-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HCDWWKBwjUrybukSI/wH5m5miLViLfueymFd3jV/Ght9U2d+DcuLbaKPMdYHrlbv 0kiVIno99fN/jCk1h8k2cg== /in/edgar/work/0000909518-00-000606/0000909518-00-000606.txt : 20001003 0000909518-00-000606.hdr.sgml : 20001003 ACCESSION NUMBER: 0000909518-00-000606 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20000714 ITEM INFORMATION: ITEM INFORMATION: FILED AS OF DATE: 20000929 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COMVERSE TECHNOLOGY INC/NY/ CENTRAL INDEX KEY: 0000803014 STANDARD INDUSTRIAL CLASSIFICATION: [3661 ] IRS NUMBER: 133238402 STATE OF INCORPORATION: NY FISCAL YEAR END: 0131 FILING VALUES: FORM TYPE: 8-K SEC ACT: SEC FILE NUMBER: 000-15502 FILM NUMBER: 731715 BUSINESS ADDRESS: STREET 1: 170 CROSSWAYS PARK DR CITY: WOODBURY STATE: NY ZIP: 11797 BUSINESS PHONE: 5166777200 MAIL ADDRESS: STREET 1: 170 CROSSWAYS PARK DRIVE STREET 2: 170 CROSSWAYS PARK DRIVE CITY: WOODBURY STATE: NY ZIP: 11797 8-K 1 0001.txt ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------- FORM 8-K CURRENT REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 Date of Report (Date of earliest event reported): SEPTEMBER 28, 2000 COMVERSE TECHNOLOGY, INC. (Exact name of Registrant as specified in its charter) NEW YORK 0-15502 13-3238402 (State or Other Jurisdiction (Commission (I.R.S. Employer of Incorporation) File Number) Identification No.) 170 CROSSWAYS PARK DRIVE WOODBURY, NEW YORK 11797 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code (516) 677-7200 NOT APPLICABLE (Former Name or Former Address, if Changed Since Last Report) ================================================================================ NY2:\966264\02\kpk_02!.DOC\37994.0017 ITEM 5. OTHER EVENTS The Registrant's Consolidated Financial Statements for the years ended December 31, 1997 and January 31, 1999 and 2000 are attached as Exhibit 99.1. ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS *23.1 Consent of Deloitte & Touche LLP. *99.1 Registrant's Consolidated Financial Statements for the years ended December 31, 1997 and January 31, 1999 and 2000. ------------------------ * Filed herewith. SIGNATURE 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 thereto duly authorized. COMVERSE TECHNOLOGY, INC. Dated: September 28, 2000 By: /s/ William F. Sorin --------------------------------- Name: William F. Sorin Title: Corporate Secretary 2 EXHIBIT INDEX EXHIBIT - ------- *23.1 Consent of Deloitte & Touche LLP. *99.1 Registrant's Consolidated Financial Statements for the years ended December 31, 1997 and January 31, 1999 and 2000. - ------------------------ * Filed herewith. 3 EX-23 2 0002.txt Exhibit 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No.'s 333-44429, 333-85565, 333-77201 and 333-43542 of Comverse Technology, Inc. on Form S-8 and in Registration Statement No.'s 333-86343, 333-77221, 333-63891 and 333-30799 of Comverse Technology, Inc. on Form S-3 of our report dated September 20, 2000, appearing in this Current Report on Form 8-K of Comverse Technology, Inc. /s/ DELOITTE & TOUCHE LLP New York, New York September 25, 2000 NY2:\966784\01\kpz401!.DOC\37994.0017 EX-99 3 0003.txt Exhibit 99.1 COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- PAGE Independent Auditors' Report F-2 Consolidated Balance Sheets as of January 31, 1999 and 2000 F-3 Consolidated Statements of Income for the Years Ended December 31, 1997 and January 31, 1999 and 2000 F-4 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1997 and January 31, 1999 and 2000 F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 1997 and January 31, 1999 and 2000 F-6 Notes to Consolidated Financial Statements F-7 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Comverse Technology, Inc. Woodbury, New York We have audited the accompanying consolidated balance sheets of Comverse Technology, Inc. and subsidiaries (the "Company") as of January 31, 1999 and 2000, and the related consolidated statements of income, stockholders' equity and cash flows for the years ended December 31, 1997 and January 31, 1999 and 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Comverse Technology, Inc. and subsidiaries as of January 31, 1999 and 2000, and the results of their operations and their cash flows for the years ended December 31, 1997 and January 31, 1999 and 2000 in conformity with accounting principles generally accepted in the United States of America. /S/ Deloitte & Touche LLP New York, New York September 20, 2000 F-2 COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS JANUARY 31, 1999 AND 2000 (IN THOUSANDS, EXCEPT SHARE DATA)
