PAY 10Q 4/30/14
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
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þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the quarterly period ended April 30, 2014 |
Or
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¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the transition period from to |
Commission file number: 001-32465
VERIFONE SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
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| | |
Delaware | | 04-3692546 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
2099 Gateway Place, Suite 600
San Jose, CA 95110
(Address of principal executive offices with zip code)
(408) 232-7800
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
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 the preceding 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 þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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Large accelerated filer þ | | | Accelerated filer ¨ |
Non-accelerated filer ¨ (Do not check if a smaller reporting company) | Smaller reporting company ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
The number of shares outstanding of each of the issuer's classes of common stock, as of the close of business on May 30, 2014: |
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Class | | | Number of shares | |
Common Stock, $0.01 par value per share | 111,722,717 | |
VERIFONE SYSTEMS, INC.
TABLE OF CONTENTS
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PART I — FINANCIAL INFORMATION |
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Item 1 | | |
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Item 2 | | |
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Item 3 | | |
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Item 4 | | |
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PART II — OTHER INFORMATION |
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Item 1 | | |
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Item 1A | | |
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Item 2 | | |
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Item 3 | | |
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Item 4 | | |
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Item 5 | | |
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Item 6 | | |
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PART I — FINANCIAL INFORMATION
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ITEM 1. | FINANCIAL STATEMENTS (Unaudited) |
VERIFONE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
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| | | | | | | | | | | | | | | |
| Three Months Ended April 30, | | Six Months Ended April 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
| (Unaudited, in thousands, except per share data) |
Net revenues: | | | | | | | |
System solutions | $ | 290,734 |
| | $ | 276,560 |
| | $ | 551,900 |
| | $ | 558,268 |
|
Services | 175,683 |
| | 149,727 |
| | 350,583 |
| | 296,766 |
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Total net revenues | 466,417 |
| | 426,287 |
| | 902,483 |
| | 855,034 |
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Cost of net revenues: | | | | | | | |
System solutions | 187,571 |
| | 180,872 |
| | 355,079 |
| | 355,115 |
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Services | 103,572 |
| | 91,109 |
| | 201,913 |
| | 173,651 |
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Total cost of net revenues | 291,143 |
| | 271,981 |
| | 556,992 |
| | 528,766 |
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Total gross margin | 175,274 |
| | 154,306 |
| | 345,491 |
| | 326,268 |
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Operating expenses: | | | | | | | |
Research and development | 49,999 |
| | 41,581 |
| | 100,531 |
| | 81,383 |
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Sales and marketing | 56,417 |
| | 46,496 |
| | 107,028 |
| | 92,244 |
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General and administrative | 48,749 |
| | 43,676 |
| | 99,663 |
| | 83,657 |
|
Litigation settlement and loss contingency expense | 9,000 |
| | 69,000 |
| | 9,000 |
| | 69,000 |
|
Amortization of purchased intangible assets | 24,657 |
| | 23,122 |
| | 49,332 |
| | 47,818 |
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Total operating expenses | 188,822 |
| | 223,875 |
| | 365,554 |
| | 374,102 |
|
Operating loss | (13,548 | ) | | (69,569 | ) | | (20,063 | ) | | (47,834 | ) |
Interest, net | (9,490 | ) | | (11,249 | ) | | (20,879 | ) | | (22,751 | ) |
Other income (expense), net | (1,183 | ) | | 2,306 |
| | (6,310 | ) | | 6,246 |
|
Loss before income taxes | (24,221 | ) | | (78,512 | ) | | (47,252 | ) | | (64,339 | ) |
Income tax benefit | (658 | ) | | (21,483 | ) | | (7,592 | ) | | (19,020 | ) |
Consolidated net loss | (23,563 | ) | | (57,029 | ) | | (39,660 | ) | | (45,319 | ) |
Net income attributable to noncontrolling interests | (352 | ) | | (1,347 | ) | | (488 | ) | | (1,219 | ) |
Net loss attributable to VeriFone Systems, Inc. stockholders | $ | (23,915 | ) | | $ | (58,376 | ) | | $ | (40,148 | ) | | $ | (46,538 | ) |
Net loss per share attributable to VeriFone Systems, Inc. stockholders: | | | | | | | |
Basic | $ | (0.22 | ) | | $ | (0.54 | ) | | $ | (0.36 | ) | | $ | (0.43 | ) |
Diluted | $ | (0.22 | ) | | $ | (0.54 | ) | | $ | (0.36 | ) | | $ | (0.43 | ) |
Weighted average number of shares used in computing net loss per share: | | | | | | | |
Basic | 111,104 |
| | 108,314 |
| | 110,706 |
| | 108,122 |
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Diluted | 111,104 |
| | 108,314 |
| | 110,706 |
| | 108,122 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
VERIFONE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
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| Three Months Ended April 30, | | Six Months Ended April 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
| (Unaudited, in thousands) |
Net loss attributable to VeriFone Systems, Inc. stockholders | $ | (23,915 | ) | | $ | (58,376 | ) | | $ | (40,148 | ) | | $ | (46,538 | ) |
| | | | | | | |
Other comprehensive income (loss): | | | | | | | |
Net change in: | | | | | | | |
Foreign currency translation | 15,680 |
| | (44,737 | ) | | (3,016 | ) | | 3,538 |
|
Unrealized gain (loss) on derivatives, net of tax | 224 |
| | (243 | ) | | 489 |
| | 684 |
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Other | 28 |
| | (299 | ) | | (144 | ) | | 11 |
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Comprehensive loss attributable to VeriFone Systems, Inc. stockholders | $ | (7,983 | ) | | $ | (103,655 | ) | | $ | (42,819 | ) | | $ | (42,305 | ) |
The accompanying notes are an integral part of these condensed consolidated financial statements.
VERIFONE SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
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| | | | | | | |
| April 30, 2014 | | October 31, 2013 |
| (Unaudited, in thousands, except par value) |
ASSETS | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 229,829 |
| | $ | 268,220 |
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Accounts receivable, net of allowances of $9,815 and $12,652 | 300,843 |
| | 284,020 |
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Inventories, net | 113,338 |
| | 138,695 |
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Prepaid expenses and other current assets | 124,698 |
| | 134,057 |
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Total current assets | 768,708 |
| | 824,992 |
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Fixed assets, net | 180,946 |
| | 172,187 |
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Purchased intangible assets, net | 559,694 |
| | 642,890 |
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Goodwill | 1,254,568 |
| | 1,252,472 |
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Deferred tax assets, net | 25,167 |
| | 23,897 |
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Other long-term assets | 72,015 |
| | 77,282 |
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Total assets | $ | 2,861,098 |
| | $ | 2,993,720 |
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LIABILITIES AND EQUITY | | | |
Current liabilities: | | | |
Accounts payable | $ | 146,858 |
| | $ | 116,533 |
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Accruals and other current liabilities | 230,677 |
| | 292,019 |
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Deferred revenue, net | 97,601 |
| | 86,576 |
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Short-term debt | 103,843 |
| | 92,536 |
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Total current liabilities | 578,979 |
| | 587,664 |
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Long-term deferred revenue, net | 49,919 |
| | 42,622 |
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Long-term deferred tax liabilities | 158,881 |
| | 175,945 |
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Long-term debt | 836,411 |
| | 943,325 |
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Other long-term liabilities | 94,656 |
| | 92,510 |
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Total liabilities | 1,718,846 |
| | 1,842,066 |
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Commitments and contingencies |
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Redeemable noncontrolling interest in subsidiary | 711 |
| | 593 |
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Stockholders’ equity: | | | |
Preferred stock: $0.01 par value, 10,000 shares authorized, no shares issued and outstanding as of April 30, 2014 and October 31, 2013, respectively
| — |
| | — |
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Common stock: $0.01 par value, 200,000 shares authorized, 111,485 and 110,160 shares issued and outstanding as of April 30, 2014 and October 31, 2013, respectively
| 1,115 |
| | 1,102 |
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Additional paid-in capital | 1,633,212 |
| | 1,598,735 |
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Accumulated deficit | (540,226 | ) | | (500,078 | ) |
Accumulated other comprehensive income | 12,176 |
| | 14,847 |
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Total stockholders’ equity | 1,106,277 |
| | 1,114,606 |
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Noncontrolling interest in subsidiaries | 35,264 |
| | 36,455 |
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Total liabilities and equity | $ | 2,861,098 |
| | $ | 2,993,720 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
VERIFONE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
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| | | | | | | |
| Six Months Ended April 30, |
| 2014 | | 2013 |
| (Unaudited, in thousands) |
Cash flows from operating activities | | | |
Consolidated net loss | $ | (39,660 | ) | | $ | (45,319 | ) |
Adjustments to reconcile consolidated net loss to net cash provided by operating activities: | | | |
Depreciation and amortization, net | 106,143 |
| | 101,224 |
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Stock-based compensation expense | 27,609 |
| | 22,388 |
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Deferred income taxes, net | (14,387 | ) | | (42,216 | ) |
Other | 6,402 |
| | 1,000 |
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Net cash provided by operating activities before changes in operating assets and liabilities | 86,107 |
| | 37,077 |
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Changes in operating assets and liabilities, net of effects of business acquisitions: | | | |
Accounts receivable, net | (16,678 | ) | | 50,140 |
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Inventories, net | 24,858 |
| | (1,646 | ) |
Prepaid expenses and other assets | 4,544 |
| | (3,294 | ) |
Accounts payable | 29,786 |
| | (41,537 | ) |
Deferred revenue, net | 18,766 |
| | 12,043 |
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Other current and long-term liabilities | (58,948 | ) | | 79,798 |
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Net change in operating assets and liabilities | 2,328 |
| | 95,504 |
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Net cash provided by operating activities | 88,435 |
| | 132,581 |
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Cash flows from investing activities | | | |
Capital expenditures | (41,902 | ) | | (42,213 | ) |
Acquisition of businesses, net of cash and cash equivalents acquired | — |
| | (11,953 | ) |
Other investing activities, net | 2,618 |
| | 7,989 |
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Net cash used in investing activities | (39,284 | ) | | (46,177 | ) |
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Cash flows from financing activities | | | |
Proceeds from debt, net of issuance costs | 86,906 |
| | 30,053 |
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Repayments of debt | (182,639 | ) | | (58,402 | ) |
Proceeds from issuance of common stock through employee equity incentive plans | 10,388 |
| | 5,075 |
|
Payments of acquisition-related contingent consideration | (415 | ) | | (9,280 | ) |
Other financing activities, net | (1,559 | ) | | (1,689 | ) |
Net cash used in financing activities | (87,319 | ) | | (34,243 | ) |
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Effect of foreign currency exchange rate changes on cash and cash equivalents | (223 | ) | | (280 | ) |
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Net increase (decrease) in cash and cash equivalents | (38,391 | ) | | 51,881 |
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Cash and cash equivalents, beginning of period | 268,220 |
| | 454,072 |
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Cash and cash equivalents, end of period | $ | 229,829 |
| | $ | 505,953 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
Note 1. Principles of Consolidation and Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of VeriFone Systems, Inc. and our wholly-owned and majority-owned subsidiaries, and have been prepared in accordance with U.S. GAAP for interim financial information and with the instructions on Form 10-Q pursuant to the rules and regulations of the U.S. Securities and Exchange Commission. All significant inter-company accounts and transactions have been eliminated. In accordance with those rules and regulations, we have omitted certain information and notes normally provided in our annual consolidated financial statements. In the opinion of management, the unaudited Condensed Consolidated Financial Statements contain all adjustments, consisting only of normal recurring items, necessary for the fair presentation of our financial position and results of operations for the interim periods. These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K for the fiscal year ended October 31, 2013. The results of operations for the three and six months ended April 30, 2014 are not necessarily indicative of the results expected for the entire fiscal year.
We operate in three segments: Americas, EMEA, and ASPAC. Our Americas segment is defined as our operations in North America, South America, Central America, and the Caribbean. Our EMEA segment is defined as our operations in Europe, the Middle East, and Africa. Our ASPAC segment consists of our operations in Asia, Australia, New Zealand, and other Asia Pacific Rim countries. Our reportable segments are the same as our operating segments. We determine our operating segments based on discrete financial information used by our Chief Executive Officer, who is our chief operating decision maker, to assess performance, allocate resources, and make decisions regarding VeriFone's operations. Our Chief Executive Officer is evaluating using global product line financial information to manage the business in the future. If our Chief Executive Officer is provided different financial information to assess performance, allocate resources and make decisions regarding VeriFone's operations, we will reassess our operating segment presentation.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions about future events that affect the amounts reported in our consolidated financial statements and accompanying notes. We evaluate our estimates on an ongoing basis when updated information related to such estimates becomes available. We base our estimates on historical experience and information available to us at the time these estimates are made. Actual results could differ materially from these estimates.
Significant Accounting Policies
During the three and six months ended April 30, 2014, there have been no changes in our significant accounting policies as described in our Annual Report on Form 10-K for the fiscal year ended October 31, 2013.
Concentrations of Credit Risk
For the three months ended April 30, 2014 and 2013 no single customer accounted for more than 10% of our total net revenues. For the three months ended April 30, 2014, one customer accounted for approximately 12.5% of total net revenues in our Americas reportable segment and one customer accounted for approximately 11.7% of total net revenues in our ASPAC reportable segment. No single customer accounted for more than 10% of total net revenues in our EMEA reportable segment for the three months ended April 30, 2014. For the three months ended April 30, 2013, one customer accounted for approximately 14.2% of total net revenues in our Americas reportable segment and one customer accounted for approximately 15.5% of total net revenues in our
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
ASPAC reportable segment. No single customer accounted for more than 10% of total net revenues in our EMEA reportable segment for the three months ended April 30, 2013.
