10-Q 1 kl09017_10q.txt FORM 10-Q QUARTERLY REPORT 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 July 31, 2003 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 APPLICABLE ONLY TO CORPORATE ISSUERS: The number of shares of Common Stock, par value $0.10 per share, outstanding as of September 5, 2003 was 190,790,147 Page 1 of 31 Total Pages TABLE OF CONTENTS ----------------- Page ---- PART I Financial Information ITEM 1. Financial Statements. 1. Condensed Consolidated Balance Sheets as of January 31, 2003 and July 31, 2003 3 2. Condensed Consolidated Statements of Operations for the Three and Six Month Periods Ended July 31, 2002 and July 31, 2003 4 3. Condensed Consolidated Statements of Cash Flows for the Six Month Periods Ended July 31, 2002 and July 31, 2003 5 4. Notes to Condensed Consolidated Financial Statements 6 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. 15 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk. 29 ITEM 4. Controls and Procedures. 29 PART II Other Information ITEM 1. Legal Proceedings. 30 ITEM 6. Exhibits and Reports on Form 8-K. 30 SIGNATURES 31 Page 2 of 31 Total Pages PART I Financial Information ITEM 1. Financial Statements.

COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets (In thousands, except share data) January 31, July 31, 2003* 2003 (Unaudited) ASSETS ------ CURRENT ASSETS: Cash and cash equivalents $ 1,402,783 $ 1,383,340 Bank time deposits and short-term investments 406,089 727,033 Accounts receivable, net 212,953 179,022 Inventories 40,015 40,455 Prepaid expenses and other current assets 65,018 54,481 ----------- ----------- TOTAL CURRENT ASSETS 2,126,858 2,384,331 PROPERTY AND EQUIPMENT, net 146,380 137,367 OTHER ASSETS 130,421 138,919 ----------- ----------- TOTAL ASSETS $ 2,403,659 $ 2,660,617 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ CURRENT LIABILITIES: Accounts payable and accrued expenses $ 260,810 $ 245,079 Advance payments from customers 53,496 41,670 Other current liabilities 46,045 2,500 ----------- ----------- TOTAL CURRENT LIABILITIES 360,351 289,249 CONVERTIBLE DEBENTURES 390,838 577,830 OTHER LIABILITIES 19,230 20,860 ----------- ----------- TOTAL LIABILITIES 770,419 887,939 ----------- ----------- MINORITY INTEREST 83,548 153,203 ----------- ----------- STOCKHOLDERS' EQUITY: Common stock, $0.10 par value - authorized, 600,000,000 shares; issued and outstanding, 187,754,407 and 189,892,900 shares 18,775 18,989 Additional paid-in capital 1,078,720 1,162,859 Retained earnings 445,285 438,408 Accumulated other comprehensive income (loss) 6,912 (781) ----------- ----------- TOTAL STOCKHOLDERS' EQUITY 1,549,692 1,619,475 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,403,659 $ 2,660,617 =========== ===========

*The Condensed Consolidated Balance Sheet as of January 31, 2003 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. Page 3 of 31 Total Pages

COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Operations (Unaudited) (In thousands, except per share data) Six months ended Three months ended July 31, July 31, July 31, July 31, 2002 2003 2002 2003 Sales $ 392,404 $ 369,020 $ 181,210 $ 188,468 Cost of sales 171,122 161,697 79,345 81,324 --------- --------- --------- --------- Gross margin 221,282 207,323 101,865 107,144 Operating expenses: Research and development, net 123,757 108,292 60,834 53,804 Selling, general and administrative 146,011 125,065 72,498 62,993 Workforce reduction, restructuring and impairment charges (credits) 2,798 (233) 2,798 (233) --------- --------- --------- --------- Loss from operations (51,284) (25,801) (34,265) (9,420) Interest and other income, net 34,105 23,130 39,349 10,588 --------- --------- --------- --------- Income (loss) before income tax provision (17,179) (2,671) 5,084 1,168 Income tax provision 2,474 4,206 1,161 2,226 --------- --------- --------- --------- Net income (loss) $ (19,653) $ (6,877) $ 3,923 $ (1,058) ========= ========= ========= ========= Earnings (loss) per share: Basic $ (0.11) $ (0.04) $ 0.02 $ (0.01) ========= ========= ========= ========= Diluted $ (0.11) $ (0.04) $ 0.02 $ (0.01) ========= ========= ========= =========

