10-Q 1 mv12-13_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 October 31, 2002 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 APPLICABLE ONLY TO CORPORATE ISSUERS: The number of shares of Common Stock, par value $0.10 per share, outstanding as of December 9, 2002 was 187,732,998 Page 1 of 29 Total Pages TABLE OF CONTENTS ----------------- Page ---- PART I FINANCIAL INFORMATION ITEM 1. Financial Statements. 1. Condensed Consolidated Balance Sheets as of January 31, 2002 and October 31, 2002 3 2. Condensed Consolidated Statements of Operations for the Three and Nine Month Periods Ended October 31, 2001 and October 31, 2002 4 3. Condensed Consolidated Statements of Cash Flows for the Nine Month Periods Ended October 31, 2001 and October 31, 2002 5 4. Notes to Condensed Consolidated Financial Statements 6 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. 13 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk. 25 ITEM 4. Controls and Procedures. 25 PART II OTHER INFORMATION ITEM 1. Legal Proceedings. 26 ITEM 6. Exhibits and Reports on Form 8-K. 26 SIGNATURES 27 CERTIFICATIONS 28 Page 2 of 29 PART I Financial Information ITEM 1. Financial Statements. COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)

JANUARY 31, OCTOBER 31, 2002* 2002 (Unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 1,361,862 $ 1,328,077 Bank time deposits and short-term investments 530,622 430,200 Accounts receivable, net 371,928 278,792 Inventories 56,024 49,222 Prepaid expenses and other current assets 76,667 62,645 --------------- --------------- TOTAL CURRENT ASSETS 2,397,103 2,148,936 PROPERTY AND EQUIPMENT, net 181,761 155,586 OTHER ASSETS 125,299 134,929 --------------- --------------- TOTAL ASSETS $ 2,704,163 $ 2,439,451 =============== =============== ------------------------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable and accrued expenses $ 322,402 $ 281,490 Advance payments from customers 39,576 41,631 Other current liabilities 4,875 45,519 --------------- --------------- TOTAL CURRENT LIABILITIES 366,853 368,640 CONVERTIBLE DEBENTURES 600,000 394,820 OTHER LIABILITIES 59,599 18,664 --------------- --------------- TOTAL LIABILITIES 1,026,452 782,124 --------------- --------------- MINORITY INTEREST 61,303 81,464 --------------- --------------- STOCKHOLDERS' EQUITY: Common stock, $0.10 par value - authorized, 600,000,000 shares; issued and outstanding, 186,248,350 and 187,661,487 shares 18,625 18,766 Additional paid-in capital 1,018,232 1,077,431 Retained earnings 574,763 475,427 Accumulated other comprehensive income 4,788 4,239 --------------- --------------- TOTAL STOCKHOLDERS' EQUITY 1,616,408 1,575,863 --------------- --------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,704,163 $ 2,439,451 =============== ===============

*The Condensed Consolidated Balance Sheet as of January 31, 2002 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 29 COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA)

NINE MONTHS ENDED THREE MONTHS ENDED OCTOBER 31, OCTOBER 31, OCTOBER 31, OCTOBER 31, 2001 2002 2001 2002 Sales $1,005,159 $559,873 $295,032 $167,469 Cost of sales 414,483 255,634 125,210 84,512 ------------- --------------- --------------- -------------- Gross margin 590,676 304,239 169,822 82,957 Operating expenses: Research and development, net 221,386 178,313 76,198 54,556 Selling, general and administrative 242,486 214,425 83,312 68,414 Workforce reduction, restructuring and impairment charges 8,875 53,716 - 50,918 ------------- --------------- --------------- -------------- Income (loss) from operations 117,929 (142,215) 10,312 (90,931) Interest and other income (expense), net (1,479) 47,302 (8,438) 13,197 ------------- --------------- --------------- -------------- Income (loss) before income tax provision 116,450 (94,913) 1,874 (77,734) Income tax provision 7,815 4,423 179 1,949 ------------- --------------- --------------- -------------- Net income (loss) $108,635 $(99,336) $1,695 $(79,683) ============= =============== =============== ============== Earnings (loss) per share: Basic $0.61 $(0.53) $0.01 $(0.43) ===== ======= ===== ======= Diluted $0.59 $(0.53) $0.01 $(0.43) ===== ======= ===== =======

The accompanying notes are an integral part of these financial statements. Page 4 of 29 COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)

NINE MONTHS ENDED OCTOBER 31, OCTOBER 31, 2001 2002 Cash flows from operating activities: Net cash from operations after adjustment for non-cash items $ 154,564 $ (30,865) Changes in assets and liabilities: Accounts receivable (61,228) 95,898 Inventories 48,485 4,239 Prepaid expenses and other current assets (6,203) 20,146 Accounts payable and accrued expenses 21,566 (54,176) Other, net (71,926) (2,738) -------------- -------------- Net cash provided by operating activities 85,258 32,504 -------------- -------------- Cash flows from investing activities: Maturities and sales (purchases) of bank time deposits and investments, net 54,495 124,845 Purchases of property and equipment (45,065) (21,063) Increase in software development costs (17,429) (10,106) Net assets acquired - (27,765) -------------- -------------- Net cash provided by (used in) investing activities (7,999) 65,911 -------------- -------------- Cash flows from financing activities: Net decrease in bank loans and other debt (2,907) (208,769) Proceeds from issuance of common stock 26,216 76,569 -------------- -------------- Net cash provided by (used in) financing activities 23,309 (132,200) -------------- -------------- Net increase (decrease) in cash and cash equivalents 100,568 (33,785) Cash and cash equivalents, beginning of period 1,275,105 1,361,862 -------------- -------------- Cash and cash equivalents, end of period $ 1,375,673 $ 1,328,077 ============== ==============

