Afternoon, everyone. Welcome to the EVERTEC first quarter 2014 earnings conference call. Today's conference is being recorded, and at this time, I would like to turn the conference over to Luis Cabrera, Senior Vice President and Head of Investor Relations. Please go ahead, sir.
Thank you, operator. Good afternoon, everyone. Welcome to EVERTEC first quarter 2014 earnings call. I'm Luis Cabrera, Senior Vice President, Head of Investor Relations for EVERTEC. With me today is Peter Harrington, our President and CEO. Juan José Román, Executive Vice President and CFO. A replay of this call will be available until Wednesday, May 14th. Access information for the replay is listed in today's financial press release, which is available on our website under the Investor Relations tab. As a reminder, this call may not be taped or otherwise reproduced without EVERTEC prior consent. For those listening to the replay, this call was held and recorded on May 7, 2014. Before we begin, I would like to remind everyone that this call may contain forward-looking statements as they are defined under the Private Securities Litigation Reform Act of 1995.
These forward-looking statements about our expectations for future performance are subject to known and unknown risks and uncertainties. EVERTEC cautions that these statements are not guarantees of future performance. All forward-looking statements made today reflect our current expectations only, and we undertake no obligation to update any statement to reflect the events that occur after this call. Please refer to the company's most recent annual report on Form 10-K filed with the Securities and Exchange Commission for factors that could cause our actual results to differ materially from any forward-looking statement. During today's call, management will provide certain information that will constitute non-GAAP financial measures under SEC rules, such as adjusted EBITDA, adjusted net income, and adjusted net income per share. Reconciliations to GAAP measures and certain additional information are also included in today's earnings press release.
With that, we'll begin by turning the call over to Peter Harrington, our President and CEO. Peter?
Thank you, Luis, and good afternoon, everyone. Thanks for joining us on today's call. Our first quarter results were in line with our plan, and we're pleased with the start of the year, particularly in our payment businesses. Overall, we're on course to achieve results within our full-year guidance range. Total revenue in the quarter was flat, with our payment businesses showing solid growth. Merchant acquiring revenue was up 10% and payment processing up 4%, while Business Solutions was down 6%. Adjusted EBITDA increased 8%, and adjusted net income grew a strong 16% to $0.40 per share. In our Merchant and Payment Processing segment, we had a solid start to the year. Our payments business continued to benefit from the ongoing cash to card conversion trend in the markets we serve.
We are executing on our growth plan and taking share by leveraging our scale, reputation, best-in-class network, and services. Revenue growth in our payments businesses outside of Puerto Rico continue to be strong as well, increasing 15% compared with the first quarter of last year. We continue to see stable and solid transaction growth within Puerto Rico, with POS processing transactions up 8% year-over-year. Demand for our payment services across our entire Latin American footprint remains solid, and our new business pipeline continues to build. I would like to take a minute to discuss a few new business highlights and payments. First, I'm excited to announce that we recently signed a financial institution customer in Colombia to whom we'll be providing card product processing services. This quarter, we also launched ATH Móvil, our new P2P product for ATH customers with six financial institutions in Puerto Rico.
Finally, I'm happy to report that the government of Puerto Rico has informed us of its intent to award us a new five-year contract to continue providing services that support the government's EBT program. We have been the sole provider of EBT processing services to the government of Puerto Rico since the program began in 1998. Now for Business Solutions. You remember that on our February call, we said expected revenue growth to be lumpy this year. In the first quarter, Business Solutions revenue was down because of lower levels of hardware and software product sales compared to the particularly strong sales we booked in the first quarter of 2013. It's worth noting that excluding hardware sales, Business Solutions revenue was up 2% in the quarter.
Based on what we're seeing today with respect to sales and project implementation timeframes, we expect Business Solutions revenue to build over the remainder of the year and still be in the low single-digit range, as previously discussed. To that point, we have approximately $3 million of hardware and software sales already committed to be delivered in Q2 and Q3. Outside of hardware and software sales, we continue to see solid demand for our core business process management solutions, such as core banking, as well as network services and IT consulting. Before turning the call over to Juan, I'd also like to tell you about a new initiative with the government of Puerto Rico. The government recently awarded us a contract expanding our current sales tax aggregation services agreement, leveraging our Evaloto product.
