Document
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 July 31, 2017 |
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.) |
88 West Plumeria Drive
San Jose, CA 95134
(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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
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Large accelerated filer þ | | Smaller reporting company o
| Accelerated filer o
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Non-accelerated filer o | | | Emerging growth company o
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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
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 August 31, 2017 |
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Class | | | Number of shares | |
Common Stock, $0.01 par value per share | 112,201,333 | |
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
ITEM 1.FINANCIAL STATEMENTS (Unaudited)
VERIFONE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS |
| | | | | | | | | | | | | | | | |
| Three Months Ended July 31, | | Nine Months Ended July 31, |
| 2017 | | 2016 | | 2017 | | 2016 | |
| (Unaudited, in thousands, except per share data) |
Net revenues: | | | | | | | | |
Systems | $ | 265,951 |
| | $ | 292,072 |
| | $ | 817,027 |
| | $ | 972,107 |
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Services | 200,915 |
| | 196,060 |
| | 577,395 |
| | 555,842 |
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Total net revenues | 466,866 |
| | 488,132 |
| | 1,394,422 |
| | 1,527,949 |
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Cost of net revenues: | | | | | | | | |
Systems | 177,774 |
| | 175,690 |
| | 520,385 |
| | 571,039 |
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Services | 114,642 |
| | 121,295 |
| | 355,395 |
| | 340,099 |
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Total cost of net revenues | 292,416 |
| | 296,985 |
| | 875,780 |
| | 911,138 |
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Gross margin | 174,450 |
| | 191,147 |
| | 518,642 |
| | 616,811 |
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Operating expenses: | | | | | | | | |
Research and development | 50,731 |
| | 52,394 |
| | 158,454 |
| | 158,150 |
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Sales and marketing | 46,665 |
| | 52,830 |
| | 146,806 |
| | 167,289 |
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General and administrative | 44,867 |
| | 49,753 |
| | 142,425 |
| | 157,040 |
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Restructuring and related charges | 65,705 |
| | 33,629 |
| | 135,743 |
| | 34,196 |
| |
Litigation settlement and loss contingency expense | — |
| | 600 |
| | — |
| | 600 |
| |
Amortization of purchased intangible assets | 16,696 |
| | 24,286 |
| | 53,873 |
| | 65,886 |
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Goodwill impairment | — |
| | — |
| | 17,384 |
| | — |
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Total operating expenses | 224,664 |
| | 213,492 |
| | 654,685 |
| | 583,161 |
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Operating income (loss) | (50,214 | ) | | (22,345 | ) | | (136,043 | ) | | 33,650 |
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Interest expense, net | (8,380 | ) | | (9,023 | ) | | (24,712 | ) | | (25,870 | ) | |
Other income (expense), net
| (1,908 | ) | | 156 |
| | 4,666 |
| | (6,833 | ) | |
Net income (loss) before income taxes | (60,502 | ) | | (31,212 | ) | | (156,089 | ) | | 947 |
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Income tax provision | 10,286 |
| | 286 |
| | 22,088 |
| | 5,372 |
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Consolidated net loss | (70,788 | ) | | (31,498 | ) | | (178,177 | ) | | (4,425 | ) | |
Net income (loss) attributable to noncontrolling interests | 167 |
| | (360 | ) | | (1,332 | ) | | 313 |
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Net loss attributable to VeriFone Systems, Inc. stockholders | $ | (70,955 | ) | | $ | (31,138 | ) | | $ | (176,845 | ) | | $ | (4,738 | ) | |
Net loss per share attributable to VeriFone Systems, Inc. stockholders: | | | | | | | | |
Basic | $ | (0.63 | ) | | $ | (0.28 | ) | | $ | (1.58 | ) | | $ | (0.04 | ) | |
Diluted | $ | (0.63 | ) | | $ | (0.28 | ) | | $ | (1.58 | ) | | $ | (0.04 | ) | |
Weighted average number of shares used in computing net loss per share attributable to VeriFone Systems, Inc. stockholders: | | | | | | | | |
Basic | 111,951 |
| | 110,689 |
| | 111,669 |
| | 110,763 |
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Diluted | 111,951 |
| | 110,689 |
| | 111,669 |
| | 110,763 |
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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) |
| | | | | | | | | | | | | | | | |
| Three Months Ended July 31, | | Nine Months Ended July 31, | |
| 2017 | | 2016 | | 2017 | | 2016 | |
| (Unaudited, in thousands) |
Consolidated net loss | $ | (70,788 | ) | | $ | (31,498 | ) | | $ | (178,177 | ) | | $ | (4,425 | ) | |
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Other comprehensive income (loss): | | | | | | | | |
Foreign currency translation adjustments, net of tax | 65,202 |
| | (46,460 | ) | | 74,563 |
| | (24,410 | ) | |
Unrealized gain (loss) on derivatives designated as cash flow hedges | | | | | | | | |
Change in unrealized gain (loss) on derivatives designated as cash flow hedges | (369 | ) | | (301 | ) | | 4,003 |
| | (3,540 | ) | |
Amounts reclassified from Accumulated other comprehensive loss | 129 |
| | 890 |
| | 1,217 |
| | 3,004 |
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Tax impact on unrealized gain (loss) on derivatives designated as cash flow hedges | 91 |
| | — |
| | (1,981 | ) | | — |
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Net change in unrealized gain (loss) on derivatives designated as cash flow hedges | (149 | ) | | 589 |
| | 3,239 |
| | (536 | ) | |
Net change in other | 136 |
| | 27 |
| | 190 |
| | 78 |
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Other comprehensive income (loss) | 65,189 |
| | (45,844 | ) | | 77,992 |
| | (24,868 | ) | |
Total comprehensive loss | (5,599 | ) | | (77,342 | ) | | (100,185 | ) | | (29,293 | ) | |
Less: Comprehensive income (loss) attributable to noncontrolling interests, net of tax | 2,352 |
| | (360 | ) | | (8,341 | ) | | 313 |
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Comprehensive loss attributable to VeriFone Systems, Inc. stockholders | $ | (7,951 | ) | | $ | (76,982 | ) | | $ | (91,844 | ) | | $ | (29,606 | ) | |
The accompanying notes are an integral part of these condensed consolidated financial statements.
VERIFONE SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
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| July 31, 2017 | | October 31, 2016 |
| (Unaudited, in thousands, except par value) |
ASSETS | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 158,826 |
| | $ | 148,352 |
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Accounts receivable, net of allowances of $14,291 and $14,063, respectively | 326,327 |
| | 323,447 |
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Inventories | 127,496 |
| | 175,231 |
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Prepaid expenses and other current assets | 165,856 |
| | 110,397 |
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Total current assets | 778,505 |
| | 757,427 |
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Property and equipment, net | 130,454 |
| | 202,277 |
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Purchased intangible assets, net | 257,532 |
| | 306,298 |
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Goodwill | 1,116,752 |
| | 1,110,493 |
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Deferred tax assets, net | 36,144 |
| | 36,989 |
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Other long-term assets | 99,786 |
| | 81,323 |
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Total assets | $ | 2,419,173 |
| | $ | 2,494,807 |
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LIABILITIES AND EQUITY | | | |
Current liabilities: | | | |
Accounts payable | $ | 157,118 |
| | $ | 154,574 |
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Accruals and other current liabilities | 253,239 |
| | 213,411 |
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Deferred revenue, net | 110,639 |
| | 104,797 |
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Short-term debt | 68,216 |
| | 66,017 |
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Total current liabilities | 589,212 |
| | 538,799 |
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Long-term deferred revenue, net | 66,806 |
| | 66,516 |
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Deferred tax liabilities, net | 102,401 |
| | 99,371 |
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Long-term debt | 809,885 |
| | 859,896 |
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Other long-term liabilities | 69,982 |
| | 76,840 |
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Total liabilities | 1,638,286 |
| | 1,641,422 |
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Commitments and contingencies |
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Redeemable noncontrolling interest in subsidiary | 1,084 |
| | 4,980 |
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Stockholders’ equity: | | | |
Preferred stock: $0.01 par value, 10,000 shares authorized, no shares issued and outstanding | — |
| | — |
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Common stock: $0.01 par value, 200,000 shares authorized, 112,188 and 111,261 shares issued and outstanding as of July 31, 2017 and October 31, 2016, respectively
| 1,122 |
| | 1,113 |
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Additional paid-in capital | 1,802,204 |
| | 1,771,951 |
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Accumulated deficit | (795,185 | ) | | (618,339 | ) |
Accumulated other comprehensive loss | (255,993 | ) | | (340,994 | ) |
Total VeriFone Systems, Inc. stockholders’ equity | 752,148 |
| | 813,731 |
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Noncontrolling interests in subsidiaries | 27,655 |
| | 34,674 |
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Total equity | 779,803 |
| | 848,405 |
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Total liabilities, redeemable noncontrolling interest in subsidiary and equity | $ | 2,419,173 |
| | $ | 2,494,807 |
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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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| Nine Months Ended July 31, |
| 2017 | | 2016 |
| (Unaudited, in thousands) |
Cash flows from operating activities | | | |
Consolidated net loss | $ | (178,177 | ) | | $ | (4,425 | ) |
Adjustments to reconcile consolidated net loss to net cash provided by operating activities: | | | |
Depreciation and amortization | 116,845 |
| | 133,795 |
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Stock-based compensation expense | 30,050 |
| | 32,889 |
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Deferred income taxes, net | (1,164 | ) | | (7,226 | ) |
Non-cash restructuring and related charges | 107,535 |
| | 29,100 |
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Goodwill impairment | 17,384 |
| | — |
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Other | 11,471 |
| | 5,044 |
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Net cash provided by operating activities before changes in operating assets and liabilities | 103,944 |
| | 189,177 |
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Changes in operating assets and liabilities: | | | |
Accounts receivable, net | (15,014 | ) | | 13,501 |
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Inventories | 30,908 |
| | (53,300 | ) |
Prepaid expenses and other assets | (11,747 | ) | | (23,209 | ) |
Accounts payable | 3,043 |
| | (2,294 | ) |
Deferred revenue, net | 5,837 |
| | 28,398 |
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Other current and long-term liabilities | 23,132 |
| | (21,764 | ) |
Net change in operating assets and liabilities | 36,159 |
| | (58,668 | ) |
Net cash provided by operating activities | 140,103 |
| | 130,509 |
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Cash flows from investing activities | | | |
Capital expenditures | (52,802 | ) | | (82,271 | ) |
Acquisition of businesses, net of cash and cash equivalents acquired | (4,973 | ) | | (172,219 | ) |
Divestiture of businesses | 1,469 |
| | — |
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Other investing activities, net | 321 |
| | 1,938 |
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Net cash used in investing activities | (55,985 | ) | | (252,552 | ) |
Cash flows from financing activities | | | |
Proceeds from debt, net of issuance costs | 215,384 |
| | 490,378 |
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Repayments of debt | (277,700 | ) | | (333,930 | ) |
Proceeds from issuance of common stock through employee equity incentive plans | 849 |
| | 3,329 |
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Stock repurchases | — |
| | (79,866 | ) |
Other financing activities, net | (3,777 | ) | | (4,078 | ) |
Net cash provided by (used in) financing activities | (65,244 | ) | | 75,833 |
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Effect of foreign currency exchange rate changes on cash, cash equivalents and restricted cash | 6,330 |
| | (2,119 | ) |
Net increase (decrease) in cash, cash equivalents and restricted cash | 25,204 |
| | (48,329 | ) |
Cash, cash equivalents and restricted cash, beginning of period | 159,181 |
| | 215,869 |
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Cash, cash equivalents and restricted cash, end of period | $ | 184,385 |
| | $ | 167,540 |
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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, including a variable interest entity where we are deemed to be the primary beneficiary, 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. The Condensed Consolidated Balance Sheet at October 31, 2016 has been derived from the audited Consolidated Balance Sheet at that date. All significant inter-company accounts and transactions have been eliminated. In accordance with these 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, 2016. The results of operations for the three and nine months ended July 31, 2017 are not necessarily indicative of the results expected for the entire fiscal year.