For the six months ended April 30, 2014 and 2013 no single customer accounted for more than 10% of our total net revenues. For the six months ended April 30, 2014, no single customer accounted for more than 10% of total net revenues in any of our reportable segments. For the six months ended April 30, 2013, three customers accounted for approximately 11.2%, 10.7% and 10.2% of total net revenues in our ASPAC reportable segment, and no single customer accounted for more than 10% of total net revenues in our other reportable segments.
As of April 30, 2014 and October 31, 2013, no single customer accounted for more than 10% of our Accounts receivable, net.
Recent Accounting Pronouncements
We adopted ASU 2013-02, Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income, effective November 1, 2013. ASU 2013-02 requires disclosure of amounts reclassified out of accumulated other comprehensive income by component and by net income line item. Adoption of ASU 2013-02 had no impact on our consolidated financial position, or results of operations.
During July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU 2013-11 provides presentation requirements for unrecognized tax benefits when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists. ASU 2013-11 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2013. Early adoption and retrospective application is permitted. ASU 2013-11 may impact the asset or liability financial statement presentation of certain unrecognized tax benefits, but will not change our assessment of the realizability of our deferred tax assets, and will not have a material impact on our consolidated results of operations. We plan to adopt ASU 2013-11 in our first quarter of fiscal year 2015.
During April 2014, the FASB issued ASU 2014-08, Presentation of Financial Statements and Property, Plant, and Equipment: Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. ASU 2014-08 limits discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have or will have a major effect on an entity’s operations and financial results, and requires expanded disclosures for discontinued operations. ASU 2014-08 is effective for all disposals of components of an entity that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. Early adoption is permitted, but only for disposals that have not been reported in financial statements previously issued or available for issuance. We adopted ASU 2014-08 effective April 30, 2014, and adoption had no impact on our financial statement presentation, financial position or results of operations.
During May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which provides new guidance on the recognition of revenue and states that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard will be effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. We are currently evaluating the impact of the adoption of this accounting standard update on our consolidated financial position or results of operations.
Note 2. Net Loss per Share of Common Stock
Basic net loss per share of common stock is computed by dividing net loss by the weighted average number of shares of common stock outstanding for the period. Diluted net loss per share of common stock is computed using the weighted average number of shares of common stock outstanding plus the effect of common stock equivalents, unless the common stock equivalents are anti-dilutive. The potential dilutive shares of our common stock resulting from assumed exercises of equity related instruments are determined using the treasury stock method. Under the treasury stock method, an increase in the fair market value of our common stock will result in a greater number of dilutive securities.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The following table presents the computation of net loss per share of common stock (in thousands, except per share data):
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| | | | | | | | | | | | | | | |
| Three Months Ended April 30, | | Six Months Ended April 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Basic and diluted net loss per share attributable to VeriFone Systems, Inc. stockholders: | | | | | | | |
Numerator: | | | | | | | |
Net loss attributable to VeriFone Systems, Inc. stockholders | $ | (23,915 | ) | | $ | (58,376 | ) | | $ | (40,148 | ) | | $ | (46,538 | ) |
Denominator: | | | | | | | |
Weighted average shares attributable to VeriFone Systems, Inc. stockholders - basic | 111,104 |
| | 108,314 |
| | 110,706 |
| | 108,122 |
|
Weighted average effect of dilutive securities: | | | | | | | |
Stock options, RSUs and RSAs | — |
| | — |
| | — |
| | — |
|
Weighted average shares attributable to VeriFone Systems, Inc. stockholders - diluted | 111,104 |
| | 108,314 |
| | 110,706 |
| | 108,122 |
|
Net loss per share attributable to VeriFone Systems, Inc. stockholders: | | | | | | | |
Basic | $ | (0.22 | ) | | $ | (0.54 | ) | | $ | (0.36 | ) | | $ | (0.43 | ) |
Diluted | $ | (0.22 | ) | | $ | (0.54 | ) | | $ | (0.36 | ) | | $ | (0.43 | ) |
For the three months ended April 30, 2014 and 2013, equity incentive awards representing 9.2 million and 6.8 million shares of common stock, respectively, were anti-dilutive. For the six months ended April 30, 2014 and 2013, equity incentive awards representing 9.2 million and 6.7 million shares of common stock, respectively, were anti-dilutive. Anti-dilutive awards, which include stock options, RSUs and RSAs, could impact future calculations of diluted net income per share in periods when we are profitable if the fair market value of our common stock increases.
Warrants to purchase 7.2 million shares of our common stock were outstanding at April 30, 2013 and expired unexercised in equal amounts on each trading day from December 19, 2013 to February 3, 2014. The warrants were anti-dilutive in all periods presented because the warrants' $62.356 exercise price was greater than the average share price of our common stock during each of those periods when they were outstanding.
Note 3. Income Taxes
We recorded an income tax benefit of $0.7 million and $21.5 million for the three months ended April 30, 2014 and 2013, respectively. We recorded income tax benefits of $7.6 million and $19.0 million for the six months ended April 30, 2014 and 2013, respectively. The income tax benefit for the six months ended April 30, 2014 includes tax benefits from statutory tax rate changes in certain foreign countries, decreases in prior year unrecognized tax benefits, and other discrete activity. Losses generated during the three and six months ended April 30, 2014 in the U.S. federal, state, and certain foreign jurisdictions did not result in a tax benefit due to valuation allowances. The income tax benefit for the three and six months ended April 30, 2013 includes a discrete tax benefit of $21.3 million related to Litigation settlement and loss contingency expense and a discrete tax benefit of $7.2 million related to the impact of changes in the statutory tax rates on deferred taxes offset by a discrete tax expense of $10.7 million related to an increase in uncertain tax positions.
Our total unrecognized tax benefits were approximately $114.3 million as of April 30, 2014. The amount of unrecognized tax benefits could be reduced upon closure of tax examinations or if the statute of limitations on certain tax filings expires without assessment from the relevant tax authorities. We believe that it is reasonably possible that there could be an immaterial reduction in unrecognized tax benefits due to statute of limitation expirations in multiple tax jurisdictions during the next 12 months. Interest and penalties accrued on these uncertain tax positions will also be released upon the expiration of the applicable statute of limitations.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Note 4. Balance Sheet and Statement of Operations Details
Cash and Cash Equivalents
As of April 30, 2014 and October 31, 2013, $203.9 million and $206.2 million, respectively, of our cash and cash equivalents were held by our foreign subsidiaries. If we decide to distribute or use such cash and cash equivalents outside those foreign jurisdictions, including a distribution to the U.S., we may be subject to additional taxes or costs.
As of April 30, 2014 and October 31, 2013, Prepaid expenses and other current assets included $6.7 million and $5.6 million, respectively, of restricted cash, and Other long-term assets included $8.2 million and $8.6 million, respectively, of restricted cash. Restricted cash was mainly comprised of pledged deposits and deposits to Brazilian courts related to tax proceedings pending adjudication.
Inventories, net
Inventories, net consisted of the following (in thousands):
|
| | | | | | | |
| April 30, 2014 | | October 31, 2013 |
Raw materials | $ | 32,658 |
| | $ | 35,247 |
|
Work-in-process | 2,844 |
| | 2,030 |
|
Finished goods | 77,836 |
| | 101,418 |
|
Total inventories, net | $ | 113,338 |
| | $ | 138,695 |
|
Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consisted of the following (in thousands):
|
| | | | | | | |
| April 30, 2014 | | October 31, 2013 |
Prepaid expenses | $ | 39,490 |
| | $ | 42,837 |
|
Prepaid taxes | 28,155 |
| | 23,427 |
|
Deferred income taxes | 26,277 |
| | 30,162 |
|
Insurance proceeds receivable | — |
| | 10,000 |
|
Other current assets | 30,776 |
| | 27,631 |
|
Total prepaid expenses and other current assets | $ | 124,698 |
| | $ | 134,057 |
|
Other current assets were primarily comprised of customer related bankers acceptances receivable, restricted cash, and other receivables.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Fixed Assets, Net
Fixed assets, net consisted of the following (in thousands):
|
| | | | | | | | | |
| Estimated Useful Life (Years) | | April 30, 2014 | | October 31, 2013 |
Revenue generating assets | 5 | | $ | 168,563 |
| | $ | 147,017 |
|
Computer hardware and software | 3-5 | | 89,106 |
| | 82,069 |
|
Machinery and equipment | 3-10 | | 47,820 |
| | 43,987 |
|
Leasehold improvements | Lesser of the term of the lease or the estimated useful life | | 24,646 |
| | 22,464 |
|
Office equipment, furniture, and fixtures | 3-5 | | 14,651 |
| | 13,694 |
|
Buildings | 40-50 | | 6,808 |
| | 6,827 |
|
Total depreciable fixed assets, at cost | | | 351,594 |
| | 316,058 |
|
Accumulated depreciation | | | (185,138 | ) | | (152,989 | ) |
Depreciable fixed assets, net | | | 166,456 |
| | 163,069 |
|
Construction in progress | | | 13,274 |
| | 7,968 |
|
Land | | | 1,216 |
| | 1,150 |
|
Total fixed assets, net | | | $ | 180,946 |
| | $ | 172,187 |
|
Total depreciation expense for the three months ended April 30, 2014 and 2013 was $14.6 million and $13.0 million, respectively. Total depreciation expense for the six months ended April 30, 2014 and 2013 was $28.8 million and $25.3 million, respectively.
Accruals and Other Current Liabilities
Accruals and other current liabilities consisted of the following (in thousands): |
| | | | | | | |
| April 30, 2014 | | October 31, 2013 |
Accrued legal loss contingencies, including interest (Note 9) | $ | 33,500 |
| | $ | 96,781 |
|
Accrued expenses | 70,108 |
| | 73,522 |
|
Accrued compensation | 63,934 |
| | 60,175 |
|
Other current liabilities | 63,135 |
| | 61,541 |
|
Total accruals and other current liabilities | $ | 230,677 |
| | $ | 292,019 |
|
Other current liabilities were primarily comprised of sales and value-added taxes payable, accrued warranty, income taxes payable, and accrued liabilities for contingencies related to tax assessments.
Accrued Warranty
Activity related to accrued warranty consisted of the following (in thousands):
|
| | | |
| Six months ended April 30, 2014 |
Balance at beginning of period | $ | 13,352 |
|
Warranty charged to Cost of net revenues | 4,646 |
|
Utilization of warranty accrual | (6,191 | ) |
Other | 903 |
|
Balance at end of period | 12,710 |
|
Less: current portion | (11,476 | ) |
Long-term portion | $ | 1,234 |
|
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Deferred Revenue, Net
Deferred revenue, net of related costs consisted of the following (in thousands):
|
| | | | | | | |
| April 30, 2014 | | October 31, 2013 |
Deferred revenue | $ | 164,558 |
| | $ | 144,181 |
|
Deferred cost of revenue | (17,038 | ) | | (14,983 | ) |
Deferred revenue, net | 147,520 |
| | 129,198 |
|
Less: current portion | (97,601 | ) | | (86,576 | ) |
Long-term portion | $ | 49,919 |
| | $ | 42,622 |
|
Stock-Based Compensation Expense
The following table presents the stock-based compensation expense recognized in our Condensed Consolidated Statements of Operations (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended April 30, | | Six Months Ended April 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Cost of net revenues | $ | 208 |
| | $ | 417 |
| | $ | 761 |
| | $ | 963 |
|
Research and development | 1,744 |
| | 1,390 |
| | 5,859 |
| | 3,007 |
|
Sales and marketing | 5,864 |
| | 3,769 |
| | 8,628 |
| | 7,862 |
|
General and administrative | 4,061 |
| | 4,454 |
| | 12,361 |
| | 10,556 |
|
Total stock-based compensation expense | $ | 11,877 |
| | $ | 10,030 |
| | $ | 27,609 |
| | $ | 22,388 |
|
Accumulated Other Comprehensive Income (Loss)
Activity related to Accumulated other comprehensive income (loss), net of tax, for the six months ended April 30, 2014 consisted of the following (in thousands):
|
| | | | | | | | | | | | | | | | |
| | Foreign currency translation adjustments | | Unrealized loss on derivatives designated as cash flow hedges (1) | | Other (2) | | Total |
Balance as of October 31, 2013 | | $ | 18,301 |
| | $ | (2,014 | ) | | $ | (1,440 | ) | | $ | 14,847 |
|
Gains (losses) before reclassifications, net of tax | | (3,016 | ) | | 1,862 |
| | 152 |
| | (1,002 | ) |
Amounts reclassified from Accumulated other comprehensive income (loss), net of tax | | — |
| | (1,373 | ) | | (296 | ) | | (1,669 | ) |
Other comprehensive gain (loss) | | (3,016 | ) | | 489 |
| | (144 | ) | | (2,671 | ) |
Balance as of April 30, 2014 | | $ | 15,285 |
| | $ | (1,525 | ) | | $ | (1,584 | ) | | $ | 12,176 |
|
| |
(1) | Amounts reclassified from Accumulated other comprehensive income (loss), net of tax, were recorded in Interest, net in the Condensed Consolidated Statements of Operations. The related tax impacts were insignificant. |
| |
(2) | Amounts reclassified from Accumulated other comprehensive income (loss), net of tax, were recorded in Other income (expense), net in the Condensed Consolidated Statements of Operations. The related tax impacts were insignificant. |
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Note 5. Financial Instruments
Fair Value Measurements
Our financial assets and liabilities consist principally of cash, money market funds, short-term time deposits, accounts receivable, investments, accounts payable, debt, foreign exchange forward contracts, interest rate swaps, and acquisition-related earn-out payables. We measure and record certain of our financial assets and liabilities at fair value on a recurring basis. The estimated fair value of cash, accounts receivable, and accounts payable approximates their carrying value. The estimated fair value of our debt approximates the carrying value because the interest rate on such debt adjusts to market rates on a periodic basis. Money market funds, short-term time deposits, investments, foreign exchange forward contracts and interest rate swaps are recorded at estimated fair value.