We've been mandated to develop and host a portal to help manage the new added value tax and credits that go into effect on July 1st. Once this service begins, we anticipate that it will yield additional payment processing volume over our current network. I will now turn the call over to Juan José, who will take you through our financial results in more detail. Juan?
Thank you, Peter, and good afternoon, everyone. As Peter mentioned, we have a good start to the year. While Business Solution revenue was down, the payment businesses did well, and we delivered solid adjusted EBITDA and double-digit earnings growth. I will now spend some time going through our first quarter financial results in more detail. Beginning with revenue on a consolidated basis, total revenue was essentially flat at $87.2 million. Merchant acquiring net revenue increased 10% to $19.3 million from $17.5 million in the prior year period, predominantly driven by an increase in transaction volumes. Payment processing revenue increased 4% to $25 million in the first quarter, up from $24.1 million in the prior year period. This growth was driven by new customer additions, an increase in accounts on file within our card product business, as well as an increase in POS processing transactions.
It's worth highlighting that the payment processing year-over-year growth this quarter was affected by the timing of revenue recognized from the Puerto Rico Department of Education program we process in Puerto Rico. In the first quarter of 2014, we recognized no revenue related to this program versus approximately $0.6 million recognized in Q1 of 2013. We began processing for this program again in April and will recognize revenue for these services in the second quarter. Excluding the effect of such program, our Q1 payment processing segment revenue would have increased 6% compared with Q1 of last year. Our payment-related businesses outside of Puerto Rico continue to grow at a strong pace in Q1, up 15% versus the prior year period, mainly driven by card product processing. Additionally, POS volume growth within Puerto Rico remains steady, up a solid 8% compared with the prior year.
Our Business Solutions segment revenue decreased 6% to $42.9 million in the first quarter, compared with $45.8 million in the prior year period. As Peter discussed, this decrease was mainly due to a decline in hardware and software product sales in the quarter, amounting to $3.5 million, partly offset by increasing money in our network and core banking products and services. Moving to expenses. On a GAAP basis, our first quarter total operating expenses were down approximately 7% compared with the prior year period. Cost of revenue, excluding depreciation and amortization, was $37.6 million, a decrease of $2.9 million or 7% from the corresponding 2013 period. This decline was due to a reduction in cost of sales resulting from lower levels of hardware and software product sales, and to a lesser extent, lower operating taxes.
Selling, general, and administrative expenses for the quarter were $8.1 million, down $0.8 million or 9% from the corresponding 2013 period. This decrease was mainly due to the absence of $0.9 million of management fees previously paid to Apollo and Popular. Our income from operations for the first quarter was $24.9 million, an increase of 22% compared with $20.4 million in the corresponding 2013 period. Total non-operating expenses were $4.5 million, a decrease of $10.4 million from the corresponding 2013 period. This decrease was driven mainly by interest expense reduction of $8.4 million, resulting from our debt refinancing and $1 million in foreign exchange gains related to an intercompany loan with our Costa Rica subsidiary. Our GAAP income tax expense in the first quarter was $2.2 million, up from $51,000 in the prior year.
On a cash basis, we pay no income tax in the first quarter because of our payments made in the 2013 fiscal year. We expect cash taxes to return to a more normalized rate beginning in the second quarter. As of March 31st, 2014, we had approximately $73 million of NOLs available to offset future tax payments related to our operations in Puerto Rico. Adjusted EBITDA for the first quarter was $45.2 million, an increase of $3.4 million or 8% from $41.8 million in the corresponding 2013 period. The increase in adjusted EBITDA was predominantly due to revenue growth and significant operating leverage in our merchant acquiring and payment processing businesses, as well as the $1 million foreign exchange gain. Adjusted EBITDA margin was 51.9% compared with 47.8% in the prior year.
