##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q (X)
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended: September 30, 2004. 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: 1-13521 HYPERCOM CORPORATION (Exact name of registrant as specified in its charter)
 Delaware
(State or other jurisdiction of
incorporation or organization)
    
    86-0828608
(I.R.S. Employer
Identification Number )
 2851 West Kathleen Road
Phoenix, Arizona 85053
(Address of principal executive offices) (Zip Code) (602) 504-5000
(Registrants telephone number, including area code) 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 [X]   No [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X]   No [  ] Number of shares of the registrants common stock, $.001 par value per share,
outstanding as of November 4, 2004, was 51,946,646.




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INDEX PagePART I. FINANCIAL INFORMATIONItem 1. Consolidated Financial StatementsConsolidated Balance Sheets  September 30, 2004 and December 31, 2003
    
    
    3Consolidated Statements of Operations  Three and nine months ended September 30, 2004 and 2003
    
    
    4Consolidated Statements of Cash Flows  Nine months ended September 30, 2004 and 2003
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    10Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    14Item 4. Controls and Procedures
    
    
    15PART II. OTHER INFORMATIONItem 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    16Item 6. Exhibits
    
    
    17SIGNATURES
    
    
    18EXHIBIT INDEX
    
    
    19EXHIBIT 10.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2EXHIBIT 99.1
  2




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PART I  FINANCIAL INFORMATION 
 Item 1. Consolidated Financial Statements HYPERCOM CORPORATION 
 CONSOLIDATED BALANCE SHEETS
 (In thousands, except share data)
 September 30, 2004(unaudited)
    December 31, 2003ASSETSCurrent assets:Cash and cash equivalents
    
    $
    27,524
    
    
    $
    65,415Marketable securities
    
    
    64,381
    
    
    
    17,400Accounts receivable, net of allowance for doubtful
accounts of $3,278 and $993, respectively
    
    
    56,280
    
    
    
    55,252Current portion of net investment in sales-type leases
    
    
    9,469
    
    
    
    8,783Inventories
    
    
    43,351
    
    
    
    42,262Prepaid expenses and other current assets
    
    
    5,818
    
    
    
    13,769Long-lived assets held for sale
    
    
    1,058
    
    
    
    852Total current assets
    
    
    207,881
    
    
    
    203,733Property, plant and equipment, net
    
    
    28,312
    
    
    
    28,217Net investment in sales-type leases
    
    
    19,471
    
    
    
    20,236Intangible assets, net
    
    
    4,734
    
    
    
    3,731Long-term marketable securities
    
    
    153
    
    
    
    153Other long-term assets
    
    
    3,945
    
    
    
    8,498Total assets
    
    $
    264,496
    
    
    $
    264,568LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    26,637
    
    
    $
    21,733Accrued payroll and related expenses
    
    
    7,828
    
    
    
    8,267Accrued sales and other taxes
    
    
    4,707
    
    
    
    6,359Accrued liabilities
    
    
    7,080
    
    
    
    7,534Deferred revenue
    
    
    2,556
    
    
    
    2,044Income taxes payable
    
    
    3,525
    
    
    
    1,690Current portion of long-term debt
    
    
    574
    
    
    
    1,058Total current liabilities
    
    
    52,907
    
    
    
    48,685Long-term debt
    
    
    8,452
    
    
    
    8,799Other non-current liabilities
    
    
    2,505
    
    
    
    2,787Total liabilities
    
    
    63,864
    
    
    
    60,271Stockholders equity:Common stock, $.001 par value; 100,000,000
shares authorized; 51,638,649 and 49,930,803
shares outstanding at September 30, 2004 and
December 31, 2003, respectively
    
    
    31
    
    
    
    29Additional paid-in capital
    
    
    226,385
    
    
    
    220,004Receivables from stockholders
    
    
    
    
    
    
    (1,056
    )Accumulated deficit
    
    
    (22,379
    )
    
    
    (11,307
    )Unearned deferred compensation
    
    
    (632
    )
    
    
    (600
    )Treasury stock, 290,211 shares (at cost)
    
    
    (2,773
    )
    
    
    (2,773
    )Total stockholders equity
    
    
    200,632
    
    
    
    204,297Total liabilities and stockholders equity
    
    $
    264,496
    
    
    $
    264,568
 The accompanying notes are an integral part of the consolidated financial
statements. 3




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HYPERCOM CORPORATION 
 CONSOLIDATED STATEMENTS OF OPERATIONS
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net revenue
    
    $
    63,173
    
    
    $
    59,405
    
    
    $
    178,627
    
    
    $
    168,101Costs of revenue
    
    
    38,560
    
    
    
    34,101
    
    
    
    104,820
    
    
    
    98,956Provision for deferred contract costs
    
    
    
    
    
    
    
    
    
    
    11,305
    
    
    
    Gross profit
    
    
    24,613
    
    
    
    25,304
    
    
    
    62,502
    
    
    
    69,145Operating expenses:Research and development
    
    
    6,637
    
    
    
    5,684
    
    
    
    19,906
    
    
    
    17,919Selling, general and administrative
    
    
    15,413
    
    
    
    14,347
    
    
    
    47,260
    
    
    
    44,111Total operating expenses
    
    
    22,050
    
    
    
    20,031
    
    
    
    67,166
    
    
    
    62,030Income (loss) from continuing
operations
    
    
    2,563
    
    
    
    5,273
    
    
    
    (4,664
    )
    
    
    7,115Interest income
    
    
    289
    
    
    
    64
    
    
    
    783
    
    
    
    211Interest expense
    
    
    (392
    )
    
    
    (647
    )
    
    
    (1,328
    )
    
    
    (1,782
    )Other income (expense)
    
    
    (1
    )
    
