10-Q 1 mv6-8_10q.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended April 30, 2004 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER: 0-15502 COMVERSE TECHNOLOGY, INC. (Exact name of registrant as specified in its charter) NEW YORK 13-3238402 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 170 CROSSWAYS PARK DRIVE, WOODBURY, NY 11797 (Address of principal executive offices) (Zip Code) (516) 677-7200 (Registrant's telephone number, including area code) NOT APPLICABLE (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. [X] Yes [ ] No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). [X] Yes [ ] No The number of shares outstanding of the registrant's common stock, par value $0.10 per share, as of June 1, 2004 was 195,633,687. TABLE OF CONTENTS ----------------- Page ---- PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. 1. Condensed Consolidated Balance Sheets as of January 31, 2004 and April 30, 2004 2 2. Condensed Consolidated Statements of Operations for the Three Month Periods Ended April 30, 2003 and April 30, 2004 3 3. Condensed Consolidated Statements of Cash Flows for the Three Month Periods Ended April 30, 2003 and April 30, 2004 4 4. Notes to Condensed Consolidated Financial Statements 5 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. 14 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 30 ITEM 4. CONTROLS AND PROCEDURES. 30 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. 31 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. 31 SIGNATURES 32 ii FORWARD-LOOKING STATEMENTS From time to time, the Company makes forward-looking statements. Forward-looking statements include financial projections, statements of plans and objectives for future operations, statements of future economic performance, and statements of assumptions relating thereto. Forward-looking statements are often identified by future or conditional words such as "will," "plans," "expects," "intends," "believes," "seeks," "estimates," or "anticipates" or by variations of such words or by similar expressions. The Company may include forward-looking statements in its periodic reports to the Securities and Exchange Commission on Forms 10-K, 10-Q, and 8-K, in its annual report to shareholders, in its proxy statements, in its press releases, in other written materials, and in statements made by employees to analysts, investors, representatives of the media, and others. By their very nature, forward-looking statements are subject to uncertainties, both general and specific, and risks exist that predictions, forecasts, projections and other forward-looking statements will not be achieved. Actual results may differ materially due to a variety of factors, including without limitation those discussed under "Certain Trends and Uncertainties" and elsewhere in this report. Investors and others should carefully consider these and other uncertainties and events, whether or not the statements are described as forward-looking. Forward-looking statements made by the Company are intended to apply only at the time they are made, unless explicitly stated to the contrary. Moreover, whether or not stated in connection with a forward-looking statement, the Company makes no commitment to revise or update any forward-looking statements in order to reflect events or circumstances after the date any such statement is made. If the Company were in any particular instance to update or correct a forward-looking statement, investors and others should not conclude that the Company will make additional updates or corrections thereafter. 1 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)

JANUARY 31, APRIL 30, 2004* 2004 (Unaudited) ASSETS ------ CURRENT ASSETS: Cash and cash equivalents $1,530,995 $1,771,809 Bank time deposits and short-term investments 667,504 374,864 Accounts receivable, net 158,236 162,096 Inventories 54,751 53,735 Prepaid expenses and other current assets 50,798 59,353 ------------- ------------- TOTAL CURRENT ASSETS 2,462,284 2,421,857 PROPERTY AND EQUIPMENT, net 125,023 119,896 OTHER ASSETS 140,735 170,901 ------------- ------------- TOTAL ASSETS $2,728,042 $2,712,654 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ CURRENT LIABILITIES: Accounts payable and accrued expenses $ 229,296 $ 226,526 Bank loans and other debt 2,649 8,864 Advance payments from customers 89,062 70,657 ------------- ------------- TOTAL CURRENT LIABILITIES 321,007 306,047 CONVERTIBLE DEBT 544,723 514,228 OTHER LIABILITIES 28,288 19,178 ------------- ------------- TOTAL LIABILITIES 894,018 839,453 ------------- ------------- MINORITY INTEREST 161,478 171,551 ------------- ------------- STOCKHOLDERS' EQUITY: Common stock, $0.10 par value - authorized, 600,000,000 shares; issued and outstanding, 194,549,886 and 195,575,044 shares 19,454 19,557 Additional paid-in capital 1,210,547 1,236,180 Unearned stock compensation (6,707) (6,276) Retained earnings 439,899 446,900 Accumulated other comprehensive income 9,353 5,289 ------------- ------------- TOTAL STOCKHOLDERS' EQUITY 1,672,546 1,701,650 ------------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $2,728,042 $2,712,654 ============= =============

*The Condensed Consolidated Balance Sheet as of January 31, 2004 has been summarized from the Company's audited Consolidated Balance Sheet as of that date. The accompanying notes are an integral part of these financial statements. 2 COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA)

THREE MONTHS ENDED APRIL 30, APRIL 30, 2003 2004 Sales $180,552 $221,395 Cost of sales 80,373 89,592 ----------- ----------- Gross margin 100,179 131,803 Operating expenses: Research and development, net 54,488 55,542 Selling, general and administrative 62,072 68,495 In-process research and development and other acquisition-related charges - 4,635 Workforce reduction, restructuring and impairment charges - 698 ----------- ----------- Income (loss) from operations (16,381) 2,433 Interest and other income, net 13,336 7,645 ----------- ----------- Income (loss) before income tax provision, minority interest and equity in the earnings (losses) of affiliates (3,045) 10,078 Income tax provision 1,980 1,492 Minority interest and equity in the earnings (losses) of affiliates (794) (1,585) ----------- ----------- Net income (loss) $(5,819) $7,001 =========== =========== Earnings (loss) per share: Basic $(0.03) $0.04 =========== =========== Diluted $(0.03) $0.03 =========== ===========

The accompanying notes are an integral part of these financial statements. 3 COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)

THREE MONTHS ENDED APRIL 30, APRIL 30, 2003 2004 Cash flows from operating activities: Net cash from operations after adjustment for non-cash items $15,594 $31,266 Changes in operating assets and liabilities: Accounts receivable, net 28,926 (3,860) Inventories (3,300) 1,016 Prepaid expenses and other current assets 9,071 (7,610) Accounts payable and accrued expenses (11,127) (5,721) Advance payments from customers (882) (18,405) Other, net (988) (2,392) ------------ ------------ Net cash provided by (used in) operating activities 37,294 (5,706) ------------ ------------ Cash flows from investing activities: Maturities and sales (purchases) of bank time deposits and investments, net 69,979 288,935 Purchase of property and equipment (8,487) (7,247) Capitalization of software development costs (2,305) (1,093) Net assets acquired - (35,599) ------------ ------------ Net cash provided by investing activities 59,187 244,996 ------------ ------------ Cash flows from financing activities: Repurchase of convertible debt (41,261) (30,038) Repayment of bank loan (42,000) - Net proceeds from issuance of stock 5,319 31,777 Other, net (3,084) (215) ------------ ------------ Net cash provided by (used in) financing activities (81,026) 1,524 ------------ ------------ Net increase in cash and cash equivalents 15,455 240,814 Cash and cash equivalents, beginning of period 1,402,783 1,530,995 ------------ ------------ Cash and cash equivalents, end of period $1,418,238 $1,771,809 ============ ============

The accompanying notes are an integralpart of these financial statements. 4 COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) BASIS OF PRESENTATION. Comverse Technology, Inc. ("CTI" and, together with its subsidiaries, the "Company") is engaged in the design, development, manufacture, marketing and support of computer and telecommunications systems and software for multimedia communications and information processing applications. The accompanying financial information should be read in conjunction with the financial statements, including the notes thereto, for the annual period ended January 31, 2004. The financial information included herein is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments), which are, in the opinion of management, necessary for a fair statement of results for the interim periods. The results of operations for the three month period ended April 30, 2004 are not necessarily indicative of the results to be expected for the full year. RECLASSIFICATIONS. Certain prior year amounts have been reclassified to conform to the presentation in the current year. STOCK-BASED COMPENSATION. The Company accounts for stock options under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. Accordingly, no stock-based employee compensation cost for stock options is reflected in net income (loss) for any periods, as all options granted had an exercise price at least equal to the market value of the underlying common stock on the date of grant. During the year ended January 31, 2004, the Company and one of its subsidiaries granted shares of restricted stock to certain key employees. For the three month periods ended April 30, 2003 and 2004, respectively, stock-based employee compensation expense relating to restricted stock of approximately $0 and $431,000 is included in `Selling, general and administrative' expenses in the Condensed Consolidated Statements of Operations. The Company estimated the fair value of employee stock options utilizing the Black-Scholes option valuation model, using appropriate assumptions, as required under accounting principles generally accepted in the United States of America. The Black-Scholes model was developed for use in estimating the fair value of traded options and does not consider the non-traded nature of employee stock options, vesting and trading restrictions, lack of transferability or the ability of employees to forfeit the options prior to expiry. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of the Company's employee stock options. 5 The following table illustrates the effect on net income (loss) and earnings (loss) per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation", to stock-based employee compensation for all periods:

