VeriFone Holdings, Inc. F3Q09 (Qtr End 07/31/09) Earnings Call Transcript

VeriFone Holdings, Inc. (PAY)

F3Q09 Earnings Call

September 1, 2009 4:30 pm ET

Executives

William Nettles - VP for Corporate Development and IR

Doug Bergeron - CEO

Bob Dykes - CFO

Albert Liu – General Counsel

Analysts

Tien-Tsin Huang – JP Morgan

Andrew Jeffrey - SunTrust Robinson Humphrey

Gil Luria - Wedbush Morgan Securities

Dan Perlin – RBC Capital Markets

Paul [Bartoli] – [PB] Research

Presentation

Operator

Welcome to the third quarter 2009 VeriFone earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Mr. William Nettles, Vice President for Corporate Development and IR. Please proceed.

William Nettles

Good afternoon and welcome to the VeriFone financial result conference call and presentation for the third fiscal quarter of 2009. Today's call is being webcast and a recording will be available on our website until September 8, 2009. With me today is Doug Bergeron, CEO and Bob Dykes, CFO and Albert Liu, General Counsel.

First, for the legalities. I want to remind everyone that VeriFone desires to take advantage of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Certain forward-looking statements in this conference call including management's view as to future events and financial performance are subject to various factors that could cause actual results to vary materially from those expressed or implied by such forward-looking statements. For a description of these factors, I refer you to our filings with the SEC. Any forward-looking statements speak only as of today and VeriFone is under no obligation to update these statements to reflect future events or circumstances.

In addition, today's call will cover certain non-GAAP financial measures on both a historic and forecast basis. Our management uses these measures to evaluate our operating performance and to compare our results with those for prior periods as well as to other peer companies. These non-GAAP measures are not substitutes for disclosures made in accordance with GAAP. Reconciliations of these measures to the most comparable GAAP measures are presented in our earnings release, which is available on our website at verifone.com.

During this presentation, your line will be in a listen-only mode. At the conclusion of today's presentation, there will be a question-and-answer session. Instructions on how to signal for a question will be given by the moderator at that time.

Now, I would like to turn the call over to Doug Bergeron, CEO of VeriFone.

Doug Bergeron

Thanks, William, and good afternoon, everyone. Revenue for the quarter increased 5% sequentially from the previous quarter to $211 million. Our third quarter earnings of $0.26 per share showed good improvement relative to the results of our last three quarters as gross profit margins expanded to 36.8% and operating expenses continued to be well managed.

In addition, we enhanced our cash position by $53 million bringing our ending cash position to over $250 million. While mindful that retailers are by and large still experiencing tough times, I believe we are seeing indications of broadening optimism across our customer base. These dynamics were reflected in the makeup for this quarter’s sequential revenue growth where almost every region grew.

Let’s begin the review of our third quarter revenue with our international operations where business increased 3% on a sequential basis. Compared to the second quarter Asia grew 74%, Europe grew 5% and Latin America declined 24%. Asia’s Q3 results as we predicted on our last call were very strong. One of the factors behind our success has been the migration to the VX platform by historical Littman customers. Fulfilling customer demand with the Nurit product line, one of the few electronic products imported into China, had created a cost structure disadvantage which has now been removed. In addition to the cost savings this migration has also enabled our China engineering team to provide faster turnaround on our customer payment applications requirements.

Customers have responded very positively. This quarter’s revenue was the best ever. The performance in greater Asia was also quite good. An encouraging development was the closing of a multimillion dollar deal to an Indian bank that had been dormant earlier in the year due to the recent volatility of currency rates and concerns about the economic outlook.

Europe results were positive overall. Russia, a problem area for us earlier in the year, completed its third quarter of increasing sequential revenue. For the United Kingdom we recorded the highest revenue in several quarters. After two years of extensive sales and engineering efforts we won a multimillion dollar deal partly shippable in the fourth quarter with one of the largest U.K. acquirers.

A key component of this win and others across Europe is the recent broadening of our product portfolio. VX 670 Bluetooth pay at the table solution which is a popular protocol in Europe and has been gaining traction in restaurants. Another product is the VX 810 Duet, a uniquely designed product which addresses merchant requests for a solution with a hand over configuration while offering the versatility of a desktop device.