Even when excluding the FX gain in the quarter, our adjusted EBITDA margin increased 290 basis points versus the prior year period, reflecting the strong operating leverage inherent in our payment businesses. Adjusted net income in the first quarter was $32 million, up 16% from $27.5 million in the prior year. This increase was due mainly to adjusted EBITDA growth and lower levels of operating depreciation and amortization expense and cash taxes. Moving to our balance sheet. As of March 31st, we reported $27.2 million of unrestricted cash and $720.8 million of total short-term borrowings and long-term debt. During the quarter, we made a mandatory repayment of approximately $4.8 million on borrowings outstanding under our Term A and Term B senior secured credit facilities, paid $10 million on our revolving line of credit, and paid dividends of $7.8 million.
As of March 31st, total liquidity, which includes unrestricted cash and available borrowing capacity under our revolver, was approximately $87.2 million. We continue to generate significant levels of free cash flows. For Q1 2014, our free cash flow, defined as adjusted EBITDA minus CapEx, cash interest expense, and cash income taxes, was approximately $37 million, up 20% compared with the prior year period. Finally, this afternoon we announced that our board of directors declared a regular quarterly dividend of $0.10 per common share. We remain committed to the prudent return of capital to our shareholders. Now on to our guidance. Based on the trends we're currently seeing in transaction volumes, new business activity, and project implementation, we are reiterating the 2014 outlook that we provided on our last quarterly call.
Revenue growth between 5% and 7%, adjusted EBITDA growth at least 100 basis points higher than our revenue growth rate, and fully diluted earnings per share of between $1.65 and $1.71. We continue to expect full year 2014 operating depreciation and amortization of approximately $32 million, cash interest expense of approximately $23 million, and fully diluted shares of approximately 79.2 million. We expect 2014 cash income tax expense of approximately $3 million. Our 2014 effective tax rate outlook on a GAAP basis remains between 10% and 12%. With that, operator, we will now open up the call for questions.
Certainly. If you'd like to signal for a question at this time, please do so by pressing star one on your telephone keypad. If you are using a speakerphone, please ensure that your mute function has been turned off to allow your signal to reach our equipment. Again, that's star one for questions at this time, and we'll pause for just a moment. We'll take our first question from Georgios Mihalos with Credit Suisse.
Great. Thank you for taking my question, guys. I think if I heard correctly, Peter, you mentioned that growth outside of Puerto Rico was 15%. I think that accelerated a little bit from the back half of 2013. I just want to confirm that. Can you give us the percentage of revenue that was sourced from outside Puerto Rico in the quarter?
Yes, it did slightly accelerate from what we saw in the fourth quarter. Yes, it's give or take for around number 15%.
Then Juan José, you reiterated the guidance of 5%-7% on the top line. Is your sense, given where the first quarter sort of came in with a bit of slower growth on the business solution side, is your sense that you're tracking more towards the lower end for the year? Or maybe another way to ask is what would have to happen for you guys to be able to hit the upper end of the range at 7%?
I think that a lot of it will depend on hardware and software. As we've said before, it's hard to predict exactly when it will fall into the P&L. Last year we saw very strong hardware and software. In the first quarter of this year, it was very soft. I think that though based on the commitment that we have already for some of the sales in the Q2 and Q3, we still feel comfortable that we're going to get to where we expected for the full year on the hardware and software side. To your point, it will be driven more by the payment businesses. It won't be driven by Business Solutions. To get to the higher end of the range will come from do the payment businesses outperform what we originally thought they would do.
Okay, great. This last question from me on the contract renewal on the EBT side. Was pricing relatively stable on that deal? Thank you.
Yeah, relatively. For us, it will be net neutral because we picked up a couple of small services that offset at a small discount that we gave them from their original pricing. Net-net, it's neutral.
We'll take our next question from Smitty Setiapromot with Morgan Stanley.
Okay, thank you. The government of Puerto Rico recently submitted a proposal for a balanced budget. What kind of impact, if any, do you anticipate from seeing from that proposal? If you could just give us just an update regarding what kind of payment trends are you seeing in Puerto Rico so far in April?
