VeriFone - The Bad News Show Continues Justifying The Aggressive Sell-Off

| About: VeriFone Systems, (PAY)

Shares of VeriFone Systems (PAY) are tumbling following the release of its second-quarter earnings report. The company, which provides secure electronic payment solutions, reported poor second-quarter results, accompanied by an even weaker outlook for the current third quarter.

If the company can regain its competitive position, and more importantly its trust among customers and partners, shares might offer long-term appeal if they consolidate in their mid-teens in the coming weeks.

Second-Quarter Results

VeriFone generated second-quarter revenues of $426.3 million, down 9.7% on the year before. Revenues fell short of consensus estimates of $440.3 million.

The decline in revenues resulted in a severe earnings decline. Non-GAAP earnings per share came in at $0.42 per share, down from $0.64 last year. Analysts were looking for non-GAAP earnings of $0.47 per share.

More importantly, the company reported a $0.54 per share GAAP loss per share, compared with a tiny profit of $0.03 per share last year. Earnings were impacted by large litigation charges.

Interim CEO Richard McGinn commented on the poor results, "We are keenly aware of the significant short-term challenges impacting our fiscal year 2013 financial results. To regain our momentum, we are addressing the critical issues head-on. We have empowered a new senior leadership team. We are substantially increasing our R&D investment to best serve our customers and regain competitiveness in markets where we have product gaps."

A Detailed Look At The Results

VeriFone was hit by a double whammy over the past quarter. Both revenues and gross margins fell, thereby heavily impacting operating earnings.

GAAP revenues fell 9.7%, which was entirely attributable to system solution revenues, which fell by 18.8% to $276.6 million. Service revenues were actually up by 13.8% to $149.7 million. Yet gross margins were under pressure in both revenue streams, falling by 4.5 percent point to 36.2% of total revenues.

The combination of falling revenues and gross margins is deadly for the bottom line, especially as operating expenses remained quite stable. Add to that a $69 million litigation loss contingency expense and VeriFone is forced to report these large losses over the past quarter.

Looking Into The Third Quarter

The near-term prospects remain very subdued for VeriFone. For the current third quarter it estimates that revenues on a non-GAAP basis will come in around $400 million, on which it expects to report non-GAAP earnings of $0.20 per share.

The guidance implies that revenues are expected to fall some 6% from the second quarter, while non-GAAP earnings stand to more than halve. Compared with last year, revenues are expected to fall by 16.5%, while non-GAAP earnings are expected to fall by almost 70%.

The weak guidance fell short of consensus estimates by a mile: on average analysts were looking for third-quarter non-GAAP earnings of $0.51 per share on revenues of $460.2 million.


VeriFone ended the quarter with $506.0 million in cash and equivalents. The company operates with $1.28 billion in short- and long-term debt, for a net debt position of around $775 million.

For the first six months of its fiscal year, VeriFone generated revenues of $855.0 million, down 4.1% on the year. After the disastrous second quarter, the company has lost $46.5 million so far for the year. At this rate, the company is on track to generate annual revenues of $1.6-$1.7 billion on which it is more than likely to report a full-year loss.

Factoring in an almost 20% drop in the share price, with shares exchanging hands just below $18 per share, the market values the company at $1.9 billion. This values VeriFone at about 1.15 times this year's expected annual revenues.

Some Historical Perspective

Long-term shareholders in VeriFone have seen their fair share of volatility. Shares were approaching highs of $50 back in 2007, before falling all the way back to lows of $4 at the end of 2008. A steady recovery sent shares all the way back up to the mid-fifties in both 2011 and 2012, but the weakening operating results have created a large sell-off over the past year.

Between 2009 and 2012, VeriFone has managed to more than double its annual revenues to $1.85 billion. The company turned a loss in 2009 into peak earnings in 2011. Despite continued revenue growth in 2012, profits have already started weakening. In all likelihood, VeriFone will report lower annual revenues for 2013.

Investment Thesis

The way people pay has rapidly evolved. From cash and checks consumers have embraced debit and credit cards. In recent times many are even paying with their mobile phones. New payment initiatives like Square, or even PayPal, which is owned by eBay (NASDAQ:EBAY) start to gain ground.

As a player in that market you need to continuously adjust to these rapid changing market circumstances, something VeriFone clearly has not done as it cut back on research and development spending. As a result, customers have run away, certification was delayed and existing customers and partners have become dissatisfied.

And so, a rapidly growing company has been pushed into turmoil reporting large losses on declining revenues. Add to that the fact that one of its distributors in the Middle East sold into an embargoed country, and the company took $69 million in litigation charges related to a 2008 shareholder litigation, and the disaster is complete. Yet VeriFone has acted swiftly after the departure of both its CEO and CFO during spring of this year, as it replaced a lot of senior management during the quarter and boosted R&D spending.

Despite the weak second quarter and an even weaker guidance for the third quarter, VeriFone sees a recovery in the fourth quarter into the first quarter of next year based on the current pipeline. Still the company has a long way to go, in order to revamp its R&D capabilities, and more importantly regain customer trust to rebuilt its market share.

Back in September of last year, I evaluated the prospects for VeriFone after the company released its third-quarter results. I concluded to remain on the sidelines given the uncertainty of its long-term business model in a rapidly changing industry. As I could not figure out whether its business model would become obsolete in five years time, or has grown into the industry standard, I stayed on the sidelines.

Don't get me wrong, Thursday's sell-off is entirely deserved. Yet shares might consolidate in their mid-teens in the period ahead giving opportunistic investors an interesting entry point if the company can rejuvenate growth and its competitive position.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Tagged: , Business Equipment, Earnings
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