- -------------------------------------------------------------------------------------------------------------------------- ASSETS 1999* 2000* - ------ ---- ---- CURRENT ASSETS: Cash and cash equivalents $ 585,584 $ 342,535 Bank time deposits 10,000 9,800 Short-term investments 63,658 429,254 Accounts receivable, net of allowance for doubtful accounts of $25,651 and $29,319 194,747 266,203 Inventories 48,614 101,728 Prepaid expenses and other current assets 36,211 41,243 --------------- --------------- TOTAL CURRENT ASSETS 938,814 1,190,763 PROPERTY AND EQUIPMENT, net 65,530 126,101 INVESTMENTS 7,902 19,749 OTHER ASSETS 30,713 36,234 --------------- --------------- TOTAL ASSETS $ 1,042,959 $ 1,372,847 =============== =============== - --------------------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY 1999* 2000* - ------------------------------------ ---- ---- CURRENT LIABILITIES: Accounts payable and accrued expenses $ 186,074 $ 235,860 Bank loans 336 1,160 Advance payments from customers 39,051 94,777 Other current liabilities 1,188 662 --------------- --------------- TOTAL CURRENT LIABILITIES 226,649 332,459 CONVERTIBLE SUBORDINATED DEBENTURES 415,000 300,000 LIABILITY FOR SEVERANCE PAY 4,338 6,185 OTHER LIABILITIES 6,117 9,364 --------------- --------------- TOTAL LIABILITIES 652,104 648,008 --------------- --------------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock, $0.01 par value--authorized, 2,500,000 shares; issued, none Common stock, $0.10 par value - authorized, 600,000,000 shares; issued and outstanding, 139,262,904 and 155,776,298 shares 13,926 15,577 Additional paid-in capital 261,218 424,075 Retained earnings 112,074 282,764 Accumulated other comprehensive income 3,637 2,423 --------------- --------------- TOTAL STOCKHOLDERS' EQUITY 390,855 724,839 --------------- --------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,042,959 $ 1,372,847 =============== ===============
* Restated for pooling of interests with Loronix Information Systems, Inc. See notes to consolidated financial statements. F-3 COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1997 AND JANUARY 31, 1999 AND 2000 (IN THOUSANDS, EXCEPT PER SHARE DATA) - --------------------------------------------------------------------------------
DECEMBER 31, JANUARY 31, JANUARY 31, 1997* 1999* 2000* ---- ---- ---- Sales $ 498,343 $ 708,805 $ 909,667 Cost of sales 209,325 288,113 352,748 -------------- --------------- -------------- Gross margin 289,018 420,692 556,919 Operating expenses: Research and development, net 98,152 134,201 169,816 Selling, general and administrative 142,055 157,106 193,996 Royalties and license fees 12,325 16,552 18,841 Merger expenses - - 2,016 -------------- ------------- -------------- Income from operations 36,486 112,833 172,250 Interest and other income, net 4,957 8,315 16,595 -------------- ------------- -------------- Income before income tax provision 41,443 121,148 188,845 Income tax provision 9,430 11,783 15,698 -------------- ------------- -------------- Net income $ 32,013 $ 109,365 $ 173,147 ============== ============= ============== Earnings per share: Basic $ 0.25 $ 0.81 $ 1.19 ============== ============= ============== Diluted $ 0.23 $ 0.75 $ 1.08 ============== ============= ==============
* Restated for pooling of interests with Loronix Information Systems, Inc. See notes to consolidated financial statements. F-4 COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1997 AND JANUARY 31, 1999 AND 2000 (IN THOUSANDS, EXCEPT SHARE DATA) - --------------------------------------------------------------------------------
Accumulated Other Comprehensive Income -------------------- Common Stock Additional Unrealized Cumulative Total Number of Par Paid-in Retained Gains Translation Stockholders' Shares Value Capital Earnings (Losses) Adjustment Equity --------------------------------------------------------------------------------------------- BALANCE, JANUARY 31, 1997 as previously reported 123,951,982 $12,395 $187,398 $86,872 $1,547 $338 $288,550 Pooling of interests 1,794,845 179 15,085 (1,337) 13,927 --------------------------------------------------------------------------------------------- BALANCE, as restated 125,746,827 12,574 202,483 85,535 1,547 338 302,477 Comprehensive income: Net income 32,013 Unrealized (loss) on available-for- sale securities (430) Translation adjustment 106 Total comprehensive income 31,689 Warrant exercises 1,656,432 166 (166) - Common stock issued for acquisition 487,500 49 (33) 16 Retained earnings of acquired company 661 661 Common stock issued for employee stock purchase plan 152,764 15 1,291 1,306 Issuance of treasury stock upon exercise of stock options (292) (292) Retirement of common stock notes receivable from stockholders (6,545) (66) (66) Exercise of stock options 3,772,890 377 14,416 14,793 Tax benefit of dispositions of stock options 6,930 6,930 - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE, DECEMBER 31, 1997* 131,809,868 $ 13,181 $ 224,855 $ 117,917 $ 1,117 $ 444 $ 357,514 ============================================================================================= BALANCE, FEBRUARY 