In Latin America the decline was mainly attributable to our Brazilian business. This quarter’s revenue was approximately $8 million lower than second quarter results. In Brazil there are two major acquirers which last year accounted for approximately 60% of the business. Sales to one acquirer were lower than normal due to a one quarter delay in completing application software. Sales to the other acquirer were also down but we expect that the new products being certified will enable us to regain our sales momentum there. The balance of our Brazil revenue increased on a sequential basis indicating signs of a stabilizing vertical business environment.

A notable win this quarter was a contract to provide Payware CMS Enterprise Software and professional services to mobile payment startup Oi [Pago] the wholly owned subsidiary of Oi, the largest telecom operator in Brazil. Our enterprise software will provide the foundation for Oi [Pago’s] mobile credit card operations.

In Mexico we had a successful third quarter with a revenue level comparable to the pre-recession 2008 run rate. One contributing factor was a countrywide roll out of EMV solutions to multi lane retailers and our selection as a preferred supplier in a vast majority of these deals. In addition, VeriFone Access, our hosted network targeted at underserved, middle tier retailers gained momentum. VeriFone Access performs many of the same functions that ISOs and acquirers do in the United States including sales, help desk and routing of the transaction from the merchant to the appropriate bank. In the third quarter we processed more than one million transactions for the first time. We are seeing banks with constrained capital budgets referring customers to VeriFone Access. In some cases they avoid the capital outlay of purchasing systems up front by redirecting a larger portion of the merchant transaction fee to VeriFone.

Let’s shift the discussion now to North America. North American revenue increased 7% sequentially. This quarter the growth was primarily attributable to Canada where EMV is being rolled out and our broad portfolio in this area and has benefited us greatly. In our third quarter we certified the VX 810 Duet with two large customers and shipped over $4 million of this product alone.

Our U.S. financial revenue in the third quarter was relatively flat with levels of the past two quarters. Our confidence in calling the third quarter a bottom is increasing as we have noticed an uptick in August orders. Also for the first time in over a year we are seeing a pickup in sell through activity at our largest distributors.

Our petroleum business had a good quarter with 12% sequential revenue growth. Customers are finally beginning to update their sites to PCI PA-DSS solutions mandated by the major oil companies. VeriFone is benefiting from this market dynamic via increased sales of indoor and outdoor solutions. The large indoor upgrade opportunity is with our installed base of over 40,000 Ruby point of sale solutions sites in the United States. Our MX, Pinpad and Sapphire solutions offer these customers three different pads to PCI PA-DSS compliance.

Our outdoor solution, Secure Pump Pay, is gaining traction in both direct and indirect channels. Starting from a small base last quarter we saw a 30% sequential increase. The impetus is a program we told you about last year where one of our major petroleum customers announced a financial incentive for operators to upgrade pumps. Other oil companies have recently begun similar programs for their operators and this is helping as well.

Our multi-lane retail group had a solid quarter. This segment has been strong recently with large customers purchasing PCI compliant products and was down 15% sequentially as the upgrade activity shifted to tier-two retailers. We continue to strengthen our position as the supplier of choice in our tier-one and tier-two retail segments where a vision of end-to-end encryption is resonating. We now have live, referenceable deployments at VeriShield Protect end-to-end encryption running including a nationwide solution with a tier-one retailer. A couple of weeks ago we announced a major, joint marketing campaign with RBS World Pay where RBS will offer VeriShield Protect to all of their installed base and use VeriShield Protect as a differentiator in winning competitive processing deals.

Finally, this week we finalized a definitive settlement with the Securities and Exchange Commission in connection with the previously disclosed SEC investigation in the company’s 2007 financial statement. We cooperated fully with the Commission’s investigation which resulted in no charge of intentional misstatement or monetary penalty being assessed against the company. Over the past 18 months we have substantially improved our governance and internal controls in order to prevent a recurrence of this type of event. We are pleased to have resolved this matter with the Commission and we will continue to focus on serving our customers, growing our business and creating a more secure electronic payment environment.

