Executives
Douglas Bergeron – CEO
Robert Dykes – SVP & CFO
William Nettles – VP IR
Analysts
Tien-Tsin Huang - JPMorgan
Andrew Jeffrey - Suntrust Robinson Humphrey
Wayne Johnson - Raymond James
Darrin Peller – Barclays Capital
Robert Dodd - Morgan, Keegan
Gil Luria - Wedbush Morgan Securities
Paul Bartolai – PB Investment Research
VeriFone Holdings, Inc. (PAY) Q4 2009 Earnings Call December 14, 2009 4:30 PM ET
Operator
Welcome to the VeriFone financial results conference call for the fourth quarter and fiscal year ended 2009. (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 for the fourth fiscal quarter of fiscal year 2009. Today's call is being webcast and a recording will be available on our website until December 21, 2009. With me today is Douglas Bergeron, CEO and Robert Dykes, CFO.
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 differ 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 www.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 Q&A 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 Douglas Bergeron, CEO of VeriFone.
Douglas Bergeron
Thanks William, and good afternoon everyone. We ended fiscal year 2009 on a strong note. Revenue for the fourth quarter increased 3% sequentially from the previous quarter to $218 million, generating non-GAAP earnings per share of $0.26.
We also enjoyed a third consecutive quarter of excellent cash flow, achieving $75 million of cash from operations. Tight working capital management including a $72 million inventory reduction, strong earnings and net cash income tax receipts, drove our year-end cash balance to $325 million, more than double the balance at the end of fiscal year 2008.
Our operating profit metrics increased as well. Fourth quarter operating margins were 360 basis points higher than the comparable period in 2008. Let me now review or provide a business review of our operating regions and then give an update on two of our most promising strategic initiatives; end-to-end encryption and our recently announced PAYWare Mobile iPhone solution before turning it over to Robert for a detailed review our financials.
In last quarter’s call we reported broadening optimism across our customer base and noted that almost every region contributed to VeriFone’s sequential revenue growth. We are pleased to report a similar breadth of contribution to this quarter’s sequential growth.
Revenue from our international operations increased 7% on a sequential basis. Compared to the third quarter Latin America increased 16%, Asia grew 9%, and Europe increased 2%. In Latin America our sequential increase was driven by a solid contribution from one of our two major financial customers in Brazil, following lower purchasing levels earlier in the year.
Looking ahead Brazilian antitrust authorities and the Central Bank have announced that they will recommend a series of measures aimed at increasing competition and transparency in the nation’s credit card industry. We believe this is a positive development for VeriFone as the purchasing of the two large local card operators should diminish and a number of new processors and networks will emerge.
VeriFone is working with many of these new businesses in helping them define their services strategies. We believe we are well positioned to help them with our PAYWare enterprise software. This software fully localized to the requirements of the Brazilian market enables customers to issue cards, acquire merchants, authorize and settle transactions, and manage loyalty and gift card programs.
Our leading point of sale solution and support capabilities will allow these upstarts to scale quickly as they enter the market. Elsewhere in Latin America we see more business opportunity in Venezuela, the market most severely disrupted by macroeconomic and political events.
Identity theft has become a significant problem in Venezuela creating a need for an upgrade of the country’s installed base to the EMV standard. However demand for our products has been restrained over the past 12 months by tight currency controls. The government has recently relaxed currency restrictions allowing the purchase of more US dollars by local companies who import American goods.
We believe that this policy if sustained it will release the pent up demand for our products. Let’s turn now to Asia, where in the fourth quarter we once again posted record revenues. Leading the way was China, which recorded a second consecutive quarter of strong results. During the quarter a major customer conducted a well-publicized analysis of supplier post sales support and awarded VeriFone with the country’s top services ranking.
The same customer then awarded VeriFone an increased share of its business. Also in China we continued to differentiate ourselves with the announcement of several localized vertical solution offerings.
For example, in 2009 we designed and shipped systems addressing the needs of insurance companies, parking garages, railway ticketing, and petroleum retailing. As the Chinese market continues to develop and mature, customers will demand more of these solutions and place a higher premium on quality and technology resulting in a significant advantage for VeriFone.
Outside of Chine we delivered steady results, particularly in Southeast Asia with significant wins in the Philippines, and in Thailand. Now let’s move on to Europe, where results were across the board. The Nordic countries made a nice contribution to our fourth quarter results. Customers in this region have been upgrading their aging installed base to the latest security standards and VeriFone has been the supplier of choice.
Sales in the Nordic countries along with the United Kingdom, Italy, and Germany all grew year over year in fiscal year 2009 amidst the most difficult macroeconomic conditions in many years. This is clear evidence of our market share expansion in these countries. Of the European countries that were hurt most by the contraction Russia showed the greatest sign of improvement.
Though still very much under its 2008 run rate, Russia experienced revenue growth for the fourth consecutive quarter. This quarter we were awarded a substantial contract with SBRF, one of the two many card-processing banks in Russia for the supply of 130,000 systems over the next two years.
This bodes well for growth in the coming year. Another significant European development in the quarter occurred in Germany, where we received certification of our VX 810 Duet and the VX 810 PIN Pad solutions. These solutions have been key growth drivers in Europe but were not previously available in Germany.
With these certifications we can now address 90% of the Germany market. This market is more open to new suppliers than ever as a result of the recent strategic decision by a competitor of ours to enter the processing market via an acquisition.
Let’s more on to North America where revenue decreased 2% sequentially. The US financial, Canada, and multi lane retail businesses declined while petroleum and some newer industry solution sets which I will speak about in more detail later, grew. Let’s first look at the US financial business, revenue in the fourth quarter declined from the levels of the second and third quarters due to fluctuations in revenue from certain customers that are accounted for on a cash basis.
