| HYPERCOM CORP Item 1A Risk Factors The risks set forth below may adversely affect our business, financial condition and operating results and cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Annual Report on Form 10-K or elsewhere in our SEC filings |
| In addition to the risks set forth below, and the factors affecting specific business operations identified with the description of these business operations elsewhere in this Annual Report on 10-K, there may also be risks of which we are currently aware, or that we currently regard as immaterial based on the information available to us, that later prove to be material |
| Risks Related To Our Business We have incurred significant losses in the past and our results of operations have and may continue to vary from quarter to quarter impacted in particular by continued business reviews performed by management |
| If our financial performance is not in line with investor expectations, the price of our common stock will suffer and our access to future capital may be impaired |
| We had a net loss from continuing operations of dlra30dtta2 million for the year ended December 31, 2005 and a net loss from continuing operations of dlra12dtta5 million for the year ended December 31, 2004 |
| If the results of our continuing efforts to improve profitability, increase our cash flow and strengthen our balance sheet do not meet or exceed the expectations of securities analysts or investors, the price of our common stock will suffer |
| Further, given the variability in our revenues, our quarterly financial results have fluctuated significantly in the past and are likely to do so in the future |
| Accordingly, we believe that period-to-period comparisons of our results of operations may be misleading and not indicative of future performance |
| If our quarterly financial results fall below the expectations of securities analysts or investors, the price of our common stock may suffer |
| Quarterly revenue and operating results can vary depending on a number of factors, including: • variations in product mix, timing and size of fulfilled orders as a result of customer deferral of purchases and/or delays in the delivery of our products and services; • accomplishment of certain performance parameters embedded in our service level agreements; • the market’s demand for new product offerings; • delays in the delivery of our products and services; • product returns and warranty claims; • incremental costs incurred as a result of product quality and/or performance issues; • write-off of doubtful accounts receivable; • inventory obsolescence and write-downs related to product life cycles; • write-offs of research and development expenses; • variations in operating expenses, including research and development, selling, and general and administrative expenses; • lease portfolio risk adjustments and loss provisions; • restructuring activities; • employment and severance agreement charges; • foreign currency exchange rate fluctuations; 14 _________________________________________________________________ [64]Table of Contents • availability and cost of financing; • variations in income tax as a function of income recognition by tax jurisdiction; and • industry and economic conditions, including competition, industry standards, product certification requirements, trade restrictions and other regulations |
| The loss of one or more of our key customers could significantly reduce our revenues and profits |
| We have derived, and believe that we may continue to derive, a significant portion of our revenues from a limited number of large customers |
| For the fiscal year ended December 31, 2005, our largest customer accounted for 12dtta1prca of our revenue, and our five largest customers accounted for 31dtta6prca of our revenue |
| In addition, our largest customer does substantial business with some of our most significant competitors |
| Our customers may buy less of our products or services depending on their own technological developments, end-user demand for our products and internal budget cycles |
| A major customer in one year may not purchase any of our products or services in another year, which may negatively affect our financial performance |
| If any of our large customers significantly reduces or delays purchases from us or if we are required to sell products to them at reduced prices or unfavorable terms, our results of operations and revenue could be materially adversely affected |
| Our products may contain defects that may be difficult or even impossible to correct |
| Product defects could result in lost sales, additional costs and customer erosion |
| We offer technically complex products which, when first introduced or released in new versions, may contain software or hardware defects that are difficult to detect and correct |
| The existence of defects and delays in correcting them could result in negative consequences, including the following: • delays in shipping products; • cancellation of orders; • additional warranty expense; • delays in the collection of receivables; • product returns; • the loss of market acceptance of our products; • diversion of research and development resources from new product development; and • inventory write-downs |
| Even though we test all of our products, defects may continue to be identified after products are shipped |
| In past periods, we have experienced various issues in connection with product launches, including the need to rework certain products and stabilize product designs |
| Correcting defects can be a time-consuming and difficult task |
| Software errors may take several months to correct, and hardware errors may take even longer |
| We may accumulate excess or obsolete inventory that could result in unanticipated price reductions and write downs and adversely affect our financial results |
| Managing the proper inventory levels for components and finished products is challenging |
| In formulating our product offerings, we have focused our efforts on providing to our customers products with greater capability and functionality, which requires us to develop and incorporate the most current technologies in our products |
| This approach tends to increase the risk of obsolescence for products and components we hold in inventory and may compound the difficulties posed by other factors that affect our inventory levels, including the following: • the need to maintain significant inventory of components that are in limited supply; • buying components in bulk for the best pricing; 15 _________________________________________________________________ [65]Table of Contents • responding to the unpredictable demand for products; • responding to customer requests for short lead-time delivery schedules; • failure of customers to take delivery of ordered products; and • product returns |
| If we accumulate excess or obsolete inventory, price reductions and inventory write-downs may result, which could adversely affect our results of operation and financial condition |