Okay. On the first one, as we've said before, we really didn't see any real negative impact at all compared to what the budget's doing. Again, to be upfront, that was the governor's proposal. We haven't seen anything on a piece of paper. There are some high-level numbers out there. From what I've seen, there's nothing that they're talking about that has any impact on EVERTEC. I think as we said before, and as we stated earlier on the call. We actually think there may be some potential positives and as we said, we were able to add on to our Evoluto product and what we do for them around sales tax to be able to provide this portal service to them on the VAT tax.
I think, if anything, I think it's neutral, worst case, and at best, I pick up some of this to help them kind of cut costs and become more efficient.
Got it. Thank you.
Just regarding the second part of the question, April is basically similar to what we saw in Q1.
Yep.
We are very happy, very comfortable that the trends continue at least so far up to April.
Yep.
Maybe can you give us an update on the Visa merchant acquiring license situation in Colombia?
We're fine with that. We're at this point, as I said before, we're waiting for Visa to get the low-value license. What I want to make sure that you guys understand is the license in and of itself doesn't generate revenue. As I've said, we will not go into the market under the EVERTEC name. It will be leveraging that license with a partner. That's when we'll start generating revenue. It's there. We're working on trying to find a partner and Visa is trying to get their low-value network license. That continues.
Okay. Thank you. Our next question will come from Bryan Keane with Deutsche Bank.
Hi, guys. Just want to clarify the Colombian signing with the financial institution. Is that relates to the merchant acquiring agreement that we talked about last quarter or is that something separate?
No, it is a separate processing customer. It's really our second Colombian customer. We have the customer today that we're still in the implementation process for. This is a second customer. As I said, I thought we were starting to make progress on sales. We've signed now our second customer. That won't generate revenue, obviously, until 2015. It has nothing to do with acquiring. It's purely for card processing.
Any update on not only Colombia, but just internationally for other kind of bank alliances?
No real update. We're still working on the one we've been working on. We're taking baby steps forward, but we're moving forward. Like I said, with the first Colombian customer, we're still in the implementation phase. There's really nothing different from what we've said before. We will generate revenue when we finish the implementation of them.
Okay. Just looking at the segmented operating margins. I might have missed this, but obviously the Merchant Acquiring margins were down quite a bit and then Payment Processing was up quite a bit. I'm not sure if I understood why the big swings there, and I assume that evens out going forward, or how do we think about that going forward? Thanks.
Yeah. You are right. Mostly it's the result of some changes that we made in terms of how we allocate expenses between segments. As you very well noticed, Payment actually increased significantly higher, right? As a relation to the revenue. It's just moving some expenses out of Merchant Payment to Acquiring. It started second quarter of last year really. It was noticed more in this quarter because it also include lower non-transactional revenue in the quarter. It will be more stable. If you take both together, the Payment and the Merchant, the margin, you will see as a percentage of the growth in revenue, the solid 41% increase in operating income.
Overall, just EBITDA margins were up quite a bit year-over-year. You still kind of reiterated the 100 basis point type margin expansion for the year. Does that mean there'll be further investments that crank up that lower kind of that first quarter kind of ahead of plan beat?
Not necessarily. Just keep in mind, hardware and software usually have much lower, significantly lower margins. We didn't have in this quarter those hardware and software sales, our margins in total are much better, right? As we start adding more hardware in the next quarters, then that reduces a little bit. The margin increases a little lower or not as significant as what you saw in Q1.
Okay. Thanks so much.
We'll take our next question from Tien-tsin Huang with JPMorgan.
Hi. Good afternoon. Thank you. I wanted to just ask a silly question. What exactly are you selling on the hardware and software front, and how discretionary is it?
The range is huge, Tien-tsin. It comes from servers to it comes from cloud. It comes from our hardware solutions business. It is made up of a number of different components. It's network equipment, routers-
Okay.
Software related to it. It all depends. In some of the projects that we do on the IT management, on the network side, and on the core banking side with Popular, there is hardware related and software related to the project. In some cases, we actually sell that hardware because we have the partnerships with the major providers like Avaya and IBM and Cisco and Dell and Microsoft, et cetera. As part of the deal, we sell them hardware and software as part of the deal. In almost all cases, we host that in our data center, but they actually own the hardware and software because it is specific for them.