We believe that end user demand is steady based on sales out reports from our distributors. Also unchanged from prior quarters is the purchasing profile of the end user market. We continue to see a very price sensitive customer group that is choosing solutions with fewer features.
Our petroleum business had a strong quarter with 10% sequential growth following 12% sequential revenue growth in the previous quarter. We spoke to you on our last call about our customers’ increasing interest in updating their sites to PCI PADFF solutions. This quarter we see two additional favorable market developments.
First, an end of life announcement of a key product line by one of our competitors unsettled some customers resulting in decisions to switch to VeriFone. Second, a growing number of grocery stores and petroleum companies have selected our technology to implement cross marketing loyalty programs.
VeriFone solution the Sapphire site controller system, enables customers to earn credits in a grocery store and redeem them at the gas pump. We see demand for Sapphire as an important growth driver for the petroleum business in 2010.
Our multi lane retail group revenue declined 7% sequentially. While the peak of Tier 1 PCI upgrade activity is behind us, we continue to gain market share. This quarter we won a number of specialty retailer PCI upgrade deals and expanded our gateway services business with Tier 2 and Tier 3 retailers.
Before leaving North America I’d like to comment on two solutions that are individually less than 10% of our North American revenue but have made a meaningful contribution to our annual results with total growth in excess of 30%.
The first solution is a retail banking solution which enabled us to close a multimillion-dollar order with one of the nation’s premier banks for a rollout extending throughout 2010. This non-payment solution delivers cost savings by helping banks drive electronic contracts and signatures as opposed to paper at the banker’s desk.
Instead of the traditional method of signature cards and paper agreements, the MX based solution displays the contract and captures the signature which is then stored in the bank’s system. As a result the need to manage and retain paper document is eliminated.
The second solution which in this quarter comprised 5% of our North American revenues is our taxi business. Our installed vehicle base is now 13,700, more than double last year’s total and includes fleets in New York, Philadelphia, Las Vegas, Miami, Fort Lauderdale, Boston, Chicago, Washington DC, and Atlanta.
A recent front page article in The New York Times provides further validation of our business model declaring credit card payments system, “savior for New York’s taxi industry, even as other cities fleets struggle to find fares in a deep recession.”
The revenue model for our taxi business includes sales of payment systems, transaction processing fees, and advertising income from our taxi TV service. With 10,700 cabs broadcasting taxi TV and an average cab ride of 14 minutes, we estimate that taxicab customers watch over 120 million minutes of content a month, a figure higher than many well-known internet based video media properties including Yahoo original programming, [NPR], and CNN Money.
You can expect a double down of our efforts to grow this wonderful asset through the ongoing efforts of a new sales team recruited from the digital advertising industry and a significant technology and content refresh in the months ahead.
Now I would like to discuss two key business initiatives that we believe can blossom into great new lines of business for VeriFone. The first strategic initiative of end-to-end encryption, the hottest topic of discussion today at the PCI Standards Council. At the September PCI meeting Price Waterhouse Cooper presented a preliminary compliance framework for end-to-end encryption environments to leading North American retail security experts.
Retailers are now definitely moving from the mode of do we need this technology to the mode of how do I implement it. In October VISA announced its data field encryption best practices statement. This statement guides the payment industry in evaluating end-to-end encryption technologies. Also in October many CIOs were invited to witness the go-live event for VeriShield Protect at a national retailer with over 5,000 lanes.
This live implementation met every single guideline of the VISA best practices field statement and removed virtually all of the point of sale and back office store systems from the PCI DSS compliance assessment delivering substantial economic value to the customer.
Adding to the momentum for VeriShield Protect in North America, a second processor Chase Paymentech announced its support joining RBS World Pay. In November we announced the extension of VeriShield Protect from both EMV and contactless transactions making VeriShield Protect the only solution that encrypts all three card data formats with a field preserving end-to-end encryption scheme.
We will start working with Beta customers in Europe towards the spring 2010 release. In summary our progress to date has been excellent. In addition to signing up two processors, we have two other processors who have now agreed to accept VSP encrypted transactions into their network and we believe the remainder will follow.
We have two national retail chains live and we are encrypting over five million transactions per week. At least five other national chains are in final testing and positioned to go live within a couple of months following the busy holiday shopping season.
And finally our volume-based transaction-pricing model is holding up very well given the significant savings that the retailers are likely to enjoy from a reduction in audit scope and the comfort that their company name isn’t the next one on the front page of the Wall Street Journal due to a data breach.
Turning to the second strategic initiative, last week we announced VeriFone PAYWare Mobile for the Apple iPhone. This complete payment solution provides small businesses with simple and secure card processing capabilities on the popular Apple Smartphone platform. PAYWare Mobile includes a PA DSS approved payment application that can be downloaded from the Apple App store and a card reader that slips over the iPhone to accommodate card swipes and allows merchants to avoid card not present fees.
In contrast competing applications generally require key entry of a credit card incur expensive card not present transaction fees and provide diminimous encryption and security. PAYWare Mobile transactions will be funneled through a VeriFone gateway for encryption purposes and then turned over to one of our many processing customers for authorization and settlement as we do not intend to act as a transaction acquirer.
PAYWare Mobile also leverages VeriFone’s 30 years of payment systems and security experience which should not be dismissed. Ultimately even the smallest most infrequent transactions need to be processed by the credit card processing and banking industry, an industry that demands the best security and quality.
To meet this requirement PAYWare Mobile integrates VeriFone’s patent pending VeriShield Protect end-to-end encryption technology, directly inside the card reader attachment meaning that card data is encrypted immediately upon swipe and never exposed even inside the iPhone. We consider this to be a revolutionary development and a natural follow on technology to our many years of industry leadership of wireless payment solutions.
