VeriFone Systems Inc. (PAY) reported third-quarter 2014 non-GAAP earnings (including stock-based compensation) of 29 cents, which beat the Zacks Consensus Estimate by 3 cents. Revenues (excluding amortization of step-down in deferred services net revenue at acquisition) of $476 million also beat the Zacks Consensus Estimate of $460 million.
The company revised up the fiscal 2014 outlook due to growing demand for EMV-based solutions. Retailers are upgrading their point-of-sale (POS) systems to process EMV chip enabled cards, which is expected to drive VeriFone’s unit shipment.
Revenues
Revenues increased 14% year over year and were also better than management’s guided range of $455–$460 million. The year-over-year growth was primarily driven by higher number of client sign-ups for the payment-as-a-service solution and incremental revenues from the acquisitions in New Zealand.
System Solutions revenues (63% of revenues) increased 8.2% year over year to $299.4 million. Services revenues (37%) surged 18% from the year-ago quarter to $176.5 million.
Revenues in North America (which comprises operations in the U.S. and Canada) increased 12% year over year to $130 million. Demand for the company’s EMV-capable MX 900 series product remained strong during the quarter, as 10 existing and four new clients selected the product.
More than 80% of VeriFone products shipped in the U.S. in the third quarter were EMV capable, up from approximately 70% in the first quarter. Per VeriFone, the transition to EMV-based payment solution will also increase installed base of Near-Field Communication (NFC) terminals, driving the usage of NFC as a payment solution.
Robust performance from petrol business, small and medium (SMB) and multilane retail was partially offset by lower non-digital taxi top advertising revenues in the quarter.
Revenues in LAC (which comprises operations in South America, Central America, including Mexico and the Caribbean) jumped 28% year over year to $89 million. Both Brazil and Mexico results improved due to competitive wins.
Revenues in EMEA (Europe, Middle East and Africa) increased 6% from the year-ago quarter to $190 million. The company’s revenues continue to improve in this market and achieved strong sales in Russia and Poland, partially offset by declining revenues in Turkey due to lower sales of mobile ECR terminals. Strong demand from Nigerian banks also drove results.
ASPAC revenues (including operations in Asia Pacific, including China, India, Japan, Australia, New Zealand and other countries in the region) surged 27% year over year to $67.6 million. The strong growth was driven by robust sales performance in Australia, New Zealand and Greater Asia partially offset by lower revenues in India.
During the quarter, VeriFone inked deals with Gilbarco Veeder-Root (one of the world's leading petroleum dispenser providers), BNP Paribas (in France), ROSSMANN (Germany’s 2nd largest drug-store chain) and English Home (in Turkey).
VeriFone signed agreements with clients such as Haverty's, Big 5 Sporting Goods, Community Choice Financial, Ten Thousand Villages, Sunoco, Tesoro and Citgo. VeriFone’s joint solution with Vantiv (VNTV) added 10 new VeriShield Protect end-to-end encryption clients in the quarter.
Margins
Gross margin (including stock-based compensation) expanded 90 basis points (bps) from the year-ago quarter to 41.5%. The year-over-year growth was due lower product costs that fully offset the negative impact of continuing investments on payment-as-a-service platform and lower non-digital taxi media revenues.
Operating expenses as percentage of revenues surged 320 bps on a year-over-year basis to 34.8%. The year-over-year rise in operating expenses was due to higher research & development (R&D), sales and marketing (S&M) and general & administrative (G&A) expenses, which increased 120 bps, 30 bps and 80 bps, respectively.
Operating income (including stock-based compensation) expanded 230 bps from the year-ago quarter to 10.4%, primarily due to higher gross margin base.
Net income (excluding stock-based compensation) was $45.3 million or 40 cents per share compared with $26.4 million or 24 cents per share in the year-ago quarter.
Liquidity
At quarter-end, VeriFone had approximately $263.8 million in cash compared with $229.8 million in the previous quarter. Total debt was $924 million compared with $940.2 million in the previous quarter.
Cash flow from operations was $59 million compared with $57 million in the previous quarter. Free cash flow increased to $38 million from $36 million in the previous quarter.
Restructuring
During the second quarter, VeriFone approved a restructuring program under which it will reduce headcount by 500 (375 at the end of third quarter) by the end of this year. During the third quarter, VeriFone closed 14 facilities and liquidated 13 legal entities (target 19).
VeriFone continues to consolidate its data centers and R&D locations. The company consolidated 9 of its 75 R&D locations during the quarter. VeriFone aims at establishing 30 R&D centers of excellence around the globe. This consolidation will further improve efficiency.
The company also divested GlobalBay enterprise product and the ChargeSmart online bill pay business in the third quarter.
VeriFone reduced legacy products to 525 from more than 1000. The company plans to reduce legacy products to less than 500 by the end of 2014.
Outlook
VeriFone expects non-GAAP revenues in the range of $478–$483 million for the fourth quarter of fiscal 2014. Management expects fourth-quarter non-GAAP earnings in the range of 39 to 40 cents. The Zacks Consensus Estimate is currently pegged at 34 cents per share.
Free cash outflow is expected to be approximately $25 million for the upcoming quarter.
For fiscal 2014, non-GAAP revenues are expected in the range of $1.858 to $1.863 billion (up from $1.825–$1.835 billion expected earlier).
Earnings are expected within $1.46 to $1.47 per share (earlier guidance $1.42 to $1.44). Currently, the Zacks Consensus Estimate is pegged at $1.06 per share, lower than the company’s outlook.
Free cash flow is expected to be $171 million for fiscal 2014. The company reported free cash flow of $159.0 million in fiscal 2013, which was approximately 100% of the net income.
Our Take
VeriFone provided positive outlook for the fourth quarter and full year. We believe that initiatives such as reduction in overlapping solutions, shifting R&D to new innovations, streamlining of data centers, legal entities and facilities will improve VeriFone’s operating fundamentals in the long run.
We believe the company has significant growth opportunity in EMV products, particularly in the domestic market, over the next 6-12 months. VeriFone’s innovative product pipeline and customer wins such as Abercrombie & Fitch (ANF) and Costco (COST) are significant positives.
Moreover, the company has strong growth opportunities in overseas market, particularly in emerging economies such as Brazil, China, Russia and India.
However, execution remains a key headwind as the benefits of restructuring will take some time to positively affect results. Moreover, intensifying competition and investments on new product development will keep margins under pressure in the near term.
Currently, VeriFone has a Zacks Rank #3 (Hold).
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