We have two operating segments: Verifone Systems and Verifone Services. Verifone Systems delivers point of sale electronic payment devices that run our unique operating systems, security and encryption software and certified payment software for both payments and commerce. Verifone Services delivers device related services and maintenance, payment transaction routing and reporting, and commerce based services. Our reportable segments are the same as our operating segments.
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 nine months ended July 31, 2017, 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, 2016, except as follows:
Equity Method Investments
Equity investments are accounted for under the equity method if we are able to exert significant influence over the investee company but do not have a controlling financial interest. Equity method investments, which are initially recorded at fair value and are adjusted for our proportionate share of the earnings and losses of the equity method investee, are included in Other long-term assets in our Consolidated Balance Sheets. Earnings and losses of equity method investments are based on the most recently available financial statements of the investee and are included in Other income (expense), net in our Consolidated Statements of Operations. Basis differences between the cost of an equity method investment and the underlying equity in the long-lived assets are amortized over the estimated economic useful life of the underlying long-lived asset. We periodically review our equity method investments for impairment and record a reduction in the carrying value, if and when necessary.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Concentrations of Credit Risk
For the three and nine months ended July 31, 2017 and 2016, no single customer accounted for more than 10% of our total Net revenues. As of July 31, 2017 and October 31, 2016, no single customer accounted for more than 10% of our total Accounts receivable, net.
Recently Adopted Accounting Pronouncements
During August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments, which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. We adopted ASU 2016-15 retrospectively, effective November 1, 2016. Adoption had no impact on our consolidated statements of cash flows in any periods presented.
During November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows - Restricted Cash, which requires entities to show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. This standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. We adopted ASU 2016-18 retrospectively, effective November 1, 2016. Restricted cash is now included as a component of Cash, cash equivalents and restricted cash on our Consolidated Statements of Cash Flows for all periods presented.
During January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment, which simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The standard is effective for annual or interim impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. We adopted this standard in connection with the goodwill impairment assessment of our Taxi Solutions reporting unit during the three months ended April 30, 2017. See Note 7, Goodwill and Purchased Intangible Assets for additional information.
Recent Accounting Pronouncements Not Yet Adopted
During May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, as amended by ASU 2015-14, 2016-08, 2016-10, and 2016-12, 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 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early adoption is permitted as of reporting periods beginning after December 15, 2016. We expect to adopt ASU 2014-09 effective in the first interim period of our fiscal year ending October 31, 2019 and are currently evaluating the transition method we will use. We expect that this standard may impact, in some cases, the timing and amount of revenue recognized, as well as our revenue disclosures. Additionally, the direct costs to obtain and fulfill customer contracts, in some cases, may be deferred and amortized under the new standard. We are in the process of assessing the specific revenue streams impacted and quantifying the materiality of these impacts.
During January 2017, the FASB issued ASU 2017-01, Business Combinations - Clarifying the Definition of a Business, which provides new guidance to assist entities with evaluating when a set of transferred assets and activities is a business. The standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted in certain circumstances. We are currently in the process of evaluating our adoption timing and the impact of this new pronouncement on our consolidated financial position and results of operations.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
During March 2017, the FASB issued ASU 2017-07, Compensation—Retirement Benefits - Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which provides guidance to improve the presentation of net periodic pension cost and net periodic postretirement benefit cost. The standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on our consolidated financial position and results of operations.
During May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation - Scope of Modification Accounting, which provides guidance that clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. The standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted for any interim and annual financial statements that have not yet been issued. We are currently in the process of evaluating our adoption timing and the impact of this new pronouncement on our consolidated financial position and results of operations.
During August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging - Targeted Improvements to Accounting for Hedging Activities, which expands and refines hedge accounting for both non-financial and financial risk components and aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. The standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted for any interim and annual financial statements that have not yet been issued. We are currently in the process of evaluating our adoption timing and the impact of this new pronouncement on our consolidated financial position and results of operations.
Note 2. Business Combinations
Fiscal year 2017 Divestiture
On June 30, 2017, we divested our controlling interest in Verifone Systems (China), Inc., the entity which operated our China business, to the former general manager of this business. In connection with this divestiture, we retained a 30% equity interest in Verifone Systems (China), Inc., in the form of non-voting preferred equity that has a $29 million liquidation preference and is non-convertible for an initial two year period. Our 30% equity interest is accounted for as a cost method investment, and its fair value, determined using the income approach, was deemed nominal. The income approach, which we believe most appropriately measures the fair value of this income producing asset, calculates fair value by discounting estimated after-tax cash flows to a present value, using a risk-adjusted discount rate. Our investment is classified as Level 3 because we use significant unobservable inputs to determine the expected cash flows and an appropriate discount rate to calculate the fair value. The significant unobservable inputs we use to value this investment include our estimate of the future expected revenues, margins and other cash outlays, as well as expected terminal value growth rates of the China business. See Note 9, Restructuring and Related Charges, for additional information.
We have determined that the divested Verifone Systems (China), Inc. entity is a variable interest entity and that we are not the primary beneficiary. Our determination is primarily based upon our conclusions that the divested entity's equity investment at risk is not sufficient to finance its activities without additional financial support, and we do not have the power to direct the activities that most significantly impact the entity's economic performance.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Fiscal year 2017 Exchange Transaction
On April 7, 2017, we entered into an exchange transaction with DMI Parent, DMI Holdings and Gas Media under which we contributed certain assets, consisting of customer contracts associated with our business of marketing, promoting, selling and distributing media and advertising solutions for display or use in petroleum forecourts in the United States, in exchange for a 50% equity interest in Gas Media, and DMI Parent contributed 100% of its equity interest in DMI Holdings in exchange for a 50% equity interest in Gas Media. Gas Media will be operated by DMI Parent and Verifone, but is not jointly controlled by both parties. In connection with the exchange transaction, we have agreed to guarantee, in certain circumstances, up to $12.5 million out of a total of $83.8 million of debt issued to Gas Media.
Our investment in Gas Media is accounted for as an equity method investment and was initially valued at $19.2 million. The debt guarantee was deemed to have a nominal value. We have used the income approach to determine the fair value of our investment in Gas Media. The income approach, which we believe most appropriately measures the fair value of this income producing asset, calculates fair value by discounting estimated after-tax cash flows to a present value, using a risk-adjusted discount rate. Our investment is classified as Level 3 because we use significant unobservable inputs to determine the expected cash flows and an appropriate discount rate to calculate the fair value. The significant unobservable inputs we use to value the Gas Media investment include our estimate of the future expected revenues, margins and other cash outlays, as well as the terminal value growth rates of the Gas Media business. The discount rate used to determine the fair value of this investment is 18.7%.
As a result of this exchange transaction, we recorded a $10.1 million gain that is included in Other income (expense), net in the Condensed Consolidated Statements of Operations. The gain was determined as the excess of the fair value of Verifone’s 50% equity interest in Gas Media over the carrying value of the contributed assets, including allocated goodwill.
We have made the election to use a one-month lag to record our share of Gas Media results. For the three and nine month periods ended July 31, 2017, we recorded a $1.2 million loss, which represents our portion of Gas Media earnings, and is included in Other income (expense), net in the Condensed Consolidated Statements of Operations.
