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Section 1: 10-Q (10-Q 4/30/2018)

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Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended April 30, 2018
Or
¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to           
Commission file number: 001-32465
VERIFONE SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
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.
Large accelerated filer  þ
 
Smaller reporting company  o


Accelerated filer   o


Non-accelerated filer o
 
 
Emerging growth company   o


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 May 31, 2018
Class
 
 
Number of shares
 
Common Stock, $0.01 par value per share
110,739,583
 
 


Table of Contents

VERIFONE SYSTEMS, INC.
TABLE OF CONTENTS
PART I — FINANCIAL INFORMATION
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
PART II — OTHER INFORMATION
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6
 
 
 
 
 
 
 
 
 


2


PART I — FINANCIAL INFORMATION


ITEM 1.FINANCIAL STATEMENTS (Unaudited)

VERIFONE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 
Three Months Ended April 30,
 
Six Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
 
(Unaudited, in thousands, except per share data)
Net revenues:
 
 
 
 
 
 
 
Systems
$
258,571

 
$
285,675

 
$
501,627

 
$
551,076

Services
179,832

 
188,010

 
373,573

 
376,480

Total net revenues
438,403

 
473,685

 
875,200

 
927,556

Cost of net revenues:
 
 
 
 
 
 
 
Systems
163,541

 
176,219

 
317,914

 
342,611

Services
96,388

 
124,705

 
200,653

 
240,753

Total cost of net revenues
259,929

 
300,924

 
518,567

 
583,364

Gross margin
178,474

 
172,761

 
356,633

 
344,192

Operating expenses:
 
 
 
 
 
 
 
Research and development
52,443

 
51,771

 
100,999

 
107,723

Sales and marketing
46,294

 
50,935

 
92,682

 
100,141

General and administrative
49,604

 
46,755

 
100,646

 
97,558

Restructuring and related
(282
)
 
68,896

 
111

 
70,038

Acquisition related
8,022

 

 
8,022

 

Amortization of purchased intangible assets
15,627

 
18,414

 
30,695

 
37,177

Goodwill impairment

 
17,384

 

 
17,384

Total operating expenses
171,708

 
254,155

 
333,155

 
430,021

Operating income (loss)
6,766

 
(81,394
)
 
23,478

 
(85,829
)
Interest expense, net
(10,234
)
 
(8,185
)
 
(19,151
)
 
(16,332
)
Other income (expense), net
(4,224
)
 
8,796

 
(5,378
)
 
6,574

Loss before income taxes
(7,692
)
 
(80,783
)
 
(1,051
)
 
(95,587
)
Income tax provision
9,060

 
8,882

 
8,546

 
11,802

Consolidated net loss
(16,752
)
 
(89,665
)
 
(9,597
)
 
(107,389
)
Net income (loss) attributable to noncontrolling interests
293

 
(398
)
 
199

 
(1,499
)
Net loss attributable to VeriFone Systems, Inc. stockholders
$
(17,045
)
 
$
(89,267
)
 
$
(9,796
)
 
$
(105,890
)
Net loss per share attributable to VeriFone Systems, Inc. stockholders:
 
 
 
 
 
 
 
Basic
$
(0.15
)
 
$
(0.80
)
 
$
(0.09
)
 
$
(0.95
)
Diluted
$
(0.15
)
 
$
(0.80
)
 
$
(0.09
)
 
$
(0.95
)
Weighted average number of shares used in computing net loss per share attributable to VeriFone Systems, Inc. stockholders:
 
 
 
 
 
 
 
Basic
110,508

 
111,688

 
111,023

 
111,522

Diluted
110,508

 
111,688

 
111,023

 
111,522

The accompanying notes are an integral part of these condensed consolidated financial statements.

3

Table of Contents

VERIFONE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
 
Three Months Ended April 30,
 
Six Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
 
(Unaudited, in thousands)
Consolidated net loss
$
(16,752
)
 
$
(89,665
)
 
$
(9,597
)
 
$
(107,389
)
 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(49,368
)
 
11,463

 
25,878

 
9,361

Unrealized gain (loss) on derivatives designated as cash flow hedges
 
 
 
 
 
 
 
Change in unrealized gain on derivatives designated as cash flow hedges
205

 
163

 
2,407

 
2,300

Amounts reclassified from Accumulated other comprehensive loss
(506
)
 
409

 
(700
)
 
1,087

Net change in unrealized gain on derivatives designated as cash flow hedges
(301
)
 
572

 
1,707

 
3,387

Net change in other
90

 
28

 
1,018

 
54

Other comprehensive income (loss)
(49,579
)
 
12,063

 
28,603

 
12,802

Total comprehensive income (loss)
(66,331
)
 
(77,602
)
 
19,006

 
(94,587
)
Less: Comprehensive loss attributable to noncontrolling interests, net of tax
(2,648
)
 
(9,592
)
 
(704
)
 
(10,693
)
Comprehensive income (loss) attributable to VeriFone Systems, Inc. stockholders
$
(63,683
)
 
$
(68,010
)
 
$
19,710

 
$
(83,894
)

The accompanying notes are an integral part of these condensed consolidated financial statements.

4

Table of Contents

VERIFONE SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
 
April 30, 2018
 
October 31, 2017
 
(Unaudited, in thousands, except par value)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
168,405

 
$
131,029

Accounts receivable, net of allowances of $7,691 and $7,900, respectively
320,072

 
322,667

Inventories
123,989

 
126,563

Prepaid expenses and other current assets
136,942

 
138,396

Total current assets
749,408

 
718,655

Property and equipment, net
126,246

 
127,872

Purchased intangible assets, net
210,070

 
236,378

Goodwill
1,125,897

 
1,104,370

Deferred tax assets, net
30,159

 
33,089

Other long-term assets
101,600

 
101,806

Total assets
$
2,343,380

 
$
2,322,170

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
164,596

 
$
144,761

Accruals and other current liabilities
212,788

 
227,295

Deferred revenue, net
106,466

 
101,427

Short-term debt
30,436

 
68,770

Total current liabilities
514,286

 
542,253

Long-term deferred revenue, net
59,190

 
61,788

Deferred tax liabilities, net
91,518

 
97,524

Long-term debt
835,745

 
762,044

Other long-term liabilities
72,423

 
76,089

Total liabilities
1,573,162

 
1,539,698

Commitments and contingencies

 

Redeemable noncontrolling interest in subsidiary

 
262

Stockholders’ equity:
 
 
 
Preferred stock: $0.01 par value, 10,000 shares authorized, no shares issued and outstanding

 

Common stock: $0.01 par value, 200,000 shares authorized, 110,723 and 112,367 shares issued and outstanding as of April 30, 2018 and October 31, 2017, respectively
1,107

 
1,124

Additional paid-in capital
1,832,419

 
1,812,209

Accumulated deficit
(851,235
)
 
(792,168
)
Accumulated other comprehensive loss
(237,067
)
 
(266,572
)
Total VeriFone Systems, Inc. stockholders’ equity
745,224

 
754,593

Noncontrolling interests in subsidiaries
24,994

 
27,617

Total equity
770,218

 
782,210

Total liabilities, redeemable noncontrolling interest in subsidiary and equity
$
2,343,380

 
$
2,322,170

The accompanying notes are an integral part of these condensed consolidated financial statements.