THREE MONTHS ENDED APRIL 30, --------------------------------------------- 2003 2004 ---- ---- (In thousands) Net income (loss), as reported $(5,819) $7,001 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (37,136) (39,052) -------------------- -------------------- Pro forma net loss $(42,955) $(32,051) ==================== ==================== Earnings (loss) per share: Basic - as reported $ (0.03) $ 0.04 Basic - pro forma $ (0.23) $ (0.16) Diluted - as reported $ (0.03) $ 0.03 Diluted - pro forma $ (0.23) $ (0.16)

INVENTORIES. The composition of inventories at January 31, 2004 and April 30, 2004 is as follows:

JANUARY 31, APRIL 30, 2004 2004 (In thousands) Raw materials $23,157 $15,826 Work in process 12,802 16,108 Finished goods 18,792 21,801 --------- --------- $54,751 $53,735 ========= =========

6 RESEARCH AND DEVELOPMENT EXPENSES. A significant portion of the Company's research and development operations are located in Israel where the Company derives benefits from participation in programs sponsored by the Government of Israel for the support of research and development activities conducted in that country. Certain of the Company's research and development activities include projects partially funded by the Office of the Chief Scientist of the Ministry of Industry and Trade of the State of Israel (the "OCS") under which the funding organization reimburses a portion of the Company's research and development expenditures under approved project budgets. Certain of the Company's subsidiaries accrue royalties to the OCS for the sale of products incorporating technology developed in these projects. Under the terms of the applicable funding agreements, products resulting from projects funded by the OCS may not be manufactured outside of Israel without government approval. The amounts reimbursed by the OCS for the three month periods ended April 30, 2003 and 2004 were approximately $1,208,000 and $2,451,000, respectively. EARNINGS (LOSS) PER SHARE. The computation of basic earnings (loss) per share is based on the weighted average number of outstanding common shares. Diluted earnings per share further assumes the issuance of common shares for all dilutive potential common shares outstanding. The calculation of earnings (loss) per share for the three month periods ended April 30, 2003 and 2004 is as follows:

THREE MONTHS ENDED THREE MONTHS ENDED APRIL 30, 2003 APRIL 30, 2004 -------------- -------------- Net Per Share Net Per Share Loss Shares Amount Income Shares Amount (In thousands, except per share data) BASIC EPS --------- Net income (loss) $(5,819) 188,094 $(0.03) $7,001 194,797 $0.04 ======= ===== EFFECT OF DILUTIVE SECURITIES ---------- Options - 6,979 ----------------------------------------- -------------------------------------------------- DILUTED EPS $(5,819) 188,094 $(0.03) $7,001 201,776 $0.03 ======== ======= ======= ====== ======= =====

The diluted loss per share computation for the three month period ended April 30, 2003 excludes incremental shares of approximately 1,524,000 related to employee stock options. These shares are excluded due to their antidilutive effect as a result of the Company's loss during the period. The shares issuable upon the conversion of the Company's 1.50% Convertible Senior Debentures due December 2005 (the "Debentures") were not included in the computation of diluted earnings (loss) per share for all periods because the effect of including them would be antidilutive. In addition, the shares issuable upon the conversion of the Company's Zero Yield Puttable Securities due 2023 ("ZYPS") were not included in the computation of diluted earnings (loss) per share for all periods. The ZYPS are convertible into shares of the Company's common stock contingent upon the occurrence of certain events that have not yet occurred. As such, the contingent conversion feature has not been satisfied and the ZYPS are not currently considered to be dilutive in accordance with the provisions of SFAS No. 128, "Earnings per Share." A full conversion of the ZYPS would result in the issuance of approximately 23,367,000 additional shares of common stock. 7 COMPREHENSIVE INCOME (LOSS). Total comprehensive income (loss) was approximately $(6,822,000) and $2,937,000 for the three month periods ended April 30, 2003 and 2004, respectively. The elements of comprehensive income (loss) include net income (loss), unrealized gains/losses on available for sale securities and foreign currency translation adjustments. CONVERTIBLE DEBT. In May 2003, the Company issued $420,000,000 aggregate principal amount of its ZYPS, for net proceeds of approximately $412.8 million. The ZYPS are unsecured senior obligations of the Company ranking equally with all of the Company's existing and future unsecured senior indebtedness and are senior in right of payment to any of the Company's existing and future subordinated indebtedness. The ZYPS are convertible, contingent upon the occurrence of certain events, into shares of the Company's common stock at a conversion price of $17.97 per share. The ability of the holders to convert the ZYPS into common stock is subject to certain conditions including: (i) during any fiscal quarter, if the closing price per share for a period of at least a thirty consecutive trading-day period ending on the last trading day of the preceding fiscal quarter is more than 120% of the conversion price per share in effect on that thirtieth day; (ii) on or before May 15, 2018, if during the five business-day period following any ten consecutive trading-day period in which the daily average trading price for the ZYPS for that ten trading-day period was less than 105% of the average conversion value for the ZYPS during that period; (iii) during any period, if following the date on which the credit rating assigned to the ZYPS by Standard & Poor's Rating Services is lower than "B-" or upon the withdrawal or suspension of the ZYPS rating at the Company's request; (iv) if the Company calls the ZYPS for redemption; or (v) upon other specified corporate transactions. The ZYPS mature on May 15, 2023. The Company has the right to redeem the ZYPS for cash at any time on or after May 15, 2008, at their principal amount. The holders have a series of put options, pursuant to which they may require the Company to repurchase all or a portion of the ZYPS on each of May 15 of 2008, 2013, and 2018 and upon the occurrence of certain events. The ZYPS holders may require the Company to repurchase the ZYPS at par in the event that the common stock ceases to be publicly traded and, in certain instances, upon a change in control of the Company. Upon the occurrence of a change in control, instead of paying the repurchase price in cash, the Company may, under certain circumstances, pay the repurchase price in common stock. In November and December 2000, the Company issued $600,000,000 aggregate principal amount of its Debentures. The Debentures are unsecured senior obligations of the Company ranking equally with all of the Company's existing and future unsecured senior indebtedness and are senior in right of payment to any of the Company's existing and future subordinated indebtedness. The Debentures are convertible, at the option of the holders, into shares of the Company's common stock at a conversion price of $116.325 per share, subject to adjustment in certain events; and are subject to redemption at any time on or after December 1, 2003, in whole or in part, at the option of the Company, at redemption prices (expressed as percentages of the principal amount) of 100.375% if redeemed during the twelve-month period beginning December 1, 2003, and 100% of the principal amount if redeemed thereafter. The Debenture holders may require the Company to repurchase the Debentures at par in the event that the common stock ceases to be publicly traded and, in certain instances, upon a change in control of the Company. Upon the occurrence of a change in control, instead of paying the repurchase price in cash, the Company may, under certain circumstances, pay the repurchase price in common stock. During the three month periods ended April 30, 2003 and 2004, the Company acquired, in open market purchases, $44,550,000 and $30,495,000 of face amount of the Debentures, respectively, resulting in a pre-tax gain, net of debt 8 issuance costs, of approximately $2,809,000 and $244,000, respectively, included in `Interest and other income, net' in the Condensed Consolidated Statements of Operations. As of April 30, 2004, the Company had outstanding Debentures of $94,228,000. During May 2004, the Company acquired, in open market purchases, $6,975,000 of face amount of the Debentures, resulting in a pre-tax gain, net of debt issuance costs, of approximately $98,000. ISSUANCE OF SUBSIDIARY STOCK. In February 2004, Starhome B.V. ("Starhome"), a subsidiary of CTI, received equity financing from an unaffiliated investor group of approximately $14,700,000, net of expenses. The Company recorded a gain of approximately $11,900,000, which was recorded as an increase in stockholders' equity as a result of the issuance of subsidiary stock. Upon the completion of this transaction, the Company's ownership interest in Starhome was approximately 69.5%. In addition, Starhome received a commitment for an additional $5,000,000 in equity financing from the unaffiliated investor group. ACQUISITION. On March 31, 2004, Verint Systems Inc. ("Verint") acquired certain assets and assumed certain liabilities of the government surveillance business of ECtel Ltd. ("ECtel"). The acquisition is expected to provide Verint with additional communications interception capabilities for the mass collection and analysis of voice and data communications. These technologies will be integrated into Verint's existing product offerings. The purchase price was $35,000,000. Verint incurred transaction costs, consisting primarily of professional fees, amounting to approximately $1,067,000 in connection with this acquisition. The acquisition was accounted for using the purchase method. The purchase price was allocated to the assets and liabilities of ECtel based on the estimated fair value of those assets and liabilities as of March 31, 2004. The results of operations of ECtel have been included in the Company's results of operations since March 31, 2004. Identifiable intangible assets consist of sales backlog, acquired technology, customer relationships, and non-competition agreements and have estimated useful lives of up to ten years. Purchased in-process research and development represents the value assigned to research and development projects of the acquired business that were commenced but not completed at the date of acquisition, for which technological feasibility had not been established and which have no alternative future use in research and development activities or otherwise. In accordance with SFAS No. 2, "Accounting for Research and Development Costs," as interpreted by FASB Interpretation No. 4, amounts assigned to purchased in-process research and development meeting the above criteria must be charged to expense at the acquisition date. At the acquisition date, it was estimated that the purchased in-process research and development was approximately 40% complete and it was expected that the remaining 60% would be completed during the ensuing year. The fair value of the purchased in-process research and development was determined by an independent valuation using the income approach, which reflects the projected free cash flows that will be generated by the purchased in-process research and development projects and discounting the projected net cash flows back to their present value using a discount rate of 21%. As a result of the acquisition of the government surveillance business of ECtel, Verint had certain capitalized software development costs that became impaired due to the existence of duplicative technology and, accordingly, were written-down to their net realizable value at the date of acquisition. Such impairment charge amounted to approximately $1,481,000 and is included in 'In-process research and development and other acquisition-related charges' in the Condensed Consolidated Statements of Operations. 9 The following is a summary of the allocation of the purchase price for this acquisition: (IN THOUSANDS) Purchase price $ 35,000 Acquisition costs 1,067 ------------ Total purchase price $ 36,067 ============ Fair value of assets acquired $ 1,417 Fair value of liabilities assumed (3,282) In-process research and development 3,154 Sales backlog 854 Acquired technology 5,307 Customer relationships 1,382 Non-competition agreements 2,221 Goodwill 25,014 ------------ Total purchase price $ 36,067 ============ A summary of pro forma results of operations has not been presented as the effect of this acquisition was not deemed material. WORKFORCE REDUCTION, RESTRUCTURING AND IMPAIRMENT CHARGES. During the year ended January 31, 2002, the Company committed to and began implementing a restructuring program, including changes to its organizational structure and product offerings, to better align its cost structure with the business environment and to improve the efficiency of its operations via reductions in workforce, restructuring of operations and the write-off of impaired assets. In connection with these actions, during the three year period ended January 31, 2004, the Company incurred net charges to operations primarily pertaining to severance and other related costs, the elimination of excess facilities and related leasehold improvements and the write-off of certain property and equipment and other impaired assets. During the three month period ended April 30, 2004, the Company incurred an additional charge of $698,000 relating to severance and other related costs. As of April 30, 2004, the Company had an accrual of approximately $26,876,000 relating to workforce reduction and restructuring. A roll-forward of the workforce reduction and restructuring accrual from January 31, 2004 is as follows: 10