Note 3. Net income (loss) per Share of Common Stock
Basic net income (loss) per share of common stock is computed by dividing net income (loss) attributable to VeriFone Systems, Inc. stockholders by the weighted average number of shares of common stock outstanding for the period. Diluted net income (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 income (loss) per share of common stock (in thousands, except per share data):
|
| | | | | | | | | | | | | | | | |
| Three Months Ended July 31, | | Nine Months Ended July 31, |
| 2017 | | 2016 | | 2017 | | 2016 | |
Basic and diluted net loss per share attributable to VeriFone Systems, Inc. stockholders: | | | | | | | | |
Numerator: | | | | | | | | |
Net loss attributable to VeriFone Systems, Inc. stockholders | $ | (70,955 | ) | | $ | (31,138 | ) | | $ | (176,845 | ) | | (4,738 | ) | |
Denominator: | | | | | | | | |
Weighted average shares attributable to VeriFone Systems, Inc. stockholders - basic | 111,951 |
| | 110,689 |
| | 111,669 |
| | 110,763 |
| |
Weighted average effect of dilutive stock options, RSUs and RSAs
| — |
| | — |
| | — |
| | — |
| |
Weighted average shares attributable to VeriFone Systems, Inc. stockholders - diluted | 111,951 |
| | 110,689 |
| | 111,669 |
| | 110,763 |
| |
Net loss per share attributable to VeriFone Systems, Inc. stockholders: | | | | | | | | |
Basic | $ | (0.63 | ) | | $ | (0.28 | ) | | $ | (1.58 | ) | | $ | (0.04 | ) | |
Diluted | $ | (0.63 | ) | | $ | (0.28 | ) | | $ | (1.58 | ) | | $ | (0.04 | ) | |
For both the three and nine months ended July 31, 2017, equity incentive awards representing 6.8 million shares of common stock, respectively, were excluded from the calculation of weighted average shares for diluted net loss per share as they were anti-dilutive because we incurred net losses for those periods. For both the three and nine months ended July 31, 2016, equity incentive awards representing 7.1 million shares of common stock were anti-dilutive because we incurred net losses for those periods. Anti-dilutive awards, which include stock options, RSUs and RSAs, could impact future calculations of diluted net income per share if the fair market value of our common stock increases.
For the nine months ended July 31, 2016, we repurchased approximately 2.6 million shares of our common stock on the open market at an average repurchase price of $28.02 per share pursuant to a stock repurchase program authorized by our Board of Directors in September 2015. No shares were repurchased during the nine months ended July 31, 2017.
Note 4. Income Taxes
We recorded tax provisions totaling $10.3 million and $0.3 million for the three months ended July 31, 2017 and 2016, respectively. The income tax provision for the three months ended July 31, 2017 was primarily attributable to foreign taxes and discrete items related to restructuring charges. The income tax provision for the three months ended July 31, 2016 was primarily related to foreign taxes, which were partially offset by the reversal of unrecognized tax benefits where statute of limitations expired or audits have been settled. We recorded tax provisions totaling $22.1 million and $5.4 million for the nine months ended July 31, 2017 and 2016, respectively. The income tax provision for the nine months ended July 31, 2017 was primarily attributable to foreign taxes and discrete items related to restructuring charges. The income tax provision for the nine months ended July 31, 2016 was primarily related to foreign taxes partially offset by the reversal of unrecognized tax benefits where statute of limitations expired or audits have been settled.
Our total unrecognized tax benefits were approximately $109.2 million as of July 31, 2017. 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)
Israel Tax Audit Assessment
We are currently under audit by the Israeli Tax Authorities for fiscal years 2011 through 2015. The Israeli Tax Authorities issued a tax assessment in October 2014 for fiscal year 2009 or alternatively for fiscal year 2008 claiming there was a business restructuring that resulted in a transfer of some functions, assets and risks from VeriFone Israel Ltd. to the U.S. parent company that the Israeli Tax Authorities claim was a sale valued at 1.36 billion New Israeli Shekels (approximately $383.8 million at the foreign exchange rate as of July 31, 2017). We filed our objection to the tax assessment in January 2015 and received the Israeli Tax Authorities decision through an Order (a second stage assessment) in January 2016. The Order increased the value of the sale to 2.20 billion New Israeli Shekels in fiscal year 2009 (approximately $620.4 million at the foreign exchange rate as of July 31, 2017) or alternatively 2.23 billion New Israeli Shekels in fiscal year 2008 (approximately $627.6 million at the foreign exchange rate as of July 31, 2017) and contended secondary adjustments relating to a deemed dividend and/or interest.
Based on the Order, these and other claims result in a tax liability and deficiency penalty assessment in the amount of 1.32 billion New Israeli Shekels (approximately $371.3 million at the foreign exchange rate as of July 31, 2017), if the claim was assessed for fiscal year 2009, to 1.56 billion New Israeli Shekels (approximately $438.2 million at the foreign exchange rate as of July 31, 2017) if the claim was assessed for fiscal year 2008, including interest, the required Israeli price index adjustments (referred to as the linkage differentials) and deficiency fines (as applicable) through July 31, 2017. The Israeli Tax Authorities' contention regarding secondary adjustments relating to deemed dividend was not quantified by them.
We continue to believe the Israeli Tax Authorities' assessment position is without merit and appealed the assessment to the district court. We have agreed with the Israeli Tax Authorities to repay our $69.0 million intercompany loan from VeriFone Israel Ltd. to the extent of the amount of a final agreed tax assessment concerning fiscal year 2008 and fiscal year 2009 or a judgment of a district court in an appeal on the decision of the Israeli Tax Authorities in the objection, if any.
Other Audits
We have certain other foreign subsidiaries under audit by foreign tax authorities, including Brazil for 2002, Germany for 2013 to 2015, India for fiscal years 2008 to 2015 and New Zealand for fiscal years 2014 and 2015. Although we believe we have appropriately provided for income taxes for the years subject to audit, the Brazil, Germany, India, Israel and New Zealand taxing authorities may adopt different interpretations. We have not yet received any final determinations with respect to these audits. We have accrued tax liabilities associated with these audits. With few exceptions, we are no longer subject to tax examination for periods prior to 2008.
Note 5. Balance Sheet and Statement of Operations Components
Cash, Cash Equivalents and Restricted Cash
The following table provides a reconciliation of cash, cash equivalents and restricted cash shown in the Condensed Consolidated Statements of Cash Flows (in thousands):
|
| | | | | | | |
| July 31, 2017 | | October 31, 2016 |
Cash and cash equivalents | $ | 158,826 |
| | $ | 148,352 |
|
Restricted cash included in Prepaid expenses and other current assets | 24,114 |
| | 9,008 |
|
Restricted cash included in Other long-term assets | 1,445 |
| | 1,821 |
|
Cash, cash equivalents and restricted cash | $ | 184,385 |
| | $ | 159,181 |
|
Restricted cash as of July 31, 2017 and October 31, 2016 was mainly comprised of pledged deposits.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Inventories
Inventories consisted of the following (in thousands):
|
| | | | | | | |
| July 31, 2017 | | October 31, 2016 |
Raw materials | $ | 31,568 |
| | $ | 35,453 |
|
Work-in-process | 551 |
| | 3,884 |
|
Finished goods | 95,377 |
| | 135,894 |
|
Total inventories | $ | 127,496 |
| | $ | 175,231 |
|
Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consisted of the following (in thousands):
|
| | | | | | | |
| July 31, 2017 |
| | October 31, 2016 |
Assets held for sale | $ | 50,731 |
| | $ | 5,131 |
|
Prepaid expenses | 53,234 |
| | 46,240 |
|
Other current assets | 61,891 |
| | 59,026 |
|
Total prepaid expenses and other current assets | $ | 165,856 |
| | $ | 110,397 |
|
Assets held for sale relate to our Taxi Solutions and petroleum media businesses. See Note 9, Restructurings and Related Charges, for additional information. Other current assets were comprised primarily of prepaid taxes and restricted cash.
Property and Equipment, Net
Property and equipment, net consisted of the following (in thousands):
|
| | | | | | | | | |
| Estimated Useful Life (Years) | | July 31, 2017 |
| | October 31, 2016 |
Revenue generating assets | 5 | | $ | 141,009 |
| | $ | 209,725 |
|
Computer hardware and software | 3-5 | | 106,830 |
| | 112,984 |
|
Machinery and equipment | 3-10 | | 49,254 |
| | 57,020 |
|
Leasehold improvements | Lesser of the term of the lease or the estimated useful life | | 30,881 |
| | 31,328 |
|
Office equipment, furniture, and fixtures | 3-5 | | 20,341 |
| | 18,573 |
|
Buildings | 40-50 | | 6,026 |
| | 6,011 |
|
Total depreciable property and equipment, at cost | | | 354,341 |
| | 435,641 |
|
Accumulated depreciation | | | (232,142 | ) | | (243,127 | ) |
Depreciable property and equipment, net | | | 122,199 |
|
| 192,514 |
|
Construction in progress | | | 7,081 |
| | 8,600 |
|
Land | | | 1,174 |
| | 1,163 |
|
Total property and equipment, net | | | $ | 130,454 |
| | $ | 202,277 |
|
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Accruals and Other Current Liabilities
Accruals and other current liabilities consisted of the following (in thousands): |
| | | | | | | |
| July 31, 2017 | | October 31, 2016 |
Accrued expenses | $ | 55,166 |
| | $ | 76,187 |
|
Accrued compensation | 59,503 |
| | 52,555 |
|
Other current liabilities | 138,570 |
| | 84,669 |
|
Total accruals and other current liabilities | $ | 253,239 |
| | $ | 213,411 |
|
Other current liabilities were comprised primarily of liabilities held for sale, accrued restructuring and related accruals, sales and value-added taxes payable, income taxes payable, and accrued warranty.