Previously VeriFone’s wireless solutions were out of reach for many home repair businesses, door-to-door sales, or virtually any other type of small mobile business. Now PAYWare Mobile allows lower volume users that want to accept credit cards to simply swipe a card on their iPhone. While we have shipped well over 300,000 wireless units in North America over the past five years, we believe that there is a mobile merchant market numbering in the millions that can now be served.
Some estimates suggest that there are in fact more business from home enterprises that could use credit card processing than there are small merchants with a storefront. In summary, I’m very pleased with our results this quarter and our progress with key strategic initiatives.
We are advancing new business models and solutions, tightly managing operations and generating strong cash flow. Now I would like to turn the call over to Robert to discuss more detail about the PAL, balance sheet, the cash flow statement and guidance.
Robert Dykes
Thanks Douglas, for the benefit of our investors a succinct spreadsheet of our non-GAAP financials and a reconciliation between non-GAAP and GAAP financials in on the Investor Relations tab of our corporate website at www.verifone.com.
As Douglas discussed revenue in some detail, I’ll begin with non-GAAP gross margin which came in at 37.9%, an increase of 110 basis points compared to the 36.8% reported in the third quarter of 2009 and our second best quarterly performance of the last two years.
The majority of the shift was due to an improvement in net inventory related charges. This quarter we booked a $700,000 credit mostly due to a favorable settlement with a contract manufacturer. This compares to a $1.3 million charge we booked in the third quarter.
Inventory charges aside, our fourth quarter domestic and international gross profit percentages were comparable to what we have reported throughout the year. Now let’s turn to operating expenses, our operating expenses increased $4 million this quarter to $47.8 million.
Sales and marketing increased $2.9 million, R&D increased by $900,000, and GAD increased by $500,000. I’ll remind you that on our last call, we projected an increase in operating expenses to address new opportunities. We did in fact make some additions of sales, marketing, and engineering heads targeted at our newest business initiatives.
These additions will increase our run rate by approximately $1 million a quarter. We have also cautiously grown travel and marketing communications spending rates above the levels established immediately after the October 2008 banking crisis.
Other operating expenses increases were more of a seasonal or transitory nature. First we have the higher variable sales compensation expense and self-insured medical costs totaling approximately $1 million. Second we had $700,000 net increase in the bad debt provision primarily due to a $400,000 credit booked in the third quarter.
Finally we experienced an unfavorable foreign currency impact of $900,000. Looking ahead we see additional foreign currency related pressure on operating expenses due to the decline of the US dollar. In addition the first quarter of 2010 will include a resumption of the [external] audit accrual.
I note that on the third quarter earnings call we mentioned that we were already fully accrued for fiscal 2009 outside audit expenses due to a favorable renegotiation of the audit fees. So as a result of both unfavorable currency and a resumption of audit fee accruals we are guiding operating expenses to be higher.
Net interest and other expenses was $4.2 million in the fourth quarter as compared to $3.6 million in the prior quarter. This reflects a slightly higher net currency loss and a charge relating to the closure of a subsidiary.
Before we move on to the balance sheet, let me touch briefly on an item outside our non-GAAP reporting. In the fourth quarter we took a $3.5 million restructuring charge. This relates to an arrangement we are in the midst of working through for contract manufacturers to assume operating responsibility for our Israel manufacturing and United Kingdom repair activities. In conjunction with the proposed timetable for transition, economic lives of various machinery, operating leases, and capitalized software have been reduced accounting for the majority of this charge.
Now let’s take a look at cash flow and the key balance sheet items, net cash provided by operations was $75 million this quarter and $203 million for fiscal year 2009 concluding an outstanding year of operating income growth. [Working capital reductions and the net cash income tax receipts.]
This quarter’s declining DSOs contributed to our record cash generation. DSO’s decreased 10 days to 68 days. Relative to the third quarter we generated more revenue early in the quarter and experienced fewer payment delays from large customers.
Inventory declined another $2.6 million in the fourth quarter and now stands at $96 million compared to $168 million at the end of fiscal year 2008. Managing this area today is challenging with a recession minded supply base being much more cautious about capacity expansion. We are working closely with our key suppliers to secure allocation and keep costs under control.
Also the work we have done in the last 18 months in terms of expansion of dual sources on key commodities has served us well in reducing inventory levels. Covenant metrics improved sequentially and were well above requirements. The total leverage ratio which compares net debt to EBITDA for the last four quarters and should not exceed 3.5, was a negative 0.3 on the fourth quarter as cash on hand as defined by the credit agreement exceeded the term loan amount.
The fixed charge coverage ratio which compares the last four quarters of EBITDA less capital expenditures and cash taxes to interest and principal payments and should not be less than 2.0 was 12.1 in the fourth quarter. On a pro forma basis excluding the Brazil interest expense reversal of the third quarter the ratio was 8.1.
For the benefit of our investors we have published details of the above compliance ratio calculations on the Investor Relations tab of our corporate website at www.verifone.com.
Before discussing guidance I would like to make a comment on VeriFone’s control environment. This year we have made tremendous strives to improve the company’s financial controls and have reported the remediation of three of the four material weaknesses in previous SEC filings. Controls over accounting for income taxes through remaining material weakness are particularly complicated by the high proportion of our business that takes place overseas.
We continue to work diligently towards remediation of that item. Now let’s look forward to 2010, our guidance for the first quarter is for revenue to be between $215 million and $218 million. We expect non-GAAP earnings per share to be between $0.22 and $0.23.
For fiscal year 2010 we now expect revenue to be between $900 and $950 million and non-GAAP earnings per share is projected to be in the range of $0.97 to $1.07. I’ll now turn it over to Douglas for some concluding remarks.
Douglas Bergeron
Thanks Robert, VeriFone has accomplished a great deal this year assuming a growing strategic role within the payments industry while delivering higher profitability metrics. These achievements were due to the dedicated employees in engineering, sales and marketing, supply chain, customer support, and administration who banded together in managing through some unusually difficult times earlier in the year.