    
    (1
    )
    
    
    19
    
    
    
    (90
    )Foreign currency loss
    
    
    (968
    )
    
    
    (914
    )
    
    
    (2,607
    )
    
    
    (1,860
    )Income (loss) before income taxes and
discontinued operations
    
    
    1,491
    
    
    
    3,775
    
    
    
    (7,797
    )
    
    
    3,594Provision for income taxes
    
    
    (907
    )
    
    
    (738
    )
    
    
    (3,276
    )
    
    
    (2,376
    )Income (loss) before discontinued
operations
    
    
    584
    
    
    
    3,037
    

    
    
    (11,073
    )
    
    
    1,218Income from discontinued operations
(including $0.6 and $2.2 million loss on
disposal for the three and nine months
ended September 30, 2003, respectively)
    
    
    
    
    
    
    956
    
    
    
    
    
    
    
    1,239Net income (loss)
    
    $
    584
    
    
    $
    3,993
    
    
    $
    (11,073
    )
    
    $
    2,457Basic and diluted income (loss) per share:Income (loss) before discontinued
operations
    
    $
    0.01
    
    
    $
    0.06
    
    
    $
    (0.22
    )
    
    $
    0.02Income from discontinued operations
    
    
    
    
    
    
    0.02
    
    
    
    
    
    
    
    0.03Basic and diluted income (loss) per share
    
    $
    0.01
    
    
    $
    0.08
    
    
    $
    (0.22
    )
    
    $
    0.05Weighted average common shares   basic
    
    
    51,568
    
    
    
    49,811
    
    
    
    51,066
    
    
    
    48,901Weighted average common shares   diluted
    
    
    53,947
    
    
    
    51,243
    
    
    
    51,066
    
    
    
    49,984
 The accompanying notes are an integral part of the consolidated financial
statements. 4




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HYPERCOM CORPORATION 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
  Nine Months Ended September 30,2004
    
    2003Cash flows from continuing operations:Net income (loss) from continuing operations
    
    $
    (11,073
    )
    
    $
    1,218Adjustments to reconcile net income (loss) from continuing
operations to net cash provided by operating activities:Amortization of deferred financing costs
    
    
    526
    
    
    
    673Depreciation/amortization
    
    
    6,386
    
    
    
    6,761Provision for bad debts
    
    
    1,109
    
    
    
    1,249Provision for losses on sales-type leases
    
    
    1,363
    
    
    
    705Provision for excess and obsolete inventory
    
    
    6,292
    
    
    
    3,081Provision for long-term contract accounts recievable
    
    
    1,385
    
    
    
    Provision for deferred contract costs
    
    
    11,305
    
    
    
    Noncash stock compensation
    
    
    329
    
    
    
    Foreign currency loss
    
    
    2,607
    
    
    
    1,860Changes in operating assets and liabilities, net
    
    
    (9,492
    )
    
    
    1,032Net cash provided by operating activities
    
    
    10,737
    
    
    
    16,579Cash flows from investing activities:Purchases of marketable securities
    
    
    (54,407
    )
    
    
    (10,000
    )Proceeds from the sale or maturity of marketable securities
    
    
    7,500
    
    
    
    Proceeds from the sale of discontinued operations
    
    
    
    
    
    
    4,039Acquisition of other assets
    
    
    (3,437
    )
    
    
    (1,035
    )Purchase of property, plant, and equipment
    
    
    (3,783
    )
    
    
    (3,316
    )Net cash used in investing activities
    
    
    (54,127
    )
    
    
    (10,312
    )Cash flows from financing activities:Repayment of long-term debt
    
    
    (803
    )
    
    
    (1,089
    )Proceeds from issuance of common stock
    
    
    6,023
    
    
    
    5,240Payments received on advances to stockholders
    
    
    1,056
    
    
    
    Advances to discontinued operations
    
    
    
    
    
    
    (1,000
    )Net cash provided by financing activities
    
    
    6,276
    
    
    
    3,151Effect of exchange rate changes on cash
    
    
    (31
    )
    
    
    466Net (decrease) increase in cash flows from continuing operations
    
    
    (37,145
    )
    
    
    9,884Net (decrease) increase in cash flows from discontinued operations
    
    
    (746
    )
    
    
    8,136Cash and cash equivalents, beginning of period
    
    
    65,415
    
    
    
    23,069Cash and cash equivalents, end of period
    
    $
    27,524
    
    
    $
    41,089
 The accompanying notes are an integral part of the consolidated financial
statements. 5




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HYPERCOM CORPORATION 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  NOTE 1  BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements of Hypercom
Corporation (Hypercom or the Company) have been prepared in accordance with
accounting principles generally accepted in the United States for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all the information and
footnotes required by accounting principles generally accepted in the United
States for complete financial statements. In the opinion of management, all
adjustments, consisting of normal recurring accruals, considered necessary for
a fair presentation have been included. During the second quarter of 2004, the
Company recorded a nonrecurring charge to operations to fully reserve all
deferred contract costs and accounts receivable related to the Companys
contract with the Brazilian Health Ministry (see Note 7). Operating results for
the nine months ended September 30, 2004, are not necessarily indicative of the
results to be expected for the year ending December 31, 2004. Certain prior year amounts have been reclassified to conform to the current
period presentation, including the results of operations and cash flows of the
Companys former direct finance lease subsidiary, Golden Eagle Leasing. This financial information is intended to be read in conjunction with
Hypercoms audited financial statements and footnotes thereto included in
Hypercoms Annual Report on Form 10-K for the year ended December 31, 2003. NOTE 2  STOCK-BASED COMPENSATION Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation, (SFAS 123) defines a fair value based method of accounting for
employee stock options or similar equity instruments. However, it also allows
an entity to continue to account for these plans according to Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees,(APB
25) and related interpretations, provided pro forma disclosures of net income
(loss) are made as if the fair value based method of accounting, defined by
SFAS 123, had been applied. The Company has elected to continue to measure compensation expense related to
employee stock options using the intrinsic value method prescribed by APB 25
and related interpretations. The following table represents the effect on net
income (loss) and income (loss) per share as if the Company had applied the
fair value method and the recognition provisions of SFAS 123 to stock based
employee compensation (amounts in thousands, except per share data): Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income (loss), as reported
    