5

Table of Contents

VERIFONE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Six Months Ended April 30,
 
2018
 
2017
 
(Unaudited, in thousands)
Cash flows from operating activities
 
 
 
Consolidated net loss
$
(9,597
)
 
$
(107,389
)
Adjustments to reconcile consolidated net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
65,375

 
76,229

Stock-based compensation expense
18,489

 
20,731

Deferred income taxes, net
(4,402
)
 
264

Non-cash restructuring and related charges
(2,299
)
 
39,579

Goodwill impairment

 
17,384

Other
14,982

 
5,640

Net cash provided by operating activities before changes in operating assets and liabilities
82,548

 
52,438

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
2,759

 
(21,483
)
Inventories
2,025

 
23,763

Prepaid expenses and other assets
(30,567
)
 
(10,021
)
Accounts payable
20,283

 
(610
)
Deferred revenue, net
1,535

 
9,067

Other current and long-term liabilities
104

 
27,078

Net change in operating assets and liabilities
(3,861
)
 
27,794

Net cash provided by operating activities
78,687

 
80,232

Cash flows from investing activities
 
 
 
Capital expenditures
(27,532
)
 
(36,411
)
Divestiture of business
30,000

 
6,492

Other investing activities, net

 
(4,534
)
Net cash provided by (used in) investing activities
2,468

 
(34,453
)
Cash flows from financing activities
 
 
 
Proceeds from debt, net of issuance costs
1,062,401

 
118,676

Repayments of debt
(1,039,633
)
 
(173,462
)
Stock repurchases
(50,000
)
 

Other financing activities, net
(2,361
)
 
(2,649
)
Net cash used in financing activities
(29,593
)
 
(57,435
)
Effect of foreign currency exchange rate changes on cash, cash equivalents and restricted cash
2,548

 
1,056

Net increase (decrease) in cash, cash equivalents and restricted cash
54,110

 
(10,600
)
Cash, cash equivalents and restricted cash, beginning of period
143,729

 
159,181

Cash, cash equivalents and restricted cash, end of period
$
197,839

 
$
148,581


The accompanying notes are an integral part of these condensed consolidated financial statements.

6

Table of Contents

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, 2017 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, 2017. The results of operations for the three and six months ended April 30, 2018 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 and reporting units 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 six months ended April 30, 2018, 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, 2017.
 
Concentrations of Credit Risk

For the three and six months ended April 30, 2018 and 2017, no single customer accounted for more than 10% of our total Net revenues. As of April 30, 2018 and October 31, 2017, no single customer accounted for more than 10% of our total Accounts receivable, net.


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Table of Contents


VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Recently Adopted Accounting Pronouncements

During March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation, to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The standard is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. We have adopted this standard, as required, effective November 1, 2017. Adoption had no impact on our cash flow presentation because we have historically presented excess tax benefits recognized on stock-based compensation expense as part of operating cash flows and employee taxes paid for withheld shares as part of financing cash flows, as required by the new standard. Adoption had no meaningful impact on our results of operations because income taxes associated with excess tax benefits (deficiencies) are substantially offset by associated valuation allowances and we have elected to continue to estimate forfeitures, so there is no change in the method of computing our stock-based compensation expense.

Recent Accounting Pronouncements Not Yet Adopted

During February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income, which allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. 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.

During May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, as amended by ASU 2015-14, 2016-08, 2016-10, 2016-12, 2017-05, and 2017-13 which outlines a comprehensive revenue recognition model and supersedes most current revenue recognition guidance. The new guidance requires a company to recognize revenue as control of goods or services transfers to a customer at an amount that reflects the expected consideration to be received in exchange for those goods or services. It defines a five-step approach for recognizing revenue, which may require a company to use more judgment and make more estimates than under the current guidance. 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. Two methods of adoption are permitted: (a) full retrospective adoption, meaning this standard is applied to all periods presented or (b) modified retrospective adoption, meaning the cumulative effect of applying the new guidance as of the date of adoption is recognized as an adjustment to the opening retained earnings balance. We expect to adopt ASU 2014-09, as required, effective in the first interim period of our fiscal year ending October 31, 2019 and currently expect to select the modified retrospective adoption method.

As this new revenue standard will supersede substantially all existing revenue guidance under U.S. GAAP, once adopted it could impact revenue and cost recognition on sales across all our businesses, in addition to our business processes, compensation, information technology systems and other financial reporting and operational elements. We expect that this standard may impact, in some cases, the timing and amount of revenue recognized, such as term based software licenses, which are not material, but that are currently recognized over the license term and will be recognized at the time the license is delivered to the customer under the new guidance. Additionally, the direct costs to obtain and fulfill customer contracts, in some cases, may be deferred and amortized under the new standard, however we do not expect that any such contract cost deferrals will be material. We are continuing to assess the potentially impacted revenue streams and costs, quantifying the materiality of these impacts and considering additional disclosure requirements.

There are no updates to our previous assessments on other recent accounting pronouncements not yet adopted from our Annual Report on Form 10-K for the fiscal year ended October 31, 2017.


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Table of Contents


VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Note 2. Business Combination and Divestiture

Pending Merger
On April 9, 2018, VeriFone Systems, Inc. entered into an Agreement and Plan of Merger with Vertex Holdco LLC, a Delaware limited liability company and Vertex Merger Sub LLC, a Delaware limited liability company and a wholly-owned subsidiary of Vertex Holdco. Pursuant to the merger agreement, Vertex Merger Sub will be merged with and into VeriFone Systems, Inc., with VeriFone Systems, Inc. continuing as the surviving company in the merger. Vertex Holdco and Vertex Merger Sub are owned by an investor group led by Francisco Partners and including British Columbia Investment Management Corporation. VeriFone Systems, Inc.'s Board of Directors have unanimously approved the merger agreement and upon completion of the transaction, VeriFone Systems, Inc. will become a privately held company.
Subject to the terms and conditions set forth in the merger agreement, each share of $0.01 par value common stock issued and outstanding immediately prior to the effective time of the merger (other than shares of our common stock owned by VeriFone Systems, Inc., Vertex Merger Sub, Vertex Holdco, or any of their respective direct or indirect wholly-owned subsidiaries, in each case not held on behalf of third parties, and shares of common stock owned by stockholders who have properly demanded and not withdrawn a demand for, or lost their right to, appraisal rights under Delaware law) will be converted into the right to receive $23.04 per share in cash, without interest.
Consummation of the merger is subject to various closing conditions, including, among others, customary conditions relating to the adoption of the merger agreement by the requisite vote of our stockholders, and expiration or early termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, as well as certain foreign regulatory approvals. On May 4, 2018, the Federal Trade Commission granted early termination of the waiting period under the Hart-Scott-Rodino Act.
We expect the merger to close during the third calendar quarter ended September 30, 2018. We also expect to incur significant costs, expenses and fees for professional services and other transactions costs in connection with the merger. If we terminate the merger agreement under specified circumstances, we may be required to pay a termination fee of $86.6 million. In the event, that we terminate the merger agreement due to breach from Vertex Holdco and Vertex Merger Sub, then we would receive a termination fee of $186.6 million. Additional information about the merger agreement is set forth in our Current Report on Form 8-K filed with the SEC on April 9, 2018.

Divestiture
On December 11, 2017, we divested our Taxi Solutions business, which was classified as held for sale as of October 31, 2017, for $22.5 million in cash paid at closing plus $7.5 million paid in April 2018. In connection with the transaction, we also received a 10% equity interest in Curb Intermediate Holdings I, a limited liability company that is an indirect parent of the buyer and that is partially owned by the former general manager of this business. The purchase price is subject to upward adjustment based on working capital in certain circumstances.


9

Table of Contents


VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The following table reflects the carrying amounts of major classes of assets and liabilities of this business as of the transaction date (in thousands):
Accounts Receivable
$
13,851

Prepaid expenses and other current assets
21,506

Revenue generating assets and other fixed assets
36,874

Purchased intangibles assets, net
5,579

Goodwill
47,432

Accounts payable, accruals and other current liabilities
(16,348
)
Other
(2,535
)
 
106,359

Goodwill impairment
(17,384
)
Fair value adjustments
(50,271
)
Fair value of assets held for sale
$
38,704


This business earned $0.8 million income before income taxes in the period November 1, 2017 through December 11, 2017, as of which date it was divested, and incurred a $22.9 million and a $26.2 million loss before income taxes for the three and six months ended April 30, 2017.

We have determined that our investment in Curb Intermediate Holdings I is an interest in a variable interest entity and that we are not the primary beneficiary. We account for this investment using the equity method, because the investee is a limited liability company and we have a greater than 3% to 5% ownership, so we are deemed to have significant influence over the entity.

The divested business assumed responsibility for approximately $50.0 million of operating lease commitments associated with the Taxi Solutions business. We have guaranteed lease commitments of up to $3.9 million per year until December 31, 2023 on one of these leases. This guarantee was deemed to have a nominal value. See Note 11, Commitments and Contingencies, for further information.

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.