WORKFORCE ACCRUAL REDUCTION, ACCRUAL BALANCE AT RESTRUCTURING BALANCE AT FEBRUARY 1, & IMPAIRMENT CASH APRIL 30, 2004 CHARGES PAYMENTS 2004 ---- ------- -------- ---- (IN THOUSANDS) Severance and related $ 3,068 $ 698 $ 1,669 $ 2,097 Facilities and related 26,427 - 1,648 24,779 -------- ------ -------- -------- Total $29,495 $ 698 $ 3,317 $ 26,876 ======== ====== ======== ========

Severance and related costs consist primarily of severance payments to terminated employees, fringe related costs associated with severance payments, other termination costs and legal and consulting costs. The balance of these severance and related costs is expected to be paid during the year ended January 31, 2005. Facilities and related costs consist primarily of contractually obligated lease liabilities and operating expenses related to facilities that were vacated primarily in the United States and Israel as a result of the restructuring. The balance of these facilities and related costs is expected to be paid at various dates through January 2011. BUSINESS SEGMENT INFORMATION. The Company's reporting segments are as follows: Comverse Network Systems ("CNS") - Enable telecommunications service providers ("TSP") to offer products to enhance the communication experience and generate TSP traffic and revenue. These services comprise four primary categories: call completion and call management solutions; advanced messaging solutions for groups, communities and person-to-person communication; solutions and enablers for the management and delivery of data and content-based services; and real-time billing and account management solutions for dynamic service environments and other components and applications. Service Enabling Signaling Software - Enable equipment manufacturers, application developers, and service providers to deploy revenue generating infrastructure and enhanced services for wireline, wireless and Internet communications. These services include global roaming, voice and text messaging, prepaid calling and emergency-911. These products are also embedded in a range of packet softswitching products to interoperate or converge voice and data networks and facilitate services such as VoIP, hosted IP telephony, and virtual private networks. This segment represents the Company's Ulticom subsidiary. Security and Business Intelligence Recording - Provides analytic software-based solutions for communications interception, networked video and contact centers. The software generates actionable intelligence through the collection, retention and analysis of voice, fax, video, email, Internet and data transmissions from multiple types of communications networks. This segment represents the Company's Verint subsidiary. All Other - Includes other miscellaneous operations. Reconciling items - consists of the following: Sales - elimination of intersegment revenues. Income (Loss) from Operations - elimination of intersegment income (loss) from operations and corporate operations. Total Assets - elimination of intersegment receivables and unallocated corporate assets. 11 The table below presents information about sales, income (loss) from operations and segment assets as of and for the three month periods ended April 30, 2003 and 2004:

Service Security and Comverse Enabling Business Network Signaling Intelligence All Reconciling Consolidated Systems Software Recording Other Items Totals ------- -------- --------- ----- ----- ------ (In thousands) THREE MONTHS ENDED APRIL 30, 2003: Sales $ 125,876 $ 9,129 $ 44,415 $ 2,244 $ (1,112) $ 180,552 Income (loss) from operations $ (18,312) $ 377 $ 3,499 $ (252) $ (1,693) $ (16,381) THREE MONTHS ENDED APRIL 30, 2004: Sales $ 150,081 $ 13,189 $ 56,638 $ 2,594 $ (1,107) $ 221,395 Income (loss) from operations $ 1,841 $ 2,640 $ 861 $ (272) $ (2,637) $ 2,433 TOTAL ASSETS: April 30, 2003 $ 959,043 $ 237,749 $ 173,698 $ 32,036 $ 899,697 $ 2,302,223 April 30, 2004 $ 829,682 $ 246,412 $ 342,005 $ 36,333 $ 1,258,222 $ 2,712,654

12 LITIGATION. On March 16, 2004, BellSouth Intellectual Property Corp. ("BellSouth") filed a complaint in the United States District Court for the Northern District of Georgia against Comverse Technology, Inc. alleging infringement of Patent Nos. 5,857,013 and 5,764,747, and, on March 17, 2004, BellSouth amended the complaint, removing any and all references to Comverse Technology, Inc., and naming Comverse, Inc., in an action captioned: BellSouth Intellectual Property Corp. v. Comverse, Inc., Civil Action No. 1:04-CV-0739. BellSouth alleges that Patent Nos. 5,857,013 and 5,764,747 cover certain aspects of some of Comverse Inc.'s systems, and it seeks, among other relief, monetary damages and injunctive relief. On May 5, 2004, Comverse, Inc. filed an answer and counterclaims which, among other things, denies any infringement and seeks a declaratory judgment that the patents at issue are invalid and unenforceable. The Company believes all claims are without merit and Comverse, Inc. will vigorously defend against BellSouth's claims. From time to time, the Company is subject to claims in legal proceedings arising in the normal course of its business. The Company does not believe that it is currently party to any other pending legal action that could reasonably be expected to have a material adverse effect on its business, financial condition and results of operations. 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. RESULTS OF OPERATIONS SUMMARY OF RESULTS Consolidated results of operations in dollars and as a percentage of sales for each of the three month periods ended April 30, 2003 and 2004 were as follows:

Three months ended Three months ended April 30, 2003 % of sales April 30, 2004 % of sales -------------------------------------------------------------------------------- (In thousands) Sales $ 180,552 100.0% $ 221,395 100.0% Cost of sales 80,373 44.5% 89,592 40.5% -------------- -------------- Gross margin 100,179 55.5% 131,803 59.5% Operating expenses: Research and development, net 54,488 30.2% 55,542 25.1% Selling, general and administrative 62,072 34.4% 68,495 30.9% In-process research and development and other acquisition-related charges - - 4,635 2.1% Workforce reduction, restructuring and impairment charges - - 698 0.3% -------------- -------------- Income (loss) from operations (16,381) (9.1)% 2,433 1.1% Interest and other income, net 13,336 7.4% 7,645 3.5% -------------- -------------- Income (loss) before income tax provision, minority interest and equity in the earnings (losses) of affiliates (3,045) (1.7)% 10,078 4.6% Income tax provision 1,980 1.1% 1,492 0.7% Minority interest and equity in the earnings (losses) of affiliates (794) (0.4)% (1,585) (0.7)% -------------- -------------- Net income (loss) $ (5,819) (3.2)% $ 7,001 3.2% ============== ==============