Now, I would like to turn the call over to Bob to discuss in more detail the P&L, balance sheet and guidance.

Bob Dykes

Thanks Doug. A Doug discussed revenue in some detail; I will begin with non-GAAP gross margins which came in at 36.8% in excess of the 33.8% reported in the second quarter of 2009 and our second best performance over the last two years. The majority of the shift related to an improvement in net inventory related charges. I will remind you we have taken some significant inventory reserves and provisions for excess parts earlier in the year to reflect the suddenly lower demand. These charges were $11.8 million in the first quarter and $9.6 million in the second quarter.

This quarter we took a $9.2 million charge which is more typical of what we are seeing in quarters with no significant product transition issues and relatively stable demand. Inventory charges aside, our third quarter domestic and international gross profit percentages were comparable to what we had reported in the first and second quarters.

Our operating expenses declined another $1.3 million this quarter to $43.5 million. G&A decreased by $1.9 million. Sales and marketing was down slightly and R&D increased by $27 million. In G&A a $0.8 million sequential reduction were due to a pause in the accrual of audits and subsequent professional service fees as we calibrate our year-to-date run rate toward the projected annual fee. Another $0.8 million was due to a favorable bad debt provision compared to the second quarter as a result of improved collections.

The balance of the G&A savings was primarily due to a reduction in IT and accounting special project consulting expenses. Partially offsetting these reductions was the adverse impact of exchange rates which accounted for half of the sequential increase in research and development and a $1.2 million increase in overall operating expenses. Over the past four quarters we have worked extremely hard to reduce operating expenses to current levels. Recently, however, we are inclined to think there is a more hospitable environment for new business ventures and going forward we are more likely to increase expenses.

Net interest and other expense was $2.6 million for the third quarter as compared to $4 million in the prior quarter. This reflects the lower interest on our LIBOR based senior debt and interest savings from the $33.5 million of convertible bonds we repurchased in Q2, partially offset by the reduced interest income on our cash balances.

At this juncture I would like to bring your attention to a large credit that was included in our Q3 GAAP results of $26 per share. This item pertains to an acquisition related Brazilian Customs Assessment and related accrued interest. We had accrued for these penalties while disputing the Brazilian government’s claim. Recently we received a favorable ruling that all but a small portion of this claim is invalid and can’t be reclaimed by the government on appeal because of the statute of limitations. Accordingly, this quarter we reversed $7.2 million in G&A expense and $4.5 million of net interest on a GAAP basis but excluded these credits from our non-GAAP reporting.

Now let’s take a look at cash flow and the key balance sheet items. Net cash provided by operations was $58 million this quarter and $127 million on a year-to-date basis, surpassing our expectations of what we would generate for the entire year. This reflects great work we have accomplished in managing our working capital. In addition, our net cash tax payments have totaled only $300,000 this year, substantially less than the tax expense we reported in our non-GAAP net income statement of 28% of pre-tax profit.

Our low cash tax payments were primarily the result of improving U.S. profitability which enabled the utilization of foreign tax credits. Our DSOs increased by one day to 78 days this quarter. Our revenue was more linear than last quarter and we experienced slightly later payments from a few customers. Inventory declined another $7 million and now stands at $98 million. This result was better than expected in part due to the stronger than anticipated business and related shipments of inventory at quarter end. We don’t project a meaningful decline in inventory next quarter but are exploring alternative supply chain structures with our contract manufacturers that may result in further reductions in 2010.

Debt covenant metrics improved sequentially and we were well above the requirements. The total leverage ratio, which compares net debt to EBITDA and should not exceed 3.5, was 0.3 in the third quarter. The fixed charge coverage ratio which compares EBITDA less capital expenditures and cash taxes to interest and principle payments and should not be less than 2, was 8.6 in the third quarter and 5.9 on a pro forma basis excluding the Brazilian interest expense reversal. Both of these ratios improved over the prior quarter. For the benefit of our investors we have published details of the above compliance ratio calculations in addition to our reconciliation between non-GAAP and GAAP financials on the Investor Relations tab of our corporate website at www.verifone.com.

