UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to __________.
Commission File No. 1-13521
HYPERCOM CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 86-0828608
(State or Other Jurisdiction (IRS Employer ID Number)
of Incorporation or Organization)
2851 WEST KATHLEEN ROAD, PHOENIX, ARIZONA 85053
(Address of Principal Executive Offices) (Zip Code)
(602) 504-5000
(Registrant's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during he past 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No[ ]
Number of shares of the registrant's common stock, $.001 par value per share,
outstanding as of May 4, 1999, was 33,099,517.
<PAGE> 1
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS 3
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 7
REPORT OF INDEPENDENT ACCOUNTANTS 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 18
PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 20
Exhibit 11.1 21
Exhibit-15.1 22
Exhibit 27.1 23
Exhibit 99.1 24
<PAGE> 2
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
HYPERCOM CORPORATION
Condensed Consolidated Balance Sheet
(Unaudited and in thousands)
<TABLE>
<CAPTION>
March 31, 1999 June 30, 1998
ASSETS
Current Assets
<S> <C> <C>
Cash and cash equivalents $ 37,220 $ 55,659
Marketable securities, at market 29,196 42,641
Accounts receivable (Net of allowance for
doubtful accounts of $3,656 and $3,729) 44,331 43,989
Inventories 61,826 60,539
Deferred income taxes 11,988 10,991
Prepaid taxes 5,218 2,893
Prepaid expenses and other current assets 10,416 7,173
------- -------
Total current assets 200,195 223,885
Property, plant and equipment, net 29,174 23,570
Advances to related parties - 258
Long-term investments 21,598 9,931
Other assets 12,333 1,933
------- -------
Total assets $263,300 $259,577
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 13,916 $ 17,134
Accrued liabilities 15,575 16,537
Deferred revenue 2,810 608
Income taxes payable 2,523 2,209
Current portion of Long-term obligations 256 598
------- -------
Total current liabilities 35,080 37,086
Deferred income taxes 1,847 861
Long term obligations 1,396 1,199
------- -------
Total liabilities 38,323 39,146
</TABLE>
(Continued)
<PAGE> 3
HYPERCOM CORPORATION
Condensed Consolidated Balance Sheet (continued)
(Unaudited and in thousands)
<TABLE>
<CAPTION>
March 31, 1999 June 30, 1998
Stockholders' equity:
<S> <C> <C>
Common stock 15 13
Paid-in capital 145,851 145,601
Receivables from stockholders (1,498) (1,498)
Retained earnings 85,009 76,315
------- -------
229,377 220,431
Treasury Stock (at cost) (4,400) -
Total stockholders' equity 224,977 220,431
------- -------
Total liabilities and stockholders' equity $263,300 $259,577
======= =======
</TABLE>
The accompanying notes are an integral part of these
condensed financial statements.
<PAGE> 4
HYPERCOM CORPORATION
Condensed Consolidated Statement of Income
(Unaudited and in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three months ended Nine months ended
March 31, March 31,
1999 1998 1999 1998
<S> <C> <C> <C> <C>
Net revenue $ 56,304 $ 54,339 $192,881 $204,485
Costs and expenses:
Costs of revenue 31,977 28,445 100,861 103,566
Research and development 6,935 6,097 22,785 17,015
Selling, general and administrative 19,136 16,637 54,389 51,218
Non-cash compensation - - - 10,963
Total costs and expenses 58,048 51,179 178,035 182,762
------- ------- ------- -------
Income (loss) from operations (1,744) 3,160 14,846 21,723
Interest and other income 1,723 1,361 4,537 2,634
Interest and other expense (292) (291) (786) (1,661)
Interest expense - related party - - - (372)
Foreign currency gain (loss) (5,000) 198 (5,999) (1,048)
------- ------- ------- -------
Income (loss) before income taxes (5,313) 4,428 12,598 21,276
(Provision) credit for income taxes 1,647 (394) (3,905) (6,291)
------- ------- ------- -------
Net income (loss) $ (3,666) $ 4,034 $ 8,693 $ 14,985
======= ======= ======= =======
Net income (loss) per share:
Basic earnings (loss) per share ($0.11) $0.12 $ 0.26 $0.51
Weighted average basic common shares 33,098 33,531 33,133 29,107
Diluted earnings (loss) per share ($0.11) $0.11 $ 0.25 $0.49
Weighted average diluted common shares 33,098 35,512 34,509 30,738
</TABLE>
The accompanying notes are an integral part of these
condensed financial statements.
<PAGE> 5
HYPERCOM CORPORATION
Condensed Consolidated Statement of Cash Flows
(Unaudited and in thousands)
<TABLE>
<CAPTION>
Nine months ended
March 31, 1999 March 31, 1998
<S> <C> <C>
Net cash from (used in) operating activities $ 4,753 $ (6,448)
Cash flow from (used in) investing activities:
Notes receivable (3,900) -
Payments received on Notes receivables 523 -
Acquition of controlling interest
in subsidary, (net of cash received) (5,347) -
Acquisition of other assets (970) (21)
Proceeds from disposal of property,
plant & equipment 830 612
Purchase of property, plant & equipment (10,013) (9,559)
Purchase of investments (47,708) (60,381)
Proceeds from maturity of investments 51,918 -
------- -------
Net cash used in investing activities (14,667) (69,349)
Cash flow from (used in) financing activities:
Proceeds of bank notes payable and
other debt instruments 46,542 59,307
Repayment of bank notes payable and
other debt instruments (49,802) (77,749)
Repayments from related parties 257 559
Proceeds from sale of common stock 252 127,500
Repurchase of common stock (5,159) -
Stock offering costs - (1,453)
Other (75) -
------- -------
Net cash from (used in) financing activities (7,985) 108,164
Effect of exchange rate changes (540) 899
------- -------
Net increase (decrease) in cash (18,439) 33,266
Cash & equivalents, beginning of period 55,659 16,318
------- -------
Cash & equivalents, end of period $ 37,220 $ 49,584
======= =======
</TABLE>
The accompanying notes are an integral part of these
condensed financial statements
<PAGE> 6
Notes to Condensed Consolidated Financial Statements
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited, condensed consolidated financial statements
do not include all the information and footnotes required by generally
accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair statement of
results for the periods have been included. Operating results for the
nine month period ended March 31, 1999, are not necessarily indicative
of the results that may be expected for the year ending June 30, 1999.
This financial information is intended to be read in conjunction with
Hypercom's audited financial statements and footnotes thereto included
in Hypercom's Annual Report on Form 10-K for the year ended June 30,
1998.
For comparative purposes, certain prior period amounts have been
reclassified to conform with the current period presentation.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
The Company generally recognizes product revenue, including sales to
distributors, upon shipment of product. Revenue from service
obligations is recognized over the lives of the contracts. The Company
accrues for warranty costs, sales returns and other allowances at the
time of shipment.
The Company has a contract in which they provide a warranty to the
customer during the installation period by a third party vendor. If
the product does not function properly during this period, the Company
is obligated to repair it. At initiation of this contract, the Company
recognized revenue at the end of the installation period due to its
lack of history with the customer and contract, and resulting inability
to estimate warranty costs. During the quarter ended March 31, 1999,
the Company began recognizing revenue upon shipment for this contract
based on the history provided by a large number of sales and its
resulting ability to accurately estimate such warranty costs. During
the quarter, revenues recognized under this contract totaled $5.7
million, which included incremental revenues of $3.8 million resulting
from recognition of revenue upon shipment.
