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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q/A
(Amendment No. 1)
 
     
(Mark One)    
 
þ
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the quarterly period ended July 31, 2007
or
o
  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 HOLDINGS, 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.)
 
 
2099 Gateway Place, Suite 600
San Jose, CA 95110
(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 o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer þ Accelerated filer o Non-accelerated filer o Smaller reporting company o
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
At August 24, 2007, the number of shares outstanding of the registrant’s common stock, $0.01 par value per share was 83,410,979.
 


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EXPLANATORY NOTE
 
This Amendment No. 1 (the “Amended 10-Q”) to the Quarterly Report on Form 10-Q of VeriFone Holdings, Inc. (the “Company” or “VeriFone”) for the three and nine months ended July 31, 2007 is being filed to correct certain errors in VeriFone’s Condensed Consolidated Financial Statements and the related disclosures.
 
As discussed in Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the notes to the accompanying Condensed Consolidated Financial Statements in this Amended 10-Q, the correction of these errors from previously reported information for the three months ended July 31, 2007 has resulted in a reduction in income (loss) before income taxes of $14.4 million, primarily as a result of a $16.2 million increase in total cost of net revenues offset by a $1.7 million reduction in operating expenses. The correction of these errors from previously reported information for the nine months ended July 31, 2007 has resulted in a reduction in income (loss) before income taxes of $36.7 million, primarily as a result of a $40.9 million increase in total cost of net revenues offset by a $4.8 million reduction in operating expenses.
 
On December 3, 2007, we announced that our management had identified errors in accounting related to the valuation of in-transit inventory and the allocation of manufacturing and distribution overhead to inventory and that as a result of these errors we anticipated that a restatement of our unaudited condensed consolidated financial statements would be required for the following interim periods:
 
  •  the three months ended January 31, 2007;
 
  •  the three and six months ended April 30, 2007; and
 
  •  the three and nine months ended July 31, 2007.
 
On December 3, 2007, following our announcement, the Audit Committee approved the commencement of an independent investigation into the errors in accounting that led to the anticipated restatement. The Audit Committee engaged independent counsel, Simpson Thacher & Bartlett LLP (“Simpson Thacher”), to conduct the independent investigation under the Audit Committee’s supervision. Simpson Thacher engaged Navigant Consulting, Inc. (“Navigant”) as independent forensic accountants. The scope of the investigation was proposed by Simpson Thacher in consultation with Navigant and approved by the Audit Committee.
 
On April 2, 2008, the Company announced that its Audit Committee had completed the independent investigation. The Audit Committee investigation found no evidence that any period prior to fiscal year 2007 required restatement.
 
Concurrently with the Audit Committee investigation, we also conducted an internal review for the purpose of restating our fiscal 2007 interim financial statements and preparing our fiscal 2007 annual financial statements and fiscal 2008 interim financial statements. This review included evaluations of the previously made accounting determinations and judgments. As a result, we have also corrected additional errors, including errors that had previously not been corrected because our management believed that individually and in the aggregate such errors were not material to our consolidated financial statements. Management also made additional adjustments to reduce certain accruals which had been recorded, such as bonuses, which were accrued based upon information which, following the restatement, was no longer accurate.
 
The following items have been amended principally as a result of, and to reflect, the restatements:
 
  •  Part I — Item 1. Financial Statements (Unaudited);
 
  •  Part I — Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations;
 
  •  Part II — Item 4. Controls and Procedures;
 
  •  Part II — Item 1. Legal Proceedings;
 
  •  Part II — Item 1A. Risk Factors; and
 
  •  Part II — Item 6. Exhibits.
 
For the convenience of the reader, this Amended 10-Q amends and restates in its entirety the Quarterly Report on Form 10-Q for the three and nine months ended July 31, 2007 (the “10-Q”). However, this Amended 10-Q amends only the items referred to above, in each case as a result of and to reflect the adjustments discussed above and more fully in Note 2 of the accompanying Condensed Consolidated Financial Statements and related disclosures. No other information in the 10-Q is amended hereby. The foregoing items have not been updated to reflect other events occurring after the filing of the 10-Q, or to modify or update those disclosures affected by other subsequent events. In particular, forward-looking statements included in this Amended 10-Q represented


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management’s views as of the date of filing of the 10-Q for the quarterly period ended July 31, 2007 on September 7, 2007. Such forward-looking statements should not be assumed to be accurate as of any future date. VeriFone undertakes no duty to update such information whether as a result of new information, future events or otherwise.
 
As required by Rule 12b-15 under the Securities Exchange Act of 1934, VeriFone’s principal executive officer and principal financial officer are providing Rule 13a-14(a) certifications dated August 19, 2008 in connection with this Amended 10-Q (but otherwise identical to their prior certifications) and are also furnishing, but not filing, written statements pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 dated August 19, 2008 (but otherwise identical to their prior statements).


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TABLE OF CONTENTS
 
VERIFONE HOLDINGS, INC.
 
INDEX
 
                 
      Financial Statements (unaudited):        
        Condensed Consolidated Balance Sheets — July 31, 2007 (restated) and October 31, 2006     5  
        Condensed Consolidated Statements of Operations — Three and Nine Months Ended July 31, 2007 (restated) and 2006     6  
        Condensed Consolidated Statements of Cash Flows — Nine Months Ended July 31, 2007 (restated) and 2006     7  
        Notes to Condensed Consolidated Financial Statements (restated)     8  
      Management’s Discussion and Analysis of Financial Condition and Results of Operations     56  
      Quantitative and Qualitative Disclosures About Market Risk     71  
      Controls and Procedures     72  
             
        PART II — OTHER INFORMATION        
      Legal Proceedings     74  
      Risk Factors     75  
      Unregistered Sales of Equity Securities and Use of Proceeds     79  
      Defaults Upon Senior Securities     80  
      Submission of Matters to a Vote of Security Holders     80  
      Other Information     80  
      Exhibits     81  
    82  
 EXHIBIT 31.1
 EXHIBIT 31.2
 EXHIBIT 32.1


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PART I — FINANCIAL INFORMATION
 
ITEM 1.   FINANCIAL STATEMENTS
 
VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
CONDENSED CONSOLIDATED BALANCE SHEETS
 
                 
    July 31,
    October 31,
 
    2007     2006  
    (Restated)(1)        
    (Unaudited)
 
    (In thousands, except par value)  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 212,946     $ 86,564  
Accounts receivable, net of allowances of $5,276 and $2,364
    182,920       119,839  
Inventories
    104,784       86,631  
Deferred tax assets
    21,991       13,267  
Prepaid expenses and other current assets
    29,438       12,943  
                 
Total current assets
    552,079       319,244  
Property, plant, and equipment, net
    40,290       7,300  
Purchased intangible assets, net
    180,396       16,544  
Goodwill
    610,351       52,689  
Deferred tax assets
    55,276       21,706  
Debt issuance costs, net
    13,427       10,987  
Transaction costs
          12,350  
Other assets
    22,961       12,125  
                 
Total assets
  $ 1,474,780     $ 452,945  
                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
Accounts payable
  $ 97,296     $ 66,685  
Income taxes payable
    41,687       5,951  
Accrued compensation
    18,641       16,202  
Accrued warranty
    10,102       4,902  
Deferred revenue, net
    39,552       23,567  
Accrued expenses
    6,138       4,752  
Accrued transaction costs
          12,000  
Other current liabilities
    71,218       13,661  
Current portion of long-term debt
    5,367       1,985  
Restructuring liabilities
    2,661       2,963  
                 
Total current liabilities
    292,662       152,668  
Accrued warranty
    426       530  
Deferred revenue
    10,310       7,371  
Long-term debt, net of current portion
    549,006       190,904  
Deferred tax liabilities
    78,470       859  
Other long-term liabilities
    10,692       1,872  
                 
Total liabilities
    941,566       354,204  
Minority interest
    2,620        
                 
Stockholders’ equity:
               
Preferred stock: 10,000 shares authorized as of July 31, 2007 and October 31, 2006; no shares issued and outstanding as of July 31, 2007 and October 31, 2006
           
Common stock: $0.01 par value, 100,000 shares authorized at July 31, 2007 and October 31, 2006; 83,316 and 68,148 shares issued and outstanding as of July 31, 2007 and October 31, 2006
    833       682  
Additional paid-in-capital
    611,565       140,569  
Accumulated deficit
    (96,351 )     (43,468 )
Accumulated other comprehensive income
    14,547       958  
                 
Total stockholders’ equity
    530,594       98,741  
                 
Total liabilities and stockholders’ equity
  $ 1,474,780     $ 452,945  
                 
 
 
(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 
                                 
    Three Months Ended July 31,     Nine Months Ended July 31,  
    2007     2006     2007     2006  
    (Restated)(1)           (Restated)(1)        
    (Unaudited)
 
    (In thousands, except per share data)  
 
Net revenues:
                               
System Solutions
  $ 205,972     $ 131,960     $ 586,407     $ 378,781  
Services
    25,729       15,657       78,540       45,656  
                                 
Total net revenues
    231,701       147,617       664,947       424,437  
Cost of net revenues:
                               
System Solutions
    132,268       72,704       391,510       211,584  
Services
    13,837       8,452       41,572       23,391  
                                 
Total cost of net revenues
    146,105       81,156       433,082       234,975  
                                 
Gross profit
    85,596       66,461       231,865       189,462  
Operating expenses:
                               
Research and development
    15,365       11,726       48,272       35,354  
Sales and marketing
    23,686       14,181       69,549       42,786  
General and administrative
    19,364       10,936       62,306       30,627  
Amortization of purchased intangible assets
    5,416       1,159       16,456       3,477  
In-process research and development
                6,650        
                                 
Total operating expenses
    63,831       38,002       203,233       112,244  
                                 
Operating income
    21,765       28,459       28,632       77,218  
Interest expense
    (9,468 )     (3,438 )     (28,731 )     (9,914 )
Interest income
    2,226       938       4,751       2,552  
Other income (expense), net
    (4,156 )     (195 )     (4,419 )     71  
                                 
Income before income taxes
    10,367       25,764       233       69,927  
Provision for income taxes
    52,753       9,009       53,116       24,342  
                                 
Net income (loss)
  $ (42,386 )   $ 16,755     $ (52,883 )   $ 45,585  
                                 
Net income (loss) per share:
                               
Basic
  $ (0.51 )   $ 0.25     $ (0.65 )   $ 0.69  
                                 
Diluted
  $ (0.51 )   $ 0.24     $ (0.65 )   $ 0.66  
                                 
Weighted average shares used in computing net income (loss) per share:
                               
Basic
    82,407       66,284       81,699       65,936  
                                 
Diluted
    82,407       69,079       81,699       68,906  
                                 
 
 
(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
                 
    Nine Months Ended July 31,  
    2007     2006  
    (Restated)(1)        
    (Unaudited)
 
    (In thousands)  
 
Cash flows from operating activities
               
Net income (loss)
  $ (52,883 )   $ 45,585  
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
Amortization of purchased intangible assets
    44,930       7,560  
Depreciation and amortization of property, plant, and equipment
    5,814       2,532  
Amortization of capitalized software
    800       892  
In-process research and development
    6,650        
Amortization of interest rate caps
    5       236  
Amortization of debt issuance costs
    1,129       819  
Stock-based compensation
    21,954       3,798  
Non-cash portion of loss on debt extinguishment
    4,764        
Minority interest and equity in earnings of affiliates
    (86 )      
Other
    (86 )     (74 )
                 
Net cash provided by operating activities before changes in working capital
    32,991       61,348  
Changes in operating assets and liabilities:
               
Accounts receivable, net
    (28,035 )     (19,097 )
Inventories
    47,967       (40,369 )
Deferred tax assets
    (7,161 )     (2,663 )
Prepaid expenses and other current assets
    (5,852 )     (1,204 )
Other assets
    (3,709 )     (924 )
Accounts payable
    19,487       15,421  
Income taxes payable
    39,475       431  
Tax benefit from stock-based compensation
    (6,882 )     (2,666 )
Accrued compensation
    (5,147 )     200  
Accrued warranty
    (2,640 )     (886 )
Deferred revenue
    10,317       5,509  
Deferred tax liabilities
    9,434        
Accrued expenses and other liabilities
    (15,432 )     (1,460 )
                 
Net cash provided by operating activities
    84,813       13,640  
Cash flows from investing activities
               
Software development costs capitalized
    (4,532 )     (1,731 )
Purchase of property, plant, and equipment, net
    (20,366 )     (2,780 )
Purchase of other assets
    (500 )     (673 )
Purchases of marketable securities
          (125,034 )
Sales and maturities of marketable securities
          127,325  
Transaction costs, pending acquisitions
          (2,497 )
Acquisition of businesses, net of cash and cash equivalents acquired
    (267,745 )      
                 
Net cash used in investing activities
    (293,143 )     (5,390 )
Cash flows from financing activities
               
Proceeds from long-term debt, net of costs
    613,252        
Purchase of convertible note hedge
    (80,236 )      
Sale of warrants
    31,188        
Repayment of long-term debt
    (262,554 )     (1,386 )
Tax benefit of stock-based compensation
    6,882       2,666  
Repayments of capital leases
    (43 )     (125 )
Investment in subsidiary by minority stockholder
    1,050        
Proceeds from exercises of stock options
    24,539       2,120  
Other
    26        
                 
Net cash provided by financing activities
    334,104       3,275  
Effect of foreign currency exchange rate changes on cash
    608       1,011  
                 
Net increase in cash and cash equivalents
    126,382       12,536  
Cash and cash equivalents, beginning of period
    86,564       65,065  
                 
Cash and cash equivalents, end of period
  $ 212,946     $ 77,601  
                 
Supplemental disclosures of cash flow information
               
Cash paid for interest
  $ 25,345     $ 9,013  
                 
Cash paid for taxes
  $ 13,779     $ 26,881  
                 
Supplemental schedule of non-cash transactions:
               
Debt issuance costs withheld from proceeds
  $ 8,333     $  
                 
Issuance of common stock and stock options for business acquisition
  $ 435,228     $  
                 
 
(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 1.   Description of Business
 
VeriFone Holdings, Inc. (“VeriFone” or the “Company”) was incorporated in the state of Delaware on June 13, 2002. VeriFone designs, markets, and services electronic payment solutions that enable secure electronic payments among consumers, merchants, and financial institutions.
 
On November 1, 2006, the Company acquired all of the outstanding ordinary shares of Lipman Electronic Engineering Ltd. (“Lipman”). The consideration paid to acquire Lipman was $347.3 million in cash, 13,462,474 shares of common stock of the Company, and assumption of all outstanding Lipman stock options. See Note 4 of Notes to Condensed Consolidated Financial Statements for additional information related to this business combination.
 
Note 2.   Restatement of Condensed Consolidated Financial Statements
 
Background
 
On December 3, 2007, the Company announced that its management had identified errors in accounting related to the valuation of in-transit inventory and the allocation of manufacturing and distribution overhead to inventory and that as a result of these errors, the Company anticipated that a restatement of its unaudited condensed consolidated financial statements would be required for the following interim periods:
 
  •  the three months ended January 31, 2007;
 
  •  the three and six months ended April 30, 2007; and
 
  •  the three and nine months ended July 31, 2007.
 
On December 3, 2007, following the announcement, the Company’s Audit Committee approved the commencement of an independent investigation into the errors in accounting that led to the anticipated restatement. The Audit Committee engaged independent counsel, Simpson Thacher & Bartlett LLP (“Simpson Thacher”), to conduct the independent investigation under the Audit Committee’s supervision. Simpson Thacher engaged Navigant Consulting, Inc. (“Navigant”) as independent forensic accountants. The scope of the investigation was proposed by Simpson Thacher in consultation with Navigant and approved by the Audit Committee. The investigation involved a program of forensic analysis designed to investigate, among other things:
 
  •  the circumstances surrounding the errors identified by management and described in the Company’s December 3, 2007 announcement;
 
  •  whether additional errors existed requiring further restatement in the interim periods of fiscal 2007 and the adjustments required to correct and restate the Company’s interim financial statements; and
 
  •  whether evidence existed indicating that periods prior to fiscal 2007 may also be required to be restated.
 
Simpson Thacher and Navigant assembled an investigative team that ultimately consisted of approximately 70 professionals. Information and documents were gathered from current and former employees worldwide. Using search technology, the investigative team evaluated over five million documents in physical and electronic form. Navigant also reviewed relevant accounting databases and journal entries. The investigative team also conducted more than 25 interviews of senior executives, former senior executives of Lipman, and current and former finance, accounting and supply chain personnel.
 
The Company announced on April 2, 2008 that the investigation was complete and that the investigation had confirmed the existence of the errors in accounting identified in the Company’s December 3, 2007 announcement. In particular, the investigation confirmed that incorrect manual journal and elimination entries had been made


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
primarily by the Company’s Sacramento, California supply chain accounting team with respect to several inventory-related matters.
 
The investigation also concluded that existing policies with respect to manual journal entries were not followed and that the review processes and controls in place were not sufficient to identify and correct the errors in a timely manner. The investigation found no evidence that any period prior to fiscal year 2007 required restatement.
 
Among the most significant errors giving rise to the restatement were:
 
  •  manual journal entries made for the three months ended January 31, 2007 that erroneously added manufacturing and distribution overhead to inventory held at former Lipman subsidiaries, notwithstanding that overhead had already been allocated to that inventory. This duplication erroneously increased reported inventory and reduced reported cost of net revenues by $7.7 million in the three months ended January 31, 2007;
 
  •  manual journal entries made for the periods ended April 30, 2007 and July 31, 2007 that erroneously recorded in-transit inventory of an additional $12.7 million at April 30, 2007 and an additional $7.3 million at July 31, 2007 based on erroneous methodology and application of source documents; and
 
  •  $6.3 million in errors made in the elimination of intercompany profit in inventory for the nine months ended July 31, 2007.
 
Concurrently with the Audit Committee investigation, the Company also conducted an internal review for the purpose of restating the Company’s fiscal 2007 interim financial statements and preparing the Company’s fiscal 2007 annual financial statements and fiscal 2008 interim financial statements. This review included evaluations of the previously made accounting determinations and judgments. As a result, the Company has also corrected additional errors, including errors that had previously not been corrected because management believed that individually and in the aggregate such errors were not material to the Company’s consolidated financial statements. Management also made additional adjustments to reduce certain accruals which had been recorded, such as bonuses, which were accrued based upon information which, following the restatement, was no longer accurate.
 