The accompanying notes are an integral part of these financial statements. Page 4 of 31 Total Pages

COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (Unaudited) (In thousands) Six months ended July 31, July 31, 2002 2003 Cash flows from operating activities: Net cash from operations after adjustment for non-cash items $ 13,457 $ 32,953 Changes in assets and liabilities: Accounts receivable 83,521 35,609 Inventories 6,340 225 Prepaid expenses and other current assets 17,328 8,422 Accounts payable and accrued expenses (79,668) (17,519) Other, net (3,160) (14,691) ----------- ----------- Net cash provided by operating activities 37,818 44,999 ----------- ----------- Cash flows from investing activities: Maturities and sales (purchases) of bank time deposits and investments, net 137,040 (326,949) Purchases of property and equipment (16,330) (19,403) Capitalization of software development costs (7,594) (4,894) Net assets acquired (27,765) (5,910) ----------- ----------- Net cash provided by (used in) investing activities 85,351 (357,156) ----------- ----------- Cash flows from financing activities: Net proceeds from issuance of debentures -- 412,974 Repurchase of debentures (166,000) (221,446) Net repayments of bank loans and other debt (77) (46,205) Net proceeds from issuance of common stock 72,751 147,391 ----------- ----------- Net cash provided by financing activities (93,326) 292,714 ----------- ----------- Net increase (decrease) in cash and cash equivalents 29,843 (19,443) Cash and cash equivalents, beginning of period 1,361,862 1,402,783 ----------- ----------- Cash and cash equivalents, end of period $ 1,391,705 $ 1,383,340 =========== ===========

The accompanying notes are an integral part of these financial statements. Page 5 of 31 Total Pages 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, 2003. 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 and six month periods ended July 31, 2003 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 ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. Accordingly, no stock-based employee compensation cost is reflected in net income for any periods, as all options granted have an exercise price at least equal to the market value of the underlying common stock on the date of grant. 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. 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: Page 6 of 31 Total Pages

Three months ended July 31, ----------------------------- 2002 2003 ---------- ---------- (In thousands) Net income (loss), as reported $ 3,923 $ (1,058) Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (20,259) (39,914) ---------- ---------- Pro forma net loss $ (16,336) $ (40,972) ========== ========== Earnings (loss) per share: Basic - as reported $ 0.02 $ (0.01) Basic - pro forma $ (0.09) $ (0.22) Diluted - as reported $ 0.02 $ (0.01) Diluted - pro forma $ (0.09) $ (0.22)

Six months ended July 31, ----------------------------- 2002 2003 ---------- ---------- (In thousands) Net loss, as reported $ (19,653) $ (6,877) Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (59,317) (77,049) ---------- ---------- Pro forma net loss $ (78,970) $ (83,926) ========== ========== Loss per share: Basic - as reported $ (0.11) $ (0.04) Basic - pro forma $ (0.42) $ (0.45) Diluted - as reported $ (0.11) $ (0.04) Diluted - pro forma $ (0.42) $ (0.45)

Page 7 of 31 Total Pages Inventories. The composition of inventories at January 31, 2003 and July 31, 2003 is as follows: January 31, July 31, 2003 2003 (In thousands) Raw materials $ 17,111 $ 19,071 Work in process 12,430 13,944 Finished goods 10,474 7,440 -------- -------- $ 40,015 $ 40,455 ======== ======== 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. One of the Company's subsidiaries accrues royalties to the OCS for the sale of products incorporating technology developed in these projects. Another subsidiary of the Company is not required to pay royalties on such grants. 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 July 31, 2002 and 2003 were $4,733,000 and $3,781,000, respectively, and for the six month periods ended July 31, 2002 and 2003 were $5,937,000 and $4,989,000, 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 and six month periods ended July 31, 2002 and 2003 is as follows: Page 8 of 31 Total Pages