    $
    584
    
    
    $
    3,993
    
    
    $
    (11,073
    )
    
    $
    2,457Add: Stock-based employee compensation
expense included in reported net income (loss)
    
    
    102
    
    
    
    
    
    
    
    329
    
    
    
    Deduct: Total stock-based employee compensation
expense determined under fair value methods
for all awards
    
    
    (554
    )
    
    
    (458
    )
    
    
    (1,975
    )
    
    
    (3,190
    )Pro forma net income (loss)
    
    $
    132
    
    
    $
    3,535
    
    
    $
    (12,719
    )
    
    $
    (733
    )Net loss per share:Basic and diluted, as reported
    
    $
    0.01
    
    
    $
    0.08
    
    
    $
    (0.22
    )
    
    $
    0.05Basic and diluted, pro forma
    
    $
    0.00
    
    
    $
    0.07
    
    
    $
    (0.25
    )
    
    $
    (0.01
    )Weighted average shares used in pro forma
computation:Basic
    
    
    51,568
    
    
    
    49,811
    
    
    
    51,066
    
    
    
    48,901Diluted
    
    
    53,947
    
    
    
    51,243
    
    
    
    51,066
    
    
    
    48,901
 6




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For purposes of this pro forma disclosure, the value of the options is
estimated using a Black-Scholes option-pricing model and amortized ratably to
expense over the options vesting periods. Because the estimated value is
determined as of the date of grant, the actual value ultimately realized by the
employee may be significantly different. See Note 16 of the Companys Annual
Report on Form 10-K for the year ended December 31, 2003 for further discussion
of the Companys stock-based employee compensation. On October 13, 2004, the Financial Accounting Standards Board (FASB)
concluded that Statement 123R, Share-Based Payment, which would require all
companies to measure compensation cost for all share-based payments (including
employee stock options) at fair value, would be effective for interim or annual
periods beginning after June 15, 2005. Statement 123R will negatively impact
the Companys earnings, however, the Company has not completed an analysis of
all of the differences between Statement 123R and SFAS No. 123. NOTE 3  INVENTORIES Inventories consist of the following (amounts in thousands): September 30, 2004
    
    December 31, 2003Purchased parts
    
    $
    22,556
    
    
    $
    17,990Work in progress
    
    
    5,328
    
    
    
    4,581Finished goods
    
    
    15,467
    
    
    
    19,691$
    43,351
    
    
    $
    42,262
 NOTE 4  RECEIVABLES FROM STOCKHOLDERS During March 2004, the Company received $1.1 million in cash from two former
principal stockholders to repay notes that came due. These notes were
historically reflected as a separate component of stockholders equity. NOTE 5  UNEARNED DEFERRED COMPENSATION In February 2004, the Company granted 60,000 shares of restricted common stock
to the Companys Chief Executive Officer under the 2000 Plan. The Company
recorded deferred compensation of $360,000, representing the market price of
the shares at the date of grant and a weighted-average fair value of $6.00 per
share. The deferred compensation is presented as a reduction of stockholders
equity and is being amortized ratably over the service period. The Company
expects to record compensation expense related to this stock grant of
approximately $27,000 per quarter through February 2007. Expense with respect
to the grants could be reduced and/or reversed if the Chief Executive Officer
leaves the Company prior to vesting in the award. NOTE 6  EQUITY TRANSACTIONS During April 2004, the Company issued 742,257 shares of common stock, par value
$0.001 per share, upon the conversion of 742,257 Series C Warrants at an
exercise price of $3.91 per share. Proceeds from the conversion amounted to
$2.9 million. During the second quarter of 2003, the Company issued 1,366,250 shares of its
common stock, par value $0.001 per share, upon the conversion of its Series A
Warrants (1,000,000 shares at an exercise price of $3.19 per share) and
Series B Warrants (366,250 shares at an exercise price of $3.16 per share).
Proceeds from the conversions amounted to $4.3 million. Additional equity activity during the nine months ended September 30, 2004 and
2003 was related to the issuance of common stock under our Employee Stock
Purchase Plan and stock option plans. NOTE 7  BRAZILIAN HEALTH MINISTRY CONTRACT The Company has been involved in a long-term contract with the Brazilian Health
Ministry requiring substantial
delivery of customized software and hardware. Revenue and a resulting margin
under this contract were recorded based 7