The accompanying notes are an integral part of these financial statements. Page 5 of 29 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, 2002. 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 nine month periods ended October 31, 2002 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 manner of presentation in the current year. INVENTORIES. The composition of inventories at January 31, 2002 and October 31, 2002 is as follows: JANUARY 31, OCTOBER 31, 2002 2002 (In thousands) Raw materials $ 30,989 $ 25,613 Work in process 12,049 12,700 Finished goods 12,986 10,909 ------------- ------------- $ 56,024 $ 49,222 ============= ============= RESEARCH AND DEVELOPMENT EXPENSES. The Company has received periodic reimbursement from the Israeli Government of a portion of the costs of approved research and development projects conducted at its facilities in Israel. Such reimbursement amounted to $1,490,000 and $8,673,000 in the three and nine month periods ended October 31, 2001, respectively, and $2,379,000 and $8,316,000 in the three and nine month periods ended October 31, 2002, respectively. See ITEM 2., "Management's Discussion and Analysis of Financial Condition and Results of Operations - Certain Trends and Uncertainties." Under the terms of the applicable funding agreements, the Company is required to pay royalties on revenues associated with certain of its products resulting from certain projects that received government funding, and certain products may not be manufactured outside of Israel without government approval. 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 Page 6 of 29 dilutive potential common shares outstanding. The calculation for earnings (loss) per share for the three and nine month periods ended October 31, 2001 and 2002 is as follows:

THREE MONTHS ENDED THREE MONTHS ENDED OCTOBER 31, 2001 OCTOBER 31, 2002 --------------------------------- ----------------------------------- Net Per Share Net Per Share Income Shares Amount Loss Shares Amount (In thousands, except per share data) BASIC EPS Net Income (loss) $1,695 185,729 $0.01 $(79,683) 187,457 $(0.43) ===== ======= EFFECT OF DILUTIVE SECURITIES Options and warrants 3,892 ------ ------- ----- --------- ------- ------- DILUTED EPS $1,695 189,621 $0.01 $(79,683) 187,457 $(0.43) ====== ======= ===== ========= ======= ======= NINE MONTHS ENDED NINE MONTHS ENDED OCTOBER 31, 2001 OCTOBER 31, 2002 ----------------------------------- ------------------------------------ Net Per Share Net Per Share Income Shares Amount Loss Shares Amount (In thousands, except per share data) BASIC EPS Net Income (loss) $108,635 177,026 $0.61 $(99,336) 187,040 $(0.53) ===== ======= EFFECT OF DILUTIVE SECURITIES Options and warrants 6,381 --------- ------- ----- --------- ------- ------- DILUTED EPS $108,635 183,407 $0.59 $(99,336) 187,040 $(0.53) ========= ======= ===== ========= ======= =======

The diluted earnings (loss) per share computation for the three and nine months ended October 31, 2002 excludes incremental shares of approximately 274,000 and 655,000, 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. In addition, the Company's 1.5% convertible 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. COMPREHENSIVE INCOME (LOSS). Total comprehensive income (loss) was $1,292,000 and $(80,601,000) for the three month periods ended October 31, 2001 and 2002, respectively, and $106,506,000 and $(99,885,000) for the nine month periods ended October 31, 2001 and 2002, respectively. The elements of comprehensive income include net income, unrealized gains/losses on available for sale securities and foreign currency translation adjustments. CONVERTIBLE DEBENTURES. In November and December 2000, the Company issued $600,000,000 aggregate principal amount of its 1.50% convertible senior debentures due December 2005 (the "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 Page 7 of 29 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 pay the repurchase price in common stock. During the three and nine month periods ended October 31, 2002, the Company acquired, in open market purchases, $39,180,000 and $205,180,000, respectively, of face amount of its convertible debentures, resulting in a pre-tax gain, net of debt issuance costs, of approximately $7,436,000 and $38,938,000, respectively, included in `Interest and other income (expense), net' in the Condensed Consolidated Statements of Operations. ACQUISITIONS. In February 2002, Verint Systems Inc. ("Verint"), a subsidiary of CTI, acquired the digital video recording business of Lanex, LLC. The Lanex business provides digital video recording solutions for security and surveillance applications primarily to North American banks. The purchase price consisted of approximately $9.5 million in cash and a $2.2 million convertible note. The note is non-interest bearing and matures on February 1, 2004. The holder of the note may