INTRODUCTION As explained in greater detail in "Certain Trends and Uncertainties", the Company's two business units serving telecommunications markets are operating within an industry that has been experiencing a challenging capital spending environment, although there is some evidence of recent improvement. Both business units achieved year over year and sequential revenue growth and operating income during the three month period ended April 30, 2004. Verint, which services the security and business intelligence markets, achieved record revenue based, in part, on increased sales due to heightened awareness surrounding homeland defense and security related initiatives in the United States and abroad as well as increased business intelligence sales. Overall, for the three month period ended April 30, 2004, the Company experienced year over 14 year and sequential sales growth of 22.6% and 9.0%, respectively, with a substantial majority of sales for the period generated from activities serving the telecommunications industry. The Company generated operating and net income for the period. THREE MONTH PERIOD ENDED APRIL 30, 2004 COMPARED TO THREE MONTH PERIOD ENDED APRIL 30, 2003 Sales. Sales for the three month period ended April 30, 2004 increased by approximately $40.8 million, or 23%, compared to the three month period ended April 30, 2003. This increase is attributable to an increase in sales in the Company's three primary business units. CNS sales increased by approximately $24.2 million due primarily to increased business in Europe and Asia Pacific only partially offset by decreased business in the Americas. Security and business intelligence recording sales increased by approximately $12.2 million and service enabling signaling software sales increased by approximately $4.1 million. On a consolidated basis, sales to customers in North America represented approximately 40% and 44% of total sales for the three month periods ended April 30, 2004 and 2003, respectively. Cost of Sales. Cost of sales for the three month period ended April 30, 2004 increased by approximately $9.2 million, or 11%, compared to the three month period ended April 30, 2003. The increase in cost of sales is primarily attributable to increased materials and overhead and personnel-related costs of approximately $4.7 million and $3.5 million, respectively, and net increase in various other costs of approximately $1.0 million. Gross margins for the three month period ended April 30, 2004 increased to approximately 59.5% from approximately 55.5% in the corresponding 2003 period. Research and Development, Net. Net research and development expenses for the three month period ended April 30, 2004 increased by approximately $1.1 million, or 2%, compared to the three month period ended April 30, 2003. The increase in net research and development expenses is primarily attributable to increased personnel-related costs of approximately $1.0 million. Selling, General and Administrative. Selling, general and administrative expenses for three month period ended April 30, 2004 increased by approximately $6.4 million, or 10%, compared to the three month period ended April 30, 2003, and as a percentage of sales for the three month period ended April 30, 2004, decreased to approximately 30.9% from approximately 34.4% in the corresponding 2003 period. The increase in the dollar amount of selling, general and administrative expenses for three month period is primarily due to increased employee and agent sales commissions, personnel-related costs, professional fees and travel costs of approximately $2.5 million, $2.2 million, $1.4 million and $1.3 million, respectively, and net increase in various other costs of approximately $1.5 million, partially offset by lower bad debt expense of approximately $2.5 million. In-process Research and Development and Other Acquisition-related Charges. During the three month period ended April 30, 2004, the Company incurred approximately $4.6 million for in-process research and development and other acquisition-related charges resulting from Verint's purchase of ECtel's government surveillance business, as follows: (i) approximately $3.1 million of purchased in-process research and development, which was charged to expense at the acquisition, and (ii) approximately $1.5 million for the write-down of 15 certain capitalized software development costs to their net realizable value at the date of acquisition, due to impairment caused by the existence of duplicative technology. Workforce reduction, restructuring and impairment charges. During the year ended January 31, 2002, the Company committed to and began implementing a restructuring program to better align its cost structure with the business environment and to improve the efficiency of its operations via reductions in workforce, restructuring of operations and the write-off of impaired assets. In connection with the restructuring, the Company changed its organizational structure and product offerings, resulting in the impairment of certain assets. In connection with these actions, during the three months ended April 30, 2004, the Company incurred charges to operations of approximately $0.7 million for severance and other related costs. The Company expects to pay out approximately $2.1 million for severance and related obligations during the year ended January 31, 2005 and approximately $24.8 million for facilities and related obligations at various dates through January 2011. Interest and Other Income, Net. Interest and other income, net, for the three month period ended April 30, 2004 decreased by approximately $5.7 million compared to the three month period ended April 30, 2003. The principal reasons for the decrease are (i) a decrease in foreign currency gains of approximately $4.8 million; (ii) a decrease in the gain recorded as a result of the Company's repurchases of its Debentures of approximately $2.6 million; and (iii) other decreases of approximately $0.1 million, net. Such items were offset by (i) decreased interest expense of approximately $1.3 million, due primarily to the Company's repurchases of its Debentures and other debt reduction; (ii) a change in the net gains/losses from the sale and write-down of investments of approximately $0.3 million; and (iii) decreased interest and dividend income of approximately $0.2 million. Income Tax Provision. Provision for income taxes for the three month period ended April 30, 2004 decreased by approximately $0.5 million, or 25%, compared to the three month period ended April 30, 2003, due primarily to shifts in the underlying mix of pre-tax income by entity and tax jurisdiction. The Company's overall rate of tax is reduced significantly by the existence of net operating loss carryforwards for Federal income tax purposes in the United States, as well as the tax benefits associated with qualified activities of certain of its Israeli subsidiaries, which are entitled to favorable income tax rates under a program of the Israeli Government for "Approved Enterprise" investments in that country. Minority Interest and Equity in the Earnings (Losses) of Affiliates. Minority interest and equity in the earnings (losses) of affiliates increased by approximately $0.8 million as a result of increased minority interest expense of approximately $0.3 million, primarily attributable to overall increased earnings at majority-owned subsidiaries, and a change in equity in the earnings (losses) of affiliates of approximately $0.5 million. Net Income (Loss). Net income (loss) for the three month period ended April 30, 2004 increased by approximately $12.8 million compared to the three month period ended April 30, 2003, while as a percentage of sales was approximately 3.2% and (3.2)% in the three month periods ended April 30, 2004 and 2003, respectively. These variances resulted primarily from the factors described above. 16 LIQUIDITY AND CAPITAL RESOURCES The Company's working capital at April 30, 2004 and January 31, 2004 was approximately $2,115.8 million and $2,141.3 million, respectively. At April 30, 2004 and January 31, 2004, the Company had total cash and cash equivalents, bank time deposits and short-term investments of approximately $2,146.7 million and $2,198.5 million, respectively. Operations for the three month periods ended April 30, 2004 and 2003, after adjustment for non-cash items, provided cash of approximately $31.3 million and $15.6 million, respectively. During such periods, other changes in operating assets and liabilities provided (used) cash of approximately $(37.0) million and $21.7 million, respectively. This resulted in net cash provided by (used in) operating activities of approximately $(5.7) million and $37.3 million, respectively. Investing activities for the three month periods ended April 30, 2004 and 2003 provided cash of approximately $245.0 million and $59.2 million, respectively. These amounts include (i) net maturities and sales (purchases) of bank time deposits and investments of approximately $288.9 million and $70.0 million, respectively; (ii) purchases of property and equipment of approximately $(7.2) million and $(8.5) million, respectively; (iii) capitalization of software development costs of approximately $(1.1) million and $(2.3) million, respectively; and (iv) net assets acquired as a result of an acquisition of approximately $(35.6) million for the three months ended April 30, 2004. Financing activities for the three month periods ended April 30, 2004 and 2003 provided (used) cash of approximately $1.5 million and $(81.0) million, respectively. These amounts include (i) repurchases of Debentures of approximately $(30.0) million and $(41.3) million, respectively; (ii) repayment of bank loan of $(42.0) million for the three months ended April 30, 2003; (iii) net proceeds from the issuance of stock in connection with the exercise of stock options and employee stock purchase plans and the sale of stock by one of the Company's subsidiaries of approximately $31.8 million and $5.3 million, respectively, and (iv) other, net of approximately $(0.2) million and $(3.1) million, respectively. During the three month periods ended April 30, 2003 and 2004, the Company acquired, in open market purchases, approximately $44.6 million and $30.5 million of face amount of the Debentures, respectively, resulting in a pre-tax gain, net of debt issuance costs, of approximately $2.8 million and $0.2 million, respectively, included in `Interest and other income, net' in the Condensed Consolidated Statements of Operations. As of April 30, 2004, the Company had outstanding Debentures of approximately $94.2 million. During May 2004, the Company acquired, in open market purchases, approximately $7.0 million of face amount of the Debentures, resulting in a pre-tax gain, net of debt issuance costs, of approximately $0.1 million. During February 2003, Verint repaid a bank loan in the amount of $42.0 million. In February 2004, Starhome received equity financing from an unaffiliated investor group of approximately $14.7 million, net of expenses. The Company recorded a gain of approximately $11.9 million, which was recorded as an increase in stockholders' equity as a result of the issuance of subsidiary stock. Upon the completion of this transaction, the Company's ownership interest in Starhome was approximately 69.5%. In addition, Starhome received a commitment 17 for an additional $5.0 million in equity financing from the unaffiliated investor group. On March 31, 2004, Verint acquired certain assets and assumed certain liabilities of the government surveillance business of ECtel. The purchase price was $35.0 million. Verint incurred transaction costs, consisting primarily of professional fees, amounting to approximately $1.1 million in connection with this acquisition. The Company's liquidity and capital resources have not been, and are not anticipated to be, materially affected by restrictions pertaining to the ability of its foreign subsidiaries to pay dividends or by withholding taxes associated with any such dividend payments. The Company regularly examines opportunities for strategic acquisitions of other companies or lines of business and anticipates that it may from time to time issue additional debt and/or equity securities either as direct consideration for such acquisitions or to raise additional funds to be used (in whole or in part) in payment for acquired securities or assets. The