10

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VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The following table presents the computation of net loss per share of common stock (in thousands, except per share data):
 
Three Months Ended April 30,
 
Six Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
Basic and diluted net loss per share attributable to VeriFone Systems, Inc. stockholders:
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Net loss attributable to VeriFone Systems, Inc. stockholders
$
(17,045
)
 
$
(89,267
)
 
$
(9,796
)
 
$
(105,890
)
Denominator:
 
 
 
 
 
 
 
Weighted average shares attributable to VeriFone Systems, Inc. stockholders - basic
110,508

 
111,688

 
111,023

 
111,522

Weighted average effect of dilutive stock options, RSUs and RSAs

 

 

 

Weighted average shares attributable to VeriFone Systems, Inc. stockholders - diluted
110,508

 
111,688

 
111,023

 
111,522

Net loss per share attributable to VeriFone Systems, Inc. stockholders:
 
 
 
 
 
 
 
    Basic
$
(0.15
)
 
$
(0.80
)
 
$
(0.09
)
 
$
(0.95
)
    Diluted
$
(0.15
)
 
$
(0.80
)
 
$
(0.09
)
 
$
(0.95
)

For both the three and six months ended April 30, 2018, equity incentive awards representing 6.9 million shares of common stock were excluded from the calculation of weighted average shares for diluted net loss per share as they were anti-dilutive as the company incurred net losses for those periods. For both the three and six months ended April 30, 2017, equity incentive awards representing 7.7 million shares of common stock were excluded from the calculation of weighted average shares for diluted net loss per share as they were anti-dilutive because the company incurred net losses for those periods.

Note 4. Income Taxes

We recorded a tax provision totaling $9.1 million for the three months ended April 30, 2018 and tax provision totaling $8.9 million for the three months ended April 30, 2017. The tax provision for the three months ended April 30, 2018 is primarily related to foreign taxes. The tax provision for the three months ended April 30, 2017 was primarily related to foreign taxes and discrete items associated with restructuring related charges. We recorded a tax provision totaling $8.5 million for the six months ended April 30, 2018 primarily related to foreign taxes partially offset by deferred rate change as a result of the U.S. Tax Reform and the reversal of unrecognized tax benefits where statute of limitations expired. We recorded a tax provision totaling $11.8 million for the six months ended April 30, 2017 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 $107.0 million as of April 30, 2018. 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.


11

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VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

U.S. Tax Cuts and Jobs Act ("the Tax Act")

The Tax Cuts and Jobs Act ("the Tax Act") was enacted on December 22, 2017 and introduces significant changes to U.S. income tax law. Effective on January 1, 2018, the Tax Act reduces the U.S. statutory tax rate from 35% to 21% and creates new taxes on certain foreign-sourced earnings and certain related-party payments, which are referred to as the global intangible low-taxed income ("GILTI") tax and the base erosion tax, respectively. The new taxes for certain foreign-sourced earnings under the Tax Act are effective for the Company after the fiscal year ending October 31, 2018. In addition, in fiscal 2018, we are subject to a one-time transition tax on post-1986 accumulated foreign earnings and profits ("E&P") not previously subject to U.S. income tax.

The decrease in the U.S. federal corporate tax rate from 35.0% to 21.0% results in a blended statutory tax rate of 23.3% for the fiscal year ending October 31, 2018. Given the significance of the legislation, the SEC staff issued Staff Accounting Bulletin No. 118 ("SAB 118"), which allows the Company to record provisional amounts for the impact of the Tax Act, with the requirement that the accounting be completed in a period not to exceed one year from the date of enactment. In March 2018, the FASB issued ASU No. 2018-05 to codify the guidance provided in SAB 118. As of April 30, 2018, the Company had not yet completed its accounting for the tax effects related to enactment of the Tax Act; however, in certain cases the Company has made a reasonable estimate of the Tax Act's effects. The Company recognized a tax benefit of $3.1 million for the period ended January 31, 2018 as a result of adjusting its deferred tax balance to reflect the new corporate tax rate. The majority of the Company's U.S. deferred taxes are offset with a valuation allowance, therefore the re-measurement which resulted in a provisional reduction of $94 million to the Company’s gross deferred tax assets with an offsetting $97 million reduction in valuation allowance for the rate reduction did not have a large impact on tax expense in the quarter ended January 31, 2018. There were no adjustments or additional amounts recorded in the quarter ended April 30, 2018.

The Company has computed an estimated transition tax liability of $50 million for the post-1986 foreign E&P and has determined that there are sufficient tax attributes to offset the income and therefore has not recorded any net tax liability. The Company has not yet completed the calculation of the total post-1986 foreign E&P and the income tax pools for all foreign subsidiaries. Further, the transition tax is based in part on the amount of those earnings held in cash and other specified assets. This amount may change when the Company finalizes the calculation of post-1986 foreign E&P previously deferred from U.S. federal taxation and finalizes the amounts held in cash or other specified assets. In addition, further interpretations from U.S. federal and state governments and regulatory organizations may change the provisional estimated income or the accounting treatment of the provisional estimated income inclusion.

The Company is still evaluating whether to make an accounting policy election to treat GILTI as a period cost or to provide U.S. deferred taxes on foreign temporary differences that are expected to generate GILTI income when they reverse in future years. In addition, the Company is still evaluating the realizability of certain deferred tax assets. There could be additional changes, including a decrease in the valuation allowance in connection with an accounting policy election on deferred tax assets which may not expire in the future and/or other changes to the Company's deferred taxes once it completes these evaluations.

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 $380.8 million at the foreign exchange rate as of April 30, 2018). 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 $615.6 million at the foreign exchange rate as of April 30, 2018) or alternatively 2.23 billion New Israeli Shekels in fiscal year 2008 (approximately $622.7 million at the foreign exchange rate as of April 30, 2018) and contended secondary adjustments relating to a deemed dividend and/or interest.


12

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VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Based on the Order, these and other claims result in a tax liability and deficiency penalty assessment in the amount of 1.36 billion New Israeli Shekels (approximately $379.9 million at the foreign exchange rate as of April 30, 2018), if the claim was assessed for fiscal year 2009, to 1.61 billion New Israeli Shekels (approximately $448.5 million at the foreign exchange rate as of April 30, 2018) 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 April 30, 2018. The Israeli Tax Authorities' contention regarding secondary adjustments relating to a 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.

The Israeli Tax Authorities issued a tax assessment in October 2017 for fiscal years 2011 and 2012 that includes secondary adjustments relating to a deemed dividend and/or interest with respect to the contention concerning business restructuring in 2008 or 2009. The Israeli Tax Authorities' contention regarding secondary adjustments relating to a deemed dividend was not quantified by them. We filed our objection to the assessment on December 28, 2017.

Other Audits

We have certain other foreign subsidiaries under audit by foreign tax authorities, including Brazil for 2002, Germany for 2013 to 2015, and India for fiscal years 2008 to 2015. Although we believe we have appropriately provided for income taxes for the years subject to audit, the Brazil, Germany, India, and Israel 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. Stock Repurchase Program
In September 2015, our Board of Directors authorized a program to repurchase shares of our common stock with an aggregate value of up to $200.0 million which was expanded in December 2017 to allow the repurchase up to an additional $100.0 million, with no expiration from the date of authorization.
During the six months ended April 30, 2018, we repurchased approximately 2.8 million shares of our common stock on the open market for $50.0 million at an average repurchase price of $18.03 per share pursuant to this program. No shares were repurchased during the six months ended April 30, 2017.
As of April 30, 2018, there was $100.0 million remaining available for stock repurchases under this program. Shares may be repurchased from time to time in the open market, through private purchases, through forward, derivative, accelerated repurchase or automatic repurchase transactions or otherwise. Certain of our share repurchases have been and may from time to time be effected through Rule 10b5-1 repurchase plans under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The timing and actual amount of the share repurchases will depend on several factors including price, capital availability, regulatory requirements, alternative investment opportunities, including mergers and acquisitions, market conditions and other factors. We are not obligated to repurchase any specific number of shares under the program and the repurchase program may be modified, suspended or discontinued at any time. Pursuant to the terms of the merger agreement, until the closing of the merger, without the consent of Vertex Holdco LLC, we cannot repurchase shares other than in accordance with the terms of our equity incentive plans, which are netted as payment, for applicable tax withholding in connection with the vesting of restricted stock awards.