The following tables present our significant assets and liabilities that are measured at fair value on a recurring basis and their classification within the fair value hierarchy (in thousands). There were no transfers between levels of fair value hierarchy in the three and six months ended April 30, 2014 and 2013.
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| April 30, 2014 | | October 31, 2013 |
| Carrying Value | | Level 1 | | Level 2 | | Level 3 | | Carrying Value | | Level 1 | | Level 2 | | Level 3 |
Assets | | | | | | | | | | | | | | | |
Current assets: | | | | | | | | | | | | | | | |
Cash and cash equivalents | | | | | | | | | | | | | | | |
Money market funds | $ | 8,634 |
| | $ | 8,634 |
| | $ | — |
| | $ | — |
| | $ | 638 |
| | $ | 638 |
| | $ | — |
| | $ | — |
|
Other current and long-term assets: | | | | | | | | | | | | | | | |
Derivative financial instruments | 150 |
| | — |
| | 150 |
| | — |
| | 435 |
| | — |
| | 435 |
| | — |
|
Total assets measured and recorded at fair value | $ | 8,784 |
| | $ | 8,634 |
| | $ | 150 |
| | $ | — |
| | $ | 1,073 |
| | $ | 638 |
| | $ | 435 |
| | $ | — |
|
| | | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | |
Other current and long-term liabilities: | | | | | | | | | | | | | | | |
Derivative financial instruments | $ | 2,581 |
| | $ | — |
| | $ | 2,581 |
| | $ | — |
| | $ | 3,720 |
| | $ | — |
| | $ | 3,720 |
| | $ | — |
|
Total liabilities measured and recorded at fair value | $ | 2,581 |
| | $ | — |
| | $ | 2,581 |
| | $ | — |
| | $ | 3,720 |
| | $ | — |
| | $ | 3,720 |
| | $ | — |
|
Derivative Financial Instruments
Interest Rate Swap Agreements Designated as Cash Flow Hedges
We use interest rate swap agreements to hedge the variability in cash flows related to interest payments. On March 23, 2012, we entered into a number of interest rate swap agreements to effectively convert $500.0 million of the term A loan from a floating rate to a 0.71% fixed rate plus applicable margin. The interest rate swaps qualify for hedge accounting treatment as cash flow hedges. The interest rate swaps are effective for the period from March 30, 2012 to March 31, 2015. The notional amounts of interest rate swap agreements outstanding as of April 30, 2014 and October 31, 2013 were $500.0 million.
Gains and losses arising from the effective portion of interest rate swap agreements are recorded in Accumulated other comprehensive income (loss), and are subsequently reclassified into earnings in the period or periods during which the underlying transactions affect earnings. As of April 30, 2014, the estimated net derivative loss related to our cash flow hedges included in Accumulated other comprehensive income (loss) that will be reclassified into earnings within the next 12 months was $2.4 million.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Foreign Exchange Forward Contracts Not Designated as Hedging Instruments
We arrange and maintain foreign exchange forward contracts so as to yield gains or losses to offset changes in foreign currency denominated assets or liabilities due to changes in foreign exchange rates, in an attempt to mitigate the volatility associated with foreign currency transaction gains or losses. Our foreign currency exposures are predominantly inter-company receivables and payables arising from product sales and loans from one of our entities to another. Our foreign exchange forward contracts generally mature within 90 days. The notional amounts of such contracts outstanding as of April 30, 2014 and October 31, 2013 were $234.0 million and $245.5 million, respectively.
We recognized the following gains (losses) on foreign exchange forward contracts not designated as cash flow hedges (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended April 30, | | Six Months Ended April 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Gains (losses) recognized in Other income (expense), net in our Condensed Consolidated Statements of Operations | $ | (5,142 | ) | | $ | (1,285 | ) | | $ | (5,573 | ) | | $ | 1,112 |
|
Note 6. Goodwill and Purchased Intangible Assets
Goodwill
Activity related to goodwill consisted of the following (in thousands):
|
| | | |
| Six months ended April 30, 2014 |
Balance at beginning of period | $ | 1,252,472 |
|
Adjustment related to prior fiscal year acquisition | (622 | ) |
Currency translation adjustments | 2,718 |
|
Balance at end of period | $ | 1,254,568 |
|
Goodwill is not amortized. We review goodwill for impairment annually, and whenever events or changes in circumstances indicate its carrying amount may not be recoverable. Based on our review for potential indicators of impairment performed during the six months ended April 30, 2014 and the fiscal year ended October 31, 2013, there were no indicators of impairment.
Purchased Intangible Assets, Net
Purchased intangible assets, net consisted of the following (in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | |
| April 30, 2014 | | October 31, 2013 |
| Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount |
Customer relationships | $ | 722,996 |
| | $ | (228,041 | ) | | $ | 494,955 |
| | $ | 726,225 |
| | $ | (182,980 | ) | | $ | 543,245 |
|
Developed and core technology | 157,613 |
| | (103,900 | ) | | 53,713 |
| | 175,981 |
| | (90,491 | ) | | 85,490 |
|
Other | 23,212 |
| | (12,186 | ) | | 11,026 |
| | 24,377 |
| | (10,222 | ) | | 14,155 |
|
Total | $ | 903,821 |
| | $ | (344,127 | ) | | $ | 559,694 |
| | $ | 926,583 |
| | $ | (283,693 | ) | | $ | 642,890 |
|
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Amortization of purchased intangible assets was allocated as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended April 30, | | Six Months Ended April 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Included in cost of net revenues | $ | 11,074 |
| | $ | 11,062 |
| | $ | 22,537 |
| | $ | 22,123 |
|
Included in operating expenses | 24,657 |
| | 23,122 |
| | 49,332 |
| | 47,818 |
|
Total amortization of purchased intangible assets | $ | 35,731 |
| | $ | 34,184 |
| | $ | 71,869 |
| | $ | 69,941 |
|
Note 7. Financings
Amounts outstanding under our financing arrangements consisted of the following (in thousands):
|
| | | | | | | |
| April 30, 2014 | | October 31, 2013 |
2011 Credit Agreement | | | |
Term A loan | $ | 883,606 |
| | $ | 922,156 |
|
Term B loan | — |
| | 48,428 |
|
Revolving loan | 55,000 |
| | 63,000 |
|
Other | 1,648 |
| | 2,277 |
|
Total amounts outstanding | 940,254 |
| | 1,035,861 |
|
Less: current portion | (103,843 | ) | | (92,536 | ) |
Long-term portion | $ | 836,411 |
| | $ | 943,325 |
|
2011 Credit Agreement
On December 24, 2013, we paid the $48.4 million balance due on the outstanding term B loan. This payment was partially funded through $47.0 million additional borrowings under the revolving loan.
Key terms of the 2011 Credit Agreement include financial maintenance covenants and certain representations, warranties, covenants, and conditions that are customarily required for similar financings, and are described in Note 9, Financings, in the Notes to Consolidated Financial Statements of our 2013 Annual Report on Form 10-K. We were in compliance with all financial covenants under the 2011 Credit Agreement as of April 30, 2014.
Borrowings under the 2011 Credit Agreement bear interest at a “Base Rate” or “Eurodollar Rate”, at our option, plus an applicable margin based on certain financial ratios, determined and payable quarterly. The interest rate of each of the term A loan and the revolving loan is one month LIBOR plus the applicable margin. As of April 30, 2014, we elected the "Eurodollar Rate" margin option and the interest margins were 2.75% for the term A loan and the revolving loan. Accordingly, as of April 30, 2014, the interest rate on the term A and revolving loan was 2.91%.
Note 8. Restructurings
As part of cost optimization and corporate transformation initiatives, during April 2014 our management approved, committed to and initiated a restructuring plan under which we will reduce headcount and close facilities. This plan is estimated to be complete by March 2015 and will cost approximately $6.5 million, including approximately $5.4 million for employee involuntary termination benefits and approximately $1.1 million related to facility exits.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Subsequent to the end of our second quarter of fiscal 2014, on June 1, 2014, our management approved, committed to and initiated another restructuring plan under which we will reduce headcount, close facilities and consolidate data centers. We expect to incur charges totaling approximately $17.0 million under this plan, including approximately $15.0 million related to employee involuntary termination benefits and approximately $2.0 million related to facility exits and data center consolidations.
The determination of when we accrue for employee involuntary termination benefits depends on whether the termination benefits are provided under a one-time benefit arrangement or under an on-going benefit arrangement. We record charges for one-time benefit arrangements in accordance with ASC 420 Exit or Disposal Cost Obligations and charges for on-going benefit arrangements in accordance with ASC 712 Nonretirement Postemployment Benefits.
Activity related to our restructuring plans for the six months ended April 30, 2014 consisted of the following (in thousands):
|
| | | | | | | | | | | |
| Employee Involuntary Termination Benefits | | Facilities Related Costs | | Total |
Balance as of October 31, 2013 | $ | — |
| | $ | 581 |
| | $ | 581 |
|
Current year charges | 5,102 |
| | 1,140 |
| | 6,242 |
|
Other adjustments | — |
| | (471 | ) | | (471 | ) |
Cash payments | (3,141 | ) | | (110 | ) | | (3,251 | ) |
Balance as of April 30, 2014 | $ | 1,961 |
| | $ | 1,140 |
| | 3,101 |
|
Less: current portion |
|
| |
|
| | (1,961 | ) |
Long-term portion |
|
| |
|
| | $ | 1,140 |
|
The restructuring liability at October 31, 2013 related to a facility that was exited under our 2008 restructuring plan and for which the lease was terminated during March 2014.
The current portion of our restructuring liability is included in Accruals and other current liabilities and the long-term portion of our restructuring liability is included in Other long-term liabilities in the Condensed Consolidated Balance Sheets.
The following table presents the restructuring expense recognized in our Condensed Consolidated Statements of Operations (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended April 30, | | Six Months Ended April 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Cost of net revenues | $ | 866 |
| | $ | — |
| | $ | 866 |
| | $ | — |
|
Research and development | 734 |
| | — |
| | 734 |
| | 323 |
|
Sales and marketing | 2,614 |
| | — |
| | 2,614 |
| | — |
|
General and administrative | 1,557 |
| | — |
| | 1,557 |
| | — |
|
| $ | 5,771 |
| | $ | — |
| | $ | 5,771 |
| | $ | 323 |
|
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Note 9. Commitments and Contingencies
Commitments
Leases
We lease certain facilities under non-cancelable operating leases. In connection with our taxi solutions business, we enter into operating lease arrangements for the right to place advertising in or on taxicabs. In general, these lease arrangements are non-cancelable for terms ranging from three to ten years, require us to pay minimum lease amounts based on the type and locations of the advertising displays in or on the taxicabs, and are subject to fee escalation clauses. Based upon the number of operational taxicabs with our advertising displays at April 30, 2014, we had total lease commitments of $104.8 million relating to such lease arrangements, which are included in the future minimum lease payments in the table below.
Future minimum lease payments and sublease rental income under these leases as of April 30, 2014 were as follows (in thousands):
|
| | | | | | | | | | | |
Years Ending October 31: | Minimum Lease Payments | | Sublease Rental Income | | Net Minimum Lease Payments |
Remainder of fiscal year 2014 | $ | 25,562 |
| | $ | (89 | ) | | $ | 25,473 |
|
2015 | 34,431 |
| | (153 | ) | | 34,278 |
|
2016 | 27,707 |
| | — |
| | 27,707 |
|
2017 | 23,468 |
| | — |
| | 23,468 |
|
2018 | 14,831 |
| | — |
| | 14,831 |
|
Thereafter | 35,872 |
| | — |
| | 35,872 |
|
Total | $ | 161,871 |
| | $ | (242 | ) | | $ | 161,629 |
|
Rent expense consisted of the following (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended April 30, | | Six Months Ended April 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Rent expense for non-cancelable taxi operating leases | $ | 9,528 |
| | $ | 7,450 |
| | $ | 17,978 |
| | $ | 15,090 |
|
Facility and other rent expense | 7,406 |
| | 6,960 |
| | 14,824 |
| | 13,947 |
|
Total rent expense | $ | 16,934 |
| | $ | 14,410 |
| | $ | 32,802 |
| | $ | 29,037 |
|
Manufacturing Agreements
We work on a purchase order basis with our contract manufacturers, which are located in China, Singapore, Malaysia, Brazil, Germany, Romania, and France, and component suppliers located throughout the world, to supply nearly all of our finished goods inventories, spare parts, and accessories. We provide each such supplier with a purchase order to cover the manufacturing requirements, which generally constitutes a binding commitment by us to purchase materials and finished goods produced by the manufacturer as specified in the purchase order. Most of these purchase orders are considered to be non-cancelable and are expected to be paid within one year of the issuance date. As of April 30, 2014, the amount of purchase commitments issued to contract manufacturers and component suppliers totaled approximately $122.3 million. Of this amount, $13.7 million has been recorded in Accruals and other current liabilities in our Condensed Consolidated Balance Sheets because these commitments are not expected to have future value to us.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Bank Guarantees
We have issued bank guarantees with maturities ranging from two months to six years to certain of our customers and vendors as required in some countries to support certain performance obligations under our service or other agreements with those parties. As of April 30, 2014, the maximum amount that may become payable under these guarantees was $13.8 million, of which $3.6 million was collateralized by restricted cash deposits.