I would like to thank them for their remarkable effort and results. Looking forward to 2010 allow me to comment on what we see ahead and how VeriFone is positioned to participate. In Asia and Latin America we believe we are returning to a pre crisis state of affairs in most major markets.
The acquirers and banks are gradually proliferating electronic payment solutions throughout their economies as a means to move their businesses forward, increase the AT collections and to make life better for the billions of new world consumers.
China is a special case, where it appears that the electronic payments industry is now growing at rates that exceed even the growth rates we enjoyed earlier in the decade. In Europe the outlook is positive. We are positioned for a year of impressive market share gains in the UK, Germany, and Italy.
Eastern Europe and the Middle East, long VeriFone’s stronghold have recovered and are growing again. Even North America should see growth in 2010. We expect only a mild recovery in the financial markets, until such time that new business openings improve.
But July, 2010 is the official PCI deadline and most reports suggest that less than 50% of those Tier 4 merchants have yet upgraded. We will see a decline in Tier 1 multi lane deals as most of the action is now shifting to Tier 2 where we expect to grow.
Petroleum is already off to an excellent start as is taxi and retail banking. And you’ve just heard my enthusiasm around end-to-end encryption and our PAYWare Mobile iPhone initiative, both potentially big drivers of services revenue as they ramp up.
In Paris a few weeks ago we announced our next generation product portfolio to a group of our leading customers. The response was outstanding and gives me confidence that our long history of being the industry’s first mover continues to reap us great rewards. We will continue to charge forward on broadening our solutions offerings with more innovative services and offerings such as those we’ve discussed today.
Thanks for listening and we will now open up the call to your questions.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from the line of Tien-Tsin Huang - JPMorgan
Good quarter, I wanted to ask about, I guess I’ll start with end to end encryption, what should we be looking for in fiscal 2010 both from a revenue standpoint or maybe if you could talk about the milestones, what should we be tracking here to really see how you’re progressing. And so just to be more specific what are you, should we expect anything from a revenue standpoint from end to end encryption and also what kind of investments are you planning on making in fiscal 2010 on this initiative.
Douglas Bergeron
I think by year-end you should start to see a faster revenue growth line in our services revenue than you have in the past. That should be the product of a number of services initiatives in the transaction services fees and the key management fees that we derive from our encryption successes will be part of that.
I think the two major things, three major things perhaps you should be asking about is how many large Tier 1 Tier 2 retailers have signed on and are going live. I think by the end of next quarter I expect there’ll be several more. And how many processors either have adopted it as their preferred solution or minimally and are marketing it to their Tier 4 retailers or minimally are accepting our encrypted transactions into their network which is a very important milestone.
We’re already at four of the top six that will be accepting these. We think there’s a certain tipping point event that occurs after a certain period of time where we should have an even easier time making that happen. But the early days are more framed by the Tier 1 and 2 retailers who are most concerned about getting the sensitive hard data out of their domain and they’ve been driving the progress to date.
Tien-Tsin Huang - JPMorgan
In your quarter you announced that First Data was coming back as a preferred vendor and you’re going to be working closer with them on a new terminal, what kind of implications will that have on the year if any and are they included in some of the end to end encryption discussions.
Douglas Bergeron
Yes, they are obviously. You don’t go far in America in the payment processing business without having First Data as your friend. First Data obviously made some announcements regarding data resident strategy with RSA but they are the processor of choice for many of our Tier 1 and 2 retailers who either have or will be implementing VSP, VeriShield Protect.
So there’s no question that First Data and VeriFone will be working together on a number of these implementations. The relationship with First Data has really never been stronger. We’re already getting great momentum internationally as a result of a halo effect that the two, of the two companies working together has brought to many of their offshore locations.
And yes we’ve formed a strategy to become the provider of a next generation of FD VeriFone [inaudible] solutions. We’re beginning working on that this month. I don’t expect that that will have revenue impact any earlier than the end of 2010. But when it does it will be significant because it’ll replace the $20 or $25 million a year of revenue that VeriFone lost when First Data was working on these types of initiatives using their own resources exclusively.
Tien-Tsin Huang - JPMorgan
Just on gross margins, obviously a lot going on, you gave a little bit of detail about how you thought about the geographic mix, but what’s the frame of gross margins that we should consider for the year given you’re jumping off point.
Douglas Bergeron
I think it is that, I think as economies improve, the propensity for buying our higher margin solutions improves as a result. I think places like China and Turkey who have long been low end product consumers are becoming more and more consumers of higher end products for us which is accretive to gross margins.
And then the overall scale advantage of selling $230 or $250 million of product versus $200 to $210 is helpful. So I think they do move around a lot for the reasons you’ve suggested especially different warranty items, but I think directionally they’re going in the right direction and I would like to see them with a four in front of it sooner rather than later.
Operator
Your next question comes from the line of Andrew Jeffrey - Suntrust Robinson Humphrey
Andrew Jeffrey - Suntrust Robinson Humphrey
Could you talk a little bit about, you’ve clearly focused on taxi as a real growth opportunity, I think you mentioned they’re 5% of the North American revenues, can you talk about both the recurring aspect of those revenues, and maybe if things go well where the total contribution and the recurring component might be a year from today.
Douglas Bergeron
I’d be hesitant to talk about a year from today, but when we started this business which was a result of an investment in a local business that has blossomed very well, we now control the lion share of the equity there and eventually we’ll hopefully own all of it, we were in the first year only 5% of transactions were electronic.
Today 30% to 35% are electronic and the consumer studies that we’ve seen suggest that once a rider uses a credit card twice, he’s very unlikely ever to go back to cash. So in my mind I see that 30% going to 80% or 90%. I don’t know if that’s next year or five years from now but that’s inevitable.
