fiscal crisis and Title III PROMESA restructuring, economic and consumer-spending volatility, hurricane and other natural-disaster exposure, cybersecurity and system failures, payment-network rules and fees, regulatory requirements, client contract renewals, high leverage, refinancing needs, variable interest rates, foreign exchange and potential loss of preferential Puerto Rico tax treatment.
• The company recognized no goodwill impairment in the first nine months of 2018. The 2017 comparable period included a $6.5 million software impairment charge, a $5.3 million contractual fee accrual and approximately $1.0 million of related maintenance expense.
• EVERTEC was involved in ordinary-course legal proceedings, but management believed any aggregate loss would not materially affect the company. No material off-balance-sheet arrangements were reported.
• The company adopted ASC 606 during 2018; management stated that the effect on income, cash flows and earnings per share was immaterial. The filing also discusses planned adoption of the new lease standard, which is expected to add operating lease right-of-use assets and liabilities to the balance sheet.

Important Facts for Investors to Verify

• Whether post-hurricane recovery and relief-related transaction volumes persist or normalize, particularly in merchant acquiring and Puerto Rico payment services.
• The sustainability of revenue growth excluding 2017 hurricane comparisons, software exit charges and PayGroup-related contributions.
• Progress and timing of the expected $3 million to $6 million Latin American revenue attrition in 2019.
• Popular’s continuing contribution, contract terms and concentration risk, including the approximately 41% to 42% revenue exposure.
• Debt maturities in April 2020, refinancing plans, covenant compliance and the company’s ability to maintain sufficient operating cash flow.
• The effect of variable interest rates, the interest-rate swap and potential counterparty exposure.
• Future dividend declarations and whether dividends remain consistent with debt restrictions, liquidity needs and Puerto Rico operating conditions.
• Potential changes in Puerto Rico tax benefits, PROMESA-related developments, government receivables and government-related transaction volumes.