13

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VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Note 6. 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):
 
April 30, 2018
 
October 31, 2017
Cash and cash equivalents
$
168,405

 
$
131,029

Restricted cash included in Prepaid expenses and other current assets
28,496

 
11,413

Restricted cash included in Other long-term assets
938

 
1,287

Total cash, cash equivalents and restricted cash
$
197,839

 
$
143,729


Restricted cash as of April 30, 2018 and October 31, 2017 was mainly comprised of cash held on behalf of customers as part of our transaction processing services.

The following table provides a reconciliation of cash, cash equivalents and restricted cash shown in the Condensed Consolidated Statements of Cash Flows (in thousands):
 
April 30, 2017
 
October 31, 2016
Cash and cash equivalents
$
134,493

 
$
148,352

Restricted cash included in Prepaid expenses and other current assets
12,507

 
9,008

Restricted cash included in Other long-term assets
1,581

 
1,821

Total cash, cash equivalents and restricted cash
$
148,581

 
$
159,181


Inventories

Inventories consisted of the following (in thousands):
 
April 30, 2018
 
October 31, 2017
Raw materials
$
35,326

 
$
32,118

Work-in-process
809

 
978

Finished goods
87,854

 
93,467

Total inventories
$
123,989

 
$
126,563



14

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VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consisted of the following (in thousands):
 
April 30, 2018
 
October 31, 2017
Assets held for sale
$
358

 
$
46,368

Prepaid expenses
54,817

 
41,824

Other current assets
81,767

 
50,204

Total prepaid expenses and other current assets
$
136,942

 
$
138,396


Assets held for sale as of October 31, 2017 relate to our Taxi Solutions business, which was divested in December 2017. See Note 2, Business Combination and Divestiture, for additional information. Other current assets were comprised primarily of restricted cash, prepaid taxes and receivables associated with divestiture transactions.

Other Long-Term Assets

Other long-term assets consisted of the following (in thousands):
 
April 30, 2018
 
October 31, 2017
Capitalized software development costs
$
49,694

 
$
50,691

Investments accounted for under the equity method
20,264

 
16,803

Other
31,642

 
34,312

Total other long-term assets
$
101,600

 
$
101,806


During the six months ended April 30, 2018, we did not have any material changes to the carrying value of our cost method investments or the known maximum exposure to loss on these investments. The maximum exposure on our investments accounted for under the equity method totaled $55.7 million as of April 30, 2018 and is based on the carrying value of the investments and the extent of our guarantees. On May 1, 2018, we canceled a $10.0 million committed line of credit that was available to one of our investees and our maximum exposure to loss on cost method investments was reduced.

Accruals and Other Current Liabilities

Accruals and other current liabilities consisted of the following (in thousands):
 
April 30, 2018
 
October 31, 2017
Accrued expenses
$
67,495

 
$
57,114

Accrued compensation
57,208

 
65,663

Other current liabilities
88,085

 
104,518

Total accruals and other current liabilities
$
212,788

 
$
227,295


Other current liabilities were comprised primarily of customer deposits, sales and value-added taxes payable, income taxes payable, accrued restructuring expense and accrued warranty. Other current liabilities as of October 31, 2017 also were comprised of accruals that were classified as held for sale in connection with the disposal of our Taxi Solutions business.


15

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VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Accrued Warranty

Activity related to accrued warranty consisted of the following (in thousands):
 
Six Months Ended April 30,
 
2018
 
2017
Balance at beginning of period
$
13,488

 
$
16,656

Warranty charged to Cost of net revenues
4,660

 
7,278

Utilization of warranty accrual
(5,732
)
 
(6,411
)
Balance at end of period
12,416

 
17,523

Less: current portion
(10,680
)
 
(15,203
)
Long-term portion
$
1,736

 
$
2,320


Deferred Revenue, Net

Deferred revenue, net of related costs consisted of the following (in thousands):
 
April 30, 2018
 
October 31, 2017
Deferred revenue
$
181,003

 
$
181,271

Deferred cost of revenue
(15,347
)
 
(18,056
)
Deferred revenue, net
165,656

 
163,215

Less: current portion
(106,466
)
 
(101,427
)
Long-term portion
$
59,190

 
$
61,788


Stock-Based Compensation Expense

The following table presents the stock-based compensation expense recognized in our Condensed Consolidated Statements of Operations (in thousands):
 
Three Months Ended April 30,
 
Six Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
Cost of net revenues
$
1,383

 
$
1,125

 
$
2,589

 
$
2,055

Research and development
1,916

 
1,831

 
3,554

 
3,399

Sales and marketing
2,110

 
3,244

 
4,717

 
5,831

General and administrative
3,189

 
4,978

 
7,629

 
9,446

Total stock-based compensation expense
$
8,598

 
$
11,178

 
$
18,489

 
$
20,731



16

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VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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 as of October 31, 2017
 
$
(265,057
)
 
$
1,814

 
$
(3,329
)
 
$
(266,572
)
Gains (losses) before reclassifications, net of tax
 
25,878

 
2,407

 

 
28,285

Amounts reclassified from Accumulated other comprehensive loss, net of tax
 
902

 
(700
)
 
1,018

 
1,220

Other comprehensive income
 
26,780

 
1,707

 
1,018

 
29,505

Balance as of April 30, 2018
 
$
(238,277
)
 
$
3,521

 
$
(2,311
)
 
$
(237,067
)

(1) Amounts reclassified from Accumulated other comprehensive loss, net of tax, 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, net of tax, were recorded in Interest expense, net in the Condensed Consolidated Statements of Operations. The related tax impacts were insignificant.
(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 7. Financial Instruments

Fair Value Measurements

Our financial assets and liabilities consist principally of cash, accounts receivable, accounts payable, debt, foreign exchange forward contracts, and interest rate swaps, and are reported at fair value. 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. Foreign exchange forward contracts and interest rate swaps are recorded at estimated fair value on a recurring basis.

The carrying value and fair value of the interest rate swap agreements designated as cash flow hedges was $5.4 million and $3.7 million as of April 30, 2018 and October 31, 2017, respectively. During the six months ended April 30, 2018, there was no other 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 six months ended April 30, 2018.

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. See Note 9, Financings, for information regarding our debt and related interest rate swaps.


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VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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 April 30, 2018 and October 31, 2017 were $235.3 million and $255.2 million, respectively. Gains and losses on foreign exchange forward contracts not designated as hedging instruments for the three and six months ended April 30, 2018 were not material.

Note 8. 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, 2017
 
$
514,904

 
$
589,466

 
$
1,104,370

Currency translation adjustments
 
9,042

 
12,485

 
21,527

Balance as of April 30, 2018
 
$
523,946

 
$
601,951

 
$
1,125,897


We review goodwill for impairment annually and whenever events or changes in circumstances indicate its carrying amount may not be recoverable. Based upon our review, there were no indicators of impairment during the six months ended April 30, 2018.

Purchased Intangible Assets, Net

Purchased intangible assets, net consisted of the following (in thousands):
 
April 30, 2018
 
October 31, 2017
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
Customer relationships
$
506,997

 
$
(312,648
)
 
$
194,349

 
$
498,951

 
$
(282,176
)
 
$
216,775

Other
37,690

 
(21,969
)
 
15,721

 
37,405

 
(17,802
)
 
19,603

Total
$
544,687

 
$
(334,617
)
 
$
210,070

 
$
536,356

 
$
(299,978
)
 
$
236,378


Other intangible assets, net, were comprised primarily of developed and core technology.