We continue to do some very good things outside of New York as well. We own 100% of the Philadelphia market, increasing market share in Boston and some of these other smaller markets for taxis, Miami, San Francisco, Las Vegas is an important market, are all growing very nicely.
So I think we could grow that business on a per installation basis, 10%, or 15% a year. I think we could grow the number of transactions 20% 25% a year and I think the real homerun which we have yet to enjoy is advertising. Obviously there’s some cyclicality, some economic sensitivity to advertising but there’s 300,000 taxi fares a day in New York City averaging 14 minutes.
Its clear to me that we have one of the most precious media venues if we execute properly for advertising in all of the digital out of home industries. There’s very few places where the user can’t option you off or turn his head, that he’s going to enjoy the content that you feed to him for 10 or 15 minutes.
So we’re going to be spending a fair amount of money and time and effort and elbow grease this year both upgrading our sales force, making it a national sales force so we can bring this technology to other cities other than New York and also hook some enterprise accounts for advertising and importantly refresh the whole look and feel of those taxis.
I have to, I’ll be the first to admit that they feel a little stale these days and they can use a little more sizzle.
Andrew Jeffrey - Suntrust Robinson Humphrey
So if you qualitatively run through the investment initiatives in 2010 where do taxis rank versus say VeriShield and then just broad investment in your distribution capabilities and sales force.
Douglas Bergeron
Everything we do is prudent. I could see us spending another $5 or $6 million this year in operating expenses. If there were some acquisitions we would look at it to broaden some of our broader portfolio but this is a business that I’m quite sure that within a few years will be a $100 million contributor to VeriFone with very high margins.
So we look at it very fondly when there’s an opportunity to invest.
Robert Dykes
For both the VSP and for the taxi advertising we are increasing our sales force in both areas.
Andrew Jeffrey - Suntrust Robinson Humphrey
And then the guidance for the year versus the first quarter implies a bit of a ramp top and bottom line, can you just comment on that a little bit.
Douglas Bergeron
That’s not inconsistent with any year prior where our first half of the year is usually trumped by the second half of the year so we hope to be ramping because we hope to be growing and we’re investing now with a little more confidence going into 2010 than we certainly had going into 2009 and in many of these initiatives the investment is a couple of laps around the track ahead of the revenue but we feel very comfortable about the return on those investments.
So this is a very comfortable but I think prudent budget that we’re putting forward.
Robert Dykes
And the ramp also happens because our first fiscal quarter is generally our seasonally weak one. There are a lot of retailers don’t allow us to make any changes in their stores over Thanksgiving through year end, etc. so things are a little bit weaker in the first quarter versus the remainder of the year.
Operator
Your next question comes from the line of Wayne Johnson - Raymond James
Wayne Johnson - Raymond James
Just a balance sheet and cash flow question, what is the company targeting and feel comfortable with in terms of inventory levels, ongoing DSO’s, a target for turns in 2010.
Robert Dykes
The inventory we certainly targeting to improve it some more, but we’re now getting down to numbers that I think are already pretty tight so I wouldn’t really be looking for significant further reductions. The DSOs did come down quite dramatically this quarter and there were some great work to achieve that in particular the way the revenue occurred during the quarter.
And so you’re going to see some bouncing around of that. I certainly wouldn’t look for further improvement from here. There may be some deterioration from quarter to quarter but we’re going to continue to work on ways that we can improve it but I certainly wouldn’t be guiding for expectations for further improvement or cash generation from that area at the moment.
Wayne Johnson - Raymond James
So as guidance stands today the current levels is what we should be looking for or modeling going into 2010, is all I was trying to get at there.
Robert Dykes
I think that’s appropriate for investors. Internally we’ll be targeting to make further improvements but I wouldn’t look for investors to be looking for improvements there. I think that you need to look at our non-GAAP profit that we show is a good reflection of the type of cash generation we can do during the year where our depreciation and CapEx are roughly equal.
Wayne Johnson - Raymond James
Can you remind us on terms of market opportunity, I thought there was a comment earlier less than 50% of Tier 4 terminals have been upgraded to PCI compliance. How many domestic Tier 4 terminals are there.
Douglas Bergeron
As embarrassing as it is we really don’t know because of the complicated channel environment that exists that serves Tier 4. We have a much better forensic map if you will to mix metaphors for Tier 1 and 2 than we do for Tier 4. But we know just through talking to our distributors and talking to ISOs and by the fact that VISA has not opened the curtain and said what the stick will be for non-compliance that’s there’s a very large opportunity in excess of one or two million small merchants that are sitting on technology that really should be recycled at this point.
Whether that all happens in 2010 I’m sure it won’t, but inevitably we’ll be the recipients for the beneficiaries of a large part of that upgrade cycle.
Wayne Johnson - Raymond James
The gas stations and the petroleum opportunities, is a separate opportunity for the Tier 4 correct.
Douglas Bergeron
Yes, we’ve always viewed that as a separate opportunity. In fact in many cases in terms of transaction volumes, the large national retailers are more of a Tier 1 or 2 merchants and the requirements for VISA as we discussed a couple of quarters ago, for technology outside of the store is different than compliance requirements and deadlines for inside the store, somewhat counter intuitive given that its potentially more prone to tampering when its outside versus inside.
But what we’ve noticed last quarter and again this quarter and already in Q1, is that the worm has turned there. Its not really the deadline that is driving this acceleration of sales. There seems to be a general epiphany that’s taken place in the petroleum industry that you have to change the stuff out.
Wayne Johnson - Raymond James
And how many gas stations are there roughly, 700,000 or so.
Douglas Bergeron
There’s in excess of 100,000 gas stations, something around 800,000 gas pumps and not all of those are connected to VeriFone site controllers which are the likely gas pumps to be upgraded with secure pump pay. But a large majority are and I think this thing will just continue to gain steam over the next six, 12, 18 months.