Restatement Adjustments
 
The following tables present the impact of the restatement adjustments on the Company’s previously reported condensed consolidated balance sheet as of July 31, 2007, condensed consolidated statements of operations for the three and nine months ended July 31, 2007, and condensed consolidated statement of cash flows for the nine months ended July 31, 2007. The impact to the statement of cash flows is the result of the adjustments to the condensed consolidated balance sheet and condensed consolidated statements of operations described below.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
CONDENSED CONSOLIDATED BALANCE SHEETS
 
                                 
    July 31, 2007  
    As Reported     Adjustments     Ref.     Restated  
    (In thousands)  
 
ASSETS
Current assets:
                               
Cash and cash equivalents
  $ 212,946     $             $ 212,946  
Accounts receivable, net of allowances
    183,096       (176 )             182,920  
Inventories
    145,398       (40,614 )     (b )     104,784  
Deferred tax assets
    20,832       1,159       (e )     21,991  
Prepaid expenses and other current assets
    24,911       4,527       (e )     29,438  
                                 
Total current assets
    587,183       (35,104 )             552,079  
Property, plant, and equipment, net
    42,857       (2,567 )     (f )     40,290  
Purchased intangible assets, net
    180,835       (439 )     (f )     180,396  
Goodwill
    564,718       45,633       (f )     610,351  
Deferred tax assets
    75,493       (20,217 )     (e )     55,276  
Debt issuance costs, net
    13,427                     13,427  
Other assets
    19,742       3,219       (f )     22,961  
                                 
Total assets
  $ 1,484,255     $ (9,475 )           $ 1,474,780  
                                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
                               
Accounts payable
  $ 97,810     $ (514 )           $ 97,296  
Income taxes payable
    5,489       36,198       (e )     41,687  
Accrued compensation
    19,990       (1,349 )             18,641  
Accrued warranty
    9,613       489               10,102  
Deferred revenue, net
    39,271       281               39,552  
Accrued expenses
    6,138                     6,138  
Other current liabilities
    73,468       (2,250 )     (f )     71,218  
Current portion of long-term debt
    5,367                     5,367  
Restructuring liabilities
    2,661                     2,661  
                                 
Total current liabilities
    259,807       32,855               292,662  
                                 
Accrued warranty
    426                     426  
Deferred revenue
    10,310                     10,310  
Long-term debt, net of current portion
    549,006                     549,006  
Deferred tax liabilities
    70,155       8,315       (e )     78,470  
Other long-term liabilities
    10,692                     10,692  
                                 
Total liabilities
    900,396       41,170               941,566  
                                 
Minority interest
    3,299       (679 )     (f )     2,620  
                                 
Total stockholders’ equity
    580,560       (49,966 )     (g )     530,594  
                                 
Total liabilities and stockholders’ equity
  $ 1,484,255     $ (9,475 )           $ 1,474,780  
                                 


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 
                                                                 
    Three Months Ended July 31, 2007     Nine Months Ended July 31, 2007  
    As Reported     Adjustments     Ref.     Restated     As Reported     Adjustments     Ref.     Restated  
                      (In thousands, except per share data)                    
 
Net revenues:
                                                               
System Solutions
  $ 206,216     $ (244 )     (a)     $ 205,972     $ 587,245     $ (838 )     (a)     $ 586,407  
Services
    25,729                     25,729       78,539       1               78,540  
                                                                 
Total net revenues
    231,945       (244 )             231,701       665,784       (837 )             664,947  
Cost of net revenues:
                                                               
System Solutions
    116,622       15,646               132,268       353,381       38,129               391,510  
Services
    13,312       525               13,837       38,812       2,760               41,572  
                                                                 
Total cost of net revenues
    129,934       16,171       (c)       146,105       392,193       40,889       (c)       433,082  
                                                                 
Gross profit
    102,011       (16,415 )             85,596       273,591       (41,726 )             231,865  
Operating expenses:
                                                               
Research and development
    15,560       (195 )             15,365       48,604       (332 )             48,272  
Sales and marketing
    23,644       42               23,686       69,490       59               69,549  
General and administrative
    21,134       (1,770 )     (d)       19,364       66,721       (4,415 )     (d)       62,306  
Amortization of purchased intangible assets
    5,167       249               5,416       16,555       (99 )             16,456  
In-process research and development
                              6,640       10               6,650  
                                                                 
Total operating expenses
    65,505       (1,674 )             63,831       208,010       (4,777 )             203,233  
                                                                 
Operating income
    36,506       (14,741 )             21,765       65,581       (36,949 )             28,632  
Interest expense
    (9,584 )     116               (9,468 )     (28,935 )     204               (28,731 )
Interest income
    2,226                     2,226       4,751                     4,751  
Other income (expense), net
    (4,386 )     230               (4,156 )     (4,417 )     (2 )             (4,419 )
                                                                 
Income (loss) before income taxes
    24,762       (14,395 )             10,367       36,980       (36,747 )             233  
Provision for income taxes
    11,323       41,430       (e)       52,753       19,666       33,450       (e)       53,116  
                                                                 
Net income (loss)
  $ 13,439     $ (55,825 )           $ (42,386 )   $ 17,314     $ (70,197 )           $ (52,883 )
                                                                 
Net income (loss) per share:
                                                               
Basic
  $ 0.16     $ (0.67 )           $ (0.51 )   $ 0.21     $ (0.86 )           $ (0.65 )
                                                                 
Diluted
  $ 0.16     $ (0.67 )           $ (0.51 )   $ 0.20     $ (0.85 )           $ (0.65 )
                                                                 
Weighted average shares used in computing net income (loss) per share:
                                                               
Basic
    82,407                     82,407       81,699                     81,699  
                                                                 
Diluted
    84,374       (1,967 )             82,407       84,507       (2,808 )             81,699  
                                                                 


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
                         
    Nine Months Ended July 31, 2007  
    Reported     Adjustments     Restated  
    (In thousands)  
 
Net income (loss)
  $ 17,314     $ (70,197 )   $ (52,883 )
                         
Net cash provided by operating activities
  $ 93,247     $ (8,434 )   $ 84,813  
Net cash used in investing activities
    (301,586 )     8,443       (293,143 )
Net cash provided by (used in) financing activities
    334,113       (9 )     334,104  
Effect of foreign currency exchange rates on cash
    608             608  
                         
Net increase in cash and cash equivalents
    126,382             126,382  
Cash and cash equivalents, beginning of period
    86,564             86,564  
                         
Cash and cash equivalents, end of period
  $ 212,946     $     $ 212,946  
                         
 
The primary restatement adjustments to the Company’s previously reported condensed consolidated balance sheet as of July 31, 2007 and condensed consolidated statements of operations for the three and nine months ended July 31, 2007 are as follows:
 
  (a)  Net revenues for the three and nine months ended July 31, 2007 were reduced primarily by errors in the timing of the recognition of revenue.
 
  (b)  The changes to inventories as of July 31, 2007 are as follows:
 
  •  $20.1 million decrease to eliminate intercompany in-transit inventory that did not exist, which was originally recorded based upon erroneous methodology and application of source documents. Intercompany in-transit inventory is inventory which is in the process of being shipped between VeriFone entities, primarily from either Israel or Singapore to the United States;
 
  •  $10.5 million decrease due to the duplicate recording of manufacturing and distribution overhead to inventories at former Lipman subsidiaries;
 
  •  $6.3 million decrease to eliminate intercompany profit in inventory. Inventory at the end of a quarter in one Verifone entity purchased from another Verifone entity contains intercompany profit which must be eliminated upon consolidation;
 
  •  $2.4 million decrease to correct errors in the capitalization of overhead;
 
  •  $0.6 million decrease to correct errors in excess and obsolete inventory;
 
  •  $1.1 million decrease to correct errors in recording and eliminating intercompany transactions; and
 
  •  $0.4 million net increase as a result of various adjustments, each individually less than $0.5 million.
 
  (c)  The changes to total cost of net revenues for the nine months ended July 31, 2007 are as follows:
 
  •  $20.1 million increase to eliminate intercompany in-transit inventory that did not exist, which was originally recorded based upon erroneous methodology and application of source documents. Intercompany in-transit inventory is inventory which is in the process of being shipped between VeriFone entities, primarily from either Israel or Singapore to the United States;
 
  •  $10.5 million increase due to the duplicate recording of manufacturing and distribution overhead to inventories at former Lipman subsidiaries;


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
  •  $6.3 million increase to eliminate intercompany profit in inventory. Inventory at the end of a quarter in one Verifone entity purchased from another Verifone entity contains intercompany profit which must be eliminated upon consolidation;
 
  •  $2.4 million increase to correct errors in the capitalization of overhead;
 
  •  $0.9 million increase due to an error in determining replacement cost of component inventory at former Lipman entities;
 
  •  $0.6 million increase to correct errors in excess and obsolete inventory;
 
  •  $0.5 million increase to correct errors in recording and eliminating intercompany transactions; and
 
  •  $0.4 million net decrease as a result of various adjustments, each individually less than $0.5 million.
 
The changes to total cost of net revenues for the three months ended July 31, 2007 are as follows:
 
  •  $8.4 million increase to eliminate intercompany in-transit inventory that did not exist, which was originally recorded based upon erroneous methodology and application of source documents. Intercompany in-transit inventory is inventory which is in the process of being shipped between VeriFone entities, primarily from either Israel or Singapore to the United States;
 
  •  $2.8 million increase due to the duplicate recording of manufacturing and distribution overhead to inventories at former Lipman subsidiaries;
 
  •  $2.4 million increase to eliminate intercompany profit in inventory. Inventory at the end of a quarter in one Verifone entity purchased from another Verifone entity contains intercompany profit which must be eliminated upon consolidation;
 
  •  $2.1 million increase to correct errors in the capitalization of overhead;
 
  •  $0.6 million increase to correct errors in excess and obsolete inventory; and
 
  •  $0.1 million net decrease as a result of various adjustments, each individually less than $0.5 million.
 
  (d)  The changes to general and administrative expenses for the nine months ended July 31, 2007 are as follows:
 
  •  $4.3 million decrease in general and administrative expenses as a result of a reversal of executive bonuses and stock-based compensation, which was originally based upon information that, following the restatement, was no longer accurate; and
 
  •  Other adjustments were each individually less than $0.5 million.
 
The changes to general and administrative expenses for the three months ended July 31, 2007 are as follows:
 
  •  $1.7 million decrease in general and administrative expenses as a result of a reversal of executive bonuses and stock-based compensation, which was originally based upon information that, following the restatement, was no longer accurate; and
 
  •  Other adjustments were each individually less than $0.5 million.
 
  (e)  Prepaid expenses and other current assets (prepaid taxes), deferred tax assets and income tax expense adjustments reflect the tax impact of the restatement adjustments, and the application of the intraperiod accounting rules to tax expense.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
  (f)  The changes to these balance sheet accounts relate to adjustments and corrections of various errors to the purchase price allocations of the Lipman, Payware and VTS acquisitions and/or reclassifications.
 
The changes to goodwill as of July 31, 2007 are as follows:
 
  •  $29.9 million increase as a result of adjustments in long-term deferred tax liabilities;
 
  •  $5.5 million increase to correct errors related to Lipman stock-options assumed at acquisition;
 
  •  $5.8 million decrease as a result of corrections related to Lipman, Payware and VTS assets and liabilities assumed at acquisition; and
 
  •  $16.0 million increase as a result of cumulative translation adjustments related to the above adjustments and correction of errors.
 
  (g)  The changes to total stockholders’ equity as of July 31, 2007 are as follows:
 
  •  $70.2 million decrease as a result of the restatement adjustments to the consolidated statement of operations;
 
  •  $3.3 million decrease due to correction of errors related to stock compensation expense;
 
  •  $5.5 million increase to correct errors related to Lipman stock-options assumed at acquisition; and
 
  •  $18.1 million increase as a result of cumulative translation adjustments related to adjustments and correction of various errors noted above.
 
Note 3.   Summary of Significant Accounting Policies
 
Principles of Consolidation
 
The accompanying condensed consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
 
Unaudited Interim Financial Information
 
The accompanying condensed consolidated balance sheet as of July 31, 2007, the condensed consolidated statements of operations for the three and nine months ended July 31, 2007 and 2006, and the condensed consolidated statements of cash flows for the nine months ended July 31, 2007 and 2006 are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and Form 10-Q and Article 10 of Regulation S-X. In the opinion of the Company’s management, the unaudited interim condensed consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and include all adjustments of a normal recurring nature necessary for the fair presentation of the Company’s financial position as of July 31, 2007 and its results of operations for the three and nine months ended July 31, 2007 and 2006, and its cash flows for the nine months ended July 31, 2007 and 2006. The results for the interim periods are not necessarily indicative of the results to be expected for any future period or for the fiscal year ended October 31, 2007. The condensed consolidated balance sheet as of October 31, 2006 has been derived from the audited consolidated balance sheet as of that date. Certain amounts reported in previous periods have been reclassified to conform to the current period presentation. The reclassifications did not impact previously reported revenues, total operating expense, operating income, net income, or stockholders’ equity.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
These unaudited interim condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and related notes included in the Company’s 2006 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on December 18, 2006.
 
Use of Estimates
 
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The Company bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from those estimates, and such differences may be material to the consolidated financial statements.
 
Revenue Recognition
 
The Company’s revenue recognition policy is consistent with applicable revenue recognition guidance and interpretations, including the requirements of Emerging Issues Task Force Issue No. 00-21 (“EITF 00-21”), Revenue Arrangements with Multiple Deliverables, Statement of Position 97-2 (“SOP 97-2”), Software Revenue Recognition, Statement of Position 81-1 (“SOP 81-1”), Accounting for Performance of Construction-Type and Certain Production Type Contracts, Staff Accounting Bulletin No. 104 (“SAB 104”), Revenue Recognition, and other applicable revenue recognition guidance and interpretations.
 
The Company records revenue when all four of the following criteria are met: (i) there is persuasive evidence that an arrangement exists; (ii) delivery of the products and/or services has occurred; (iii) the selling price is fixed or determinable; and (iv) collectibility is reasonably assured. Cash received in advance of revenue recognition is recorded as deferred revenue, net.
 
Net revenues from System Solutions sales to end-users, resellers, value added resellers, and distributors are recognized upon shipment of the product with the following exceptions:
 
  •  if a product is shipped free on board destination, revenue is recognized when the shipment is delivered, or
 
  •  if an acceptance or a contingency clause exists, revenue is recognized upon the earlier of receipt of the acceptance letter or when the clause lapses.
 
End-users, resellers, value added resellers, and distributors generally have no rights of return, stock rotation rights, or price protection.
 
The Company’s System Solutions sales include software that is incidental to the electronic payment devices and services included in its sales arrangements.
 
The Company enters into revenue arrangements for individual products or services. As a System Solutions provider, the Company’s sales arrangements often include support services in addition to electronic payment devices (“multiple deliverables”). These services may include installation, training, consulting, customer support, product maintenance, and/or refurbishment arrangements.
 
Revenue arrangements with multiple deliverables are evaluated to determine if the deliverables (items) should be divided into more than one unit of accounting. An item can generally be considered a separate unit of accounting if all of the following criteria are met:
 
  •  the delivered item(s) has value to the customer on a standalone basis;
 
  •  there is objective and reliable evidence of the fair value of the undelivered item(s); and
 
  •  if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the Company.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
Deliverables that do not meet these criteria are combined into a single unit of accounting.
 
If there is objective and reliable evidence of fair value for all units of accounting, the arrangement consideration is allocated to the separate units of accounting based on their relative fair values. In cases where there is objective and reliable evidence of the fair value(s) of the undelivered item(s) in an arrangement but no such evidence for one or more of the delivered item(s), the residual method is used to allocate the arrangement consideration. In cases in which there is no objective and reliable evidence of the fair value(s) of the undelivered item(s), the Company defers all revenues for the arrangement until the period in which the last item is delivered.
 
For revenue arrangements with multiple deliverables, upon shipment of its electronic payment devices, the Company allocates revenue based on the relative fair value for all remaining undelivered elements and recognizes the residual amount within the arrangement as revenue for the delivered items as prescribed in EITF 00-21. Fair value is determined based on the price charged when each element is sold separately and/or the price charged by third parties for similar services.
 
Net revenues from services such as customer support and product maintenance are initially deferred and then recognized on a straight-line basis over the term of the contract. Net revenues from services such as installations, equipment repairs, refurbishment arrangements, training, and consulting are recognized as the services are rendered.
 
For software development contracts, the Company recognizes revenue using the completed contract method pursuant to SOP 81-1. During the period of performance of such contracts, billings and costs are accumulated on the balance sheet, but no profit is recorded before completion or substantial completion of the work. The Company uses customers’ acceptance of such products as the specific criteria to determine when such contracts are substantially completed. Provisions for losses on software development contracts are recorded in the period they become evident.
 
For operating lease arrangements, the Company recognizes the revenue ratably over the term of the lease.
 
In addition, the Company sells products to leasing companies that, in turn, lease these products to end-users. In transactions where the leasing companies have no recourse to the Company in the event of default by the end-user, the Company recognizes revenue at the point of shipment or point of delivery, depending on the shipping terms and when all the other revenue recognition criteria have been met. In arrangements where the leasing companies have substantive recourse to the Company in the event of default by the end-user, the Company recognizes both the product revenue and the related cost of the product as the payments are made to the leasing company by the end-user, generally ratably over the lease term.
 
Foreign Currency Translation
 
The assets and liabilities of foreign subsidiaries, where the local currency is the functional currency, are translated from their respective functional currencies into U.S. dollars at the rates in effect at the balance sheet date, with resulting foreign currency translation adjustments recorded as accumulated other comprehensive income in the accompanying condensed consolidated balance sheets. Revenue and expense amounts are translated at average rates during the period.
 
Gains and losses realized from transactions, including intercompany balances not considered to be a permanent investment, denominated in currencies other than an entity’s functional currency are included in other income (expense), net in the accompanying condensed consolidated statements of operations.
 
Concentrations of Credit Risk
 
Cash is placed on deposit in major financial institutions in the United States and other countries. Such deposits may be in excess of insured limits. Management believes that the financial institutions that hold the Company’s cash are financially sound and, accordingly, minimal credit risk exists with respect to these balances.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The Company invests cash not required for use in operations in high credit quality securities based on its investment policy. The investment policy has restrictions based on credit quality, investment concentration, investment type, and maturity that the Company believes will result in reduced risk of loss of capital. Investments are of a short-term nature and include investments in money market funds and corporate debt securities.
 
The Company has not experienced any investment losses due to institutional failure or bankruptcy.
 
The Company’s accounts receivable are derived from sales to a large number of direct customers, resellers, and distributors in the Americas, Europe, and the Asia Pacific region. The Company performs ongoing evaluations of its customers’ financial condition and limits the amount of credit extended when deemed necessary, but generally requires no collateral.
 
An allowance for doubtful accounts is established with respect to those amounts that the Company has determined to be doubtful of collection using specific identification of doubtful accounts and an aging of receivables analysis based on invoice due dates. Actual collection losses may differ from management’s estimates, and such differences could be material to the Company’s consolidated financial position, results of operations, and cash flows. Uncollectible receivables are written off against the allowance for doubtful accounts when all efforts to collect them have been exhausted and recoveries are recognized when they are received. Generally, accounts receivable are past due 30 days after the invoice date unless special payment terms are provided.
 
In the three and nine months ended July 31, 2007, no customer accounted for more than 10% of net revenues. In the three and nine months ended July 31, 2006, First Data Corporation and its affiliates, accounted for 16% and 13%, respectively, of net revenues and no other customer accounted for 10% or more of net revenues in either of such periods. At July 31, 2007, no customer accounted for more than 10% of accounts receivable. At October 31, 2006, First Data Corporation and its affiliates accounted for 13% of accounts receivable and no other customer accounted for 10% or more of accounts receivable at that date.
 
The Company is exposed to credit loss in the event of nonperformance by counterparties to the foreign currency forward contracts used to mitigate the effect of exchange rate changes, the interest rate caps used to mitigate the effect of interest rate changes, and the purchased call option for the Company’s stock related to the senior convertible notes. These counterparties are large international financial institutions and to date, no such counterparty has failed to meet its financial obligations to the Company. The Company does not anticipate nonperformance by these counterparties.
 
Besides those noted above, the Company had no other off-balance-sheet concentrations of credit risk, such as option contracts or other derivative arrangements, as of July 31, 2007 or October 31, 2006.
 
Product Manufacturing
 
The Company outsources a majority of the manufacturing of its products to contract manufacturers with facilities in China, Singapore, and Brazil. The Company also utilizes third-party service providers in the United States, Canada, United Kingdom, Poland, France, Italy, Spain, and Mexico for its equipment repair service. In November 2006, the Company added in-house manufacturing and services capabilities in Israel and Turkey as a result of the Lipman acquisition.
 
Fair Value of Financial Instruments
 
Financial instruments consist principally of cash and cash equivalents, marketable securities, accounts receivable, accounts payable, long-term debt, foreign currency forward contracts, interest rate caps, and the purchased call option with respect to the Company’s own stock. Foreign currency forward contracts and interest rate caps are recorded at fair value. The estimated fair value of cash, accounts receivable, and accounts payable approximates their carrying value due to the short period of time to their maturities. The estimated fair value of long-term debt related to the Term B loan approximates its carrying value since the rate of interest on the long-term


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
debt adjusts to market rates on a periodic basis. The estimated fair value of the senior convertible notes approximates their carrying value due to the short time since issuance. The fair value of cash equivalents, marketable securities, foreign currency forward contracts, interest rate caps, and purchased call options are based on quotes from brokers using market prices for those or similar instruments.
 