Understood. To the extent that is tied, I guess, to an IT budget, or I guess maybe in this case, a contract. I'm just trying to get a sense of how much visibility you have. I understand the timing of when it might come through, could it fall off completely is what I'm trying to understand.
No, that's why we tried to give you some flavor that we've already got $3 million of it committed for delivery in the second and third quarter.
Right.
It comes with the projects, we don't see anything at this point that's telling us that there won't be these projects that will deliver this hardware and software. The nice thing about hardware and software is the timeframe from contract to revenue generation is very quick, right?
Not like the processing businesses where you have to implement the customer, right? There are projects that we expect that we've got in the pipeline that we're working on, that we've already got $3 million committed from. There are projects that just historically we do on a year-over-year basis, that we still expect to get between now and the end of the year.
Okay, good. No, that's helpful to hear. Just wanted to get that education. Thanks. I heard the comments on the acquiring stuff, just how about just in general movement in the pipeline, how does it feel tonewise? Then same thing with project ramps. Are things ramping on time, in general here, in terms of the stuff you're implementing?
Yeah, I would say, as we pointed out, Colombia has been slower than we had expected. Outside of that-
Right
We don't see any negative impact in both the pipeline, the new sales pipeline for the processing business or the delivery of customers. As Juan said, some of the growth we're seeing is because we're bringing on customers that we sold last year or at the very end of 2013, right? That we signed, that we're now bringing that revenue on. We don't see anything based on what we sold last year. The only thing that's been delayed has been Colombia beyond what we thought. Outside of that, and that we've talked about before.
Right.
No, we don't see any other issues.
That's great. Thanks. That's it.
We'll take our next question from Sarah Gubens with Bank of America Merrill Lynch.
Hi, thank you. How big of a benefit could the new value-added contract with the government be?
It will be a project that we'll do between now and June. Because it adds on to what we do in Evoluto, there's probably about, give or take, I don't know, $1 million-$2 million maybe of benefit that we'll see over a full-year basis, probably next year.
Okay. Should we think about it as a $1 million run rate? Is that about right, or?
Probably more than that. Somewhere between one and two million. This just landed on the door. We just signed it. We think somewhere between maybe one and a half and two million probably is more realistic.
Okay, great. Within the payment processing segment, the revenue growth decelerated in spite of the easier comparison, and I know that you mentioned some of it was the government contract, but given that the comparison was significantly easier, I just wanted to understand if there are any other factors that are driving the deceleration.
No. I think what you're going to see is we expected it to be at around 6%, and I think what you're going to see in the second quarter is it will accelerate because the revenue we expected in the first quarter will be in the second quarter, right? I think you'll see that in the second quarter, and then it will flatten out to where we expected it to be in the third and the fourth quarter.
Okay. Thank you.
As a reminder, that's star one if you would like to ask a question at this time. Star one for questions. We'll hear next from Robert Napoli with William Blair.
Thank you. Good afternoon. First of all, just on the hardware software sales, the margins on that must be extremely low because you beat our EBITDA number even while you missed the revenue number by a fair amount. Are we talking about 5% gross profit margin?
Five to 10. Yep, five to 10 is probably not a bad. We try to get as much as 10, but yeah, they're very low-margin deals.
Does it make sense to break out that separately? In last year's revenue, $184 million, how much of there I guess it's all in Business Solutions? How much was it? What was it for the full year last year?
We don't have the number in front of us, Bob, but we can look into that for you.
Yeah, it just might be worthwhile to break that out separately because it's a big number and it moves and everybody looks at revenue, but it's zero and very, very little in profit.
Yeah
distortion, an immaterial distortion.
Exactly. As Juan said, it distorts the margin too, because when it's not there.
Right
The margin goes way up. When we get a big quarter like we did last year, it drags the margin down.
Yes.
Yeah, you're right. At the end of the day, it doesn't have a real impact on our ability to grow earnings.
Just a question on the growth of the payments revenue, the 15% growth.
Yep.