Software Capitalization
Statement of Financial Accounting Standards No. 86, Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed
(SFAS No. 86), requires capitalization of certain software development
costs subsequent to the establishment of technological feasibility.
The Company's product development process is such that technological
feasibility is established upon completion of a working model. Costs
incurred between completion of the working model and the point at which
the product is ready for initial shipment have not been significant in
the past. Accordingly, all software development costs have been
expensed as incurred and included in research and development costs.
However, during the third quarter of fiscal year ending June 30, 1999,
the Company began to capitalize software development costs in relation
to the development of software enhancements. The amount that was
capitalized in the third quarter ended March 31, 1999, was approximately
$1.4 million.
<PAGE> 7
Use Of Derivative Financial Instruments
Due to the increasing market risks resulting from fluctuations in
foreign currencies, the Company has begun to use derivative financial
instruments to reduce exposures to its net investments in certain
foreign locations (principally Brazil). The Company does not enter
into financial instruments for trading or speculative purposes. The
derivative financial instruments entered into generally include forward
exchange contracts and foreign currency options maturing in less than
one year. The counterparties to these contracts are major financial
institutions and management believes the risk of loss from
nonperformance by any counterparty is remote.
Any premiums or discounts related to forward exchange contracts are
reported in the balance sheet at cost and amortized to results of
operations over the life of the contract. Foreign currency options are
reported in the balance sheet at quoted market values. Changes in the
market value of foreign currency options are reported in results of
operations in the period in which the change occurs. Gains and losses
on the forward contracts arising from changes in foreign currency
exchange rates are included in results of operations in the period as
the rate changes. As of March 31, 1999, the Company had contracts
totaling $10.0 million outstanding to hedge against its net investment
in Brazil. These contracts expire in May and June 1999. Management
intents to continue to hedge its net investments in foreign locations
as deemed necessary on an ongoing basis.
New Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities.
This statement requires recognition of all derivatives as either assets
or liabilities on the balance sheet and measurement of those
instruments at fair value. Changes in the fair value of derivatives
are recorded each period in current earnings or other comprehensive
income (loss). Proper accounting for changes in fair value of
derivatives held, is dependent on whether the derivative transaction
qualifies as an accounting hedge and on the classification of the hedge
transaction. The statement is required to be adopted and is effective
for all fiscal quarters of fiscal years beginning after June 15, 1999,
and the Company will adopt it in the first quarter of Fiscal Year 2000.
The Company is evaluating the effect this statement will have on its
financial reporting and disclosures as well as on its derivative and
hedging activities.
In March 1998, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of
Position (SOP) 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use, relating to the treatment of
costs incurred to develop software for internal use. This SOP is
effective for financial statements for fiscal years beginning after
December 15, 1998, and should be applied to internal-use computer
software costs incurred in those fiscal years for all projects,
including those projects in progress upon initial application of this
SOP. The Company will adopt this SOP in the first quarter of Fiscal
Year 2000. The Company is evaluating the effect this SOP will have on
its financial reporting and disclosures.
<PAGE> 8
In April 1998, SOP 98-5, Reporting on the Costs of Start-Up Activities,
was issued and provides guidance on the financial reporting of start-up
costs and organization costs. It requires costs of start-up activities
and organization costs to be expensed as incurred. This SOP is
effective for fiscal years beginning after December 15, 1998. The
adoption of this standard will have no material effect on the Company's
financial reporting and disclosures.
In December 1998, SOP 98-9, Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions, was isssued. This
SOP modified SOP 97-2 to permit recognition of revenue for the
delivered elements of a contract when vendor-specific objective evidence
of fair value exists for the undelivered elements of the contract. The
SOP will be effective for transactions that are entered into in fiscal
years beginning after March 15, 1999. Hypercom is currently evaluating
this SOP's impact on its financial statements.
NOTE 3 - INVENTORIES
Inventories, stated at the lower of cost on a first-in, first-out basis
or market value, consisted of the following amounts (in thousands):
March 31, 1999 June 30, 1998
Purchased parts $ 24,162 $ 18,710
Work in process 5,339 11,388
Finished goods 32,325 30,441
------- -------
$ 61,826 $ 60,539
======= =======
NOTE 4 - SEGMENT INFORMATION
Hypercom has two reportable segments: Point-of-Sale (POS) Systems and
Network Systems. POS Systems develops, manufactures, markets, and
supports products that automate electronic payment transactions at the
point of sale in merchant establishments. Network Systems develops,
manufactures, markets, and supports enterprise-networking systems.
Hypercom's reportable segments are strategic business units that offer
different products and services. They are managed separately because
each requires different technologies and marketing strategies.
The following table presents certain segment financial information
unaudited and in thousands for the three month and nine month periods
ended March 31, 1999, and March 31, 1998:
<PAGE> 9
(Unaudited and in thousands)
<TABLE>
<CAPTION>
Three months ended Nine months ended
March 31, 1999 March 31, 1999
POS Network Total POS Network Total
Systems Systems Systems Systems
<S> <C> <C> <C> <C> <C> <C>
Revenue from external customers $46,846 $ 9,458 $56,304 $167,488 $25,393 $192,881
Intersegment revenues 1,925 1,942 3,867 6,832 4,258 11,090
------ ------ ------ ------- ------ -------
Total revenues $48,771 $11,400 $60,171 $174,320 $29,651 $203,971
====== ====== ====== ======= ====== =======
Segment income (loss) from
operations $ 2,803 $ 1,715 $ 4,518 $ 26,400 $ 2,035 $ 28,435
====== ====== ====== ======= ====== =======
Segment assets $301,543 $27,084 $328,627
======= ====== =======
</TABLE>
<TABLE>
<CAPTION>
Three months ended Nine months ended
March 31, 1998 March 31, 1998
POS Network Total POS Network Total
Systems Systems Systems Systems
<S> <C> <C> <C> <C> <C> <C>
Revenue from external customers $50,041 $4,298 $54,339 $182,685 $21,800 $204,485
Intersegment revenues - 1,182 1,182 - 9,050 9,050
------ ------ ------ ------- ------ -------
Total revenues $50,041 $ 5,480 $55,521 $182,685 $30,850 $213,535
====== ====== ====== ======= ====== =======
Segment income from (loss)
operations $10,380 $(2,243) $ 8,137 $ 47,856 $ (393) $ 47,463
====== ====== ====== ======= ====== =======
Segment assets $294,897 $32,552 $327,449
</TABLE>
<TABLE>
<CAPTION>
Reconciliation Three months ended Nine months ended
March 31, March 31,
1999 1998 1999 1998
<S> <C> <C> <C> <C>
Income from operations for reportable segments $ 4,518 $ 8,137 $28,435 $47,463
Elimination of intersegment profits (807) (1,028) 1,992 (1,870)
Unallocated amounts
Corporate expenses (5,455) (3,949) (15,581) (23,870)
------- ------ ------ ------
Consolidated income from operations $(1,744) $ 3,160 $14,846 $21,723
======= ====== ====== ======
</TABLE>
NOTE 5 - ACQUISITIONS
Effective October 1, 1998, Hypercom purchased substantially all the
assets of The Horizon Group, Inc. (Horizon). Horizon is a national
distributor of equipment for Hypercom and other POS equipment
manufacturers. In addition to sales of new equipment, the Company
provides a variety of services, including refurbishing equipment, help
desk, PIN pad key loading, terminal deployment and other custom
programs. The acquisition allows Hypercom to meet the needs of a
segment of its customer base that requires direct-from-manufacturer
terminal services.