Letters of Credit
We provide standby letters of credit in the ordinary course of business to third parties as required. As of April 30, 2014, the maximum amounts that may become payable under these letters of credit was $8.0 million, of which $4.9 million was collateralized by restricted cash deposits.
Contingencies
We evaluate the circumstances regarding outstanding and potential litigation, and other contingencies on a quarterly basis to determine whether there is at least a reasonable possibility that a loss exists requiring accrual or disclosure, and if so, whether an estimate of the possible loss or range of loss can be made, or whether such an estimate cannot be made. When a loss is probable and reasonably estimable, we accrue for such amount based on our estimate of the probable loss considering information available at the time. When a loss is reasonably possible, we disclose the estimated possible loss or range of loss in excess of amounts accrued. Except as otherwise disclosed below, we do not believe that losses were probable or that there was a reasonable possibility that a material loss may have been incurred with respect to the matters disclosed.
Brazilian Tax Assessments
State Value-Added Tax
The Brazilian subsidiary we acquired as part of our acquisition of Hypercom in August 2011 received an unfavorable administrative decision on a tax enforcement action against it filed by the São Paulo State Revenue Department for collection of state sales taxes related to purported sales of software for the 1998 and 1999 tax years. In 2004, an appeal against this unfavorable administrative decision was filed in a judicial proceeding. The first level decision in the judicial proceeding was issued in our favor. The São Paulo State Revenue Department filed an appeal of this decision. The second level administrative decision ordered that the case be returned to the lower court in order to allow the production of further evidence. Based on our current understanding of the underlying facts of this matter, we believe it is reasonably possible that we may receive an unfavorable decision in this proceeding. The tax assessment including estimated interest through April 30, 2014 for this matter totals approximately 7.4 million Brazilian reais (approximately $3.3 million at the foreign exchange rate as of April 30, 2014). As of April 30, 2014, we have not accrued for this matter.
Federal Tax Assessments
Brazilian Federal Tax Amnesty
In December 2013, without admitting any fault or liability, we elected to enroll certain of our pending Brazilian tax assessments in the Brazilian Federal Tax Amnesty Program created by Law n. 11.941/2009 in 2009 and reopened for enrollment from October 2013 to December 2013, known as the "REFIS Amnesty.” The REFIS Amnesty is a program administered by the Brazilian tax authorities and allows entities charged with tax assessments that fall within the program’s scope to voluntarily settle such assessments with certain discounts applied to the amounts due. After conducting an evaluation of our existing Brazilian federal tax assessments and the terms offered by the REFIS Amnesty, we determined to voluntarily settle a number of our pending assessments.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Tax assessment matters that fall within the REFIS Amnesty's scope are generally listed in the program's web-based portal for enrollment. Although no formal acceptance by the tax authorities is issued at the time of our enrollment of a matter, we expect the tax authorities to confirm our enrollment as they complete their process to formally consolidate the matters we enrolled in the REFIS Amnesty. In connection with our enrollment of the tax assessments into the REFIS Amnesty, we were required to forego any further legal defense or proceedings with respect to the merits of such assessments. In exchange, the enrolled assessments are closed and we are granted discounts on our payment of the related accrued interest and penalties and are able to pay under an installment plan, subject to our compliance with the terms of the program. For certain assessments, existing net operating loss carryforwards, or net operating losses, may be used to satisfy a portion of the settlement obligation. Under the terms of the REFIS Amnesty, our right to fund the settlement through the installment payment plan would be canceled after three instances of our not timely paying the installment amounts as scheduled, in which case the full amounts of the original tax debts, including interest and penalties without the benefit of discount, would become immediately due and payable. We have included the terms and amounts below for those assessments that we have placed into the REFIS Amnesty.
Federal Tax Assessments related to Brazilian Subsidiaries from Lipman Acquisition
Two of our Brazilian subsidiaries that were acquired as a part of the November 2006 acquisition of Lipman Electronic Engineering Ltd. (“Lipman”) were notified of assessments regarding Brazilian customs penalties that relate to alleged infractions in the importation of goods. The assessments were issued by the Federal Revenue Department in the City of Vitória, the City of São Paulo, and the City of Itajai. In each of these cases, the tax authorities allege that the structure used for the importation of goods was simulated with the objective of evading taxes levied on the importation by under-invoicing the imported goods. The tax authorities allege that the simulation was created through an interposition of parties and that the real sellers and buyers of the imported goods were hidden. In February 2013, the São Paulo assessment was canceled following a favorable second level decision that was not appealed.
In the Vitória tax assessment, the fines were reduced from 4.7 million Brazilian reais (approximately $2.1 million at the foreign exchange rate as of April 30, 2014) to 1.5 million Brazilian reais (approximately $657,000 at the foreign exchange rate as of April 30, 2014) on a first level administrative decision on January 26, 2007. Both we and the tax authorities filed appeals of the first level administrative decision. In this appeal, we argued that the tax authorities did not have enough evidence to determine that the import transactions were indeed fraudulent and that, even if there were some irregularities in such importations, they could not be deemed to be our responsibility since all the transactions were performed by the third-party importer of the goods. On June 30, 2010, the Taxpayers Administrative Council of Tax Appeals decided to reinstate the original claim amount of 4.7 million Brazilian reais (approximately $2.1 million at the foreign exchange rate as of April 30, 2014) against us. On February 27, 2013, the Taxpayers Administrative Council of Tax Appeals issued its formal ruling reinstating the original claim amount. On May 31, 2013, we filed a motion to clarify such ruling, which is pending a decision.
In the Itajai tax assessment, we were notified on January 18, 2008, of a first level administrative decision rendered that maintained the total fine of 2.0 million Brazilian reais (approximately $888,000 at the foreign exchange rate as of April 30, 2014) as imposed, excluding interest. On May 27, 2008, we appealed the first level administrative decision to the Taxpayers Council. This matter is pending second level decision.
In December 2013, we sought to enroll the entire amount of tax liabilities in dispute for both the Vitória and Itajai assessments in the REFIS Amnesty. However, because we are named as a jointly-liable party rather than as the primary defendant in these matters, these assessments were not listed in the REFIS Amnesty web-based portal as available for election under the REFIS Amnesty. We believe these matters qualify for inclusion in the REFIS Amnesty and have filed the required notifications to our local tax office and commenced payments to indicate our decision to enroll these matters in the REFIS Amnesty. We expect the tax authorities' confirmation that these matters have been included in the REFIS Amnesty once they complete their procedures to consolidate the enrolled assessments. We elected to make the amnesty payments for these matters in monthly installments over a 30-month period for total payments, inclusive of interest and penalties, of 7.6 million Brazilian reais (approximately $3.4 million at the foreign exchange rate as of April 30, 2014). We accrued the full amount of the payments, plus estimated interest, under the REFIS Amnesty for these matters in December 2013 when we enrolled in the program, and made our first payment on December 26, 2013. As of April 30, 2014, we have remaining installment payments totaling 6.3 million Brazilian reais (approximately $2.8 million at the foreign exchange rate as of April 30, 2014).
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
We had previously accrued the estimated liability for both the Vitória and Itajai assessments. Based on our understanding of the underlying facts of these matters, we believe it is probable we may receive an unfavorable decision for each of these assessments unless we are able to resolve these matters through the REFIS Amnesty. Upon confirmation of acceptance of these matters into the REFIS Amnesty, we will reduce our accrued liabilities related to these matters to reflect the discounted amounts due under the REFIS Amnesty. As of April 30, 2014, we have accruals totaling 12.3 million Brazilian reais (approximately $5.5 million at the foreign exchange rate as of April 30, 2014).
Federal Tax Assessments related to Brazilian Subsidiary from Hypercom Acquisition
The Brazilian subsidiary we acquired as part of our acquisition of Hypercom in August 2011 is the subject of outstanding tax assessments by the federal tax authorities alleging unpaid IRPJ, CSL, COFINS and PIS taxes from 2002 and 2003. The 2002 assessments are the subject of an administrative proceeding and the 2003 assessments are the subject of a civil enforcement action. Three of the four claims for the 2002 assessments were previously settled prior to our acquisition of Hypercom. The first level administrative court issued an unfavorable decision for the remaining claim related to the 2002 tax assessments. Our appeal to the Administrative Tax Appeals Council was denied in December 2013. With respect to the 2003 tax assessments, we received a partially favorable ruling, and our appeal for the remaining assessments is pending decision in the civil courts. In December 2013, we elected to enroll the tax liability for the remaining 2002 assessment in dispute and the portion of the 2003 assessments for which we received an unfavorable ruling in the REFIS Amnesty.
For the 2002 assessment, we applied available net operating losses, to the extent permitted, toward the interest and penalties portion of the settlement obligation under the REFIS Amnesty. For the remaining balance, we elected to make the amnesty payments in monthly installments over a 90-month period for total payments of 2.2 million Brazilian reais (approximately $994,000 at the foreign exchange rate as of April 30, 2014). We accrued the full amount of the payments, plus estimated interest, under the REFIS Amnesty for this matter in December 2013 when we enrolled in the program, and made our first payment on December 26, 2013. As of April 30, 2014, we have remaining installment payments totaling 2.2 million Brazilian reais (approximately $971,000 at the foreign exchange rate as of April 30, 2014).
For the 2003 assessments, we applied available net operating losses, to the extent permitted, toward the interest and penalties portion of the settlement obligation under the REFIS Amnesty. At the time we initially appealed the 2003 assessments to the civil courts, we were required to make a deposit of 2.8 million Brazilian reais (approximately $1.3 million at the foreign exchange rate as of April 30, 2014) to the court in order to perfect our appeal. In light of our enrollment of certain of the 2003 assessments in the REFIS Amnesty, we have notified the civil court of our enrollment and requested the release of the portion of the deposit for the assessments enrolled in the REFIS Amnesty, which totals 675,000 Brazilian reais (approximately $303,000 at the foreign exchange rate as of April 30, 2014). Once approved by the court, the released funds will be applied against the settlement obligation under the REFIS Amnesty. Approximately 2.2 million Brazilian reais (approximately $973,000 at the foreign exchange rate as of April 30, 2014) will remain deposited in connection with the 2003 assessments that will continue in the civil courts and which deposits will be released to the prevailing party after resolution of the underlying assessments.
Excluding the assessments that have been enrolled in the REFIS Amnesty for this matter, which have been accrued as described above, the remaining assessments total 3.8 million Brazilian reais (approximately $1.7 million at the foreign exchange rate as of April 30, 2014), including estimated penalties and interest, as of April 30, 2014. Based on our current understanding of the underlying facts of this matter, we believe it is reasonably possible we may receive an unfavorable decision related to these remaining assessments.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
We also elected to enroll a number of outstanding tax offset requests that were previously applied for by the Brazilian subsidiary we acquired as part of our acquisition of Hypercom in August 2011 in the REFIS Amnesty. These outstanding tax offset requests relate to non-income tax debts, primarily for IRPJ, PIS and COFINS for past tax years, and total approximately 2.5 million Brazilian reais (approximately $1.1 million at the foreign exchange rate as of April 30, 2014), including estimated penalties and interest. We applied available net operating losses toward the interest and penalties portion of the settlement obligation under the REFIS Amnesty. For the remaining balance, we elected to make the amnesty payments in monthly installments over a 90-month period for total payments of 1.3 million Brazilian reais (approximately $600,000 at the foreign exchange rate as of April 30, 2014). We accrued the full amount of the payments, plus estimated interest, under the REFIS Amnesty for these matters in December 2013 when we enrolled in the program, and made our first payment on December 26, 2013. As of April 30, 2014, we have remaining installment payments totaling 1.3 million Brazilian reais (approximately $586,000 at the foreign exchange rate as of April 30, 2014).
Municipality Services Tax Assessments
In December 2009, one of the Brazilian subsidiaries that were acquired as part of the Lipman acquisition was notified of a tax assessment regarding alleged nonpayment of tax on services rendered for the period from September 2004 to December 2004. This assessment was issued by the municipality of São Paulo (the "municipality"), and asserts a services tax deficiency and related penalties totaling 875,000 Brazilian reais (approximately $392,000 at the foreign exchange rate as of April 30, 2014), excluding interest. The municipality claims that the Brazilian subsidiary rendered certain services within the municipality of São Paulo but simulated that those services were rendered in another city. At the end of December 2010 the municipality issued further tax assessments alleging the same claims for 2005 through June 2007. These additional subsequent claims assert services tax deficiencies and related penalties totaling 5.9 million Brazilian reais (approximately $2.6 million at the foreign exchange rate as of April 30, 2014), excluding interest. We received unfavorable decisions from the administrative courts, which ruled to maintain the tax assessments for each of these matters. No further grounds of appeal are available to us for these assessments within the administrative courts. In October 2012, as a result of the decision at the administrative level, the tax authorities filed an enforcement action in the civil courts to collect on the services tax assessments amounts awarded by the administrative court, and seeking other related costs and fees. On March 6, 2013, we filed our defensive claims in the civil courts in response to the tax authorities' enforcement action. In February 2013 the tax authorities filed an additional enforcement action in the civil courts to collect on the penalties related to the services tax assessments amounts awarded by the administrative courts. Based on our understanding of the underlying facts of this matter and our evaluation of the potential outcome at the judicial level, we believe it is reasonably possible that our Brazilian subsidiary will be required to pay some amount of the alleged tax assessments and penalties related to these matters, as well as amounts of interest and certain costs and fees imposed by the court related thereto. As of April 30, 2014, the amount of the alleged tax assessments and penalties related to these matters was approximately 5.8 million Brazilian reais (approximately $2.6 million at the foreign exchange rate as of April 30, 2014), and the estimated interest, costs and fees related thereto were approximately 11.9 million Brazilian reais (approximately $5.3 million at the foreign exchange rate as of April 30, 2014).
