Good afternoon, and welcome to the Evertec Incorporated Second Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] please also note today’s event is being recorded. At this time, I would like to turn the conference call over to Ms. Kay Sharpton, Head of Investor Relations. Ma’am, you may begin.

Good afternoon. With me today are Mac Schuessler, our President and Chief Executive Officer; and Peter Smith, our Chief Financial Officer. A replay of this call will be available until Tuesday, August 7. Access information for the replay is listed in today’s financial release, which is available on our website under Investor Relations section of evertecinc.com. For those listening to the replay, this call was held July 31. Please note, there is a presentation that accompanies this conference call, and it also is accessible on the Investor Relations section of our website. Before we begin, I’d like to remind everyone that this call may contain forward-looking statements as 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 statements 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 statements. 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 earnings per common share. Reconciliation to GAAP measures and certain additional information are also included in today’s earnings release and related supplemental slides. I’ll now hand the call over to Mac.

Thanks, Kay, and good afternoon, everyone. We are pleased that our results for the second quarter of 2018 exceeded our expectations and we continued to benefit from Puerto Rico’s increased rebuilding and recovering activity. Beginning on Slide 4, I’ll cover some of the quarter’s financial highlights and provide you with an update on recent developments. Total revenue was $113 million, an increase of 10% compared to 2017, which was stronger-than-anticipated due to increased sales volumes and an improved net revenue mix. Adjusted EBITDA was $54 million or 7% over the prior year, and adjusted earnings per share was $0.46, an increase of 5% compared to last year. We generated significant operating cash flow year-to-date of approximately $77 million, which is $6 million above last year. Given the quarter results and our increased confidence with the remainder of the year, we are raising our guidance, and Peter will provide further details later on the call. Before I turn to our business update, I want to highlight some recent achievements on Slide 5. On June 22, the company received the President’s Special Award from the Puerto Rico Chamber of Commerce for outstanding and timely support to the local business sector in the aftermath of Hurricane Maria. This was a significant honor for Evertec, and I’m very proud of our team and their contributions to the recovery of dollar. Regarding innovation, our ATH Móvil application has grown to over 1.1 million users, and we have processed over $3.6 billion in annualized volume. Our ATH Móvil Business solution launched last June has over 10,000 active businesses. And last quarter, we implemented revenue-generating features, which will create incremental profits for Evertec in 2018. Additionally, we recently expanded functionality for non-profits to receive donations from ATH Móvil users, and it is currently in use by 12…

Thank you, Mac, and good afternoon, everyone. I’ll now provide a review of our second quarter 2018 results. Turning to Slide 9, you’ll see the consolidated second quarter results for Evertec. Total revenue for the second quarter was $113.3 million, up 10% compared to $103.5 million in the prior year. Our sales volume continued to be elevated across most of our merchant payment categories. Total revenue for the six months year-to-date was $223.6 million and up 9% year-over-year. Adjusted EBITDA for the quarter was $53.8 million, an increase of 7% from $20.1 million in the prior year. Adjusted EBITDA margin was 47.4% and this represents a 100 basis point decrease in our adjusted EBITDA margin compared to the prior year. The decline in year-over-year margin primarily reflects the lower-margin contribution of PayGroup, which was partially offset by an improved revenue mix in our cost reduction initiatives. Year-to-date adjusted EBITDA was $107.7 million, an increase of 9%. Adjusted net income in the quarter was $34.5 million, an increase of 7% as compared to the prior year, and the increase primarily reflects the higher adjusted EBITDA offset by increased interest and tax expense. The effective tax rate in the quarter was 13.4%, reflecting increased taxes in Latin America, and we now anticipate the full year tax rate to be in a range of 13% to 14%. Adjusted earnings per share was $0.46 for the quarter and grew 5% compared to the prior year. Year-to-date adjusted net income was $69.1 million, up 6% and adjusted earnings per common share was $0.93, up 4% from $0.89 in the prior year. Moving on to Slide 10. I’ll now cover our segment results starting with Merchant Acquiring. In the second quarter, Merchant Acquiring net revenue increased 10% year-over-year to approximately $26 million. The revenue increase was…

Ladies and gentlemen, at this time, we’ll begin the question-and-answer session. [Operator Instructions] And our first question today comes from Bob Napoli from William Blair. Please go ahead with your question.