issuance of such securities could be expected to have a dilutive impact on the Company's shareholders, and there can be no assurance as to whether or when any acquired business would contribute positive operating results commensurate with the associated investment. The Company believes that its existing working capital, together with funds generated from operations, will be sufficient to provide for its planned operations for the foreseeable future. CERTAIN TRENDS AND UNCERTAINTIES The Company derives the majority of its revenue from the telecommunications industry, which is experiencing a challenging capital spending environment. While there is some evidence that the capital spending environment has improved, the spending by the Company's customers remains uncertain. The Company's operating results and financial condition have been adversely affected by declines in technology purchases and capital expenditures by TSPs, and the Company's operating results and financial condition will be adversely affected in the event deterioration in capital expenditures by TSPs resumes. For these reasons and the risk factors outlined below, it has been and continues to be very difficult for the Company to accurately forecast future revenues and operating results. The Company's business is particularly dependent on the strength of the telecommunications industry. The telecommunications industry, including the Company, have been negatively affected by, among other factors, the high costs and large debt positions incurred by some TSPs to expand capacity and enable the provision of future services (and the corresponding risks associated with the development, marketing and adoption of these services as discussed below), including the cost of acquisitions of licenses to provide broadband services and reductions in TSPs' actual and projected revenues and deterioration in their actual and projected operating results. Accordingly, TSPs, including the Company's customers, have significantly reduced their actual and planned expenditures to expand or replace equipment and delayed and reduced the deployment of services. A number of TSPs, including certain customers of the Company, also have indicated the existence of conditions of excess capacity in certain markets. 18 In addition, certain TSPs have delayed the planned introduction of new services, such as broadband mobile telephone services, that would be supported by certain of the Company's products. Certain of the Company's customers also have implemented changes in procurement practices and procedures, including limitations on purchases in anticipation of estimated future capacity requirements, and in the management and use of their networks, that have reduced the Company's sales, which also has made it very difficult for the Company to project future sales. The continuation and/or exacerbation of these negative trends will have an adverse effect on the Company's future results. In addition to loss of revenue, weakness in the telecommunications industry has affected and will continue to affect the Company's business by increasing the risks of credit or business failures of suppliers, customers or distributors, by customer requirements for vendor financing and longer payment terms, by delays and defaults in customer or distributor payments, and by price reductions instituted by competitors to retain or acquire market share. The Company's current plan of operations is predicated in part on a recovery in capital expenditures by its customers. In the absence of such improvement, the Company would experience deterioration in its operating results, and may determine to modify its plan for future operations accordingly, which may include, among other things, additional reductions in its workforce. The Company intends to continue to make significant investments in its business, and to examine opportunities for growth through acquisitions and strategic investments. These activities may involve significant expenditures and obligations that cannot readily be curtailed or reduced if anticipated demand for the associated products does not materialize or is delayed. The impact of these decisions on future financial results cannot be predicted with assurance, and the Company's commitment to growth may increase its vulnerability to downturns in its markets, technology changes and shifts in competitive conditions. The Company also may not be able to identify future suitable merger or acquisition candidates, and even if the Company does identify suitable candidates, it may not be able to make these transactions on commercially acceptable terms, or at all. If the Company does make acquisitions, it may not be able to successfully incorporate the personnel, operations and customers of these companies into the Company's business. In addition, the Company may fail to achieve the anticipated synergies from the combined businesses, including marketing, product integration, distribution, product development and other synergies. The integration process may further strain the Company's existing financial and managerial controls and reporting systems and procedures. This may result in the diversion of management and financial resources from the Company's core business objectives. In addition, an acquisition or merger may require the Company to utilize cash reserves, incur debt or issue equity securities, which may result in a dilution of existing stockholders, and the Company may be negatively impacted by the assumption of liabilities of the merged or acquired company. Due to rapidly changing market conditions, the Company may find the value of its acquired technologies and related intangible assets, such as goodwill as recorded in the Company's financial statements, to be impaired, resulting in charges to operations. The Company may also fail to retain the acquired or merged companies' key employees and customers. In May 2003, the Company issued $420,000,000 aggregate principal amount of its ZYPS. The ZYPS are convertible into shares of the Company's common stock at a conversion price of $17.97 per share, which would result in the issuance of an aggregate of approximately 23.4 million shares, subject to 19 adjustment upon the occurrence of specified events. The ability of the holders to convert the ZYPS into common stock is subject to certain conditions including: (i) during any fiscal quarter, if the closing price per share for a period of at least a thirty consecutive trading-day period ending on the last trading day of the preceding fiscal quarter is more than 120% of the conversion price per share in effect on that thirtieth day; (ii) on or before May 15, 2018, if during the five business-day period following any ten consecutive trading-day period in which the daily average trading price for the ZYPS for that ten trading-day period was less than 105% of the average conversion value for the ZYPS during that period; (iii) during any period, if following the date on which the credit rating assigned to the ZYPS by Standard & Poor's Rating Services is lower than "B-" or upon the withdrawal or suspension of the ZYPS rating at the Company's request; (iv) if the Company calls the ZYPS for redemption; or (v) upon other specified corporate transactions. The ZYPS mature on May 15, 2023. The Company has the right to redeem the ZYPS for cash at any time on or after May 15, 2008, at their principal amount. The holders have a series of put options, pursuant to which they may require the Company to repurchase all or a portion of the ZYPS on each of May 15 of 2008, 2013, and 2018 and upon the occurrence of certain events. The ZYPS holders may require the Company to repurchase the ZYPS at par in the event that the common stock ceases to be publicly traded and, in certain instances, upon a change in control of the Company. The Company may not have enough cash or have the ability to access enough cash to pay the ZYPS. If any of the conditions for conversion of the ZYPS is achieved it will result in dilution of the Company's earnings per share by adding approximately 23.4 million shares to the share count in calculating the Company's earnings per share. If the ZYPS are converted into the Company's shares it will result in dilution of existing stockholders. The Company has made, and in the future, may continue to make strategic and other investments in companies. These investments have been made in, and future investments will likely be made in, immature businesses with unproven track records and technologies. Such investments have a high degree of risk, with the possibility that the Company may lose the total amount of its investments. The Company may not be able to identify suitable investment candidates, and, even if it does, the Company may not be able to make those investments on acceptable terms, or at all. In addition, even if the Company makes investments, it may not gain strategic or other benefits from those investments. The Company's products involve sophisticated hardware and software technology that performs critical functions to highly demanding standards. There can be no assurance that the Company's current or future products will not develop operational problems, which could have a material adverse effect on the Company. The Company offers complex products that may contain undetected defects or errors, particularly when first introduced or as new versions are released. The Company may not discover such defects or errors until after a product has been released and used by the customer. Significant costs may be incurred to correct undetected defects or errors in the Company's products and these defects or errors could result in future lost sales. Defects or errors in the Company's products also may result in product liability claims, which could cause adverse publicity and impair their market acceptance. In addition, the Company may incur fees or penalties in connection with problems associated with its products and services. The telecommunications industry is subject to rapid technological change. The introduction of new technologies in the telecommunications market, including the delay in the adoption of such new technologies, and new alternatives for the delivery of services are having, and can be expected to 20 continue to have, a profound effect on competitive conditions in the market and the success of market participants, including the Company. In addition, some of the Company's products, such as call answering, have experienced declines in usage resulting from, among other factors, the introduction of new technologies and the adoption and increased use of existing technologies, which may include enhanced areas of coverage for mobile telephones and Caller ID type services. The Company's continued success will depend on its ability to correctly anticipate technological trends in its industries, to react quickly and effectively to such trends and to enhance its existing products and to introduce new products on a timely and cost-effective basis. As a result, the life cycle of the Company's products is difficult to estimate. The Company's new product offerings may not enter the market in a timely manner for their acceptance. New product offerings may not properly integrate into existing platforms, and the failure of these offerings to be accepted by the market could have a material adverse effect on the Company's business, results of operations, and financial condition. The Company's sales and operating results may be adversely affected in the event customers delay purchases of existing products as they await the Company's new product offerings. Changing industry and market conditions may dictate strategic decisions to restructure some business units and discontinue others. Discontinuing a business unit or product line may result in the Company recording accrued liabilities for special charges, such as costs associated with a reduction in workforce. These strategic decisions could result in changes to determinations regarding a product's useful life and the recoverability of the carrying basis of certain assets. The Company has made and continues to make significant investments in the areas of sales and marketing, and research and development. The Company's research and development activities, which may be delayed and behind schedule, include ongoing significant investment in the development of additional features and functionality for its existing and new product