The Brazilian subsidiary we acquired as part of our acquisition of Hypercom in August 2011 received an unfavorable administrative decision on a tax enforcement action against it filed by the municipality of Curitiba for collection of alleged services tax deficiency. An appeal against this unfavorable administrative decision was filed in a judicial proceeding and currently the case is pending the municipality of Curitiba's compliance with the writ of summons. As of April 30, 2014, the underlying assessment, including estimated interest, was approximately 7.3 million Brazilian reais (approximately $3.3 million at the foreign exchange rate as of April 30, 2014). Based on our current understanding of the underlying facts of this matter, we believe it is reasonably possible that we may receive an unfavorable decision in this proceeding.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Patent Infringement and Commercial Litigation
Cardsoft, Inc. et al v. VeriFone Holdings, Inc., VeriFone, Inc., Hypercom Corporation, et al
On March 6, 2008, Cardsoft, Inc. and Cardsoft (Assignment for the Benefit of Creditors), LLC (collectively, “Cardsoft”) commenced an action in the United States District Court for the Eastern District of Texas, Marshall Division, against us and Hypercom Corporation, among others, alleging infringement of U.S. Patents No. 6,934,945 and No. 7,302,683 purportedly owned by Cardsoft. Cardsoft sought, in its complaint, a judgment of infringement, an injunction against further infringement, damages, interest and attorneys' fees. On June 8, 2012, the jury returned an unfavorable verdict finding that Cardsoft's patents were valid and were infringed by the accused VeriFone and Hypercom devices, and further determined that a royalty rate of $3 per unit should be applied. Accordingly, the jury awarded Cardsoft infringement damages and royalties of approximately $15.4 million covering past sales of the accused devices by VeriFone and Hypercom. The jury concluded there was no willful infringement by either VeriFone or Hypercom.
Following the jury's verdict, we determined that it is probable we will incur a loss on this litigation based on the jury's verdict and current status of the litigation proceedings.
We filed our motions for judgment as a matter of law to overturn the jury's verdict and motions for a new trial, which the District Court denied. Cardsoft filed a motion for permanent injunction or in the alternative for a future royalty of $8 per unit on our future U.S. sales of the accused products through the March 16, 2018 expiration date of the patents. Cardsoft also filed a motion seeking pre-judgment interest at a rate of 5%. On October 30, 2013, the District Court issued judgment upholding the jury's verdict that the patent was valid and infringed. The judgment confirmed the jury's award of infringement damages and royalties of approximately $15.4 million covering past sales of the VeriFone and Hypercom accused devices, plus pre-judgment interest, post-judgment interest and costs. The court also ruled that an ongoing royalty should be applied for sales of the accused devices after the verdict date. However, the court did not set an ongoing royalty rate but instead ordered the parties to mediate on the issue of an ongoing royalty rate. The judgment confirmed that there was no willful infringement and that an injunction was not warranted. On December 18, 2013, we and Cardsoft participated in mediation but we were unable to reach resolution on this matter. In March 2014, Cardsoft filed a motion requesting the court to set an ongoing royalty rate. In April 2014, we filed our opposition to such motion as well as a motion requesting the court to issue a ruling as to whether an ongoing royalty applies in light of our redesigns of the products subject to the court’s infringement ruling.
Given that we believed it probable that the District Court would award an ongoing royalty, and such amount was deemed estimable effective from our fiscal quarter ended July 31, 2012 when the jury verdict was issued, we accrued $3 per unit to Cost of net revenues for potential ongoing royalties, plus estimated pre-judgment interest. During the fiscal quarter ended October 31, 2012, we completed redesigns of the terminals subject to the jury's verdict specifically to address the Cardsoft allegations, and implemented such redesigns in the U.S. We obtained the legal opinion of independent intellectual property counsel that our terminals, as redesigned, do not infringe the Cardsoft patents-in-suit, taking into account the claim construction of the District Court in the Cardsoft action. Accordingly, although the question of whether our products, as redesigned, infringe the Cardsoft patents-in-suit is subject to determination by a court, whether the District Court in the underlying trial or another court, we concluded based on the procedures taken and legal reviews obtained, that it is not probable that an ongoing royalty based on the jury's verdict applies to our terminals as redesigned, and ceased accruing an ongoing royalty on the basis for our implementation of the redesigns. We continued to accrue for pre-judgment interest until judgment was entered. Our estimate of pre-judgment interest applies a rate of 4.12% which represents the seven year Treasury rate as of August 23, 2005, the date of the relevant hypothetical negotiation of the underlying claim. As noted above, Cardsoft previously filed a motion claiming royalties on our future U.S. sales of the accused products at a royalty rate higher than the rate awarded by the jury and pre-judgment interest at a rate higher than used in our estimates. Following entry of judgment, we have accrued for post-judgment interest at the statutorily determined rate equal to the one year constant maturity Treasury rate, currently 0.11% per annum, compounded annually.
Based on our assessment and the status of this case as described above, we have accrued an estimated loss through April 30, 2014, including estimated pre-judgment interest, potential ongoing royalties and post-judgment interest, totaling $20.0 million related to this ongoing litigation.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
On February 18, 2014, we filed our opening brief in our appeal of the District Court’s judgment before the U.S. Court of Appeals for the Federal Circuit. Cardsoft filed its responsive brief in the appeal on April 30, 2014 and we filed our reply brief on May 19, 2014. We intend to vigorously pursue our appeal of any unfavorable judgment issued by the District Court and to defend any further claims related to this litigation. At this time we are unable to estimate the range of additional loss exceeding amounts already recognized, if any, related to any further amounts Cardsoft may seek and the District Court may award. Unfavorable rulings on such motions, including any unfavorable rulings by the District Court with respect to our redesigns, could have a material adverse effect on our business, financial condition, results of operations, and cash flows.
Creative Mobile Technologies, LLC v. VeriFone Systems, Inc. et al.
On December 17, 2012, Creative Mobile Technologies, LLC (“CMT”), a provider of in-taxi payment processing solutions, filed a complaint in the Supreme Court of the State of New York alleging breach by VeriFone Systems, Inc. and VeriFone Media, LLC (f/k/a Clear Channel Taxi Media, LLC) (“VML”) of a sales representation agreement between CMT and VML. According to the complaint, CMT seeks damages and accounting, alleging breach of contract, breach of the duty of good faith and fair dealing and tortious interference with contract. On January 15, 2013, we removed this action to the United States District Court for the Southern District of New York. On February 13, 2013, we filed our answer and counterclaim, setting forth our general denial of the allegations, responses to specific allegations, our affirmative defenses and our counterclaim. The initial status conference was held in April 2013 and the parties engaged in discovery in the case. Without admitting any wrongdoing or violation of law, we entered into an agreement-in-principle on April 25, 2014, and a confidential settlement agreement on May 27, 2014, with CMT to settle the case for a total consideration of $9.0 million consisting of a $7.5 million one-time cash payment and a $1.5 million credit that may be applied by CMT within 24 months against purchases of certain VeriFone electronic payment terminals. We accrued the full amount of the settlement consideration in April 2014 when we entered into the agreement-in-principle. We paid the cash portion of the settlement consideration in June 2014. On June 4, 2014, the parties jointly filed with the court a stipulation of dismissal with prejudice to dismiss the action. On June 5, 2014, the court issued an order dismissing the case with prejudice.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Class Action and Derivative Lawsuits
In re VeriFone Holdings, Inc. Securities Litigation
On or after December 4, 2007, several securities class action complaints were filed against us and certain of our officers, former officers, and a former director. These lawsuits were consolidated in the U.S. District Court for the Northern District of California and are currently captioned as In re VeriFone Holdings, Inc. Securities Litigation, C 07-6140 EMC. The original actions were: Eichenholtz v. VeriFone Holdings, Inc. et al., C 07-6140 EMC; Lien v. VeriFone Holdings, Inc. et al., C 07-6195 JSW; Vaughn et al. v. VeriFone Holdings, Inc. et al., C 07-6197 VRW (Plaintiffs voluntarily dismissed this complaint on March 7, 2008); Feldman et al. v. VeriFone Holdings, Inc. et al., C 07-6218 MMC; Cerini v. VeriFone Holdings, Inc. et al., C 07-6228 SC; Westend Capital Management LLC v. VeriFone Holdings, Inc. et al., C 07-6237 MMC; Hill v. VeriFone Holdings, Inc. et al., C 07-6238 MHP; Offutt v. VeriFone Holdings, Inc. et al., C 07-6241 JSW; Feitel v. VeriFone Holdings, Inc., et al., C 08-0118 CW. On August 22, 2008, the court appointed plaintiff National Elevator Fund lead plaintiff and its attorneys lead counsel. Lead plaintiff filed its consolidated amended class action complaint on October 31, 2008, which asserts claims under the Securities Exchange Act Sections 10(b), 20(a), and 20A and SEC Rule 10b-5 for securities fraud and control person liability against us and certain of our current and former officers and directors, based on allegations that we and the individual defendants made false or misleading public statements regarding our business and operations during the putative class periods, and seeks unspecified monetary damages and other relief. We filed our motion to dismiss on December 31, 2008. The court granted our motion on May 26, 2009 and dismissed the consolidated amended class action complaint with leave to amend within 30 days of the ruling. The proceedings were stayed pending a mediation held in October 2009 at which time the parties failed to reach a mutually agreeable settlement. Lead plaintiff's first amended complaint was filed on December 3, 2009 followed by a second amended complaint filed on January 19, 2010. We filed a motion to dismiss the second amended complaint and the hearing on our motion was held on May 17, 2010. In July 2010, prior to any court ruling on our motion, lead plaintiff filed a motion for leave to file a third amended complaint on the basis that it had newly obtained evidence. Pursuant to a briefing schedule issued by the court we submitted our motion to dismiss the third amended complaint and lead plaintiff filed its opposition, following which the court took the matter under submission without further hearing. On March 8, 2011, the court ruled in our favor and dismissed the consolidated securities class action without leave to amend. On April 5, 2011, lead plaintiff filed its notice of appeal of the district court's ruling to the U.S. Court of Appeals for the Ninth Circuit. On June 24 and June 27, 2011, lead plaintiff dismissed its appeal as against defendants Paul Periolat, William Atkinson, and Craig Bondy. Lead plaintiff filed its opening brief on appeal on July 28, 2011. We filed our answering brief on September 28, 2011 and lead plaintiff filed its reply brief on October 31, 2011. A hearing on oral arguments for this appeal was held before a judicial panel of the Ninth Circuit on May 17, 2012. On December 21, 2012, the Ninth Circuit issued its opinion reversing the district court's dismissal of the consolidated shareholder securities class action against us and certain of our officers and directors, with the exception of the dismissal of lead plaintiff's claims under Section 20(a) of the Securities Exchange Act, which the Ninth Circuit affirmed. On January 4, 2013, we filed a petition for en banc rehearing with the Ninth Circuit. On January 30, 2013, the Ninth Circuit denied the petition for rehearing. On February 8, 2013, the Ninth Circuit issued a mandate returning this case to the U.S. District Court for the Northern District of California for further proceeding on lead plaintiff's claims, except for the dismissed Section 20(a) claim.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
On August 9, 2013, we entered into a stipulation of settlement in this consolidated shareholder securities class action with and among the other defendants and the lead plaintiff therein. The settlement is subject to various customary conditions, including preliminary approval by the U.S. District Court for the Northern District of California, notice to class members, class member opt-out thresholds and final approval by the court. If the settlement becomes final, the total settlement consideration paid for the benefit of the settlement class would be $95.0 million, plus a potential contingent adjustment if we had been acquired on or before April 15, 2014. We have coverage from our insurance carriers for this settlement consideration in the amount of approximately $33.8 million. The net amount of approximately $61.2 million (excluding the contingent adjustment) would be paid by us. On October 15, 2013, the court entered an order preliminarily approving the settlement. On November 5, 2013, we deposited approximately $61.2 million, and our insurance carriers have deposited the remaining portion, of the $95.0 million settlement consideration into an escrow account for the settlement. The hearing on final approval of the settlement was held on February 14, 2014. On February 18, 2014, the court issued an order granting the parties’ motion for settlement, and indicated that it intended to issue a final approval of the settlement, subject to the lead plaintiff's submission of a notice plan regarding Israeli investors that includes (i) a longer time period for Israeli class members to file their claims and (ii) the dissemination to Israeli investors of a Hebrew language version of the notice of the proposed settlement, proof of claim and release form (the “Hebrew-Language Notice”). On February 20, 2014, in response to the court’s order, the lead plaintiff filed a proposed notice plan that included (i) an extension of the time period for Israeli class members to file claims to April 30, 2014, (ii) a plan to mail the Hebrew-Language Notice to Israeli investors, (iii) a plan to publish the Hebrew-Language Notice in a leading newspaper in Israel, and (iv) a revision to the claims website to post the Hebrew-Language Notice and make clear that the claims deadline for Israeli class members has been extended to April 30, 2014. On February 25, 2014, the court issued a final order approving the settlement, dismissing the case with prejudice and entering judgment in the action. One of the objectors to the settlement filed a notice of appeal to the court’s February 25, 2014 judgment and orders, and subsequently filed a motion for voluntary dismissal of the appeal with prejudice. On June 2, 2014, the U.S. Court of Appeals for the Ninth Circuit issued an order, dismissing the appeal with prejudice.