Three Months Ended Three Months Ended July 31, 2002 July 31, 2003 ------------- ------------- Net Per Share Net Per Share Income Shares Amount Loss Shares Amount (In thousands, except per share data) Basic EPS --------- Net Income (loss) $ 3,923 186,948 $ 0.02 $(1,058) 188,844 $ (0.01) ======== ======== Effect of Dilutive Securities ---------- Options 465 ----- Diluted EPS $ 3,923 187,413 $ 0.02 $(1,058) 188,844 $ (0.01) ======= ======= ======== ======= ======= ========

Six Months Ended Six Months Ended July 31, 2002 July 31, 2003 ------------- ------------- Net Per Share Net Per Share Loss Shares Amount Loss Shares Amount (In thousands, except per share data) Basic and Diluted EPS --------------------- Net loss $(19,653) 186,762 $ (0.11) $(6,877) 188,531 $ (0.04) ======== ======= ========= ======= ======= ========

The diluted loss per share computation for the three and six month periods ended July 31, 2003 and for the six month period ended July 31, 2002 excludes incremental shares of approximately 5,639,000, 3,935,000 and 1,262,000, respectively, related to employee stock options. These shares are excluded due to their antidilutive effect as a result of the Company's loss during these periods. The Company's 1.50% Convertible Senior Debentures due December 2005 (the "Debentures") were not included in the computation of diluted earnings per share for all periods because the effect of including them would be antidilutive. In addition, the Company's Zero Yield Puttable Securities due 2023 ("ZYPS") were not included in the computation of diluted earnings 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." Comprehensive Income (Loss). Total comprehensive income (loss) was $8,190,000 and $(7,748,000) for the three month periods ended July 31, 2002 and 2003, respectively, and $(19,284,000) and $(14,570,000) for the six month periods ended July 31, 2002 and 2003, respectively. The elements of comprehensive income (loss) include net income (loss), unrealized gains/losses on available for sale securities and foreign currency translation adjustments. Page 9 of 31 Total Pages Convertible Debentures. In May 2003, the Company issued $420,000,000 aggregate principal amount of its ZYPS, for net proceeds of approximately $413.0 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, among others, the closing price of the common stock exceeding 120% of the conversion price over certain periods and other specified events. 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 and six month periods ended July 31, 2002, the Company acquired, in open market purchases, $166,000,000 of face amount of the Debentures, resulting in a pre-tax gain, net of debt issuance costs, of approximately $31,502,000 included in 'Interest and other income, net' in the condensed consolidated statements of operations. During the three and six month periods ended July 31, 2003, the Company acquired, in open market purchases, $188,458,000 and $233,008,000 of face amount of the Debentures, respectively, resulting in a pre-tax gain, net of debt issuance costs, of approximately $6,405,000 and $9,214,000, respectively, included in 'Interest and other income, net' in the condensed consolidated statements of operations. As of July 31, 2003, the Company had outstanding Debentures of approximately $157,830,000. From August 1 through September 5, 2003, the Company acquired, in open Page 10 of 31 Total Pages market purchases, an additional $18,667,000 of face amount of the Debentures, resulting in a pre-tax gain, net of debt issuance costs, of approximately $733,000. Bank loan. In January 2002, Verint Systems Inc. ("Verint"), a majority-owned subsidiary of CTI, took a bank loan in the amount of $42,000,000. This loan, which matured in February 2003, bore interest at LIBOR plus 0.55% and was guaranteed by CTI. During February 2003, Verint repaid the bank loan. Acquisition. In May 2003, Verint acquired all of the issued and outstanding shares of Smartsight Networks Inc. ("Smartsight"), a Canadian corporation that develops IP-based video edge devices and software for wireless video transmission. The purchase price consisted of approximately $7,144,000 in cash and 149,731 shares of Verint common stock, valued at approximately $3,063,000, or $20.46 per share. In connection with this acquisition, Verint incurred transaction costs, consisting primarily of professional fees amounting to approximately $263,000. The acquisition was accounted for using the purchase method. The results of operations of Smartsight have been included in the Company's results of operations from May 1, 2003. A summary of the purchase price allocation as well as pro forma results of operations have not been presented as the effect of the acquisition is not deemed material to the Company's financial position or results of operations. Issuance of Subsidiary Stock. In June 2003, Verint completed a public offering of 5,750,000 shares of its common stock at a price of $23.00 per share. The shares offered included 149,731 shares issued to Smartsight's former shareholders in connection with its acquisition. CTI was not a selling stockholder in the offering. The proceeds of the offering were approximately $122.2 million, net of offering expenses. As a result of the offering, the Company's ownership interest in Verint was reduced to approximately 62.9% following completion of the offering. The Company recorded a gain of approximately $62.9 million, which was recorded as an increase in stockholders' equity as a result of the issuance. Workforce Reduction, Restructuring and Impairment Charges. During the years ended January 31, 2002 and 2003, the Company took steps 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, the Company took 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. As of July 31, 2003 the Company had an accrual of approximately $39,009,000 relating to workforce reduction and restructuring. A roll-forward of the workforce reduction and restructuring accrual from January 31, 2003 is as follows: Page 11 of 31 Total Pages