Accrued Warranty
Activity related to accrued warranty consisted of the following (in thousands):
|
| | | | | | | |
| Nine Months Ended July 31, |
| 2017 | | 2016 |
Balance at beginning of period | $ | 16,656 |
| | $ | 16,320 |
|
Warranty charged to Cost of net revenues | 8,546 |
| | 7,156 |
|
Utilization of warranty accrual | (10,005 | ) | | (7,348 | ) |
Other | 385 |
| | 124 |
|
Balance at end of period | 15,582 |
| | 16,252 |
|
Less: current portion | (13,667 | ) | | (12,918 | ) |
Long-term portion | $ | 1,915 |
| | $ | 3,334 |
|
Deferred Revenue, Net
Deferred revenue, net of related costs consisted of the following (in thousands):
|
| | | | | | | |
| July 31, 2017 | | October 31, 2016 |
Deferred revenue | $ | 199,050 |
| | $ | 185,788 |
|
Deferred cost of revenue | (21,605 | ) | | (14,475 | ) |
Deferred revenue, net | 177,445 |
| | 171,313 |
|
Less: current portion | (110,639 | ) | | (104,797 | ) |
Long-term portion | $ | 66,806 |
| | $ | 66,516 |
|
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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 July 31, | | Nine Months Ended July 31, |
| 2017 | | 2016 | | 2017 | | 2016 | |
Cost of net revenues | $ | 1,172 |
| | $ | 871 |
| | $ | 3,227 |
| | 2,563 |
| |
Research and development | 1,776 |
| | 1,850 |
| | 5,175 |
| | 5,644 |
| |
Sales and marketing | 2,929 |
| | 3,204 |
| | 8,760 |
| | 10,303 |
| |
General and administrative | 3,442 |
| | 4,925 |
| | 12,888 |
| | 14,379 |
| |
Total stock-based compensation expense | $ | 9,319 |
| | $ | 10,850 |
| | $ | 30,050 |
| | $ | 32,889 |
| |
Accumulated Other Comprehensive Loss
Activity related to Accumulated other comprehensive loss consisted of the following (in thousands):
|
| | | | | | | | | | | | | | | | |
| | Foreign currency translation adjustments (1) | | Unrealized gain (loss) on derivatives designated as cash flow hedges (2) | | Other (3) | | Total |
Balance at October 31, 2016 | | $ | (333,280 | ) | | $ | (2,419 | ) | | $ | (5,295 | ) | | $ | (340,994 | ) |
Gains before reclassifications | | 74,952 |
| | 4,003 |
| | — |
| | 78,955 |
|
Amounts reclassified from Accumulated other comprehensive loss | | 7,011 |
| | 1,217 |
| | 190 |
| | 8,418 |
|
Tax effect | | (391 | ) | | (1,981 | ) | | — |
| | (2,372 | ) |
Other comprehensive income | | 81,572 |
| | 3,239 |
| | 190 |
| | 85,001 |
|
Balance at July 31, 2017 | | $ | (251,708 | ) | | $ | 820 |
| | $ | (5,105 | ) | | $ | (255,993 | ) |
(1) Amounts reclassified from Accumulated other comprehensive loss were recorded in Redeemable noncontrolling interest in subsidiary and Noncontrolling interests in subsidiaries in the Condensed Consolidated Balance Sheets.
(2) Amounts reclassified from Accumulated other comprehensive loss were recorded in Interest expense, net in the Condensed Consolidated Statements of Operations.
(3) Amounts reclassified from Accumulated other comprehensive loss, net of tax, were recorded in General and administrative expenses in the Condensed Consolidated Statements of Operations. The related tax impacts were insignificant.
Note 6. Financial Instruments
Fair Value Measurements
Our financial assets and liabilities consist principally of cash, accounts receivable, accounts payable, debt, foreign exchange forward contracts, interest rate swaps and contingent consideration payable. 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. Assets held for sale, foreign exchange forward contracts, interest rate swaps and contingent consideration payable are recorded at estimated fair value.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
During the nine months ended July 31, 2017, there was no material change in the items we measure and record at fair value on a recurring basis. Additionally, there were no transfers between levels of the fair value hierarchy in the nine months ended July 31, 2017.
Fair Value of Contingent Consideration Payable
The fair value of contingent consideration payable totaled zero at July 31, 2017 and $6.0 million at October 31, 2016, and is comprised of amounts payable related to acquisitions. We evaluate changes in the assumptions used to calculate the fair value of contingent consideration payable at the end of each period. The maximum liability on contingent consideration payable is indeterminate because it is based on contributions from the acquired businesses.
See Note 9, Restructurings and Related Charges, for information regarding assets measured and recorded at fair value on a non-recurring basis.
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. As of July 31, 2017, we have outstanding interest rate swap agreements to effectively convert $450.0 million of the term A loan from a floating rate plus applicable margin to a fixed rate of 1.20% plus applicable margin through March 30, 2018. The principal amount under the term A loan covered by the interest rate swap agreements will decrease to $400.0 million from October 1, 2017 through March 30, 2018. In addition, we have an outstanding interest rate swap agreement to effectively convert $350.0 million of the term A loan to a fixed rate of 0.975% plus applicable margin from March 30, 2018 through June 30, 2019.
The interest rate swaps qualify for hedge accounting treatment as cash flow hedges. The notional amounts of interest rate swap agreements outstanding as of July 31, 2017 and October 31, 2016 were $450.0 million and $500.0 million, respectively.
Foreign Exchange Forward Contracts Not Designated as Hedging Instruments
We arrange and maintain foreign currency 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, with the objective 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 July 31, 2017 and October 31, 2016 were $249.0 million and $175.0 million, respectively. Gains and losses on foreign exchange forward contracts not designated as hedging instruments for the three and nine months ended July 31, 2017 were not material.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Note 7. Goodwill and Purchased Intangible Assets
Goodwill
Activity related to goodwill by reportable segment consisted of the following (in thousands):
|
| | | | | | | | | | | |
| Verifone Systems | | Verifone Services | | Total |
Balance at October 31, 2016 | $ | 497,126 |
| | $ | 613,367 |
| | $ | 1,110,493 |
|
Additions | — |
| | 5,647 |
| | 5,647 |
|
Goodwill impairment | — |
| | (17,384 | ) | | (17,384 | ) |
Reclassification to assets held for sale | — |
| | (28,327 | ) | | (28,327 | ) |
Disposals | — |
| | (10,096 | ) | | (10,096 | ) |
Currency translation adjustments | 22,173 |
| | 34,246 |
| | 56,419 |
|
Balance at July 31, 2017 | $ | 519,299 |
| | $ | 597,453 |
| | $ | 1,116,752 |
|
We review goodwill for impairment annually and whenever events or changes in circumstances indicate its carrying amount may not be recoverable. During the second quarter of fiscal year 2017, management concluded that the carrying amount of the goodwill related to our Taxi Solutions reporting unit may not be recoverable, and based on a quantitative assessment, considering potential sales transactions, management determined the fair value of the reporting unit and concluded that the goodwill was impaired by $17.4 million. Also, during the second quarter of fiscal year 2017, our management committed to a plan to sell our Taxi Solutions reporting unit, and the remaining $28.3 million of goodwill was reclassified to assets held for sale. See Note 9, Restructuring and Related Charges, for additional information.
Goodwill disposals relate to the exit from our petroleum media business during March 2017. See Note 9, Restructuring and Related Charges, for additional information.
There were no indicators of impairment for our Verifone Systems and Verifone Payment Services reporting units during the nine months ended July 31, 2017.
Purchased Intangible Assets, Net
Purchased Intangible assets, net consisted of the following (in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | |
| July 31, 2017 | | October 31, 2016 |
| Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount |
Customer relationships | $ | 512,812 |
| | $ | (279,020 | ) | | $ | 233,792 |
| | $ | 521,964 |
| | $ | (249,513 | ) | | $ | 272,451 |
|
Other | 46,179 |
| | (22,439 | ) | | 23,740 |
| | 73,175 |
| | (39,328 | ) | | 33,847 |
|
Total | $ | 558,991 |
| | $ | (301,459 | ) | | $ | 257,532 |
| | $ | 595,139 |
| | $ | (288,841 | ) | | $ | 306,298 |
|
Other intangible assets, net, were comprised primarily of developed and core technology.