The acquisition was accounted for under the purchase method of
accounting. The results of Horizon's operations are included in
Hypercom's condensed consolidated statements of Income and Cash Flows
beginning with the date of acquisition.
Horizon was acquired for $5.0 million in cash and $0.5 million in
Hypercom common stock. The agreement provides for additional payments
up to $7.0 million, based on Horizon's earnings over the three-year
period subsequent to the acquisition date. The additional payments are
to be in the form of Hypercom common stock. The intangible assets
arising from this transaction will be amortized over periods ranging
from five to twenty years.
<PAGE> 10
NOTE 6 - BRAZIL DEVALUATION
As a result of the recent devaluation of the Brazilian Real, the
Company recorded a pretax loss of $4.7 million, related to the net
monetary asset exposure for the three months ended March 31, 1999.
The Company has entered into hedging strategies to mitigate the impact
of future foreign currency fluctuations.
NOTE 7 - SUBSEQUENT EVENTS
Loan Agreement
On April 1, 1999, the Company entered into a floating rate option note
payable to refinance certain property of the Company. The principal
amount of $10,238,000 is payable in semi-annual installments plus
interest at a variable rate, amortized over twenty years with
the final maturity on April 1, 2019. The Company has entered into an
interest rate swap to fix the interest rate at 7.895%. The notes are
collateralized by an unconditional, irrevocable, direct pay letter of
credit. The letter of credit is subject to renewal on April 1, 2006.
If the letter of credit is not renewed, the entire remaining principal
balance will become due and payable. The letter of credit is
collateralized by land and buildings. The Company is required to make
increasing monthly deposits of $18,490 up to $81,752 over the life of
the notes into a sinking fund to provide periodic repayment of the notes.
The projected aggregate principal payments on the Floating Rate Option
Notes, beginning April 1, 1999 are (dollars in thousands):
Fiscal Year
2000 $ 230
2001 247
2002 267
2003 287
2004 310
Thereafter 8,897
------
$10,238
======
Change Of Year End
On April 20, 1999, the Company's Board of Directors approved the change
of Hypercom's fiscal year end from June 30 to December 31. This change
will be implemented as of December 31, 1999. The change aligns the
year to more accurately reflect the Company's natural business cycle.
<PAGE> 11
Report of Independent Accountants
To the Board of Directors and Stockholders of Hypercom Corporation
We have reviewed the condensed consolidated balance sheet of
Hypercom Corporation and subsidiaries as of March 31, 1999, and the
related condensed consolidated statements of income and cash flows for
the three-month and nine-month periods ended March 31, 1999 and 1998.
These financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of
interim financial information consists principally of applying
analytical procedures to financial data and making inquiries of persons
responsible for financial and accounting matters. It is substantially
less in scope than an audit conducted in accordance with generally
accepted auditing standards, the objective of which is the expression
of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications
that should be made to the condensed consolidated financial statements
referred to above for them to be in conformity with generally accepted
accounting principles.
We have previously audited, in accordance with generally accepted
auditing standards, the consolidated balance sheet as of June 30, 1998,
and the related consolidated statements of income, stockholders'
equity, and cash flows for the year then ended (not presented herein);
and in our report dated July 24, 1998, we expressed an unqualified
opinion on those consolidated financial statements. In our opinion,
the information set forth in the accompanying condensed consolidated
balance sheet as of June 30, 1998, is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it
has been derived.
/s/ PricewaterhouseCoopers LLP
Phoenix, Arizona
May 6, 1999
<PAGE> 12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of The Private Securities Litigation Reform Act of
1995. Words such as "believe", "expect", "intend", "anticipate",
"estimate", "project", and similar expressions identify forward-looking
statements, which speak only as of the date the statement was made.
These forward-looking statements may include, but not be limited to,
projections of revenue or net income and issues that may affect revenue
or net income, projections of capital expenditures, plans for future
operations, products or services, financing needs of the Company, and
economic conditions, as well as assumptions relating to the foregoing.
Forward-looking statements are inherently subject to risks and
uncertainties, some of which cannot be predicted or quantified. Future
events and actual results could differ materially from those set forth
in, contemplated by, or underlying the forward-looking statements.
Statements in this Quarterly Report, including the Notes To The
Condensed Consolidated Financial Statements and Management's Discussion
and Analysis of Results of Operations describe factors, among others,
that could contribute to or cause such differences. Additional risk
factors that could cause actual results to differ materially from those
expressed in such forward-looking statements are set forth in Exhibit
99.1 which is attached hereto and incorporated by reference into this
Quarterly Report on Form 10-Q. The Company undertakes no obligation to
publicly update or revise any forward-looking statements, whether as a
result of new information, future events, or otherwise.
Results of Operations
Net Revenue
Net revenues for the three month period ended March 31, 1999, increased
$2.0 million or 3.6% to $56.3 million from $54.3 million in the three
months ended March 31, 1998. Within Hypercom's Point of Sales (POS)
business segment, net revenues from the United States increased $6.2
million due to $7.3 million generated from the Horizon Group, Inc.,
which was acquired by Hypercom effective October 1, 1998. Net revenues
from the POS segment also increased in Europe by $1.3 million. These
increases were offset by decreases in Latin America ($6.3 million) and
in Asia ($4.4 million). The $3.2 million revenue decline in the POS
business segments was offset by a $5.2 million increase in revenue from
Hypercom's Network Systems business segment. This increase primarily
stems from a large branch bank customer in the United Kingdom.
For the nine month period ended March 31, 1999, net revenue decreased
$11.6 million to $192.9 million from $204.5 million for the nine month
period ended March 31, 1998. This decrease in revenue is attributable
to slower POS revenues in Asia (decrease of $23.8 million) and Latin
America (decrease of $14.6 million). These decreases were partially
offset by increased POS revenue from the United States (increase of
$17.1 million) and Europe (increase of $6.0 million). Revenue from The
Horizon Group, Inc. accounted for $15.0 million of the increase in
United States revenue. Revenue from Network Systems has increased
$3.6 million from $21.8 million in the nine months ended March 31, 1998,
to $25.4 million for the nine months ended March 31, 1999, due to a
large branch bank customer in the United Kingdom.
<PAGE> 13
Cost of Revenue
Hypercom's cost of revenue includes the cost of raw materials,
manufacturing labor, overhead, and subcontracted manufacturing costs.
The cost of revenue increased by $3.6 million from $28.4 million to
$32.0 million for the three month period ended March 31, 1999, compared
to the same three month period ended March 31, 1998. Hypercom's cost of
revenue as a percentage of revenue increased to 56.8% for the three
months ended March 31, 1999, up from 52.3% for the three months ended
March 31, 1998. The cost of revenue as a percentage of revenue for the
nine months ended March 31, 1999, was 52.3%, an increase from the 50.6%
for the nine months ended March 31, 1998.
This increase in cost of revenue as a percentage of revenue is the
result of the previously mentioned decline in international POS sales
that have been replaced by lower margin revenues from the recently
acquired Horizon Group. Horizon accounted for $6.9 million of the
$32.0 million in cost of revenues for the three months ended March 31,
1999, and $13.1 million of the $100.9 million in cost of revenue for
the nine months ended March 31, 1999.