Amortization of purchased intangible assets was allocated as follows (in thousands):
 
Three Months Ended April 30,
Six Months Ended April 30,
 
2018
 
2017
2018
 
2017
Included in Cost of net revenues
$
1,139

 
$
1,629

$
2,263

 
$
4,074

Included in Operating expenses
15,627

 
18,414

30,695

 
37,177

Total amortization of purchased intangible assets
$
16,766

 
$
20,043

$
32,958

 
$
41,251



18

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VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Note 9. Financings

Amounts outstanding under our financing arrangements consisted of the following (in thousands):
 
April 30, 2018
 
October 31, 2017
Credit Agreement
 
 
 
     Term A loan
$
350,000

 
$
465,000

     Term B loan
350,000

 
193,500

     Revolving loan
167,001

 
168,447

Capital leases and other debt
12,079

 
10,734

Total principal payments due
879,080

 
837,681

Less: original issue discount and debt issuance costs
(12,899
)
 
(6,867
)
Total amounts outstanding
866,181

 
830,814

Less: current portion
(30,436
)
 
(68,770
)
Long-term portion
$
835,745

 
$
762,044


Amended and Restated Credit Agreement

On February 2, 2018, we entered into an amended and restated credit agreement to increase the borrowing capacity, extend the maturity dates, provide more favorable interest rates, and make certain changes to the covenants and other terms of the credit agreement. The amended and restated credit agreement provides for an aggregate amount of up to $1.4 billion of debt consisting of a $350.0 million new term A loan, a $350.0 million new term B loan and a new revolving loan with a committed amount of $700.0 million. The initial amounts borrowed were used to repay $775.2 million of outstanding balances due under the existing credit agreement as well as $12.9 million of costs associated with the refinancing. No penalties were due in connection with such repayments. The repayment of outstanding debt as part of the amendment and restatement was deemed an extinguishment of $277.9 million of outstanding debt. As a result, during February 2018, we expensed $2.2 million of previously capitalized debt issuance costs to Interest expense, net in our Condensed Consolidated Statement of Operations.

Borrowings under the amended and restated credit agreement bear interest at a “Base Rate” or “Eurodollar Rate”, at our option, plus an applicable margin based on certain financial ratios, determined and payable quarterly. In addition, we pay an undrawn commitment fee on the unused portion of the revolving loan ranging from 0.20% to 0.30% per annum, depending on our leverage ratio and credit ratings.

The outstanding principal balance of the new term A loan is required to be repaid in quarterly installments of the following percentages of the original balance outstanding under the new term A loan: 1.25% for each quarter from the quarter ending June 30, 2018 through the quarter ending December 31, 2019, 2.50% for each quarter from the quarter ending March 31, 2020 through the quarter ending December 31, 2022, with the balance being due at maturity on February 2, 2023. The outstanding principal balance of the new term B loan is required to be repaid in equal quarterly installments of 0.25% of the original balance outstanding under the new term B loan, with the balance being due at maturity on February 2, 2025. The revolving loan terminates on February 2, 2023. Outstanding amounts may also be subject to mandatory repayment with the proceeds of certain asset sales and debt issuances, and, in the case of the new term B loan only, from a portion of annual excess cash flows depending on our total leverage ratio, as defined under the agreement.


19

Table of Contents


VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The amended and restated credit agreement also contains representations and warranties, affirmative covenants, negative covenants, financial covenants and conditions that are customarily required for similar financings including the following:

A restriction on incurring additional indebtedness, subject to specified permitted debt;
A restriction on creating certain liens, subject to specified exceptions;
A restriction on mergers and consolidations, subject to specified exceptions;
A restriction on asset dispositions, subject to specified exceptions for ordinary course and other transactions;
A restriction on certain investments, subject to certain exceptions and a suspension if we achieve certain credit ratings;
A restriction on the payment of dividends, subject to specified exceptions; and
A restriction on entering into certain transactions with affiliates, subject to specified exceptions.

Borrowings under the amended and restated credit agreement are guaranteed by certain of our wholly owned domestic subsidiaries and secured by a first priority lien and security interest in certain of our assets, subject to customary exceptions.

As of February 2, 2018, we have elected the Eurodollar option for all of our borrowings under the amended and restated credit agreement. Eurodollar loans bear interest at a monthly market interest rate plus a margin according to the amended and restated credit agreement. As of February 2, 2018, the monthly market interest rate was 1.58% for our new term A, new term B and new revolver loans, and the margins were 1.75% for our new term A and revolver loans and 2.00% for our new term B loan. Accordingly, as of February 2, 2018, the interest rate was 3.33% for the new term A and new revolving loans and 3.58% for the new term B loan.

As of April 30, 2018, 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 $533.0 million.

We complied with all financial covenants under the credit agreement as of April 30, 2018.

Future principal payments due under our financing arrangements are as follows (in thousands):
 
Amounts
Years ending October 31:
 
Remainder of fiscal year 2018
$
18,911

2019
23,292

2020
35,162

2021
38,569

2022
38,524

Thereafter
724,622

Total
$
879,080


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. During the three months ended April 30, 2018, we did not have any changes to our interest rate swap agreements. The interest rate swaps on the term loan qualify for hedge accounting treatment as cash flow hedges. The notional amounts of interest rate swap agreements outstanding as of April 30, 2018 and October 31, 2017 were $350.0 million and $400.0 million, respectively. As of April 30, 2018, the estimated net derivative gain related to our cash flow hedges included in Accumulated other comprehensive loss that will be reclassified into earnings in the next 12 months is $4.5 million.


20

Table of Contents


VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

As of April 30, 2018, our outstanding interest rate swap agreements remained effective and convert $350.0 million of the new term A and new term B loans to a fixed rate of 0.975% plus applicable margin.

Note 10. 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 six months ended April 30, 2018 consisted of the following (in thousands):
 
 
Restructuring Plans
 
 
 
 
 
 
June 2016 Plan
 
June 2017 Plan
 
 
 
 
 
 
Employee Involuntary Termination Benefits
 
Facilities Related Costs
 
Employee Involuntary Termination Benefits
 
Other Business Exit Costs
 
Total
Balance at October 31, 2017
 
$
3,097

 
$
997

 
$
5,431

 
$
18,367

 
$
27,892

Charges, net of adjustments
 
(2,141
)
 
752

 
3,297

 
(2,798
)
 
(890
)
Cash payments
 
(193
)
 
(1,067
)
 
(4,760
)
 
(2,729
)
 
(8,749
)
Balance at April 30, 2018
 
$
763

 
$
682

 
$
3,968

 
$
12,840

 
$
18,253

Cumulative costs to date
 
$
15,864

 
$
3,477

 
$
15,116

 
$
25,887

 



Activities under these Restructuring Plans are expected to be substantially complete by the end of fiscal year 2018.

Restructuring and related charges were allocated as follows (in thousands):
 
Three Months Ended April 30,
 
Six Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
Included in Cost of net revenues
$
(452
)
 
$
11,601

 
$
(1,001
)
 
$
12,357

Included in Operating expenses
(282
)
 
68,896

 
111

 
70,038

Total restructuring and related charges
$
(734
)
 
$
80,497

 
$
(890
)
 
$
82,395


During March 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, for the three and six months ended April 30, 2017, we recorded a $49.1 million write-down to reflect the assets of this business 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 Statement of Operations. Additionally during the three and six months ended April 30, 2017, we recorded a $28.1 million charge in Restructuring and related charges for future obligations associated with the terminated customer agreements in the petroleum media business of which $12.8 million was payable as of April 30, 2018.



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VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Note 11. Commitments and Contingencies

Commitments

Leases

We lease certain facilities under non-cancelable operating leases that contain free rent periods, leasehold improvement rebates or rent escalation clauses. Rent expense under these leases is recorded on a straight-line basis over the lease term. We are committed to pay a portion of the related actual operating expenses under some of these lease agreements, and those operating expenses are not included in the table below. The difference between amounts paid and rent expense is recorded as deferred rent. The short-term and long-term portions are included in Accruals and other current liabilities and Other long-term liabilities, respectively, in our Condensed Consolidated Balance Sheets.

On December 11, 2017, we divested our Taxi Solutions business, which was classified as held for sale as of October 31, 2017. In connection with this transaction, the divested business assumed responsibility for approximately $50.0 million of operating lease commitments associated with this business. Future minimum lease payments on our remaining leases as of April 30, 2018 were as follows (in thousands):
 
Minimum
Lease Payments
 
Sublease
Rental Income
 
Net Minimum
Lease Payments
Years Ending October 31:
 
 
 
 
 
Remainder of fiscal year 2018
$
14,282

 
$
(343
)
 
$
13,939

2019
20,044

 
(645
)
 
19,399

2020
17,027

 
(659
)
 
16,368

2021
12,192

 
(672
)
 
11,520

2022
6,706

 
(687
)
 
6,019

Thereafter
8,582

 
(1,510
)
 
7,072

Total
$
78,833

 
$
(4,516
)
 
$
74,317


Rent expense consisted of the following (in thousands):
 
Three Months Ended April 30,
 
Six Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
Rent expense for non-cancelable taxi operating leases
$

 
$
6,840

 
$
2,794

 
$
14,935

Facility and other rent expense
6,565

 
6,640

 
13,284

 
13,388

Total rent expense
$
6,565

 
$
13,480

 
$
16,078

 
$
28,323


Manufacturing Related Agreements

On April 3, 2017, to lock in pricing on certain components, we committed to purchase $144.0 million of such components over a four-year period, $36.0 million per year, from one of our existing suppliers. As of April 30, 2018, our remaining non-cancelable commitment under this agreement totaled $82.0 million.