When purchased intangible assets reach the end of their useful lives, gross carrying amount and accumulated amortization are offset. During the nine months ended July 31, 2017, we offset $40.9 million of Gross carrying amount and Accumulated amortization of intangible assets related to customer relationships and $27.1 million related to other intangible assets, because they reached the end of their useful lives.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Amortization of purchased intangible assets was allocated as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended July 31, | | Nine Months Ended July 31, |
| 2017 | | 2016 | | 2017 | | 2016 |
Included in Cost of net revenues | $ | 1,428 |
| | $ | 3,952 |
| | $ | 5,502 |
| | $ | 11,761 |
|
Included in Operating expenses | 16,696 |
| | 24,286 |
| | 53,873 |
| | 65,886 |
|
Total amortization of purchased intangible assets | $ | 18,124 |
| | $ | 28,238 |
| | $ | 59,375 |
| | $ | 77,647 |
|
Total future amortization expense for purchased intangible assets that have finite lives, based on our existing intangible assets and their current estimated useful lives as of July 31, 2017, is estimated as follows (in thousands):
|
| | | | | | | | | | | |
| Cost of Net Revenues | | Operating Expenses | | Total |
Fiscal Years Ending October 31: | | | | | |
Remaining of fiscal year 2017 | $ | 1,504 |
| | $ | 15,388 |
| | $ | 16,892 |
|
2018 | 5,564 |
| | 58,256 |
| | 63,820 |
|
2019 | 5,441 |
| | 52,494 |
| | 57,935 |
|
2020 | 3,730 |
| | 44,386 |
| | 48,116 |
|
2021 | 2,552 |
| | 32,258 |
| | 34,810 |
|
Thereafter | 1,101 |
| | 34,858 |
| | 35,959 |
|
Total future amortization expense | $ | 19,892 |
| | $ | 237,640 |
| | $ | 257,532 |
|
Note 8. Debt
Amounts outstanding under our financing arrangements consisted of the following (in thousands):
|
| | | | | | | |
| July 31, 2017 | | October 31, 2016 |
Credit Agreement | | | |
Term A loan | $ | 480,000 |
| | $ | 525,000 |
|
Term B loan | 194,000 |
| | 195,500 |
|
Revolving loan | 201,153 |
| | 204,684 |
|
Capital leases and other debt | 10,793 |
| | 11,573 |
|
Total principal payments due | 885,946 |
| | 936,757 |
|
Less: original issue discount and debt issuance costs | (7,845 | ) | | (10,844 | ) |
Total amounts outstanding | 878,101 |
| | 925,913 |
|
Less: current portion | (68,216 | ) | | (66,017 | ) |
Long-term portion | $ | 809,885 |
| | $ | 859,896 |
|
Credit Agreement
Key terms of our credit agreement include financial maintenance covenants and certain representations, warranties, covenants and conditions that are customarily required for similar financings. We complied with all financial covenants under our credit agreement as of July 31, 2017.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Borrowings under the credit agreement may be “Base Rate Borrowings” or “Eurodollar Borrowings” at our option. As of July 31, 2017, we have elected the Eurodollar option for all of our borrowings. Eurodollar loans bear interest at a monthly market interest rate plus a margin according to the credit agreement. As of July 31, 2017, the monthly market interest rate was 1.24% for our term A and revolver loans, and 1.24% for our term B loan, and the margins were 2.00% for our term A and revolver loans and 2.75% for our term B loan. Accordingly, as of July 31, 2017, the interest rate was 3.24% for the term A and revolving loans and 3.99% for the term B loan.
We have a number of interest rate swap agreements under which we currently pay banks a fixed rate of 1.20% and receive a monthly floating rate, which effectively converts $450.0 million of the term A loan from a floating interest rate to a fixed interest rate as of July 31, 2017. See Note 6, Financial Instruments, for additional information.
As of July 31, 2017, the commitment fee for the unused portion of the revolving loan was 0.25% per annum, payable quarterly in arrears, and the amount available to draw under the revolving loan was $298.7 million.
Note 9. Restructuring and Related Charges
As part of cost optimization and corporate transformation initiatives, our management has approved, committed to and initiated various restructuring plans to reduce headcount, exit under-performing businesses, and consolidate facilities and data centers.
Activity related to our restructuring and related accruals for the nine months ended July 31, 2017 consisted of the following (in thousands): |
| | | | | | | | | | | | | | | | | | | | | | | |
| Restructuring Plans | | | | |
| Prior year Plans | | June 2016 Plan | | June 2017 Plan | | | | |
| Employee Involuntary Termination Benefits | | Employee Involuntary Termination Benefits | | Facilities Related Costs | | Employee Involuntary Termination Benefits | | Other Business Exit Costs | | Total |
Balance at October 31, 2016 | $ | 1,700 |
| | $ | 5,225 |
| | $ | 2,807 |
| | $ | — |
| | $ | — |
| | $ | 9,732 |
|
Charges, net of adjustments | (736 | ) | | 7,283 |
| | (750 | ) | | 9,783 |
| | 28,063 |
| | 43,643 |
|
Cash payments | (822 | ) | | (7,793 | ) | | (857 | ) | | (3,765 | ) | | (5,809 | ) | | (19,046 | ) |
Balance at July 31, 2017 | $ | 142 |
| | $ | 4,715 |
| | $ | 1,200 |
| | $ | 6,018 |
| | $ | 22,254 |
| | $ | 34,329 |
|
Cumulative costs to date | $ | 18,596 |
| | $ | 19,190 |
| | $ | 2,679 |
| | $ | 9,783 |
| | $ | 28,063 |
| |
|
|
| | | | | | | | | | |
|
|
Activities under these Restructuring Plans are expected to be substantially complete by the end of fiscal year 2017.
Restructuring and related charges were allocated as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended July 31, | | Nine Months Ended July 31, |
| 2017 | | 2016 | | 2017 | | 2016 |
Included in Cost of net revenues | $ | 12,893 |
| | $ | 2,301 |
| | $ | 25,250 |
| | $ | 2,212 |
|
Included in Operating expenses | 65,705 |
| | 33,629 |
| | 135,743 |
| | 34,196 |
|
Total restructuring and related charges | $ | 78,598 |
| | $ | 35,930 |
| | $ | 160,993 |
| | $ | 36,408 |
|
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
During the second quarter of fiscal year 2017, our management committed to a plan to exit our petroleum media business, which was part of our Verifone Services segment. In connection with this decision, we contributed certain assets to Gas Media, terminated certain customer agreements and classified the remaining assets of this business as held for sale, resulting in a $49.1 million write-down to reflect the assets held for sale at fair value, of which $10.6 million is included in Cost of net revenues and $38.5 million is included in Restructuring and related charges in the Condensed Consolidated Statements of Operations. The fair value of these assets held for sale was determined based upon the value at which the assets are being offered to customers in connection with the termination of the associated customer agreements. Additionally, during the second quarter of fiscal year 2017, we recorded a $28.1 million accrual for future obligations associated with the terminated customer agreements.
During the second quarter of fiscal year 2017, our management committed to a plan to sell our Taxi Solutions reporting unit and we classified the net assets and liabilities of this business, including Accounts receivable, Prepaid expenses and other current assets, Fixed Assets, Goodwill and Accruals and other current liabilities, as held for sale. These assets held for sale were stated at fair value in connection with the quantitative assessment of goodwill impairment discussed in Note 7, Goodwill and Purchased Intangible Assets. Additionally, during July 2017, based upon continued negotiations of potential sales transactions, management updated the fair value of the assets held for sale, resulting in a $43.2 million fair value adjustment, which is included in Restructuring and related charges in the Condensed Consolidated Statements of Operations. As of July 31, 2017, the gross assets held for sale are presented in Prepaid expenses and other current assets in the Condensed Consolidated Balance Sheet and the gross liabilities held for sale are presented in Accruals and other current liabilities in the Condensed Consolidated Balance Sheet.
During June 2017, we divested our controlling interest in the entity that operated our China business, including primarily Accounts receivable, Inventories, Prepaid expenses and other current assets, as well as Accounts payable, and Accruals and other current liabilities, resulting in a $24.4 million charge, of which $11.1 million is included in Cost of net revenues and $13.3 million is included in Restructuring and related charges in the Condensed Consolidated Statements of Operations. The fair value of these net assets and liabilities was determined based upon the consideration received in the divestiture transaction. See Note 2, Business Combinations, for additional information.
Businesses that we have disposed or are committed to sell incurred losses totaling $70.3 million and $176.4 million for the three and nine months ended July 31, 2017, respectively, and $40.6 million and $68.7 million for the three and nine months ended July 31, 2016, respectively. The losses in the three and nine months ended July 31, 2017 include the restructuring and related charges discussed above.
Note 10. Commitments and Contingencies
Commitments
On April 3, 2017, to lock in pricing on certain components, we committed to purchase $144 million of such components over a four year period, $36 million per year, from one of our existing suppliers. As of July 31, 2017 our remaining non-cancelable commitment under this agreement totaled $112.1 million. Other than this arrangement, there have been no material changes to our non-cancelable operating lease commitments and manufacturing agreements since October 31, 2016.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Bank Guarantees
We have arranged bank guarantees with maturities ranging from two months to eight 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 July 31, 2017, the maximum amount that may become payable under these guarantees was $17.8 million, of which $2.3 million was collateralized by restricted cash deposits.
In addition, in connection with our investment in Gas Station TV we have agreed to guarantee, in certain circumstances, up to $12.5 million of debt issued to Gas Media. As of July 31, 2017, we have not made any payments and no amounts are accrued related to this guarantee.
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, if material. Except as otherwise disclosed below, we do not believe that material 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 July 31, 2017 for this matter totals approximately 9.3 million Brazilian reais (approximately $3.0 million at the foreign exchange rate as of July 31, 2017). As of July 31, 2017, we have not accrued for this matter, but we have posted a bank bond as a guaranty.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Municipality Services Tax Assessments
In December 2009, one of the Brazilian subsidiaries that was 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 $280,000 at the foreign exchange rate as of July 31, 2017), 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 5.8 million Brazilian reais (approximately $1.8 million at the foreign exchange rate as of July 31, 2017), 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 July 31, 2017, the amount of the alleged tax assessments and penalties related to these matters was approximately 26.4 million Brazilian reais (approximately $8.4 million at the foreign exchange rate as of July 31, 2017), including interest, costs and fees related thereto.
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 July 31, 2017, the underlying assessment, including estimated interest, was approximately 5.9 million Brazilian reais (approximately $1.9 million at the foreign exchange rate as of July 31, 2017). 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.