1, 1998 as previously reported 130,172,392 $ 13,017 $ 210,684 $ 6,559 $ 641 $ 489 $ 231,390 Pooling of interests 1,788,782 179 15,023 (3,850) 11,352 --------------------------------------------------------------------------------------------- BALANCE, as restated 131,961,174 13,196 225,707 2,709 641 489 242,742 Comprehensive income: Net income 109,365 Unrealized gain on available-for- sale securities 2,874 Translation adjustment (367) Total comprehensive income 111,872 Warrant exercise 1,299,000 130 (130) - Common stock issued for employee stock purchase plan 210,666 21 2,277 2,298 Exercise of stock options 5,792,064 579 33,364 33,943 - ----------------------------------------------------------------------------------------------------------------------------------- BALANCE, JANUARY 31, 1999* 139,262,904 13,926 261,218 112,074 3,515 122 390,855 Comprehensive income: Net income 173,147 Unrealized (loss) on available-for- sale securities (397) Translation adjustment (817) Total comprehensive income 171,933 Warrant exercises 1,746,635 175 (175) - Common stock issued for acquisitions 1,371,216 137 930 1,067 Retained earnings of acquired companies (2,457) (2,457) Common stock issued for employee stock purchase plan 377,016 38 5,514 5,552 Exercise of stock options 5,477,611 547 44,464 45,011 Conversion of debentures 7,540,916 754 112,079 112,833 Tax benefit of dispositions of stock options 45 45 - ----------------------------------------------------------------------------------------------------------------------------------- BALANCE, JANUARY 31, 1999* 155,776,298 $ 15,577 $ 424,075 $ 282,764 $ 3,118 $ (695) $ 724,839 =========== ======== ========= ========= ======= ======= =========
* Restated for pooling of interests with Loronix Information Systems, Inc. See notes to consolidated financial statements. F-5 COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1997 AND JANUARY 31, 1999 AND 2000 (IN THOUSANDS) - --------------------------------------------------------------------------------
DECEMBER 31, JANUARY 31, JANUARY 31, 1997* 1999* 2000* ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 32,013 $ 109,365 $ 173,147 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 23,068 22,106 34,969 Changes in assets and liabilities: Accounts receivable (25,104) (112,456) (68,024) Inventories (15,753) 15,723 (53,085) Prepaid expenses and other current assets (17,181) (5,735) (3,055) Accounts payable and accrued expenses 8,812 58,789 49,117 Advance payments from customers 8,595 16,371 48,114 Liability for severance pay 807 (143) 1,847 Other 3,708 (398) (5,680) ------------- --------------- -------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 18,965 103,622 177,350 ------------- -------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Maturities and sales (purchases) of bank time deposits and investments, net (53,463) 24,257 (377,613) Purchase of property and equipment (37,284) (25,632) (85,638) Capitalization of software development costs (6,468) (9,120) (12,482) -------------- --------------- ------------- NET CASH USED IN INVESTING ACTIVITIES (97,215) (10,495) (475,733) -------------- --------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from issuance of debentures - 292,672 - Proceeds from issuance of common stock in connection with exercise of stock options, warrants, and employee stock purchase plan 23,045 36,241 50,563 Net proceeds (repayments) from bank loans and other debt 29,680 (20,645) 3,064 ------------- -------------- ------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 52,725 308,268 53,627 ------------- ------------- ------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (25,525) 401,395 (244,756) CASH ACQUIRED IN POOLING OF INTERESTS TRANSACTIONS - - 1,707 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 216,882 184,189 585,584 ------------- ------------- ------------ CASH AND CASH EQUIVALENTS, END OF YEAR $ 191,357 $ 585,584 $ 342,535 ============= ============= ============ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for interest $ 9,218 $ 14,169 $ 20,329 ============= ============= ============ Cash paid during the year for income taxes $ 10,812 $ 2,453 $ 708 ============= ============= ============