Thank you. Congratulations on solid results. Just on the numbers question. You had $2.3 million of expenses for $2.6 million M&A expense, I think, you said, from a deal that did not occur. Where does that show up? In which segment? Does it show up in a segment? Or is it out of adjusted EBITDA or is it in adjusted EBITDA?

It’s of out of adjusted EBITDA, Bob. This is Peter. Yes, and so it’s – we performed it out, out of all of our adjusted numbers.

Thank you. As we think about – I mean, you gave the guidance in the back half of the year and just trying to think through. It seems like Puerto Rico has really stabilized. And I know it’s still confusing with some of the funds coming in. But the longer-term model for Evertec, as we think about 2019, 2020, and what type of revenue growth rate this company should have and what the margin should look like. Can you give any thoughts? Should this be a high single-digit revenue grower with expanding margins? Or – and what does the model look like longer-term, now that things seem to have stabilized in Puerto Rico?

Yes. Bob, this is Mac. I’ll answer, then I’ll hand it to Peter. As you said, at the beginning of the question, it’s still difficult to model past this year, and we’re trying to do a good job in letting what 2018 looks like. 2019 and 2020, we’ll address those years as they come forward. But there’s still some unpredictability in Puerto Rico, because we don’t know – we’re pretty confident there’s going to be a lot of money in relief funding and insurance that are coming to the island. But the timing of that is still uncertain. But we will continue to focus on executing well here and growing the business in LatAm. Peter, I don’t know if you want to.

Yes. Just for a little more color on 2018, at the high end of our guidance, we anticipate a continuation of the exceptionally high average ticket that we’ve had this year. And an insignificant impact from immigration. We’re still in the middle of the summer and the pattern on immigration. So we’re anxious to see the school openings and so forth, which will give us a better data point. As we projected the second half of the year, we factored in our July volumes, which were lower than the Q2 volumes. We had volumes of low-double digits and experienced a lower average ticket in high-single digits and that impacts our margin. And so we projected that throughout the remainder of the year. Our transaction volumes were slightly lower, and we projected that out as well. Out of caution, on the lower end of our guidance, we reduced those amounts slightly, just out of caution more than anything else. With respect to the funding and the items that are still open, there has been a recent announcement of approximately $1.5 billion in a HUD grant, but the rest of the process is quite uncertain with respect to timing. So that’s also going to impact us, and as you are aware, the fiscal situation still remains unresolved vis-a-vis the board and the government with respect to the fiscal plan or the budget, excuse me, for next year, which is also an uncertain item here as we look forward to the rest of the year.

And last question for me. Just on the non-Puerto Rico, LatAm and – your balance sheet looks really healthy. You brought your dividend back to half of what it was. Debt to EBITDA is going to be under 2.5, I think, by the end of the year. And you are looking at deals. Where are – where do you see opportunities? Do you have a pipeline? And what interests you the most on the M&A front?

Yes, Bob, this is Mac. Consistent with the past, we’re focused on continuing to expand our footprint where we can. We’ve already got a pretty good footprint with the existing deals. So we’re very focused on the PayGroup acquisition, making sure we’re making the best of that. We’re getting the cross-sells, which we feel pretty confident. But we are continuing to look across the market for products and expansion opportunities. And as you know, with the deal that we announced – that we didn’t proceed with, is still an important part of what we’re focused on.

Great, thank you.

Thanks, Bob.

Our next question comes from Jim Schneider from Goldman Sachs. Please go ahead with your question.

Good afternoon. Thanks for taking my question and congratulations on the strong recovery. I just wanted to may be ask, is it possible to parse out between the Merchant Acquiring business and the Payment Services business? Can you maybe isolate how much of the benefit that you’re seeing right now? Is it specifically down to the relief effort, vis-a-vis the kind of just the recovery or balance you’re seeing in the rest of the business? That will be helpful.