Workforce Accrual Reduction, Accrual Balance at Restructuring Balance at January 31, & Impairment Cash Non-Cash July 31, 2003 Credit, net Payments Charges 2003 ---------- ------------- -------- -------- ---------- (In thousands) Severance and related $ 9,367 $ 295 $ 7,758 $ -- $ 1,904 Facilities and related 40,454 (774) 2,575 -- 37,105 Property and equipment -- 246 -- 246 -- ------- ------- ------- ------- ------- Total $49,821 $ (233) $10,333 $ 246 $39,009 ======= ======= ======= ======= =======

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 by January 2004. Facilities and related costs consist primarily of contractually obligated lease liabilities and operating expenses related to facilities to be 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. Property and equipment costs consist primarily of the write-down of various assets to their current estimable fair value. Business Segment Information. The Company's reporting segments are as follows: Enhanced Services Solutions Products ("ESS"). Enable telecommunications service providers to offer a variety of revenue and traffic generating services accessible to large numbers of simultaneous users. These services include a broad range of messaging, information distribution and personal communications services, such as call answering with one-touch call return, voicemail, unified messaging (voice, fax, text, multimedia content and email in a single mailbox, media conversion such as email to voice and visual mailbox presentation), value-added services for roamers, prepaid wireless calling services, wireless data and Internet-based services such as short messaging services, wireless information and entertainment services, multimedia messaging services, wireless instant messaging, interactive voice response, and voice portal services, which are part of a voice-controlled portfolio of services such as voice dialing, voice-controlled messaging, and other applications. Service Enabling Signaling Software Products. Interconnect the complex circuit switching, database and messaging systems and manage vital number, routing and billing information that form the backbone of today's public telecommunications networks. These products also are embedded in a range of packet softswitching products to interoperate or converge voice and data networks and facilitate services such as voice over the Internet and Internet offload. This segment represents the Company's Ulticom, Inc. subsidiary. Page 12 of 31 Total Pages Security and Business Intelligence Recording Products. Provides analytic solutions for communications interception, digital video security and surveillance, and enterprise business intelligence. 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. The table below presents information about sales, income (loss) from operations and segment assets as of and for the three and six month periods ended July 31, 2002 and 2003:

Service Security and Enhanced Enabling Business Services Signaling Intelligence Solutions Software Recording All Reconciling Consolidated Products Products Products Other Items Totals -------- --------- ------------- ----- ----------- ------------ (In thousands) Three Months Ended July 31, 2002: Sales $ 135,233 $ 6,103 $ 38,470 $ 2,588 $ (1,184) $ 181,210 Income (loss) from operations $ (29,117) $ (4,726) $ 2,232 $ (189) $ (2,465) $ (34,265) Three Months Ended July 31, 2003: Sales $ 130,401 $ 9,434 $ 46,892 $ 2,673 $ (932) $ 188,468 Income (loss) from operations $ (12,506) $ 855 $ 4,133 $ (200) $ (1,702) $ (9,420) Six Months Ended July 31, 2002: Sales $ 301,771 $ 13,200 $ 74,787 $ 4,881 $ (2,235) $ 392,404 Income (loss) from operations $ (43,936) $ (7,627) $ 4,307 $ (454) $ (3,574) $ (51,284) Six Months Ended July 31, 2003: Sales $ 256,277 $ 18,563 $ 91,307 $ 4,917 $ (2,044) $ 369,020 Income (loss) from operations $ (30,818) $ 1,232 $ 7,632 $ (452) $ (3,395) $ (25,801) Page 13 of 31 Total Pages