Derivative Financial Instruments
 
The Company uses foreign currency forward contracts to hedge certain existing and anticipated foreign currency denominated transactions. The terms of foreign currency forward contracts used are generally consistent with the timing of the foreign currency transactions. Under its foreign currency risk management strategy, the Company utilizes derivative instruments to protect its interests from unanticipated fluctuations in earnings and cash flows caused by volatility in currency exchange rates. This financial exposure is monitored and managed by the Company as an integral part of its overall risk management program which focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results. The Company has entered into interest rate caps in order to manage its variable interest rate risk on its secured credit facility. The Company has also purchased a call option on its own stock in connection with the issuance of its 1.375% Senior Convertible Notes.
 
The Company records certain derivatives, namely foreign currency forward contracts and interest rate caps, on the balance sheet at fair value. Changes in the fair value of derivatives that do not qualify or are not effective as hedges are recognized currently in earnings. The Company does not use derivative financial instruments for speculative or trading purposes, nor does it hold or issue leveraged derivative financial instruments.
 
The Company formally documents relationships between hedging instruments and associated hedged items. This documentation includes: identification of the specific foreign currency asset, liability, or forecasted transaction being hedged; the nature of the risk being hedged; the hedge objective; and the method of assessing hedge effectiveness. Hedge effectiveness is formally assessed, both at hedge inception and on an ongoing basis, to determine whether the derivatives used in hedging transactions are highly effective in offsetting changes in foreign currency denominated assets, liabilities, and anticipated cash flow of hedged items. When an anticipated transaction is no longer likely to occur, the corresponding derivative instrument is ineffective as a hedge, and changes in fair value of the instrument are recognized in net income.
 
The Company’s international sales are generally denominated in currencies other than the U.S. dollar. For sales in currencies other than the U.S. dollar, the volatility of the foreign currency markets represents risk to the Company’s profit margins. The Company defines its exposure as the risk of changes in the functional-currency-equivalent cash flows (generally U.S. dollars) attributable to changes in the related foreign currency exchange rates. From time to time the Company enters into certain foreign currency forward contracts with terms designed to substantially match those of the underlying exposure. The Company does not qualify these foreign currency forward contracts as hedging instruments and, as such, records the changes in the fair value of these derivatives immediately in other income (expense), net in the accompanying condensed consolidated statements of operations. As of July 31, 2007 and October 31, 2006, the Company did not have any outstanding foreign currency forward contracts. On August 1, 2007 the Company entered into foreign currency forward contracts with aggregate notional amounts of $33.2 million to hedge exposures to non-functional currencies. The Company’s foreign currency forward contracts have maturities of 95 days or less.
 
The Company is exposed to interest rate risk related to a portion of its debt, which bears interest based upon the three-month LIBOR rate. On October 31, 2006, the Company’s principal subsidiary, VeriFone, Inc., entered into a credit agreement (the “Credit Facility”) with a syndicate of financial institutions, led by J.P. Morgan Chase Bank, N.A. and Lehman Commercial Paper Inc. The Credit Facility consists of a Term B Loan facility of $500 million and a revolving loan permitting borrowings of up to $40 million. The Term B Loan was drawn down in its entirety on October 31 and November 1, 2006. Through July 31, 2007, the Company had repaid an aggregate of $262.5 million leaving a loan balance of $237.5 million. Under the Credit Facility, the Company is required to fix the interest rate


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
through swaps, rate caps, collars, and similar agreements with respect to at least 30% of the outstanding principal amount of all loans and other indebtedness that have floating interest rates.
 
In May and December 2006, the Company purchased two-year interest rate caps for a total premium of $118,000. The interest rate caps have an initial notional amount of $200 million declining to $150 million after one year under which the Company will receive interest payments if the three-month LIBOR rate exceeds 6.5%. The interest rate caps were purchased to fix the interest rate related to the existing secured credit facility, or any refinancing thereof which is explained in Note 6. The fair value of the interest rate caps as of July 31, 2007 was $6,000 which was recorded in prepaid expenses and other current assets in the condensed consolidated balance sheets, with the related $107,000 unrealized loss recorded as a component of accumulated other comprehensive income, net of a $42,000 tax benefit.
 
For the three and nine months ended July 31, 2006, the Company received payments of $157,000 and $269,000, respectively, as a result of the three-month LIBOR rate on its previous Term B Loan exceeding the cap rate which amounts were recorded as offsets to interest expense in the condensed consolidated statements of operations.
 
Cash and Cash Equivalents
 
Cash and cash equivalents consist of cash, money market funds, and other highly liquid investments with maturities of three months or less when purchased.
 
Marketable Securities
 
The Company classifies its marketable securities as available-for-sale in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting for Certain Investments in Debt and Equity Securities. Available-for-sale securities are carried at fair value, with unrealized holding gains and losses reported in accumulated other comprehensive income, which is a separate component of stockholders’ equity, net of tax, in the accompanying condensed consolidated balance sheets. The amortization of premiums and discounts on the investments and realized gains and losses, determined by specific identification based on the trade date of the transactions, are recorded in interest income in the accompanying condensed consolidated statements of operations.
 
Minority Interest
 
The Company made a minority investment in VeriFone Transportation Systems, Inc. (“VTS”) in October 2005. Prior to the fiscal quarter ended April 30, 2007, the investment in VTS was accounted for under the equity method and was included in other assets in the accompanying condensed consolidated balance sheets. In February 2007, the Company made an additional investment in VTS, which increased its ownership percentage in VTS to 51% at which time the Company began consolidating this investment. As of July 31, 2007, the Company’s equity interest in VTS is 60.1%.
 
During the quarter ended July 31, 2007, the Company acquired the remaining minority interest of its Chinese subsidiary which it acquired in the acquisition of Lipman.
 
Debt Issuance Costs
 
Debt issuance costs are stated at cost, net of accumulated amortization. Amortization expense is calculated using the effective interest method and recorded in interest expense in the accompanying condensed consolidated statements of operations. The Company recorded a $4.8 million write-off of debt issuance costs related to the portion of the Credit Facility which was repaid.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Inventories
 
Inventories are stated at the lower of standard cost or market. Standard costs approximate the first-in, first-out (“FIFO”) method. The Company regularly monitors inventory quantities on hand and records write-downs for excess and obsolete inventories based primarily on the Company’s estimated forecast of product demand and production requirements. Such write-downs establish a new cost-basis of accounting for the related inventory. Actual inventory losses may differ from management’s estimates.
 
Shipping and Handling Costs
 
Shipping and handling costs are expensed as incurred and are included in cost of net revenues in the accompanying condensed consolidated statements of operations. In those instances where the Company bills shipping and handling costs to customers, the amounts billed are classified as revenue.
 
Warranty Costs
 
The Company accrues for estimated warranty obligations when revenue is recognized based on an estimate of future warranty costs for delivered products. Such estimates are based on historical experience and expectations of future costs. The Company periodically evaluates and adjusts the accrued warranty costs to the extent actual warranty costs vary from the original estimates. The Company’s warranty period typically extends from 13 months to five years from the date of shipment. Costs associated with maintenance contracts, including extended warranty contracts, are expensed when they are incurred. Actual warranty costs may differ from management’s estimates.
 
Research and Development Costs
 
Research and development costs are generally expensed as incurred. Costs eligible for capitalization under SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed, were $1.6 million and $4.5 million for the three and nine months ended July 31, 2007, respectively, compared to $0.6 million and $1.7 million for the comparable periods in fiscal 2006. Capitalized software development costs of $12.0 million and $7.5 million as of July 31, 2007 and October 31, 2006, respectively, are being amortized on a straight-line basis over the estimated three-year life of the product to which the costs relate. These costs, net of accumulated amortization of $4.0 million and $3.2 million as of July 31, 2007 and October 31, 2006, respectively, are recorded in other assets in the accompanying condensed consolidated balance sheets.
 
Advertising Costs
 
Advertising costs are expensed as incurred and totaled approximately $306,000 and $854,000 for the three and nine months ended July 31, 2007, respectively, compared to $106,000 and $167,000 for the comparable periods in fiscal 2006, respectively.
 
Income Taxes
 
Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts using enacted tax rates in effect for the year the differences are expected to reverse. The Company records a valuation allowance to reduce deferred tax assets to the amount that is expected to be realized on a more likely than not basis.
 
Comprehensive Income (Loss)
 
Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes certain changes in equity that are excluded from results of operations. Specifically, foreign currency translation adjustments, changes in the fair value of derivatives designated as hedges,


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
and unrealized gains and losses on available-for-sale marketable securities are included in accumulated other comprehensive income in the accompanying condensed consolidated balance sheets.
 
Property, Plant, and Equipment, net
 
Property, plant, and equipment are stated at cost, net of accumulated depreciation and amortization. Property, plant, and equipment are depreciated on a straight-line basis over the estimated useful lives of the assets, generally two to ten years, except buildings which are depreciated over 40 years. The cost of equipment under capital leases is recorded at the lower of the present value of the minimum lease payments or the fair value of the assets and is amortized on a straight-line basis over the shorter of the term of the related lease or the estimated useful life of the asset. Amortization of assets under capital leases is included with depreciation expense.
 
Goodwill and Purchased Intangible Assets
 
Goodwill and purchased intangible assets have been recorded as a result of the Company’s acquisitions. Goodwill is not amortized for accounting purposes. Purchased intangible assets are amortized over their estimated useful lives, generally one and one-half to seven years.
 
The Company is required to perform an annual impairment test of goodwill. Should certain events or indicators of impairment occur between annual impairment tests, the Company would perform the impairment test of goodwill when those events or indicators occurred. In the first step of the analysis, the Company’s assets and liabilities, including existing goodwill and other intangible assets, are assigned to the identified reporting units to determine the carrying value of the reporting units. Based on how the business is managed, the Company has five reporting units. Goodwill is allocated to the reporting unit based on its relative contribution to the Company’s operating results. If the carrying value of a reporting unit is in excess of its fair value, an impairment may exist, and the Company must perform the second step of comparing the implied fair value of the goodwill to its carrying value to determine the impairment charge, if any.
 
The fair value of the reporting units is determined using the income approach. The income approach focuses on the income-producing capability of an asset, measuring the current value of the asset by calculating the present value of its future economic benefits such as cash earnings, cost savings, tax deductions, and proceeds from disposition. Value indications are developed by discounting expected cash flows to their present value at a rate of return that incorporates the risk-free rate for the use of funds, the expected rate of inflation, and risks associated with the particular investment. For the three and nine months ended July 31, 2007, no impairment charges have been recorded.
 
Accounting for Impairment of Long-Lived Assets
 
The Company periodically evaluates whether changes have occurred that would require revision of the remaining useful life of property, plant and equipment and purchased intangible assets or render them not recoverable. If such circumstances arise, the Company uses an estimate of the undiscounted value of expected future operating cash flows to determine whether the long-lived assets are impaired. If the aggregate undiscounted cash flows are less than the carrying amount of the assets, the resulting impairment charge to be recorded is calculated based on the excess of the carrying value of the assets over the fair value of such assets, with the fair value determined based on an estimate of discounted future cash flows. For the three and nine months ended July 31, 2007, no impairment charges have been recorded.
 
Stock-Based Compensation
 
The Company follows the fair value recognition and measurement provisions of SFAS No. 123(R), Share-Based Payment. SFAS No. 123(R) is applicable for stock-based awards exchanged for employee services and in certain circumstances for non-employee directors. Pursuant to SFAS No. 123(R), stock-based compensation


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
cost is measured at the grant date, based on the fair value of the award, and is recognized as expense over the requisite service period.
 
Severance Pay
 
The Company’s liability for severance pay to its Israeli employees is calculated pursuant to Israeli severance pay law based on the most recent salary of the employee multiplied by the number of years of employment of such employee as of the applicable balance sheet date. Employees are entitled to one month’s salary for each year of employment, or a pro-rata portion thereof. The Company funds the liability by monthly deposits in insurance policies and severance pay funds. The expense for the three and nine months ended July 31, 2007 was $430,000 and $1,228,000, respectively.
 
Segment Reporting
 
The Company maintains two reportable segments, North America, consisting of the United States and Canada, and International, consisting of all other countries in which the Company makes sales outside of the United States and Canada.
 
Net Income (Loss) Per Share
 
Basic net income (loss) per common share is computed by dividing income (loss) attributable to common stockholders by the weighted average number of common shares outstanding for the period, less the weighted average number of common shares subject to repurchase. Diluted net income (loss) per common share is computed using the weighted average number of common shares outstanding plus the effect of common stock equivalents, unless the common stock equivalents are anti-dilutive. The potential dilutive shares of the Company’s common stock resulting from the assumed exercise of outstanding stock options and equivalents and the assumed exercise of the warrants relating to the senior convertible notes and the dilutive effect of the senior convertible notes are determined under the treasury stock method.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following table sets forth the computation of basic and diluted net income (loss) per share (in thousands, except per share amounts):
 
                                 
    Three Months Ended
    Nine Months Ended
 
    July 31,     July 31,  
    2007     2006     2007     2006  
    (Restated)           (Restated)        
 
Basic and diluted net income (loss) per share:
                               
Numerator:
                               
Net income (loss)
  $ (42,386 )   $ 16,755     $ (52,883 )   $ 45,585  
                                 
Denominator:
                               
Weighted-average shares of voting common stock outstanding
    83,078       67,956       82,589       67,822  
Less: weighted-average shares subject to repurchase
    (671 )     (1,672 )     (890 )     (1,886 )
                                 
Weighted-average shares used in computing basic net income (loss) per share
    82,407       66,284       81,699       65,936  
Add dilutive securities:
                               
Weighted-average shares subject to repurchase
          1,672             1,886  
Stock options and restricted stock units
          1,123             1,084  
                                 
Weighted-average shares used in computing diluted net income (loss) per share
    82,407       69,079       81,699       68,906  
                                 
Net income (loss) per share:
                               
Basic
  $ (0.51 )   $ 0.25     $ (0.65 )   $ 0.69  
                                 
Diluted
  $ (0.51 )   $ 0.24     $ (0.65 )   $ 0.66  
                                 
 
As of July 31, 2007, options and restricted stock units to purchase 10,423,023 common shares were excluded from the calculation of weighted average shares for diluted net loss per share as they were anti-dilutive. For the three and nine months ended July 31, 2006, options to purchase 2,356,220 and 2,496,220 common shares, respectively, were excluded from the calculation of weighted average shares for diluted net income per share as they were anti-dilutive.
 
The senior convertible notes are considered to be Instrument C securities as defined by Emerging Issues Task Force Issue No. 90-19 (“EITF 90-19”), Convertible Bonds with Issuer Option to Settle for Cash upon Conversion; therefore, only the conversion spread relating to the senior convertible notes is included in the Company’s diluted earnings per share calculation, if dilutive. The potential dilutive shares of the Company’s common stock resulting from the assumed settlement of the conversion spread of the senior convertible notes are determined under the method set forth in EITF 90-19. Under such method, the settlement of the conversion spread of the senior convertible notes has a dilutive effect when the average share price of the Company’s common stock during the period exceeds $44.02. The average share price of the Company’s common stock during the three and nine months ended July 31, 2007 did not exceed $44.02.
 
Warrants to purchase 7.2 million shares of the Company’s common stock were outstanding at July 31, 2007, but were not included in the computation of diluted net income (loss) per share because the warrants’ exercise price was greater than the average market price of the Company’s common stock during the three and nine months ended July 31, 2007; therefore, their effect was anti-dilutive.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Recent Accounting Pronouncements
 
In June 2006, FASB issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109, which clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position. FIN 48 indicates that an enterprise shall initially recognize the financial statement effects of a tax position when it is more likely than not of being sustained on examination, based on the technical merits of the position. In addition, FIN 48 indicates that the measurement of a tax position that meets the more likely than not threshold shall consider the amounts and probabilities of the outcomes that could be realized upon ultimate settlement. This interpretation is effective for fiscal years beginning after December 15, 2006 and interim periods within those fiscal years. The Company is in the process of evaluating the impact of adopting FIN 48 on the Company’s consolidated results of operations, financial position or cash flows.
 
In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”), Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of determining whether the current year’s financial statements are materially misstated. SAB 108 is effective for fiscal years ending after November 15, 2006. The implementation of SAB 108 did not have a material impact on the Company’s consolidated results of operations, financial position or cash flows.
 
In September 2006, FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The implementation of SFAS No. 157 is not expected to have a material impact on the Company’s consolidated results of operations, financial position or cash flows.
 
In February 2007, FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of the guidance is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years, provided the provisions of SFAS No. 157 are applied. The Company is evaluating SFAS No. 159 and has not yet determined the impact, if any, that the adoption will have on the Company’s consolidated financial statements.
 
Note 4.   Business Combination
 
Lipman Electronic Engineering Ltd. (“Lipman”)
 
On November 1, 2006, the Company acquired all of the outstanding common stock of Lipman. The Company acquired Lipman to enhance the Company’s ability to reach certain of its strategic and business objectives, which include (i) extending the Company’s product and service offerings to include Lipman’s products, (ii) enabling the Company to leverage its distribution channels, international presence, customer base, and brand recognition to accelerate Lipman’s market penetration and growth, (iii) enabling the Company to enhance its position in areas where the Company is already strong by offering complementary products and services developed by Lipman, (iv) enhancing its product offerings in a variety of its core product areas, and (v) enhancing the Company’s manufacturing capacity.
 
The consideration paid to acquire Lipman was $347.3 million in cash, 13,462,474 shares of common stock of the Company, and assumption of all outstanding Lipman stock options. To fund a portion of the cash consideration,


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
the Company used $307.2 million of the Term B Loan proceeds under its Credit Facility on November 1, 2006. See Note 6 of Notes to Condensed Consolidated Financial Statements for additional information related to the Credit Facility.
 
The purchase price is as follows (in thousands).
 
         
    (Restated)  
 
Cash
  $ 347,347  
Value of common stock issued
    417,606  
Value of Lipman vested and unvested options assumed
    38,008  
Transaction costs and expenses
    15,964  
         
Sub-total
    818,925  
Less: Value of unvested Lipman options assumed
    (19,356 )
         
Total purchase price
  $ 799,569  
         
 
Pursuant to the proration and allocation provisions of the merger agreement, the total merger consideration consisted of (i) a number of shares of the Company’s common stock equal to the product of 0.50 multiplied by the number of Lipman ordinary shares issued and outstanding on the closing date and (ii) an amount in cash equal to the product of $12.804 multiplied by the number of Lipman ordinary shares issued and outstanding on the closing date, as reduced by the aggregate amount of the special cash dividend paid by Lipman prior to the merger. The Company issued 13,462,474 shares of common stock and paid $344.7 million (excluding the aggregate amount of the special cash dividend). The Company subsequently paid an additional $2.6 million in cash to acquire the remaining minority interest of Lipman’s Chinese subsidiary.
 
The 13,462,474 shares have been valued at $31.02 per share based on an average of the closing prices of the Company’s common stock for a range of trading days two days before April 10, 2006, the announcement date of the proposed merger, the announcement date, and two days after the announcement date.
 
Pursuant to the merger agreement, the Company assumed, generally on a one-for-one basis, all Lipman share options outstanding at closing. The Company assumed options to purchase approximately 3,375,527 shares of Lipman ordinary shares at a weighted average exercise price of $24.47. The fair value of the outstanding vested and unvested options of $38.0 million, was determined using a Black-Scholes valuation model using the following weighted-average assumptions: stock price of $31.02 per share (determined as described above), expected term of 2.5 years, expected volatility of 41%, and risk free interest rate of 4.7%.
 
For accounting purposes the fair value of unvested options as of the closing date is considered unrecognized share-based compensation and is deducted in determining the purchase price. This unrecognized share-based compensation is being recognized as compensation expense on a straight line basis over the estimated remaining service period of 2.8 years. The fair value of the outstanding unvested options of $19.4 million was determined using a Black-Scholes valuation model using the assumptions noted above, except that the stock price on the closing date of $30.00 per share was used, as required, instead of the average price around the announcement date of $31.02 per share. The Company determined the number of unvested options based on the ratio of the number of months of service remaining to be provided by employees as of November 1, 2006 to the total vesting period for the options.
 