Hi Jim, it’s Peter. So it’s very difficult to pinpoint the release effort as there’s nothing direct that we can tie to exactly. One item that is direct that we do identify discretely is relief funding with respect to our EBT, or electronic benefit transfer, card payment volumes. And that volume has contributed approximately 7% to our sales volume growth just on those cards this year. So that is direct – as a direct result of the relief effort. Apart from that, it’s very difficult.

Understand. Hard to isolate. And then, I guess, can you maybe just kind of provide us with a broader review of what you are seeing in Puerto Rico now, in terms of the go-forward normalized competitive environment, both in the Merchant Acquiring and Payment Services sectors? Are you seeing any of your competitors retrench or more importantly, any of your competitors start to back off the market or potentially exit?

This is Mac. No, what I would say, given that it’s typically the extension of their U.S. business and often times, they’re exploring it or exploiting it through ISO. We don’t see a significant change in the market dynamics. We do see that, again, the banks that we partner with, FirstBank and Popular are the strongest financial institutions on the island, which plays to our benefit. But, again, it is still a competitive environment.

The only thing I’d add to, what Mac just mentioned, is that we are here in greater scale on the island and can provide more timely service arguably, as we go to help merchants as things are so difficult in the recovery with respect to the service levels. Additionally, we’ve added the ATH Móvil Business solution, which is unique here on the island and that’s something that we’re focused on.

Great. And then may be one final one. With respect to Bob’s earlier question on M&A. You’re, obviously, considering a larger transaction, it sounds like. Can you maybe give us a sense about how much latitude you see in your balance sheet at this point? You’re sub three right now. I mean, would you at this point reconsider for the right deal, you could imagine scaling up to kind of four times leverage? Is that something that you see as doable or desirable at this point?

I would say, with respect to our views on that, it really depends on the strategy and the asset. So if we fund the right asset, we would feel comfortable doing that in the right business case. But in each case, it’s going to have to add value to shareholders long-term. One other follow-up just that I’ll add to Bob’s question earlier is just that, with respect to the charge, just for housekeeping, it’s in the corporate segment and in the SG&A segment.

Yes, and Jim, this is Mac. I mean, look, I think what we’re very proud and excited about at Evertec is we think we’re building a unique franchise in Latin America. And we think that the products that we have, the footprint we have that we’ve built over the last three years is – there’s no comparable. So any asset that comes up, we’ll take a hard look at. And to your point, we’ve got a great balance sheet. And we look at transactions of any size that makes sense for our strategy and create shareholder value, but we’ll just as equally walk away from one if the complexity is too great or if it doesn’t make financial sense. But this is, I mean, still the big focus for our company. So we’ll look at every opportunity in the region.

Understood. Thank you very much.

Our next question comes from Georgios Mihalos from Cowen. Please go ahead with your question.

Good afternoon, gentlemen. Let me add my congrats as well on the quarter. Firstly, Pete, wanted to ask as we sort of model out the back half of 2018, should we now be looking at the typical seasonality? So if we look at how sort of revenue breaks down going back to 2016. Is that a good template to use? And then also I just wanted to ask on the margins, specifically as it relates to Payment Services in Puerto Rico and Business Solutions, you had some revenue growth there that, obviously, didn’t flow down to the bottom line in 2Q. Is there any reason why we shouldn’t be expecting margin expansion now over the back half of the year, specifically for those two segments?

Thanks. With respect to seasonality, George, I think absent some of the uncertain factors that I called out earlier that a typical seasonal pattern would be appropriate for how we look at it, which is typically weighted in the fourth quarter. The third quarter tends to be lighter. With respect to your question on the margins and the contribution, so if you look at, as you identified in the Payments and the Business Solutions segment that we didn’t get the conversion, and individually, on that Payment segment, we had some investments that we made in infrastructure and product initiatives, which happen to fall in that quarter and held it back a bit. And then with respect to Business Solution, it’s really predicated on the timing of service delivery. We have some more deferred revenue as a consequence of that and revenue recognition, but there’s not anything individually that I could call out that we don’t think is just the timing-related item.

Great, thanks. And then I’m not sure if I missed it in the prepared remarks. But can you update us on the percentage of your merchant base that’s still not processing post the hurricane? Thanks and congrats again.