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on the achievement of contract
milestones approved by the Brazilian Health Ministry in accordance with
Statement of Position 81-1, Accounting for Performance of Construction-Type and
Certain Production-Type Contracts. The margin for the entire contract was
estimated to be 9%. Inherent in this margin was an expectation of realizing all
amounts owed under the terms of the original contract and recovering claims for
additional contract revenue, due to changes in the scope of the contract and
additional currency exchange variation adjustments. Scope changes involved
expanding the overall design specifications requiring additional hours and
administration costs. The currency adjustments represented the inflation of
cost on imported equipment caused by currency movements. At the end of 2003,
the Company formally presented a claim to the Brazilian Health Ministry
detailing the amount and nature of the scope changes and currency variation
impact. While additional revenues above the original contract amount have not been
recorded, under the percentage-of-completion milestone approach, contract costs
associated with the scope changes and currency adjustments had been previously
deferred in anticipation of recognizing contract revenue. Deferred contract
costs were reported within other current assets and other long-term assets and
treated as normal costs of contract performance. As of June 30, 2004, such
costs amounted to $11.3 million. During April 2004, the final maintenance phase of the contract expired and the
Brazilian Health Ministry informed the Company of their intent to extend the
maintenance element of the contract. However, no formal agreement has been
entered into regarding the extension of the maintenance element of the contract
and no official authoritative answer has been received regarding the pending
claim. The Company believes that the delay in payment and extension of the
maintenance element of the contract relates to an internal scandal within the
Brazilian Health Ministry, which in no way relates to the Company or the
Companys pending claim, but nevertheless, casts doubt and concern over the
ability to recover, timely, the amounts owed under the contract. Accordingly,
due to the lack of timely acknowledgement and acceptance of the pending claim,
the expiration of the contract during April 2004 and the delay in the
negotiation of the extension of the maintenance element of the contract, the
Company recorded a $12.9 million charge to operations during the second quarter
of 2004 to fully reserve all remaining amounts recorded under the contract. The
charge consisted of an $11.3 million reserve against deferred contract costs,
which was recorded in cost of revenues and presented separately in the
statement of operations, and a $1.6 million reserve against accounts
receivable, which was recorded in selling expense. Since the second quarter
2004, the Company has received $0.3 million from the Brazilian Health Ministry,
and, accordingly, reversed $0.3 million of the previously established accounts
receivable reserve during the third quarter of 2004. The Company is actively pursuing discussions with the Brazilian Health Ministry
regarding both the collection of the remaining reserved balances as well as
renewal of the maintenance element of the contract, however, there is no
certainty as to how much will ultimately be collected or if the maintenance
element of the contract will ultimately be extended. NOTE 8  DISCONTINUED OPERATIONS The Companys discontinued operations include the results of operations of
certain under-performing operating units previously identified and reported as
discontinued operations together with the results of operations of the
Companys former direct finance lease subsidiary, Golden Eagle Leasing,
initially reported in discontinued operations during the third quarter of 2003.
All periods prior to the third quarter of 2003 have been reclassified to
present the operating results of Golden Eagle Leasing in discontinued
operations. Net revenues and pretax income of the operating units classified as
discontinued operations for the three and nine months ended September 30, 2003
was $5.9 million and $1.0 million, and $22.6 million and $1.2 million,
respectively. These amounts include net revenue and pretax income from Golden
Eagle Leasing in the amount of $5.4 million and $1.9 million, and $16.8 million
and $5.6 million, respectively. During the second and third quarters of 2003, the Company disposed of all the
assets of the remaining two operating units, initially held for sale in
September of 2002, resulting in a loss on disposal of $2.2 million comprised of
$1.3 million in non-cash asset and inventory write-downs, $0.5 million in
one-time severance costs, $0.1 million in remaining facility lease costs, and
$0.3 million related to a final cash infusion made in accordance with the terms
of the sale. 8




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NOTE 9  INCOME TAXES The Companys income tax expense is principally comprised of income taxes
associated with its profitable foreign locations. As discussed in the Companys 2003 Annual Report on Form 10-K, the Company has
recorded a full valuation reserve against its deferred tax asset balances
existing at December 31, 2003. Facts and circumstances have lead to the
Companys conclusion to continue to provide a full valuation reserve against
its deferred tax assets as of September 30, 2004. The valuation reserve is
subject to reversal in future years at such time that the benefits are actually
utilized or, the operating profits in the U.S. become sustainable at a level
that meets the recoverability criteria under SFAS 109. Due to the Companys net operating loss position and the provision of full
valuation reserves against the Companys deferred tax assets, the consolidated
effective tax rates for the nine months ended September 30, 2004 and 2003 are
not meaningful. NOTE 10  EARNINGS PER SHARE DISCLOSURES The table below provides a reconciliation of the numerators and denominators of
the basic and diluted per share computations for income (loss) before
discontinued operations (amounts in thousands, except per share data). Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Income (loss) before discontinued operations
    
    $
    584
    
    
    $
    3,037
    
    
    $
    (11,073
    )
    
    $
    1,218Weighted average shares of common stock
outstanding:Basic
    
    
    51,568
    
    
    
    49,811
    
    
    
    51,066
    
    
    
    48,901Effect of stock options and warrants
    
    
    2,379
    
    
    
    1,432
    
    
    
    
    
    
    
    1,083Diluted
    
    
    53,947
    
    
    
    51,243
    
    
    
    51,066
    
    
    
    49,984Income (loss) per share before discontinued
operationsBasic and diluted:
    
    $
    0.01
    
    
    $
    0.06
    
    
    $
    (0.22
    )
    
    $
    0.02
 Weighted average shares issuable upon the exercise of stock options and
warrants which were not included in the computation of diluted income (loss)
per share because they were anti-dilutive amounted to 2,956,173 and 10,125,547,
and 6,183,167 and 6,462,514 for the three and nine months ended September 30,
2004 and 2003, respectively. 9