We have denied and continue to deny each and all of the claims alleged in the consolidated shareholder securities class action. Nonetheless, we have agreed to the settlement to eliminate the uncertainty, distraction, burden and expense of further litigation. This settlement also applies to members of the putative class of plaintiffs in the Israel Class Action described below under U.S. law.
In re VeriFone Holdings, Inc. Shareholder Derivative Litigation Proceedings
Beginning on December 13, 2007, several actions were also filed against certain current and former directors and officers derivatively on our behalf. These derivative lawsuits were filed in: (1) the U.S. District Court for the Northern District of California, as In re VeriFone Holdings, Inc. Shareholder Derivative Litigation, Lead Case No. C 07-6347 MHP, which consolidates King v. Bergeron, et al. (Case No. 07-CV-6347), Hilborn v. VeriFone Holdings, Inc., et al. (Case No. 08-CV-1132), Patel v. Bergeron, et al. (Case No. 08-CV-1133), and Lemmond, et al. v. VeriFone Holdings, Inc., et al. (Case No. 08-CV-1301); and (2) the Superior Court of California, County of Santa Clara, as In re VeriFone Holdings, Inc. Derivative Litigation, Lead Case No. 1-07-CV-100980, which consolidates Catholic Medical Mission Board v. Bergeron, et al. (Case No. 1-07-CV-100980) and Carpel v. Bergeron, et al. (Case No. 1-07-CV-101449). We prevailed in our motion to dismiss the federal derivative claims before the U.S. District Court for the Northern District of California and, on November 28, 2011, in ruling on lead plaintiff's appeal against the district court's judgment dismissing lead plaintiff's derivative claims, the Ninth Circuit issued judgment affirming the dismissal of lead plaintiff's complaint against us. Lead plaintiff did not appeal the Ninth Circuit's judgment and the federal derivative action is now closed.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
On October 31, 2008, the state derivative plaintiffs filed their consolidated derivative complaint in the Superior Court of California, County of Santa Clara naming us as a nominal defendant and bringing claims for insider selling, breach of fiduciary duty, unjust enrichment, waste of corporate assets and aiding and abetting breach of fiduciary duty against certain of our current and former officers and directors and our largest stockholder as of October 31, 2008, GTCR Golder Rauner LLC. On February 18, 2009, plaintiff Catholic Medical Mission Board voluntarily dismissed itself from the action. In November 2008, we filed a motion to stay the state court action pending resolution of the parallel federal actions, and the parties agreed by stipulation to delay briefing on the motion to stay until after the issue of demand futility was resolved in the federal derivative case. On June 2, 2011, the court entered a stipulated order requiring the parties to submit a case status report on August 1, 2011 and periodically thereafter. The parties submitted status reports to the court through February 1, 2013 as requested by the court. On January 30, 2013, counsel for plaintiff informed us that Mr. Carpel, the nominal plaintiff, had sold his shares in the company and therefore no longer had standing to maintain a derivative action against us. On February 15, 2013, plaintiff filed a motion for leave to publish notice to our stockholders seeking a new nominal plaintiff. On May 10, 2013, the court adopted its tentative order granting the motion to publish notice, which was formally entered on May 17, 2013. Under the terms of the order, the parties were ordered to publish notice of the potential dismissal of the action and any qualifying shareholder who wishes to intervene must notify the court within ninety days from the formal entry of the order. Otherwise, the action will be dismissed. On August 14, 2013, counsel for the former nominal plaintiff, Mr. Carpel, filed a notice of intent to substitute a new nominal plaintiff, Joel Gerber, into the action. On September 16, 2013, counsel for former plaintiff Carpel filed a motion to substitute a new plaintiff, Joel Gerber, into the action. On October 16, 2013, the court granted the motion and deemed the amended complaint filed as of the same date. Pursuant to the parties’ stipulation, VeriFone’s demurrer to the amended complaint was filed on April 7, 2014. On May 23, 2014, plaintiff filed a statement of non-opposition to VeriFone's demurrer and filed a motion to stay the action to allow plaintiff to make a demand on VeriFone's current Board of Directors. A hearing on the demurrer, the motion to stay, and a case management conference are scheduled for July 11, 2014.
Israel Class Action
On January 27, 2008, a class action complaint was filed against us in the Central District Court in Tel Aviv, Israel on behalf of purchasers of our stock on the Tel Aviv Stock Exchange. The complaint seeks compensation for damages allegedly incurred by the class of plaintiffs due to the publication of erroneous financial reports. We filed a motion to stay the action, in light of the proceedings already filed in the United States, on March 31, 2008. A hearing on the motion was held on May 25, 2008. Further briefing in support of the stay motion, specifically with regard to the threshold issue of applicable law, was submitted on June 24, 2008. On September 11, 2008, the Israeli District Court ruled in our favor, holding that U.S. law would apply in determining our liability. On October 7, 2008, plaintiffs filed a motion for leave to appeal the Israeli District Court's ruling to the Israeli Supreme Court. Our response to plaintiffs' appeal motion was filed on January 18, 2009. The Israeli District Court has stayed its proceedings until the Israeli Supreme Court rules on plaintiffs' motion for leave to appeal. On January 27, 2010, after a hearing before the Israeli Supreme Court, the court dismissed the plaintiffs' motion for leave to appeal and addressed the case back to the Israeli District Court. The Israeli Supreme Court instructed the Israeli District Court to rule whether the Israel class action should be stayed, under the assumption that the applicable law is U.S. law. Plaintiffs subsequently filed an application for reconsideration of the Israeli District Court's ruling that U.S. law is the applicable law. Following a hearing on plaintiffs' application, on April 12, 2010, the parties agreed to stay the proceedings pending resolution of the U.S. securities class action, without prejudice to plaintiffs' right to appeal the Israeli District Court's decision regarding the applicable law to the Israeli Supreme Court. On May 25, 2010, plaintiff filed a motion for leave to appeal the decision regarding the applicable law with the Israeli Supreme Court. In August 2010, plaintiff filed an application to the Israeli Supreme Court arguing that the U.S. Supreme Court's decision in Morrison et al. v. National Australia Bank Ltd., 561 U.S. __, 130 S. Ct. 2869 (2010), may affect the outcome of the appeal currently pending before the Court and requesting that this authority be added to the Court's record. Plaintiff concurrently filed an application with the Israeli District Court asking that court to reverse its decision regarding the applicability of U.S. law to the Israel class action, as well as to cancel its decision to stay the Israeli proceedings in favor of the U.S. class action in light of the U.S. Supreme Court's decision in Morrison. On August 25, 2011, the Israeli District Court issued a decision denying plaintiff's application and reaffirming its ruling that the law applicable to the Israel class action is U.S. law. The Israeli District Court also ordered that further proceedings in the case be stayed pending the decision on appeal in the U.S. class action.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
On November 13, 2011, plaintiff filed an amended application for leave to appeal addressing the Israeli District Court's ruling. We filed an amended response on December 28, 2011. On January 1, 2012, the Israeli Supreme Court ordered consideration of the application by three justices. On July 2, 2012, the Israeli Supreme Court ordered us to file an updated notice on the status of the proceedings in the U.S. securities class action then pending in the U.S. Court of Appeals for the Ninth Circuit by October 1, 2012. On October 11, 2012, we filed an updated status notice in the Israeli Supreme Court on the proceedings in the U.S. securities class action pending at the time in the U.S. Court of Appeals for the Ninth Circuit. On January 9, 2013, the Israeli Supreme Court held a further hearing on the status of the appeal in the U.S. Court of Appeals for the Ninth Circuit and recommended that the parties meet and confer regarding the inclusion of the Israeli plaintiffs in the federal class action pending in the U.S. On February 10, 2013, the Israeli Supreme Court issued an order staying the case pursuant to the joint notice submitted to the court by the parties on February 4, 2013. The plaintiff and putative class members in this action are included in the stipulated settlement of the federal securities class action, In re VeriFone Holdings, Inc., disclosed above unless an individual plaintiff opts out. Following the February 25, 2014 judgment and orders by the U.S. court, in April 2014, the parties in the Israeli class action filed a joint motion requesting that the Israeli Supreme Court renew the proceedings on appeal concerning the determination of the applicable law. A hearing is scheduled for June 23, 2014.
In re VeriFone Securities Litigation
On March 7, 2013, a putative securities class action was filed in the U.S. District Court for the Northern District of California against us certain of our former officers and one of our current officers and alleged claims in connection with our February 20, 2013 announcement of preliminary financial results for the fiscal quarter ended January 31, 2013. The action, captioned Sanders v. VeriFone Systems, Inc. et al., Case No. C 13-1038, and subsequently re-captioned In re VeriFone Securities Litigation, was initially brought on behalf of a putative class of purchasers of VeriFone securities between December 14, 2011 and February 19, 2013 and asserted claims under the Securities Exchange Act Sections 10(b) and 20(a) and SEC Rule 10b-5 for securities fraud and control person liability. The claims were based on allegations that we and the individual defendants made false or misleading public statements regarding our business, operations, and financial controls during the putative class period. The complaint sought unspecified monetary damages and other relief. Two additional class actions related to the same matter (Laborers Local 235 Benefit Funds v. VeriFone Systems, Inc. et al., Case No. CV 13-1676 and Bland v. VeriFone Systems, Inc. et al., Case No. CV 13-1853) were filed in April 2013. On May 6, 2013, several putative plaintiffs and plaintiffs' law firms filed motions to consolidate these three securities class actions and requesting appointment as lead plaintiff and lead counsel, respectively. The plaintiffs in Laborers Local 235 Benefit Funds v. VeriFone Systems, Inc. et al. and Bland v. VeriFone Systems, Inc. et al. voluntarily dismissed their respective actions, without prejudice, on July 10, 2013 and July 17, 2013, respectively, and filed motions to be appointed lead plaintiff in the action previously captioned Sanders v. VeriFone Systems, Inc. et al. On October 7, 2013, the court entered an order appointing the Selz Funds as lead plaintiffs and appointing Gold Bennett Cera & Sidener LLP as lead counsel. Lead plaintiffs' first amended complaint was filed on December 16, 2013. The first amended complaint expanded the putative class period to December 14, 2011 and February 20, 2013, inclusive, and removed the current officer who was named in the original complaint from the action. We filed our motion to dismiss the amended complaint on February 14, 2014, lead plaintiffs filed their opposition on April 15, 2014 and we filed our reply on May 16, 2014. On May 27, 2014, the court took the motion to dismiss under submission without oral argument.
Dolled v. Bergeron et al.
On April 19, 2013, a derivative action, Dolled v. Bergeron et al., Case No. 113-CV-245056, was filed in the Superior Court of California, County of Santa Clara in connection with our February 20, 2013 announcement of preliminary financial results for the fiscal quarter ended January 31, 2013. The action, brought derivatively on behalf of VeriFone, names VeriFone as a nominal defendant and brings claims for insider selling, breach of fiduciary duty and unjust enrichment variously against certain of our current and former officers and directors. The complaint seeks unspecified monetary damages, restitution and disgorgement of profits and compensation paid to defendants, injunctive relief directing us to reform its corporate governance, and payment of the plaintiff's costs and attorneys' fees. On May 30, 2013, the court entered the parties' stipulation and proposed order, which appointed plaintiff and plaintiff's counsel as lead plaintiff and lead counsel, respectively, in the consolidated action, captioned In re VeriFone Systems, Inc. Derivative Litigation. The next case management conference is scheduled for July 18, 2014.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Zoumboulakis v. McGinn et al.
On May 24, 2013, a federal derivative action, Zoumboulakis v. McGinn et al., Case No. 13-CV-02379, was filed in the U.S. District Court for the Northern District of California against certain current and former directors and officers derivatively on our behalf. The complaint, which names us as a nominal defendant, alleges breach of fiduciary duty and abuse of control and asserts claims under Section 14(a) of the Securities Exchange Act of 1934 for false or misleading financial statements and proxy statement disclosures. The complaint seeks unspecified monetary damages, including exemplary damages, restitution from defendants, injunctive relief directing us to make certain corporate governance reforms, and payment of the plaintiff's costs and attorneys' fees. On August 12, 2013, the court entered defendants' motion seeking to relate this action to the pending shareholder class action, Sanders v. VeriFone Systems, Inc. et al. On October 31, 2013, the court entered a stipulation and order setting a December 31, 2013 deadline for the filing of an amended complaint and setting a January 30, 2014 deadline for defendants to move or answer. An initial case management conference was held on January 17, 2014. On January 21, 2014, plaintiff filed an amended complaint, which removed one of our former officers from the action and added an additional former director as a defendant. The amended complaint brings claims against the defendants for breach of fiduciary duty, abuse of control, violations of Securities Exchange Act Section 14(a), and unjust enrichment. The amended complaint also brings claims for insider trading against three of the named former and current directors. We filed our motion to dismiss the amended complaint on March 7, 2014, plaintiff filed her opposition on April 23, 2014, and we filed our reply on May 16, 2014. On May 27, 2014, the court took the motion to dismiss under submission without oral argument.
