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VeriFone Systems Inc. (PAY - Analyst Report) reported fiscal fourth-quarter 2013 earnings of 27 cents per share, which plunged 64.5% from the year-ago quarter but increased 12.5% sequentially. However, including stock-based compensation, earnings were 13 cents per share, which missed the Zacks Consensus Estimate by a nickel.

Revenues

Revenues (excluding acquisition, divestiture and restructuring related revenues) decreased 11.5% from the year-ago quarter but increased 3.5% sequentially to $432.3 million. This was, however, better than the Zacks Consensus Estimate of $421.0 million.

System Solutions revenues (60.0% of revenues) decreased 22.8% year over year but climbed up 3.4% quarter over quarter to $259.4 million. Services revenues (40.0% of revenues) increased 13.5% from the year-ago quarter and 3.7% sequentially to $172.9 million in the quarter.

Revenues in North America (which comprises operations in the U.S. and Canada) declined 14.3% year over year but increased 7.6% sequentially to $124.6 million.

Revenues in LAC (which comprises operations in South America, Central America, including Mexico and the Caribbean) decreased 11.5% year over year but increased 1.3% quarter over quarter to $70.8 million.

Revenues in EMEA (Europe, Middle East and Africa) declined 11.7% from the year-ago quarter but increased 0.6% sequentially to $180.1 million.

ASPAC revenues (including operations in Asia Pacific, including China, India, Japan, Australia, New Zealand and other countries in the region) declined 4.2% year over year but increased 7.6% sequentially to $56.8 million.

Margins

Gross margin (including stock-based compensation) contracted 310 basis points (bps) from the year-ago quarter but increased 40 bps from the previous quarter to 41.0%.

The year-over-year decline was due to 430 bps contraction in System solution gross margin. The decline was primarily attributed to unfavorable regional and product mix. Services gross margin declined 270 bps on a year-over-year basis.

The sequential improvement was due to a 140 bps jump in System Solution gross margin, which fully offset a 120 bps contraction in the services gross margin.

Operating expense surged 28.1% year over year and 8.8% quarter over quarter to $147.5 million. 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 21.1%, 23.2% and 42.6%, respectively.

Operating income plunged 70.4% year over year and 12.6% quarter over quarter to $29.7 million, primarily due to lower gross margin base and higher operating expense.

Net income fell 81.7% from the year-ago quarter and 20.2% from the previous quarter to $13.4 million in the reported quarter.

Liquidity

At quarter-end, VeriFone had approximately $268.2 million in cash compared with $309.3 million in the previous quarter. Total debt was $1.04 billion compared with $1.12 billion in the previous quarter. Cash flow from operations was $55.0 million and free cash flow was $38.0 million in the quarter.

Outlook

VeriFone expects non-GAAP revenues to be in the range of $425.0 million–$430.0 million for the first quarter of fiscal 2014. The company reported revenues of $429.0 million in fiscal first-quarter 2013.

Operating expense of approximately $133.0 million is expected to decrease 11.0% on a sequential basis. Management expects first-quarter non-GAAP earnings to be approximately 26 cents, down from 40 cents in the year-ago quarter but up sequentially. The Zacks Consensus Estimate is currently pegged at 25 cents.

Free cash outflow is expected to be $25.0 million including $61.0 million related to legal settlement.

For fiscal 2014, non-GAAP revenues are expected to be in the range of $1.77 billion–$1.80 billion, higher than $1.71 billion reported in fiscal 2013. Operating expense is expected to increase approximately 11.0% to $535.0 million.

Earnings are expected to be in the range of $1.35 to $1.40 per share. Currently, the Zacks Consensus Estimate is pegged at $1.27 per share.

Free cash flow is expected to be 85% 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.

Recommendation

VeriFone reported relatively weak fourth-quarter results and provided a cautious outlook for fiscal 2014. We believe that tepid revenue growth coupled with higher operating expenses will hurt profitability in the near term.

Additionally, competition continues to be stiff and is a major headwind. Organic growth also remains a matter of concern amid volatile macroeconomic conditions.

 However, VeriFone’s innovative product pipeline and partnerships with American Express (AXP - Analyst Report) as well as leading retailers like Costco (COST - Analyst Report) and McDonald’s (MCD - Analyst Report)) are expected to drive the top-line in the near term.

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

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