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Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of The Private Securities Litigation Reform Act of 1995. Words such
as believe, expect, intend, anticipate, estimate, project, and
similar expressions identify forward-looking statements, which speak only as of
the date the statement was made. These forward-looking statements may include,
but are not limited to, projections of revenue or net income and issues that
may affect revenue or net income, projections of capital expenditures, future
levels of research and development expenditures, plans for future operations,
products or services, our ability to fund our projected liquidity and capital
requirements from our cash flow from operations and our current cash reserves,
and general economic conditions, as well as assumptions relating to the
foregoing. Forward-looking statements are inherently subject to risks and uncertainties,
some of which cannot be predicted or quantified. Future events and actual
results could differ materially from those set forth in, contemplated by, or
underlying the forward-looking statements. Statements in this Quarterly Report,
including the Notes to the Consolidated Financial Statements and Managements
Discussion and Analysis of Financial Condition and Results of Operations
describe factors, among others, that could contribute to or cause such
differences. Additional risk factors that could cause actual results to differ
materially from those expressed in such forward-looking statements, and that
could affect the Companys results of operations and financial position
generally, are set forth in Exhibit 99.1, which is attached hereto and
incorporated by reference into this Quarterly Report on Form 10-Q. The Company
undertakes no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events, or
otherwise. RESULTS OF CONTINUING OPERATIONS The results of continuing operations exclude the operations of the operating
units being reported as discontinued operations (see Note 8 to the financial
statements). NET REVENUE Net revenue increased $3.8 million or 6.4% to $63.2 million from $59.4 million
for the three months ended September 30, 2004 and 2003, respectively. Net
revenue for the third quarter of 2003 benefited by $2.4 million from a
transaction in Brazil involving the sale of fully depreciated terminals we had
previously leased to a third party under an operating lease. Excluding the $2.4
million in revenue, net revenue increased $6.2 million or 10.9%. No similar
transaction occurred during the third quarter of 2004. The year over year quarterly increase in revenues is principally attributable
to increased sales in our European region. This growth is related to
a diversification of our Swedish product offering into new vertical
markets and a new security standard (EMV), which was
developed by the worlds major credit card companies, Europay, Mastercard and
Visa. EMV governs the replacement of traditional magnetic strip cards with
chip cards. Merchants must upgrade their terminals to meet the new EMV
standards or potentially bear the liability of fraudulent transactions which
chip technology would have prevented. We anticipate continued demand due to
the EMV initiative and our Swedish product offering. Offsetting the increase in net revenue for the quarter ended September 30,
2004, was a component shortage which caused a delay in scheduled shipments
principally in the United States. The component shortage has since been
addressed and the product has been shipped. In addition to the component
shortage, we experienced lower average selling prices on product sold under the
terms of a newly signed domestic processor agreement during the third quarter
of 2004. We expect to reap the benefits of higher unit volumes on this newly
signed agreement during the fourth quarter of 2004 and beyond. On a year to date basis, revenues increased $10.5 million or 6.2% from $168.1
million to $178.6 million. Excluding the 2003 sale of fully depreciated
terminals in Brazil, year to date revenues increased
$12.9 million or 7.1%. This
year over year increase is principally attributable to sales in our European
region attributable to the new EMV security standard as previously discussed. 10




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COST OF REVENUE Cost of revenue includes the cost of raw materials, manufacturing labor,
overhead and subcontracted manufacturing costs, as well as loan loss provisions
with respect to sales-type leases. Cost of revenues as a percent of revenues
increased to 61.1% from 57.4% for the three months ended September 30, 2004 and
2003, respectively, and decreased to 58.7% from 58.9% for the nine months ended
September 30, 2004 and 2003, respectively. Excluding the sale of fully
depreciated terminals in Brazil during 2003, cost of revenues as a percent of
revenues was 59.8% and 59.7% for the three and nine months ended September 30,
2003. The year over year quarterly increase in cost of sales as a percent of
revenues was principally attributable to incremental inventory reserves and
lower margins attributable to a change in product mix associated with a newly
signed domestic processor agreement. On a year-to-date basis, the increase in
gross margin as a percentage of revenues is the result of manufacturing
efficiencies attributable to lower negotiated raw material component prices,
engineered hardware cost reductions, as well as greater absorption of fixed
overhead expenses given the higher revenues partially offset by incremental
inventory reserves and a shift in product mix as previously discussed. The
incremental inventory reserves in the 2004 third quarter and year to date were
attributable to technology obsolescence induced by our new product offerings
and prevailing market requirements. PROVISION FOR DEFERRED CONTRACT COSTS During the second quarter 2004, we recorded an $11.3 million charge to cost of
revenue to reserve all costs previously deferred under our long-term contract
with the Brazilian Health Ministry (see Note 7). Our decision to record the
provision was principally due to the lack of timely acknowledgement and
acceptance of the pending claim, the expiration of the contract during April
2004 and the delay in the negotiation of the extension of the maintenance
element of the contract. We believe the delay is due to an internal scandal
within the Brazilian Health Ministry, which in no way relates to Hypercom or
our pending claim, but nevertheless, casts doubt and concern over the ability
to recover, timely, the amounts owed under the contract. We are actively
pursuing discussions with the Brazilian Health Ministry regarding both the
collection of the reserved contract costs as well as renewal of the maintenance
element of the contract, however, there is no certainty as to how much will
ultimately be collected or that the maintenance contract will ultimately be
extended. GROSS PROFIT Gross profit as a percent of revenue decreased to 39.0% from 42.6% for the
three months ended September 30, 2004 and 2003, respectively. As discussed
previously, the third quarter of 2003 benefited from the sale of fully
depreciated terminals in Brazil. Excluding that sale, gross margin as a
percentage of revenue would have been 40.2% for the quarter ended September 30,
2003. The decline in gross profit as a percent of revenue is principally due to
lower average selling price and margin on comparable product sold under the
terms of a newly signed domestic processor agreement and incremental inventory
reserves recorded during the third quarter of 2004. For the nine months ended September 30, 2004, gross margin as a percent of
revenues was 35.0% compared to 41.1% for the same period a year ago. The
decline in gross profit as a percent of revenue is attributable to the
provision recorded to reserve all costs previously deferred under our contract
with the Brazilian Health Ministry. Excluding the contract provision, gross
profit as percent of revenue was 41.3% for the nine months ended September 30,
2004. As noted above, the modest revenue increase in adjusted gross profit
percentage is primarily due to manufacturing efficiencies and greater
absorption of fixed overhead expenses. These factors were partially offset by
incremental inventory reserves and a shift in product mix in 2004. RESEARCH AND DEVELOPMENT Research and development expenses consist mainly of software and hardware
engineering costs and the cost of development personnel. Research and
development expenses increased $0.9 million or 15.8% from $5.7 million to $6.6
million for the three months ended September 30, 2004 and 2003, respectively.
On a year to date basis, research and development expense increased $2.0
million or 11.2% to $19.9 million in 2004. The increase in research and
development spending is reflective of new products launched during the first
half of 2004 including several new terminals under our Optimum product family
and an internet protocol (IP) enabling device, IN-tact, that converts
existing Hypercom terminals into faster IP-enabled card payment terminals. We
expect research and development spending for the remainder of 2004 to continue
to outpace that of 2003. 11