Israel Securities Class Actions
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 sought compensation for damages allegedly incurred by the class of plaintiffs due to the publication of erroneous financial reports. On April 2, 2015, the Israeli Supreme Court ruled that the applicable law is U.S. law and dismissed this action as estopped by settlement of the similar consolidated federal securities class action in the U.S. (In re VeriFone Holdings, Inc., previously reported). The plaintiff and putative class members in this Israeli action are included in the stipulated settlement of the U.S. class action unless an individual plaintiff opts out. On June 29, 2015, the plaintiff filed a motion for award of compensation and attorneys' fees based on the amount of settlement compensation received by Israelis in the U.S. class action. On January 14, 2016, the Israeli District Court denied this motion. Plaintiff has not timely appealed, that ruling is now final, and this 2008 action is now concluded.
On May 12, 2015, a new class action complaint was filed against us in Israel alleging similar claims as the dismissed Israeli class action and alleging that Israeli shareholders were deprived of due process in the U.S. class action settlement proceedings. We are opposing the new class action and plaintiff's class certification motion on substantially the same grounds on which the previous case was dismissed. The court held a pretrial hearing on that motion on May 19, 2016, at which it requested additional information including expert reports, a position paper from the Israel Securities Authority ("ISA") and further briefing. In July 2016, the ISA submitted a position paper supporting our position regarding applicable law. Other requested information has also now been submitted, but the court has not yet ruled.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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 October 27, 2017.
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 named 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 original complaint sought 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 granted defendants' motion to relate this action to the pending shareholder class action, Sanders v. VeriFone Systems, Inc. et al. On January 21, 2014, plaintiff filed a first amended complaint, which removed one of our former officers from the action and added an additional former director as a defendant. The first amended complaint asserted claims against the defendants for breach of fiduciary duty, abuse of control, violations of Securities Exchange Act Section 14(a) and unjust enrichment. The first amended complaint also included claims for insider trading against three of the named former and current directors. On August 7, 2014, the court granted our motion to dismiss the first amended complaint with leave to amend. On October 17, 2014, plaintiff filed a second amended complaint, to which we responded by filing another motion to dismiss. On December 3, 2015, the court granted our motion to dismiss, again with leave to amend. On January 20, 2016, plaintiff filed a third amended complaint alleging demand futility with respect to the current Board. On March 1, 2016, we filed another motion to dismiss, on which the court has not yet ruled.
If either of these 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.
Indian Antitrust Proceedings
The Competition Commission of India ("CCI") investigated certain complaints made against us alleging unfair practices based on certain provisions in our software development license arrangements in India. We 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. VeriFone India Sales Pvt. Ltd. filed objections to that report.
In April 2015, the CCI issued rulings directing Verifone India to cease and desist from engaging in the alleged anti-competitive conduct and imposing a penalty, the amount of which is not material to our results of operations. We have deposited 10% of this penalty amount and accrued the balance while we appeal these rulings.
On June 15, 2015, we filed appeals and interim applications with the Competition Appellate Tribunal ("COMPAT") to stay the CCI orders. The appellate court granted our interim applications to stay all proceedings at least until the final appellate hearing. That appellate hearing commenced on January 19, 2016, and was next scheduled to continue on May 31, 2017, but was taken off that tribunal's calendar due to the May 26, 2017 merger of the COMPAT with the National Company Law Appellate Tribunal ("NCLAT"). These appeals will now be reheard before the NCLAT Bench starting on September 18, 2017.
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The CCI's rulings reserved the right to pursue additional proceedings against individuals that it deems responsible for the alleged conduct. We are unable to make any estimate of potential loss for any further proceedings the CCI may pursue but do not expect it to be material to our results of operations.
Other Litigation
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, other than as described above. 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. 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 anticipated 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.
Income Tax Uncertainties
As of July 31, 2017, the amount payable for unrecognized tax benefits was $36.4 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 July 31, 2017. We are unable to make a reasonably reliable estimate as to when cash settlement with a taxing authority may occur.
Note 11. Segment and Geographic Information
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 include amortization of purchased intangible assets, amortization of step-down in deferred services net revenues and associated costs of net revenues at acquisition, restructuring and related charges, goodwill impairment, stock-based compensation, as well as general and administrative and corporate research and development expense. We do not separately evaluate assets by segment and therefore assets by segment are not presented below.
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 July 31, | | Nine Months Ended July 31, |
| 2017 | | 2016 | | 2017 | | 2016 |
Segment net revenues: | | | | | | | |
Verifone Systems | $ | 265,951 |
| | $ | 292,072 |
| | $ | 817,027 |
| | $ | 972,107 |
|
Verifone Services | 200,915 |
| | 200,513 |
| | 580,388 |
| | 566,390 |
|
Total segment net revenues | 466,866 |
| | 492,585 |
| | 1,397,415 |
| | 1,538,497 |
|
Amortization of step down in deferred services net revenues at acquisition | — |
| | (4,453 | ) | | (2,993 | ) | | (10,548 | ) |
Total net revenues | $ | 466,866 |
| | $ | 488,132 |
| | $ | 1,394,422 |
| | $ | 1,527,949 |
|
VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The following table sets forth operating income for our reportable segments and reconciles segment operating income to consolidated operating income (loss) (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended July 31, | | Nine Months Ended July 31, |
| 2017 | | 2016 | | 2017 | | 2016 |
Operating income by segment: | | | | | | | |
Verifone Systems | $ | 43,627 |
| | $ | 63,564 |
| | $ | 131,368 |
| | $ | 222,434 |
|
Verifone Services | 56,017 |
| | 50,400 |
| | 144,576 |
| | 138,975 |
|
Total segment operating income | 99,644 |
| | 113,964 |
|
| 275,944 |
|
| 361,409 |
|
Items not attributable to segment operating income: | | | | | | | |
Amortization of step down in deferred services gross margin at acquisition
| — |
| | (3,057 | ) | | (2,385 | ) | | (7,482 | ) |
Restructuring and related charges | (78,598 | ) | | (38,851 | ) | | (160,993 | ) | | (39,329 | ) |
Amortization of purchase intangible assets | (18,124 | ) | | (28,238 | ) | | (59,375 | ) | | (77,647 | ) |
Stock-based compensation expense | (9,319 | ) | | (10,850 | ) | | (30,050 | ) | | (32,889 | ) |
Litigation settlement and loss contingency expense | — |
| | (600 | ) | | — |
| | (600 | ) |
Goodwill impairment | — |
| | — |
| | (17,384 | ) | | — |
|
Unallocated general and administrative expenses | (41,425 | ) | | (44,828 | ) | | (129,539 | ) | | (142,663 | ) |
Unallocated research and development expenses | 1,470 |
| | (5,652 | ) | | (6,456 | ) | | (15,245 | ) |
Other unallocated costs | (3,862 | ) | | (4,233 | ) | | (5,805 | ) | | (11,904 | ) |
Total operating income (loss) | $ | (50,214 | ) | | $ | (22,345 | ) | | $ | (136,043 | ) | | $ | 33,650 |
|
| |
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 2016 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 2016 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 2016 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 2016 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: A discussion of our business.
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 nine months ended July 31, 2017 to the three and nine months ended July 31, 2016.
Segment Results of Operations: An analysis and discussion of our financial results comparing the results of operations for each of our two reportable segments, Verifone Systems and Verifone Services, for the three and nine months ended July 31, 2017 to the three and nine months ended July 31, 2016.
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 July 31, 2017.
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 global leader in payments and commerce solutions. We provide expertise and solutions that add value at the retail point-of-sale (POS) and enable innovative forms of commerce. For 35 years, we have been a leader in designing, manufacturing, marketing and supplying a broad range of innovative payment solutions, including customer payments acceptance, connectivity between merchants and financial institutions, as well as security and comprehensive payment and commerce services. We focus on delivering solutions that include innovative POS payment capabilities, value-added services that increase merchant revenues and enhance the consumer experience, and solutions that enrich and improve the interaction between merchants and consumers and help merchants run their businesses more efficiently. Key industries in which we operate include financial services, retail, petroleum, restaurant, hospitality, transportation and healthcare.
The markets in which we operate are highly competitive. We compete based on various factors, including product functions and features, pricing, product quality and reliability, design innovation, interoperability with third-party systems and brand reputation. We also compete based on product availability and certifications, as well as service offerings and support. We continue to experience competition from traditional POS terminal providers as well as suppliers of electronic cash registers (ECRs) that provide built-in electronic payment capabilities and producers of software that facilitates electronic payments over the Internet, and we also see new companies entering our markets, including entrants offering various forms of mobile device based payment options. In certain geographic markets, such as Brazil, we see customers requiring a choice of lower cost offerings. This trend has increased competition and pricing pressures in those geographies.
We have two operating segments: Verifone Systems and Verifone Services. Verifone Systems delivers point of sale electronic payment devices that run our unique operating systems, security and encryption software, and certified payment software for both payments and commerce. Verifone Services delivers device related services and maintenance, payment transaction routing and reporting, and commerce based services. Our reportable segments are the same as our operating segments.
Systems
Sales of our point of sale electronic payment devices and systems comprise approximately 57.0% and 58.6% of our net revenues in the three and nine months ended July 31, 2017, respectively. Our point of sale electronic payment devices run our unique operating systems, security and encryption software, and certified payment software, and are designed to suit our clients' needs in a variety of environments, including traditional multilane and countertop implementations, self-service or unattended environments, in-vehicle and portable deployments, mobile point-of-sale solutions, as well as fully integrated POS solutions. Our systems can securely process a wide range of payment types including signature and PIN-based debit cards, credit cards, NFC/contactless/radio frequency identification cards, or RFID cards, smart cards, pre-paid gift and other stored-value cards, electronic bill payment, signature capture and electronic benefits transfer, or EBT. Our unique 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 applications to reside on the same system without requiring recertification upon the addition of new applications. During the past year we introduced Verifone Engage, the next generation of our best-selling suite of devices, which is a family of interactive, commerce-enabled payment devices that we believe offer an innovative connected payments experience. We also launched Verifone Carbon, an integrated dual-screen connected point-of-sale solution that enables merchants to run register and business applications from a tablet screen while enabling consumers to pay and interact with a consumer-facing screen. Combining our Verifone Engage and Carbon payment solutions with our mobile and value family of devices, we are able to deliver rich media and complex commerce enablement services on our payment terminals to our merchant clients, as well as mobile solutions and products geared for price sensitive emerging markets.