elect to convert the note, in whole or in part, into shares of Verint's common stock at a conversion price of $16.06 per share. The note is guaranteed by CTI. Pro forma results of operations have not been presented because the effects of this acquisition are not material. In June 2002, the Company acquired Odigo, Inc. ("Odigo"), a privately-held provider of instant messaging and presence management solutions to service providers. The purchase price was approximately $20.1 million in cash. Prior to the acquisition, the Company was a strategic partner with Odigo holding an equity position which it previously acquired for approximately $3 million. Pro forma results of operations have not been presented because the effects of this acquisition are not material. WORKFORCE REDUCTION, RESTRUCTURING AND IMPAIRMENT CHARGES. During the year ended January 31, 2002, the Company took steps to better align its cost structure with the business environment and to improve the efficiency of its operations. These steps included a reduction in workforce announced in April 2001 and a restructuring plan, which included an additional reduction in workforce, announced in December 2001. During the three and nine month periods ended October 31, 2002, the Company took additional steps to reduce its workforce, restructure its operations and write-off impaired assets, resulting in a charge of approximately $50,918,000 and $53,716,000, respectively, 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 October 31, 2002 the Company had an accrual of approximately $53,827,000 related to the workforce reduction and restructuring plans. A roll forward of the workforce reduction and restructuring plan accrual from January 31, 2002 is as follows: Page 8 of 29

WORKFORCE ACCRUAL REDUCTION, ACCRUAL BALANCE AT RESTRUCTURING BALANCE AT JANUARY 31, & IMPAIRMENT CASH NON-CASH OCTOBER 31, 2002 CHARGES PAYMENTS CHARGES 2002 ---- ------- -------- ------- ---- (IN THOUSANDS) Severance and related $ 11,862 $ 21,530 $ 21,667 $ - $ 11,725 Facilities and related 24,347 19,248 1,493 - 42,102 Property and equipment - 12,938 - 12,938 - ----------- ----------- ---------- ----------- ------------ Total $ 36,209 $ 53,716 $ 23,160 $ 12,938 $ 53,827 =========== =========== ========== =========== ============

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 July 2003. 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 plan. 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, including the value of certain unimproved land in Israel that the Company had acquired with a view to the future construction of facilities for its Israeli operations. The Company expects to continue to reduce its workforce during the three months ending January 31, 2003 and incur additional restructuring related charges during such period. BUSINESS SEGMENT INFORMATION. The Company's reporting segments are as follows: Enhanced Services Solutions Products - Enable telecommunications service providers to offer a variety of revenue-generating services accessible to large numbers of simultaneous users. These services include a broad range of integrated multimodal messaging, information distribution and personal communications services, such as call answering with one-touch call return, voicemail, IP-based unified messaging (voice, fax 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 services, interactive voice response, and voice portal services, which are part of a voice-controlled portfolio of services such as voice dialing, voice-controlled Web browsing and 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 9 of 29 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, operating income (loss) and segment assets as of and for the three and nine month periods ended October 31, 2001 and 2002:

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 OCTOBER 31, 2001: Sales $ 251,102 $ 13,013 $ 31,039 $ 2,510 $ (2,632) $ 295,032 Operating Income (Loss) $ 12,117 $ 357 $ (786) $ (171) $ (1,205) $ 10,312 THREE MONTHS ENDED OCTOBER 31, 2002: Sales $ 117,212 $ 7,764 $ 40,671 $ 2,437 $ (615) $ 167,469 Operating Income (Loss) $ (93,607) $ (537) $ 2,717 $ 393 $ 103 $ (90,931) NINE MONTHS ENDED OCTOBER 31, 2001: Sales $ 859,805 $ 47,972 $ 97,614 $ 7,265 $ (7,497) $ 1,005,159 Operating Income (Loss) $ 115,917 $ 8,422 $ (1,808) $ (613) $ (3,989) $ 117,929 NINE MONTHS ENDED OCTOBER 31, 2002: Sales $ 418,983 $ 20,964 $ 115,458 $ 7,318 $ (2,850) $ 559,873 Operating Income (Loss) $ (137,543) $ (8,164) $ 7,024 $ (542) $ (2,990) $ (142,215) TOTAL ASSETS: October 31, 2001 $ 1,217,172 $ 240,820 $ 113,587 $ 60,176 $ 1,071,496 $ 2,703,251 October 31, 2002 $ 1,025,965 $ 235,069 $ 199,596 $ 34,839 $ 943,982 $ 2,439,451

