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VeriFone Systems Inc. (PAY - Analyst Report) reported fiscal third quarter 2013 earnings of 15 cents per share, which beat the Zacks Consensus Estimate by 3 cents. Earnings (including stock-based compensation) however plunged 77.3% year over year and 58.3% sequentially.

Excluding stock-based compensation, amortization charges and acquisition-related charges VeriFone reported earnings of 24 cents, slightly better than management’s forecast of 20 cents.

Revenues

Revenues (excluding amortization of step-down in deferred revenues at acquisition) decreased 15.3% from the year-ago quarter and 2.9% sequentially to $417.5 million. This was however better than the Zacks Consensus Estimate of $411.0 million.

System Solutions revenues (60.1% of revenues) decreased 28.5% year over year and 10.2% quarter over quarter to $250.8 million. Services revenues (39.9% of revenues) increased 17.1% from the year-ago quarter and 10.7% sequentially to $166.7 million in the quarter.

Revenues in North America (which comprises operations in the US and Canada) declined 16.3% year over year and 5.2% sequentially to $115.8 million. The weak result was primarily due to negative impact from higher MX 900 systems volume in the year-ago quarter.

Revenues in LAC (which comprises operations in South America, Central America, including Mexico, and the Caribbean) decreased 26.0% year over year and 18.1% quarter over quarter to $69.9 million.

Revenues in EMEA (Europe, Middle East and Africa) declined 12.0% from the year-ago quarter but increased 3.6% sequentially at $179.0 million.

ASPAC revenues (which comprises of operations in Asia Pacific, including China, India, Japan, Australia, New Zealand and other countries in the region) declined 7.4% year over year but increased 6.2% sequentially to $52.8 million.

Margins

Gross margin (including stock-based compensation) contracted 470 basis points (“bps”) from the year-ago quarter and 150 bps from the previous quarter to 40.6%. The year-over-year decline was due to 670 bps contraction in System solution gross margin. The decline was primarily attributed to unfavorable regional and product mix.

Operating expenses as a percentage of sales jumped 740 bps from the year-ago quarter and 350 bps on a sequential basis to 32.5%. This sharp rise in operating expenses was due to higher research & development expense (“R&D”), which as a percentage of revenues increased 340 bps from the year-ago quarter and 140 bps from the previous quarter to 11.0%.

Sales and marketing (“S&M”) as a percentage of revenues jumped 230 bps year over year and 80 bps quarter over quarter to 11.5%. General & administrative (“G&A”) was up 170 bps from the year-ago quarter and 120 bps from the previous quarter to 9.9%.

Operating margin plunged to 8.1% from 20.2% reported in the year-ago quarter and 500 bps sequentially. The significant decline was primarily due to higher operating expenses and lower gross margin base.  

Net income margin plunged to 6.3% from 16.8% reported in the year-ago quarter and 10.9% in the previous quarter.

Liquidity

At quarter end, VeriFone had approximately $309.3 million in cash compared with $506.0 million in the previous quarter. Total debt was $1.12 billion compared with $1.28 billion in the previous quarter. Cash flow from operations was $49.0 million and free cash flow was $30.9 million in the quarter.

Outlook

VeriFone expects non-GAAP revenues to be in the range of $418.0-$422.0 million for fiscal fourth quarter 2013. Management expects fourth quarter non-GAAP earnings to be approximately 25 cents. Free cash flow is expected to be $25.0 million.

Recommendation

VeriFone reported better-than-expected third quarter results but provided a cautious outlook for the remainder of fiscal 2013. We believe that VeriFone’s innovative product pipeline and strong partnerships with leading retailers Costco (COST - Analyst Report) and McDonald’s (MCD - Analyst Report) will boost top-line growth going forward.

Moreover, VeriFone’s additional spending on research & development and technical sales personnel will drive sales volume going forward. However, this additional spending will continue to keep margins under pressure in the near term.

Additionally, competition continues to be stiff from the likes of NCR Corp. (NCR - Analyst Report), and is a major headwind. Organic growth also remains a matter of concern amid volatile macro economic conditions. Further, we believe that the rebuilding of the Middle East and African distribution channel will take some time and remain a headwind for top-line growth in the near term.

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

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