Yes, thanks. With respect to normal levels, 10% is the amount that is not processing. However, we would like to say that we’re in a new environment, and so we’ve seen the uptick in merchants still continue, but it has decelerated. And so we believe and factored at this level is probably appropriate as we go forward. As we called out, we have these merchants that we still collect fees from. It generates approximately $1.5 million per year, and we factored in approximately half of that going away in the second half of the year as well.

Our next question comes from Tien-tsin Huang from JPMorgan. Please go ahead with your question.

Thank you. Great results. I wanted to ask on the decision to not do the Latin American acquisition. Why was that, Mac? Was it fit or just the timing not right?

It really was around the complexity of the deal and also the market conditions – the markets that the asset does business in.

Understood. So – but from an appetite standpoint, it sounds like it’s still there and from a resource and where you are in the recovery, the interest level on doing deals is – sounds like it’s higher.

Yes, so it was not – I mean, look, we were very interested in the asset. We’re interested in assets that are available in the region. Like I said, we think we’ve got a unique platform and products that no one else has. So it wasn’t that we have a lack of appetite for these things. It was just we didn’t think the asset was appropriate, again, given the market conditions. Peter?

Okay.

Yes, just adding to it. There were some unique regulatory constraints in this – the added complexity as well as market conditions, which ultimately changed or got worse throughout the process, which also contributed it. But the asset we really liked.

And when we say market conditions, we mean the markets that the country specifically – that the company operates in.

Yes, got it. Thanks for that clarification. Just as a follow-up unrelated. The ATH branded share. It sounds like maybe that’s up a little bit. Can you confirm? And if so, are you doing something differently to drive that? And I think, I also heard that pricing was up too. Can you clarify that? Thanks.

Yes. What I would say, we – so with ATH, we continue to roll out new features. We announced in the quarter we have a new feature for not-for-profits. We also are now charging for some of the features for small businesses to actually accept ATH Móvil. So it’s actually a better solution for small merchants than a POS, because they don’t have to make that investment. And we’ve also started charging some of the financial institutions, a small transaction fee for the service that we provide. So if we are seeing an expansion of the ATH transactions across the island, not only because it’s the best product and it’s in the most people’s wallets but because of the new features and the innovations that we’ve rolled out really over the last year, but we’re beginning to see the financial impact within the last quarter.

Right, great. [indiscernible] thank you.

Our next question comes from Vasu Govil from Morgan Stanley. Please go ahead with your question.

Hi, thanks for taking my question and congrats on a great quarter. I guess, just – the question I wanted to ask is that, you had some headwinds this quarter from the bank moratorium on payments ending. And we still saw pretty solid volume growth, and the full benefit from insurance proceeds as the uptick. So – and I guess I understand it’s prudent to have some caution in your outlook, but any reason why growth shouldn’t accelerate from here, especially given the easy comps in the fourth quarter versus, I think, you’re guiding to a stable revenue growth in the back half versus the first half?

I’ll give you my view, then Peter. Again, timing is what’s difficult to predict with the relief funding and the interest funding. If you think about $3 billion of $8 billion, it’s probably come through the island. It’s surprising given that some of the claims are in the insurance companies. And on the relief funding as well. Again, we believe in the budget. It has over $60 million coming through the island. But there’s a lot that needs to be done from an approval and a process perspective to actually see those funds locally. Peter can talk specifically to how we look at 2018.

Yes. We will see our growth improve due to the effects of the hurricane in the second half. What we were speaking to about to is that we will not see a continuation, particularly in the merchant segment of Q2, as we’ve seen in July it decelerate a bit and that’s what we factored in into our outlook.

Understood. And if you could clarify, was there a change in impact from client migration that you’re anticipating for this year?

Yes. We had an uptick from a couple of clients that they’ve chosen to delay their migrations. And so what we’ve done is we’ve reduced the outlook to $2 million to $4 million for the year from previously $4 million to $6 million. And that has an effect on next year, which the same change just goes forth to next year, which we currently view as $5 million to $6 million.

Understood. And then just longer term on Latin America. What sort of review on potential organic growth once we’re past the client deconversion? And correct me if I’m wrong, but my understanding is that most of your presence in Latin America today is on the Payment Processing side, but very little direct Merchant Acquiring business outside of Puerto Rico. Is it a big focus to expand sort of the Merchant Acquiring piece into Latin America and it’s not something you can do with your existing assets or would that be accomplished only through M&A.