Research and Development Expense
Research and development expenses consist mainly of software and
hardware engineering costs and the cost of development personnel.
Research and development expense increased by $0.8 million, or 13.7%,
to $6.9 million in the three month period ended March 31, 1999,
compared to $6.1 million for the three month period ended March 31,
1998. This increase reflects Hypercom's continued investment in new
product development.
For the nine month period ended March 31, 1999, Hypercom's research and
development expense increased 33.9% to $22.8 million compared to $17.0
million for the same period ended March 31, 1998. The overall increase
is a result of development costs for new POS products including the
Interactive Customer Environment (ICE) terminal family and the
Ascendent Server software.
Statement of Financial Accounting Standards No. 86, Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed
(SFAS No. 86), requires capitalization of certain software development
costs subsequent to the establishment of technological feasibility.
The Company's product development process is such that technological
feasibility is established upon completion of a working model. Costs
incurred between completion of the working model and the point at which
the product is ready for initial shipment have not been significant in
the past. Accordingly, all software development costs have been
expensed as incurred and included in research and development costs.
However, during the third quarter of fiscal year ended June 30, 1999,
the Company began to capitalize software development costs in relation
to the development of software enhancements. The amount that was
capitalized in the third quarter ended March 31, 1999, was approximately
$1.4 million.
Selling, General, and Administrative Expense
Sales and marketing expenses, administrative personnel costs, and
facilities operation make up the selling, general, and administrative
expenses. These expenses totaled $19.1 million for the three month
<PAGE> 14
period ended March 31, 1999, or $2.5 million more than the three month
period ended March 31, 1998. As a percentage of revenues, these
expenses increased from 30.6% of revenue for the three month period
ended March 31, 1998, to 34.0% for three month period ended March 31,
1999. The $2.5 million increase is attributable to:
* $0.5 million of selling, general and administrative expenses related
to the operations of The Horizon Group, Inc.,
* $2.0 million increase in international selling expenses related to
Asian, Australian, and Latin American markets, and
* Increased corporate overhead expenses related to facilities
expansion, personnel and management information systems (MIS)
upgrades.
For the nine month period ended March 31, 1999, selling, general and
administrative expenses were up $3.2 million to $54.4 million from
$51.2 million for the nine month period ended March 31, 1998. The $3.2
million increase was primarily attributable to the following factors:
* $1.7 million of selling, general and administrative expenses related
to the operations of The Horizon Group, Inc.,
* $0.7 million of amortized costs related to the acquisition of the
Advantage Group, and
* Increased corporate overhead related to facilities expansion,
personnel and management information systems (MIS) upgrades.
Non-cash Compensation
Hypercom did not have any non-cash compensation expenses for the three
or nine month periods ended March 31, 1999. The non-cash charges for
the nine month period ended March 31, 1998, resulted from specific
provisions of a compensation package for the President and Chief
Executive Officer which terminated upon completion of Hypercom's
initial public offering.
Income from Operations
Income from operations decreased by $4.9 million from $3.2 million in
the three month period ended March 31, 1998, to a loss of $1.7 million
for the three month period ended March 31, 1999. As a percentage of
revenue, income from operations decreased from 5.8% to -3.1%,
respectively. This loss was attributable to the following:
* $0.8 million in additional research and development expenses,
* $2.5 million of increases in selling, general and administrative
expenses, and
* $1.6 million reduction in gross margin.
Income from operations decreased $6.9 million to $14.8 million for the
nine month period ended March 31, 1999, from $21.7 million in the nine
month period ended March 31, 1998. The decrease in income from
operations was attributable to the following:
* Revenue decreased 5.7%, or $11.6 million, with the relating decrease
in gross margin of $8.9 million,
* Research and development expense increased 33.9% or $5.8 million, and
* $3.2 million of increased selling, general and administrative
expenses.
<PAGE> 15
Net Interest, Foreign Currency Losses and Other Items
Interest income consisted primarily of returns on short and long-term
investments, while foreign currency losses resulted from operations in
volatile markets, principally in Brazil. During the three month period
ended March 31, 1999, the net interest and foreign currency losses
amounted to a net loss of $3.6 million compared to income of $1.3
million for the same period ended March 31, 1998. The decrease relates
primarily to the Brazilian currency fluctuations. As a result of the
recent devaluation of the Brazilian Real, the Company recorded a pretax
loss of $4.7 million, related to the net monetary asset exposure for
the three months ended March 31, 1999. The Company has entered into
hedging strategies for Brazil and Australia to mitigate the impact of
future foreign currency fluctuations.
During the nine month period ended March 31, 1999, net interest and
other items were a net loss of $2.2 million, as compared to a loss of
$0.4 million during the same period ended March 31, 1998.
Income Taxes
The provisions (credits) for Federal, State and foreign taxes were
($1.6) million and $0.4 million in the three months ended March 31,
1999, and March 31, 1998, respectively. The provisions for Federal,
State and foreign taxes were $3.9 million and $6.3 million in the nine
months ended March 31, 1999, and March 31, 1998. Hypercom's effective
tax rate was 31% and 30% for the nine month periods ended March 31,
1999 and 1998, respectively. Hypercom's tax rate is typically lower
than the US federal statutory rate due to the following factors:
* Research and experimentation tax credits in Australia and the US,
* Sales in foreign jurisdictions with lower tax rates, and
* The use of a foreign sales corporation offering lower taxes on
certain international sales.
Liquidity and Capital Resources
Hypercom requires working capital to support inventory, maintain
accounts receivable balances and fund capital expenditures needed to
support its operations and net growth.
As of March 31, 1999, Hypercom's working capital was $165.0 million,
which included cash, cash equivalents, and short-term investments of
$66.4 million. Hypercom funds working capital requirements with cash
from operations and short-term borrowing when necessary. Net cash
from operating activities was $4.8 million for the nine month period
ended March 31, 1999 and the net cash used in operating activities
was $6.5 million for the same period in 1998.
Hypercom's capital commitments primarily consist of the purchase or
lease of facilities and equipment. Hypercom used $10.0 million in the
nine months ended March 31, 1999, to purchase fixed assets. These
consisted of:
* $ 4.5 million for facilities expansions, and
* $ 5.5 million for additional equipment including manufacturing
equipment, computer hardware and software.
Hypercom maintains a two-year $10.0 million revolving line of credit
that expires in December 2000. Hypercom believes that its current net
capital position combined with the cash generated by operations and
available borrowings are sufficient to fund operations for the
foreseeable future.
<PAGE> 16
On April 1, 1999, the Company entered into a floating rate option note
payable to refinance certain property of the Company. The principal
amount of $10,238,000 is payable in semi-annual installments plus
interest a variable rate, amortized over twenty years with
the final maturity on April 1, 2019. The Company has entered into an
interest rate swap to fix the interest rate at 7.895%. The notes are
collateralized by an unconditional, irrevocable, direct pay letter of
credit. The letter of credit is subject to renewal on April 1, 2006.
If the letter of credit is not renewed, the entire remaining principal
balance will become due and payable. The letter of credit is
collateralized by land and buildings. The Company is required to make
increasing monthly deposits of $18,490 up to $81,752 over the life of
the notes into a sinking fund to provide periodic repayment of the
notes.
New Accounting Pronouncements
See Note 2 of the Notes to Condensed Consolidated Financial Statements
in Part I.