Reconciling items consist of the following: Sales - elimination of intersegment revenues. Operating Income (Loss) - elimination of intersegment operating income and corporate operations. Total Assets - elimination of intersegment receivables and unallocated corporate assets. Page 10 of 29 EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS. In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets. Under SFAS No. 142, goodwill and some intangible assets will no longer be amortized, but rather reviewed for impairment on a periodic basis. The provisions of this Statement are required to be applied starting with fiscal years beginning after December 15, 2001. This Statement is required to be applied at the beginning of the Company's fiscal year and is to be applied to all goodwill and other intangible assets recognized in its financial statements at that date. Impairment losses for goodwill and certain intangible assets that arise due to the initial application of this Statement are to be reported as resulting from a change in accounting principle. Goodwill and intangible assets acquired after June 30, 2001 will be subject immediately to the provisions of this Statement. The adoption of SFAS No. 142 did not have a material effect on the Company's consolidated financial statements. In August 2001, the 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; however, early adoption is encouraged. The adoption of SFAS No. 143 is not expected to have a material effect on the Company's consolidated financial statements. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and certain provisions of Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years; however, early adoption is encouraged. The adoption of SFAS No. 144 did not have a material effect on the Company's consolidated financial statements. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 rescinds SFAS No. 4, which required all gains and losses from the extinguishment of debt to be classified as an extraordinary item. SFAS No. 145 recognizes that the use of debt extinguishment has become part of the risk management strategy of many companies and therefore may be considered as part of a company's operating activities. The rescission of SFAS No. 4 is effective for fiscal years beginning after May 15, 2002 with earlier application encouraged. The Company adopted SFAS No. 145 in the three month period ended July 31, 2002. Accordingly, as the Company intends to periodically extinguish its debt as part of its risk management strategy, the gain of Page 11 of 29 approximately $38.9 million on the extinguishment of debt relating to the Company's 1.50% convertible debentures was recorded through continuing operations in the Condensed Consolidated Statement of Operations and is included in the "Net cash from operations after adjustment for non-cash items" in the Condensed Consolidated Statement of Cash Flows for the nine month period ended October 31, 2002. In addition, SFAS No. 145 also rescinds SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers", and amends SFAS No. 13, "Accounting for Leases", to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. The statement is generally effective for transactions occurring after May 15, 2002 with earlier application encouraged for these items. In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal Activities." This statement addresses the recognition, measurement and reporting of costs that are associated with exit and disposal activities. This statement includes the restructuring activities that are currently accounted for pursuant to the guidance set forth in Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)," costs related to terminating a contract that is not a capital lease and one-time benefit arrangements received by employees who are involuntarily terminated - nullifying the guidance under EITF Issue No. 94-3. Under SFAS No. 146 the cost associated with an exit or disposal activity is recognized in the periods in which it is incurred rather than at the date the company committed to the exit plan. This statement is effective for exit or disposal activities initiated after December 31, 2002 with earlier application encouraged. The Company is currently evaluating the impact that SFAS No. 146 will have on its consolidated financial statements. OPTION EXCHANGE PROGRAM. In May 2002, the Company announced the commencement of a voluntary stock option exchange program for its eligible employees. Under the program, which was approved by the Company's shareholders, participating employees were given the opportunity to have unexercised stock options previously granted to them cancelled, in exchange for replacement options that will be granted at a future date. Replacement options will be granted at a ratio of 0.85 new options for each existing option cancelled, at an exercise price equal to the fair market value of the Company's stock on the date of the re-grant, which currently is expected to be December 23, 2002. The exchange program was designed in accordance with FASB Interpretation No. 44. As per FASB Interpretation No. 44, the grant of replacement options not less than six months and one day after cancellation will not result in any variable compensation charges relating to these options. As a result of the stock option exchange program, the Company is currently obligated to grant replacement options to acquire a maximum of approximately 14.5 million shares of the Company's common stock. ISSUANCE OF SUBSIDIARY STOCK. In May 2002, Verint issued 4,500,000 shares of its common stock in an initial public offering. As a result of the initial public offering, the Company's ownership interest in Verint was reduced to approximately 79%. Proceeds from the offering, based on the offering price of $16.00 per share, totaled approximately $65.4 million, net of offering expenses. The Company recorded a gain of approximately $48.2 million during the three months ended July 31, 2002, which was recorded as an increase in stockholders' equity