Hypercom second quarter losses widen

The Company reported:

Second quarter revenue was $64.0 million versus $63.1 in the same quarter last year, an increase of 1.5% year-over-year and a 17.4% increase over first quarter revenues of $54.5 million. Delays in software certifications prevented certain Optimum family products from shipping in as high a volume as originally forecasted. The sequential quarter-over-quarter increase in revenue is consistent with prior years where first quarter revenues are typically seasonally lower, reflecting lower POS deployments by channel partners particularly in international markets.

Gross profit for the second quarter was $9.8 million or 15.4% of revenues, versus adjusted non-GAAP gross profit of $26.9 million or 42.6% of revenues in the same quarter last year. The current year gross profit was negatively impacted by a variety of charges from interim executive management's business review, referenced in connection with the announcement of the first quarter results, totaling $13.7 million. Excluding these charges, the normalized gross
margin for the second quarter was 36.5%. Second quarter 2004 gross margin was abnormally high due to significant amounts of high margin POS product being shipped to a specific customer that accounted for substantially less volume at reduced gross margins in second quarter 2005. The lower gross margin level in second quarter 2005 is also due to reduced average selling prices for older 8-bit POS products. The Company intends to aggressively pursue and protect market share while completing its product transition to the full Optimum product line.
This transition may negatively impact gross margin for the balance of 2005 compared to 2004 gross margins.

The second quarter financial results reflect $13.7 million of adjustments to gross margin related to an ongoing business review by interim executive management that commenced at the beginning of the second quarter and has continued to the present date. Management's conclusions from the business review have resulted in decisions driving the need for additional provisions and accruals, principally amounts related to the initiation of end-of-product-life management programs, obsolete inventory, warranty costs, severance costs, legal and tax contingencies, and other expenses or losses that have been or are expected to be incurred given management's best assessment of existing circumstances at June 30, 2005, including:

• $7.1 million of reserves and write-downs for inventory, primarily related to products at or near end-of-life, for which the Company now has an end-of-life product plan.
• $4.8 million of replacement cost reserves related to certain POS equipment that the Company has elected to provide to certain customers to reduce future warranty costs, increase customer satisfaction, drive future revenue opportunities and protect the Company's competitive positioning.
• $1.3 million of charges related to additional negotiated warranty work and replacement cost provision for customer-owned product as a result of higher than expected repair costs.
• $0.5 million of various other charges related to cost of sales.

Operating expenses for the second quarter were $25.5 million, an increase of $3.7 million over the adjusted non-GAAP operating expenses of $21.8 million in the same quarter of the prior year.

$2.5 million of the increase reflects expenses related to decisions arising from interim executive management's business review, including:

• $2.0 million related to recent termination and severance of certain executives and employees, and the elimination of certain executive perquisites. The Company recently announced a reduction in workforce of over 100 full time positions including more than 25 executive-level positions, in order to reduce operating expenses related to salaries and related costs by more than $15 million annually. Although the Company will begin to realize some cost savings benefit in the third and fourth quarters of 2005, the full financial benefit associated with this reduction in workforce will be realized in fiscal year 2006.
• $0.5 million of various other charges related to selling, general, and administrative costs including tax and legal contingency accruals.

$1.2 million of the incremental operating expenses over the comparable quarter in the prior year are related to:

• $0.5 million of increased R&D expense as a result of reduced capitalization of software development costs and a reduced direct recovery of software development expenses from our customers.
• $0.4 million of increased bad debt expense for additional reserves of accounts receivable.
• $0.3 million are a result of the management changes initiated at the end of first quarter 2005, including costs related to various general and administrative expense areas including interim executive management compensation and executive search fees.

Below the operating income line, the Company is reporting a combined $0.8 million improvement from the comparable quarter in 2004, related to net interest income and foreign currency expense, due to increased cash balances, and improved foreign currency management and reduced consulting costs.

The second quarter net loss was $16.7 million, or -$0.32 per share. The adjusted non-GAAP second quarter net loss was -$0.5 million, or - $0.01 per share, compared to the adjusted non-GAAP net income of $2.4 million, or $0.04 per share for the same quarter of the prior year.

Cash and short-term investment balances decreased from $98.6 million at March 31, 2005 to $93.4 million at June 30, 2005, primarily related to increased working capital requirements in a higher revenue quarter. The Company continues to reduce its debt, comprised of financing for office requirements, from $8.7 million at March 31, 2005 to $8.6 million at June 30, 2005. Additionally, in the second quarter, the Company repurchased 398,900 shares of its common stock at a cost of approximately $2.5 million.

"During the second quarter, interim executive management forced a comprehensive, rigorous and accelerated review of the Company. The quarter's results reflect management's judgments regarding accounting valuations, reserves and accruals, as well as reductions to the Company's operating cost structure," stated Chairman and Interim CEO William Keiper. "While we believe the majority of issues have been recognized, this will be an ongoing process that may result in additional period costs. We are now driving for market share but with a stronger company that is leaner, more focused, efficient and cost effective."

In summary, the Company recorded total charges of approximately $16.2 million ($13.7 million related to gross margin, $2.5 million related to operating expenses) in the second quarter of 2005. The charges included approximately $8.4 million of cash charges, most of which will be paid in future quarters, and $7.8 million of non-cash charges. Non-GAAP second quarter and year-to-date financial results excluding these charges for both the current and prior year are presented in the attached reconciliation. These charges are also discussed in the Company's Form 10-Q filed today with the Securities and Exchange Commission.

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