If any of these class action or derivative lawsuits is resolved adversely to us, it could have a material adverse effect on our business, financial condition, results of operations, and cash flows.
Antitrust Investigation
The Competition Commission of India ("CCI") is investigating certain complaints made against us alleging unfair practices based on certain provisions in our software development license arrangements in India. We have cooperated with requests by the CCI in its investigation. In March 2014, the director general of the CCI investigating the allegations issued a report rejecting certain of the allegations, but also finding that certain provisions of our licenses may constitute unfair business practices. We are preparing our response to the director general's report. A hearing in this matter is scheduled for July 2014.
Other Litigation
After termination of their services, several former contractors of one of our Brazilian subsidiaries filed individual lawsuits in the Labor Court of São Paulo against the subsidiary alleging an employer-employee relationship and wrongful termination, and claiming, among other damages, statutorily-imposed salaries, vacations, severance and bonus amounts, social contributions and penalties and moral damages. In October 2012, we received a partially unfavorable judgment for one of these lawsuits, with the court ruling that an employer-employee relationship existed. We did not prevail in our appeal of the unfavorable judgment and this matter is now pending final appeal. We believe it is probable that we may not prevail on this matter. As of April 30, 2014, we have accrued for the estimated probable loss for this matter, which amount is not material to our results of operations. We have settled, without admitting any wrongdoing or violation of law, the other filed lawsuits, in each case, for a cash payment. The amounts of these settlements are not material to our results of operations.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Certain of the foregoing cases are still in the preliminary stages, and we are not able to quantify the extent of our potential liability, if any. Further, the outcome of litigation is inherently unpredictable and subject to significant uncertainties. If any of these matters are resolved adversely to us, this could have a material adverse effect on our business, financial condition, results of operations, and cash flows. In addition, defending these legal proceedings is likely to be costly, which may have a material adverse effect on our financial condition, results of operations and cash flows, and may divert management's attention from the day-to-day operations of our business. We are subject to various other legal proceedings related to commercial, customer, and employment matters that have arisen during the ordinary course of business, including a number of pending labor-related claims that arose in the ordinary course of business against the Hypercom Brazilian subsidiary prior to our acquisition of Hypercom. The outcome of such legal proceedings is inherently unpredictable and subject to significant uncertainties. Although there can be no assurance as to the ultimate disposition of these matters, our management has determined, based upon the information available at the date of these financial statements, including expected availability of insurance coverage, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.
Export Control Matters
As disclosed in Part II Item 5, Other Information, of our Quarterly Report on Form 10-Q for our fiscal quarter ended January 31, 2013, we previously discovered certain unauthorized activities which may potentially constitute violations of U.S. export control laws and regulations that prohibit the shipment of our products and the provision of our services to countries, governments and persons targeted by U.S. sanctions. In connection with our discoveries we have made a voluntary disclosure to the U.S. Department of Treasury's Office of Foreign Assets Control (“OFAC”) regarding these potential violations. This voluntary disclosure process with OFAC is in the initial stages and we cannot predict whether or when OFAC would review this matter or what enforcement action, if any, it may take. If we were found to be in violation of U.S. sanctions or export control laws, it could result in fines or penalties for us, which could harm our results of operations.
Income Tax Uncertainties
As of April 30, 2014, the amount payable for unrecognized tax benefits was $65.6 million, including accrued interest and penalties, none of which is expected to be paid within one year. This amount is included in Other long-term liabilities in our Condensed Consolidated Balance Sheet as of April 30, 2014. We are unable to make a reasonably reliable estimate as to when cash settlement with a taxing authority may occur.
Note 10. Segment and Geographic Information
Segment Information
Our operating segments are Americas, EMEA, and ASPAC. We determine our operating segments based on the discrete financial information used by our Chief Executive Officer, who is our chief operating decision maker, to assess performance, allocate resources, and make decisions regarding VeriFone's operations. We do not separately evaluate assets by segment, and therefore assets by segment are not presented below. Net revenues and operating income (loss) of each segment reflect net revenues and expenses that are directly attributable to that segment. Net revenues and expenses not allocated to segment net revenues and segment operating income (loss) include amortization of purchased intangible assets, increase to fair value (step-up) of inventory at acquisition, fair value decrease (step-down) in deferred revenue at acquisition, some inventory reserves, asset impairments, restructuring expenses, stock-based compensation, as well as corporate research and development, sales and marketing, general and administrative, and litigation settlement and loss contingency expenses.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The following table sets forth net revenues for our reportable segments and reconciles segment net revenues to total net revenues (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended April 30, | | Six Months Ended April 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Segment net revenues: | | | | | | | |
Americas | $ | 208,631 |
| | $ | 207,375 |
| | $ | 399,147 |
| | $ | 413,128 |
|
EMEA | 190,575 |
| | 172,719 |
| | 376,876 |
| | 345,603 |
|
ASPAC | 67,569 |
| | 49,654 |
| | 127,902 |
| | 100,671 |
|
Total segment net revenues | 466,775 |
| | 429,748 |
| | 903,925 |
| | 859,402 |
|
Net revenues not allocated to segment net revenues: | | | | | | | |
Amortization of step-down in deferred revenue at acquisition | (358 | ) | | (961 | ) | | (1,442 | ) | | (2,396 | ) |
Other net revenues not allocated to segment net revenues | — |
| | (2,500 | ) | | — |
| | (1,972 | ) |
Total net revenues | $ | 466,417 |
| | $ | 426,287 |
| | $ | 902,483 |
| | $ | 855,034 |
|
The following table sets forth operating income for our reportable segments and reconciles segment operating income to consolidated operating loss (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended April 30, | | Six Months Ended April 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Operating income by segment: | | | | | | | |
Americas | $ | 49,194 |
| | $ | 54,537 |
| | $ | 99,636 |
| | $ | 117,497 |
|
EMEA | 52,597 |
| | 43,035 |
| | 106,334 |
| | 94,602 |
|
ASPAC | 16,101 |
| | 9,572 |
| | 27,865 |
| | 19,398 |
|
Total segment operating income | 117,892 |
| | 107,144 |
| | 233,835 |
| | 231,497 |
|
Items not allocated to segment operating income: | | | | | | | |
Net revenues not allocated to segment net revenues | (358 | ) | | (3,461 | ) | | (1,442 | ) | | (4,368 | ) |
Amortization of purchased intangible assets | (35,731 | ) | | (34,184 | ) | | (71,869 | ) | | (69,941 | ) |
Stock-based compensation expense | (11,877 | ) | | (10,030 | ) | | (27,609 | ) | | (22,388 | ) |
Restructuring expense | (5,771 | ) | | — |
| | (5,771 | ) | | (323 | ) |
Litigation settlement and loss contingency expense | (9,000 | ) | | (69,000 | ) | | (9,000 | ) | | (69,000 | ) |
Other expenses not allocated to segments | (68,703 | ) | | (60,038 | ) | | (138,207 | ) | | (113,311 | ) |
Total operating loss | $ | (13,548 | ) | | $ | (69,569 | ) | | $ | (20,063 | ) | | $ | (47,834 | ) |
Geographic Information
Our net revenues, by country with net revenues over 10% of total net revenues, were as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended April 30, | | Six Months Ended April 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
United States | $ | 121,300 |
| | $ | 117,933 |
| | $ | 240,371 |
| | $ | 246,491 |
|
Brazil | 51,496 |
| | 47,600 |
| | 90,657 |
| | 81,518 |
|
Other countries | 293,621 |
| | 260,754 |
| | 571,455 |
| | 527,025 |
|
Total net revenues | $ | 466,417 |
| | $ | 426,287 |
| | $ | 902,483 |
| | $ | 855,034 |
|
Net revenues are allocated to countries based on the shipping destination or service delivery location of customer orders.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
| |
ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
This section should be read in conjunction with our consolidated financial statements and related notes included in our 2013 Annual Report on Form 10-K and the Condensed Consolidated Financial Statements and Notes included in Part I, Item I of this Quarterly Report on Form 10-Q. This section and other parts of this Quarterly Report on Form 10-Q and certain information incorporated by reference herein contain forward-looking statements that involve risks and uncertainties. In some cases, forward-looking statements can be identified by words such as "may," "should," "expect," "plan," "intend," "anticipate," "believe," "estimate," "predict," "potential," or "continue," the negative of such terms, or comparable terminology. Such forward-looking statements are based on current expectations, estimates, and projections about our industry and management's beliefs and assumptions, and do not reflect the potential impact of any mergers, acquisitions, or other business combinations or divestitures that have not been completed. Forward-looking statements are not guarantees of future performance, and our actual results may differ materially from the results expressed or implied in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part I, Item 1A, Risk Factors, in our 2013 Annual Report on Form 10-K and in Part II, Item 1A, Risk Factors, of this Quarterly Report on Form 10-Q, and elsewhere in these reports, including our disclosures of Critical Accounting Policies and Estimates in Part II, Item 7 in our 2013 Annual Report on Form 10-K and in Part I, Item 2 of this Quarterly Report on Form 10-Q, and our disclosures in Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk in our 2013 Annual Report on Form 10-K and in Part I, Item 3, Quantitative and Qualitative Disclosures About Market Risk of this Quarterly Report on Form 10-Q, as well as in our Condensed Consolidated Financial Statements and Notes thereto. We are under no duty to update any of the forward-looking statements after the date of this Quarterly Report on Form 10-Q to conform such statements to actual results or to changes in expectations. We assume no obligation to revise or update any forward-looking statements for any reason, except as required by law.
In this Quarterly Report on Form 10-Q, each of the terms “VeriFone,” "Company," "us," "we," and "our" refers to VeriFone Systems, Inc. and its consolidated subsidiaries.
Our Management's Discussion and Analysis of Financial Condition and Results of Operations is provided in addition to our Condensed Consolidated Financial Statements and accompanying notes to assist readers in understanding our results of operations, financial condition, and cash flows. This section is organized as follows:
Overview: Discussion of our business and overall financial results, and other highlights related to our results of operations for the periods presented.
Results of Operations:
| |
• | Consolidated Results of Operations: An analysis and discussion of our financial results comparing our consolidated results of operations for the three and six months ended April 30, 2014 to the three and six months ended April 30, 2013. |
| |
• | Segment Results of Operations: An analysis and discussion of our financial results comparing the results of operations for each of our three reportable segments, Americas, EMEA, and ASPAC, for the three and six months ended April 30, 2014 to the three and six months ended April 30, 2013. |
Financial Outlook: A discussion of our expectations regarding certain trends that may affect our financial condition and results of operations.
Liquidity and Capital Resources: An analysis of changes in our balance sheets and cash flows, and discussion of our financial condition and potential sources of liquidity.
Contractual Obligations and Off-Balance Sheet Arrangements: Disclosures related to our contractual obligations, contingent liabilities, commitments, and off-balance-sheet arrangements, as of April 30, 2014.
Critical Accounting Policies and Estimates: A discussion of the accounting policies and estimates that we believe are most important to understanding the assumptions and judgments incorporated in our reported financial results and forecasts, as well as recent accounting pronouncements that have had or are expected to have a material impact on our results of operations.
Overview
Our Business
We are a leading global provider of secure electronic payment solutions and value-added services at the point of sale. We focus on delivering value to our customers at the point of sale where merchant and consumer requirements drive increasingly innovative point of sale payment capabilities, value-added services and expertise that increase merchant revenues and consumer experience solutions that enrich the point of interaction between merchant and consumers. Today we are an industry leader in multi-application payment systems deployments. Key industries in which we operate include financial services, retail, petroleum, restaurant, hospitality, taxi, transportation and healthcare.
We operate in three segments: Americas, EMEA, and ASPAC. Our Americas segment includes our operations in North America, South America, Central America, and the Caribbean. Our EMEA segment is comprised of our operations in Europe, the Middle East, and Africa. Our ASPAC segment consists of our operations in Asia, Australia, New Zealand, and other Asia Pacific Rim countries. We determine our operating segments based on discrete financial information used by our Chief Executive Officer, who is our chief operating decision maker, to assess performance, allocate resources, and make decisions regarding VeriFone's operations. Our Chief Executive Officer is evaluating using global product line financial information to manage the business in the future. If our Chief Executive Officer is provided different financial information to assess performance, allocate resources and make decisions regarding VeriFone's operations, we will reassess our operating segment presentation.
Our Sources of Revenue
Sales of our point of sale electronic payment devices and systems continue to be a significant source of revenues. Our terminal solutions are differentiated based on our unique operating systems and security and encryption capabilities, as well as flexibility to support a variety of payment types, deployment options and integrated value-added capabilities, such as for media at the point of sale. Our architecture enables multiple value-added applications, including third-party applications, such as gift card and loyalty card programs, healthcare insurance eligibility, and time and attendance tracking, and allows these services to reside on the same system. For terminal solutions, security continues to be an important factor for our clients. We also see increased demand in our markets for integrated mobile point of sale solutions and, in the U.S., we see increasing demand for EMV capable terminal solutions.
Services are an important part of our business strategy. We are focused on offering full-service Payment-as-a-Service solutions and other managed services, such as gateways, encryption, tokenization, and end-to-end terminal estate management services. We are investing in select markets in order to expand our Payment-as-a-Service offering in new countries. We are also focused on commerce enablement solutions, using our consumer-facing point of sale terminals to offer services complementary to our payment solutions that facilitate commerce between merchants and consumers. These commerce enablement solutions include our VNET media platform deployed at gas dispensers and in taxis, PAYMedia/LIFT retail services that enable basket-level targeting of media content at convenience stores, and other digital media solutions that utilize media-enabled equipment to display digital content at the POS. We also offer a broad range of traditional services, including professional services related to customized application development, equipment repair and maintenance, helpdesk support and software post-contract support, installation and deployment, and training.