as a result of the issuance. Page 12 of 29 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 deep capital spending contraction and, consequently, have experienced year over year revenue declines. In contrast, Verint, which services the security and enterprise business intelligence markets, achieved revenue growth based, in part, on heightened awareness surrounding homeland defense and security related initiatives in the U.S. and worldwide. Overall, however, with a substantial majority of the quarter's sales generated from activities serving the telecommunications industry, during the quarter ended October 31, 2002 the Company experienced a sequential sales decline of approximately 8% and a year over year sales decline of approximately 43% resulting in an operating loss for the quarter. NINE MONTH AND THREE MONTH PERIODS ENDED OCTOBER 31, 2002 COMPARED TO NINE MONTH AND THREE MONTH PERIODS ENDED OCTOBER 31, 2001 Sales. Sales for the nine month and three month periods ended October 31, 2002 decreased by approximately $445.3 million, or 44%, and $127.6 million, or 43%, respectively, compared to the nine month and three month periods ended October 31, 2001. This decrease is primarily attributable to a decrease in sales of enhanced services solutions ("ESS") products in the nine month and three month periods ended October 31, 2002 of approximately $440.8 million and $133.9 million, respectively. In addition, sales of security and business intelligence recording products and service enabling signaling software products increased (decreased) by approximately $17.8 million and $(27.0) million, respectively, in the nine month period and approximately $9.6 million and $(5.2) million, respectively, in the three month period. Cost of Sales. Cost of sales for the nine month and three month periods ended October 31, 2002 decreased by approximately $158.8 million, or 38%, and $40.7 million, or 33%, respectively, as compared to the nine month and three month periods ended October 31, 2001. The decrease in cost of sales in the nine month and three month periods ended October 31, 2002 is primarily attributable to decreased materials and overhead costs of approximately $125.5 million and $31.0 million, respectively, due to the decrease in sales, and decreased royalty expense of approximately $22.2 million and $7.0 million, respectively, partially offset by a charge of approximately $5.9 million for the nine and three month periods ended October 31, 2002, pertaining to the write-down of the value of certain inventory and the write-off of certain prepaid licenses for which there is no estimable future use. Gross margins for the nine month and three month periods ended October 31, 2002 decreased to approximately 54.3% and 49.5%, respectively, from approximately 58.8% and 57.6%, respectively, in the corresponding 2001 periods. Research and Development, net. Net research and development expenses for the nine month and three month periods ended October 31, 2002 decreased by approximately $43.1 million, or 19%, and $21.6 million, or 28%, respectively, as Page 13 of 29 compared to the nine month and three month periods ended October 31, 2001 primarily due to the reductions in workforce and a reduction of research and development projects. Selling, General and Administrative Expenses. Selling, general and administrative expenses for the nine month and three month periods ended October 31, 2002 decreased by approximately $28.1 million, or 12%, and $14.9 million, or 18%, respectively, compared to the nine month and three month periods ended October 31, 2001, and as a percentage of sales for the nine month and three month periods ended October 31, 2002 increased to approximately 38% and 41%, respectively, from approximately 24% and 28% in the corresponding 2001 periods. The decrease in the dollar amount of the expense was primarily due to the reductions in workforce. Workforce Reduction, Restructuring and Impairment Charges. During the nine months ended October 31, 2001 the Company reduced its workforce, resulting in a charge of approximately $8.9 million to operations for severance and other related costs during the period. During the nine and three month periods ended October 31, 2002, the Company took additional steps to reduce its workforce, restructure its operations and write-off impaired assets, resulting in a charge to operations of approximately $53.7 million and $50.9 million, respectively, 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. Interest and Other Income (Expense), net. Interest and other income (expense), net, for the nine month and three month periods ended October 31, 2002 increased by approximately $48.8 million and $21.6 million, respectively, as compared to the nine month and three month periods ended October 31, 2001. The principal reasons for the increase in the nine month and three month periods ended October 31, 2002 are (i) decreased interest expense of approximately $5.7 million and $0.7 million, respectively, due to the redemption of the Company's $300 million 4.50% convertible debentures in June 2001, as well as the Company buying back $205.2 million face value of its 1.50% convertible debentures during the nine months ended October 31, 2002; (ii) change in foreign currency gains/losses of approximately $40.9 million and $2.3 million, respectively, due