| Security is vital to our customers and therefore breaches in the security of transactions involving our products or services could adversely affect our reputation and results of operations |
| Protection against fraud is of key importance to the purchasers and end-users of our solutions |
| We incorporate security features, such as encryption software and secure hardware, into our solutions to protect against fraud in electronic payment transactions and to ensure the privacy and integrity of consumer data |
| Our solutions may be vulnerable to breaches in security due to defects in the security mechanisms, the operating system and applications or the hardware platform |
| Security vulnerabilities could jeopardize the security of information transmitted or stored using our solutions |
| In general, liability associated with security breaches of a certified electronic payment system belongs to the institution that acquires the financial transaction |
| In addition, we have not experienced any material security breaches affecting our business |
| However, if the security of our solutions is compromised, our reputation and marketplace acceptance of our solutions will be adversely affected, which would adversely affect our results of operations, and subject us to potential liability |
| If we are unable to adequately protect our proprietary technology, our competitors may develop products substantially similar to our products and use similar technologies, which may result in the loss of customers |
| We rely on patent, copyright, trademark and trade secret laws, as well as confidentiality, licensing and other contractual arrangements, to establish and protect the proprietary aspects of our products |
| Our efforts may result in only limited protection, and our competitors may develop, market and sell products substantially equivalent to our products, or utilize technologies similar to those used by us |
| If we are unable to adequately protect our proprietary technology, these third parties may be able to compete more effectively against us, which could result in the loss of customers and adversely affect our business |
| In addition, the legal systems of many foreign countries do not protect or honor intellectual property rights to the same extent as the legal system of the United States |
| For example, in China, the legal system in general, and the intellectual property regime in particular, is still in the development stage |
| It may be very difficult, time-consuming and costly for us to attempt to enforce our intellectual property rights in these jurisdictions |
| Our products and other proprietary rights may infringe on the proprietary rights of third parties, which may expose us to claims and litigation |
| Although we believe that our products do not infringe on any third party’s patents, from time to time we have become involved in claims and litigation involving patents or proprietary rights |
| Patent and proprietary rights litigation entails substantial legal and other costs, and diverts the attention of our management resources |
| There can be no assurance that we will have the necessary financial resources to appropriately defend or prosecute our rights in connection with any such litigation |
| In the past we have received third-party claims and may receive additional notices of such claims of infringement in the future |
| To date, such activities have not had a material adverse effect on our business and we have either prevailed in all litigation, obtained a license on commercially acceptable terms or otherwise been able to modify any affected products or technology |
| However, there can be no assurance that we will continue to prevail in any such actions or that any license required under any such patent or other intellectual property would be made available on commercially acceptable terms, if at all |
| 16 _________________________________________________________________ [66]Table of Contents A disruption in our manufacturing capabilities or those of our third-party manufacturers or suppliers would negatively impact our ability to meet customer requirements |
| We manufacture the majority of our products at our facility in Shenzhen, China but also rely on third-party manufacturers to manufacture and assemble certain of our products |
| We also depend upon third-party suppliers to deliver components that are free from defects, competitive in functionality and cost, and in compliance with our specifications and delivery schedules |
| Since we generally do not maintain large inventories of our products or components, any termination of, or significant disruption in, our manufacturing capability or our relationship with our third-party manufacturers or suppliers may prevent us from filling customer orders in a timely manner |
| We have occasionally experienced, and may in the future experience, delays in delivery of products and delivery of products of inferior quality from third-party manufacturers |
| Although alternate manufacturers and suppliers are generally available to produce our products and product components, the number of manufacturers or suppliers of some of our products and components is limited, and qualifying a replacement manufacturer or supplier could take several months |
| In addition, our use of third-party manufacturers reduces our direct control over product quality, manufacturing timing, yields and costs |
| Disruption of the manufacture or supply of our products and components, or a third-party manufacturer’s or supplier’s failure to remain competitive in functionality, quality or price, could delay or interrupt our ability to manufacture or deliver our products to customers on a timely basis, which would have a material adverse effect on our business and financial performance |
| International operations pose additional challenges and risks that if not properly managed could adversely affect our financial results |
| For the year ended December 31, 2005, we derived approximately 61prca of our total revenues outside of the United States, principally in Latin America and Europe |
| We expect that international sales will continue to account for a significant percentage of our net income in the foreseeable future |
| In addition, substantially all of our manufacturing operations are located outside of the United States |
| Accordingly, we face numerous risks associated with conducting international operations, any of which could negatively affect our results of operations and financial condition |
| These risks include the following: • changes in foreign country regulatory requirements; • various import/export restrictions and the availability of required import/export licenses; • imposition of foreign tariffs and other trade barriers; • political and economic instability; • foreign currency exchange rate fluctuations; • extended payment terms and the ability to collect accounts receivable; • the ability to repatriate funds; • complicated tax and regulatory schemes, such as in Brazil, where failure to comply may result in fines, penalties or litigation; • complications associated with enforcing legal agreements in certain foreign countries, including Brazil, China and in developing countries; and • availability of qualified and affordable staff with which to manage our foreign operations |