Year 2000 Issues
Hypercom began a comprehensive project in 1996 to prepare its internal
computer systems for the year 2000. Hypercom believes it's
implementation of a new enterprise-wide information management system,
principally installed to improve operating efficiency, will address
Hypercom's internal year 2000 compliance issues, and therefore does not
believe the year 2000 will have a significant impact on operations.
Hypercom has also reviewed other systems within the Company, from
desktop applications to the software utilized within Hypercom's
telecommunications system, and has concluded that only a few
applications are not capable of making the transition from 1999 to
2000. The costs associated with such upgrades are minimal, and will be
substantially offset through savings generated through increased
productivity and enhanced functionality.
At this time, Hypercom does not believe it is necessary to adopt a
contingency plan covering the possibility that the remaining year 2000
upgrades will not be completed on a timely manner, but will continue to
assess the need for such a plan.
Hypercom develops and distributes computer hardware and software, and
has thoroughly reviewed such systems for year 2000 compliance. Because
of the interaction between Hypercom's hardware/software with other
manufacturer's hardware/software, Hypercom refrains from warranting
Year 2000 compliance. In order to make Hypercom's POS terminal
customers aware of potential issues with the transition from 1999 to
2000, Hypercom has, at its own expense, provided over ten thousand test
cards to enable Hypercom's customers to fully test the ability of
Hypercom's products, when interacting with other vendors
software/hardware, to ascertain whether or not a Year 2000 compliance
issue is present.
Hypercom's IEN/NAC products do not utilize an internal "clock," and
there are no Year 2000 compliance issues with such products.
Workstation software products may have a Year 2000 compliance issue
because of the operating system and database program utilized by
Hypercom's customers, not related to the applications developed and
distributed by Hypercom.
Nevertheless, Hypercom makes no warranty or representation regarding
Year 2000 compliance and believes it is the customer's ultimate
responsibility to verify whether or not there is a Year 2000 compliance
issue.
<PAGE> 17
Hypercom faces risk to the extent that suppliers of products and
services purchased by Hypercom and others with whom Hypercom transacts
business on a worldwide basis do not have business products and
services that comply with the year 2000 requirements. Hypercom is in
the process of obtaining assurances from most of its key suppliers that
their products and services are year 2000 compliant. In the event any
such third party cannot in a timely manner, provide Hypercom with
products and services that meet the year 2000 requirements, Hypercom
could be materially adversely affected.
Backlog
As of March 31, 1999, Hypercom had backlog of $131.0 million, or an
increase of 80.9% compared to the same date in 1998. December 31, 1998
backlog was $118 million, September 30, 1998, backlog was $92.2 million
and June 30, 1998, was $77.6 million. Backlog includes all revenue
specified in signed contracts and purchase orders expected to be
realized within one year.
Forward-Looking Statements
Certain statements made above, which are summarized below, are forward-
looking statements that involve risks and uncertainties, and actual
results may be materially different. Factors that could cause actual
results to differ include those identified as follows:
The belief that Hypercom's effective tax rate is typically lower than
the us federal statutory rate - Changes in the mix of sales to or away
from foreign jurisdictions with lower tax rates and changes in US or
foreign tax laws may inhibit Hypercom's ability to maintain its overall
effective tax rate at present levels.
The belief that Hypercom's current net capital position, combined with
the Cash generated by operations and available borrowings, is
sufficient to fund operations for the foreseeable future - Changes in
anticipated operating results, credit availability and equity market
conditions may inhibit Hypercom's ability to maintain or raise
appropriate levels of cash.
The belief that the cost of transitioning to year 2000 compatible
Information systems will be offset by cost savings generated through
Increased productivity and the ability to enhance internal reporting -
Changes in anticipated levels of expenditures, degrees of difficulty in
implementing new systems and amounts of cost savings may inhibit
Hypercom's ability to offset the cost of transitioning to year 2000
compatible systems.
Item 3. Quantitative and Qualitative Disclosures About Market
Risk
Hypercom is exposed to financial market risks, including changes in
interest rates and foreign currency exchange rates. Nevertheless, the
fair value of Hypercom's investment portfolio or related income would
not be significantly impacted by either a 100 basis point increase or
decrease in interest rates, due primarily to the short-term nature of
the major portion of Hypercom's investment portfolio.
<PAGE> 18
A substantial portion of Hypercom's revenue and capital spending is
transacted in U.S. dollars. However, Hypercom does at times enter into
these transactions in other currencies, such as the Hong Kong dollar,
Australian dollar, Brazilian Real and other Asian and European
currencies. Hypercom has, from time to time, established revenue and
balance sheet hedging programs to protect against reductions in value
and cash flow volatility caused by changes in foreign exchange rates.
Such programs are intended to reduce market risks, but do not always
eliminate the impact of foreign currency exchange volatility.
Hypercom does not purchase or hold any derivative financial instruments
for the purpose of speculation or arbitrage. See information/discussion
appearing in subcaption "Risks Associated with International Operations
and Foreign Currency Fluctuations" of "CAUTIONARY STATEMENT REGARDING
FORWARD-LOOKING STATEMENTS AND RISK FACTORS" set forth in Exhibit 99.1,
attached hereto.
<PAGE> 19
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Item 1 of Part II of Hypercom's Form 10-Q for the three month
period ended September 30, 1998, for disclosures regarding pending
matters.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit Number Description of Exhibit
- -------------- ---------------------
11.1 Statement re: Computation of Per Share Earnings
15.1 Letter re: Unaudited Interim Financial Information
27.1 Financial Data Schedule
99.1 Cautionary Statement Regarding Forward-
Looking Statements and Risk Factors
(b) Reports on Form 8-K
The Company filed Form 8-K on April 27, 1999, regarding the change in
the Company's fiscal year end.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
HYPERCOM CORPORATION
Date: May 11, 1999 By: /s/ Jonathon E. Killmer
Jonathon E. Killmer
Senior Vice President and
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
11.1 Statement re: Computation of Per Share Earnings
15.1 Letter re: Unaudited Interim Financial Information
27.1 Financial Data Schedule
99.1 Cautionary Statement Regarding Forward Looking
Statements and Risk Factors
<PAGE> 20
Exhibit 11.1
In accordance with the disclosure requirements of SFAS 128, a
reconciliation of the numerator and denominator of basic and diluted
EPS is provided below.
<TABLE>
<CAPTION>
(Unaudited and in thousands, except per share amounts)
Three months ended Nine months ended
March, 31 March, 31
1999 1998 1999 1998
<S> <C> <C> <C> <C>
Numerator - Basic and Diluted EPS:
Net income $(3,666) $ 4,034 $ 8,693 $ 14,985
Denominator - Basic EPS:
Common stock outstanding 33,098 33,531 33,133 29,107
Basic earnings per share ($0.11) $ 0.12 $ 0.26 $ 0.51
======= ======= ======= ======
Denominator - Diluted EPS:
Denominator - Basic EPS 33,098 33,531 33,133 29,107
Effect of Dilutive Securities
Common stock options - 1,981 1,376 1,631
------- ------- ------ ------
Diluted shares outstanding 33,098 35,512 34,509 30,738
Diluted earnings per share $(0.11) $ 0.11 $ 0.25 $ 0.49
======= ======= ======= ======
<PAGE> 21
</TABLE>
Exhibit-15.1
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
We are aware that our report dated May 6, 1999, on our review of interim
condensed consolidated financial information of Hypercom Corporation
(the "Company") for the three month and nine month periods ended March
31, 1999 and 1998, and included in the Company's quarterly report on
Form 10-Q for the quarters then ended, is incorporated by reference in
the Company's registration statements on Form S-8 (Registration Nos.