Our guidance for the fourth quarter is for revenue to be between $208 million and $215 million. We expect non-GAAP earnings per share to be between $0.23 and $0.25. For the full year we now expect revenue to be between $835-842 million and our non-GAAP earnings per share is projected to be in the range of $0.83 to $0.85. For the next fiscal year we are still developing our budgets, however, assuming the worldwide economy experiences a continued moderate recovery we believe we should see growth of around 10%.

In summary, we had a good quarter from a financial perspective. The non-GAAP EPS was still burdened by some inventory and other charges, cash generation was outstanding and we continued to strengthen our organization. While we are not yet ready to say that aggressive growth is back, we are saying we expect revenue to be more predictable from here; gross margins should remain healthy with further improvements targeted. Although there was some increase in operating expenses, we will keep those increases under control.

I will now turn it over to Doug for some concluding remarks.

Doug Bergeron

Thanks Bob. I would like to conclude with a few final comments on our end-to-end encryption initiative. We believe VeriShield Protect End-to-end Encryption may be the single most important and transformative stimulant to VeriFone’s business model since EMV was announced in Europe ten years ago. End-to-end encryption needs to be deeply embedded in the point of sale technology’s outermost touch point. It requires ongoing maintenance and recalculations of the operating system. Similar to other large encryption implementations outside of the payment industry, the complexity and heavy lifting are all around dynamic key generation and key maintenance.

Because those changes can only be implemented with full cooperation by VeriFone, end-to-end encryption technology cannot simply sit as a third party application on the stack. This makes VeriFone the key contributor and beneficiary of the reallocation of IT budgets going forward. We know large retailers today are prepared to spend hundreds of thousands of dollars annually for the safety and benefit of not hosting reusable hard data.

Our unique, fixed format solution reduces the need to change in-store systems and as a result IT infrastructure investments to protect against breaches as well as associated audit fees can be dramatically lowered. The math is even more compelling when factoring in the contingent costs of responding to breaches which inevitably occur. We expect customers adopting these new strategies to want to employ one, not several, end-to-end encryption processes across their enterprises.

In addition, they will demand end-to-end encryption to address integrated point of sale environments like PC based systems, Petroleum and ECRs and to support these requirements and our goal of achieving end-to-end encryption in a multi-vendor environment, VeriShield Protect will be licensable from us for use in all point of sale systems and devices, including those offered by our competitors.

Incented by a slice of our revenue stream, we expect card acceptance technology companies to embrace VeriShield Protect over the next several months and years. Furthermore, as we have been stating for years, increased functionality and increased requirements at the point of sale require newer and faster processing technology. We expect that end-to-end encryption will usher in a whole new technology refresh cycle in the post-PCI world.

In conclusion, we are very pleased with our execution this quarter and by the early signs that the business climate for our solutions has begun to improve. We remain cautious and prudent but we believe a new era of opportunity has begun. Thank you for listening and we will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Tien-Tsin Huang – JP Morgan.

Tien-Tsin Huang – JP Morgan

I thought maybe I would ask a pretty simple, high level question. Maybe the biggest surprise in the quarter, with a lot of positive signs here I am just curious what sort of surprised you the most in the quarter relative to the last time you issued guidance?

Doug Bergeron

Two things. The sequential revenue growth wasn’t isolated to one or two or three areas that maybe were having a better post-recessionary environment or had better sales execution. With the exception of Brazil and we talked about that, it was across the board. That made it somewhat relevant to me and to Bob and others that are looking at these numbers.

The second thing was the adoption by the Royal Bank of Scotland’s U.S. processing business of the VeriShield program. They absolutely believe that not only is end-to-end encryption required but it could be a key differentiator for them and for other processors as they compete in the competitive processing business. I think we have seen the first stages of this going from a good idea to a practical in-field competitiveness.

Tien-Tsin Huang – JP Morgan

On Asia Pac, can you rehash again what exactly drove the strength there? Obviously it looks like your biggest quarter there in history. It sounded like it was mostly China migration to VX? I just wanted to make sure that was the case. If so, how much more can you squeeze out of China and how far along are we in terms of the growth there?