Under the purchase method of accounting, the total estimated purchase price as shown in the table above is allocated to Lipman’s tangible and intangible assets acquired and liabilities assumed as well as in-process research and development based on their estimated fair values as of the closing date. The excess of the purchase price over the net tangible and intangible assets is recorded as goodwill. The preliminary allocation of the purchase price is based on preliminary estimates and currently available information.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Based on the preliminary valuation which has not been finalized and other information currently available, the preliminary estimated purchase price is allocated as follows (in thousands):
 
         
    (Restated)  
 
Cash
  $ 95,931  
Accounts receivable
    33,433  
Inventories
    65,765  
Property, plant, and equipment
    18,631  
Other assets
    12,743  
Deferred revenue
    (8,607 )
Other current liabilities
    (89,157 )
Net deferred tax liabilities
    (65,576 )
Non current liabilities
    (9,635 )
         
Net tangible assets
    53,528  
         
Amortizable intangible assets:
       
Developed and core technology
    133,480  
Customer backlog
    50  
Customer relationships
    64,870  
Internal use software
    3,460  
         
Sub-total intangible assets
    201,860  
         
In-process research and development
    6,650  
Excess over fair value of vested options
    1,030  
Goodwill
    536,501  
         
Total preliminary estimated purchase price allocation
  $ 799,569  
         
 
Net Tangible Assets
 
Of the total estimated purchase price, a preliminary estimate of approximately $53.5 million has been allocated to net tangible assets acquired. Except for inventories, property, plant, and equipment, deferred revenue, accrued liabilities, and deferred taxes, the Company has valued net tangible assets at their respective carrying amounts as of November 1, 2006 as the Company believes these amounts approximate their current fair values or the fair values have not yet been determined.
 
The Company has increased Lipman’s historical value of inventories by $13.9 million to adjust inventories to an amount equivalent to the selling price less an appropriate profit margin. The Company reduced Lipman’s historical value of deferred revenue by $3.6 million to adjust deferred revenue to an amount equivalent to the estimated cost plus an appropriate profit margin to perform the services related to Lipman’s service contracts. The Company reduced Lipman’s historical net book value of property, plant, and equipment by $1.4 million to adjust property, plant, and equipment to estimated fair value. As of July 31, 2007, the purchase price allocation is preliminary and is subject to adjustment.
 
The Company has identified and recorded provisions related to certain pre-acquisition contingencies of $21.4 million related to liabilities that are probable and the amount of the liability is reasonably estimable. With respect to certain other identified pre-acquisition contingencies, the Company continues to accumulate information to assess whether or not the related asset, liability, or impairment is probable and the amount of the asset, liability, or


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
impairment can be reasonably estimated and as such accrued in the purchase price allocation prior to the end of the purchase price allocation period.
 
Pursuant to a detailed restructuring plan which is not complete, the Company accrued $6.4 million of costs for severance, costs of vacating facilities, and costs to exit or terminate other duplicative activities in accordance with the requirements of EITF 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination (see Note 7). As the Company finalizes its restructuring plan, additional amounts may be accrued.
 
Certain deferred tax liabilities have been recorded based upon preliminary conclusions regarding the tax positions expected to be taken. Included in the amounts recorded on a preliminary basis is a foreign deferred tax liability of approximately $32.8 million recorded in connection with undistributed pre-acquisition foreign earnings subject to an approved enterprise status in Israel.
 
Intangible Assets
 
Developed and core technology, which comprises products that have reached technological feasibility, includes products in Lipman’s product lines, principally the Nurit product line. Lipman’s technology and products are designed for hardware, software, solutions, and services, serving the point of sale market internationally. This proprietary know-how can be leveraged by the Company to develop new technology and improved products and manufacturing processes. The Company expects to amortize the developed and core technology over estimated lives of 18 months to 7 years.
 
Customer relationships represent the distribution channels through which Lipman sells the majority of its products and services. The Company expects to amortize the fair value of these assets over estimated lives of 4 to 6 years.
 
Internal use software represents the internal use software assets which have been developed internally but have not previously been capitalized. The Company expects to amortize the fair value of these assets over estimated lives of 5 to 7 years.
 
The fair value of intangible assets was based on a preliminary valuation using an income approach, as well as discussions with Lipman management and a review of certain transaction-related documents and forecasts prepared by the Company and Lipman management. The rate utilized to discount net cash flows to their present values is 13%. The discount rate was determined after consideration of the Company’s weighted average cost of capital specific to this transaction.
 
Estimated useful lives for the intangible assets were based on historical experience with technology life cycles, product roadmaps, branding strategy, historical and projected maintenance renewal rates, historical treatment of the Company’s acquisition-related intangible assets, and the Company’s intended future use of the intangible assets.
 
In-Process Research and Development
 
Of the total estimated purchase price, $6.7 million was allocated to in-process research and development and was charged to expense in the nine months ended July 31, 2007. In-process research and development represents incomplete Lipman research and development projects that had not reached technological feasibility and had no alternative future use. Lipman was developing new products that qualify as in-process research and development in multiple product areas. Lipman’s research and development projects were focused on developing new products, integrating new technologies, improving product performance and broadening features and functionalities. The principal research and development efforts of Lipman are related primarily to three products. There is a risk that these developments and enhancements will not be competitive with other products using alternative technologies that offer comparable functionality.
 
The value assigned to in-process research and development was determined by considering the importance of each project to the overall development plan, estimating costs to develop the purchased in-process research and


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
development into commercially viable products, estimating the resulting net cash flows from the projects when completed and discounting the net cash flows to their present value. The revenue estimates used to value the purchased in-process research and development were based on estimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by Lipman and its competitors.
 
The rates utilized to discount the net cash flows to their present value were based on the Company’s weighted average cost of capital. The weighted average cost of capital was adjusted to reflect the difficulties and uncertainties in completing each project and thereby achieving technological feasibility, the percentage of completion of each project, anticipated market acceptance, and penetration, market growth rates, and risks related to the impact of potential changes in future target markets. Based on these factors, a discount rate of 19% was deemed appropriate for valuing the in-process research and development.
 
Excess Over Fair Value of Vested Options
 
The Company assumed Lipman options to purchase shares based generally on a one-for-one exchange ratio, which differed from the all-stock exchange ratio of 0.9336 (the all stock consideration exchange ratio of 0.9844 as reduced by the per share value of the $1.50 per share special cash dividend) for Lipman ordinary shares. As a result, the Company recognized $1.0 million of share-based compensation for the excess fair value of vested options in the nine months ended July 31, 2007.
 
Goodwill
 
Of the total purchase price, approximately $536.5 million is estimated to be allocated to goodwill. Goodwill represents the excess of the purchase price of an acquired business over the fair value of the underlying net tangible and intangible assets, in-process research and development and excess of fair value of vested options. Goodwill arose because of Lipman’s ability to help the Company reach certain of its strategic and business objectives. Goodwill will not be amortized but instead will be tested for impairment at least annually (more frequently if certain indicators are present). In the event that the management of the combined company determines that the value of goodwill has become impaired, the combined company will incur an accounting charge for the amount of impairment during the fiscal quarter in which the determination is made. The goodwill has been allocated $530.0 million to the International segment and $6.5 million to the North America segment. Most of the goodwill is expected to be deductible for income tax purposes.
 
The results of operations of Lipman are included in the Company’s consolidated financial statements from November 2006. The following table presents pro forma results of operations and gives effect to the acquisition of Lipman as if the acquisition had been consummated at the beginning of fiscal year 2006. The unaudited pro forma results of operations are not necessarily indicative of what would have occurred had the acquisition been made as of the beginning of the period or of the results that may occur in the future. Net income includes the write-off of acquired in-process research and development of zero and $6.7 million, additional interest expense of $5.1 million and $17.3 million, deferred revenue step down of $0.7 million and $3.1 million, fair value step up of inventory of zero and $13.9 million, stock-based compensation for the excess fair value on vested options of zero and


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
$1.0 million, and amortization of intangible assets related to the acquisition of $12.1 million and $36.3 million for the three and nine months ended July 31, 2006, respectively. The unaudited pro forma information is as follows:
 
                 
    Three Months Ended
    Nine Months Ended
 
    July 31, 2006     July 31, 2006  
    (Restated)  
    (In millions, except per share amounts)  
 
Total net revenues
  $ 209.7     $ 610.5  
Net income
  $ 8.8     $ 14.2  
Net income per share — basic
  $ 0.11     $ 0.18  
Net income per share — diluted
  $ 0.11     $ 0.17  
 
The pro forma amounts above were compiled using the three and nine month periods ended June 30, 2006 for Lipman and the three and nine month periods ended July 31, 2006 for VeriFone.
 
PayWare
 
On September 1, 2006, the Company acquired PayWare, the payment systems business of Trintech Group PLC, for approximately $10.7 million, comprised of $9.6 million in cash consideration and $1.1 million transaction costs. The cash consideration includes $2.0 million which has been placed in an escrow account pending resolution of certain items. The Company acquired PayWare to broaden the Company’s EMEA presence at the point of sale beyond its core solutions. The Company’s consolidated financial statements include the operating results of the business acquired from the date of acquisition.
 
The total estimated purchase price of $10.7 million was allocated as follows: $11.9 million to goodwill (not deductible for income tax purposes); $7.7 million to intangible assets, comprised of developed technology of $3.0 million, backlog of $1.4 million, and customer relationships of $3.3 million; and $8.9 million to net tangible liabilities assumed. The estimated useful economic lives of the identifiable intangible assets acquired are 3 to 5 years for the developed technology, one year for backlog, and 4 to 6 years for the customer relationship. The weighted average amortization period for developed technology and customer relationships was 3.7 years. As of July 31, 2007, the purchase price allocation is preliminary and subject to adjustment for any pre-acquisition contingencies. Pro forma financial information is not provided as PayWare’s results of operations are not material to the Company’s results of operations.
 
VeriFone Transportation Systems, Inc.
 
In February 2007, the Company made an additional investment in VeriFone Transportation Systems, Inc. (“VTS”) to increase its ownership percentage to 51%. The total purchase price of $5 million was allocated to the net assets of VTS. In May 2007, the Company made an additional investment of $5.0 million in VTS to increase its ownership percentage from 51.0% to 63.2%. In addition, the Company provided VTS with a working capital loan of $1.0 million. In July 2007, VTS issued capital stock to a third party reducing the Company’s equity interest in VTS from 63.2% to 60.1%. As of July 31, 2007, the purchase price allocation is preliminary and is subject to adjustments for the fair value of purchased intangibles. Pro forma financial information is not provided as VTS’ results of operations are not material to the company’s results of operations.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Note 5.   Balance Sheet and Statements of Operations Detail
 
Inventories
 
Inventories consisted of the following (in thousands):
 
                 
    July 31,
    October 31,
 
    2007     2006  
    (Restated)        
 
Raw materials
  $ 23,916     $ 4,095  
Work-in-process
    4,160       808  
Finished goods
    76,708       81,728  
                 
    $ 104,784     $ 86,631  
                 
 
Prepaid Expenses and Other Current Assets
 
Prepaid expenses and other current assets consisted of the following (in thousands):
 
                 
    July 31,
    October 31,
 
    2007     2006  
    (Restated)        
 
Prepaid taxes
  $ 6,781     $ 5,241  
Prepaid expenses
    14,924       3,208  
Other receivables
    7,161       750  
Other current assets
    572       3,744  
                 
    $ 29,438     $ 12,943  
                 
 
Property, Plant, and Equipment, net
 
Property, plant, and equipment, net consisted of the following (in thousands):
 
                 
    July 31,
    October 31,
 
    2007     2006  
    (Restated)        
 
Computer hardware and software
  $ 11,809     $ 7,049  
Office equipment, furniture, and fixtures
    4,444       3,972  
Machinery and equipment
    9,824       5,602  
Leasehold improvements
    6,920       3,897  
Construction in progress
    14,726       966  
Land
    1,633        
Buildings
    5,206        
                 
Total
    54,562       21,486  
Accumulated depreciation and amortization
    (14,272 )     (14,186 )
                 
Property, plant, and equipment, net
  $ 40,290     $ 7,300  
                 
 
The increase in construction in progress during the nine months ended July 31, 2007 was $13.8 million. This increase was primarily attributable to the Company’s migration to a new enterprise resource planning information system, which will replace certain of its existing systems in fiscal 2008. At each of July 31, 2007 and October 31, 2006, equipment amounting to $1.3 million was capitalized under capital leases. Related accumulated amortization as of July 31, 2007 and October 31, 2006 amounted to $1.3 million and $1.2 million, respectively.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Purchased Intangible Assets, net
 
Purchased intangible assets subject to amortization consisted of the following (in thousands):
 
                                                 
    July 31, 2007     October 31, 2006  
    Gross
                Gross
             
    Carrying
    Accumulated
          Carrying
    Accumulated
       
    Amount     Amortization     Net     Amount     Amortization     Net  
          (Restated)                          
 
Developed technology
  $ 170,607     $ (55,109 )   $ 115,498     $ 35,164     $ (28,616 )   $ 6,548  
Core technology
    14,442       (14,442 )           14,442       (12,517 )     1,925  
Trade name
    22,225       (22,225 )           22,225       (19,942 )     2,283  
Internal use software
    4,288       (647 )     3,641                    
Customer relationships
    88,230       (26,973 )     61,257       19,314       (13,526 )     5,788  
                                                 
    $ 299,792     $ (119,396 )   $ 180,396     $ 91,145     $ (74,601 )   $ 16,544  
                                                 
 
Amortization of purchased intangibles was allocated as follows (in thousands):
 
                                 
    Three Months Ended
    Nine Months Ended
 
    July 31,     July 31,  
    2007     2006     2007     2006  
    (Restated)           (Restated)        
 
Included in cost of net revenues
  $ 9,278     $ 1,071     $ 28,474     $ 4,083  
Included in operating expenses
    5,416       1,159       16,456       3,477  
                                 
    $ 14,694     $ 2,230     $ 44,930     $ 7,560  
                                 
 
Estimated future amortization expense of intangible assets recorded as of July 31, 2007 was as follows (in thousands):
 
                         
    Cost of
    Operating
       
Fiscal Year
  Revenues     Expenses     Total  
          (Restated)        
 
2007 (remaining three months)
  $ 9,819     $ 3,653     $ 13,472  
2008
    31,917       25,125       57,042  
2009
    31,173       20,180       51,353  
2010
    24,311       11,808       36,119  
Thereafter
    18,278       4,132       22,410  
                         
    $ 115,498     $ 64,898     $ 180,396  
                         


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Goodwill
 
Activity related to goodwill consisted of the following (in thousands):
 
                 
    July 31,
    October 31,
 
    2007     2006  
    (Restated)        
 
Balance, beginning of year
  $ 52,689     $ 47,260  
Additions related to acquisitions
    545,417       6,352  
Resolution of tax contingencies and adjustments to tax reserves and valuation allowances established in purchase accounting
    (3,262 )     (923 )
Currency translation adjustments
    15,507        
                 
Balance, end of period
  $ 610,351     $ 52,689  
                 
 
Warranty
 
Activity related to warranty consisted of the following (in thousands):
 
                 
    July 31,
    October 31,
 
    2007     2006  
 
Balance, beginning of year
  $ 5,432     $ 5,243  
Warranty charged to cost of net revenues
    2,412       3,311  
Utilization of warranty
    (5,530 )     (3,815 )
Changes in estimates
    483       693  
Warranty assumed in acquisitions
    7,731        
                 
Balance, end of period
    10,528       5,432  
Less current portion
    (10,102 )     (4,902 )
                 
Long-term portion
  $ 426     $ 530  
                 
 
Deferred Revenue, net
 
Deferred revenue, net consisted of the following (in thousands):
 
                 
    July 31,
    October 31,
 
    2007     2006  
    (Restated)        
 
Deferred revenue
  $ 53,431     $ 34,309  
Less long-term portion
    (10,310 )     (7,371 )
                 
      43,121       26,938  
Deferred cost of revenue
    (3,569 )     (3,371 )
                 
Current portion, net
  $ 39,552     $ 23,567  
                 


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Other Current Liabilities
 
Other current liabilities consisted of the following (in thousands):
 
                 
    July 31,
    October 31,
 
    2007     2006  
 
Taxes payable (excluding income tax)
  $ 31,999     $ 1,990  
Other accounts payable
    13,758       7,511  
Accrued audit and legal fees
    5,221       3,135  
Interest payable
    482       5  
Other liabilities
    19,758       1,020  
                 
    $ 71,218     $ 13,661  
                 
 
Other Income (Expense), net
 
Other income (expense), net consisted of the following (in thousands):
 
                                 
    Three Months
    Nine Months
 
    Ended
    Ended
 
    July 31,     July 31,  
    2007     2006     2007     2006  
    (Restated)           (Restated)        
 
Refund of foreign customs fees
  $     $     $     $ 288  
Foreign currency transaction gains, net
    1,213       137       3,106       309  
Foreign currency contract losses, net
    (914 )     (354 )     (2,929 )     (543 )
Loss on debt extinguishment
    (4,764 )           (4,764 )      
Other, net
    309       22       168       17  
                                 
    $ (4,156 )   $ (195 )   $ (4,419 )   $ 71  
                                 
 
Note 6.   Financing
 
The Company’s financing consisted of the following (in thousands):
 
                 
    July 31,
    October 31,
 
    2007     2006  
 
Secured credit facility:
               
Revolver
  $     $  
Term B loan
    237,500       192,780  
1.375% Senior convertible notes
    316,250        
Capital leases and other
    623       109  
                 
      554,373       192,889  
Less current portion
    (5,367 )     (1,985 )
                 
Long-term portion
  $ 549,006     $ 190,904  
                 
 
Secured Credit Facility
 
On October 31, 2006, the Company’s principal subsidiary, VeriFone, Inc. (the “Borrower”), entered into a credit agreement consisting of a Term B Loan facility of $500 million and a revolving loan permitting borrowings of up to $40 million (the “Credit Facility”). The proceeds from the Term B loan were used to repay all outstanding


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
amounts relating to an existing senior secured credit agreement, pay certain transaction costs and partially fund the cash consideration in connection with the acquisition of Lipman on November 1, 2006. The Term B Loan was drawn down in its entirety on October 31 and November 1, 2006. Through July 31, 2007, the Company repaid an aggregate of $262.5 million, leaving a Term B Loan balance of $237.5 million at July 31, 2007.
 
The Credit Facility is guaranteed by the Company and certain of its subsidiaries and is secured by collateral including substantially all of the Company’s assets and stock of the Company’s subsidiaries. At July 31, 2007 and October 31, 2006, the interest rates were 7.11% and 7.12% on the Term B Loan and 6.61% and 6.87% on the revolving loan, respectively. The Company pays a commitment fee on the unused portion of the revolving loan under its Credit Facility at a rate that varies between 0.375% and 0.30% per annum depending upon its consolidated total leverage ratio. At July 31, 2007 and October 31, 2006, the Company was paying a commitment fee at a rate of 0.30% and 0.375% per annum, respectively. The Company pays a letter of credit fee on the unused portion of any letter of credit issued under the Credit Facility at a rate that varies between 1.50% and 1.25% per annum depending upon its consolidated total leverage ratio. At July 31, 2007 and October 31, 2006, the Company was subject to a letter of credit fee at a rate of 1.25% and 1.50% per annum, respectively.
 
As of July 31, 2007, at the Company’s option, the revolving loan bears interest at a rate of 1.25% over the three-month LIBOR, which was 5.36%, or 0.25% over the lender’s base rate, which was 8.25%. As of October 31, 2006, at the Company’s option, the revolving loan bore interest at a rate of 1.50% over the three-month LIBOR, which was 5.37%, or 0.50% over the lender’s base rate, which was 8.25%. As of July 31, 2007, the entire $40 million revolving loan was available for borrowing to meet short-term working capital requirements. At the Company’s option, the Term B Loan bears interest at a rate of 1.75% over the three-month LIBOR or 0.75% over the base rate.
 