Services
Services are an important part of our business and revenues, accounting for approximately 43.0% and 41.4% of our net revenues in the three and nine months ended July 31, 2017, respectively. We offer a wide portfolio of services including device, payment, commerce and omni-channel services. Our traditional device services include professional services related to installation and deployment, helpdesk support, training, equipment repair and maintenance, terminal management services and software post-contract support. Our payment services include gateway solutions that enable more efficient routing of transactions, multi-channel acceptance and processing, along with end-to-end encryption to reduce the complexity and costs of Payment Card Industry (PCI), standards compliance. Our commerce services leverage our terminals to drive incremental consumer sales by engaging consumers at the point of sale through value-added applications such as loyalty and couponing applications, targeted offers and real-time reward redemptions. Our omni-channel services provide seamless interoperability between online and offline payments.
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 delay orders due to regulatory and industry standards compliance, budget considerations, product feature availability, dual vendor sourcing requirements, technology refresh cycles, economic conditions or other concerns that impact their business or purchasing decisions. For example, the timing of customer orders is often impacted by the timing of technology refreshes or the timing of completed product certifications by a particular customer or in a particular market. Customer purchases have also been impacted by regulatory factors such as new or pending banking regulations and government initiatives to drive cashless transactions.
In addition, revenues can be back-end weighted when we receive sales orders and deliver a higher proportion of our systems 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 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
Business Divestitures
As part of our strategic review of under-performing businesses, our management has completed several recent divestitures.
China Business
During June 2017, we completed the divestiture of a controlling interest in Verifone Systems (China), Inc., the entity which operated our China business. In connection with this divestiture, we retained a 30% preferred equity interest in form of non-voting equity that has a liquidation preference of $29.0 million and is non-convertible for an initial two year period. We recorded a $24.4 million loss in connection with the sale of this business.
Petroleum Media Business
During March 2017, we committed to a plan to exit our petroleum media business. In connection with this decision, we are in the process of terminating certain customer agreements and have contributed certain assets to a newly formed business, Gas Media, in exchange for a 50% ownership interest in that business. We recorded a net $67.6 million net charge in connection with the divestiture and planned contract terminations, and have classified the remaining net assets and liabilities of this business as held for sale.
Taxi Solutions Business
During March 2017, we committed to a plan to sell our Taxi Solutions reporting unit. During the second quarter of fiscal year 2017 we recorded a $17.4 million goodwill impairment, considering potential sales transactions and the then fair market value of the reporting unit. During July 2017, based on continued negotiations, we recognized a $43.2 million additional write down of the net assets to fair market value, considering ongoing negotiations of potential sales transactions. The net assets and liabilities of this business are classified as held for sale.
Revenue from these businesses that we have disposed or are committed to sell totaled $30.5 million and $96.2 million for the three and nine months ended July 31, 2017, respectively, as well as $41.1 million and $115.3 million for the three and nine months ended July 31, 2016, respectively. Operating losses from these businesses totaled $70.3 million and $176.4 million for the three and nine months ended July 31, 2017, respectively, and $40.6 million and $68.7 million for the three and nine months ended July 31, 2016, respectively, including the charges discussed above.
Restructuring Plans
Additionally, as part of cost optimization and corporate transformation initiatives, our management has approved, committed to and initiated various restructuring plans to reduce headcount, exit under-performing businesses, and consolidate facilities and data centers over the past two years. During June 2017, our management committed to a new plan under which we have spent $9.8 million primarily related to headcount reductions. This plan is expected to be substantially complete by the end of fiscal year 2017. During June 2016, our management committed to a restructuring plan that is substantially complete and under which we have incurred charges totaling $21.9 million.
Results of Operations
Consolidated Results of Operations
Three Months Ended July 31, 2017 compared to July 31, 2016
|
| | | | | | | | | | | |
| Three Months Ended July 31, |
| 2017 | | % of Net revenues (1) | | 2016 | | % of Net revenues (1) |
| (in thousands, except percentages) |
Net revenues: | |
Systems | $ | 265,951 |
| | 57.0% | | $ | 292,072 |
| | 59.8% |
Services | 200,915 |
| | 43.0% | | 196,060 |
| | 40.2% |
Total net revenues | 466,866 |
| | 100.0% | | 488,132 |
| | 100.0% |
| | | | | | | |
Gross margin: | | | | | | | |
Systems | 88,177 |
| | 33.2% | | 116,382 |
| | 39.8% |
Services | 86,273 |
| | 42.9% | | 74,765 |
| | 38.1% |
Gross margin | 174,450 |
| | 37.4% | | 191,147 |
| | 39.2% |
| | | | | | | |
Operating expenses: | | | | | | | |
Research and development | 50,731 |
| | 10.9% | | 52,394 |
| | 10.7% |
Sales and marketing | 46,665 |
| | 10.0% | | 52,830 |
| | 10.8% |
General and administrative | 44,867 |
| | 9.6% | | 49,753 |
| | 10.2% |
Restructuring and related charges | 65,705 |
| | 14.1% | | 33,629 |
| | 6.9% |
Litigation settlement and loss contingency expense | — |
| | —% | | 600 |
| | 0.1% |
Amortization of purchased intangible assets | 16,696 |
| | 3.5% | | 24,286 |
| | 5.0% |
Total operating expenses | 224,664 |
| | 48.1% |
| 213,492 |
| | 43.7% |
Operating loss | (50,214 | ) | | (10.8)% | | (22,345 | ) | | (4.6)% |
Interest expense, net | (8,380 | ) | | (1.8)% | | (9,023 | ) | | (1.8)% |
Other income (expense), net
| (1,908 | ) | | (0.4)% | | 156 |
| | —% |
Net loss before income taxes | (60,502 | ) | | (13.0)% | | (31,212 | ) | | (6.4)% |
Income tax provision | 10,286 |
| | 2.2% | | 286 |
| | 0.1% |
Consolidated net loss | $ | (70,788 | ) | | (15.2)% | | $ | (31,498 | ) | | (6.5)% |
(1) Systems and Services gross margin as a percentage of net revenues is computed as a percentage of the corresponding Systems and Services net revenues.
Net revenues for the three months ended July 31, 2017 were $466.9 million, compared to $488.1 million for the three months ended July 31, 2016, down $21.2 million or 4.3%. Net revenues decreased primarily in North America due to decreased demand for EMV enabled devices where there had been higher than usual demand in the petroleum market during the prior year. This decrease was partially offset by increased revenue in Latin America. See further discussion of net revenues by segment and geography below.
Net Revenues by Geography
|
| | | | | | | | | | | | | | |
| | | | Three Months Ended July 31, |
| | | | 2017 | | % of Net revenues | | 2016 | | % of Net revenues |
| | | | (in thousands, except percentages) |
Net Revenues |
North America | | $ | 152,866 |
| | 32.7% | | $ | 191,509 |
| | 39.2% |
Latin America | | 71,266 |
| | 15.3% | | 55,069 |
| | 11.3% |
EMEA | | 193,483 |
| | 41.4% | | 190,045 |
| | 38.9% |
Asia-Pacific | | 49,251 |
| | 10.6% | | 51,509 |
| | 10.6% |
| | Total | | $ | 466,866 |
| | 100.0% | | $ | 488,132 |
| | 100.0% |
| |
• | North America net revenues decreased $38.6 million, due primarily to reduced demand for our EMV capable terminals by customers, particularly in the petroleum market, that had upgraded to products that support EMV requirements in the prior year associated with the expected EMV liability deadline that has since been extended. |
| |
• | Latin America net revenues increased $16.2 million, due primarily to changes in timing of purchase decisions by large customers, which were influenced by factors such as macroeconomic conditions and compliance with various government e-payment initiatives. This increase includes a $5.9 million increase in services net revenues due to new service contracts with customers. |
| |
• | EMEA net revenues increased $3.4 million, primarily due to growth in services revenues and as a result of changes in timing of purchase decisions by large customers in Russia and Germany and increased systems sales in Greece to comply with government fiscalization requirements, partially offset by lower sales in other European countries. |
| |
• | Asia-Pacific net revenues decreased $2.3 million, due primarily to decreased revenue in Australia as a result of reduced demand from some of our large banking customers that were upgrading and expanding terminals at their merchant customers in the prior year. The decrease was partially offset by increased revenue in India as a result of government demonetization initiatives. |
Gross margin for the three months ended July 31, 2017 was $174.5 million or 37.4% of total net revenues, compared to $191.1 million or 39.2% of total net revenues, for the three months ended July 31, 2016, down $16.6 million or 1.8 percentage points. Gross margin in dollars decreased due primarily to the decrease in net revenues and also due to an $11.1 million charge related to the divestiture of our China business. Gross margin as a percentage of net revenues decreased due primarily to changes in geographic and product mix, such as the decrease in net revenues from North America, which generally have higher gross margins compared to other geographies, and due to the $11.1 million charge associated with the China business divestiture.