Total Assets: July 31, 2002 $ 1,098,474 $ 235,748 $ 192,962 $ 39,751 $ 966,880 $ 2,533,815 July 31, 2003 $ 927,718 $ 238,983 $ 309,072 $ 35,045 $ 1,149,799 $ 2,660,617

Reconciling items consist of the following: Sales - elimination of intersegment revenues. Income (loss) from operations - elimination of intersegment operating income and corporate operations. Total Assets - elimination of intersegment receivables and unallocated corporate assets. Effect of New Accounting Pronouncements. In August 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 establishes accounting standards for recognition and measurement of a liability for an asset retirement obligation and the associated asset retirement cost. SFAS No. 143 applies to legal obligations associated with the retirement of a tangible long-lived asset that result from the acquisition, construction, development and/or normal operation of a long-lived asset. This Statement is effective for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 143 did not have a material effect on the Company's condensed consolidated financial statements. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 is generally effective for derivative instruments, including derivative instruments embedded in certain contracts, entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The adoption of SFAS No. 149 did not have a material effect on the Company's condensed consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how to classify and measure certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003. The adoption of SFAS No. 150 did not have a material effect on the Company's condensed consolidated financial statements. Page 14 of 31 Total Pages ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. RESULTS OF OPERATIONS 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 experiencing a difficult capital spending environment. Despite these conditions, both business units achieved sequential revenue growth during the three month period ended July 31, 2003. In contrast, Verint, which services the security and enterprise business intelligence markets, achieved record revenue growth based, in part, on heightened awareness surrounding homeland defense and security related initiatives in the United States and abroad. Overall, for the three month period ended July 31, 2003, the Company experienced sequential and year over year sales increases of 4.4% and 4.0%, respectively, with a substantial majority of sales for the period generated from activities serving the telecommunications industry. Nevertheless, the Company still incurred an operating loss for the period. Six Month and Three Month Periods Ended July 31, 2003 Compared to Six Month and Three Month Periods Ended July 31, 2002 Sales. Sales for the six month period ended July 31, 2003 decreased by approximately $23.4 million, or 6%, compared to the six month period ended July 31, 2002. The decrease is primarily attributable to a decrease in sales of ESS products of approximately $45.5 million across all major geographic regions. This decrease is partially offset by sales of security and business intelligence recording products, which increased by approximately $16.5 million, primarily as a result of increased digital security and surveillance sales, and sales of service enabling signaling software products, which increased by approximately $5.4 million. Sales for the three month period ended July 31, 2003 increased by approximately $7.3 million, or 4%, compared to the three month period ended July 31, 2002. This increase is primarily attributable to an increase in sales of security and business intelligence recording products of approximately $8.4 million, primarily as a result of increased digital security and surveillance sales, and an increase in sales of service enabling signaling software products of approximately $3.3 million, partially offset by a decrease in sales of ESS products of approximately $4.8 million. On a consolidated basis, sales to customers in North America represented approximately 36% and 39% of total sales for the six month periods ended July 31, 2003 and 2002, respectively, and 28% and 33% of total sales for the three month periods ended July 31, 2003 and 2002, respectively. Cost of Sales. Cost of sales for the six month period ended July 31, 2003 decreased by approximately $9.4 million, or 6%, compared to the six month period ended July 31, 2002. The decrease in cost of sales is primarily attributable to decreased personnel-related and travel and entertainment costs of approximately $13.7 million and $3.6 million, respectively, primarily the result of cost reduction efforts combined with the decrease in sales, partially offset by increased royalty expense of approximately $5.5 million, primarily the result of a prior period credit realized upon a settlement with the OCS, and net increase in various other costs of approximately $2.4 million. Gross margins for the six month period ended July 31, 2003 decreased to Page 15 of 31 Total Pages approximately 56.2% from approximately 56.4% in the corresponding 2002 period. Cost of sales for the three month period ended July 31, 2003 increased by approximately $2.0 million, or 3%, compared to the three month period ended July 31, 2002. The increase in cost of sales is primarily attributable to increased materials and overhead costs of approximately $8.2 million, increased royalty expense of approximately $4.7 million, primarily the result of a prior period credit realized upon a settlement with the OCS, partially offset by decreased personnel-related and travel and entertainment costs of approximately $6.1 million and $1.9 million, respectively, primarily the result of cost reduction efforts, and net decrease in various other costs of approximately $2.9 million. Gross margins for the three month period ended July 31, 2003 increased to approximately 56.8% from