Doug Bergeron

I think Asia was highlighted by excellent performance in China and good performance; there was no drag on Asia from any area and even some green shoots if you will in places like India. There is just a tremendous amount of opportunity in China. We remain the largest provider there. Our sales team and the management team is world class and I am actually heading to Beijing on Monday. We are spending a lot of time and money right now building a business that is capable of selling our broader range of systems into the Chinese payment ecosystem including our petroleum systems, gateway systems, pay at the table systems, things we for the most part don’t sell at all today. I have very high hopes and very confident hopes about what we can do in China over the next several years.

Tien-Tsin Huang – JP Morgan

I guess you did give a rough schedule next year assuming modest recovery continuing. Can we get some color around what gross margin outlook could look like? It sounded like 37+ is sustainable. Can we see something with a 4 in front on gross margin?

Doug Bergeron

That has been our goal. Obviously our revenues this year are less than what we would have liked. They are starting to improve. As we get some natural expansion in gross margin as a result of more typical revenue growth we get some natural expansion in gross margin as we shift to a more traditional wireless/non-wireless mix. Many of the new initiatives we are working on like encryption in particular but also things like VeriFone Access in Mexico and the CMS deal we announced in Brazil are all accretive to gross margins. I don’t think you should see anything structurally different in the next several quarters but clearly this business has many periods over the last 15 years with gross margins above 40%. That is what we are aiming to get to at some point.

Operator

The next question comes from the line of Andrew Jeffrey - SunTrust Robinson Humphrey.

Andrew Jeffrey - SunTrust Robinson Humphrey

Can you talk about North America and in particular your two primary competitors had very strong sequential performance. You were up but not as much as they. Was there any share shift that we should be thinking about here?

Doug Bergeron

No. I think both of them had extremely weak Q1’s so this was an arithmetic phenomenon. We are not seeing any share shift. We are seeing VeriFone win the vast majority of multi-lane business. Both of those companies don’t participate in the petroleum business. They don’t participate in the taxi business. They don’t participate for the most part in healthcare which we have a very strong interest in. In the North American financial retail group, the group that serves the ISO community, we continue to think we are holding our own there. We have very strong market presence and we intend to keep it.

Andrew Jeffrey - SunTrust Robinson Humphrey

That is consistent with what we have heard from the channel. I think you made a comment about X inventory charges gross margin being roughly consistent with where it was in the first half. Could you speak a little bit to mix both geographic and product that might have held underlying gross margin relatively flat given you had good sequential uptick everywhere except Latin America this quarter?

Bob Dykes

Well I would say Latin America and China happen to be the two areas, or in particular Brazil and China, are the two areas we happened to have weaker gross margins in general. So the shift between those didn’t have much of an impact. The strength that we see in the U.K. and the U.S. and Canada, those are all stronger gross margin areas and so I think that the mix didn’t contribute very much to the gross margin at this time. That is why we said that excluding those changes in inventory reserves the margins were about the same.

Andrew Jeffrey - SunTrust Robinson Humphrey

So if we see continued strength in North America, for example, we should expect gross margin to improve from here?

Bob Dykes

That is certainly true. As we have said in the past, we also have some very aggressive programs underway to continue to drive costs out of our products through engineering improvements and you will see those come through quarter-by-quarter over the next year.

Andrew Jeffrey - SunTrust Robinson Humphrey

You have done a nice job with inventory. Is there any concern now that you have drawn down inventory so far that if demand really rebounds meaningfully there is a supply issue?

Doug Bergeron

No. Inventory was too high. It wasn’t being managed as carefully as it could have been. Bob’s lifelong experience with companies like Flex Products has added just a lot of value to the way we look at that whole problem. I think we have a very leverageable model and should demand return to historical levels which I think it is not going to in the next quarter or two, my personal opinion, we will not be flat footed and we will be able to meet that demand.

Operator

The next question comes from the line of Gil Luria - Wedbush Morgan Securities.

Gil Luria - Wedbush Morgan Securities

First I want to revisit the top line thoughts for next year. I think you said 10% assuming moderate recovery. Is a moderate recovery what you are seeing now or is that a little bit beyond that or what do you think you would grow if the trends just continue as they are now?