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SELLING, GENERAL AND ADMINISTRATIVE EXPENSE Sales and marketing expenses, administrative personnel costs, and facilities
operations make up the selling, general and administrative expenses. These
expenses totaled $15.4 million and $14.3 million for the three months ended
September 30, 2004 and 2003, respectively. The $1.1 million or 7.7% increase
is principally related to variable costs attributable to our increase in
revenues and additional costs incurred to comply with the substantial
scope, documentation and internal control validation requirements
imposed by Section 404 of the
Sarbanes-Oxley Act. These expenses were somewhat mitigated by a $0.3 million reversal of
a bad debt provision for amounts subsequently received from the Brazilian
Health Ministry (see Note 7). Selling, general and administrative increased $3.2 million or 7.3% to $47.3
million for the nine months ended September 30, 2004. The increase principally
relates to a $1.4 million charge incurred during 2004 to reserve all
outstanding account receivable balances with the Brazilian Health Ministry (see
Note 7). We are actively pursuing discussions with the Brazilian Health
Ministry regarding the collection of the receivables, however, there is no
certainty as to how much will ultimately be collected. Excluding the reserve
against the Brazilian Health Ministry accounts receivable, selling, general and
administrative expenses increased $1.8 million or 4.1% for the nine months ended
September 30, 2004. The increase is principally related to variable costs
attributable to our increase in revenues and incremental costs incurred to
comply with Section 404 of the Sarbanes-Oxley Act regarding attestation of the
effectiveness of our internal controls. INCOME (LOSS) FROM CONTINUING OPERATIONS Our income from continuing operations for the three months ended September 30,
2004 declined $2.7 million to $2.6 million compared to $5.3 million in the same
period a year ago. The decline is principally attributable to a lower gross
profit as a percent of revenue and an increase in operating expenses as
previously discussed. On a year over year comparative basis, our loss from
continuing operations increased $11.8 million to a loss of $4.7 million
compared to income from continuing operations of $7.1 million for the nine
months ending September 30, 2004 and 2003, respectively. This decrease in
operating income is principally the result of a $12.7 million charge recorded
during the nine months ended September 30, 2004 to fully reserve all deferred
costs and accounts receivable recorded under our Brazilian Health Ministry
contract (see Note 7). INTEREST EXPENSE, FOREIGN CURRENCY LOSSES, AND INCOME TAXES We incurred interest expense of $0.4 million and $1.3 million, and $0.6 million
and $1.8 million for the three and nine months ended September 30, 2004 and
2003, respectively. The decline in interest expense is primarily due
to a
continued decline in our long-term debt, reduced fees under our Senior Secured
Credit Facility, which was amended effective December 31, 2003,
and a
reduction in amortization of debt issuance costs as all costs were fully
amortized effective July 2004. Foreign currency loss for the three and nine
months ended September 30, 2004 and 2003 was $1.0 million and $2.6 million, and
$0.9 million and $1.9 million, respectively. The increase in foreign currency
expense is principally attributable to the appreciation of the US dollar
against the Companys foreign currency exposures. During most of 2003, the
opposite was true as most of the Companys foreign currency exposures
appreciated against the US dollar. Income tax expense before discontinued operations for state and
foreign taxes was $0.9 million and $0.7 million for the three months ended
September 30, 2004 and 2003, respectively, and $3.3 million and $2.4 million
for the nine months ended September 30, 2004 and 2003,
respectively. Income
tax expense is principally comprised of income taxes associated with our
profitable foreign locations. As discussed in our 2003 Annual Report on Form 10-K, we recorded a full
valuation reserve against our deferred tax asset balance existing at December
31, 2003. Facts and circumstances have lead to our conclusion to continue to
provide a full valuation reserve against our deferred tax assets as of
September 30, 2004. The valuation reserve is subject to reversal in future
years at such time that the benefits are actually utilized or, the operating
profits in the U.S. become sustainable at a level that meets the recoverability
criteria under SFAS 109. Due to our net operating loss position and our provision for a full valuation
reserve against our deferred tax assets, the consolidated effective tax rates
for the three and nine months ended September 30, 2004 and 2003 are not
meaningful. 12