Wayne Johnson - Raymond James
And then on the restaurant side, any movement at all on the wireless opportunity domestically.
Douglas Bergeron
Nope, very frustrating and the likes of Micros and Radiant will attest to this. Their customers during the depths of the recession were fighting for survival, not so much worried about bringing convenience to their customers lives. Somewhat ironic in a way because we not only bring convenience with our pay at the table solution but we bring debit which gives large restaurant organizations an opportunity to save their whole cost of credit card acceptance.
But we’ve integrated to all of these restaurant systems. We continue to market it. We had a great quarter on pay at the table in Europe, increasing the VeriFone VX 670 is the pay at the table solution of choice throughout several countries in Europe but we just haven’t hit that tipping point in North America.
Perhaps some of our iPhone initiatives will bring some smaller restaurants to the forefront and maybe that as an unintended consequence will drive some of the larger restaurants to acquire some of our more robust dedicated solutions for pay at the table.
Wayne Johnson - Raymond James
I was just going to ask, what are your expectations for the, in the first year of the product offering for PAYWare, where do you think it could be and did I read correctly that that doesn’t get rolled out until mid-January.
Douglas Bergeron
Yes, we’re taking orders now and the response has been fantastic. In fact we’re not going to go out and put a number out there. It’s a new market for us. We’re marketing directly into our processor and ISO channels. We have a number of ways that we’re going to measure it over the next few months and I should be able to give you a crisper set of state of the union on this next time we meet in February.
Operator
Your next question comes from the line of Darrin Peller – Barclays Capital
Darrin Peller – Barclays Capital
Good quarter, just a quick question first of all you suggested I think during your last call that assuming an economic recovery you could see as much as 10% revenue growth, your guidance here is calling for using the mid range about 7%, and I think it would actually only work out being only about 4% if you annualize the fourth quarter revenue number, so sequential increases have also been 5%, 3% range this quarter, I think a lot of that was strength in Asia, and improvements in the US and so is there any reason why we shouldn’t expect the similar sequential type growth from a revenue standpoint over the next four quarters.
Robert Dykes
I think we have to be mindful of the US economy and where people are thinking that’s its heading that is a major factor. We don’t want investors to get too far ahead of where we think the economy is heading but the major growth in Asia and these new initiatives that we have started on and Douglas talked about in depth certainly should give us a good long-term strong growth.
But we’re just mindful of what may be lurking in fiscal 2010 in the US economy.
Douglas Bergeron
I think many of us are just a little bit cynical after the sustainability in the US of what has felt like a recovery over that last three or four months. I would love to be proven wrong and maybe what we’re seeing is the real catalyst of something that’s going to sustain itself but I think we’d be unwise to not at least factor in the possibility that what we’re seeing is a stimulus led recovery that when the stimulus finishes we’ll be very difficult for the US to continue to grow.
And we factored a little bit of that pessimism particularly are the US into our numbers. We feel very bullish about the things that we’re doing, about the way we’ve positioned ourselves in the market relative to our competitors. And if there’s GDP growth we’re going to grow well above that.
But its still kind of a shaky world out there and there’s not a lot of small businesses being formed today and that’s a real driver of our growth.
Darrin Peller – Barclays Capital
So overall you’d say your guidance is probably predicated on Latin America, maybe Asia continuing to grow but the US being, you’re being very conservative around the US market.
Douglas Bergeron
We’re assuming very little growth in the US. We suggested we’re going to see some good growth in Tier 2 retail. We’ll see some growth in level four because of PCI but we’re worried about level four because of new businesses closing not opening. We’re going to see some good growth in taxi and in retail banking, but we’ll probably see a contraction in multi lane.
So all in all, low to mid single-digit growth hopefully in the US, could be better, but we’re just being conservative.
Darrin Peller – Barclays Capital
And then you had mentioned that Latin America is returning to more normalized growth, if we look back a few quarters and we see numbers being somewhere in the $40 to $45 million range for that segment, is that a fair assumption as to where you think you can get through this year.
Douglas Bergeron
It won’t be as consistent as that but I think you’ll see somewhere in the $35 to $40 million neighborhood for a while. The market has contracted. What we’re seeing is a comparison to the depths of the recession in the spring and things are clearly better and we’re seeing some new ventures in Brazil that are positioned to do, to really be good growth drivers for us but Mexico is still soft.
And many parts of Latin America that are more dependent upon the US than let’s say areas in Asia are still not at 2008 levels. So 2008 levels, $45 million, 2009 levels of $30 to $35 million I think somewhere in the middle there is probably where you should model.
Darrin Peller – Barclays Capital
And then just to help understand a little more about your margin, on the gross margin side it increased sequentially, I think it was about 3% if you think about it that way, it seemed like it almost increased in line with what your revenue increased sequentially, is that something we should be thinking about from a modeling standpoint, does it have a lot more to do with higher end products being sold now or help us understand how the margin expanded as much as it did this quarter sequentially.
Robert Dykes
As I said that really wasn’t to do with the underlying cost of goods, it was to do with those adjustments that we made for the inventory etc. We received a credit from one of our contract manufacturers during the fourth quarter.
Darrin Peller – Barclays Capital
So that’s still going on this quarter.
Robert Dykes
This is a credit, this means money to us. What was happening in the prior quarters was us having to make reserves for obviously product etc. Third quarter things got in pretty good shape with regard to that. Fourth quarter we actually got some money back from one of our contract manufacturers.
This is nothing like what happened in the prior—
Darrin Peller – Barclays Capital
Did you say how the margin would have been without the adjustment on inventory.
Robert Dykes
I did say there was less than $1 million refund from the contract manufacturer so you could adjust that.