Interest payments are generally paid quarterly but can be based on one, two, three, or six-month periods. The lender’s base rate is the greater of the Federal Funds rate plus 50 basis points or the JPMorgan prime rate. The respective maturity dates on the components of the Credit Facility are October 31, 2012 for the revolving loan and October 31, 2013 for the Term B Loan. Payments on the Term B Loan are due in equal quarterly installments of $1.2 million over the seven-year term on the last business day of each calendar quarter with the balance due on maturity.
 
The terms of the Credit Facility require the Company to comply with financial covenants, including maintaining leverage and fixed charge coverage ratios at the end of each fiscal quarter, obtaining protection against fluctuation in interest rates, and limits on annual capital expenditure levels. As of July 31, 2007, the Company was required to maintain a total leverage ratio of not greater than 4.0 to 1.0 and a fixed charge coverage ratio of at least 2.0 to 1.0. Total leverage ratio is equal to total debt less cash as of the end of a reporting fiscal quarter divided by the consolidated EBITDA for the most recent four consecutive fiscal quarters. Some of the financial covenants become more restrictive over the term of the Credit Facility. Noncompliance with any of the financial covenants without cure or waiver would constitute an event of default under the Credit Facility. An event of default resulting from a breach of a financial covenant may result, at the option of lenders holding a majority of the loans, in an acceleration of repayment of the principal and interest outstanding and a termination of the revolving loan. The Credit Facility also contains non-financial covenants that restrict some of the Company’s activities, including its ability to dispose of assets, incur additional debt, pay dividends, create liens, make investments, make capital expenditures and engage in specified transactions with affiliates. The terms of the Credit Facility permit prepayments of principal and require prepayments of principal upon the occurrence of certain events including, among others, the receipt of proceeds from the sale of assets, the receipt of excess cash flow as defined, and the receipt of proceeds of certain debt issues. The Credit Facility also contains customary events of default, including defaults based on events of bankruptcy and insolvency; nonpayment of principal, interest, or fees when due, subject to specified grace periods; breach of specified covenants; change in control and material inaccuracy of representations and warranties. The Company was in compliance with its financial and non-financial covenants as of July 31, 2007.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
1.375% Senior Convertible Notes
 
On June 22, 2007, the Company sold $316.2 million aggregate principal amount of 1.375% Senior Convertible Notes due 2012 (the “Notes”) in an offering through Lehman Brothers Inc. and JP Morgan Securities Inc. (together “initial purchasers”) to qualified institutional buyers pursuant to Section 4(2) and Rule 144A under the Securities Act. The net proceeds from the offering, after deducting transaction costs, were approximately $307.9 million. The Company incurred approximately $8.3 million of debt issuance costs. The transaction costs, consisting of the initial purchasers’ discounts and offering expenses, were primarily recorded in debt issuance costs, net and are being amortized to interest expense using the effective interest method over five years. The Company will pay 1.375% interest per annum on the principal amount of the Notes, payable semi-annually in arrears in cash on June 15 and December 15 of each year, commencing on December 15, 2007, subject to increase in certain circumstances as described below.
 
The Notes were issued under an Indenture between the Company and U.S. Bank National Association, as trustee. Each $1,000 of principal of the Notes will initially be convertible into 22.719 shares of VeriFone common stock, which is equivalent to a conversion price of approximately $44.02 per share, subject to adjustment upon the occurrence of specified events. Holders of the Notes may convert their Notes prior to maturity during specified periods as follows: (1) on any date during any fiscal quarter beginning after October 31, 2007 (and only during such fiscal quarter) if the closing sale price of the Company’s common stock was more than 130% of the then current conversion price for at least 20 trading days in the period of the 30 consecutive trading days ending on the last trading day of the previous fiscal quarter; (2) at any time on or after March 15, 2012; (3) if the Company distributes, to all holders of its common stock, rights or warrants (other than pursuant to a rights plan) entitling them to purchase, for a period of 45 calendar days or less, shares of the Company’s common stock at a price less than the average closing sale price for the ten trading days preceding the declaration date for such distribution; (4) if the Company distributes, to all holders of its common stock, cash or other assets, debt securities or rights to purchase the Company’s securities (other than pursuant to a rights plan), which distribution has a per share value exceeding 10% of the closing sale price of the Company’s common stock on the trading day preceding the declaration date for such distribution; (5) during a specified period if certain types of fundamental changes occur; or (6) during the five business-day period following any five consecutive trading-day period in which the trading price for the Notes was less than 98% of the average of the closing sale price of the Company’s common stock for each day during such five trading-day period multiplied by the then current conversion rate. Upon conversion, the Company would pay the holder the cash value of the applicable number of shares of VeriFone common stock, up to the principal amount of the note. Amounts in excess of the principal amount, if any, will be paid in stock. Unless and until the Company obtains stockholder approval to amend its certificate of incorporation to increase its authorized capital, the maximum number of shares available for issuance upon conversion of each $1,000 principal amount of Notes will be the pro rata portion of an aggregate of 3,250,000 shares allocable to such Note, which equates to 10.2766 shares per $1,000 principal amount of Notes. Because the Company did not increase its authorized capital to permit conversion of all of the Notes at the initial conversion rate by June 21, 2008, beginning on June 21, 2008 the Notes began to bear additional interest at a rate of 2.0% per annum (in addition to the additional interest described below) on the principal amount of the Notes, which will increase by 0.25% per annum on each anniversary thereafter if the authorized capital has not been increased. If stockholder approval to increase the Company’s authorized capital is received, such additional interest will cease to accrue.
 
As of July 31, 2007, none of the conditions allowing holders of the Senior Notes to convert had been met. If a fundamental change, as defined in the Indenture, occurs prior to the maturity date, holders of the Notes may require the Company to repurchase all or a portion of their Notes for cash at a repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus any accrued and unpaid interest (including additional interest, if any) to, but excluding, the repurchase date.
 
The Notes are senior unsecured obligations and rank equal in right of payment with all of the Company’s existing and future senior unsecured indebtedness. The Notes are effectively subordinated to any secured


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
indebtedness to the extent of the value of the related collateral and structurally subordinated to indebtedness and other liabilities of the Company’s subsidiaries including any secured indebtedness of such subsidiaries.
 
In connection with the sale of the Notes, the Company entered into a registration rights agreement, dated as of June 22, 2007, with the initial purchasers of the Notes (the “Registration Rights Agreement”). Under the Registration Rights Agreement, the Company has agreed (1) to use reasonable best efforts to cause a shelf registration statement covering resales of the Notes and the shares of common stock issuable upon conversion of the Notes to be declared effective by December 19, 2007 or to cause an existing shelf registration statement to be made available within 180 days after the original issuance of the Notes and (2) to use its reasonable best efforts to keep effective the shelf registration statement until the earliest of (i) the date when the holders of transfer-restricted Notes and shares of common stock issued upon conversion of the Notes are able to sell all such securities immediately without restriction under Rule 144(k) under the Securities Act of 1933, as amended (the “Securities Act”), (ii) the date when all transfer-restricted Notes and shares of common stock issued upon conversion of the Notes are registered under the registration statement and sold pursuant thereto and (iii) the date when all transfer-restricted Notes and shares of common stock issued upon conversion of the Notes have ceased to be outstanding. If the Company fails to meet these terms, it will be required to pay additional interest on the Notes at a rate of 0.25% per annum for the first 90 days and at a rate of 0.50% per annum thereafter.
 
Due to the delay in the filing of the 2007 Annual Report on Form 10-K, the Company has not yet been able to register the Notes and the shares underlying the Notes. Accordingly, the interest rate on the Notes increased by 0.25% per annum on December 20, 2007 and by an additional 0.25% per annum on March 19, 2008 relating to the Company’s obligations under the Registration Rights Agreement. Once a registration statement covering the Notes and shares underlying the Notes is declared effective, such additional interest will cease to accrue.
 
In addition, the interest rate on the Notes increased an additional 0.25% per annum on May 1, 2008 (in addition to the additional interest described above) because the Company failed to file and deliver the 2007 Annual Report. Such additional 0.25% interest will cease to accrue upon the filing of the 2007 Annual Report.
 
In connection with the offering of the Notes, the Company entered into note hedge transactions with affiliates of the initial purchasers (the “counterparties”) whereby the Company has the option to purchase up to 7,184,884 shares of its common stock at a price of approximately $44.02 per share. The cost to the Company of the note hedge transactions was approximately $80.2 million. The note hedge transactions are intended to mitigate the potential dilution upon conversion of the Notes in the event that the volume weighted average price of the Company’s common stock on each trading day of the relevant conversion period or other relevant valuation period is greater than the applicable strike price of the convertible note hedge transactions, which initially corresponds to the conversion price of the Notes and is subject, with certain exceptions, to the adjustments applicable to the conversion price of the Notes.
 
In addition, the Company sold warrants to the counterparties whereby they have the option to purchase up to approximately 7.2 million shares of VeriFone common stock at a price of $62.356 per share, which price may reset, if higher, to a 70% premium over the market price of the Company’s common stock determined approximately six months after the original issue date of the warrants. The Company received approximately $31.2 million in cash proceeds from the sale of these warrants. If the volume weighted average price of the Company’s common stock on each trading day of the measurement period at maturity of the warrants exceeds the applicable strike price of the warrants, there would be dilution to the extent that such volume weighted average price of the Company’s common stock exceeds the applicable strike price of the warrants. Unless and until the Company obtains stockholder approval to amend its certificate of incorporation to increase its authorized capital, the maximum number of shares issuable upon exercise of the warrants will be 1,000,000 shares of the Company’s common stock. If the Company does not obtain stockholder approval to amend its certificate of incorporation to increase its authorized capital by the date of the second annual meeting of the Company’s stockholders after the date of the pricing of the Notes, the number of shares of the Company’s common stock underlying the warrants will increase by 10%, and the warrants will be subject to early termination by the counterparties.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The cost incurred in connection with the note hedge transactions, net of the related tax benefit and the proceeds from the sale of the warrants, totaled $17.8 million and is included as a net reduction in additional paid-in capital in the accompanying condensed consolidated balance sheets as of July 31, 2007, in accordance with the guidance in Emerging Issues Task Force Issue No. 00-19 (“EITF 00-19”), Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.
 
In accordance with SFAS No. 128, Earnings per Share, the Notes will have no impact on diluted earnings per share, or EPS, until the price of the Company’s common stock exceeds the conversion price of $44.02 per share because the principal amount of the Notes will be settled in cash upon conversion. Prior to conversion the Company will include the effect of the additional shares that may be issued if its common stock price exceeds $44.02 per share using the treasury stock method. If the price of the Company’s common stock exceeds $62.356 per share, it will also include the effect of the additional potential shares that may be issued related to the warrants using the treasury stock method. Prior to conversion, the note hedge transactions are not considered for purposes of the EPS calculation as their effect would be anti-dilutive.
 
Note 7.   Restructuring Charges
 
Fiscal Year 2002 Restructuring Plan
 
In connection with the acquisition of VeriFone, Inc. by the Company on July 1, 2002, the Company assumed the liability for a restructuring plan (fiscal 2002 restructuring plan). The remaining accrued restructuring balance represents primarily future facilities lease obligations, net of estimated future sublease income, which are expected to be paid through the end of 2009. The payment of the restructuring costs for the International segment was zero and $8,000 for the nine months ended July 31, 2007 and 2006, respectively. The Company paid restructuring costs of $182,000 and $533,000 for the nine months ended July 31, 2007 and 2006, respectively, in the North America segment. As of July 31, 2007, the Company had a liability of $48,000 and $15,000 for the North America segment and International segment, respectively.
 
Activities related to the fiscal 2002 restructuring plan are as follows (in thousands):
 
                                         
                      Short-Term
    Long-Term
 
    Facilities     Other     Total     Portion     Portion  
    (Restated)  
 
Balance at October 31, 2006
  $ 486     $ 60     $ 546     $ 503     $ 43  
Additions
    10             10       10        
Reductions
    (266 )     (49 )     (315 )     (300 )     (15 )
Cash payments
    (182 )           (182 )     (182 )      
Foreign exchange impact
          4       4       4        
                                         
Balance at July 31, 2007
  $ 48     $ 15     $ 63     $ 35     $ 28  
                                         
 
                                         
                      Short-Term
    Long-Term
 
    Facilities     Other     Total     Portion     Portion  
 
Balance at October 31, 2005
  $ 1,200     $ 60     $ 1,260     $ 765     $ 495  
Additions (reductions)
          8       8       455       (447 )
Cash payments
    (533 )     (8 )     (541 )     (541 )      
                                         
Balance at July 31, 2006
  $ 667     $ 60     $ 727     $ 679     $ 48  
                                         
 
GO Software Restructuring Plan
 
In connection with the acquisition of the assets of the GO Software business from Return on Investment Corporation on March 1, 2005, the Company accrued in the purchase price allocation $313,000 of restructuring


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
costs related to the integration of GO Software’s Savannah helpdesk facility with the Company’s helpdesk facility in Clearwater, Florida. Payments against this liability of $269,000 were made as of October 31, 2006. The restructuring activities have been completed and the Company reversed the remaining accrual balance of $44,000 in the quarter ended July 31, 2007.
 
Fiscal Year 2006 Restructuring Plan
 
In the first quarter of fiscal 2006, the Company implemented a restructuring plan that established Singapore supply chain operations to leverage a favorable tax environment and manufacturing operations in the Asia Pacific region (fiscal 2006 restructuring plan). During the year ended October 31, 2006, the Company accrued and paid $591,000 and $583,000, respectively, in restructuring costs leaving a liability of $8,000 in the North America segment. During the six months ended April 30, 2007, the Company reversed the remaining reserve of $8,000. No activity was recorded in the three months ended July 31, 2007 as the restructuring activities have been completed.
 
Activities related to the fiscal 2006 restructuring plan are as follows (in thousands):
 
                         
          Short-Term
    Long-Term
 
    Severance     Portion     Portion  
          (Restated)        
 
Balance at October 31, 2006
  $ 8     $ 8     $  
Reductions
    (8 )     (8 )      
Cash payments
                 
                         
Balance at July 31, 2007
  $     $     $  
                         
 
                         
          Short-Term
    Long-Term
 
    Severance     Portion     Portion  
 
Balance at October 31, 2005
  $     $     $  
Additions
    599       599        
Cash payments
    (575 )     (575 )      
                         
Balance at July 31, 2006
  $ 24     $ 24     $  
                         
 
PayWare Restructuring Plan
 
In the fourth quarter of fiscal 2006, the Company completed the acquisition of PayWare, the payment system business of Trintech Group PLC. The Company developed a restructuring plan and accrued restructuring costs related to a workforce reduction and future facilities lease obligations which were included in the purchase price allocation of PayWare. During the fourth quarter of fiscal 2006, the company accrued and paid $2.9 million and $0.5 million, respectively, for the International segment. As of October 31, 2006, the Company had a remaining liability of $2.4 million. During the nine months ended July 31, 2007, the Company accrued and paid $1.1 million and $2.5 million, respectively, for the International segment. As of July 31, 2007, the Company had a liability of $1.0 million for the International segment.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Activities related to the PayWare acquisition restructuring plan are as follows (in thousands):
 
                                                 
                            Short-Term
    Long-Term
 
    Severance     Facilities     Other     Total     Portion     Portion  
    (Restated)  
 
Balance at October 31, 2006
  $ 1,234     $ 1,098     $ 76     $ 2,408     $ 2,408     $  
Additions
    663       357       105       1,125       1,125        
Cash payments
    (1,846 )     (497 )     (181 )     (2,524 )     (2,524 )      
                                                 
Balance at July 31, 2007
  $ 51     $ 958     $     $ 1,009     $ 1,009     $  
                                                 
 
Fiscal Year 2007 Restructuring Plan
 
In the nine months ended July 31, 2007, the Company implemented a restructuring plan that included reductions in workforce of employees in the United States, China, Hong Kong, Mexico, and the Philippines. The Company incurred and paid restructuring costs of $727,000 and $615,000, respectively, for the North America segment for the nine months ended July 31, 2007. For the nine months ended July 31, 2007, the Company incurred and paid restructuring costs of $95,000 and $94,000, respectively, for the International segment. As of July 31, 2007, the Company had a liability of $112,000 and $1,000 for the North American segment and International segment, respectively.
 
Activities related to the fiscal 2007 restructuring plan are as follows (in thousands):
 
                                                 
                            Short-Term
    Long-Term
 
    Severance     Facilities     Other     Total     Portion     Portion  
    (Restated)  
 
Balance at October 31, 2006
  $     $     $     $     $     $  
Additions
    808       10       4       822       822        
Cash payments
    (696 )     (10 )     (3 )     (709 )     (709 )      
Foreign exchange impact
                                       
                                                 
Balance at July 31, 2007
  $ 112     $     $ 1     $ 113     $ 113     $  
                                                 
 
Lipman Restructuring Plan
 
In the first quarter of fiscal 2007, the Company completed the acquisition of Lipman and began formulating a restructuring plan which is expected to be completed by the end of the fiscal year. For those portions of the plan completed during the nine months ended July 31, 2007, the Company accrued into the purchase price allocation restructuring costs related to reduction in workforce and future facilities lease obligation. For the nine months ended July 31, 2007, the Company incurred and paid restructuring costs of $4.4 million, for the International segment. For the nine months ended July 31, 2007, the Company incurred and paid restructuring costs of $0.5 million for the North America segment. As of July 31, 2007, the Company had a liability of $1.5 million for the International segment.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Activities related to the Lipman acquisition restructuring plan are as follows (in thousands):
 
                                                 
                            Short-Term
    Long-Term
 
    Severance     Facilities     Other     Total     Portion     Portion  
    (Restated)  
 
Balance at October 31, 2006
  $     $     $     $     $     $  
Additions
    3,394       3,030             6,424       3,929       2,495  
Cash payments
    (1,979 )     (2,952 )           (4,931 )     (2,436 )     (2,495 )
Foreign exchange impact
    14       (3 )           11       11        
                                                 
Balance at July 31, 2007
  $ 1,429     $ 75     $     $ 1,504     $ 1,504     $  
                                                 
 
All Restructuring Plans
 
As of July 31, 2007 and October 31, 2006, $2.7 million and $3.0 million, respectively, of the restructuring liability was included in other current liabilities and $28,000 and $43,000, respectively, was included in other long-term liabilities in the accompanying condensed consolidated balance sheets.
 
Note 8.   Commitments and Contingencies
 
The Company leases certain real and personal property under non-cancelable operating leases. Additionally, the Company subleases certain real property to third parties. Future minimum lease payments and sublease rental income under these leases as of July 31, 2007 were as follows (in thousands):
 
                         
    Minimum Lease
    Sublease Rental
    Net Minimum
 
    Payments     Income     Lease Payments  
 
Fiscal Year
                       
Remainder of 2007
  $ 2,676     $ 34     $ 2,642  
2008
    9,500       137       9,363  
2009
    7,292       89       7,203  
2010
    6,612       4       6,608  
2011
    5,374             5,374  
Thereafter
    15,834             15,834  
                         
    $ 47,288     $ 264     $ 47,024  
                         
 
Certain leases require the Company to pay property taxes, insurance, and routine maintenance, and include rent escalation clauses and options to extend the term of certain leases. Rent expense was approximately $4.4 million and $10.5 million for the three and nine months ended July 31, 2007, respectively, compared to $2.3 million and $6.7 million for the comparable periods in fiscal 2006. Sublease rental income was approximately $45,000 and $168,000 for the three and nine months ended July 31, 2007, respectively, compared to $73,000 and $217,000 for the comparable periods in fiscal 2006.
 
Manufacturing Agreements
 
The Company works on a purchase order basis with third-party contract manufacturers and component suppliers with facilities in China, Singapore, and Brazil to manufacture a majority of the Company’s inventories. The Company issues a forecast to the third-party contract manufacturers and subsequently agrees to a build schedule to drive component material purchases and capacity planning. In conjunction with this, the Company issues a combination of purchase order and written direction to drive manufacturing activity for finished goods product. The Company provides each manufacturer with a purchase order on a monthly basis to cover the following month’s manufacturing requirements, which constitutes a binding commitment by the Company to purchase


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
materials produced by the manufacturer as specified in the purchase order. The total amount of purchase commitments as of July 31, 2007 and October 31, 2006 was approximately $43.0 million and $17.9 million, respectively, and are generally paid within one year. Of this amount, $2.5 million and $1.4 million has been recorded as accrued expenses in the accompanying condensed consolidated balance sheets as of July 31, 2007 and October 31, 2006, respectively, because the commitment is expected not to have future value to the Company.
 
