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VeriFone Systems Inc. (PAY - Analyst Report) reported impressive fiscal second-quarter 2014 results. Earnings of 27 cents per share (including stock-based compensation) beat the Zacks Consensus Estimate by 6 cents.

Revenues

Revenues (excluding amortization of step-down in deferred services net revenue at acquisition) increased 8.6% year over year to $466.8 million, much better than the Zacks Consensus Estimate. Revenues were also better than management’s guided range of $440.0–$445.0 million.

VeriFone’s strong revenue growth was primarily driven by higher number of client sign-ups for the payment-as-a-service solution, growth in the U.S. taxi market and incremental revenues from the acquisitions in New Zealand and France.

System Solutions revenues (62.3% of revenues) increased 5.1% year over year to $290.7 million. Services revenues (37.6% of revenues) surged 17.4% from the year-ago quarter to $175.7 million in the quarter.

Revenues in North America (which comprises operations in the U.S. and Canada) increased 2.7% year over year to $125.3 million. Demand for the company’s EMV-capable MX 900 series product remained strong during the quarter, as 15 existing clients selected the product.

VeriFone began to rollout in CVS and Kohl’s Corp (KSS - Analyst Report), won orders from 6 clients earlier using a competitor’s product and three new customers. In the second quarter, six retailers, including Nike, Godiva, Abercrombie & Fitch (ANF - Analyst Report) and PetSmart agreed to implement EMV capable mobile solutions that integrate with Apple’s (AAPL - Analyst Report) latest iPhone.

Revenues from the taxi business were almost flat sequentially. Small and medium business was up from the previous quarter, while the U.S. petrol business revenues were down sequentially as clients deferred purchases as the company shifts its products to EMV enabled solutions.

Revenues in LAC (which comprises operations in South America, Central America, including Mexico and the Caribbean) decreased 2.3% year over year to $83.3 million. Brazil increased on a sequential basis due to competitive wins.

Revenues in EMEA (Europe, Middle East and Africa) increased 10.3% from the year-ago quarter to $190.6 million. The company’s revenues continue to improve in this market and achieved strong sales in Spain due to growing relationship with Redsys, the country’s largest processor. 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 36.0% year over year to $67.6 million. The strong growth was driven by robust sales performance in Australia.

During the quarter, VeriFone launched portable VX 690, the first of several new EMV capable devices that will allow merchants to use NFC, low-energy Bluetooth, and many more additional mobile point-of-sale bandwidths. This new terminal will first be available in Australia.

Margins

Gross margin (including stock-based compensation) contracted 70 basis points (bps) from the year-ago quarter to 41.4%. The year-over-year decline was due to 190 bps contraction in services gross margin, which fully a 90 bps expansion in System solutions gross margin.

Operating expenses as percentage of revenues surged 250 bps on a year-over-year basis to 33.2%. 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 100 bps, 130 bps and 20 bps, respectively.

Operating income (including stock-based compensation) contracted 280 bps from the year-ago quarter to 10.3%, primarily due to lower gross margin base and higher operating expenses.

Net income (including stock-based compensation) was $31.0 million or 27 cents per share compared with $38.9 million or 35 cents per share in the year-ago quarter.

Liquidity

At quarter-end, VeriFone had approximately $229.8 million in cash compared with $249.3 million in the previous quarter. Total debt was $940.2 million compared with $1.00 billion in the previous quarter. Cash flow from operations was $57.0 million compared with $31.9 million in the previous quarter. Free cash flow increased to $36.0 million from $11.0 million in the previous quarter.

Restructuring

During the quarter, VeriFone approved a restructuring program under which it will reduce headcount by 500 (150 in the second quarter). The company plans to close 10 facilities, liquidate 19 legal entities and consolidate 20.0% of data centers.

VeriFone has identified approximately 100 cost saving projects that it will execute eventually. The company has also selected 10 R&D sites where it will relocate staff from its 75 individual sites. This consolidation will further improve efficiency.

VeriFone also plans to reduce legacy products to 500 (from 1000) by the end of 2014. These programs are expected to save at least $35.0 million annually.

Outlook

VeriFone expects non-GAAP revenues to be in the range of $455.0–$460.0 million for the third quarter of fiscal 2014.

Operating expense is forecasted to be $134.0 million. Management expects second-quarter non-GAAP earnings to be in the range of 33 to 34 cents. The mid-point of the guided range is up from 15 cents reported in the year-ago quarter. The Zacks Consensus Estimate is currently pegged at 25 cents per share.

Free cash outflow is expected to be in the range of $20.0 to $25.0 million for the upcoming quarter.

For fiscal 2014, non-GAAP revenues are expected to be in the range of $1.825 to $1.835 billion (up from $1.78–$1.81 billion expected earlier).

Operating expenses are expected to increase approximately 11.0% to $535.0 million. Earnings are expected to be in the range of $1.42 to $1.44 per share (earlier guidance $1.40). Currently, the Zacks Consensus Estimate is pegged at 97 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 third 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 and Costco are significant positives. The partnership with American Express 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.

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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