Operator
Your next question comes from the line of Robert Dodd - Morgan, Keegan
Robert Dodd - Morgan, Keegan
Just a couple of questions on your recurring revenue business, during 2009 average it was 14%, obviously between your enterprise solution in Brazil, the taxi advertising per transaction, PAYWare etc. do you have a target not a year out, but maybe three to five years out. Is your target to get your service component perhaps your recurring revenue piece to 20% of revenues or do you have a more aggressive target than that.
Douglas Bergeron
It depends how fast our core business, our legacy business where we make the technology products that drive these services grows. We expect that business in a fully normalized economic recovery as we’ve said before to grow at 10%. I think services revenue because of our focus on them and because of the fact that it’s a real differentiator in many cases can always grow at a premium to that, call it, in a normal economic environment call it 15 or 20% per annum.
When that gets to 20 or 30% of total revenue I haven’t done the vector math on that but clearly the more services, the more recurring revenue the better. Its long-term customer stickiness and its something that we’re always looking for.
Robert Dodd - Morgan, Keegan
On the VeriShield solution, you said you’ve been adding sales could you walk us through what the sales approach there is given that so many of your Tier 1 and unfortunately your Tier 2 multi lane customers have just been through a PCI upgrade cycle and how you picture, the obvious you don’t be on the phone [inaudible] but if I remember this does require a terminal replacement rather than just a software upgrade.
Douglas Bergeron
That’s the beauty of our solution, the fact is it does not require a terminal replacement unless their terminals are three or four years old. The vast majority of the PCI compliant MX family that we’ve sold into the Tier 1 and 2 retail and continue this year into Tier 2 retail over the past three years can support VeriShield Protect with simply key injection and remote download. So no, if we needed to go out and start replacing new systems again, we would face an awful amount of sales resistance despite the value that we bring.
So you’re under bad data there.
Robert Dodd - Morgan, Keegan
On the PAYWare, on the mobile side, I realize you don’t want to be an acquirer but are you going to be influencing your partners on the pricing structure of this. Obviously some cases for a small, call it a home business or something, the monthly minimums on a merchant inquiring account can make the cost of card acceptance relatively high. So if they’re low transactors, are you going to be providing any kind of [inaudible] service or something to prevent those cost barriers.
Douglas Bergeron
Listen, just as micropayments became a theme for acquirers over the last five years, remember they weren’t interested at one point in transaction sub $10 or $15 and until they realized that there were billions of them out there and they add up to real money, these unattended to merchants, small businesses, will probably require much lower monthly requirements, or monthly minimums by the processors.
But they get it. These are smart guys. They want to grow their business and every medium sized business started off as a small business. The good news here is we have a unique way of finding these customers through our technology. We hope to be working with some more innovative ways in the next couple of months and as I said in my script, the increasing thought there is that there’s actually more small businesses that could and are not currently accepting credit cards that don’t have a storefront that are working from home.
The small guy selling anything out of his garage, the guy that comes to your house to fix something. All of these are places where you use checks today and the US banking industry wants to get rid of these checks. So we think we’ve got a real value proposition on our hands and we’re going to push forward quite aggressively on it.
Operator
Your next question is a follow-up from the line of Tien-Tsin Huang - JPMorgan
Tien-Tsin Huang - JPMorgan
Just wanted to ask about the use of cash, obviously that’s bubbled up a bit here, what’s the latest thinking on that.
Douglas Bergeron
We think there are plenty of opportunities particularly in our higher growth regions, Turkey, China, Brazil, encryption that would require, would offer small sub $10, sub $15 million opportunities where the acquired product or technology instantly blossoms with the VeriFone sales force and the VeriFone brand.
That’s the nature of the types of acquisitions that you should expect us to engage in. Low risk high value add, leveraging our disproportionately high growth rates in some of these great markets around the world where we already have 100, 120 people and they already have merchants that are crying for new products.
Tien-Tsin Huang - JPMorgan
So similar in spirit I guess to a Simtech investment.
Douglas Bergeron
Yes, Simtech was more early stage, it was more of a technology investment but we will look at those. I think the more typical investment is a product that has grown from two guys in a bathtub to $3 or $4 million of revenue per year in a country like China or Turkey or Brazil where we can wrap a half dozen sales people of VeriFone brand in a VeriFone services agreement around that and all of a sudden it jumps from $3 or $4 million to $15 or $20 million.
Those are the types of deals we like.
Tien-Tsin Huang - JPMorgan
Just Canada, I didn’t hear the detail on how that performed this quarter and what the outlook could be in light of EMV kicking in next year there.
Douglas Bergeron
We’ve had just a tremendous few years in Canada. I think this quarter was so-so. It was pretty flat. But we’ve really developed a great market and a great management team. We continue to add people there. Had some good market share gains versus our competitor in France who long had a strong hold in Canada.
And we expect good things next year. There’s still a lot of the untapped replacement market for 2010, 2011 terminals upgrades. But the market in general is a good market for us.
Tien-Tsin Huang - JPMorgan
I’ve got to ask you about [Hartland] payments. I guess impact on the business from that if any and what sort of is the outlook here, what’s next to expect on [Hartland].
Douglas Bergeron
[Hartland] represent or represented 0.5 or 0.6 or 0.4 depending on the quarter of our annual revenue. It’s a rounding error. Conversely we provide technology to support 75% of their merchants. So you’re asking the wrong company with respect to the impact. We seek to be an honorable supplier of leading edge technology to the payment industry and what we will not do is tolerate patent infringement and when it happens, inadvertently or advertently, we’ll approach the counter party and ask them to stop.
And when they don’t we have to ask the courts for assistance. Its certainly what our shareholders would demand of management when we invest these types of tens of millions of dollars a year in technology. Next steps we hope they stop and we would love to get back to business with them again at some point.
But in the meantime its not impacting our business at all.