| Additionally, we are subject to the Foreign Corrupt Practices Act, which may place us at a competitive disadvantage to foreign companies that are not subject to similar regulations |
| 17 _________________________________________________________________ [67]Table of Contents Our failure to sell our UK lease business where we provide our POS products directly to end-user merchants under sales-type leases that are subject to governmental regulation and involve a risk of default may result in us having to take a further write down of the value of this business or result in higher than anticipated lease defaults that, if excessive, could impair our profitability |
| Our subsidiary in the United Kingdom provides POS equipment directly to end-user merchants under lease arrangements |
| Currently this business owns and manages over 30cmam000 leases |
| The customer base of this leasing business is characterized by higher incidences of delinquencies and defaults and is distinctly different from our usual customer base of large domestic and international financial institutions, electronic payment processors, independent sales organizations, distributors and resellers |
| We maintain an allowance for estimated uncollectible sales-type lease receivables at an amount that we believe is sufficient to provide adequate protection against losses in our sales-type lease portfolio based on historical loss experience |
| The value of this lease portfolio could be substantially impaired if our existing lease loss reserves prove inadequate due to a default rate greater than that for which we have established reserves |
| This business activity is also subject to governmental consumer protection regulations |
| A failure to comply with such regulations could adversely affect our ability to enforce the leases, which could negatively impact the net realizable value of the leases |
| We are currently pursuing a potential sale of our UK leasing business and we have written down the book value of the lease assets to estimated fair value, however a sale may result in a financial loss if total sale proceeds turn out to be less than this estimated value |
| Furthermore, at this time, a sale agreement has not been reached with any buyer and a failure to do so in the future may result in us having to liquidate the lease portfolio over time |
| A liquidation of the leases over time may result in a financial loss if total collections are less than the current estimated value due to higher than anticipated lease defaults and/or lower lease renewal income in the future due to changed economic or competitive conditions |
| Additionally, if we continue to operate this lease business, significant capital investments may have to be incurred to enhance the management reporting systems used to manage and monitor the leases |
| Fluctuations in currency exchange rates may adversely affect our financial results |
| A substantial part of our business consists of sales made to international customers |
| A portion of revenues and expenses related to our international operations are denominated in currencies other than the US dollar |
| We cannot assure you that adverse currency exchange rate fluctuations will not have a material impact in the future |
| In addition, our balance sheet reflects non-US dollar denominated assets and liabilities which can be adversely affected by fluctuations in currency exchange rates |
| Prior to 2002, we did not hedge our exposure to these fluctuations |
| More recently, we have entered into foreign currency forward contracts intended to hedge our exposure to adverse fluctuations in exchange rates |
| Nevertheless, these hedging arrangements may not always be effective, particularly in the event of imprecise forecasts of non-US denominated assets and liabilities |
| Further, we are not able to hedge against our entire foreign currency risk |
| Accordingly, if there is an adverse movement in exchange rates, we might suffer significant losses |
| In the year ended December 31, 2005, we incurred foreign currency expense of dlra1dtta3 million net of foreign currency transaction gains or losses |
| Adverse resolution of litigation, including litigation arising out of the restatement of our consolidated financial statements, may adversely affect our business or financial results |
| We are party to litigation in the normal course of our business |
| Litigation can be expensive, lengthy and disruptive to normal business operations |
| Moreover, the results of complex legal proceedings are difficult to predict |
| An unfavorable resolution of a particular lawsuit could have a material adverse effect on our business, operating results, or financial condition |
| In February and March, 2005, various shareholder class action complaints were filed in the United States District Court, District of Arizona, against us and certain of our executive officers and members of our board of directors, on behalf of a class of purchasers of our common stock in the period from April 30, 2004 to February 3, 2005 |
| The complaints alleged that we, and certain of our executive management, violated the Securities Exchange Act of 1934 based on our February 2005 announcement that certain leases in the United Kingdom had been incorrectly accounted for as sales-type leases, rather than operating leases, and that 18 _________________________________________________________________ [68]Table of Contents we would restate our financial statements for the first three quarters of 2004 |
| In May 2005, these class actions were consolidated into one action and the designated lead plaintiff filed a consolidated amended class action compliant |
| In January 2006, the court dismissed the consolidated amended class action complaint, and in February 2006, the plaintiffs filed a second consolidated amended class action complaint |
| Also in March and April 2005, two shareholders’ derivative actions were filed in the United States District Court, District of Arizona and Superior Court of Maricopa County, Arizona, against us and certain of our executive officers, our board of directors and a former director, alleging breach of fiduciary duties, among other matters |
| Litigating the class action and the shareholder derivative actions relating to the restatement of our consolidated financial statements will likely require significant attention and resources of management and, regardless of the outcome, result in significant legal expenses |
| In the case of the securities class action, if our defenses were ultimately unsuccessful, or if we were unable to achieve a favorable settlement, we could be liable for large damages awards that could seriously harm our business, results of operations and financial condition |
| For additional information regarding the securities class action, the shareholder derivative actions and other litigation in which we are involved |