Employee Health and Dental Costs
 
The Company is primarily self-insured for employee health and dental costs and has stop-loss insurance coverage to limit per-incident liability for health costs. The Company believes that adequate accruals are maintained to cover the retained liability. The accrual for self-insurance is determined based on claims filed and an estimate of claims incurred but not yet reported.
 
Litigation
 
The Company is subject to various legal proceedings related to commercial, customer, and employment matters that have arisen during the ordinary course of its business. Although there can be no assurance as to the ultimate disposition of these matters, the Company’s management has determined, based upon the information available at the date of these financial statements, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.
 
One of the Company’s Brazilian subsidiaries has been notified of a tax assessment regarding Brazilian state value added tax (“VAT”), for the periods from January 2000 to December 2001 that relates to products supplied to the Company by a contract manufacturer. The assessment relates to an asserted deficiency of 8.1 million Brazilian reais (approximately $4.3 million) including interest and penalties. The tax assessment was based on a clerical error in which the Company’s Brazilian subsidiary omitted the required tax exemption number on its invoices. Management does not expect that the Company will ultimately incur a material liability in respect of this assessment, because they believe, based in part on advice of the Company’s Brazilian tax counsel, that the Company is likely to prevail in the proceedings relating to this assessment. On May 25, 2005, the Company had an administrative hearing with respect to this audit. Management expects to receive the decision of the administrative body sometime in 2008. In the event the Company receives an adverse ruling from the administrative body, the Company will decide whether or not to appeal and would reexamine the determination as to whether an accrual is necessary. It is currently uncertain what impact this state tax examination may have with respect to the Company’s use of a corresponding exemption to reduce the Brazilian federal VAT.
 
Two of the Company’s Brazilian subsidiaries that were acquired as a part of the Lipman acquisition have been notified of assessments regarding Brazilian customs penalties that relate to alleged infractions in the importation of goods. The assessments were issued by the Federal Revenue Department in the City of Vitória and the City of São Paulo and relate to asserted deficiencies totaling 24.9 million Brazilian reais (approximately $13.3 million) excluding interest. The tax authorities allege that the structure used for the importation of goods was simulated with the objective of evading taxes levied on the importation by under invoicing the imported goods; the tax authorities allege that the simulation was created through a fraudulent interposition of parties, where the real sellers and buyers of the imported goods were hidden.
 
In the Vitória tax assessment, the fines were reduced from 4.7 million Brazilian reais (approximately $2.5 million) to 1.5 million Brazilian reais (approximately $0.8 million) on a first level administrative decision on January 26, 2007. The proceeding has been remitted to the Taxpayers Council to adjudicate the appeal of the first level administrative decision filed by the tax authorities. The Company also appealed the first level administrative decision on February 26, 2007. In this appeal, the Company argued that the tax authorities did not have enough evidence to determine that the import transactions were indeed fraudulent and that, even if there were some irregularities in such importations, they could not be deemed to be the Company’s responsibility since all the


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
transactions were performed by the third-party importer of the goods. Management expects to receive the decision of the Taxpayers Council sometime in 2008. In the event the Company receives an adverse ruling from the administrative body, the Company will decide whether or not to appeal to the judicial level. Based on the Company’s current understanding of the underlying facts, the Company believes that it is probable that its Brazilian subsidiary will be required to pay some amount of fines. At July 31, 2007, the Company has accrued 4.7 million Brazilian reais (approximately $2.5 million), excluding interest, which it believes is the probable payment.
 
On July 12, 2007, the Company was notified of a first administrative level decision rendered in the São Paulo tax assessment, which maintained the total fine of 20.2 million Brazilian reais (approximately $10.8 million) imposed. On August 10, 2007, the Company appealed the first administrative level decision to the Taxpayers Council. Based on the Company’s current understanding of the underlying facts, the Company believes that it is probable that its Brazilian subsidiary will be required to pay some amount of fines. Accordingly, at July 31, 2007, the Company has accrued 20.2 million Brazilian reais (approximately $10.8 million), excluding interest.
 
On December 11, 2006, the Company received a civil investigative demand from the U.S. Department of Justice (“DOJ”) regarding an investigation into its acquisition of Lipman which requests certain documents and other information, principally with respect to the companies’ integration plans and communications prior to the completion of this acquisition. The Company is producing documents and certain current and former employees have provided information to a representative of the DOJ in response to this request. The Company is not aware of any violations in connection with the matters that are the subject of the investigation but cannot predict what actions, if any, will result from this investigation.
 
Note 9.   Comprehensive Income (Loss)
 
The components of comprehensive income (loss) were as follows (in thousands):
 
                                 
    Three Months Ended
    Nine Months Ended
 
    July 31,     July 31,  
    2007     2006     2007     2006  
    (Restated)           (Restated)        
 
Net income (loss)
  $ (42,386 )   $ 16,755     $ (52,883 )   $ 45,585  
Foreign currency translation adjustments, net of tax
    3,345       (110 )     13,608       208  
Unrecognized gain (loss) on interest rate hedges, net of tax
    4       (35 )     (18 )     17  
Unrealized gain (loss) on marketable securities, net of tax
          1       (1 )     2  
                                 
Comprehensive income (loss)
  $ (39,037 )   $ 16,611     $ (39,294 )   $ 45,812  
                                 
 
The components of accumulated other comprehensive income consisted of the following (in thousands):
 
                 
    July 31,
    October 31,
 
    2007     2006  
    (Restated)        
 
Foreign currency translation adjustments, net of tax of $3,395 and $1,068
  $ 14,611     $ 1,003  
Unrecognized loss on interest rate hedges, net of tax of $42 and $29
    (64 )     (46 )
Unrealized gain on marketable securities, net of tax of zero and $1
          1  
                 
Accumulated other comprehensive income
  $ 14,547     $ 958  
                 


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Note 10.   Stockholders’ Equity
 
Common and Preferred Stock
 
The Company has authorized 100,000,000 shares of Common Stock, par value $0.01 per share, and 10,000,000 shares of Preferred Stock, par value $0.01 per share. The board of directors has the authority to issue the undesignated Preferred Stock in one or more series and to fix the rights, preferences, privileges, and restrictions thereof. The holder of each share of Common Stock has the right to one vote. As of July 31, 2007 and October 31, 2006, there were no shares of Preferred Stock outstanding and there were 83,315,613 and 68,148,245 shares of Common Stock outstanding, respectively.
 
On November 1, 2006, the Company completed its acquisition of Lipman. As part of the acquisition consideration, the Company issued 13,462,474 shares of its common stock. See Note 4 of Notes to Condensed Consolidated Financial Statements for additional information.
 
Restricted Common Stock
 
The Company had a right to repurchase shares of Common Stock sold to the Company’s Chief Executive Officer (the “CEO”) at the original sale price, $0.0333 per share, in the event the CEO ceased to be employed by the Company or any of its subsidiaries. This right lapsed at a rate of 20% of the original 3,910,428 shares per year. Upon the sale of the Company, any remaining unvested shares would become vested. At July 31, 2007, no shares of Common Stock issued to the CEO remained subject to this repurchase right which lapsed in July 2007.
 
The Company has a right to repurchase shares of Common Stock sold to certain executives of the Company pursuant to the Company’s 2002 Securities Purchase Plan at the lesser of the original sale price, $0.0333 per share, or the fair value on the date of separation in the event that the executive ceases to be employed by the Company or any of its subsidiaries. This right lapses at a rate of 20% of the original 1,929,145 shares per year. Upon the sale of the Company, all remaining unvested shares will become vested. At July 31, 2007, 20,856 shares of Common Stock remained subject to this repurchase right which will lapse in October 2007.
 
Stock Option Plans
 
As of July 31, 2007, the Company had a total of 9,336,148 stock options outstanding with a weighted average exercise price of $26.23 per share. The number of shares that remained available for future grants was 1,746,701 as of July 31, 2007. The following table provides a summary of options outstanding and exercisable under the various option plans for the period ended July 31, 2007:
 
         
    Shares
 
    Under
 
    Option  
    (Restated)  
 
Balance at November 1, 2006
    5,406,108  
Assumed in Lipman acquisition
    3,375,527  
Granted
    3,169,205  
Exercised
    (1,686,220 )
Cancelled
    (928,472 )
         
Balance at July 31, 2007
    9,336,148  
         
Vested or expected to vest at July 31, 2007
    8,575,419  
         
Exercisable at July 31, 2007
    1,842,257  
         


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
New Founders’ Stock Option Plan
 
On April 30, 2003, the Company adopted the New Founders’ Stock Option Plan (the “New Founders’ Plan”) for executives and employees of the Company. A total of 1,500,000 shares of the Company’s Common Stock were reserved for issuance under the New Founders’ Plan. The Company will no longer grant options under the New Founders’ Plan and will retire any options cancelled hereafter. Option awards under the New Founders’ Plan were generally granted with an exercise price equal to the market price of the Company’s stock on the date of grant. Those option awards generally vest in equal annual amounts over a period of five years from the date of grant and have a maximum term of 10 years.
 
The following table summarizes option activity under the New Founders’ Plan during the nine months ended July 31, 2007:
 
                                 
                Weighted
       
                Average
       
          Weighted
    Remaining
    Aggregate
 
    Shares
    Average
    Contractual
    Intrinsic
 
    Under
    Exercise
    Term
    Value
 
    Option     Price     (Years)     (Thousands)  
 
Balance at November 1, 2006
    898,062     $ 4.22                  
Exercised
    (322,082 )     4.04                  
Cancelled
    (11,740 )     7.33                  
                                 
Balance at July 31, 2007
    564,240     $ 4.26       6.77     $ 18,138  
                                 
Vested or expected to vest at July 31, 2007
    531,594     $ 4.21       6.75     $ 17,117  
                                 
Exercisable at July 31, 2007
    259,090     $ 3.62       6.46     $ 8,496  
                                 
 
The options expected to vest are the result of applying the pre-vesting forfeiture rate assumptions to total outstanding options. The option balance at July 31, 2007 excludes 20,856 options which were exercised but not vested. The total intrinsic value of options exercised during the nine months ended July 31, 2007 was $10.4 million.
 
As of July 31, 2007, pursuant to SFAS No. 123(R), there was $727,867 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the New Founders’ Plan. The cost is expected to be recognized over a remaining weighted average period of 2.0 years. The total fair value of shares vested during the nine months ended July 31, 2007 was $332,000.
 
Outside Directors’ Stock Option Plan
 
In January 2005, the Company adopted the Outside Directors’ Stock Option Plan (the “Directors’ Plan”) for members of the Board of Directors of the Company who are not employees of the Company or representatives of major stockholders of the Company. A total of 225,000 shares of the Company’s Common Stock had been reserved for issuance under the Directors’ Plan. The Company will no longer grant options under the Directors’ Plan and will retire any options cancelled hereafter. Option grants for members of the Board of Directors of the Company who are not employees of the Company or representatives of major stockholders of the Company will be covered under the 2006 Equity Incentive Plan.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following table summarizes option activity under the Directors’ Plan during the nine months ended July 31, 2007:
 
                                 
                Weighted
       
                Average
       
          Weighted
    Remaining
    Aggregate
 
    Shares
    Average
    Contractual
    Intrinsic
 
    Under
    Exercise
    Term
    Value
 
    Option     Price     (Years)     (Thousands)  
 
Balance at November 1, 2006
    90,000     $ 10.00                  
Exercised
    (18,750 )     10.00                  
Cancelled
                           
                                 
Balance at July 31, 2007
    71,250     $ 10.00       4.48     $ 1,882  
                                 
Vested or expected to vest at July 31, 2007
    71,250     $ 10.00       4.48     $ 1,882  
                                 
Exercisable at July 31, 2007
    35,625     $ 10.00       4.49     $ 941  
                                 
 
The options expected to vest are the result of applying the pre-vesting forfeiture rate assumptions to total outstanding options. The total intrinsic value of options exercised during the nine months ended July 31, 2007 was $456,000.
 
As of July 31, 2007, pursuant to SFAS No. 123(R), there was $200,877 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Directors’ Plan. The cost is expected to be recognized over a remaining weighted average period of 1.5 years. The total fair value of shares vested during the nine months ended July 31, 2007 was $104,000.
 
2005 Equity Incentive Option Plan
 
On April 29, 2005, the Company adopted the 2005 Equity Incentive Option Plan (the “EIP Plan”) for executives and employees of the Company and other individuals who perform services to the Company. A total of 3,100,000 shares of the Company’s Common Stock were reserved for issuance under the EIP Plan. The Company will no longer grant options under the EIP Plan and will retire any options cancelled hereafter. Option awards were generally granted with an exercise price equal to the market price of the Company’s stock at the date of grant. Those options generally vest over a period of four years from the date of grant and have a maximum term of 7 years.
 
The following table summarizes option activity under the EIP Plan during the nine months ended July 31, 2007:
 
                                 
                Weighted
       
                Average
       
          Weighted
    Remaining
    Aggregate
 
    Shares
    Average
    Contractual
    Intrinsic
 
    Under
    Exercise
    Term
    Value
 
    Option     Price     (Years)     (Thousands)  
    (Restated)  
 
Balance at November 1, 2006
    1,878,801     $ 12.13                  
Exercised
    (405,114 )     11.24                  
Cancelled
    (62,414 )     11.39                  
                                 
Balance at July 31, 2007
    1,411,273     $ 12.42       4.51     $ 33,857  
                                 
Vested or expected to vest at July 31, 2007
    1,276,180     $ 12.41       4.51     $ 30,623  
                                 
Exercisable at July 31, 2007
    411,072     $ 12.78       4.48     $ 9,713  
                                 


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The options expected to vest are the result of applying the pre-vesting forfeiture rate assumptions to total outstanding options. The total intrinsic value of options exercised during the nine months ended July 31, 2007 was $10.2 million.
 
As of July 31, 2007, pursuant to SFAS No. 123(R), there was $5.1 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the EIP Plan. The cost is expected to be recognized over a remaining weighted average period of 1.8 years. The total fair value of shares vested during the nine months ended July 31, 2007 was $2.6 million.
 
2006 Equity Incentive Plan
 
On March 22, 2006, the stockholders of VeriFone approved the 2006 Equity Incentive Plan (the “2006 Plan”) for officers, directors, employees and consultants of the Company. A total of 9,000,000 shares of the Company’s Common Stock have been reserved for issuance under the 2006 Plan. Awards are granted with an exercise price equal to the market price of the Company’s Common Stock at the date of grant except for restricted stock units (RSUs). The awards generally vest over a period of four years from the date of grant and have a maximum term of seven years. Any shares granted as stock options and stock appreciation rights shall be counted as one share for every share granted. Any awards granted other than stock options or stock appreciation rights are counted, for the purpose of the number of shares issuable under the 2006 Plan, as 1.75 shares for every share granted.
 
The following table summarizes option activity under the 2006 Plan during the nine months ended July 31, 2007:
 
                                 
                Weighted
       
                Average
       
          Weighted
    Remaining
    Aggregate
 
          Average
    Contractual
    Intrinsic
 
          Exercise
    Term
    Value
 
    Shares     Price     (Years)     (Thousands)  
    (Restated)  
 
Balance at November 1, 2006
    2,539,245     $ 29.10                  
Granted
    3,169,205       35.31                  
Exercised
    (66,435 )     29.28                  
Cancelled
    (392,401 )     31.56                  
                                 
Balance at July 31, 2007
    5,249,614     $ 32.74       6.21     $ 19,260  
                                 
Vested or expected to vest at July 31, 2007
    4,855,397     $ 32.70       6.21     $ 18,011  
                                 
Exercisable at July 31, 2007
    471,045     $ 29.23       5.65     $ 3,381  
                                 
 
The options expected to vest are the result of applying the pre-vesting forfeiture rate assumptions to total outstanding options. The total intrinsic value of options exercised during the nine months ended July 31, 2007 was $500,000. The weighted average grant date fair value of options granted during the nine months ended July 31, 2007 was $9.49 per share.
 
As of July 31, 2007, pursuant to SFAS No. 123(R), there was $40.4 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements related to options granted under the 2006 Plan. The cost is expected to be recognized over the remaining weighted average period of 3.5 years. The total fair value of shares vested during the nine months ended July 31, 2007 was $5.2 million.
 
In March 2006, September 2006, January 2007, and July 2007, the Company issued 90,000, 80,000, 14,000, and 33,000 RSUs, respectively, to its executive officers and key employees with a zero value exercise price. Twenty-five percent of these awards shall vest one year from the date of grant and 1/16th vest quarterly thereafter. The fair value of the RSUs granted is the stock price on March 22, 2006, September 12, 2006, January 3, 2007 and


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
July 2, 2007 of $28.86, $27.50, $35.45 and $35.47, respectively. As of July 31, 2007, 186,875 RSUs are vested or are expected to vest, with an aggregate intrinsic value of $6.8 million. As of July 31, 2007, pursuant to SFAS No. 123(R), there was $4.4 million of total unrecognized compensation cost related to non-vested RSUs. The cost is expected to be recognized over the remaining weighted average period of 3.1 years.
 
In January 2007, the Company made an award of up to 900,000 RSUs to the Company’s CEO. These RSUs may vest in three tranches over a four-year period based upon annual growth in the Company’s net income, as adjusted, per share and its share price. Two-thirds of the RSUs are “performance units” that will vest based on achievement of net income, as adjusted, targets, and one-third of the RSUs are “market units” that will vest based on achievement of net income, as adjusted, targets and specified targets for the share price of the Company’s stock. The performance units are earned in three annual tranches of up to 200,000 each in the event that the Company meets or exceeds specified annual increases in net income, as adjusted, per share for fiscal 2007, 2008, and 2009, based on a target of 20% annual increases. In addition, in each of fiscal 2007, 2008, and 2009, the CEO may earn a further 100,000 market units if the Company achieves both the targeted improvement in net income, as adjusted, per share and there is a corresponding improvement in the Company’s share price, with a final target of $62.20 for fiscal 2009. Each year’s RSUs will not vest until the end of the fiscal year following the year for which the specified target is met.
 
As of July 31, 2007, the Company had not recognized any compensation expense related to these RSUs as achievement of the fiscal year 2007 financial targets was not considered probable. The financial targets for the fiscal 2008 and 2009 tranches have not yet been determined; therefore, no measurement date has occurred for those tranches. The Company will value the fiscal 2008 and 2009 tranches when all factors for measurement have been determined and a measurement date has occurred. Because these shares are contingently issuable, they are excluded from the earnings per share calculation.
 
Lipman Plans
 
As part of the acquisition of Lipman on November 1, 2006, VeriFone assumed all of Lipman’s outstanding options. The Company will no longer grant options under the Lipman Plans. The following table summarizes option activity under the Lipman Electronic Engineering, Ltd. Plans (Lipman Plans) during the nine months ended July 31, 2007:
                                 
                Weighted
       
                Average
       
          Weighted
    Remaining
    Aggregate
 
          Average
    Contractual
    Intrinsic
 
          Exercise
    Term
    Value
 
    Shares     Price     (Years)     (Thousands)  
    (Restated)  
 
Options assumed on acquisition of Lipman on
                               
November 1, 2006
    3,375,527     $ 24.47                  
Exercised
    (873,839 )     19.65                  
Cancelled
    (461,917 )     27.69                  
                                 
Balance at July 31, 2007
    2,039,771     $ 25.68       4.56     $ 22,037  
                                 
Vested or expected to vest at July 31, 2007
    1,840,997     $ 25.44       4.56     $ 20,194  
                                 
Exercisable at July 31, 2007
    665,425     $ 22.60       4.88     $ 9,189  
                                 
 
The options expected to vest are the result of applying the pre-vesting forfeiture rate assumptions to total outstanding options. The total intrinsic value of options exercised during the nine months ended July 31, 2007 was $14.7 million.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
As of July 31, 2007, pursuant to SFAS No. 123(R), there was $11.4 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Lipman Plans. The cost is expected to be recognized over remaining weighted average period of 2.3 years. The total fair value of shares vested during the nine months ended July 31, 2007 was $8.5 million.
 