Yes. So this is Mac. The – so the growth in Latin America, once we get to the attrition, we like to be at low double digits, which is sort of aspirational given that, that’s what we think the market should grow at. But two things. One is we’ve got to get to the client attrition, and we also have to change the model with the PayGroup business from a licensing business to processing. To your question about would we – Merchant Acquiring versus Processing, it is a thing that Evertec has been successful at is offering whatever the market needs at the time. So we very deliberately enter these markets with what the market – what’s best suited for the market. So in most of these markets we are a processor, like Merchant Acquiring is still owned by the banks or through a monopoly or duopoly. As it opens up, which we think it will, as it has slowly done in some of the larger markets, we’re going to be the technology solution with the resources on the ground to help run their merchant business.

Understood. That’s very helpful. And one last one, if I can squeeze it in. I guess, just on the government budget. That’s still not been finalized. Any view on how quickly that situation can get resolved? At this point, it seems like it will mostly be a 2019 impact to the extent that there might be any austerity measures. Is that correct?

I’ll just say, I wish I knew to give you the result. That, of course, we’d do that, but that’s taking time. I don’t know, Peter, if you’ve gotten any?

Yes. We’re waiting for a ruling from the courts on the next steps. And so we’re uncertain as to what and when that will take place.

I mean, it’s unprecedented given that this is not a state and how this plays out. But, hopefully, from outside, now that’s in the course, we’ll reach to some conclusions, but…

Other than that, there’s recognition of the importance of resolving it, which I think is understood by all parties and that’s what we’re hopeful we’ll bring into closure here shortly.

Understood. Thanks a lot.

Our next question comes from Bryan Keane from Deutsche Bank. Please go ahead with your question.

Hi, guys. Just wanted to ask on the Merchant Acquiring moderation. Do you guys have any idea what’s causing that in July?

It’s predominately just a lower average ticket. We’re seeing the same spending across the categories. But it’s generally just the lower average ticket. As we noted, the transactions are off slightly as well. But that would be the observation in terms of what caused it? We don’t know, whether it is – it has anything to do perhaps with the immigration or any other cause related to funding, et cetera, which is what creates the uncertainty.

Okay. And then just on EBITDA margins. Historically, there hasn’t been that big of a difference between the first half and the second half. Obviously, last year was a huge a different impact, but we all know a lot of the reasons why. So just thinking, is there a reason why margins would stay on the depressed level for the back half of this year, and why wouldn’t they be more similar to the first half?

Well, the first thing I want to note is, although the hurricane, obviously, had the biggest impact, we also acquired PayGroup last early July. And that has an impact as that comes on at lower revenue or EBITDA contribution. So that – you need to consider that. Other than that, I think it’s the reasons that we called out, which if we go by segment, where the Merchant Acquiring volume, lower average ticket and transactions and the Payment Processing section, it’s just a slightly lower transaction volume. And in Business Solutions, we expect that to rebound, as we noted. And then in Latin America, it’s the attrition, which is impacting us adversely.

Yes. And these specific infrastructure expenses and product development initiatives that we see in payment and also – I think, it’s also in the business services segment. Do we – do those end by the end of this year or is there a timeframe when we get back to more normalized margins in that – in those segments?

Well, in the payment segment, the product initiatives are for future growth, we’re building ATH Móvil and other solution capabilities here that will help us grow. With respect to the infrastructure in both categories, those are just necessary expenses. We, every year, challenge ourselves to reduce them. But we’re always going to ensure that the business runs safely and securely, and that’s what that represents.

And the product initiatives then will be ongoing in those costs, just to continue for growth?

Throughout 2018, we’ll look very carefully at capital allocations. We always do going into 2019.

Yes. And this is Mac. In 2018, we’re – as we look at the back half of the year, we’re trying to make investments. We’ve demonstrated that ATH Móvil we can make money. We’ve demonstrated that when we roll out any features, we exceed the list. So we’re trying very hard to try and accelerate some of those investments in 2018.

Okay, all right. Thanks for the color.

