VeriFone Systems Inc. (PAY - Analyst Report) reported first-quarter 2013 earnings of 40 cents, which surpassed the Zacks Consensus Estimate by 3 cents. However, VeriFone’s reported revenues missed the Zacks Consensus Estimate of $460.0 million.
The miss was primarily due to soft macroeconomic conditions in Europe, currency headwinds in Venezuela (usually a strong market for VeriFone), postponement and delay of certain projects, particularly in Asia; the cancellation of the Washington D.C. taxi project and certain internal execution challenges.
Revenues (excluding amortization of step-down in deferred revenues on acquisition and expenses related to acquisition & divestiture) increased 1.0% from the year-ago quarter but decreased 12.1% from the previous quarter to $429.7 million. Organic revenues declined 7.0% year over year in the reported quarter.
Revenues were within the management’s guided range of $425.0 million to $430.0 million as announced on Feb 20, 2013 (please see VeriFone Reports 1Q Prelim Results). However, revenues were much lower than the initial guided range of $495.0 million to $500.0 million.
System Solutions revenues (65.6% of revenues) decreased 10.4% year over year and 16.2% quarter over quarter to $281.8 million in the reported quarter. Services revenues (34.4% of revenues) jumped 33.7% from the year-ago quarter but declined 3.0% sequentially in the last quarter.
Revenues were negatively impacted by VeriFone’s increased focus on long-term service initiatives in multiple regions, which hurt near-term hardware and software features. However, a number of external challenges also reduced top-line growth.
VeriFone’s result was negatively impacted by a soft European market, much against the management’s expectation of sequential growth. Although VeriFone shipped new products in Germany, it did not boost top-line growth in the quarter. Revenues in EMEA (Europe, Middle East and Africa) declined 14.8% from the fourth quarter of 2012. On a year-over-year basis, revenues increased 10.8% to $171.6 million.
VeriFone management blamed poor sales planning and execution as one of the reasons behind the revenue decline in the quarter. Increase in deferred revenues (by $23.0 million) due to higher volume shipments to a new mix of customers in the Middle East and Africa, which did not meet the first-quarter revenue recognition criteria, hurt top-line growth.
Postponement and cancellation of certain projects in the Asia region (particularly in India and China) negatively impacted top-line growth. In India, sales were hurt by Reserve Bank of India's directive to reduce and cap the merchant discount rate for debit transactions. Moreover, one of VeriFone’s large Indian customers implemented a capital freeze during the quarter.
As a result, ASPAC (which comprises operations in Asia-Pacific, including China, India, Japan, Australia, New Zealand and other countries in the region) plunged 13.5% sequentially but increased 13.8% from the year-ago quarter to $50.9 million.
During the quarter, VeriFone won a managed services contract from China PnR. The company acquired New Zealand-based ENZ and Sektor Payments during the quarter. VeriFone expects these acquisitions to be completed by the end of second or third quarter.
The success of payments-as-a-service (“PaaS”) model in ASPAC, particularly in Australia encourages company growth opportunities in the region. Moreover, the recent acquisitions are expected to help the company improve its penetration going forward.
Revenues in LAC (which comprises operations in South America, Central America, including Mexico, and the Caribbean) decreased 27.2% year over year and 8.7% quarter over quarter to $73.0 million. Revenues suffered from a shortfall of approximately $5.0 million due to currency controls in Venezuela. Software localization issues in other Latin American countries also hurt top-line growth.
The cancellation of a 5-year $35 million to $45 million taxi in-payment project in Washington D.C. also negatively impacted top-line growth in the reported quarter. Revenues in North America (which comprises operations in the U.S. and Canada) declined 8.3% sequentially. On a year-over-year basis, revenues increased 11.4% to $133.2 million.
The strong year-over-year growth in North American revenues was primarily due to a strong product portfolio. VeriFone’s multi-lane retail sales increased 11% from the year-ago quarter, driven by strong demand for MX 900 systems.
Petroleum revenues were up 10% year over year, driven primarily by strong sales of the Topaz platform, which is currently used by approximately 60,000 to 100,000 gas stations in the US. Revenues in the North American small business sector were up 30% year over year, with strong growth in both U.S. and Canada sales.