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VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Guarantees

We have issued 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 April 30, 2018, the maximum amount that may become payable under these guarantees was $16.8 million, of which $4.7 million was collateralized by restricted cash deposits.

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 April 30, 2018, we have not made any payments and no amounts are accrued related to this guarantee.

Additionally, we have guaranteed lease commitments of up to $3.9 million per year until December 31, 2023 on a lease that was part of our divested Taxi Solutions business and was assigned to the divested business. Post divestiture, payments on this lease are made by the divested business, which has agreed to indemnify us for this lease obligation. As of April 30, 2018, the maximum exposure under this guarantee was $21.5 million, we had not made any payments under the guarantee and no amounts were 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. On January 24, 2018, that lower court ruled in our favor, finding no additional tax owed. Based on that ruling (which the State Treasury is now appealing) and our current understanding of the underlying facts of this matter, we now believe the likelihood is remote that we may receive an unfavorable decision in this proceeding. The tax assessment including estimated interest through April 30, 2018 for this matter totals approximately 9.5 million Brazilian reais (approximately $2.7 million at the foreign exchange rate as of April 30, 2018). As of April 30, 2018, we have not accrued for this matter, but we have posted a bank bond as a guaranty.


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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 0.9 million Brazilian reais (approximately $0.3 million at the foreign exchange rate as of April 30, 2018), excluding interest. The municipality claims that the Brazilian subsidiary rendered certain services within the municipality of São Paulo but simulated that those services were rendered in another city. At the end of December 2010 the municipality issued further tax assessments alleging the same claims for 2005 through June 2007. These additional subsequent claims assert services tax deficiencies and related penalties totaling 5.9 million Brazilian reais (approximately $1.7 million at the foreign exchange rate as of April 30, 2018), excluding interest. We received unfavorable decisions from the administrative courts, which ruled to maintain the tax assessments for each of these matters. No further grounds of appeal are available to us for these assessments within the administrative courts. In October 2012, as a result of the decision at the administrative level, the tax authorities filed an enforcement action in the civil courts to collect on the services tax assessments amounts awarded by the administrative court and seeking other related costs and fees. On March 6, 2013, we filed our defensive claims in the civil courts in response to the tax authorities' enforcement action. In February 2013 the tax authorities filed an additional enforcement action in the civil courts to collect on the penalties related to the services tax assessments amounts awarded by the administrative courts. Based on our understanding of the underlying facts of this matter and our evaluation of the potential outcome at the judicial level, we believe it is reasonably possible that our Brazilian subsidiary will be required to pay some amount of the alleged tax assessments and penalties related to these matters, as well as amounts of interest and certain costs and fees imposed by the court related thereto. As of April 30, 2018, the amount of the alleged tax assessments and penalties related to these matters was approximately 28.0 million Brazilian reais (approximately $8.0 million at the foreign exchange rate as of April 30, 2018), 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 an alleged services tax deficiency. An appeal against this unfavorable administrative decision was filed in a judicial proceeding and currently the case is pending the municipality of Curitiba's compliance with the writ of summons. As of April 30, 2018, the underlying assessment, including estimated interest, was approximately 6.2 million Brazilian reais (approximately $1.8 million at the foreign exchange rate as of April 30, 2018). 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.

U.S. Securities Class Actions

On May 17, May 30, and June 1, 2018, four securities class-action complaints were filed in federal courts in the District of Delaware and the Northern District of California against VeriFone Systems, Inc. and its directors claiming that the preliminary proxy statement filed on May 7, 2018, omitted material information about the proposed Francisco Partners transaction announced on April 9, 2018. The complaints include causes of action for violations of Section 14(a) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 14a-9 and seek to enjoin the proposed transaction and also to recover an unspecified amount of attorneys’ and experts’ fees and costs. We have not yet been served with the complaints in these actions, and no trial dates have been set in these cases.

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.

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VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


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 opposed this new class action and plaintiff's class certification motion on substantially the same grounds on which the previous case was dismissed. On May 14, 2018, the Israeli District Court denied plaintiff’s class-certification motion and dismissed this action, finding that the U.S. class action settlement satisfied due-process requirements and was therefore res judicata against the Israeli sub-class. The Court did award the individual plaintiff and his counsel NIS 1,150,000 plus VAT (totaling NIS 1,345,500 or approximately $0.4 million at the foreign exchange rate as of April 30, 2018), finding that their work had contributed to reconsideration of and additional distribution of settlement funds for certain Israeli institutional investors’ claims in the U.S. class action settlement. The appeal deadline is June 28, 2018.

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 are now being reheard before the NCLAT Bench. That rehearing began on November 7, 2017 and is scheduled to continue on July 16, 2018.

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.


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VERIFONE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Income Tax Uncertainties

As of April 30, 2018, the amount payable for unrecognized tax benefits was $35.3 million, including accrued interest and penalties, none of which is expected to be paid within one year. This amount is included in Other long-term liabilities in our Condensed Consolidated Balance Sheet as of April 30, 2018. We are unable to make a reasonably reliable estimate as to when cash settlement with a taxing authority may occur.

Note 12. 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, acquisition related charges, restructuring and related charges, stock-based compensation, goodwill impairment as well as general and administrative and corporate research and development expense. We do not allocate other income and expenses to our operating segments. In addition, 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 April 30,
 
Six Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
Segment net revenues:
 
 
 
 
 
 
 
Verifone Systems
$
258,571

 
$
285,675

 
$
501,627

 
$
551,076

Verifone Services
179,832

 
188,255

 
373,573

 
379,473

Total segment net revenues
438,403

 
473,930

 
875,200

 
930,549

Amortization of step down in deferred services net revenues at acquisition

 
(245
)
 

 
(2,993
)
Total net revenues
$
438,403

 
$
473,685

 
$
875,200

 
$
927,556



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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 April 30,
 
Six Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
Operating income by segment:
 
 
 
 
 
 
 
Verifone Systems
$
35,079

 
$
47,029

 
$
68,583

 
$
87,741

Verifone Services
49,960

 
43,736

 
106,032

 
88,559

Total segment operating income
85,039

 
90,765


174,615


176,300

Items not attributable to segment operating income:
 
 
 
 
 
 
 
Amortization of step down in deferred services gross margin at acquisition

 
(191
)
 

 
(2,385
)
Acquisition related
(8,022
)
 

 
(8,022
)
 

Restructuring and related
735

 
(80,497
)
 
890

 
(82,395
)
Amortization of purchase intangible assets
(16,766
)
 
(20,043
)
 
(32,958
)
 
(41,251
)
Stock-based compensation expense
(8,598
)
 
(11,178
)
 
(18,489
)
 
(20,731
)
Goodwill impairment

 
(17,384
)
 

 
(17,384
)
Unallocated general and administrative expenses
(46,415
)
 
(41,777
)
 
(93,017
)
 
(88,114
)
Unallocated research and development expenses
800

 
(1,051
)
 
469

 
(9,833
)
Other unallocated costs
(7
)
 
(38
)
 
(10
)
 
(36
)
Total operating income (loss)
$
6,766

 
$
(81,394
)
 
$
23,478

 
$
(85,829
)



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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 2017 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 2017 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 2017 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 2017 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 six months ended April 30, 2018 to the three and six months ended April 30, 2017.
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 six months ended April 30, 2018 to the three and six months ended April 30, 2017.
Financial Outlook: A discussion of our expectations regarding certain trends that may affect our financial condition and results of operations.
Liquidity and Capital Resources: An analysis of changes in our balance sheets and cash flows, and discussion of our financial condition and potential sources of liquidity.
Contractual Obligations and Off-Balance Sheet Arrangements: Disclosures related to our contractual obligations, contingent liabilities, commitments and off-balance sheet arrangements, as of April 30, 2018.
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.