offerings. The success of these initiatives will be dependent upon, among other things, the emergence of a market for these types of products and their acceptance by existing and new customers. The Company's business may be adversely affected by its failure to correctly anticipate the emergence of a market demand for certain products or services, and changes in the evolution of market opportunities. If a sufficient market does not emerge for new or enhanced product offerings developed by the Company, if the Company is late in introducing new product offerings, or if the Company is not successful in marketing such products, the Company's continued growth could be adversely affected and its investment in those products may be lost. The Company relies on a limited number of suppliers and manufacturers for specific components and may not be able to find alternate manufacturers that meet its requirements and existing or alternative sources may not be available on favorable terms and conditions. Thus, if there is a shortage of supply for these components, the Company may experience an interruption in its product supply. In addition, loss of third party software licensing could materially and adversely affect the Company's business, financial condition and results of operations. The telecommunications industry continues to undergo significant change as a result of deregulation and privatization worldwide, reducing restrictions on competition in the industry. Unforeseen changes in the regulatory environment also may have an impact on the Company's revenues and/or costs in any given part of the world. The worldwide enhanced services industry is already highly competitive and the Company expects competition to intensify. The Company believes that existing competitors will continue to present substantial competition, and that other companies, many with considerably 21 greater financial, marketing and sales resources than the Company, may enter the enhanced services markets. Moreover, as the Company enters into new markets as a result of its own research and development efforts or acquisitions, it is likely to encounter new competitors. The Company's competitors may be able to develop more quickly or adapt faster to new or emerging technologies and changes in customer requirements, or devote greater resources to the development, promotion and sale of their products. Some of the Company's competitors have, in relation to it, longer operating histories, larger customer bases, longer standing relationships with customers, greater name recognition and significantly greater financial, technical, marketing, customer service, public relations, distribution and other resources. New competitors continue to emerge and there continues to be consolidation among existing competitors, which may reduce the Company's market share. In addition, some of the Company's customers may in the future decide to develop internally their own solutions instead of purchasing them from the Company. Increased competition could force the Company to lower its prices or take other actions to differentiate its products. The market for Verint's security and business intelligence products in the past has been affected by weakness in general economic conditions, delays or reductions in customers' information technology spending and uncertainties relating to government expenditure programs. Verint's business generated from government contracts may be adversely affected if: (i) Verint's reputation or relationship with government agencies is impaired, (ii) Verint is suspended or otherwise prohibited from contracting with a domestic or foreign government or any significant law enforcement agency, (iii) levels of government expenditures and authorizations for law enforcement and security related programs decrease, remain constant or shift to programs in areas where Verint does not provide products and services, (iv) Verint is prevented from entering into new government contracts or extending existing government contracts based on violations or suspected violations of laws or regulations, including those related to procurement, (v) Verint is not granted security clearances required to sell products to domestic or foreign governments or such security clearances are revoked, (vi) there is a change in government procurement procedures, or (vii) there is a change in political climate that adversely affects Verint's existing or prospective relationships. Competitive conditions in this sector also have been affected by the increasing use by certain potential customers of their own internal development resources rather than outside vendors to provide certain technical solutions. In addition, a number of established government contractors, particularly developers and integrators of technology products, have taken steps to redirect their marketing strategies and product plans in reaction to cut-backs in their traditional areas of focus, resulting in an increase in the number of competitors and the range of products offered in response to particular requests for proposals. The markets for Verint's security and business intelligence products are still emerging. Verint's growth is dependent on, among other things, the size and pace at which the markets for its products develop. If the markets for its products decrease, remain constant or grow slower than Verint anticipates, Verint will not be able to maintain its growth. Continued growth in the demand for Verint's products is uncertain as, among other reasons, its existing customers and potential customers may: (i) not achieve a return on their investment in its products; (ii) experience technical difficulty in utilizing its products; or (iii) use alternative solutions to achieve their security, intelligence or business objectives. In addition, as Verint's enterprise business intelligence products are sold primarily to contact centers, slower 22 than anticipated growth or a contraction in the number of contact centers will have a material adverse effect on the Verint's ability to maintain its growth. The global market for analytical solutions for security and business applications is intensely competitive, both in the number and breadth of competing companies and products and the manner in which products are sold. For example, Verint often competes for customer contracts through a competitive bidding process that subjects it to risks associated with: (i) the frequent need to bid on programs in advance of the completion of their design, which may result in unforeseen technological difficulties and cost overruns; and (ii) the substantial time and effort, including design, development and marketing activities, required to prepare bids and proposals for contracts that may not be awarded to Verint. A subsidiary of Verint, Verint Technology Inc. ("Verint Technology"), which sells and supports its communications interception solutions to various U.S. government agencies, is required by the National Industrial Security Program to maintain facility security clearances and to be insulated from foreign ownership, control or influence. The Company, Verint, Verint Technology and the Department of Defense entered into a proxy agreement, under which Verint, among other requirements, appointed three U.S. citizens holding the requisite security clearances to exercise all prerogatives of ownership of Verint Technology (including, without limitation, oversight of Verint Technology's security arrangements) as holders of proxies to vote Verint Technology stock. The proxy agreement may be terminated and Verint Technology's facility security clearances may be revoked in the event of a breach of the proxy agreement, or if it is determined by the Department of Defense that termination is in the national interest. If Verint Technology's facility security clearance is revoked, sales to U.S. government agencies will be adversely affected and may adversely affect sales to other international government agencies. In addition, concerns about the security of Verint, its personnel or its products may have a material adverse affect on Verint's business, financial condition and results of operations, including a negative impact on sales to U.S. and international government agencies. Many of Verint's government contracts contain provisions that give the governments party to those contracts rights and remedies not typically found in private commercial contracts, including provisions enabling the governments to: (i) terminate or cancel existing contracts for convenience; (ii) in the case of the U.S. government, suspend Verint from doing business with a foreign government or prevent Verint from selling its products in certain countries; (iii) audit and object to Verint's contract- related costs and expenses, including allocated indirect costs; and (iv) change specific terms and conditions in Verint's contracts, including changes that would reduce the value of its contracts. In addition, many jurisdictions have laws and regulations that deem government contracts in those jurisdictions to include these types of provisions, even if the contract itself does not contain them. If a government terminates a contract with Verint for convenience, Verint may not recover its incurred or committed costs, any settlement expenses or profit on work completed prior to the termination. If a government terminates a contract for default, Verint may not recover those amounts, and, in addition, it may be liable for any costs incurred by a government in procuring undelivered items and services from another source. Further, an agency within a government may share information regarding Verint's termination with other government agencies. As a result, Verint's on-going or prospective relationships with such other government agencies could be impaired. Verint must comply with domestic and foreign laws and regulations relating to the formation, administration and performance of government contracts. These laws and regulations affect how Verint does business with 23 government agencies in various countries and may impose added costs on its business. For example, in the United States, Verint is subject to the Federal Acquisition Regulations, which comprehensively regulate the formation, administration and performance of federal government contracts, and to the Truth in Negotiations Act, which requires certification and disclosure of cost and pricing data in connection with contract negotiations. Verint is subject to similar regulations in foreign countries as well. If a government review or investigation uncovers improper or illegal activities, Verint may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or debarment from doing business with government agencies, which could materially and adversely affect its business, financial condition and results of operations. In addition, a government may reform its procurement practices or adopt new contracting rules and regulations that could be costly to satisfy or that could impair Verint's ability to obtain new contracts. Verint's products are often used by customers to compile and analyze highly sensitive or confidential information and data, including information or data used in intelligence gathering or law enforcement activities. Verint may come into contact with such information or data when it performs support or maintenance functions for its customers. While Verint has internal policies, procedures and training for employees in connection with performing these functions, even the perception that such potential contact may pose a security risk or that any of Verint's employees has improperly handled sensitive or confidential information and data of a customer could harm its reputation and could inhibit market acceptance of its products. As the communications industry continues to evolve, governments may increasingly regulate products that monitor and record voice, video and data transmissions over public communications networks, such as Verint's solutions. For example, products which Verint sells in the United States to law enforcement agencies and which interface with a variety of wireline, wireless and Internet protocol networks, must comply with the technical standards established by the Federal Communications Commission pursuant to the Communications Assistance for Law Enforcement Act and products that it sells in Europe must comply with the technical standards established by the European Telecommunications