All Plans
 
The total cash received from employees as a result of employee stock option exercises under all plans for the nine months ended July 31, 2007 was approximately $25.1 million. In connection with these exercises, the tax benefits realized by the Company and credited to equity for the nine months ended July 31, 2007 were $6.9 million.
 
The Company estimates the grant-date fair value of stock options using a Black-Scholes valuation model, consistent with the provisions of SFAS No. 123(R) and SEC Staff Accounting Bulletin No. 107, Share-Based Payment. Expected volatility of the stock is based on a blend of the Company’s peer group in the industry in which it does business and the Company’s historical volatility data for its own stock. The expected term of options granted is estimated by the Company considering vesting periods and historical trends within the Company’s equity plans and represents the period of time that options granted are expected to be outstanding. The risk-free rate is based on the U.S. Treasury zero-coupon issues with a remaining term equal to the expected term of the options used in the Black-Scholes valuation model. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by employees who receive equity awards, and subsequent events are not indicative of the reasonableness of the original estimates of fair value made by the Company under SFAS No. 123(R).
 
The fair value of each stock option was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:
 
                                 
    Three Months Ended
    Nine Months Ended
 
    July 31,     July 31,  
    2007     2006     2007     2006  
    (Restated)           (Restated)        
 
Expected term of the options
    2 years       3 years       2 years       3.1 years  
Risk-free interest rate
    4.8 %     5.2 %     4.8 %     5.0 %
Expected stock price volatility
    40 %     41 %     40 %     42 %
Expected dividend rate
    0.0 %     0.0 %     0.0 %     0.0 %
 
The following table presents the stock-based compensation expense recognized in accordance with SFAS No. 123(R) during the nine months ended July 31, 2007 and 2006 (in thousands):
 
                                 
          Nine Months Ended
 
    Three Months Ended July 31,     July 31,  
    2007     2006     2007     2006  
    (Restated)           (Restated)        
 
Cost of net revenues
  $ 570     $ 204     $ 2,417     $ 519  
Research and development
    1,443       326       4,342       716  
Sales and marketing
    1,974       569       5,486       1,309  
General and administrative
    1,872       587       9,709       1,254  
                                 
    $ 5,859     $ 1,686     $ 21,954     $ 3,798  
                                 
 
In the nine months ended July 31, 2007, stock-based compensation expense includes $1,039,000 related to the excess over fair value of the vested Lipman options assumed.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following table presents the stock-based compensation expense recognized by plan in accordance with SFAS No. 123(R) during the following periods (in thousands):
 
                 
    Three Months Ended
    Nine Months Ended
 
    July 31,
    July 31,
 
    2007     2007  
    (Restated)  
 
New Founders’ Stock Option Plan
  $ 103     $ 323  
Executive Plan
    12       45  
Outside Directors’ Stock Option Plan
    35       104  
2005 Equity Incentive Option Plan
    761       2,233  
2006 Equity Incentive Plan
    2,822       7,062  
Lipman Plans
    2,126       12,187  
                 
    $ 5,859     $ 21,954  
                 
 
Note 11.   Segment and Geographic Information
 
Segment Information
 
The Company is primarily structured in a geographic manner. The Company’s Chief Executive Officer has been identified as the Chief Operating Decision Maker (“CODM”) as defined by SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. The CODM reviews consolidated financial information on revenues and gross profit percentage for System Solutions and Services. The CODM also reviews operating expenses, certain of which are allocated to the Company’s two segments described below.
 
The Company operates in two business segments: North America and International. The Company defines North America as the United States and Canada, and International as the countries in which it makes sales outside the United States and Canada.
 
Net revenues and operating income of each business segment reflect net revenues generated within the segment, standard cost of System Solutions net revenues, actual cost of Services net revenues and expenses that directly benefit only that segment. Corporate net revenues and operating income (loss) reflect non-cash acquisition charges, including amortization of purchased core and developed technology assets, step-up of inventory and step-down in deferred revenue and other Corporate charges, including inventory obsolescence and scrap at corporate distribution centers, rework, specific warrant provisions, non-standard freight, over-and-under absorption of materials management, and supply chain engineering overhead. Corporate operating income also reflects the difference between the actual and standard cost of System Solutions net revenues and shared operating costs that benefit both segments, predominately research and development expenses and centralized supply chain management.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following table sets forth net revenues and operating income for the Company’s segments (in thousands):
 
                                 
    Three Months Ended
    Nine Months Ended
 
    July 31,     July 31,  
    2007     2006     2007     2006  
    (Restated)           (Restated)        
 
Net revenues:
                               
International
  $ 128,391     $ 62,289     $ 379,136     $ 181,791  
North America
    103,961       85,404       288,899       243,045  
Corporate
    (651 )     (76 )     (3,088 )     (399 )
                                 
Total net revenues
  $ 231,701     $ 147,617     $ 664,947     $ 424,437  
                                 
Operating income:
                               
International
  $ 28,789     $ 16,819     $ 90,615     $ 45,052  
North America
    43,148       32,763       113,974       94,268  
Corporate
    (50,172 )     (21,123 )     (175,957 )     (62,102 )
                                 
Total operating income
  $ 21,765     $ 28,459     $ 28,632     $ 77,218  
                                 
 
The Company’s long-lived assets which consist primarily of property, plant, and equipment, net by segment were as follows (in thousands):
 
                 
    July 31,
    October 31,
 
    2007     2006  
    (Restated)        
 
International
  $ 22,138     $ 3,277  
North America
    20,817       6,270  
                 
    $ 42,955     $ 9,547  
                 
 
The Company’s goodwill by segment was as follows (in thousands):
 
                 
    July 31,
    October 31,
 
    2007     2006  
    (Restated)        
 
International
  $ 555,576     $ 19,102  
North America
    54,775       33,587  
                 
    $ 610,351     $ 52,689  
                 
 
The Company’s total assets by segment were as follows (in thousands):
 
                 
    July 31,
    October 31,
 
    2007     2006  
    (Restated)        
 
International
  $ 1,116,916     $ 125,681  
North America
    357,864       327,264  
                 
    $ 1,474,780     $ 452,945  
                 


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The Company’s depreciation and amortization expense by segment were as follows (in thousands):
 
                                 
    Three Months Ended
    Nine Months Ended
 
    July 31,     July 31,  
    2007     2006     2007     2006  
    (Restated)           (Restated)        
 
International
  $ 1,258     $ 207     $ 3,639     $ 560  
North America
    792       674       2,175       1,972  
                                 
    $ 2,050     $ 881     $ 5,814     $ 2,532  
                                 
 
Geographic Information
 
The net revenues by geographic area were as follows (in thousands):
 
                                 
    Three Months Ended
    Nine Months Ended
 
    July 31,     July 31,  
    2007     2006     2007     2006  
    (Restated)           (Restated)        
 
Europe
  $ 69,912     $ 31,554     $ 209,875     $ 80,754  
Latin America
    42,673       23,981       124,841       74,426  
Asia
    15,806       6,754       44,420       26,611  
United States
    92,513       79,976       257,569       231,400  
Canada
    10,797       5,352       28,242       11,246  
                                 
    $ 231,701     $ 147,617     $ 664,947     $ 424,437  
                                 
 
Revenues are allocated to the geographic areas based on the shipping destination of customer orders. Corporate revenues are included in the United States geographic area revenues.
 
The Company’s long-lived assets exclusive of intercompany accounts were as follows (in thousands):
 
                 
    July 31,
    October 31,
 
    2007     2006  
    (Restated)        
 
North America
  $ 20,817     $ 6,409  
Europe
    20,194       2,191  
Asia
    1,039       270  
Latin America
    905       677  
                 
    $ 42,955     $ 9,547  
                 
 
Note 12.   Related-Party Transactions
 
In June 2004, the Company paid a placement fee of $2,920,000 to GTCR Golder Rauner, L.L.C., the manager of equity funds that are stockholders of the Company, for services related to the Credit Facility acquired from Banc of America Securities and Credit Suisse First Boston. The debt issuance costs were amortized over the term of the related debt. The Company recorded amortization of debt issuance costs related to these costs of $69,000 and $201,000 for the three and nine months ended July 31, 2006, respectively, which is included in interest expense in the accompanying condensed consolidated statements of operations. On October 31, 2006, the Company entered into a new secured credit facility with a syndicate of financial institutions, led by JPMorgan Chase Bank, N.A. and Lehman Commercial Paper Inc. The proceeds were used to repay the outstanding amounts due from the existing secured credit facility and to pay the transaction costs and fund the cash consideration in connection with the merger with Lipman on November 1, 2006. The Company wrote off the remaining balance of unamortized debt issuance


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
cost of the credit facility acquired from Banc of America Securities and Credit Suisse First Boston in the amount of $6.4 million in October 2006 of which $1.6 million relates to the placement fee with GTCR Golden Rauner, L.L.C.
 
For the three and nine months ended July 31, 2007, the Company recorded sales of $3.6 million and $6.9 million, respectively, from affiliates of related parties which are included in System Solutions net revenues in the accompanying condensed consolidated statements of operations. For the comparable periods in fiscal 2006, the Company recorded sales of $0.7 million and $1.1 million, respectively.
 
Note 13.   Income Taxes
 
The Company expects to provide for taxes in the fiscal year ended October 31, 2007 notwithstanding an expected loss on its consolidated statement of operations for the full fiscal year. This is because, in significant part, it has net profits in its international operations and a loss in the United States. The tax benefit of the U.S. financial reporting loss is also offset by an expected increase in the valuation allowance on U.S. deferred tax assets. The effect of these circumstances is to create a tax rate in both the three and nine months ended July 31, 2007 that is unusually high. The application of the intraperiod tax accounting rules of FIN 18 coupled with the accounting for discrete items related to the write-off of debt costs and losses at certain entities results in a computed charge for tax provision of $52.8 million and $53.2 million in the three and nine months ended July 31, 2007, respectively. For the three and nine months ended July 31, 2006, the tax provision was $9.0 million and $24.3 million, respectively. The Company expects to report a substantially lower tax provision for fiscal year 2007 estimated at approximately $24.7 million.
 
The Company is currently under audit by the Internal Revenue Service (“IRS”) for its fiscal years 2002 to 2004. Although the Company believes it has correctly provided income taxes for the years subject to audit, the IRS may adopt different interpretations. The Company has not yet received any final determinations with respect to this audit.
 
Note 14.   Employee Benefit Plans
 
The Company maintains a defined contribution 401(k) plan that allows eligible employees to contribute up to 60% of their pretax salary up to the maximum allowed under Internal Revenue Service regulations. Discretionary employer matching contributions of $0.5 million and $1.5 million were made to the plan during the three and nine months ended July 31, 2007, respectively, compared to $0.5 million and $1.4 million for the comparable periods in fiscal 2006.
 
Note 15.   Subsequent Events
 
Class Action and Derivative Lawsuits
 
On or after December 4, 2007, several securities class action claims were filed against the Company and certain of the Company’s officers. The various complaints specify different class periods, with the longest proposed class period being August 31, 2006 through December 3, 2007. These lawsuits have been consolidated in the U.S. District Court for the Northern District of California as In re VeriFone Holdings, Inc. Securities Litigation, C 07-6140 MHP. The original actions were: Eichenholtz v. VeriFone Holdings, Inc. et al., C 07-6140 MHP; Lien v. VeriFone Holdings, Inc. et al., C 07-6195 JSW; Vaughn et al. v. VeriFone Holdings, Inc. et al., C 07-6197 VRW (Plaintiffs voluntarily dismissed this complaint on March 7, 2008); Feldman et al. v. VeriFone Holdings, Inc. et al., C 07-6218 MMC; Cerini v. VeriFone Holdings, Inc. et al., C 07-6228 SC; Westend Capital Management LLC v. VeriFone Holdings, Inc. et al., C 07-6237 MMC; Hill v. VeriFone Holdings, Inc. et al., C 07-6238 MHP; Offutt v. VeriFone Holdings, Inc. et al., C 07-6241 JSW; Feitel v. VeriFone Holdings, Inc., et al., C 08-0118 CW. On March 17, 2008, the Court held a hearing on Plaintiffs’ motions for Lead Plaintiff and Lead Counsel and in May 2008, the Court requested additional briefing on these matters, which was submitted in June 2008. The Company currently expects that following the Court’s order appointing Lead Plaintiff and Lead Counsel, a Consolidated Complaint will be filed. Each of the consolidated actions alleges, among other things, violations of Sections 10(b)


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, based on allegations that the Company and the individual defendants made false or misleading public statements regarding the Company’s business and operations during the putative class periods and seeks unspecified monetary damages and other relief. At this time, the Company has not recorded any liabilities as it is unable to estimate any potential liability.
 
Beginning on December 13, 2007, several derivative actions were also filed against certain current and former directors and officers. These derivative lawsuits were filed in: (1) the U.S. District Court for the Northern District of California, as In re VeriFone Holdings, Inc. Shareholder Derivative Litigation, Lead Case No. C 07-6347, which consolidates King v. Bergeron, et al. (Case No. 07-CV-6347), Hilborn v. VeriFone Holdings, Inc., et al. (Case No. 08-CV-1132), Patel v. Bergeron, et al. (Case No. 08-CV-1133), and Lemmond, et al. v. VeriFone Holdings, Inc., et al. (Case No. 08-CV-1301); and (2) California Superior Court, Santa Clara County, as In re VeriFone Holdings, Inc. Derivative Litigation, Lead Case No. 1-07-CV-100980, which consolidates Catholic Medical Mission Board v. Bergeron, et al. (Case No. 1-07-CV-100980), and Carpel v. Bergeron, et al. (Case No. 1-07-CV-101449). The complaints allege, among other things, that certain of the Company’s current and former directors and officers breached their fiduciary duties to the Company and violated provisions of the California Corporations Code and certain common law doctrines by engaging in alleged wrongful conduct complained of in the securities class action litigation described above. The Company is named solely as a nominal defendant against whom the plaintiffs seek no recovery. Amended consolidated complaints are expected to be filed in September 2008 in each set of consolidated cases.
 
On January 27, 2008, a class action complaint was filed against the Company in the Central District Court in Tel Aviv, Israel on behalf of purchasers of the Company’s stock on the Tel Aviv Stock Exchange. The complaint seeks compensation for damages allegedly incurred by the class of plaintiffs due to the publication of erroneous financial reports. On May 25, 2008, the Court held a hearing on the Company’s motion to dismiss or stay the proceedings, after which the Court requested that the plaintiff and the Company submit additional information to the Court with respect to the applicability of Israeli law to dually registered companies. This additional information was submitted to the Court in June 2008 and the parties are currently awaiting the Court’s ruling on this issue. At this time, the Company has not recorded any liabilities as it is unable to estimate the potential liabilities.
 
The foregoing cases are still in the preliminary stages, and the Company is not able to quantify the extent of its potential liability, if any. An unfavorable outcome in any of these matters could have a material adverse effect on the Company’s business, financial condition and results of operations. In addition, defending this litigation is likely to be costly and may divert management’s attention from the day-to-day operations of the Company’s business.
 
Regulatory Actions
 
The Company has responded to inquiries and provided information and documents related to the restatement of its fiscal year 2007 interim financial statements to the Securities and Exchange Commission, the Department of Justice, the New York Stock Exchange and the Chicago Board Options Exchange. The SEC has also expressed an interest in interviewing several current and former officers and employees of the Company, and the Company is continuing to cooperate with the SEC in responding to the SEC’s requests for information. The Company is unable to predict what consequences, if any, any investigation by any regulatory agency may have on the Company. There is no assurance that other regulatory inquiries will not be commenced by other U.S. federal, state or foreign regulatory agencies.
 
With regard to the civil investigative demand from the Department of Justice discussed in Note 8, on June 20, 2008, counsel for the Company received written confirmation from the Department of Justice that it had closed its civil investigation into the Company’s acquisition of Lipman.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Brazilian Tax Assessment
 
A hearing in the São Paulo tax assessment matter discussed in Note 8 was held on August 12, 2008 before the Taxpayers Council, but the Taxpayers Council did not render a decision pending its further review of the records. Management expects to receive the decision of the Taxpayers Council sometime in 2008. In the event the Company receives an adverse ruling from the Taxpayers Council, the Company will decide whether or not to appeal to the judicial level.
 
Two of the Company’s Brazilian subsidiaries that were acquired as a part of the Lipman acquisition have been notified of an additional assessment regarding Brazilian customs penalties that relates to alleged infractions in the importation of goods. The assessment was issued by the Federal Revenue Department in the City of Itajai. On May 22, 2008, the Company was notified of a first administrative level decision rendered in the Itajai assessment, which maintained the total fine of 2.0 million Brazilian reais (approximately $1.1 million) imposed, excluding interest. On May 27, 2008, the Company appealed the first level administrative level decision to the Taxpayers Council.
 
Amendments to the Credit Facility
 
On January 25, 2008, the Company’s subsidiaries, VeriFone, Inc. (the “Borrower”) and VeriFone Intermediate Holdings, Inc. entered into a First Amendment to the Credit Agreement and Waiver (the “First Amendment”) with the Lenders under its Credit Facility, dated October 31, 2006. The First Amendment extends the deadlines for delivery of certain required financial information for the three-month periods ended January 31, April 30, and July 31, 2007, the year ended October 31, 2007, and the three-month period ended January 31, 2008. In connection with the First Amendment, the Borrower paid to consenting Lenders a fee of $0.7 million, or 0.25% of the aggregate amount outstanding under the Term B loan and revolving credit commitment made available by the consenting Lenders, and agreed to an increase in the interest rate payable on the term loan of 0.25% per annum.
 
On April 28, 2008, the Borrower and VeriFone Intermediate Holdings, Inc. entered into a Second Amendment to the Credit Agreement (the “Second Amendment”) with the Lenders under its Credit Facility. The Second Amendment extends the time periods for delivery of certain required financial information for the three-month periods ended January 31, April 30, and July 31, 2007, the year ended October 31, 2007, and the three-month periods ended January 31 and April 30, 2008. In connection with the Second Amendment, the Borrower paid to consenting Lenders a fee of $0.7 million, or 0.25% of the aggregate amount outstanding under the term loan and revolving credit commitment made available by the consenting Lenders, agreed to an additional increase in the interest rate payable on the Term B loan and any revolving commitments of 0.75% per annum, agreed to an increase of 0.125% per annum to the commitment fee for unused revolving commitments, and agreed to an increase of 0.75% per annum to the letter of credit fees, each of which are effective from the date of the Second Amendment.
 
On July 31, 2008, the Borrower and VeriFone Intermediate Holdings, Inc. entered into a Third Amendment to the Credit Agreement (the “Third Amendment”) with the Lenders under its Credit Facility. The Third Amendment extends the time periods for delivery of certain required financial information for the three-month periods ended January 31, April 30, and July 31, 2007, the year ended October 31, 2007, and the three-month periods ended January 31 and April 30, 2008 to August 31, 2008. In connection with the Third Amendment, the Borrower paid to consenting Lenders a fee of $0.3 million, or 0.125% of the aggregate amount outstanding under the Term B loan and the amount of the revolving credit commitment made available by the consenting Lenders. Following the Third Amendment, the Borrower pays interest on the Term B loan at a rate of 2.75% over three-month LIBOR (the Borrower may elect at the end of an interest period to have the term loan bear interest at 1.75% over the lender’s base rate) and any revolving loans would bear interest, at the Borrower’s option, at either 2.0% over LIBOR or 1.0% over the lender’s base rate, assuming the Borrower remains in the lowest rate tier based on its total consolidated leverage ratio.