Bob Dykes

We think that what we are experiencing now is somewhat of a recovery certainly in our business. Certainly there is a debate over where the economy overall is recovering but if this environment continues I think we would see that type of improvement.

Gil Luria - Wedbush Morgan Securities

In terms of some of the ancillary businesses that you are developing, the taxi business, the transaction business, are those in aggregate more than 5% at this point? Are you going to start breaking them out soon?

Bob Dykes

No they are not. Probably it would be a bit more than that before we broke them out. We think those areas, the security business itself just selling software for the security business, the advertising for the taxi business, the other businesses we mentioned we are actually gaining a per transaction fee, those are good upsides over more years down the road and we will start talking about them in more detail as they become significant. There is really good growth opportunity for us in those areas.

Gil Luria - Wedbush Morgan Securities

In terms of your relationship with RBS are there other opportunities in the pipeline to have other processor partners to help you distribute this?

Doug Bergeron

Absolutely. There are opportunities to sell encryption into large retail, into tier-two and tier-three retail and into petroleum companies, the big oils and there is also when you start getting into the tier-four and tier-five retail there are opportunities to work closely with the network operators and the end processors to help them add more value to their customers. The revenue models will evolve in each of those but we are quite optimistic that we have some unique technology but more importantly a unique distribution platform that will help promulgate this fairly quickly in an environment where people are looking for a solution.

Operator

The next question comes from the line of Tien-Tsin Huang – JP Morgan.

Tien-Tsin Huang – JP Morgan

U.S. versus Canada growth, did you break that out for us?

Bob Dykes

We said that part of the strength in North America was from Canada because it is going through the significant upgrade at the moment so there was higher growth than the U.S. itself.

Tien-Tsin Huang – JP Morgan

Within Canada, I think of the 2010 deadline in EMV, how much more to go is there within that upgrade?

Doug Bergeron

I give our Canadian team a lot of praise because I believe what they have accomplished over the last year or two has more to do with market share expansion and becoming the credible first choice supplier at all of the major processors than it does the EMV deadline. We have built a very sustainable business in Canada that has quadrupled in size over the last few years and we will continue to be the beneficiary of ongoing business with all of those processors and with tier-one retail well beyond 2010.

Tien-Tsin Huang – JP Morgan

Visa about a month or so ago put out a release over the world with some new standards outside of the U.S. I think mostly in 2010. How important is that to VeriFone or is that just more of the same? I’m trying to better understand the implications.

Doug Bergeron

There are an ongoing series of PCI standards coming out today in the U.K. for example EMV there is an upgrade there we are driving to. Then we already have on the books a PCI 2.0 standard and so these will be implementing and forcing retailers to interact over time. We are already in discussions on PCI 3.0. So continued upgrades in about 3 year cycles is going to be the norm for the foreseeable future. We think that is a good driver of our business throughout the world. Then in addition to that the end-to-end encryption I think is going to be a very strong driver of business as well.

Tien-Tsin Huang – JP Morgan

From the Brazil standpoint it sounded like some of it was related to getting some certifications done but given the regulatory changes that are coming in Brazil how could that impact the VeriFone business going forward?

Doug Bergeron

We actually think it would be very net positive for us. Right now, as you know probably more than anyone in history given what you are writing about that all of the pieces of the pie are concentrated into two main entities. As that is forced to be broken up and more competition comes out of it I think Brazil will start looking more like the U.S. for us which is very good because then people start competing with each other on the value that they are adding to their customers and they go out and try to buy the best technology to try to serve that goal. That hasn’t been the case frankly over the last couple of years because we are only dealing with a couple of very, very strong customers.

Operator

The next question comes from the line of Dan Perlin – RBC Capital Markets.

Dan Perlin – RBC Capital Markets

In the past couple of quarters you talked about product trade down and some of the implications you have had on your margins. It sounds like maybe we are starting to see signs of clients moving back up stream. Is that kind of a correct characterization?

