VeriFone Systems Earnings Call Nuggets: Mideast Distribution Channel and Sequential Trend Outlook

VeriFone Systems (NYSE:PAY) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

Mideast Distribution Channel

Darrin Peller – Barclays Capital: I just want to start off. Last quarter I know you disclosed earlier that some of the same problems that were affecting last quarter are affecting this quarter in the outlook again. You talked the last quarter about revenue deferral and some product certification issues and market share. This quarter you’re saying now for third quarter $400 million, (which as you said another step down) and you said it’s related to similar problems. What I think would be helpful, though, is number one if you can give us more specifics. Is it further deferral of revenue? One would think deferral of revenue from last quarter would start showing up positively by the third quarter. Maybe you can explain that. And then also on the product certification and market share, how much of that is still an issue? Is it an increasing issue versus what you saw last quarter? And then maybe just leave us with how much confidence we can have that this new $400 million revenue number is really the low and not the right level and it’s going to accelerate from there.

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Richard A. McGinn – Interim CEO: This is Rich. First of all, the process for estimating or analyzing the prospects of the business that have been in place for a long time have changed. We’ve taken a much more comprehensive view and adjusted upward risk profiles to business possibilities during a quarter. So we changed that system for how we think about our prospects. We feel that gives us a much higher likelihood that what we say is what is going to happen and we are trying to build confidence to say, that going forward, what we say is what we are going do. Very important to us, we know it’s important to you. To your point on deferral, this is not about deferred revenue. There was some conversation about some expectation of some business in U.S. petro was expected in the quarter, it has been moved to the following quarter, that’s not deferral per se. Really what we have here is that our distribution channel in the Mideast basically has been dismantled. We lost business last quarter, this quarter and for a good portion the rest of this year. We have to rebuild that. But really you should think about that as a step function downward in our business as we moved away from the distributor who did not meet our standards, and in fact didn’t meet the standards of the government. We are working in other places to build a better and greater book of business to compensate for that but we think that the work that we’re doing to stabilize the business comes in at about the $400 million level. That’s the guidance we’re giving for Q3. And as Marc indicated, sequentially up in the fourth quarter and then an improving situation throughout the year in 2014. To your point on product certification, this issue is an issue writ large for us, going hand-in-hand with product development because we underinvested in R&D thinking we could get more productivity out of the dollars that we were spending. It was not a correct assumption. It was a judgment and it did not work; and we have made a decision to invest more money in both the resources required for certification, finalization of R&D projects and in some cases to actually restart projects that were slowed down or stopped altogether and had put us in a bad situation in a few places in the world. You can see by the comments I made about the wins that we are having where we did not pull back on investments. We are doing very well. But where we did, we were not able to hold the line with the products we had in place. So, that gives us a sense that we have the confidence that when we invest properly, we’ll come out in the right place. Hopefully that answers your…

Darrin Peller – Barclays Capital: That’s helpful. Just based on your comments on the end of year showing up some of these new products wins, I mean, I would assume that the run rate going at fourth quarter to be substantially higher. I mean, is that something that we can count on for 2014 being sort of a step-up year from a revenue standpoint?

Richard A. McGinn – Interim CEO: Well, you say substantial step-up this year. I didn’t say that and I don’t think that Marc said that. I think he said sequentially higher. And what we said is that going into 2014, we can expect – during the year 2014 to have a rate greater than the overall growth rate in the marketplace.

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Marc E. Rothman – EVP and CFO: Darrin, just to – again just to reiterate what Rich said, $400 million approximately for Q3, up sequentially again in Q4, and up sequentially off of that baseline not making the comparison to the first quarter of 2013.

Darrin Peller – Barclays Capital: Just one quick follow-up and I’ll turn it back over. On the cash flow side from operations, really from – actually from a free cash flow side I think you said $58 million in the quarter, there was $33 million last quarter. And then, Marc, I think you said you expect about $40 million to $50 million, was it a second half or in per quarter, I mean, just can you give me more color on that?

Marc E. Rothman – EVP and CFO: Sure, Darrin, it’s $40 million to $50 million planned for the second half of the year. And it reflects the takedown of the earnings per share that I discussed earlier. Additionally, it could include the litigation item of $69 million that I mentioned earlier if it gets paid in the second half of this year. It could go into next year but I wanted to put it out there $70 million, approximately $70 million may be paid in the third or fourth quarter…

Darrin Peller – Barclays Capital: The $40 million to $50 million in the second half assumes that, that $69 million is already in it.