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VERIFONE HOLDINGS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Patent Infringement Lawsuits
 
On September 18, 2007, SPA Syspatronic AG (“SPA”) commenced an action in the United States District Court for the Eastern District of Texas, Marshall Division, against the Company and others, alleging infringement of U.S. Patent No. 5,093,862 purportedly owned by SPA. The plaintiff is seeking a judgment of infringement, an injunction against further infringement, damages, interest and attorneys’ fees. The Company filed an answer and counterclaims on November 8, 2007, and intend to vigorously defend this litigation. On January 28, 2008, the Company requested that the U.S. Patent and Trademark Office (the “PTO”) perform a re-examination of the patent. The PTO granted the request on April 4, 2008. The Company then filed a motion to stay the proceedings with the Court and on April 25, 2008, the Court agreed to stay the proceedings pending the re-examination.
 
On March 6, 2008, Cardsoft, Inc. and Cardsoft (Assignment for the Benefit of Creditors), LLC (“Cardsoft”) commenced an action in the United States District Court for the Eastern District of Texas, Marshall Division, against the Company and others, alleging infringement of U.S. Patents No. 6,934,945 and No. 7,302,683 purportedly owned by Cardsoft. The plaintiff is seeking a judgment of infringement, an injunction against further infringement, damages, interest and attorneys’ fees. The Company intends to vigorously defend this litigation.


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ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Forward-Looking Statements
 
This section and other parts of this Quarterly Report on Form 10-Q contain forward-looking statements that involve risks and uncertainties. In some cases, forward-looking statements can be identified by words such as “anticipates,” “expects,” “believes,” “plans,” “predicts,” and similar terms. Such forward-looking statements are based on current expectations, estimates, and projections about our industry, management’s beliefs, and assumptions made by management. Forward-looking statements are not guarantees of future performance and our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part II, Item 1A “Risk Factors” below and in Item 1A of our Annual Report on Form 10-K for the year ended October 31, 2006 filed with the SEC on December 18, 2006. The following discussion should be read in conjunction with our consolidated financial statements and related notes included in our 2006 Annual Report on Form 10-K and the condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q. Unless required by law, we expressly disclaim any obligation to update publicly any forward-looking statements, whether as result of new information, future events, or otherwise.
 
When we use the terms “VeriFone,” “we,” “us,” and “our” in this item, we mean VeriFone Holdings, Inc., a Delaware corporation, and its consolidated subsidiaries.
 
The discussion and analysis set forth below in this Item 2 has been amended to reflect the restatement as described above in the Explanatory Note to this amended Quarterly Report on Form 10-Q/A and in Note 2, “Restatement of Condensed Consolidated Financial Statements,” to the Notes to Condensed Consolidated Financial Statements. For this reason, the data set forth in this section may not be comparable to discussions and data in our previously filed Quarterly Reports.
 
Restatement and Audit Committee Investigation
 
Background
 
On December 3, 2007, we announced that our management had identified errors in accounting related to the valuation of in-transit inventory and allocation of manufacturing and distribution overhead to inventory and that as a result of these errors, we anticipated that a restatement of our unaudited condensed consolidated financial statements would be required for the following interim periods:
 
  •  the three months ended January 31, 2007;
 
  •  the three and six months ended April 30, 2007; and
 
  •  the three and nine months ended July 31, 2007.
 
Our management originally estimated that the restatement would result in changes to previously reported results as follows:
 
                         
    As of and for the Three Months Ended  
    January 31,
    April 30,
    July 31,
 
    2007     2007     2007  
    (In millions)  
 
Reduction in Inventories
  $ 7.7     $ 16.5     $ 30.2  
Reduction in Income before income taxes
  $ 8.9     $ 7.0     $ 13.8  
 
Audit Committee Investigation
 
On December 3, 2007, following our announcement, the Audit Committee approved the commencement of an independent investigation into the errors in accounting that led to the anticipated restatement. The Audit Committee engaged independent counsel, Simpson Thacher & Bartlett LLP (“Simpson Thacher”), to conduct the independent investigation under the Audit Committee’s supervision. Simpson Thacher engaged Navigant Consulting, Inc.


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(“Navigant”) as independent forensic accountants. The scope of the investigation was proposed by Simpson Thacher in consultation with Navigant and approved by the Audit Committee. The investigation involved a program of forensic analysis designed to investigate, among other things:
 
  •  the circumstances surrounding the errors identified by management and described in our December 3, 2007 announcement;
 
  •  whether additional errors existed requiring further restatement in the interim periods of fiscal 2007 and the adjustments required to correct and restate our interim financial statements; and
 
  •  whether evidence existed indicating that periods prior to fiscal 2007 may also be required to be restated.
 
Simpson Thacher and Navigant assembled an investigative team that ultimately consisted of approximately 70 professionals. Information and documents were gathered from current and former employees worldwide. Using search technology, the investigative team evaluated over five million documents in physical and electronic form. Navigant also reviewed relevant accounting databases and journal entries. The investigative team also conducted more than 25 interviews of senior executives, former senior executives of Lipman and current and former finance, accounting and supply chain personnel.
 
We announced on April 2, 2008 that the investigation was complete and that the investigation had confirmed the existence of the errors in accounting identified in our December 3, 2007 announcement. In particular, the investigation confirmed that incorrect manual journal and elimination entries had been made primarily by our Sacramento supply chain accounting team with respect to several inventory-related matters.
 
The investigation also concluded that existing policies with respect to manual journal entries were not followed and that the review processes and controls in place were not sufficient to identify and correct the errors in a timely manner. The investigation found no evidence that any period prior to fiscal year 2007 required restatement.
 
Restatement
 
Concurrently with the Audit Committee investigation, we also conducted an internal review for the purpose of restating our fiscal 2007 interim condensed consolidated financial statements and preparing our fiscal 2007 annual consolidated financial statements and fiscal 2008 interim condensed consolidated financial statements. This review included evaluations of the previously made accounting determinations and judgments. As a result, we have also corrected additional errors, including errors that had previously not been corrected because our management believed that individually and in the aggregate such errors were not material to our consolidated financial statements. Management also made additional adjustments to reduce certain accruals which had been recorded, such as bonuses, which were accrued based upon information which, following the restatement, was no longer accurate.
 
The restatements of fiscal 2007 interim results resulted in the following adjustments:
 
                         
    As of and for the Three Months Ended  
    January 31,
    April 30,
    July 31,
 
    2007     2007     2007  
    (In millions)  
 
Reduction in Inventory
  $ 13.3     $ 23.9     $ 40.6  
Reduction in Income before income taxes
  $ 12.5     $ 9.9     $ 14.4  
Reduction in Net Income
  $ 4.7     $ 9.7     $ 55.8  
 
A complete analysis of the adjustments reflected in the restatement as of and for the three and nine months ended July 31, 2007 is included in Note 2, “Restatement of Condensed Consolidated Financial Statements,” to the Notes to Condensed Consolidated Financial Statements.
 
The provision for income taxes for the three and nine months ended July 31, 2007, as restated, are each significantly higher than as originally reported due to two principal factors. First, under FIN 18, our quarterly tax provision is determined by applying the estimated annual effective tax rate to our pretax income for the quarter as adjusted for discrete items. For the three months ended July 31, 2007, the estimated annual rate for FIN 18 purposes was 340% and our pretax income, as adjusted for discrete items, was $16 million. This results in approximately


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$55 million of taxes before discrete tax adjustments. We offset this with approximately $2.2 million of discrete tax benefit in determining the provision for income taxes for the quarter. Second, we also recorded a significant increase in the valuation allowance for deferred tax assets during the year ended October 31, 2007 due primarily to the restated (or revised projected) pre-tax income (loss) for fiscal year ended October 31,2007 and ending October 31, 2008. The increase in the valuation allowance resulted in a significantly larger provision for taxes, which has been allocated to the quarterly results under FIN 18.
 
Among the most significant errors giving rise to the restatement were:
 
  •  manual journal entries made for the three months ended January 31, 2007 that erroneously added manufacturing and distribution overhead to inventory held at former Lipman subsidiaries, notwithstanding that overhead had already been allocated to that inventory. This duplication erroneously increased reported inventory and reduced reported cost of net revenues by $7.7 million in the three months ended January 31, 2007;
 
  •  manual journal entries made for the periods ended April 30, 2007 and July 31, 2007 that erroneously recorded in-transit inventory of an additional $12.7 million at April 30, 2007 and an additional $7.3 million at July 31, 2007 based on erroneous methodology and application of source documents; and
 
  •  $6.3 million in errors made in the elimination of intercompany profit in inventory for the nine months ended July 31, 2007.
 
In connection with the Audit Committee investigation and restatement process, we identified material weaknesses in our internal control over financial reporting, as a result of which our senior management has concluded that our disclosure controls and procedures were not effective as of July 31, 2007. These material weaknesses and management’s remediation efforts are summarized under Item 4 “Controls and Procedures” in this Quarterly Report.
 
Overview
 
We are a global leader in secure electronic payment solutions. We provide expertise, solutions, and services that add value to the point of sale with merchant-operated, consumer-facing, and self-service payment systems for the financial, retail, hospitality, petroleum, government, and healthcare vertical markets. Since 1981, we have designed and marketed system solutions that facilitate the long-term shift toward electronic payment transactions and away from cash and checks. We believe that we have one of the leading electronic payment solutions brands and, supported by our recent acquisition of Lipman Electronic Engineering Ltd (“Lipman”), we are one of the largest providers of electronic payment systems worldwide in terms of revenues and research and development spending.
 
Our System Solutions consist of point of sale electronic payment devices that run our proprietary and third-party operating systems, security and encryption software, and certified payment software as well as third-party, value-added applications. Our System Solutions are able to process a wide range of payment types including signature and PIN-based debit cards, credit cards, contactless / radio frequency identification, or RFID, cards and tokens, smart cards, pre-paid gift and other stored-value cards, electronic bill payment, check authorization and conversion, signature capture, and electronic benefits transfer, or EBT. Our proprietary architecture was the first to enable multiple value-added applications, such as gift card and loyalty card programs, healthcare insurance eligibility, and time and attendance tracking, to reside on the same system without requiring recertification when new applications are added to the system. We are an industry leader in multi-application payment system deployments and we believe we have the largest selection of third-party certified value-add applications.
 
We design our System Solutions to meet the demanding requirements of our direct and indirect customers. Our electronic payment systems are available in several distinctive modular configurations, offering our customers flexibility to support a variety of connectivity options, including wireline and wireless internet protocol, or IP, technologies. We also offer our customers support for installed systems, consulting and project management services for system deployment, and customization of integrated software solutions.


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Our customers are primarily global financial institutions, payment processors, petroleum companies, large retailers, government organizations, and healthcare companies, as well as independent sales organizations, or ISOs. The functionality of our System Solutions includes transaction security, connectivity, compliance with certification standards, and the flexibility to execute a variety of payment and non-payment applications on a single system solution.
 
Results of Operations
 
Net Revenues
 
We generate net revenues through the sale of our electronic payment systems and solutions that enable electronic payments, which we identify as System Solutions, and to a lesser extent, warranty and support services, field deployment, installation and upgrade services, and customer specific application development, which we identify as Services.
 
Net revenues, which include System Solutions and Services, are summarized in the following table (in thousands, except percentages):
 
                                                                 
    Three Months Ended July 31,     Nine Months Ended July 31,  
                Change
    Change
                Change
    Change
 
    2007     2006     in Dollars     in Percent     2007     2006     in Dollars     in Percent  
    (Restated)                       (Restated)                    
 
Systems Solutions
  $ 205,972     $ 131,960     $ 74,012       56 %   $ 586,407     $ 378,781     $ 207,626       55 %
Services
    25,729       15,657       10,072       64 %     78,540       45,656       32,884       72 %
                                                                 
Total
  $ 231,701     $ 147,617     $ 84,084       57 %   $ 664,947     $ 424,437     $ 240,510       57 %
                                                                 
 
System Solutions
 
System Solutions net revenues increased $74.0 million, or 56%, to $206.0 million for the three months ended July 31, 2007 from $132.0 million for the three months ended July 31, 2006. System Solutions net revenues comprised 89% of total net revenues both for the three months ended July 31, 2007 and the three months ended July 31, 2006.
 
International System Solutions net revenues for the three months ended July 31, 2007 increased $55.5 million, or 93%, to $115.1 million. The increase was largely attributable to growth across emerging economies, in particular the countries of Brazil and Turkey, and to a lesser extent, Western Europe. Factors driving the emerging economies increase were the addition of the Nurit, Secura, and Xplorer product lines, acquired in the Lipman acquisition, and the continued desire of these countries to modernize their infrastructure and improve collection of VAT. In Western Europe, acquisition-related sales in the UK, Spain, and Italy were the primary reason for growth. We expect that the proportion of International System Solutions net revenues, relative to North America System Solutions net revenues, will increase at a higher growth rate for at least the next year. In addition, we may experience periodic variations in sales to our International markets.
 
North America System Solutions net revenues for the three months ended July 31, 2007 increased $18.5 million, or 26%, to $91.0 million. This increase was primarily attributable to an increase in demand for wireless products due to our customers’ interest in differentiating the service they provide to merchants, multi-lane retail solutions which enable PCI security compliance, and higher sales in Canada, where customers are preparing for a transition to EMV and Interac Chip acceptance. Partially offsetting this increase was a decline in sales for a legacy check processing solution.
 
System Solutions net revenues increased $207.6 million, or 55%, to $586.4 million for the nine months ended July 31, 2007 from $378.8 million for the nine months ended July 31, 2006. System Solutions net revenues comprised 88% of total net revenues for the nine months ended July 31, 2007 as compared to 89% for the nine months ended July 31, 2006.
 
International System Solutions net revenues for the nine months ended July 31, 2007 increased $161.9 million, or 92%, to $337.2 million. The increase was largely attributable to growth across emerging economies, in particular


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Brazil, Turkey, countries of Eastern Europe, China, and to a lesser extent, Western Europe. Factors driving the emerging economies increase were the addition of the Nurit, Secura, and Xplorer product lines, acquired in the Lipman acquisition, and continued desire of these countries to modernize their infrastructure and improve collection of VAT. In Western Europe, acquisition related sales in the UK, Spain, and Italy were the primary reason for growth.
 
North America System Solutions net revenues for the nine months ended July 31, 2007 increased $46.3 million, or 23%, to $249.8 million. This increase was primarily attributable to an increase in demand for wireless products due to our customers’ interest in differentiating the service they provide to merchants, and higher sales in Canada, where customers are preparing for a transition to EMV and Interac Chip acceptance, and growth of multi-lane retail solutions which enable PCI security compliance and enhanced customer interaction through full motion video. Partially offsetting this increase was a decline in sales for a legacy check processing solution.
 
Services
 
Services net revenues increased $10.1 million, or 64%, to $25.7 million for the three months ended July 31, 2007 from $15.7 million for the three months ended July 31, 2006. This growth occurred mainly in International Services due to higher growth in maintenance and deployment revenues in Europe and Brazil associated with the acquisition of Lipman. North America revenues were essentially unchanged from the prior year.
 
Services net revenues increased $32.9 million, or 72%, to $78.5 million for the nine months ended July 31, 2007 compared to the nine months ended July 31, 2006. This growth occurred entirely in International, while North America had a slight decline. International growth was due to higher growth in maintenance revenues and deployment revenues in Europe and Brazil associated with the acquisition of Lipman. The North America decline was due to fewer installations for quick service restaurant customers.
 
Gross Profit
 
The following table shows the gross profit for System Solutions and Services (in thousands, except percentages):
 
                                                                 
    Three Months Ended July 31,     Nine Months Ended July 31,  
    Amount     Gross Profit Percentage     Amount     Gross Profit Percentage  
    2007     2006     2007     2006     2007     2006     2007     2006  
    (Restated)                       (Restated)                    
 
Systems Solutions
  $ 73,704     $ 59,256       35.8 %     44.9 %   $ 194,897     $ 167,197       33.2 %     44.1 %
Services
    11,892       7,205       46.2 %     46.0 %     36,968       22,265       47.1 %     48.8 %
                                                                 
Total
  $ 85,596     $ 66,461       36.9 %     45.0 %   $ 231,865     $ 189,462       34.9 %     44.6 %
                                                                 
 
Gross profit on System Solutions increased $14.4 million, or 24%, to $73.7 million for the three months ended July 31, 2007 from $59.3 million for the three months ended July 31, 2006. Gross profit on System Solutions represented 35.8% of System Solutions net revenues for the three months ended July 31, 2007 down from 44.9% for the three months ended July 31, 2006.
 
North America gross profit percentage declined primarily due to the lower proportion of Petroleum system solution sales, which carry higher than average gross margins and the growth in retail system solutions, which carry lower than average gross margins. Wireless solutions, which increased year over year and carry above average gross margins, partially offset these declines.
 
International gross profit percentage declined due to increased price competition in Turkey, unfavorable product mix in Brazil, and the delivery of a large, low margin custom payment solution in Western Europe. In addition, with our acquisition of Lipman, international sales, which typically carry lower gross margins relative to domestic gross margins, increased with a resulting adverse impact on gross margins. Partially offsetting these declines was an increase in wireless solutions, which carry higher gross margins than landline solutions.


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Table of Contents

Corporate costs increased as a percentage of System Solutions net revenues in part due to the amortization of purchased core and developed technology assets as a result of the Lipman acquisition. Corporate costs increased to 7.8% of Systems Solutions net revenues for the three months ended July 31, 2007 compared to 2.7% for the three months ended July 31, 2006. These Corporate costs were also impacted by inventory write-downs and scrap, partially offset by reduced air freight as a percentage of sales. Corporate costs are comprised of non-cash acquisition charges, including amortization of purchased core and developed technology assets, step-up of inventory and step-down in deferred revenue, and other Corporate charges, including inventory obsolescence and scrap at corporate distribution centers, rework, non-standard freight, over-and-under absorption of materials management and supply chain engineering overhead. Since these costs are generally incurred on a company-wide basis, it is impractical to allocate them to either the North America or International segment.
 
Gross profit on System Solutions, including amortization of purchased core and developed technology assets, increased $27.7 million, or 16.6%, to $194.9 million for the nine months ended July 31, 2007 from $167.2 million for the nine months ended July 31, 2006. Gross profit on System Solutions represented 33.2% of System Solutions net revenues for the nine months ended July 31, 2007 down from 44.1% for the nine months ended July 31, 2006. Gross profit percentage also declined due to the higher proportion of international net revenues, which typically carry a lower margin than North American net revenues. This decline was partially offset by higher sales of wireless solutions, which typically carry a higher margin than landline solutions.
 
North America gross profit percentage declined primarily due to the lower proportion of Petroleum system solution sales, which carry higher than average gross margins, and the growth in Retail system solutions and single application solutions sales, which carry lower than average margins.
 
International gross profit percentage declined primarily due to increased price competition in Turkey, unfavorable product mix in Brazil and the inclusion of low margin Secura and Xplorer product lines, which carry lower than average gross margins relative to other International System Solutions.
 
Corporate costs increased as a percentage of System Solutions revenues primarily due to amortization of purchased core and developed technology assets and step-up of inventory fair value. These Corporate costs increased to 10.5% of Systems Solutions net revenues in the nine months ended July 31, 2007 compared to 3.2% in the nine months ended July 31, 2006, as a result of the Lipman acquisition. Partially offsetting this increase were lower air freight costs as a percentage of Systems Solutions net revenues and the fact that setup costs for the Singapore International headquarters established in 2006 did not recur in 2007.
 
Gross profit on Services increased $4.7 million, or 65%, to $11.9 million for the three months ended July 31, 2007 from $7.2 million for the three months ended July 31, 2006. Gross profit on Services represented 46.2% of Services net revenues for the three months ended July 31, 2007 as compared to 46.0% for the three months ended July 31, 2006.
 
Gross profit on Services increased $14.7 million, or 66%, to $37.0 million for the nine months ended July 31, 2007 from $22.3 million for the nine months ended July 31, 2006. Gross profit represented 47.1% of Services net revenues for the nine months ended July 31, 2007 as compared to 48.8% for the nine months ended July 31, 2006. The decline was due to the inclusion of service revenues related to the Lipman acquisition which earned a gross margin percent below our historical averages.
 
Research and Development Expenses
 
Research and development (“R&D”) expenses are summarized in the following table (in thousands, except percentages):
 
                                                                 
    Three Months Ended July 31,     Nine Months Ended July 31,  
                Change
    Change
                Change