* Restated for pooling of interests with Loronix Information Systems, Inc. See notes to consolidated financial statements. F-6 COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997 AND JANUARY 31, 1999 AND 2000 - -------------------------------------------------------------------------------- 1. ORGANIZATION AND BUSINESS Comverse Technology, Inc. ("Comverse" and, together with its subsidiaries, "CTI" or the "Company") was organized as a New York corporation in October 1984. The Company is engaged in the design, development, manufacture, marketing and support of special purpose computer and telecommunications systems and software for multimedia communications and information processing applications. In 1998, the Company changed its fiscal year from the calendar year to the fiscal year ending January 31. As a result of the change in fiscal year, the Company's results of operations for the one month ended January 31, 1998 have previously been reported separately as a transition period and included on a transition report on Form 10-K. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of Comverse and its wholly-owned and majority-owned subsidiaries. All material intercompany balances and transactions have been eliminated. CASH, CASH EQUIVALENTS AND BANK TIME DEPOSITS - The Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. Bank deposits with maturities in excess of three months are classified as bank time deposits. SHORT-TERM INVESTMENTS - The Company classifies all of its short-term investments (including U.S. treasury bills) as available-for-sale, accounted for at fair value, with resulting unrealized gains or losses reported as a separate component of stockholders' equity, on a net-of-tax basis. CONCENTRATION OF CREDIT RISK - Financial instruments which potentially expose the Company to concentration of credit risk, consist primarily of cash investments and accounts receivable. The Company places its cash investments with high-credit quality financial institutions and currently invests primarily in bank time deposits, money market funds placed with major banks and financial institutions, corporate commercial paper, corporate medium-term notes, and U.S. government obligations. Accounts receivable are generally diversified due to the number of commercial and government entities comprising the Company's customer base and their dispersion across many geographical regions. The Company believes no significant concentration of credit risk exists with respect to these cash investments and accounts receivable. INVENTORIES - Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out method. PROPERTY AND EQUIPMENT - Property and equipment are carried at cost less accumulated depreciation and amortization. The Company depreciates its property and equipment on a straight-line basis over periods ranging from three to seven years. The cost of maintenance and repairs is charged to operations as incurred. Significant renewals and betterments are capitalized. F-7 INCOME TAXES - The Company accounts for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. REVENUE AND EXPENSE RECOGNITION - Revenue is generally recognized at the time of shipment for sales of systems which do not require significant customization to be performed by the Company and collection of the resulting receivable is deemed probable by the Company. The Company's systems are generally a bundled hardware and software solution that are shipped together. The Company generally has no obligations to customers after the date products are shipped, except for product warranties. The Company generally warranties its products for one year after sale. A provision for estimated warranty costs is recorded at the time of sale. Customers may also purchase separate maintenance contracts, which generally consist of bug-fixing and telephone access to Company technical personnel, but in certain circumstances may also include the right to receive unspecified product updates, upgrades and enhancements. Revenue from these services is recognized ratably over the contract period. Revenues from certain development contracts are recognized under the percentage-of-completion method on the basis of physical completion to date or using actual costs incurred to total expected costs under the contract. Revisions in estimates of costs and profits are reflected in the accounting period in which the facts that require the revision become known. At the time a loss on a contract is known, the entire amount of the estimated loss is accrued. Amounts received from customers in excess of revenues earned under the percentage-of-completion method are recorded as advance payments from customers. Related contract costs include all direct material and labor costs and those indirect costs related to contract performance, and are included in cost of sales in the consolidated statements of income. Expenses incurred in connection with research and development activities, other than certain software development costs that are capitalized, and selling, general and administrative expenses are charged to operations as incurred. SOFTWARE DEVELOPMENT COSTS - Software development costs are capitalized upon the establishment of technological feasibility and are amortized over the estimated useful life of the software, which to date has been four years or less. Amortization begins in the period in which the related product is available for general release to