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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 and enable innovative forms of commerce. For over 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 point of sale 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 point of sale 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 globally, 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 59.0% and 57.3% of our net revenues in the three and six months ended April 30, 2018, respectively. Our point of sale electronic payment devices run our unique operating systems, security and encryption software, and certified payment software. Our systems solutions 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 point of sale solutions. Our solutions 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 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.


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Services

Services are an important part of our business and revenues, accounting for approximately 41.0% and 42.7% of our net revenues in the three and six months ended April 30, 2018, respectively. We offer a wide portfolio of services, ranging from traditional device related support services, transaction payment services and commerce enablement offerings that are designed to facilitate commerce and payment opportunities for merchants, to cloud-based services. Our services offerings include transaction services, managed services and terminal management solutions, security solutions, cloud services, and other value-added services at the point of sale. We also offer a host of support services, including software development, installation and deployment, warranty, post-sale support, repairs and training.

Timing of Revenue

The timing of our customer orders may cause our revenue to vary from period to period. Specifically, revenues recognized in our fiscal quarters can vary significantly when larger customers or our distributors 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

Pending Merger
On April 9, 2018, VeriFone Systems, Inc. entered into a definitive agreement with Vertex Holdco LLC and Vertex Merger Sub LLC to be acquired for $23.04 in cash for each share of Verifone Systems Inc. common stock. Consummation of the merger is subject to various closing conditions, including, among others, customary conditions relating to the adoption of the merger agreement by the requisite vote of our stockholders, and expiration or early termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, as well as certain foreign regulatory approvals. On May 4, 2018, the Federal Trade Commission granted early termination of the waiting period under the Hart-Scott-Rodino Act.
We expect the merger to close during the third calendar quarter ended September 30, 2018. We also expect to incur significant costs, expenses and fees for professional services and other transactions costs in connection with the merger. If we terminate the merger agreement under specified circumstances, we may be required to pay a termination fee of $86.6 million. In the event, that we terminate the merger agreement due to breach from Vertex Holdco and Vertex Merger Sub, then we would receive a termination fee of $186.6 million.

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Additional information about the merger agreement is set forth in our Current Report on Form 8-K filed with the SEC on April 9, 2018.

Business Divestiture - Taxi Solutions Business
On December 11, 2017, we divested our Taxi Solutions business, which was classified as held for sale as of October 31, 2017, for approximately $38.7 million. In connection with the transaction, we also received a 10% equity interest in Curb Intermediate Holdings I, a limited liability company that is an indirect parent of the buyer. In connection with the transaction, the divested business assumed responsibility for approximately $50.0 million of operating lease commitments associated with the Taxi Solutions business.
Net revenues from this business totaled $12.2 million for both the three and six months ended April 30, 2018, as well as $26.2 million and $53.3 million for the three and six months ended April 30, 2017, respectively. This business earned $0.8 million income before income taxes in the period November 1, 2017 through December 11, 2017, when it was divested, and incurred a $22.9 million and a $26.2 million loss before income taxes for the three and six months ended April 30, 2017.

Credit Agreement
On February 2, 2018, we entered into an amended and restated credit facility that increased the borrowing capacity, extended the maturity dates, provided more favorable interest rates, and made certain changes to the covenants and other terms of our existing credit agreement. The amended and restated credit agreement provides for an aggregate amount of up to $1.4 billion of debt consisting of a $350.0 million term A loan, a $350.0 million term B loan and a revolving loan with a committed amount of $700.0 million. The initial amounts borrowed, together with cash on hand, were used to repay $775.2 million of outstanding balances due under the existing credit agreement as well as the costs of the refinancing. See Note 9, Financings, in the Notes to Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q for more information.

Share Repurchase Program
During the six months ended April 30, 2018, we repurchased approximately 2.8 million shares of our common stock on the open market at an average repurchase price of $18.03 for approximately $50.0 million in cash. Pursuant to the terms of the merger agreement, until the closing of the merger, without the consent of Vertex Holdco LLC, we cannot repurchase shares other than in accordance with the terms of our equity incentive plans, which are netted as payment, for applicable tax withholding in connection with the vesting of restricted stock awards. See Note 5, Stock Repurchase Program, in the Notes to Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q for additional information regarding this stock repurchase program.


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Results of Operations

Consolidated Results of Operations

Three Months Ended April 30, 2018 compared to April 30, 2017

 
Three Months Ended April 30,
 
2018
 
% of Net revenues (1)
 
2017
 
% of Net revenues (1)
 
(in thousands, except percentages)
Net revenues:
 
Systems
$
258,571

 
59.0%
 
$
285,675

 
60.3%
Services
179,832

 
41.0%
 
188,010

 
39.7%
Total net revenues
438,403

 
100.0%
 
473,685

 
100.0%
 
 
 
 
 
 
 
 
Gross margin:
 
 
 
 
 
 
 
Systems
95,030

 
36.8%
 
109,456

 
38.3%
Services
83,444

 
46.4%
 
63,305

 
33.7%
Gross margin
178,474

 
40.7%
 
172,761

 
36.5%
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
Research and development
52,443

 
12.0%
 
51,771

 
10.9%
Sales and marketing
46,294

 
10.6%
 
50,935

 
10.8%
General and administrative
49,604

 
11.3%
 
46,755

 
9.9%
Restructuring and related
(282
)
 
(0.1)%
 
68,896

 
14.5%
Acquisition related
8,022

 
1.8%
 

 
—%
Amortization of purchased intangible assets
15,627

 
3.6%
 
18,414

 
3.9%
Goodwill impairment

 
—%
 
17,384

 
3.7%
Total operating expenses
171,708

 
39.2%

254,155

 
53.7%
Operating income (loss)
6,766

 
1.5%
 
(81,394
)
 
(17.2)%
Interest expense, net
(10,234
)
 
(2.3)%
 
(8,185
)
 
(1.7)%
Other income (expense), net
(4,224
)
 
(1.0)%
 
8,796

 
1.9%
Net loss before income taxes
(7,692
)
 
(1.8)%
 
(80,783
)
 
(17.1)%
Income tax provision
9,060

 
2.1%
 
8,882

 
2.0%
Consolidated net loss
$
(16,752
)
 
(3.8)%
 
$
(89,665
)
 
(18.9)%
(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 April 30, 2018 were $438.4 million, compared to $473.7 million for the three months ended April 30, 2017, down $35.3 million or 7.5%. Net revenues decreased $29.4 million as a result of the divestiture of the China and Taxi Solutions businesses, and $29.4 million in India due primarily to government demonetization initiatives in the prior year that did not recur. These decreases were partially offset by increased revenues in Latin America and EMEA. See further discussion of net revenues by segment and geography below.

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Table of Contents

Net Revenues by Geography
 
 
 
 
Three Months Ended April 30,
 
 
 
 
2018
 
% of Net revenues
 
2017
 
% of Net revenues
 
 
 
 
(in thousands, except percentages)
Net Revenues
North America
 
$
122,914

 
28.0%
 
$
157,438

 
33.2%
Latin America
 
84,489

 
19.3%
 
62,542

 
13.2%
EMEA
 
182,274

 
41.6%
 
177,713

 
37.5%
Asia-Pacific
 
48,726

 
11.2%
 
75,992

 
16.0%
 
 
Total
 
$
438,403

 
100.0%
 
$
473,685

 
100.0%

North America net revenues decreased $34.5 million, due primarily to the divestiture of the Taxi Solutions business, which generated $24.2 million of net revenues in the prior year. The remaining systems net revenues decrease is attributed 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 $21.9 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, particularly in Brazil and Argentina.

EMEA net revenues increased $4.6 million, due to the impact of foreign currency fluctuations and the timing of customer orders, which are driven by factors such as changes in government fiscalization programs and the timing of customer technology refreshes in the prior year that did not recur. Net revenues includes a $16.1 million positive impact due to favorable foreign currency fluctuations.