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CASH FLOWS, LIQUIDITY AND CAPITAL RESOURCES We have historically financed our operations primarily through cash generated
from operations and occasionally from borrowings under a line of credit and/or
other debt facilities. Cash provided by continuing operations declined $5.9 million from $16.6 million
for the nine months ended September 30, 2003 to $10.7 million for the nine
months ended September 30, 2004. The year over year decline is principally
attributable to the receipt of a $9.1 million income tax refund related to a
U.S. net operating loss carryback claim. The overall decline is partially
offset by an increase in our cash flows attributable to our current year
earnings adjusted for noncash items such as charges related to the provision
for deferred contract costs, depreciation and amortization, foreign currency
adjustments, noncash stock compensation, and provisions for bad debt and
inventory obsolescence. Our positive cash flow attributable to our current
year earnings is reflective of our year over year increase in sales volume. Cash used in investing
activities increased $43.8 million to $54.1 million for
the nine months ended September 30, 2004 from $10.3 million for the nine months
ended September 30, 2003. The increase in cash used in investing activities is
principally related to the investment of surplus cash in marketable securities
offset by a decline in cash received from the disposition of discontinued
operations. All operating units previously classified as held for sale were
disposed of during 2003. Capital expenditures were incrementally higher on a
year over year basis. Capital expenditures for the nine months ended September
30, 2004 were principally for upgrades to computer software and hardware as
well as manufacturing related expenditures related to new products recently
launched. Capital expenditures are expected to rise during the remainder of
2004, principally due to the expansion of our manufacturing facilities in
China. Cash provided by financing activities increased $3.1 million from $3.2 million
for the nine months ended September 30, 2003 to $6.3 million for the nine
months ended September 30, 2004. This increase was partially attributable to
cash proceeds from the exercise of stock options and warrants of $6.0 million
in the nine months ended September 30, 2004 compared to $5.2 million in the
same period a year ago. In addition, we received $1.1 million in cash from two
former principal shareholders to repay notes which came due during the first
quarter of 2004. Lastly, cash advances to discontinued operations declined by
$1.0 million as we have since disposed of all remaining operating units
previously held for sale. Long-term debt decreased $0.9 million to $9.0 million at September 30, 2004,
from $9.9 million at December 31, 2003. At September 30, 2004, working capital
and cash and cash equivalents was $155.0 million and $27.5 million,
respectively, compared to $155.0 and $65.4 million, respectively, at December
31, 2003. Marketable securities have increased by $47.0 million to $64.4
million at September 30, 2004 from $17.4 million at December 31, 2003. During April 2004, the Company issued 742,257 shares of common stock, par value
$0.001 per share, upon the conversion of 742,257 Series C Warrants at an
exercise price of $3.91 per share. During the second quarter of 2003, the
Company issued 1,366,250 shares of its common stock, par value $0.001 per
share, upon the conversion of its Series A Warrants (1,000,000 shares
at an exercise price of $3.19 per share) and Series B Warrants (366,250 shares
at an exercise price of $3.16 per share). Proceeds from the conversions
amounted to $2.9 million and $4.3 million for the nine months ended September
30, 2004 and 2003, respectively. We continue to accelerate cash generation through aggressively pursuing
collection of trade receivables and sales-type lease receivables, maintaining
inventories and controlling expenses. We believe our cash flow from operations,
together with our current cash reserves, will be sufficient to fund our
projected liquidity and capital resource requirements through 2004. If
operating results are unfavorable, we may need to use additional capital
sources to meet our short-term liquidity and capital resource requirements. In August 2003, the Board of Directors approved a stock repurchase program of
up to $10 million of our common stock from time to time when warranted by
market conditions. As of the end of fiscal 2003, the Company had repurchased
60,000 shares of common stock at an average price per share of $4.50. There
were no purchases made under this program during the nine months ended
September 30, 2004. 13




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BACKLOG As of September 30, 2004, we had backlog of $49.5 million, compared to $69.9
million at September 30, 2003. The decrease in backlog is primarily related to
a general trend towards purchase commitments with shorter delivery schedules as
a result of the Companys increasing percentage of international revenues and
domestic sales to multi-lane retailers. International revenues are generally
on a per order basis outside of long term purchase agreements and multi-lane
sales orders are generally received and fulfilled within short lead times given
other information sharing between the Company and customer. Additionally,
certain sales orders included in backlog are for periods longer than one
quarter and accordingly all amounts included in backlog will not be recognized
as revenue in the next quarter. Accordingly, management does not believe its
reported backlog to be an accurate predictor of future quarter revenues given
the Companys high percentage of international revenues and increasing domestic
sales to multi-lane retailers. We include in backlog all revenue specified in signed contracts and purchase
orders to the extent that we contemplate recognition of the related revenue
within one year. There can be no assurance that the contracts included in
backlog will actually generate the specified revenues or that the actual
revenues will be generated within the one-year period. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS On October 13, 2004, the Financial Accounting Standards Board (FASB)
concluded that Statement 123R, Share-Based Payment, which would require all
companies to measure compensation cost for all share-based payments (including
employee stock options) at fair value, would be effective for interim or annual
periods beginning after June 15, 2005. Statement 123R will negatively impact
the Companys earnings, however, the Company has not completed an analysis of
all of the differences between Statement 123R and SFAS No. 123. 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk At September 30, 2004, our cash equivalent investments were primarily in money
market accounts and certificates of deposit and were reflected as cash
equivalents because all maturities were within 90 days. Our interest rate risk
with respect to existing investments is limited due to the short-term duration
of these arrangements and the yields earned which approximate current interest
rates. Our marketable securities, consisting of fixed income securities, were $64.4
million as of September 30, 2004. These securities, like all fixed income
instruments, are subject to interest rate risk and will decline in value if
market interest rates increase. If market rates were to increase immediately
and uniformly by 10% from the levels of September 30, 2004, the decline in the
fair value of our investment portfolio would not be material given that our
investments typically have interest rate reset features that regularly adjust
to current market rates. Additionally, we have the ability to hold our fixed
income investments until maturity and, therefore, we would not expect to
recognize any material adverse impact in income or cash flows. We are exposed to financial market risks, including changes in interest rates
and foreign currency exchange rates in connection with our foreign operations
and markets. Nevertheless, the fair value of our investment portfolio or
related income would not be significantly impacted by either a 100 basis point
increase or decrease in interest rates, due primarily to the short-term nature
of the major portion of our investment portfolio. A substantial portion of our revenue and capital spending is transacted in U.S.
dollars. However, we do at times enter into these transactions in other
currencies, such as the Hong Kong dollar, Australian dollar, Brazilian real,
British pound and other Asian and European currencies. As a policy, we hedge
the translation of our net investment in foreign subsidiaries in an attempt to
neutralize the effect of translation gains or losses in the statement of
operations. Financial hedging instruments are limited by Company policy to
foreign-currency forward or option contracts and foreign-currency debt. We
enter into forward or option contracts with our bank or other financial
institutions to accomplish our hedging strategy. At September 30, 2004, we had
foreign currency forward contracts outstanding in the amount of $29.2 million,
denominated principally in the Brazilian real and British pound. Gains and
losses on these contracts principally consist of mark-to-market adjustments,
recorded in earnings as foreign currency gains or losses. We do not purchase or hold any derivative financial instruments for the purpose
of speculation or arbitrage. See information/discussion appearing in subcaption
Risks Associated with International Operations and Foreign Currency 14