333-40457, 333-40459, 333-40461 and 333-40333). Pursuant to Rule
436(c), under the Securities Act of 1933, this report should not be
considered a part of the registration statements prepared or certified
by us within the meaning of Sections 7 and 11 of that Act.
PricewaterhouseCoopers LLP
Phoenix, Arizona
May 6, 1999
<PAGE> 22
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<MULTIPLIER> 1,000
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> MAR-31-1999
<CASH> 37,220
<SECURITIES> 29,196
<RECEIVABLES> 47,987
<ALLOWANCES> 3,656
<INVENTORY> 61,826
<CURRENT-ASSETS> 200,195
<PP&E> 41,863
<DEPRECIATION> 12,689
<TOTAL-ASSETS> 263,300
<CURRENT-LIABILITIES> 35,080
<BONDS> 0
0
0
<COMMON> 15
<OTHER-SE> 224,962
<TOTAL-LIABILITY-AND-EQUITY> 263,300
<SALES> 192,881
<TOTAL-REVENUES> 192,881
<CGS> 100,861
<TOTAL-COSTS> 178,035
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 4,127
<INTEREST-EXPENSE> 777
<INCOME-PRETAX> 12,598
<INCOME-TAX> 3,905
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,693
<EPS-PRIMARY> $0.26
<EPS-DILUTED> $0.25
</TABLE>
[DESCRIPTION]EX-99.1
Exhibit 99.1
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS AND
RISK FACTORS
In passing the Private Securities Litigation Reform Act of 1995
(the "Reform Act"), Congress encouraged public companies to make
"forward-looking statements" by creating a safe harbor to protect
companies from securities law liability in connection with
forward-looking statements. Hypercom Corporation intends to
qualify both its written and oral forward-looking statements for
protection under the Reform Act and any other similar safe harbor
provisions.
"Forward-looking statements" are defined by the Reform Act.
Generally, forward-looking statements include expressed
expectations of future events and the assumptions on which the
expressed expectations are based. All forward-looking
statements are inherently uncertain as they are based on various
expectations and assumptions concerning future events and they
are subject to numerous known and unknown risks and uncertainties
that could cause actual events or results to differ materially
from those projected. Due to those and other uncertainties and
risks, the investment community is urged not to place undue
reliance on written or oral forward-looking statements of
Hypercom. Hypercom undertakes no obligation to update or revise
this Cautionary Statement Regarding Forward-Looking Statements to
reflect future developments. In addition, Hypercom undertakes no
obligation to update or revise forward-looking statements to
reflect changed assumptions, the occurrence of unanticipated
events, or changes to future operating results over time.
Hypercom provides the following risk factor disclosure in
connection with its continuing effort to qualify its written and
oral forward-looking statements under the safe harbor protection
of the Reform Act and any other similar safe harbor provisions.
Important factors currently known to management that could cause
actual results to differ materially from those in forward-looking
statements include the disclosures contained in the Quarterly
Report on Form 10-Q to which this statement is appended as an
exhibit and also include the following:
RISK FACTORS
Difficulty in Forecasting Net Revenue
Hypercom's net revenue in any period is difficult to forecast.
Some of the factors affecting net revenue include the timing of
product purchases and the length of the sales cycle for
Hypercom's products.
Hypercom POS Systems and its customers enter into purchase
agreements that generally have a one-year term and minimum
purchase commitments. However, customers are not required to make
purchases at any particular times during the term of the
agreement or to purchase products exclusively from Hypercom.
Because the timing of product purchases in any given period is at
the customers' exclusive discretion and control, net revenue for
POS products is difficult to forecast.
<PAGE> 24
It is also difficult to forecast net revenue in certain
international markets where large orders for complete systems
occur more frequently than in the U.S. Due to the significant
cost of buying complete systems, their sales cycle is long and
difficult to predict.
Hypercom Network Systems operates with little backlog and, as a
result, net revenue in any quarter is substantially dependent on
the orders booked and shipped in that quarter. The highly
technical nature of these sales generally results in a sales
cycle that ranges from 12 to 18 months.
Hypercom's operating results are subject to other uncertainties,
including the following:
* Industry and economic conditions;
* Competitive pressures;
* Type, timing, and size of orders and shipments for major
customers;
* Variations in product mix and cost;
* Overhead costs;
* Obsolescence of inventory;
* Manufacturing or production difficulties; and
* Nonrecurring charges.
Significant Fluctuations in Quarterly Results
Hypercom's operating results vary from quarter to quarter. If
sales and shipments in any quarter do not meet expectations, the
results may be adversely affected. Any unexpected decline in the
growth of the net revenue without a quick reduction in the growth
of operating expenses could have a serious negative effect on
operating results and financial condition. Hypercom cannot be
sure that it will meet profitability objectives for a quarter if
sales fall or the gross margin is reduced.
Seasonality
Hypercom continues to experience some degree of seasonality. For
this reason, net revenue and results of operations are stronger
in the first half of the fiscal year reflecting:
* Increased POS purchases to satisfy increased retail demand
during the holiday season,
* Incentive programs VISA and MasterCard offer from July to
December to encourage merchants to offer card-based payment
systems, and
* Allocation of customers' capital budgets by the end of March
with volume shipments beginning in July.
Risks Associated with International Operations and Foreign
Currency Fluctuations
Hypercom's net revenue from international sales for fiscal years
1996, 1997 and 1998 was approximately 58%, 56% and 57%,
respectively, of Hypercom's net revenue. Hypercom expects that
international sales will continue to account for a significant
<PAGE> 25
percentage of its net revenue in the foreseeable future.
Accordingly, Hypercom is subject to risks associated with
international operations. Examples of these risks include:
* Management of a multinational organization,
* Fluctuations in currency exchange rates,
* Compliance with local laws,
* Regulatory and product certification requirements,
* Changes in international laws and requirements,
* Tariffs and other trade barriers,
* Import and export controls,
* Restrictions on the repatriation of funds,
* Inflationary conditions,
* Staffing, employment, and severance issues,
* Political instability and economic downturns, which include
the impact of revenue generated from Hypercom's shipments
into Asia,
* War or other hostilities,
* Expropriation or nationalization of assets,
* Overlap of tax structures,
* Renegotiations or nullification of contracts, and
* Longer payment cycles.
In some countries these risks and other factors that relate to
doing business abroad may have negative effects on Hypercom.
Hypercom takes steps such as hedging to partially offset changes
in currency exchange rates. However, there is no assurance that
such strategies enable Hypercom to avoid losses due to changes in
the exchange rate. In addition, the inability to effectively
manage these and other risks could have a serious negative effect
on Hypercom's business or financial condition.
Hypercom generally does not engage in hedging transactions that
could partially offset the effects of fluctuations in currency
exchange rates. However, as Hypercom continues to expand its
international operations, exposure to gains and losses on foreign
currency transactions may increase. Hypercom may choose to limit
such exposure by entering into forward foreign exchange contracts
or engaging in similar hedging strategies. For example, the
Company recently entered into hedging transactions to mitigate
the adverse effects of significant foreign currency fluctuations
in Brazil. There can be no assurance that any currency exchange
strategy would be successful in avoiding exchange-related losses
or that the failure to manage currency risks will not have a
material adverse effect on Hypercom's business, operating results
or financial condition.