Gross margin (including stock-based compensation) improved 60 basis points (“bps”) from the year-ago quarter but contracted 70 bps from the previous quarter to 43.4%. The year-over-year growth was driven by 230 bps service gross margin expansion, which fully offset a 30 bps decline in system solutions gross margin. The year-over-year growth in service gross margin was due to the inclusion of the full quarter sales of higher-margin point business.
The sequential decline was due to 240 bps contraction in service gross margin, which primarily reflected the negative impact of lower taxi advertising revenues and absence of certain higher-margin sales in the first quarter, which positively affected the fourth quarter gross margins.
Operating expenses as a percentage of sales jumped 320 bps from the year-ago quarter and 450 bps on a sequential basis to 28.0%. This sharp rise in operating expenses was due to higher research & development expense (“R&D”), which as a percentage of revenues increased 110 bps from the year-ago quarter and 120 bps from the previous quarter to 8.9%.
Sales and marketing (“S&M”) as a percentage of revenues jumped 130 bps year over year and 160 bps quarter over quarter to 10.5% in the last quarter. General & administrative (“G&A”) was up 80 bps from the year-ago quarter and 170 bps from the previous quarter to 8.6%.
Operating margin declined 260 bps year over year and 520 bps sequentially to 15.4% in the last quarter. The significant decline was primarily due to higher operating expenses and lower gross margin base.
Net income margin declined 220 bps from the year-ago quarter but increased 460 bps sequentially to 10.3% in the reported quarter.
Earnings per Share
Earnings per share (“EPS”) including share-based compensation decreased 18.0% year over year and 39.7% sequentially in the reported quarter. Excluding stock-based compensation, amortization charges, acquisition related charges and related tax effect, VeriFone reported EPS of 51 cents. However, EPS was slightly better than the management’s preliminary result of 47 cents to 50 cents, but was well short of the previously guided range of 70 cents to 73 cents.
On a GAAP basis, EPS was 11 cents, slightly better than the company’s preliminary result of 7 cents to 10 cents. EPS declined from 24 cents reported in the previous quarter but improved significantly from a loss of 3 cents in the year-ago quarter.
At quarter end, VeriFone had approximately $476.7 million in cash compared with $454.1 million in the previous quarter. Total debt was $1.29 billion compared with $1.31 billion in the previous quarter. Cash flow from operations was $53.0 million and free cash flow was $33.0 million in the quarter.
VeriFone expects non-GAAP revenues to be in the range of $435.0 million to $450.0 million for the second quarter of 2013. Management expects second quarter non-GAAP EPS to be in the range of 45 cents to 50 cents.
For fiscal 2013, non-GAAP revenues are projected in the range of $1.8 billion to $1.83 billion, EPS in the range of $1.90 to $2.10 and free cash flow in the range of $170 million to $190 million. VeriFone expects non-GAAP net revenues and non-GAAP EPS to grow sequentially in the third and fourth quarters of fiscal 2013.
While there are certain European countries that are performing at or above plan for VeriFone, the company expects overall demand in Europe to remain weak throughout the rest of fiscal 2013.
For the remainder of fiscal 2013, VeriFone expects operating expenses to ramp up to approximately $120 million to $130 million per quarter, reflecting increased investments on its products.
VeriFone expects to launch a mobile payment application in the near term for both Apple’s (AAPL - Analyst Report) iOS and Google’s Android based phones. Currently in beta, VeriFone’s new mobile wallet has been tested by New York City Cab passengers over the last month. The application allows users to load payment cards, tip preferences and receipt delivery preferences on their phone and quickly prepay their fare with a single tap using advanced sound-based technology.
VeriFone announced a number of steps to boost its operating results going forward. The steps include a comprehensive review of the strategic operating plan to boost near-term productivity along with increasing service offerings over the long term. Moreover, the company expects to take steps to improve cost efficiencies of the acquisitions.
We believe that these initiatives will drive VeriFone’s results going forward. Additionally, VeriFone’s accretive acquisitions are expected to boost customer base going forward.
However, 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 macroeconomic conditions. Moreover, increasing investments will hurt profitability in the near term.
Currently, VeriFone has a Zacks Rank #5 (Strong Sell).