Operator
Your next question comes from the line of Gil Luria - Wedbush Morgan Securities
Gil Luria - Wedbush Morgan Securities
If I could ask a quick question about guidance, in terms of your expectations for other charges, restructuring, are there other charges for next year or are any of those built into the guidance, should we expect any of those types of expenses next year.
Robert Dykes
There aren’t any in the guidance, the guidance are non-GAAP numbers that would exclude any one-time charge from our restructuring etc. We did have some restructuring in the fourth quarter but, and there may be some in the first quarter to do with exactly the same functions, will carry over between the two quarters but obviously we don’t anticipate in our guidance any M&A action or activity like that which if it were to occur may result in some such charges.
Gil Luria - Wedbush Morgan Securities
And then in terms of the US obviously you’re not expecting to lose a lot of business from Hartland and they [inaudible] control every decision about who, which of their customers buy from VeriFone, but would there be any additional expenses from now supporting bigger part of their customers directly doing all of the support for those customers, are those customers relying on Hartland for the first year of support.
Douglas Bergeron
Yes there are some small incremental costs but remember we already have 100 or 200 services personnel manning help desks to support, providing second line support in most markets and first line support in our petroleum markets so incrementally its not too painful. The likely outcome is these customers switch to another processor who every other processor in this country has a gold standard relationship with VeriFone and the Tier 1 support costs go to the other processor not to us.
So its really a transitory type cost for just getting them up and running and making sure that software updates are maintained, run time libraries are maintained, any new changes around certifications are provided, and that’s what we’re doing. We don’t want an unfortunate dispute between VeriFone and Hartland to impact the VeriFone brand or certainly impact their customers of ours that are using our products.
We want to make sure that their held harmless if you will from any disruption.
Gil Luria - Wedbush Morgan Securities
And then in terms of the co-branding agreement with First Data, so the products that they’re going to come, that you’re going to design for them are those going to have a visible VeriFone logo on them when you sell those.
Douglas Bergeron
Yes of course. VeriFone brand is very important to all of us and that was part of the agreement. That’s why I think when we issued the press release, it said it was co-branded, that means First Data and VeriFone. It will be VeriFone inside, we’re not spinning new technology for First Data but it will have its own look and feel. That will give First Data and the sales force the pride of ownership that they would like to have.
So I think it will meet everybody’s goals here and I’m looking forward to getting those products out.
Operator
Your final question comes from the line of Paul Bartolai – PB Investment Research
Paul Bartolai – PB Investment Research
Just on the revenue outlook sounds like you’re taking a bit of a conservative view there, just curious what you’re expecting in terms of currency and maybe you could just remind us how currency impacts the top line. If I recall I think most of it is priced in US dollars—
Douglas Bergeron
Yes, obviously all the US which is about 40% of our business is in US dollars. Most of Latin America although the invoice might have one of their currencies because of the historical volatility there, they’re negotiated in dollars and if necessary we’ll hedge, if its big enough we’ll hedge that transaction.
Asia its been very much a dollar like environment. They may have different names but they’re all but pegged to the dollar. Same with Eastern Europe. Where in Russia we bill in dollars, Middle East is effectively a dollar world, so the only impact that currency has on revenue is in Italy and Spain and in the UK and increasingly in Germany as we’ll have some good expectations there.
But those four countries I’m doing in my head it would probably represent less than 15%, 16% of total revenue which would not have a strong dollar flavor to it.
Paul Bartolai – PB Investment Research
So the net impact of currency is its just going to be a bit of a negative on the Op expenses.
Douglas Bergeron
Yes because so much of our R&D is done locally. This is what creates those barriers of entry. Its that last mile if you will of programming and customization that we do for local banks and our sales and marketing expenses are very international. So we do have some negative headwind on a dollar that seemed for a while to only go in one direction because it increases local expenses.
But we’re constantly monitoring that and we’ll make it more efficient if we have to.
Paul Bartolai – PB Investment Research
And then 4Q was it $900,000 is the number I heard of the currency impact.
Robert Dykes
Yes, that’s right.
Douglas Bergeron
Relative to Q3.
Paul Bartolai – PB Investment Research
And then switching to gross margin, it looked like in the systems business even adjusting for the inventory that there was a bit of a sequential improvement there, any guidance what’s driving that and what you’re expecting—
Douglas Bergeron
Well its what we said earlier in the year that we’re, we have a whole set of products that have undergone a cost reengineering program and as those products make their way through the supply chain and on to the income statement, we’ll incrementally start to benefit from that. Also as the revenue environment improves, so does the mood of our customers and so does their propensity to buy higher value solutions.
We’re seeing that in many places today but for the North American ISO market who is still in my mind in the depths of a recession. Everywhere else as you can see their confidence brewing with higher revenue you’re also, you can expect incrementally maybe not materially, but incrementally some help to gross margins are a result of the product mix becoming more favorable to us.
Paul Bartolai – PB Investment Research
Okay but you are starting to see some of the reengineering benefits start to flow through now and we should see—
Douglas Bergeron
Yes, and we’ll continue to see that throughout next year and then obviously the long awaited launch of our next generation [Trident] product happens at the end of next year which is a replacement next gen product for our VX and [Noriet] lines simultaneously using the same silicon and that as in most areas of electronics will have additional COGS benefit to the company.
Paul Bartolai – PB Investment Research
On Op expenses, I just want to clarify your comments, I think you said they were up $4 million sequentially, did you say there’s another step up as we head into 1Q or is that just the audit accruals that are going to be coming back.
Robert Dykes
I did say there was that million step up which included the audit accruals. That was the point that we were guiding to slightly higher OpEx next quarter.
Paul Bartolai – PB Investment Research
So in 1Q is when we’re going to see that additional step up, the $1 million.
Robert Dykes
Yes.
Operator
There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.
Douglas Bergeron
Thank you everyone. This was a little longer than usual call today but we have a lot to talk about and we’re excited about 2010. Talk to you again in late February.
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