Richard A. McGinn – Interim CEO: It does not, $40 million to $50 million assumes cash flow ex that item…

Darrin Peller – Barclays Capital: Then just to be clear why would it be, I mean you are calling for at least revenue pick up, understanding that earnings is a little bit lower why would it be only about $20 million to $25 million quarterly run rate with a similar. At least a similar revenue number for the third quarter versus this quarter, so just that investments we are making in the business to lower earnings.

Richard A. McGinn – Interim CEO: It’s a combination of the revenue coming down in the second half certainly the earnings per share is coming down in the second half and that will impact the cash flow clearly our efforts and focus on working capital management will be pressed and will be looking to improve upon that number, but as of now, the range that I gave you at $40 million to $50 million ex the litigation is most appropriate for modeling.

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Sequential Trend Outlook

John Williams – UBS: So I just wanted to dig a little bit deeper on the revenue guide of $400 million. So just looking at where you are now in the second quarter and where you are implying you are going to be in the third quarter. It implies that in all or some of the geographies you are expecting to see a pretty substantial downtick in growth even from where we are here and so what would be helpful I think is we try to model, but you could give us a sense of within the four markets, North America, LatAm, EMEA and Asia, how we should think about the sequential trend relative to what we saw in this quarter? Because it seems like LatAm ticked back up nicely, EMEA was flat which was better than down, I suppose, but how should we think about the geographic split as we look at the third quarter and potentially even the fourth quarter?

Marc E. Rothman – EVP and CFO: Very good, John, I can do that. We want to give more transparency given the state of the business today. So let me give you some color on the regional flow for the next quarter or so. So North America generally speaking, from Q2 to Q3, I expect it to be flattish and ramping up in Q4 as we begin to execute on the contracts and other opportunities that Rich discussed earlier. In the Middle East and Africa and Europe, we expect continued softness that’s mostly product driven, as well as the continued rebuild in the Middle East, Africa region that we discussed. And in Latin America, most importantly, although we’re very pleased with the 17% growth year-on-year, we’re going to see a downtick, a significant downtick in Q3 because of temporary competitive losses. There’s just a number of delays in the certifications specifically in the 3G dual SIM products that we have in Brazil and it’s in the lab, and we will get them certified probably late Q4, early Q1 but that’s impacting the second half of the year for us. We’re pleased when we did the first half of the year in Latin America, but Latin America is going to be a downtick, temporary downtick for the second half. In Asia, real quickly, it will be relatively flat throughout the second half, in second-half relative to what we just reported. It should be maybe slight uptick with the M&A work that we did…

Richard A. McGinn – Interim CEO: Setting aside the Mid-East, the glaring example of the back – with the product in place to get it certified, and that’s a function of the decision made on resources. And now we’ve really – we double our efforts in that area. We understand the importance of the products. The customers tell us that, but they need stopgap efforts to put in some 3G based products, they will get them elsewhere. And with the confidence that they have in us that we will deliver high quality products to them, we feel good about what happens once the price are stable.

John Williams – UBS: Just if I could dig a little deeper, just into the EMEA business. So, Marc, you said continued softness and obviously the rebuild going on there, but I guess how do you think of just in terms of Symantec’s softness. Is it soft relative to what you put up in the second half of last year where the run rate was basically $200 million, or is it soft relative to what you put up in the first half of this year, which is $170 million $175 million or so?

Marc E. Rothman – EVP and CFO: It’s a baseline off of the current numbers this year, so the $173 million that we had in Q2, that’s the baseline and it will be modestly down from those numbers.

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John Williams – UBS: Another question I had was just in terms of the incremental EMV impact in the U.S. particularly starting to filter its way into the model, how do we think about that, when should that start to come in, because my sense is that investors are looking at ’14 now for the most part, and I just want to make sure that again as we think about that we’re bringing that EMV impact in at some point as an incremental improvement?

Marc E. Rothman – EVP and CFO: The marketplace is beginning to make some moves now to embrace EMV. Some important players are making decisions to implement EMV and also NFC in their future rollouts. We expect that it will increase during 2014. Again, we’re talking non-petrol here, which has the capacity to wait until 2017. But we expect it’ll be in full bloom by the end of 2014 and 2015 and that is something, of course, given our relationship with the customers in the U.S., we have a good position to take advantage of, but it doesn’t occur to any great extent during the early part of the year.

John Williams – UBS: And are the products generally in the U.S. much more I guess in tune with what customers need and are they compliant for that roll out, or is there any additional work you might have to do here to make sure you’re providing the right things?

Richard A. McGinn – Interim CEO: The good news about this is that we have been deploying EMV products around the world for years now, with 75% of our business ex-U.S. So we are well positioned in terms of both knowledge and experience in doing this and bring that to bear on the U.S. rollouts in a very positive way.

A Closer Look: VeriFone Systems Earnings Cheat Sheet>>