Timing of Revenue
The timing of our customer orders may cause our revenue to vary from period to period. Specifically, revenues recognized in our fiscal quarters can vary significantly when larger customers or our distributors hold back orders due to regulatory, certification or budget concerns that impact their business or purchase decisions. In addition, revenues can be back-end weighted when we receive sales orders and deliver a higher proportion of our System solutions toward the end of our fiscal quarters. This variability and back-end weighting of orders may adversely affect our results of operations in a number of ways, and could negatively impact revenues and profits. First, the product mix of orders may not align with manufacturing forecasts, which could result in a shortage of the components needed for production. Second, existing manufacturing capacity may not be sufficient to deliver the desired volume of orders in a concentrated time when they are received. Third, back-end weighted demand could negatively impact gross margins through higher labor, delivery, and other manufacturing and distribution costs. If, on the other hand, we were to seek to manage the fulfillment of back-end weighted orders through holding increased inventory levels, we would risk higher inventory obsolescence charges if our sales fall short of our expectations.
Because our revenue recognition depends on, among other things, the timing of product shipments, decisions we make about product shipments, particularly toward the end of a fiscal quarter, may impact our reported revenues. The timing of product shipments may depend on a number of factors, including price discussions with our customers, operating costs, including costs of air shipments if required, the delivery date requested by customers, and our operating capacity to fill orders and ship products, as well as our own long and short-term business planning and supply chain management. These factors may affect timing of shipments and consequently revenues recognized for a particular period.
Significant Matters
Transformation Initiatives
During December 2013 we launched transformation initiatives that focus on, among other things, improving our cost structure world-wide. As part of these initiatives, during April 2014 our management approved a restructuring plan under which we will reduce headcount and close facilities. This plan is estimated to be complete by March 2015 and cost approximately $6.5 million, including approximately $5.4 million for employee involuntary termination benefits and approximately $1.1 million related to facility exits.
On June 1, 2014, our management approved a second restructuring plan under which we will reduce headcount, close additional facilities and consolidate data centers. We expect to incur charges totaling approximately $17.0 million under this restructuring plan, including approximately $15.0 million related to employee involuntary termination benefits and approximately $2.0 million related to facility exits and data center consolidations.
We estimate that these plans will result in a net headcount reduction of approximately 500 employees and approximately $35 million of annualized run rate savings by the end of fiscal year 2014. Much of this savings will be reinvested into growth initiatives as part of our transformation program.
Charges under both restructuring plans are expected to be incurred during fiscal years 2014 and 2015, and the majority of the cash payments are expected to be made by the end of fiscal year 2015.
2011 Credit Agreement
On December 24, 2013, we paid in full the $48.4 million remaining outstanding balance of the term B loan under our 2011 Credit Agreement. This payment was partially funded through $47.0 million of additional borrowings under the revolving loan that is part of the same credit agreement. During the three months ended April 30, 2014, we made $35.0 million of additional voluntary pre-payments on our revolving loan facility. Key terms of the 2011 Credit Agreement are described in Note 9, Financings, in the Notes to Consolidated Financial Statements of our 2013 Annual Report on Form 10-K.
Litigation Contingencies and Settlement
We entered into an agreement in principle on April 25, 2014 and a confidential settlement agreement on May 27, 2014, to settle the pending action captioned, Creative Mobile Technologies, LLC v. VeriFone Systems, Inc. et al. for a total consideration of $9.0 million. On June 4, 2014, the parties jointly filed with the court a stipulation of dismissal with prejudice to dismiss the action. On June 5, 2014, the court issued an order dismissing the case with prejudice.
On November 5, 2013, we paid $61.2 million into an escrow account to fund the uninsured portion of the settlement pursuant to the preliminary court approval dated October 15, 2013 in the pending securities class action captioned, In re VeriFone Holdings, Inc. Securities Litigation. This amount was funded from cash on hand and available credit under the revolving loan under the 2011 Credit Agreement. Our insurance carriers paid the remaining $33.8 million settlement amount into that escrow account. On February 25, 2014, the court in such class action issued a final order approving the settlement. One of the objectors to the settlement filed a notice of appeal to the court’s February 25, 2014 judgment and orders, and subsequently filed a motion for voluntary dismissal of the appeal with prejudice. On June 2, 2014, the U.S. Court of Appeals for the Ninth Circuit issued an order, dismissing the appeal with prejudice.
For further information on litigation settlements and loss contingencies, see Note 9, Commitments and Contingencies, in the Notes to Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q.
Financial Results Highlights
Overall
| |
• | Our consolidated total net revenues for the three months ended April 30, 2014 were $466.4 million, compared to $426.3 million for the three months ended April 30, 2013, up 9.4% year over year. |
| |
• | Services net revenues for the three months ended April 30, 2014 were $175.7 million, compared to $149.7 million for the three months ended April 30, 2013, up 17.3% year over year. |
| |
• | Net cash provided by operating activities for the six months ended April 30, 2014 totaled $88.4 million. |
Segment Revenues
The following chart summarizes our total net revenues by segment for the three months ended April 30, 2014 and 2013 (in millions), as well as our System solutions and Services net revenues in each segment as a percentage of total net revenues for that segment in each period.
Results of Operations
Consolidated Results of Operations
Three Months Ended April 30, 2014 compared to April 30, 2013
|
| | | | | | | | | | | |
| Three Months Ended April 30, |
| 2014 | | % of Net revenues (1) | | 2013 | | % of Net revenues (1) |
| (in thousands, except percentages) |
Net revenues: | |
System solutions | $ | 290,734 |
| | 62.3% | | $ | 276,560 |
| | 64.9% |
Services | 175,683 |
| | 37.7% | | 149,727 |
| | 35.1% |
Total net revenues | 466,417 |
| | 100.0% | | 426,287 |
| | 100.0% |
| | | | | | | |
Gross margin: | | | | | | | |
System solutions | 103,163 |
| | 35.5% | | 95,688 |
| | 34.6% |
Services | 72,111 |
| | 41.0% | | 58,618 |
| | 39.1% |
Total gross margin | 175,274 |
| | 37.6% | | 154,306 |
| | 36.2% |
| | | | | | | |
Operating expenses: | | | | | | | |
Research and development | 49,999 |
| | 10.7% | | 41,581 |
| | 9.8% |
Sales and marketing | 56,417 |
| | 12.1% | | 46,496 |
| | 10.9% |
General and administrative | 48,749 |
| | 10.5% | | 43,676 |
| | 10.2% |
Litigation settlement and loss contingency expense | 9,000 |
| | 1.9% | | 69,000 |
| | 16.2% |
Amortization of purchased intangible assets | 24,657 |
| | 5.3% | | 23,122 |
| | 5.4% |
Total operating expenses | 188,822 |
| | 40.5% | | 223,875 |
| | 52.5% |
Operating loss | (13,548 | ) | | (2.9)% | | (69,569 | ) | | (16.3)% |
Interest, net | (9,490 | ) | | (2.0)% | | (11,249 | ) | | (2.6)% |
Other income (expense), net | (1,183 | ) | | (0.3)% | | 2,306 |
| | 0.5% |
Loss before income taxes | (24,221 | ) | | (5.2)% | | (78,512 | ) | | (18.4)% |
Income tax benefit | (658 | ) | | (0.1)% | | (21,483 | ) | | (5.0)% |
Consolidated net loss | $ | (23,563 | ) | | (5.1)% | | $ | (57,029 | ) | | (13.4)% |
(1) System solutions and Services gross margin as a percentage of total net revenues is computed as a percentage of the corresponding System solutions and Services net revenues.
System solutions net revenues for the three months ended April 30, 2014 were $290.7 million, compared to $276.6 million for the three months ended April 30, 2013, up $14.2 million or 5.1%, primarily due to an increase in our EMEA and ASPAC segments. We continued to experience competition and pricing pressures globally, as well as changes in customer demand related to factors such as the timing of customer technology refreshes, the availability of products with desired functionality and the timing of product certifications. See further discussion under Segment Results of Operations below.
Services net revenues for the three months ended April 30, 2014 were $175.7 million, compared to $149.7 million for the three months ended April 30, 2013, up $26.0 million or 17.3%, as a result of continued expansion of our Services offerings globally. Of this increase, $10.6 million was due to our fiscal year 2013 acquisitions. See further discussion under Segment Results of Operations below.
Total gross margin for the three months ended April 30, 2014 was $175.3 million, or 37.6% of total net revenues, compared to $154.3 million, or 36.2% of total net revenues, for the three months ended April 30, 2013, up $21.0 million or 1.4 percentage points. Gross margin in dollars increased primarily due to the increase in total net revenues. Gross margin as a percentage of total net revenues increased primarily because increased Services net revenues had relatively higher margins.
Research and development for the three months ended April 30, 2014 was $50.0 million compared to $41.6 million for the three months ended April 30, 2013, up $8.4 million or 20.2%, primarily due to an increase in personnel and outside contractor expenses as we invested in additional resources to focus on platform development efforts and shorten our product development life-cycle and time to market.
Sales and marketing for the three months ended April 30, 2014 was $56.4 million, compared to $46.5 million for the three months ended April 30, 2013, up $9.9 million or 21.3%, primarily due to additional personnel expenses associated mainly with the expansion of our Services offerings into new geographies, such as personnel related expenses related to our fiscal year 2013 acquisitions. The increase includes $2.6 million of charges related to employee involuntary termination benefits under our restructuring plans.
General and administrative for the three months ended April 30, 2014 was $48.7 million compared to $43.7 million for the three months ended April 30, 2013, up $5.1 million or 11.6%, primarily due to professional service fees and other costs related to our transformation initiatives. The increase includes $0.9 million of charges related to employee involuntary termination benefits and $1.1 million of charges related to facility exits under our transformation restructuring plans.
Litigation settlement and loss contingency expense for the three months ended April 30, 2014 was $9.0 million due to an accrual related to the agreement in principle in the pending action captioned, Creative Mobile Technologies, LLC v. VeriFone Systems, Inc. et al. during April 2014. Litigation settlement and loss contingency expense for the three months ended April 30, 2013 was $69.0 million primarily due to accruals related to the pending securities class action captioned, In re VeriFone Holdings, Inc. Securities Litigation, and the related Israel class action. See Note 9, Commitments and Contingencies, in the Notes to Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q for disclosures related to our legal proceedings.
Amortization of purchased intangible assets for the three months ended April 30, 2014 and 2013 were $24.7 million and $23.1 million, respectively, up $1.5 million or 6.6%, primarily due to additional amortization during the three months ended April 30, 2014 related to acquisitions in fiscal year 2013.
Interest, net for the three months ended April 30, 2014 was $9.5 million compared to $11.2 million for the three months ended April 30, 2013, down $1.8 million or 15.6%, primarily due to lower loan balances in fiscal year 2014.
Income tax benefit for the three months ended April 30, 2014 was $0.7 million compared to $21.5 million for the three months ended April 30, 2013, a $20.8 million decrease. The decrease is primarily due to a $21.3 million discrete tax benefit during the three months ended April 30, 2013 related to the Litigation settlement and loss contingency expense in that period.
Six Months Ended April 30, 2014 compared to April 30, 2013
|
| | | | | | | | | | | |
| Six Months Ended April 30, |
| 2014 | | % of Net revenues (1) | | 2013 | | % of Net revenues (1) |
| (in thousands, except percentages) |
Net revenues: | |
System solutions | $ | 551,900 |
| | 61.2% | | $ | 558,268 |
| | 65.3% |
Services | 350,583 |
| | 38.8% | | 296,766 |
| | 34.7% |
Total net revenues | 902,483 |
| | 100.0% | | 855,034 |
| | 100.0% |
| | | | | | | |
Gross margin: | | | | | | | |
System solutions | 196,821 |
| | 35.7% | | 203,153 |
| | 36.4% |
Services | 148,670 |
| | 42.4% | | 123,115 |
| | 41.5% |
Total gross margin | 345,491 |
| | 38.3% | | 326,268 |
| | 38.2% |
| | | | | | | |
Operating expenses: | | | | | | | |
Research and development | 100,531 |
| | 11.1% | | 81,383 |
| | 9.5% |
Sales and marketing | 107,028 |
| | 11.9% | | 92,244 |
| | 10.8% |
General and administrative | 99,663 |
| | 11.0% | | 83,657 |
| | 9.8% |
Litigation settlement and loss contingency expense | 9,000 |
| | 1.0% | | 69,000 |
| | 8.1% |
Amortization of purchased intangible assets | 49,332 |
| | 5.5% | | 47,818 |
| | 5.6% |
Total operating expenses | 365,554 |
| | 40.5% | | 374,102 |
| | 43.8% |
Operating loss | (20,063 | ) | | (2.2)% | | (47,834 | ) | | (5.6)% |
Interest, net | (20,879 | ) | | (2.3)% | | (22,751 | ) | | (2.7)% |
Other income (expense), net | (6,310 | ) | | (0.7)% | | 6,246 |
| | 0.7% |
Loss before income taxes | (47,252 | ) | | (5.2)% | | (64,339 | ) | | (7.5)% |
Income tax benefit | (7,592 | ) | | (0.8)% | | (19,020 | ) | | (2.2)% |
Consolidated net loss | $ | (39,660 | ) | | (4.4)% | | |