Doug Bergeron

We didn’t see a dramatic shift this quarter in the product mix from Q2. There was a little bit. I believe that is probably more of a development we would expect as the recovery truly unfolds. I would say especially in the developing world purchasing behavior was still around rice and beans. Maybe their volumes the servings of rice and beans were up a little bit but the content didn’t change a lot. We would see as the opportunity seekers and the acquirers start revving up their engines again to go after new areas they hadn’t been looking at during the recession then the sale of our higher technology products will return to more historical levels which of course would be very helpful to the consolidate gross margin.

Dan Perlin – RBC Capital Markets

You talked a little bit about the pick up within the petro space. I was wondering if you could kind of rehash that a little bit. Are you seeing a rebound or an acceleration in kind of the wireless products that are being sold there? You alluded to it but I wasn’t sure if that was a meaningful up tick or just the beginning.

Bob Dykes

We are seeing a few wireless products being sold in several areas around the world where they are actually using them in some countries where they require; [inaudible] we have seen wireless products actually be taken into the driver of the car to make a payment. So there is an uptick there. In the U.S. there are only two elements of the petro space. One is the products in the kiosk and they are going through an upgrade right now for a variety of reasons we are having some strength in that part of the world. Then in the products that are out at the pump that is the area that over the last year we have been looking for a much stronger growth and quite frankly we have been quite disappointed with the growth there. We are seeing some uptick partly because of the subsidies being put in and applied by the petro brands but also greater recognition by the operators that they do need to have some security at the pump.

Doug Bergeron

It might have been once the world was declared not coming to an end a realization in some of the big oil environments that it doesn’t matter if Visa, for instance, is relaxing rules for PCI compliance at the pump or deadlines for upgrades. This is the right thing to do and there is a franchise risk associated with being party to continued data breaches. We have mentioned this before but these outdoor kiosks, these outdoor pay at the pump self service environments are one of the most dangerous service areas for credit card theft. There are 800,000 of them in the country. All of them are using decade’s old technology to read your card and move the card in an unencrypted way. The same key opens up about 550,000 of them and they get serviced in the middle of the night by a group of independent contractors so there is a real problem with card skimming devices being input into these self-service gas pumps. The way to get around that is with fully PCI compliant, Secure Pay pump technology at the pump and frankly more over to add encryption technology that will encrypt the data at the point of acceptance so if it is somehow stolen in the journey from the merchant through to the processor off to the card member, the data that is stolen is not usable. Everyone we have talked to says that is absolutely the most sensible way to approach this.

Dan Perlin – RBC Capital Markets

You mentioned there is more than one oil company offering subsidies? Or is it just the one?

Bob Dykes

We haven’t named them all but some of them have come out.

Dan Perlin – RBC Capital Markets

So it used to be one and now you are starting to see a few?

Bob Dykes

Not all are as aggressive as the first one but they are providing subsidies.

Dan Perlin – RBC Capital Markets

You also mentioned within the VeriShield Protect product that you are going to offer I think the word you used was “enticing” revenue sharing or something to that effect similar to other payment companies. Can you talk about maybe what does that mean in terms of the revenue model for you and what do the margin profiles look like?

Doug Bergeron

The gross margin profile obviously are very high because it is a service in software and it has to get serviced because this key management complexity it has to be handled on an ongoing basis. It is non-trivial. It is actually quite complex. We envision, we haven’t announced it formally, but for the script today that other providers integrated systems providers and even competitive terminal providers will have the opportunity of licensing this product from us for the benefit of their customers and we are hearing from our large merchants and our large processing friends that they would like a solution that is somewhat systems agnostic. So if this is available to run on both competitor systems and on stand-alone terminal systems it has a much higher chance of becoming a def acto standard and we will be generous in terms of sharing the upside of that with the other participants.

Dan Perlin – RBC Capital Markets

Lastly, you talked about re-engineering the product and how that is going to offer up pretty significant gross margin opportunities over the next couple of years probably. One of the things that keeps coming up is this shifting to contract manufacturing away from your Israeli based manufacturing. I was just wondering if you could provide more detail than you did in the scripted remarks.

Bob Dykes

What has been happening in the dynamics of the company is that we have been transitioning customers from the Nurit products over to the VX products. We talked a little bit about that in the call. The products that we manufacture in Israel are going to have a continuing long life but the [inaudible] are declining there and so the mix shift alone causes us to be moving much more of our manufacturing into China.