primarily to the strengthening of the euro during the 2002 periods; (iii) during the 2002 periods, the Company recorded a gain of approximately $38.9 million and $7.4 million, respectively, as a result of buying back $205.2 million face value of its 1.50% convertible debentures; (iv) a decrease of approximately $2.5 million in the minority interest in the nine month period; and (v) a decrease in net losses from the sale and write-down of investments of approximately $19.2 million in the three month period. Such items were offset by (i) decreased interest and dividend income of approximately $22.8 million and $5.2 million, respectively, due to the decline in interest rates in the 2002 periods; (ii) an increase in net losses from the sale and write-down of investments of approximately $13.1 million during the nine month period; (iii) change in the equity of affiliates of approximately $1.5 million in each of the nine and three month periods; (iv) an increase of approximately $0.5 million in the minority interest in the three month period; and (v) other changes of approximately $1.8 million and $0.8 million, respectively. Income Tax Provision. Provision for income taxes for the nine month and three month periods ended October 31, 2002 increased (decreased) by approximately $(3.4) million, or (43)%, and $1.8 million, or 989%, respectively, as compared to the nine month and three month periods ended October 31, 2001 due Page 14 of 29 primarily to decreased pre-tax income. The Company's overall rate of tax is reduced significantly by 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 nine month and three month periods ended October 31, 2002 decreased by approximately $208.0 million and $81.4 million, respectively, as compared to the nine month and three month periods ended October 31, 2001, and as a percentage of sales was approximately 10.8% and (17.7)% in the nine month periods ended October 31, 2001 and 2002, respectively, and was approximately 0.6% and (47.6)% in the three month periods ended October 31, 2001 and 2002, respectively. LIQUIDITY AND CAPITAL RESOURCES The Company's working capital at October 31, 2002 and January 31, 2002 was approximately $1,780.3 million and $2,030.3 million, respectively. Operations for the nine month periods ended October 31, 2002 and 2001, after adjustment for non-cash items, provided (used) cash of approximately $(30.9) million and $154.6 million, respectively. During such periods, other changes in operating assets and liabilities provided (used) cash of approximately $63.4 million and $(69.3) million, respectively. This resulted in net cash provided by operating activities of approximately $32.5 million and $85.3 million, respectively. Investing activities for the nine month periods ended October 31, 2002 and 2001 provided (used) cash of approximately $65.9 million and $(8.0) million, respectively. These amounts include (i) additions to property and equipment of approximately $(21.1) million and $(45.1) million, respectively; (ii) net maturities and sales (purchases) of bank time deposits and investments of approximately $124.8 million and $54.5 million, respectively; (iii) capitalization of software development costs of approximately $(10.1) million and $(17.4) million, respectively and (iv) net assets acquired as a result of acquisitions in the 2002 period of approximately $(27.8) million. Financing activities for the nine month periods ended October 31, 2002 and 2001 provided (used) cash of approximately $(132.2) million and $23.3 million, respectively. These amounts include (i) proceeds from the issuance of common stock in connection with the exercise of stock options, warrants and employee stock purchase plan of the Company and the issuance of common stock of Verint in the nine month periods ended October 31, 2002 and 2001 of approximately $76.6 million and $26.2 million, respectively and (ii) net decrease in bank loans and other debt of approximately $(208.8) million and $(2.9) million, respectively. As of October 31, 2002, the Company had outstanding convertible debentures of $394.8 million. In January 2002, Verint took a bank loan in the amount of $42 million. This loan, which matures in February 2003, bears interest at LIBOR plus 0.55% and may be prepaid without penalty. The loan is guaranteed by CTI. In February 2002, Verint acquired the digital video recording business of Lanex, LLC. The Lanex business provides digital video recording solutions for security and surveillance applications primarily to North American Page 15 of 29 banks. The purchase price consisted of $9.5 million in cash and a $2.2 million convertible note. The note is non-interest bearing and matures on February 1, 2004. The holder of the note may elect to convert the note, in whole or in part, into shares of Verint's common stock at a conversion price of $16.06 per share. The note is guaranteed by CTI. In June 2002, the Company acquired Odigo, a privately-held provider of instant messaging and presence management solutions to service providers. The purchase price was approximately $20.1 million in cash. Prior to the acquisition, the Company was a strategic partner with Odigo holding an equity position which it previously acquired for approximately $3 million. The Company believes that its existing working capital will be sufficient to provide for its planned operations for the foreseeable future. 