Standard Institute. The adoption of new laws governing the use of Verint's products or changes made to existing laws could cause a decline in the use of its products and could result in increased expenses for Verint, particularly if it is required to modify or redesign its products to accommodate these new or changing laws. The Company has historically derived a significant portion of its sales and operating profit from contracts for large system installations with major customers. The Company continues to emphasize large capacity systems in its product development and marketing strategies. Contracts for large installations typically involve a lengthy and complex bidding and selection process, and the ability of the Company to obtain particular contracts is inherently difficult to predict. The timing and scope of these opportunities and the pricing and margins associated with any eventual contract award are difficult to forecast, and may vary substantially from transaction to transaction. The Company's future operating results may accordingly exhibit a higher degree of volatility than the operating results of other companies in its industries that have adopted different strategies, and also may be more volatile than the Company has experienced in prior periods. The degree of dependence by the Company on large system orders, and the investment required to enable the Company to perform such orders, without assurance of continuing order flow from the same customers and predictability of gross margins on any future orders, 24 increase the risk associated with its business. Because a significant proportion of the Company's sales of these large system installations occur in the late stages of a quarter, a delay, cancellation or other factor resulting in the postponement or cancellation of such sales may cause the Company to miss its financial projections, which may not be discernible until the end of a financial reporting period. The Company's gross margins also may be adversely affected by increases in material or labor costs, obsolescence charges, price competition and changes in channels of distribution or in the mix of products sold. During the period between the evaluation and purchase of a system, customers may defer or scale down proposed orders of the Company's products for, among other reasons: (i) changes in budgets and purchasing priorities; (ii) reduced need to upgrade existing systems; (iii) deferrals in anticipation of enhancements or new products; (iv) introduction of products by the Company's competitors; and (v) lower prices offered by the Company's competitors. Geopolitical, economic and military conditions could directly affect the Company's operations. The outbreak of severe acute respiratory syndrome ("SARS") curtailed travel to and from certain countries (primarily in the Asia-Pacific region). Restrictions on travel to and from these and other regions on account of additional incidents of SARS could have a material adverse effect on the Company's business, results of operations, and financial condition. The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause disruptions to the Company's business. To the extent that such disruptions result in delays or cancellations of customer orders, or the manufacture or shipment of the Company's products, the Company's business, operating results and financial condition could be materially and adversely affected. More recently, the U.S. military involvement in overseas operations including, for example, the war with Iraq, could have a material adverse effect on the Company's business, results of operations, and financial condition. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab neighbors, and the continued state of hostility, varying in degree and intensity, has led to security and economic problems for Israel. Since October 2000, there has been a significant increase in violence, primarily in the West Bank and Gaza Strip, and more recently Israel has experienced terrorist incidents within its borders. During this period, peace negotiations between Israel and representatives of the Palestinian Authority have been sporadic and currently are suspended. The Company could be materially adversely affected by hostilities involving Israel, the interruption or curtailment of trade between Israel and its trading partners, or a significant downturn in the economic or financial condition of Israel. In addition, the sale of products manufactured in Israel may be materially adversely affected in certain countries by restrictive laws, policies or practices directed toward Israel or companies having operations in Israel. The continuation or exacerbation of violence in Israel or the outbreak of violent conflicts involving Israel may impede the Company's ability to sell its products or otherwise adversely affect the Company. In addition, many of the Company's Israeli employees in Israel are required to perform annual compulsory military service in Israel and are subject to being called to active duty at any time under emergency circumstances. The absence of these employees may have an adverse effect upon the Company's operations. The Company's costs of operations have at times been affected by changes in the cost of its operations in Israel, resulting from changes in the value of the Israeli shekel relative to the United States dollar, which for certain periods had a negative impact, and from difficulties in attracting and 25 retaining qualified scientific, engineering and technical personnel in Israel, where the availability of such personnel has at times been severely limited. Changes in these cost factors have from time to time been significant and difficult to predict, and could in the future have a material adverse effect on the Company's results of operations. The Company's historical operating results reflect substantial benefits received from programs sponsored by the Israeli government for the support of research and development, as well as tax moratoriums and favorable tax rates associated with investments in approved projects ("Approved Enterprises") in Israel. Some of these programs and tax benefits have ceased and others may not be continued in the future and the availability of such benefits to the Company may be affected by a number of factors, including budgetary constraints resulting from adverse economic conditions, government policies and the Company's ability to satisfy eligibility criteria. The Israeli government has reduced the benefits available under some of these programs in recent years, and Israeli government authorities have indicated that the government may further reduce or eliminate some of these benefits in the future. The Company has regularly participated in a conditional grant program administered by the OCS under which it has received significant benefits through reimbursement of up to 50% of qualified research and development expenditures. Certain of the Company's subsidiaries currently pay royalties, of between 3% and 5% (or 6% under certain circumstances) of associated product revenues (including service and other related revenues) to the Government of Israel for repayment of benefits received under this program. Such royalty payments are currently required to be made until the government has been reimbursed the amounts received by the Company, which is linked to the U.S. dollar, plus, for amounts received under projects approved by the OCS after January 1, 1999, interest on such amount at a rate equal to the 12-month LIBOR rate in effect on January 1 of the year in which approval is obtained. As of April 30, 2004, such subsidiaries of the Company received approximately $54.7 million in cumulative grants from the OCS and recorded approximately $23.0 million in cumulative royalties to the OCS. During the year ended January 31, 2003, one of the Company's subsidiaries finalized an arrangement with the OCS whereby the subsidiary agreed to pay a lump sum royalty amount for all past amounts received from the OCS. In addition, this subsidiary began to receive lower amounts from the OCS than it had historically received, but will not have to pay royalty amounts on such grants. The amount of reimbursement received by the Company under this program has been reduced significantly, and the Company does not expect to receive significant reimbursement under this program in the future. In addition, permission from the Government of Israel is required for the Company to manufacture outside of Israel products resulting from research and development activities funded under these programs, or to transfer outside of Israel related technology rights. In order to obtain such permission, the Company may be required to increase the royalties to the applicable funding agencies and/or repay certain amounts received as reimbursement of research and development costs. The continued reduction in the benefits received by the Company under the program, or the termination of its eligibility to receive these benefits at all in the future, could adversely affect the Company's operating results. The Company's overall effective tax rate benefits from the tax moratorium provided by the Government of Israel for Approved Enterprises undertaken in that country. The Company's effective tax rate may increase in the future due to, among other factors, the increased proportion of its taxable income associated with activities in higher tax jurisdictions, and by the relative ages of the Company's eligible investments in Israel. The tax 26 moratorium on income from the Company's Approved Enterprise investments made prior to 1997 is four years, whereas subsequent Approved Enterprise projects are eligible for a moratorium of only two years. Reduced tax rates apply in each case for certain periods thereafter. To be eligible for these tax benefits, the Company must continue to meet conditions, including making specified investments in fixed assets and financing a percentage of investments with share capital. If the Company fails to meet such conditions in the future, the tax benefits would be canceled and the Company could be required to refund the tax benefits already received. Israeli authorities have indicated that additional limitations on the tax benefits associated with Approved Enterprise projects may be imposed for certain categories of taxpayers, which would include the Company. If further changes in the law or government policies regarding those programs were to result in their termination or adverse modification, or if the Company were to become unable to participate in, or take advantage of, those programs, the cost of the Company's operations in Israel would increase and there could be a material adverse effect on the Company's results of operations and financial condition. The Company's success is dependent on recruiting and retaining key management and highly skilled technical, managerial, sales, and marketing personnel. The market for highly skilled personnel remains very competitive despite the current economic conditions. The Company's ability to attract and retain employees also may be affected by recent cost control actions, including reductions in the Company's workforce and the associated reorganization of operations. The occurrence or perception of security breaches within the Company could harm the Company's business, financial condition and operating results. While the Company implements sophisticated security measures, third parties may attempt to breach the Company's security through computer viruses, electronic break-ins and other disruptions. If successful, confidential information, including passwords, financial information, or other personal information may be improperly obtained and the Company may be subject to lawsuits and other liability. Even if the Company is not held liable, a security breach could harm the Company's reputation, and even the perception of security risks, whether or not valid, could inhibit market acceptance of the Company's products. The Company currently derives a significant portion of its total sales from customers outside of the United States. International transactions involve particular risks, including political decisions affecting tariffs and trade conditions, rapid and unforeseen changes in economic conditions in individual countries, turbulence in foreign currency and credit markets, and increased costs resulting from lack of proximity to the customer. The Company is