Research and development for the three months ended July 31, 2017 was $50.7 million compared to $52.4 million for the three months ended July 31, 2016, down $1.7 million or 3.2%, due to higher costs in the prior year associated with additional personnel and outside resources that were hired to develop and bring next generation products and solutions to market, such as our recently announced Verifone Engage and Carbon payment solutions.
Sales and marketing for the three months ended July 31, 2017 was $46.7 million, compared to $52.8 million for the three months ended July 31, 2016, down $6.1 million or 11.6%, due primarily to reduced variable costs associated with lower revenues and decreased spend associated with cost savings initiatives.
General and administrative for the three months ended July 31, 2017 was $44.9 million, compared to $49.8 million for the three months ended July 31, 2016, down $4.9 million or 9.9%, due primarily to decreased spend associated with cost savings initiatives.
Restructuring and related charges for the three months ended July 31, 2017 was $65.7 million, compared to $33.6 million for the three months ended July 31, 2016, up $32.1 million primarily as a result of increased restructuring activities and divestitures. The $65.7 million charge in the three months ended July 31, 2017 is mainly comprised of a $56.5 million fair market value write-downs associated with assets held for sale and an $8.9 million employee and facility related restructuring charge. The $33.6 million charge in the three months ended July 31, 2016 is comprised of a $20.4 million fair market value write-down associated with assets held for sale, $7.4 million of employee and facility related restructuring charges, and a $5.8 million charge related to a contract cancellation.
Amortization of purchased intangible assets for the three months ended July 31, 2017 was $16.7 million, compared to $24.3 million for the three months ended July 31, 2016, down $7.6 million or 31.3%, primarily because a portion of our purchased intangible assets were fully amortized in the prior year.
Income tax provision for the three months ended July 31, 2017 was $10.3 million, compared to $0.3 million for the three months ended July 31, 2016, up $10.0 million. The income tax provision for three months ended July 31, 2017 was primarily attributable to foreign taxes and discrete items related to restructuring charges. The income tax provision for the three months ended July 31, 2016 was primarily related to foreign taxes that were substantially offset by the reversal of unrecognized tax benefits where statutes of limitations expired or audits have been settled.
Nine Months Ended July 31, 2017 compared to July 31, 2016
|
| | | | | | | | | | | |
| Nine Months Ended July 31, |
| 2017 | | % of Net revenues (1) | | 2016 | | % of Net revenues (1) |
| (in thousands, except percentages) |
Net revenues: | |
Systems | $ | 817,027 |
|
| 58.6% | | $ | 972,107 |
|
| 63.6% |
Services | 577,395 |
| | 41.4% | | 555,842 |
| | 36.4% |
Total net revenues | 1,394,422 |
| | 100.0% | | 1,527,949 |
| | 100.0% |
| | | | | | | |
Gross margin: | | | | | | | |
Systems | 296,642 |
| | 36.3% | | 401,068 |
| | 41.3% |
Services | 222,000 |
| | 38.4% | | 215,743 |
| | 38.8% |
Total gross margin | 518,642 |
| | 37.2% | | 616,811 |
| | 40.4% |
| | | | | | | |
Operating expenses: | | | | | | | |
Research and development | 158,454 |
| | 11.4% | | 158,150 |
| | 10.4% |
Sales and marketing | 146,806 |
| | 10.5% | | 167,289 |
| | 10.9% |
General and administrative | 142,425 |
| | 10.2% | | 157,040 |
| | 10.3% |
Restructuring and related charges | 135,743 |
| | 9.7% | | 34,196 |
| | 2.2% |
Litigation settlement and loss contingency expense | — |
| | —% | | 600 |
| | —% |
Amortization of purchased intangible assets | 53,873 |
| | 3.9% | | 65,886 |
| | 4.3% |
Goodwill impairment | 17,384 |
| | 1.2% | | — |
| | —% |
Total operating expenses | 654,685 |
| | 46.9% | | 583,161 |
| | 38.2% |
Operating income (loss) | (136,043 | ) | | (9.8)% | | 33,650 |
| | 2.2% |
Interest expense, net | (24,712 | ) | | (1.8)% | | (25,870 | ) | | (1.7)% |
Other income (expense), net
| 4,666 |
| | 0.3% | | (6,833 | ) | | (0.4)% |
Income (loss) before income taxes | (156,089 | ) | | (11.2)% | | 947 |
| | 0.1% |
Income tax provision | 22,088 |
| | 1.6% | | 5,372 |
| | 0.4% |
Consolidated net loss | $ | (178,177 | ) | | (12.8)% | | $ | (4,425 | ) | | (0.3)% |
(1) Systems and Services gross margin as a percentage of net revenues is computed as a percentage of the corresponding Systems and Services net revenues.
Net revenues for the nine months ended July 31, 2017 were $1.39 billion, compared to $1.53 billion for the nine months ended July 31, 2016, down $133.5 million or 8.7%. Net revenues decreased primarily in North America due to decreased demand for EMV enabled devices and in other geographies primarily due to the timing of certain large customer purchases. These decreases were partially offset by increased revenues due to India demonetization initiatives. See further discussion of revenues by segment and geography below.
Net Revenues by Geography
|
| | | | | | | | | | | | | | |
| | | | Nine Months Ended July 31, |
| | | | 2017 | | % of net revenues | | 2016 | | % of net revenues |
| | | | (in thousands, except percentages) |
Net Revenues |
North America | | $ | 476,107 |
| | 34.2% | | $ | 636,543 |
| | 41.7% |
Latin America | | 190,806 |
| | 13.7% | | 179,637 |
| | 11.8% |
EMEA | | 539,318 |
| | 38.6% | | 557,415 |
| | 36.4% |
Asia-Pacific | | 188,191 |
| | 13.5% | | 154,354 |
| | 10.1% |
| | Total | | $ | 1,394,422 |
| | 100.0% | | $ | 1,527,949 |
| | 100.0% |
| |
• | North America net revenues decreased $160.4 million, due primarily to reduced demand for our EMV capable terminals by customers that had upgraded to products that support EMV requirements in the prior year. |
| |
• | Latin America net revenues increased $11.2 million, due primarily to changes in timing of purchase decisions by large customers, which were influenced by factors such as macroeconomic conditions and compliance with various government e-payment initiatives. |
| |
• | EMEA net revenues decreased $18.1 million, as a result of changes in timing of purchase decisions, which were influenced by factors such as macroeconomic conditions, government fiscalization programs, timing of customer technology refreshes, and ongoing competitive pricing. Also, EMEA net revenues increased $9.9 million due to our acquisition of InterCard in December 2015. |
| |
• | Asia-Pacific net revenues increased $33.8 million, due primarily to increases in India as a result of government demonetization initiatives. |
Gross margin for the nine months ended July 31, 2017 was $518.6 million or 37.2% of net revenues, compared to $616.8 million, or 40.4% of net revenues, for the nine months ended July 31, 2016, down $98.2 million or 3.2 percentage points. Gross margin in dollars decreased due primarily to the decrease in net revenues, a $10.6 million charge related to the divestiture of our petroleum media business and an $11.1 million charge related to our China business divestiture. Gross margin as a percentage of net revenues decreased due primarily to changes in geographic and product mix, such as decreases in net revenues from North America, which generally have higher gross margins compared to other geographies, as well as the charges associated with our petroleum media and China business divestitures.
Research and development for the nine months ended July 31, 2017 was $158.5 million compared to $158.2 million for the nine months ended July 31, 2016, up $0.3 million or 0.2%, due primarily to a $9.1 million write-down of capitalized costs associated with development projects that will not be completed, which was partially offset by a net $8.3 million decrease in spend due to higher costs in the prior year associated with additional personnel and outside resources that were hired to develop and bring next generation products and solutions to market, such as our recently announced Engage and Carbon payment solutions.
Sales and marketing for the nine months ended July 31, 2017 was $146.8 million, compared to $167.3 million for the nine months ended July 31, 2016, down $20.5 million or 12.3%, due primarily to reduced variable costs associated with lower revenues and decreased spend associated with cost savings initiatives.
General and administrative for the nine months ended July 31, 2017 was $142.4 million compared to $157.0 million for the nine months ended July 31, 2016, down $14.6 million or 9.3%, due primarily to decreased spend associated with cost savings initiatives, partially offset by additional costs associated with acquired businesses.
Restructuring and related charges for the nine months ended July 31, 2017 was $135.7 million compared to $34.2 million for the nine months ended July 31, 2016, up $101.5 million, primarily as a result of increased restructuring activities and divestitures. The $135.7 million charge in the nine months ended July 31, 2017 is comprised of a $94.5 million fair market value write-down associated with assets held for sale, a $28.1 million charge related to contract cancellation obligations and a $12.9 million employee and facility related restructuring charge. The $34.2 million charge in the nine months ended July 31, 2016 is comprised of a $20.4 million fair market value write-down associated with assets held for sale, a $8.0 million employee and facility related restructuring charge, and a $5.8 million charge related to a contract cancellation.
Amortization of purchased intangible assets for the nine months ended July 31, 2017 was $53.9 million compared to $65.9 million for the nine months ended July 31, 2016, down $12.0 million or 18.2%, primarily because a portion of our purchased intangible assets were fully amortized in the prior year, partially offset by an increase in amortization for purchased intangible assets associated with acquired businesses.
Goodwill impairment for the nine months ended July 31, 2017 was $17.4 million related to our Taxi Solutions reporting unit based on a quantitative assessment and potential sales transactions.
Other income (expense), net for the nine months ended July 31, 2017 was $4.7 million of net income compared to net expense of $6.8 million for the nine months ended July 31, 2016, an $11.5 million change. This change is due primarily to a $10.1 million gain recognized in connection with our investment in Gas Media.
Income tax provision for the nine