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'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. CERTAIN TRENDS AND UNCERTAINTIES The Company derives the majority of its revenue from the telecommunications industry, which continues to face an unprecedented recession. This has resulted in a significant reduction of capital expenditures made by telecommunications service providers ("TSP"). The Company's operating results and financial condition have been, and will continue to be, adversely affected by the severe decline in technology purchases and capital expenditures by TSPs worldwide. Consequently, the Company's operating results have deteriorated significantly in recent periods and may continue to 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, in general, and the Company, in particular, 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 future broadband services and reductions in TSPs' actual and projected revenues and deterioration in their actual and projected operating results. Accordingly, TSPs in general and the Company's customers in particular 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 Page 16 of 29 certain customers of the Company, also have indicated the existence of conditions of excess capacity in certain markets. In addition, 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 and order backlog, 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 predicated 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. Page 17 of 29 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 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. 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. In addition, 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'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 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 would 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 Page 18 of 29 weakness in general economic conditions, delays or reductions in customers' purchases of capital equipment and uncertainties relating to government expenditure programs. The Company's business generated from government contracts may be adversely affected if: (i) 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, (ii) 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, (iii) the Company is not granted security clearances required to sell products to domestic or foreign governments or such security clearances are revoked, (iv) the Company's reputation or relationship with government agencies is impaired, (v) there is a change in government procurement procedures, or (vi) the Company is suspended from contracting with a domestic or foreign government or any significant law enforcement agency. 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. 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. Political, economic and military conditions in Israel directly affect the Company's operations. 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. As a result, negotiations between Israel and representatives of the Palestinian Authority have been sporadic and have failed to result in peace. 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 Page 19 of 29 practices directed toward Israel or companies having operations in Israel. The continuation or exacerbation of violent conflicts involving Israel and other nations may impede the Company's ability to sell its products in certain countries. In addition, some of the Company's employees in Israel are subject to being called upon to perform military service in Israel, and their absence may have an adverse effect upon the Company's operations. Generally, unless exempt, male adult citizens and permanent residents of Israel under the age of 54 are obligated to perform up to 36 days of military reserve duty annually. Additionally, all such residents are subject to being called to active duty at any time under emergency circumstances. These conditions could disrupt the Company's operations in Israel and its business, financial condition and results of operations could be adversely affected. 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 it has 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 will receive lower amounts from the OCS than it has historically received, but will not have to pay royalty amounts on future 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 Page 20 of 29 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 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 operations and financial results. 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 Page 21 of 29 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, financial condition and results of operations. 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, significant 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 recently have been positively impacted 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. Page 22 of 29 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 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. Ronald A. Katz Technology Licensing ("RAKTL") has sent letters to and/or has instituted litigation against certain customers of the Company suggesting that the customer infringes patents owned by RAKTL. The patents asserted by RAKTL allegedly relate to various aspects of telephone call processing. Certain customers have indicated they may request the Company to indemnify and defend them against claims based on allegations of infringement of RAKTL's patents. The Company is currently considering whether it has potential liability under the RAKTL patents. If the Company does become involved in litigation in connection with the RAKTL patent portfolio, under a contractual indemnity or any other legal theory, the Company intends to vigorously contest the claims and to assert appropriate defenses. 