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Fluctuations of CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS AND
RISK FACTORS set forth in Exhibit 99.1, attached hereto. At present, we have $9.0 million in debt obligations and there are no
borrowings under our line of credit facility at September 30, 2004. As such,
our interest rate risk is limited with respect to existing debt. During the normal course of business we are routinely subjected to a variety of
market risks, examples of which include, but are not limited to, interest rate
movements and foreign currency fluctuations, as we discuss in this Item 3, and
collectibility of accounts receivable. We continuously assess these risks and
have established policies and procedures to protect against the adverse effects
of these and other potential exposures. Although we do not anticipate any
material losses in these risk areas, no assurance can be made that material
losses will not be incurred in these areas in the future. 
 Item 4. Controls and Procedures Our Chief Executive Officer and Chief Financial Officer, based on the
evaluation of our disclosure controls and procedures (as defined in Rules
13a-15(e) or 15d-15(e), of the Securities Exchange Act of 1934, as amended)
required by paragraph (b) of Rule 13a-15 or Rule 15d-15, have concluded that,
as of September 30, 2004, our disclosure controls and procedures were effective
to ensure that the information we are required to disclose in reports that we
file or submit under the Securities and Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms. During the three and nine
months ended September 30, 2004, there was no change in our internal control
over financial reporting identified in connection with the evaluation required
by paragraph (d) of Rule 13a-15 or Rule 15d-15 that has materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting. 15




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PART II  OTHER INFORMATION 
 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities In August 2003, the Board of Directors approved a stock repurchase program of
up to $10 million of our common stock from time to time when warranted by
market conditions. As of the end of fiscal 2003, the Company had repurchased
60,000 shares of common stock at an average price per share of $4.50. There
were no purchases made under this program during the nine months ended
September 30, 2004. 16




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Item 6. Exhibits Exhibit Number
    
    Description of Exhibit3.1
    
    Amended and Restated Certificate of Incorporation of Hypercom Corporation
(incorporated by reference to Exhibit 3.1 to Hypercom Corporations
Registration Statement on Form S-1 (Registration No. 333-35641))3.2
    
    Amended and Restated Bylaws of Hypercom Corporation (incorporated by
reference to Exhibit 3.2 to Hypercom Corporations Quarterly Report on Form
10-Q for the quarter ended September 30, 2002)4
    
    Amended and Restated Certificate of Incorporation of Hypercom Corporation
(incorporated by reference to Exhibit 3.1 to Hypercom Corporations
Registration Statement on Form S-1 (Registration No. 333-35641))10.1
    
    Factory Premises and Quarters Lease Agreement between Hypercom Electronics
Manufacturing (Shenzhen) Co., Ltd. and Xin He Economic Development Company,
Fu Yong Town, Boa An District, Shenzhen City, dated September 1, 2004 *31.1
    
    Certification of Chief Executive Officer, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 *31.2
    
    Certification of Chief Financial Officer, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 *32.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*32.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*99.1
    
    Cautionary Statement Regarding Forward-Looking Statements and Risk Factors *
   *
    
    Filed herewith. 17




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. HYPERCOM CORPORATIONDate: November 9, 2004
    
    By:
    
    /s/ John W. SmolakJohn W. SmolakExecutive Vice President and Chief Financial andAdministrative Officer (duly authorized officer andPrincipal Financial Officer)
 18




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EXHIBIT INDEX Exhibit Number
    
    Description of Exhibit3.1
    
    Amended and Restated Certificate of Incorporation of Hypercom Corporation
(incorporated by reference to Exhibit 3.1 to Hypercom Corporations
Registration Statement on Form S-1 (Registration No. 333-35641))3.2
    
    Amended and Restated Bylaws of Hypercom Corporation (incorporated by
reference to Exhibit 3.2 to Hypercom Corporations Quarterly Report on Form
10-Q for the quarter ended September 30, 2002)4
    
    Amended and Restated Certificate of Incorporation of Hypercom Corporation
(incorporated by reference to Exhibit 3.1 to Hypercom Corporations
Registration Statement on Form S-1 (Registration No. 333-35641))10.1
    
    Factory Premises and Quarters Lease Agreement between Hypercom Electronics
Manufacturing (Shenzhen) Co., Ltd. and Xin He Economic Development Company,
Fu Yong Town, Boa An District, Shenzhen City, dated September 1, 2004 *31.1
    
    Certification of Chief Executive Officer, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 *31.2
    
    Certification of Chief Financial Officer, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 *32.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*32.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*99.1
    
    Cautionary Statement Regarding Forward-Looking Statements and Risk Factors *
   *
    
    Filed herewith.