Operator

The next question comes from the line of Paul [Bartoli] – [PB] Research.

Paul [Bartoli] – [PB] Research

You mentioned the visibility and improved predictability returning to the business. I am just curious what gives you that confidence? Is it more heavily weighted towards contracts in hand or is this just discussions with customers? What gives you that confidence?

Doug Bergeron

It is both. We started this quarter with a much better bookings backlog. We don’t recite these numbers since the dark days of the first of the last quarter last year and the first calendar quarter this year where all customers were afraid to make any type of purchase decisions. That seems to have begun a path to normalcy. It is still not back to normal in places like Russia, Venezuela, the U.S. small business ISO market is still not a great place to be. There is no or very few new stores opening but there are pockets in the world like China, Canada, the U.K. largely due to some great management we have been able to develop over the last few years and multi-lane retail is continuing to do very well. Turkey has had an excellent quarter.

So we are seeing enough good things where we don’t think it is an accident that there is a mildly recovering environment. We remain cautious. We read the same daily newspapers that everybody else reads and we want to be cautious this isn’t just some sort of inventory replenishment phase we are going through and that three months from now it will start feeling like February 2009 again. But we want to be positioned to continue to lead this industry with the best solutions and the best distribution and if the world continues to behave economically in our markets like it has this quarter then I think 2010 will be a very good year.

Paul [Bartoli] – [PB] Research

So then it does feel like it is more than an inventory buildup and it does feel like people are kind of comfortable enough to look forward and think about 2010 go into businesses again?

Bob Dykes

It is definitely not an inventory buildup. We do monitor distributor inventories and they have been trimming down over the last few quarters and are more stable now. This is not a sell-in type issue.

Paul [Bartoli] – [PB] Research

The delays in Brazil of the large processor there, did you say is that going to come back in the fourth quarter here? The one that was just delayed one quarter?

Doug Bergeron

We know some of the delay was self-inflicted with just some complexity with getting some applications written and certified. So that should be repairing itself. I don’t know if I am close enough to those two particular deals. I know our non-processor business is doing very well which probably speaks better to the overall Brazilian macroeconomic environment which seems to have joined the group of countries that are in recovery.

Paul [Bartoli] – [PB] Research

Lastly, on the G&A, you highlighted some of the things that benefited the sequential decline there. It sounds like some of the professional fees in consulting are normalizing. Is this kind of a pretty decent base rate? I know you talked about expenses kind of creeping back up as business improves but is this a pretty good run rate number?

Bob Dykes

Actually the G&A is running a little bit below the run rate because we found we had fully accrued in the first six months for our professional services and audit fees so there isn’t an expense in the third and fourth quarter we anticipate so actually it will bounce up a little bit in the first quarter of next year.

Paul [Bartoli] – [PB] Research

You mentioned some of the recurring revenues on some of the new products. I know some of the taxi cab stuff is recurring. Is that getting to a meaningful enough number of the business as far as a revenue base on a returning basis?

Doug Bergeron

Yes, I think two things you can track over time are both our services revenue and our deferred revenue and you will see that both have been growing quite nicely. It is clearly where we would like to take large parts of the business. We recently completed a deal, I won’t mention the name of the retailer, but a national retailer that included encryption and it included a bunch of other ancillary services and bundled all together. We are going to ratably recognize that deal over multiple years including the hardware component and including some transaction fees. So you can’t build Rome in a day as they say and you can’t move mountains. Where our systems become so complex that it makes sense to be able to offer a fully bundled, recurring level services fee which are at odds with just a large product sale we are perfectly willing to do that because we know that it is in the long-term interest of the business. We certainly have now with the balance sheet repair that we have done, we have the balance sheet to support that type of business initiative.

Operator

There are no further questions in the queue at this time. I would now like to turn the call back over to Mr. Doug Bergeron. Please proceed.

Doug Bergeron

Thanks everyone. Yes there is an improvement in tone. We remain, however, cautious and we will continue to manage the business in a very prudent and conservative way taking advantage where we can of some of the new era of opportunities that seem to be developing. We will talk to you next quarter.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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