Shares Surge on VeriFone's Q1 Earnings Beat

VeriFone Systems Inc. (PAY) reported better-than-expected fiscal first-quarter 2014 results. Earnings of 20 cents per share (including stock-based compensation) beat the Zacks Consensus Estimate by a nickel. However, earnings per share declined 52.0% from the year-ago quarter due to modest growth in revenues and contracting operating margin.

Shares were up 12.1% ($3.55) in after-hours trading.

Revenues

Revenues (excluding amortization of step-down in deferred services net revenues at acquisition) climbed 1.8% year over year to $437.1 million, better than the Zacks Consensus Estimate of $429.0 million.

System Solutions revenues (60.0% of revenues) decreased 7.3% year over year to $261.2 million. Services revenues (40.0% of revenues) increased 19.0% from the year-ago quarter to $175.0 million in the quarter.

Revenues in North America (which comprises operations in the U.S. and Canada) declined 8.0% year over year to $122.1 million. Demand for the company’s EMV-capable MX 900 series product remained strong during the quarter. Revenues from the taxi business grew 2.0% sequentially. The network currently has 31K taxis servicing approximately 1 million passengers daily.

Revenues in LAC (which comprises operations in South America, Central America, including Mexico and the Caribbean) decreased 6.3% year over year to $68.4 million. Brazil increased on a sequential basis due to competitive wins. However, revenue growth was negatively impacted by lower sales in Mexico.

Revenues in EMEA (Europe, Middle East and Africa) increased 7.6% from the year-ago quarter to $186.3 million. The company introduced new mobile ECR product in Turkey where revenues increased on a sequential basis. VeriFone’s payment-as-a-service business also continued to gain significant customers due to strong demand for value-added-services.

ASPAC revenues (including operations in Asia Pacific, including China, India, Japan, Australia, New Zealand and other countries in the region) surged 18.4% year over year to $60.4 million. The strong growth was driven by robust sales performance in China greater Asia.

Margins

Gross margin (including stock-based compensation) contracted 110 basis points (bps) from the year-ago quarter to 42.3%. The year-over-year decline was due to 230 bps and 20 bps contraction in system solutions and services gross margin, respectively.

Operating expenses as percentage of revenues surged 560 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 230 bps, 90 bps and 230 bps, respectively.

Operating income (including stock-based compensation) plunged 43.3% year over year to $37.5 million, primarily due to lower gross margin base and higher operating expenses. Net income (including stock-based compensation) fell 51.1% from the year-ago quarter to $22.3 million in the last quarter.

Liquidity

At quarter-end, VeriFone had approximately $249.3 million in cash compared with $268.2 million in the previous quarter. Total debt was $1.00 billion compared with $1.04 billion in the previous quarter. Cash flow from operations was $31.9 million compared with $55.0 million in the previous quarter. Free cash flow decreased to $11.0 million from $37.7 million in the previous quarter.

Outlook

VeriFone expects non-GAAP revenues to be in the range of $440.0–$445.0 million for the second quarter of fiscal 2014. This reflects approximately 4.0% year-over-year growth. The current Zacks Consensus Estimate is in line with the lower end of the guided range.

Management expects North America revenues to increase on a sequential basis in the second quarter.

Operating expense of approximately $135.0 million is expected to decrease 11.2% on a sequential basis. Management expects second-quarter non-GAAP earnings to be in the range of 30 to 32 cents. The mid-point of the guided range is down from 36 cents reported in the year-ago quarter. The Zacks Consensus Estimate is currently pegged at 20 cents.

Free cash outflow is expected to be $25.0 million for the upcoming quarter.

For fiscal 2014, non-GAAP revenues are expected to be in the range of $1.78–$1.81 billion (higher than previous outlook of $1.77–$1.80 billion), reflecting approximately 5.0% year-over-year growth.

VeriFone expects gross margin to increase in the second half of 2014. Operating expenses are expected to increase approximately 11.0% to $535.0 million. Management continues to expect sequential improvement in operating margin throughout the year.

Earnings are expected to be $1.40 per share (earlier guided range was $1.35 to $1.40 per share). This reflects 35.0% year-over-year growth. Currently, the Zacks Consensus Estimate is pegged at 94 cents per share, lower than the company’s outlook.

Free cash flow is expected to be 95% of non-GAAP net income 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 second 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. The partnership with American Express (AXP) will also boost VeriFone’s customer base, going forward.

Moreover, the company has strong growth opportunities in overseas market, particularly in emerging economies such as Brazil, China, Russia and India. VeriFone plans to develop a low-end product for the Chinese market, which will boost its customer base, going forward.

We believe these strong growth opportunities strengthen VeriFone’s position against its peers in the near term.

Currently, VeriFone has a Zacks Rank #2 (Buy).

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