Asia-Pacific net revenues decreased $27.3 million, due primarily to a $29.4 million decrease in net revenues in India mainly associated with government demonetization initiatives in the prior year that did not recur. Net revenues also decreased $3.2 million as a result of the divestiture of the China business.

Gross margin for the three months ended April 30, 2018 was $178.5 million or 40.7% of total net revenues, compared to $172.8 million or 36.5% of total net revenues, for the three months ended April 30, 2017, up $5.7 million or 4.2 percentage points. Gross margin in dollars and as a percentage of net revenues increased primarily due to a $10.6 million write-down of inventory related to our petroleum media business in the prior year. Gross margin as a percentage of net revenues also increased due to changes in geographic mix in the current year.

Research and development for the three months ended April 30, 2018 was $52.4 million, compared to $51.8 million for the three months ended April 30, 2017, up $0.6 million or 1.2%, remaining relatively flat due to continued cost controls.

Sales and marketing for the three months ended April 30, 2018 was $46.3 million, compared to $50.9 million for the three months ended April 30, 2017, down $4.6 million or 9.0%, 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 April 30, 2018 was $49.6 million, compared to $46.8 million for the three months ended April 30, 2017, up $2.8 million or 6.0%, primarily due to $3.1 million of costs related to the amendment and restatement of credit agreement offset by benefits from continued cost controls.


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Table of Contents

Restructuring and related for the three months ended April 30, 2018 was a benefit of $0.3 million, compared to a charge of $68.9 million for the three months ended April 30, 2017, down $69.2 million primarily as a result of a $38.5 million fair market value write-down associated with our exit from the petroleum media business, as well as a $28.1 million charge for future obligations associated with terminated customer agreements that was recognized in 2017 that did not recur.

Acquisition related charges for the three months ended April 30, 2018 was $8.0 million and was comprised primarily of fees for professional services in connection with the pending merger.

Amortization of purchased intangible assets for the three months ended April 30, 2018 was $15.6 million, compared to $18.4 million for the three months ended April 30, 2017, down $2.8 million or 15.2%, primarily because a portion of our purchased intangible assets were fully amortized during the prior year.

Goodwill impairment for the three months ended April 30, 2017 was $17.4 million and resulted from a quantitative assessment of the fair value of our Taxi Solutions reporting unit.

Interest expense, net for the three months ended April 30, 2018 was $10.2 million, compared to $8.2 million, up by $2.0 million or 24.4%, due primarily to a $2.2 million accelerated amortization of debt issuance costs related to the amendment and restatement of our credit agreement.

Other income (expense), net for the three months ended April 30, 2018 was $4.2 million of net expense, compared to $8.8 million of net income, a $13.0 million change. The Other income (expense), net for the three months ended April 30, 2018 is primarily related to $2.9 million loss recognized on equity method investments in the second quarter of 2018. The Other income (expense), net for the three months ended April 30, 2017 was primarily related to $9.6 million gain recognized in connection with our investment in Gas Media in the second quarter of 2017.

Income tax provision for the three months ended April 30, 2018 was $9.1 million compared to $8.9 million for the three months ended April 30, 2017, a change of $0.2 million. The income tax provision for the three months ended April 30, 2018 is primarily related to foreign taxes. The income tax provision for three months ended April 30, 2017 was primarily related to foreign taxes and discrete items associated with restructuring related charges.


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Table of Contents


Six Months Ended April 30, 2018 compared to April 30, 2017

 
Six Months Ended April 30,
 
2018
 
% of Net revenues (1)
 
2017
 
% of Net revenues (1)
 
(in thousands, except percentages)
Net revenues:
 
Systems
$
501,627


57.3%
 
$
551,076


59.4%
Services
373,573

 
42.7%
 
376,480

 
40.6%
Total net revenues
875,200

 
100.0%
 
927,556

 
100.0%
 
 
 
 
 
 
 
 
Gross margin:
 
 
 
 
 
 
 
Systems
183,713

 
36.6%
 
208,465

 
37.8%
Services
172,920

 
46.3%
 
135,727

 
36.1%
Total gross margin
356,633

 
40.7%
 
344,192

 
37.1%
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
Research and development
100,999

 
11.5%
 
107,723

 
11.6%
Sales and marketing
92,682

 
10.6%
 
100,141

 
10.8%
General and administrative
100,646

 
11.5%
 
97,558

 
10.5%
Restructuring and related
111

 
—%
 
70,038

 
7.6%
Acquisition related
8,022

 
0.9%
 

 
—%
Amortization of purchased intangible assets
30,695

 
3.5%
 
37,177

 
4.0%
Goodwill impairment

 
—%
 
17,384

 
1.9%
Total operating expenses
333,155

 
38.0%
 
430,021

 
46.4%
Operating income (loss)
23,478

 
2.7%
 
(85,829
)
 
(9.3)%
Interest expense, net
(19,151
)
 
(2.2)%
 
(16,332
)
 
(1.8)%
Other income (expense), net
(5,378
)
 
(0.6)%
 
6,574

 
0.7%
Income (loss) before income taxes
(1,051
)
 
(0.1)%
 
(95,587
)
 
(10.3)%
Income tax provision
8,546

 
1.0%
 
11,802

 
1.3%
Consolidated net income (loss)
$
(9,597
)
 
(1.1)%
 
$
(107,389
)
 
(11.6)%

(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 six months ended April 30, 2018 were $875.2 million, compared to $927.6 million for the six months ended April 30, 2017, down $52.4 million or 5.6%. Net revenues decreased $48.7 million as a result of the divestiture of the China and Taxi Solutions businesses, and higher revenues from government demonetization initiatives in India and higher demand for EMV enabled devices in North America in the prior year, both of which did not recur. These decreases were partially offset by increased revenues in Latin America and EMEA. See further discussion of net revenues by segment and geography below.

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Table of Contents

Net Revenues by Geography
 
 
 
 
Six Months Ended April 30,
 
 
 
 
2018
 
% of Net revenues
 
2017
 
% of Net revenues
 
 
 
 
(in thousands, except percentages)
Net Revenues
North America
 
$
246,696

 
28.2%
 
$
323,241

 
34.8%
Latin America
 
172,805

 
19.7%
 
119,540

 
12.9%
EMEA
 
366,321

 
41.9%
 
345,835

 
37.2%
Asia-Pacific
 
89,378

 
10.2%
 
138,940

 
15.0%
 
 
Total
 
$
875,200

 
100.0%
 
$
927,556

 
100.0%

North America net revenues decreased $76.5 million, due primarily to a $41.1 million decrease as a result of the divestiture of the Taxi Solutions business. The remaining decrease is attributed 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 $53.3 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, particularly in Brazil.

EMEA net revenues increased $20.5 million, due primarily to the impact of foreign currency fluctuations and the timing of customer orders, which are due to factors such as changes in government fiscalization programs and the timing of customer technology refreshes. Net revenues includes a $27.7 million positive impact due to favorable foreign currency fluctuations.

Asia-Pacific net revenues decreased $49.6 million, due primarily to a $49.9 million decrease in revenues in India, which is primarily as a result of government demonetization initiatives that resulted in increased revenues in the prior year that did not recur. Additionally, net revenues decreased $7.5 million as a result of the divestiture of the China business.

Gross margin for the six months ended April 30, 2018 was $356.6 million or 40.7% of net revenues, compared to $344.2 million, or 37.1% of net revenues, for the six months ended April 30, 2017, up $12.4 million or 3.6 percentage points. Gross margin in dollars and as a percentage of net revenues increased primarily due to a $10.6 million charge write-down of inventory related to the divestiture of our petroleum media business in the prior year. Gross margin as a percentage of net revenues also increased due to a greater mix of higher margin services net revenues and next generation products.

Research and development for the six months ended April 30, 2018 was $101.0 million, compared to $107.7 million for the six months ended April 30, 2017, down $6.7 million or 6.2%, primarily due to a $7.1 million write-down of capitalized costs associated with development projects in the six months ended April 30, 2017 that did not recur in 2018.

Sales and marketing for the six months ended April 30, 2018 was $92.7 million, compared to $100.1 million for the six months ended April 30, 2017, down $7.4 million or 7.4%, due primarily to reduced variable costs associated with lower revenues and decreased spend associated with cost savings initiatives.