Uncertainty of Profitability for Hypercom Network Systems
Hypercom established Hypercom Network Systems in 1994 to continue
to develop enterprise networking products and technologies for
the electronic payments industry and to leverage these
technologies to address other enterprise networking
opportunities. Since its formation, Hypercom Network Systems has
expended substantial sums on research and development and on
establishing distinct manufacturing operations and distribution
channels. Hypercom Network Systems has recently incurred losses
as a standalone business, and management is implementing plans to
return it to profitability. However, there can be no assurance
that it will return to profitability, particularly in light of
the competitive nature of the industry in which it operates.
<PAGE> 26
Industry and Technological Changes; Dependence on Development and
Market Acceptance of New Products
Hypercom believes that in the next few years the following
factors will create major changes in the POS industry:
* Lower-cost products,
* Greater functionality at the point of sale,
* Faster and more accurate transaction processing,
* Improvements in security features, and
* Emerging technologies and payment programs.
In addition, the enterprise networking industry is characterized
by rapid changes in technology and numerous new product
introductions. Hypercom's success, particularly in the enterprise
networking industry, will depend to a large degree upon its
continued ability to offer new products and enhancements to its
existing products to meet changing market and industry
requirements. New products and technologies may have an effect on
the sales of existing products and technologies. There can be no
assurance that the introduction of new products and technologies
will not have a material adverse affect on Hypercom's business
and financial condition.
Developing new products and technologies is a complex, uncertain
process requiring innovation and accurate anticipation of
technological and market trends. Hypercom cannot provide complete
assurance of its ability to successfully:
* Identify, develop, or manufacture new products and
technologies,
* Market or support these new products and technologies,
* Control delays in introducing new products,
* Gain market acceptance for the new products and
technologies,
* Respond to technological changes and new industry
standards, and
* Respond to competitors' announcements of new products.
The inability to respond effectively to any of these challenges
may have a negative impact on Hypercom's business and financial
success. Hypercom may suffer other business and financial losses
if it is successful in marketing new products and responding to
competitive and industry changes. When changes to the product
line are announced, Hypercom will be challenged to:
* Manage possible shortened life cycles for existing
products,
* Continue to sell existing products, and
* Prevent customers from returning existing products.
Dependence on Current Management and Key Personnel
George Wallner, Albert A. Irato, Paul Wallner, and Jairo Gonzalez
are instrumental in Hypercom's development, growth, and
operations. Hypercom has employment agreements with Mr. Irato and
Mr. Gonzalez. However it does not have employment agreements with
George Wallner, Paul Wallner, or any other member of senior
management. Although Hypercom has no plans to enter into employment
agreements with other executive officers or key employees, Hypercom
may review the value of such employment agreements in the future.
<PAGE> 27
Hypercom is the beneficiary of key-man life insurance of $1.0
million on both George Wallner and Paul Wallner. The loss of any
of the key executives of Hypercom could have a negative effect on
Hypercom's business and financial condition.
Hypercom's continued growth and operations also depend on the
continued service of other key employees and the hiring of
qualified new employees. Competition for highly skilled business,
technical, marketing, and other staff is intense. Competition is
particularly fierce given the current strong economy for high-
technology companies. In addition, competing for skilled
employees may result in increased compensation costs. If Hypercom
is not successful in retaining and hiring qualified staff,
negative effects on its business and financial condition may
result.
Excess or Obsolete Inventory
Managing Hypercom's inventory of components and finished products
is a complex task. Hypercom must avoid maintaining excess
inventory as a result of:
* The need to maintain significant inventory of components
that are in limited supply,
* Buying components in bulk for the best pricing,
* Responding to the unpredictable demand for products,
* Responding to customer requests for quick delivery
schedules, and
* Storing products made obsolete by new product offerings.
If Hypercom accumulates excess or obsolete inventory, price
reductions and inventory write-downs may result. Such a situation
could adversely affect Hypercom's business and financial
condition.
Competition
Hypercom is active in very competitive markets. Among the main
competitive factors are the following:
* Product quality
* Reliability
* Performance
* Functionality
* Pricing
* Certification
* Upgradeability
Hypercom's main competition in the electronic payment industry is
VeriFone, Inc. Hewlett-Packard Company acquired VeriFone, Inc.
in 1997. Enterprise networking competitors include Cisco Systems,
Inc, 3Com Corporation, and Motorola Information Systems Group.
Some competitors have significantly greater financial and
technical resources, better name recognition, and a larger
customer base than Hypercom.
<PAGE> 28
Hypercom faces additional competitive challenges in foreign
countries. These factors include the following:
* Preferences for national vendors,
* Difficulties in obtaining necessary certifications and
* Difficulties in meeting the requirements of government
policies
These competitive challenges may result in price discounts or
other concessions and in sales lost to competitors. As a result,
Hypercom's business and financial condition could suffer. In
addition, Hypercom cannot be certain of its ability to compete
successfully in the future.
Dependence on Certain Suppliers and Third-Party Distributors
Hypercom contracts with an independent manufacturer to build
networking products. It is also dependent on sole-source
suppliers for microprocessors, some integrated circuits, and
other electronic components. Other components are available from
only a limited number of sources. Hypercom has generally been
able to obtain adequate supplies of these products. However, in
the future if Hypercom could not secure enough products or
develop alternate sources, product introductions or shipments
could be delayed. Significant delays could have a serious
negative effect on Hypercom's business and financial condition.
Hypercom markets and distributes its products to end-users
through third-party distributors. Third-party distributors are a
prime channel for distribution in some international markets. In
the U.S. they are becoming more important, especially for the
enterprise networking products. Therefore, the ability to market
and distribute products depends significantly on Hypercom's
relationship with third-party distributors.
The performance and financial condition of distributors could
have a negative impact on Hypercom's business and financial
condition if:
* Hypercom's relationships with them were to deteriorate,
* They could not perform as expected or pay Hypercom, or
* Local laws prevented Hypercom from using distributors
that perform poorly.
Reliance on Certain Hypercom POS Systems Customers
Many Hypercom POS Systems sales result from large purchases by a
few large organizations. Although no one customer accounted for
more than 10% of Hypercom's net revenue in fiscal 1998, the two
largest customers accounted for 17.9% of the net that year. The
five largest accounted for 28.9% of net revenue.
Hypercom typically enters into one-year purchase agreements with
its larger customers. These agreements generally provide for
minimum purchase commitments and do not require the customers to
buy POS products from Hypercom exclusively.
Serious negative impacts could result if any of the larger POS
customers delayed or stopped buying from Hypercom. Hypercom
expects to continue to rely on a limited number of customers in
any given period for a significant part of its net revenue.
<PAGE> 29
Further, customer demand can be adversely affected by many
factors including the following:
* Budgetary constraints,
* Changes in the customer's competitive environment,
* Customer involvement in mergers or other strategic
alignments,
* Price increases by Hypercom or its competitors,
* Personnel changes,
* The number, timing, and significance of new and enhanced
products,
* The ability of Hypercom to market new and enhanced
products, and
* General economic factors.
Hypercom cannot be assured that its important customers will
continue to buy its products at historical or any particular
level.