What markets? Is that primarily the Caribbean, or are you seeing that out of Panama? What markets are you getting the growth in?
Quarter by quarter, it changes market by market. It's probably more so right now in Central America than it is in the Caribbean.
Okay. Which countries in particular? Just curious.
Well, our fundamental countries are Panama, Costa Rica, El Salvador.
Okay. What is going on in Colombia? What is causing the delay? I know the first customer you had, I think you were pretty excited. It might be $5 million, maybe even as much as $10 million of revenue once that customer got ramped up, and it's just taken so much. What is causing the delay? Is it regulatory issues in Colombia? Are you still really comfortable with that market? What's causing that kind of delay, and do you still think that type of revenue is likely from that customer?
Yeah, I think maybe something got lost in translation. The first customer will not generate $5 million annually for that customer.
Okay.
What I think we were talking about is that the total contract value was $5 million.
Okay.
I may have misled you there with my comments. The delay is around two things. It's one, it's a scope issue to some extent, exactly what we're doing for them, how we're doing it for them. Some of it is just fundamental in the first customer in a new market. It is always the most painful, the most difficult, because we have to put all of the connections in place with the local networks to operate the customer. As you can imagine, they are not necessarily in a rush to have a new competitor in the market. They don't say no, it takes longer. Once we build the connection, Bob, to that network, then I don't have to do that for the second, the third, and the fourth customer. The first time around, it's more painful and takes longer.
Do you think you're going to be able to build? Colombia is a bigger market than all of the other markets put together, pretty much. Are you getting the momentum? Is that going to be kind of a game changer market for you over the next three to five years?
Without a doubt. That's why I was happy that we signed the second customer. That was, to me, a very good sign that we're starting to pick up momentum on the sales side. Obviously, I can't do it with one customer alone. We've got the salespeople on the ground, start building the pipeline, which we have been doing. Now we're starting to see the benefits of that as we start to sign additional customers in the market.
Agreed. Thank you.
I'm still very comfortable, though, that that will be a very good market for us over the next three to five years.
Thank you.
As a final reminder, that is star one for questions at this time. We will pause for just another moment to allow everyone the opportunity to signal. We will take a question from John Davis with Stifel.
Hey, guys. Thanks for taking my question. Quickly, Peter Harrington, you referenced processing growth up 8% year-over-year in the first quarter. That is a slight acceleration from 2013 and 4Q specifically. Can you talk about what is driving that there? Is the Puerto Rican economy getting any better? Any color there would be appreciated.
It has been in the 7%, 8% range. The numbers we have been giving out for the last year were at 7 and 8. It is in around the same time. We do not see any real acceleration. I guess what is more positive to us is we see no negative impact on that. With all of the noise and everything that has gone on in Puerto Rico over the last year, the consumption remains very strong, and we are seeing that in just the year-over-year, quarter-over-quarter, month-over-month POS processing. We expect that based on what we have seen for the last, now what? Probably a year. We expect that that number will probably stay in the 7% to 8% range for the rest of 2014.
Okay, thanks. That is helpful. Juan José Román, quickly, D&A ticked down a little bit this quarter. It was a little bit lower than we were expecting. Anything going on there, and kind of how should we think about that going forward? Thanks.
No, it's mostly the natural. There were some software and hardware that just are fully depreciated. I think it's just timing. As we keep adding CapEx, it will get more to the average that you have seen in the last year. That's why for the full year, we should be around the $31 million-$32 million in D&A.
Okay, great. Thanks for the color, guys.
It was just mostly hardware and software fully depreciated. That's the reason.
Okay, great. Thanks.
That will conclude today's question and answer session. Mr. Harrington, I'll turn the call back to you for any additional or closing remarks.
Thank you, operator. In summary, I am pleased with the start of the year. EVERTEC is well-positioned to continue to increase its share in Latin American payment processing markets. We will remain focused on executing our strategic growth initiatives, serving our clients, and driving profitability and shareholder value. We thank you for your support, and we look forward to discussing our second quarter results with you in our next earnings call. Operator, you may now end the call.
Thank you. That will conclude today's conference. Thank you all for your participation.