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, while the Company's interest and other income has benefited from the positive spread between the fixed interest it pays on its outstanding indebtedness and interest earned on the investment of its cash balances, 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 rely on equity incentive arrangements as a means to recruit and retain talented Page 23 of 29 employees, and has impacted the ability of the Company to raise capital on terms as advantageous to the Company as in the past. 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 24 of 29 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 maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company's filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the periods specified in the rules and forms of the Securities and Exchange Commission. Such information is accumulated and communicated to the Company's management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. The Company's management, including the principal executive officer and the principal financial officer, recognizes that any set of controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Within 90 days prior to the filing date of this quarterly report on Form 10-Q, the Company has carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's principal executive officer and the Company's principal financial officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on such evaluation, the Company's principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures are effective. (b) There have been no significant changes in the Company's internal controls or in other factors that could significantly affect the internal controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Page 25 of 29 PART II Other Information ITEM 1. Legal Proceedings. On or about October 19, 2001, a securities class action complaint entitled Kevin Beier v. Comverse Technology, Inc., et al., CV 016972, was filed against CTI and certain of its executive officers in the United States District Court for the Eastern District of New York ("the Court"). An amended consolidated complaint was filed on March 4, 2002. The amended consolidated complaint generally alleges violations of federal securities laws on behalf of individuals who allege that they purchased CTI's common stock during a purported class period between April 30, 2001 and July 10, 2001. The amended consolidated complaint sought an unspecified amount in damages on behalf of persons who purchased CTI stock during the purported class period. On April 22, 2002, CTI filed a Motion to Dismiss the amended consolidated complaint in its entirety. On September 30, 2002, the Court granted CTI's Motion to Dismiss the amended consolidated complaint. On November 8, 2002, the Court entered a final judgment dismissing the amended consolidated complaint with prejudice. On November 26, 2002, plaintiffs agreed to waive their right to appeal the judgment in exchange for CTI's agreement that each side bear its own costs and legal fees. Plaintiffs' time to appeal has expired and no appeal was filed, and the case is now closed. ITEM 6. Exhibits and Reports on Form 8-K. (a) Exhibit Index. None. (b) Reports on Form 8-K. During the third quarter of 2002, the Company filed a report on Form 8-K dated September 13, 2002. Item 9. Regulation FD Disclosure: (1) Statements Under Oath of Principal Executive Officer and Principal Financial Officer Regarding Facts and Circumstances Relating to Exchange Act Filings pursuant to Securities and Exchange Commission Order No. 4-460, dated June 27, 2002. (2) Certifications of the Principal Executive Officer and the Principal Financial Officer as required pursuant to 18 U.S.C. Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Page 26 of 29 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: December 13, 2002 /s/ Kobi Alexander ---------------------------------- Kobi Alexander Chairman of the Board and Chief Executive Officer Dated: December 13, 2002 /s/ David Kreinberg ---------------------------------- David Kreinberg Executive Vice President and Chief Financial Officer Page 27 of 29 CERTIFICATIONS I, Kobi Alexander, the Chief Executive Officer of Comverse Technology, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Comverse Technology, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: December 13, 2002 /s/ Kobi Alexander -------------------------------- Name: Kobi Alexander Title: Chief Executive Officer Page 28 of 29 I, David Kreinberg, the Chief Financial Officer of Comverse Technology, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Comverse Technology, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: December 13, 2002 /s/ David Kreinberg ------------------------------- Name: David Kreinberg Title: Chief Financial Officer Page 29 of 29