Impact of Industry Regulation and Standards
Before sales are completed in the United States, Hypercom's
products must:
* Meet industry standards as imposed by VISA, MasterCard,
and others,
* Be certified to connect to some public telecommunications
networks,
* Comply with Federal Communications Commission (FCC)
regulations, and
* Comply with Underwriters Laboratories regulations.
Similarly, before completing sales in foreign countries,
Hypercom's products must comply with:
* Local telecommunications standards,
* Recommendations of quasi-regulatory authorities and
* Recommendations of standards-setting committees.
In addition, public carriers require that equipment connected to
their networks comply with their own standards. These standards
in part reflect their currently installed equipment. Some public
carriers have equipment that does not fully meet current industry
standards. Hypercom must address this issue in designing
enterprise-networking products.
Although Hypercom believes its products currently meet all
applicable industry standards, it has no assurance that its
products will comply with future standards. Negative impacts to
Hypercom's business and financial condition could result in the
future if Hypercom cannot:
* Obtain needed regulatory approvals or certifications,
* Retain domestic or foreign approvals or certifications,
and
* Meet new industry standards.
In addition, carriers set the tariffs that govern rates for
public telecommunications services, including their features and
capacity. These services are subject to regulatory approval.
Changes in the tariffs could have a serious negative effect on
Hypercom's business and financial condition.
<PAGE> 30
Hypercom must comply with state, federal, and international laws
governing such areas as:
* Occupational health and safety,
* Minimum wages,
* Work hours and overtime,
* Retirement and profit-sharing plans and severance
payments, and
* The use, storage, handling, and disposal of dangerous
chemicals.
Failure to comply with requirements could impose additional costs
on Hypercom. Such failure could also require Hypercom to stop
some activities or otherwise have a serious negative effect on
Hypercom's business and financial condition.
Product Defects
Hypercom offers very complex products. When they are first
introduced or released in new versions, they may contain software
or hardware defects that are difficult to detect and correct.
Even though Hypercom and customers test all these products, it is
likely that such errors will continue to be identified after
products are shipped.
When they are detected, correcting these defects can be a time-
consuming or impossible task. Software errors may take several
months to correct, and hardware errors may take even longer. The
existence of defects and delays in correcting them could result
in negative consequences including:
* Delays in shipping products,
* Loss of market acceptance for Hypercom products,
* Additional warranty expenses,
* Diversion of resources from product development, and
* Loss of credibility with distributors and customers.
Because Hypercom's POS products are used to process payment
transactions, the security features of such products are
important. In general, these products are designed to comply with
industry practices relating to transaction security. Failure of
the security features could adversely affect the marketing of
Hypercom products. Any violation of its product warranties
resulting from security breaches could result in claims against
Hypercom.
Dependence on Proprietary Technology
Hypercom seeks to establish and protect the proprietary aspects
of its products by relying on patent, copyright, trademark, and
trade secret laws. It also relies on confidentiality, licensing,
and other contractual arrangements, all of which may provide only
limited protection. Although Hypercom tries to protect its
proprietary rights, unauthorized third parties may be able to
copy some portions of or to reverse engineer products to obtain
technology that Hypercom regards as proprietary.
In addition, the laws of certain countries do not protect
Hypercom's proprietary rights to the same extent as U.S. laws.
Accordingly, Hypercom may not be able to protect its proprietary
technology against unauthorized copying or use, which could
adversely affect Hypercom's competitive position.
<PAGE> 31
Hypercom has applied for patents and trademarks that may not be
granted. If they are granted, the patents may not cover all
claims Hypercom is trying to protect. Further, a challenge could
find any Company patent or trademark invalid and unenforceable.
Hypercom products and technologies incorporate some subject
matter it believes is in the public domain or otherwise within
the rights of Hypercom to use. Such products and technologies
include some designed and provided by third parties. These third
parties could assert patent or other intellectual property
infringement claims against Hypercom with respect to its products
and technologies.
From time to time, third parties claim that Hypercom's products
infringe their proprietary rights. Hypercom may experience
similar claims in the future. Regardless of its merit, any claim
can be time-consuming, result in costly litigation, and require
Hypercom to enter into royalty and licensing agreements. The
terms of these agreements may not be acceptable to Hypercom. If a
claim against Hypercom is successful and Hypercom fails to
develop or license a substitute technology quickly, it could be
adversely affected.
Risks of Potential Acquisitions
Hypercom may acquire or make substantial investments in related
businesses, technologies, or products in the future. Any
acquisition or investment would entail various risks including
the following:
* The difficulty of assimilating the technologies,
operations and personnel of the acquired business,
technology or product,
* The potential disruption of Hypercom's ongoing business
and
* The possible inability of Hypercom to obtain the desired
financial and strategic benefits from the acquisition or
investment.
These factors could have a serious negative effect on Hypercom's
business and financial condition. Future acquisitions and
investments could also result in the following:
* Substantial cash expenditures,
* Potentially dilutive issuance of equity securities,
* The incurring of additional debt and contingent
liabilities and
* Amortization expenses related to goodwill and other
intangible assets that could adversely affect Hypercom's
business, operating results, and financial condition.
The acquisition of the assets and business of The Horizon Group,
Inc. has consumed and will continue to consume substantial
management attention and resources of Hypercom, and will require
substantial efforts and entail certain risks in the integration
of its operations. There can be no assurance that anticipated
cost savings or synergies will be achieved. Hypercom will be
dependent on the retention and performance of Horizon's existing
management and employees for the day-to-day management and future
operation results of the business.
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Voting Control by Existing Stockholders
George Wallner and Paul Wallner together own 63.4% of Hypercom's
outstanding Common Stock. Accordingly, the Wallners have the
ability to control the affairs of Hypercom, including the
election of all directors to Hypercom's Board of Directors. They
can also, except as otherwise provided by law, approve or
disapprove other matters submitted to a vote of Hypercom's
stockholders, including a merger, consolidation, or sale of
assets. This voting control also may have the effect of delaying
or preventing a change in control of Hypercom and may affect the
price investors are willing to pay in the future for shares of
Hypercom's Common Stock.
Potential Volatility of Stock Price
In recent years, the stock market has experienced extreme price
changes. The market price of Hypercom's Common Stock has been and
may continue to be affected by various factors such as the
following:
* Quarterly variations in Hypercom's operating results,
* Changes in revenue growth rates for specific geographic
areas, business units, products, or Hypercom as a whole,
* Earnings estimates or changes in estimates by market
analysts,
* Speculation in the press or analyst community,
* Announcement of new or enhanced products by Hypercom or
its competitors, and
* General market conditions or market conditions specific
to particular industries.
Anti-takeover Effect of Certain Charter and Bylaw Provisions and
Delaware Law
Hypercom has provisions in its Amended and Restated Certificate
of Incorporation and Amended and Restated Bylaws, which:
* Make it more difficult for a third party to take control
of Hypercom,
* Discourage a third party from attempting to take control
of Hypercom or
* Limit the price some investors are willing to pay for
shares of Hypercom's Common Stock,
* Enable Hypercom to issue Preferred Stock without a vote
or other stockholder action,
* Provide for a classified Board of Directors and regulate
nominations for the Board of Directors,
* Make it more difficult for stockholders to take certain
corporate actions, and
* Delay or prevent a change in control of Hypercom.
In addition, certain provisions of Delaware law applicable to
Hypercom could also delay a merger, tender offer, or proxy
contest or make one more difficult.