required to obtain export licenses and other authorizations from applicable governmental authorities for certain countries within which it conducts business. The failure to receive any required license or authorization would hinder the Company's ability to sell its products and could adversely affect the Company's business, results of operations and financial condition. In addition, legal uncertainties regarding liability, compliance with local laws and regulations, labor laws, employee benefits, currency restrictions, difficulty in accounts receivable collection, longer collection periods and other requirements may have a negative impact on the Company's operating results. Volatility in international currency exchange rates may have a significant impact on the Company's operating results. The Company has, and anticipates that it will continue to receive, contracts denominated in foreign currencies, particularly the euro. As a result of the unpredictable timing of 27 purchase orders and payments under such contracts and other factors, it is often not practicable for the Company to effectively hedge the risk of significant changes in currency rates during the contract period. The Company may experience risk associated with the failure to hedge the exchange rate risks associated with contracts denominated in foreign currencies and its operating results have been negatively impacted for certain periods and may continue to be affected to a material extent by the impact of currency fluctuations. Operating results may also be affected by the cost of such hedging activities that the Company does undertake. While the Company generally requires employees, independent contractors and consultants to execute non-competition and confidentiality agreements, the Company's intellectual property or proprietary rights could be infringed or misappropriated, which could result in expensive and protracted litigation. The Company relies on a combination of patent, copyright, trade secret and trademark law to protect its technology. Despite the Company's efforts to protect its intellectual property and proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use its products or technology. Effectively policing the unauthorized use of the Company's products is time-consuming and costly, and there can be no assurance that the steps taken by the Company will prevent misappropriation of its technology, particularly in foreign countries where in many instances the local laws or legal systems do not offer the same level of protection as in the United States. If others claim that the Company's products infringe their intellectual property rights, the Company may be forced to seek expensive licenses, reengineer its products, engage in expensive and time-consuming litigation or stop marketing its products. The Company attempts to avoid infringing known proprietary rights of third parties in its product development efforts. The Company does not regularly conduct comprehensive patent searches to determine whether the technology used in its products infringes patents held by third parties, however. There are many issued patents as well as patent applications in the fields in which the Company is engaged. Because patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed which relate to the Company's software and products. If the Company were to discover that its products violated or potentially violated third-party proprietary rights, it might not be able to obtain licenses to continue offering those products without substantial reengineering. Any reengineering effort may not be successful, nor can the Company be certain that any licenses would be available on commercially reasonable terms. While the Company occasionally files patent applications, it cannot be assured that patents will be issued on the basis of such applications or that, if such patents are issued, they will be sufficiently broad to protect its technology. In addition, the Company cannot be assured that any patents issued to it will not be challenged, invalidated or circumvented. Substantial litigation regarding intellectual property rights exists in technology related industries, and the Company expects that its products may be increasingly subject to third-party infringement claims as the number of competitors in its industry segments grows and the functionality of software products in different industry segments overlaps. In addition, the Company has agreed to indemnify certain customers in certain situations should it be determined that its products infringe on the proprietary rights of third parties. Any third-party infringement claims could be time consuming to defend, result in costly litigation, divert management's attention and resources, cause product and service delays or require the Company to enter into royalty or licensing agreements. Any royalty or licensing arrangements, if required, may 28 not be available on terms acceptable to the Company, if at all. A successful claim of infringement against the Company and its failure or inability to license the infringed or similar technology could have a material adverse effect on its business, financial condition and results of operations. The Company holds a large proportion of its net assets in cash equivalents and short-term investments, including a variety of public and private debt and equity instruments, and has made significant venture capital investments, both directly and through private investment funds. Such investments subject the Company to the risks inherent in the capital markets generally, and to the performance of other businesses over which it has no direct control. Given the relatively high proportion of the Company's liquid assets relative to its overall size, the results of its operations are materially affected by the results of the Company's capital management and investment activities and the risks associated with those activities. Declines in the public equity markets have caused, and may be expected to continue to cause, the Company to experience realized and unrealized investment losses. In addition, reduction in prevailing interest rates due to economic conditions or government policies has had and may continue to have an adverse impact on the Company's results of operations. The severe decline in the public trading prices of equity securities, particularly in the technology and telecommunications sectors, and corresponding decline in values of privately-held companies and venture capital funds in which the Company has invested, have, and may continue to have, an adverse impact on the Company's financial results. The Company has in the past benefited from the long-term rise in the public trading price of its shares in various ways, including its ability to use equity incentive arrangements as a means of attracting and retaining the highly qualified employees necessary for the growth of its business and its ability to raise capital on relatively attractive conditions. The decline in the price of the Company's shares, and the overall decline in equity prices generally, and in the shares of technology companies in particular, can be expected to make it more difficult for the Company to significantly rely on equity incentive arrangements as a means to recruit and retain talented employees. The Company's operating results have fluctuated in the past and may do so in the future. The trading price of the Company's shares has been affected by the factors disclosed herein as well as prevailing economic and financial trends and conditions in the public securities markets. Share prices of companies in technology-related industries, such as the Company, tend to exhibit a high degree of volatility, which at times is unrelated to the operating performance of a company. The announcement of financial results that fall short of the results anticipated by the public markets could have an immediate and significant negative effect on the trading price of the Company's shares in any given period. Such shortfalls may result from events that are beyond the Company's immediate control, can be unpredictable and, since a significant proportion of the Company's sales during each fiscal quarter tend to occur in the latter stages of the quarter, may not be discernible until the end of a financial reporting period. These factors may contribute to the volatility of the trading value of its shares regardless of the Company's long-term prospects. The trading price of the Company's shares may also be affected by developments, including reported financial results and fluctuations in trading prices of the shares of other publicly-held companies in the telecommunications equipment industry in general, and the Company's business segments in particular, which may not have any direct relationship with the Company's business or prospects. The Company's board of directors' ability to designate and issue up to 2,500,000 shares of preferred stock and to issue additional shares of common stock could adversely affect the voting power of the holders of common stock, 29 and could have the effect of making it more difficult for a person to acquire, or could discourage a person from seeking to acquire, control of the Company. If this occurs, investors could lose the opportunity to receive a premium on the sale of their shares in a change of control transaction. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Refer to Item 7A in the Company's Annual Report on Form 10-K for a discussion about the Company's exposure to market risks. ITEM 4. CONTROLS AND PROCEDURES. (a) The Company's management evaluated, with the participation of the Company's principal executive and principal financial officers, the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")), as of April 30, 2004. Based on their evaluation, the Company's principal executive and principal financial officers concluded that the Company's disclosure controls and procedures were effective as of April 30, 2004. (b) There has been no change in the Company's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the Company's fiscal quarter ended April 30, 2004, that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 30 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. On March 16, 2004, BellSouth Intellectual Property Corp. ("BellSouth") filed a complaint in the United States District Court for the Northern District of Georgia against Comverse Technology, Inc. alleging infringement of Patent Nos. 5,857,013 and 5,764,747, and, on March 17, 2004, BellSouth amended the complaint, removing any and all references to Comverse Technology, Inc., and naming Comverse, Inc., in an action captioned: BellSouth Intellectual Property Corp. v. Comverse, Inc., Civil Action No. 1:04-CV-0739. BellSouth alleges that Patent Nos. 5,857,013 and 5,764,747 cover certain aspects of some of Comverse Inc.'s systems, and it seeks, among other relief, monetary damages and injunctive relief. On May 5, 2004, Comverse, Inc. filed an answer and counterclaims which, among other things, denies any infringement and seeks a declaratory judgment that the patents at issue are invalid and unenforceable. The Company believes all claims are without merit and Comverse, Inc. will vigorously defend against BellSouth's claims. From time to time, the Company is subject to claims in legal proceedings arising in the normal course of its business. The Company does not believe that it is currently party to any other pending legal action that could reasonably be expected to have a material adverse effect on its business, financial condition and results of operations. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibit Index. 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certifications of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K. During the first quarter of 2004, the Company furnished a report on Form 8-K dated March 10, 2004, reporting under Items 7 and 12 that on March 10, 2004, the Company issued a press release announcing its financial results for the fourth quarter and fiscal year ended January 31, 2004. 31 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COMVERSE TECHNOLOGY, INC. Dated: June 8, 2004 /s/ Kobi Alexander ----------------------------------- Kobi Alexander Chairman of the Board and Chief Executive Officer Dated: June 8, 2004 /s/ David Kreinberg ----------------------------------- David Kreinberg Executive Vice President and Chief Financial Officer 32