approximately 56.2% in the corresponding 2002 period. Research and Development, Net. Net research and development expenses for the six month and three month periods ended July 31, 2003 decreased by approximately $15.5 million, or 13%, and $7.0 million, or 12%, respectively, compared to the six month and three month periods ended July 31, 2002. The decrease in net research and development expenses is primarily attributable to decreased personnel and other labor related costs of approximately $15.1 million and $6.3 million for the six and three month periods, respectively, which is primarily the result of cost reduction efforts and a reduction of research and development projects. Selling, General and Administrative. Selling, general and administrative expenses for the six month and three month periods ended July 31, 2003 decreased by approximately $20.9 million, or 14%, and $9.5 million, or 13%, respectively, compared to the six month and three month periods ended July 31, 2002, and as a percentage of sales for the six month and three month periods ended July 31, 2003, decreased to approximately 33.9% and 33.4% from approximately 37.2% and 40.0% in the corresponding 2002 periods. The decrease in the dollar amount of selling, general and administrative expenses for the six month and three month periods is primarily due to lower bad debt expense of approximately $27.0 million and $15.9 million, respectively, partially offset by increased agent commissions of approximately $2.8 million and $2.7 million, respectively, due primarily to increased international sales, increased personnel and other labor related costs of approximately $3.4 million and $1.1 million, respectively, due primarily to increased headcount at Verint, and net increase (decrease) in various other costs of approximately $(0.1) million and $2.6 million, respectively. Workforce reduction, restructuring and impairment charges (credits). In order to better align its cost structure with the business environment and improve the efficiency of its operations, the Company took steps to reduce its workforce, restructure its operations and write-off impaired assets during the six and three month periods ended July 31, 2002, and incurred a charge of approximately $2.8 million, 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. During the six and three month periods ended July 31, 2003, the Company recorded a credit of approximately $0.2 million for the reversal of a previously taken restructuring charge. Interest and Other Income, Net. Interest and other income, net, for the six month and three month periods ended July 31, 2003 decreased by approximately $11.0 million and $28.8 million, respectively, compared to the six month and three month periods ended July 31, 2002. The principal reasons for the decrease in the six month and three month periods are (i) a decrease Page 16 of 31 Total Pages in the gain recorded as a result of the Company's repurchases of its Debentures of approximately $22.3 million and $25.1 million, respectively; (ii) a decrease in foreign currency gains of approximately $15.6 million and $18.9 million, respectively, due primarily to the strengthening of the euro during the 2002 periods; (iii) decreased interest and dividend income of approximately $7.9 million and $4.6 million, respectively, due primarily to the decline in interest rates; (iv) an increase of approximately $2.9 million and $1.5 million, respectively, in the minority interest; (v) a decrease in the equity of affiliates of approximately $0.5 million for the three months ended July 31, 2003; and (vi) other decreases of approximately $0.1 million and $0.7 million, respectively. Such items were offset by (i) a decrease in net losses from the sale and write-down of investments of approximately $33.9 million and $19.7 million, respectively; and (ii) decreased interest expense of approximately $3.9 million and $2.8 million, respectively, due primarily to the Company's repurchases of its Debentures and other debt reduction. Income Tax Provision. Provision for income taxes for the six month and three month periods ended July 31, 2003 increased by approximately $1.7 million, or 70%, and $1.1 million, or 92%, respectively, compared to the six month and three month periods ended July 31, 2002, due primarily to shifts in the underlying mix of pre-tax income by 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. Net Income (Loss). Net (income) loss for the six month and three month periods ended July 31, 2003 increased (decreased) by approximately $12.8 million and $(5.0) million, respectively, compared to the six month and three month periods ended July 31, 2002, while as a percentage of sales was approximately (1.9)% and (5.0)% in the six month periods ended July 31, 2003 and 2002, respectively, and approximately (0.6)% and 2.2% in the three month periods ended July 31, 2003 and 2002, respectively. These variances resulted primarily from the factors described above. LIQUIDITY AND CAPITAL RESOURCES The Company's working capital at July 31, 2003 and January 31, 2003 was approximately $2,095.1 million and $1,766.5 million, respectively. At July 31, 2003 and January 31, 2003, the Company had total cash and cash equivalents, bank time deposits and short-term investments of approximately $2,110.4 million and $1,808.9 million, respectively. Operations for the six month periods ended July 31, 2003 and 2002, after adjustment for non-cash items, provided cash of approximately $33.0 million and $13.5 million, respectively. During such periods, other changes in operating assets and liabilities provided cash of approximately $12.0 million and $24.3 million, respectively. This resulted in net cash provided by operating activities of approximately $45.0 million and $37.8 million, respectively. Investing activities for the six month periods ended July 31, 2003 and 2002 provided (used) cash of approximately $(357.2) million and $85.4 million, respectively. These amounts include (i) net maturities and sales (purchases) of bank time deposits and investments of Page 17 of 31 Total Pages approximately $(326.9) million and $137.0 million, respectively; (ii) purchases of property and equipment of approximately $(19.4) million and $(16.3) million, respectively; (iii) capitalization of software development costs of approximately $(4.9) million and $(7.6) million, respectively; and (iv) net assets acquired as a result of acquisitions of approximately $(5.9) million and $(27.8) million, respectively. Financing activities for the six month periods ended July 31, 2003 and 2002 provided (used) cash of approximately $292.7 million and $(93.3) million, respectively. These amounts include (i) net proceeds from the issuance of ZYPS of approximately $413.0 million during the six months ended July 31, 2003; (ii) the repurchase of Debentures of approximately $(221.4) million and $(166.0) million, respectively; (iii) net repayments of bank loans and other debt of approximately $(46.2) million and $(0.1) million, respectively; and (iv) net proceeds from the issuance of common stock in connection with Verint stock offerings and the exercise of stock options and employee stock purchase plans of approximately $147.4 million and $72.8 million, respectively. In May 2003, the Company issued $420,000,000 aggregate principal amount of its ZYPS, for net proceeds of approximately $413.0 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, among others, the closing price of the common stock exceeding 120% of the conversion price over certain periods and other specified events. 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. During the six month period ended July 31, 2003, the Company acquired, in open market purchases, approximately $233.0 million of face amount of the Debentures, for approximately $221.4 million in cash, resulting in a pre-tax gain, net of debt issuance costs, of approximately $9.2 million included in 'Interest and other income, net' in the condensed consolidated statements of operations. As of July 31, 2003, the Company had outstanding Debentures of approximately $157.8 million. From August 1 through September 5, 2003, the Company acquired, in open market purchases, approximately $18.7 million of face amount of the Debentures, for approximately $17.8 million in cash, resulting in a pre-tax gain, net of debt issuance costs, of approximately $0.7 million. During February 2003, Verint repaid a bank loan in the amount of $42.0 million. Page 18 of 31 Total Pages In May 2003, Verint acquired all of the issued and outstanding shares of Smartsight, a Canadian corporation that develops IP-based video edge devices and software for wireless video transmission. The purchase price consisted of approximately $7.1 million in cash and 149,731 shares of Verint common stock, valued at approximately $3.1 million, or $20.46 per share, plus transaction costs of approximately $0.3 million. In June 2003, Verint completed a public offering of 5,750,000 shares of its common stock at a price of $23.00 per share. The shares offered included 149,731 shares issued to Smartsight's former shareholders in connection with its acquisition. CTI was not a selling stockholder in the offering. The proceeds of the offering were approximately $122.2 million, net of offering expenses. As a result of the offering, the Company's ownership interest in Verint was reduced to approximately 62.9% following completion of the offering. The Company recorded a gain of approximately $62.9 million, which was recorded as an increase in stockholders' equity as a result of the issuance. 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 difficult capital spending environment. The Company's operating results and financial condition have been, and will continue to be, adversely affected by the decline in technology purchases and capital expenditures by telecommunications service providers ("TSP") worldwide. Consequently, the Company's operating results may deteriorate in future periods if such conditions remain in effect. 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 Page 19 of 31 Total Pages 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. 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 further 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 Page 20 of 31 Total Pages 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. The Company has made, and in the future, may continue to make strategic investments in other 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 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. In addition, defects or errors in the Company's products may result in product liability claims, which could cause adverse publicity and impair their market acceptance. 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 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 Page 21 of 31 Total Pages 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 ESS system 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 greater financial, marketing and sales resources than the Company, may enter the ESS system 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 market for the Company's digital security and surveillance and enterprise 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. The Company's business generated from government contracts may be adversely affected if: (i) the Company's reputation or relationship with government agencies is impaired, (ii) the Company 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 the Company does not provide products and services, (iv) the Company is prevented from entering into new government contracts or extending existing government contracts based on violations or suspected violations of procurement laws or regulations, (v) the Company is not granted security Page 22 of 31 Total Pages clearances required to sell products to domestic or foreign governments or such security clearances are revoked, or (vi) there is a change in government procurement procedures. 