Our next question comes from John Davis from Raymond James. Please go ahead with your question.

Hey, good afternoon guys. Really, maybe, Mac, just wanted to start on M&A. Just specifically the pipeline. I think, obviously, you guys looked at what feels like a pretty sizable deal. Are there three to four deals that you guys are looking at quarterly? Is it ebb and flow? Just trying to get a sense of what the Latin American pipeline looks like and also the size of deal that you would potentially do.

Yes. I mean, we don’t talk about deals until they’re done. What I would will tell you, again, it continues to be a focus. If you look at Latin America historically in this space, most of the deals tend to be small and most of the deals, there’ve been a handful. We’ve done several of those, if you include PayGroup and Processa. That tends to be the typical size. The larger deals are going to be the outliers. So the larger types of deals where we have to really leverage the balance sheet are going to be unusual. But we will look at those because those could really fit well into our thesis. But I can tell you right now, we constantly are evaluating opportunities across South America, different types of deals, but they tend to be smaller than the types of deals that we’ve done in the past.

Okay. That’s helpful. And then you mentioned in your prepared remarks modernization of the mobile app. You’ve got 1 million users or over 1 million today. I mean, how meaningful is that and what specifically – like, how are you monetizing? Is it transaction fee? Like, who’s paying the fee? And do you think that could be an actual significant contributor P&L down the road?

So originally ATH Móvil was rolled out as a free service to sort of encourage adoption, and it was P2P. So people were paying each other. They were paying very small businesses, babysitters, lawn maintenance people, if you owe somebody $20, it was that type of transaction. And we waited until we had the scale, so that it was kind of one of the things that you have to have and you use on a weekly, if not daily, basis to actually start charging fees. The fees that we charge primarily are to the financial institutions, because we are processing transactions for those financial institutions. But as we add new features, like the ability for small businesses to get better reporting on their transactions, we’re actually charging small businesses, like we would if they were a credit card transaction. And as we look at other features, we will charge consumers or small businesses for those features. But we do believe that it’s not only going to be good for the financial growth of the company, but also strengthening the brand on the traditional transactions as well.

Okay. Very helpful. And Peter, quickly, one more margin question for you. By my math, guidance implies basically 300 basis points lower margin in second half versus first half. I think, you called out client attrition. In my math, that’s like 100 basis points. So 200 basis points there, is that really just elevated spending, a little bit of conservatism? I just want to make sure that we’re not missing any kind of big expenses that are expected kind of in the back half.

Yes. I think that’s accurate. I would call out that the Merchant Acquiring segment has the most leverage, if you will – operating leverage, based on volumes. So that’s where the biggest impact is from the first to the second half in our guidance.

All right. Thanks, guys.

[Operator Instructions] Our next question is a follow-up from Bob Napoli from William Blair. Please go ahead with your follow-up.

Thanks. Just quickly on questions have been asked around ATH Móvil. But the 1.1 million users, 10,000 businesses, where was that quarter ago and kind of what is the momentum on adding users and businesses?

Yes. So – I mean, we haven’t published historical information. What I can tell you that’s continually growing. As you add, it’s not growing at the same rate. The 1.1 million on a population of 3.2 million, and you’ve got a significant amount of the adult population. We are now seeing quick adoption rate as we roll out new features. So the base of consumers is still growing, but where we’re seeing the acceleration is when we launch new products. So the nonprofits, we have a lot of applications to add nonprofits. Small businesses. That ramped very, very quickly because that’s only been out for a couple of quarters. So we are seeing a quick adoption once we roll out new features.

I mean, is this going to move the needle on the financials in 2019? Or how material can the revenue stream off of that be?

I wouldn’t say it’s material at this stage, but it’s growing very, very significantly. And we can provide further update on that as we look out to 2019.

Great, thank you.

Thanks, Bob.

And ladies and gentlemen, at this time, I’m showing no additional questions. I’d like to turn the conference call back over to management for any closing remarks.

This is Mac. I want to thank everyone for joining the call. We look forward to seeing you at upcoming investor conferences and talking to you again on the next earnings call. Thanks, again.

Ladies and gentlemen, that does conclude today’s conference call. We do thank you for joining. You may now disconnect your lines.