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 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, 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. Geopolitical, economic and military conditions could directly affect the Company's operations. The outbreak of severe acute respiratory syndrome ("SARS") earlier this year curtailed travel to and from certain countries (primarily in the Asia-Pacific region). Continued or additional 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, our 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 Page 23 of 31 Total Pages 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 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 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 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 Office of the Chief Scientist of the Ministry of Industry and Trade of the State of Israel ("OCS") under which it has received significant benefits through reimbursement of up to 50% of qualified research and development expenditures. Verint currently pays 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 by Verint are currently required to be made until the government has been reimbursed the amounts received by the Company 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. During fiscal 2001, Comverse entered into an arrangement with the OCS whereby Comverse agreed to pay a lump sum royalty amount for all past amounts received from the OCS. In addition, Comverse began to receive Page 24 of 31 Total Pages 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 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. Certain of the Company's products are often used by customers to compile and analyze highly sensitive or confidential information and data. The Company may come into contact with such information or data when it performs support or maintenance functions for its customers. While it has internal policies, procedures and training for employees in connection with performing these functions, even the perception that any of its 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. Page 25 of 31 Total Pages 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 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. Page 26 of 31 Total Pages 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. 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 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 Page 27 of 31 Total Pages 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 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. 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. 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. 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 undertakes no obligation to correct or update a forward-looking statement should the Company later become aware that it is not likely to be achieved. 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. Page 28 of 31 Total Pages 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. As of the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of the principal executive officer and principal financial officer, 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 (the "Exchange Act")). Based on this evaluation, the principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. There was no change in the Company's internal control over financial reporting during the Company's most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. Page 29 of 31 Total Pages PART II Other Information ITEM 1. Legal Proceedings. None. ITEM 6. Exhibits and Reports on Form 8-K. (a) Exhibit Index. ------------- 31.1 Certification executed by Kobi Alexander, Chairman of the Board and Chief Executive Officer of the Company as required pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002* 31.2 Certification executed by David Kreinberg, Executive Vice President and Chief Financial Officer of the Company as required pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002* 32 Certifications executed by Kobi Alexander, Chairman of the Board and Chief Executive Officer of the Company and David Kreinberg, Executive Vice President and Chief Financial Officer of the Company as required pursuant to Rule 13a-14(b) or Rule 15d-14(b) under the Securities Exchange Act of 1934 and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. Section 1350), as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002* *These exhibits are being "furnished" with this periodic report and are not deemed "filed" with the Securities and Exchange Commission and are not incorporated by reference in any filing of Comverse Technology, Inc. under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation by reference language in any such filings. (b) Reports on Form 8-K. ------------------- During the second quarter of 2003, the Company filed or furnished the following reports on Form 8-K: 1. Form 8-K, dated May 2, 2003, regarding the announcement of a private placement of $350 million principal amount of Zero Yield Puttable Securities due 2023; 2. Form 8-K, dated May 7, 2003, regarding the announcement of the closing of $350 million principal amount of the Company's Zero Yield Puttable Securities due 2023; and 3. Form 8-K, dated June 3, 2003, regarding the announcement of the Company's financial results for the fiscal quarter ended April 30, 2003. Page 30 of 31 Total Pages 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: September 12, 2003 /s/ Kobi Alexander ------------------------- Kobi Alexander Chairman of the Board and Chief Executive Officer Dated: September 12, 2003 /s/ David Kreinberg ------------------------- David Kreinberg Executive Vice President and Chief Financial Officer Page 31 of 31 Total Pages