customers. Amortization expenses amounted to $3,844,000, $3,649,000 and $6,304,000 for the years ended December 31, 1997 and January 31, 1999 and 2000, respectively. FUNCTIONAL CURRENCY AND FOREIGN CURRENCY TRANSACTION GAINS AND LOSSES - The United States dollar (the "dollar") is the functional currency of the major portion of the Company's foreign operations. Most of the Company's sales, and materials purchased for manufacturing, are denominated in or linked to the dollar. Certain operating costs, principally salaries, of foreign operations are denominated in local currencies. In those instances where a foreign subsidiary has a functional currency other than the dollar, the Company records any necessary foreign currency translation adjustment, reflected in stockholders' equity, at the end of each reporting period. Net gains (losses) from foreign currency transactions, included in the consolidated statements of income, approximated $(2,192,000), $2,847,000 and $(9,422,000) for the years ended December 31, 1997 and January 31, 1999 and 2000, respectively. F-8 The Company occasionally enters into foreign exchange forward contracts and options on foreign currencies. The purpose of the Company's foreign currency hedging activities is to protect the Company from the risk that the eventual dollar cash flows resulting from the sale of products to international customers will be adversely affected by changes in exchange rates. Any gain or loss on a foreign exchange contract which hedges a firm commitment is deferred until the underlying transaction is realized, at which time it is included in the consolidated statement of income. The Company also purchases foreign exchange options which permit, but do not require, the Company to exchange foreign currencies at a future date with another party at a contracted exchange rate. To finance premiums paid on such options, from time to time the Company may also write offsetting options at exercise prices which limit, but do not eliminate, the effect of purchased options as a hedge. As of January 31, 2000, the Company had no material outstanding foreign exchange contracts. OTHER ASSETS - Licenses of patent rights and acquired "know-how" are recorded at cost and amortized using the straight-line method over the estimated useful lives of the related technology, not exceeding five years. Goodwill and other intangible assets associated with acquired subsidiaries are amortized over periods ranging from five to twelve years. Debt issue costs are amortized using the effective interest method over the term of the related debt. LONG-LIVED ASSETS - The Company reviews for the impairment of long-lived assets and certain identifiable intangibles whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss would be recognized when estimated future cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. No such impairment losses have been identified by the Company. PERVASIVENESS OF ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. RECLASSIFICATIONS - Certain prior year amounts have been reclassified to conform to the manner of presentation in the current year. 3. RESEARCH AND DEVELOPMENT A significant portion of the Company's research and development operations are located in Israel where the Company derives substantial benefits from participation in programs sponsored by the Government of Israel for the support of research and development activities conducted in that country. 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. The Company is currently involved in several ongoing research and development projects supported by the OCS. The Company accrues royalties to the OCS for the sale of products incorporating technology developed in these projects. In addition, 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 years ended December 31, 1997 and January 31, 1999 and 2000 were $16,276,000, $16,732,000 and $16,797,000, respectively. F-9 4. SHORT-TERM INVESTMENTS The Company classifies all of its short-term investments as available-for-sale securities. The following is a summary of available-for-sale securities as of January 31, 2000:
GROSS GROSS ESTIMATED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ----------------------------------------------------------------------------------- (IN THOUSANDS) Corporate debt securities $ 397,325 $ 478 $ 668 $ 397,135 U.S. Government agency bonds 8,096 - 604 7,492 ------------ ---------- --------- ------------- Total debt securities 405,421 478 1,272 404,627 ------------ ---------- --------- ------------- Common stock 14,336 5,010 1,670 17,676 Mutual funds investing in U.S. government and agencies obligations 1,878 - 45 1,833 Preferred stock 4,211 1,565 658 5,118 ------------- ---------- --------- ------------- Total equity securities 20,425 6,575 2,373 24,627 ------------- ---------- --------- ------------- $ 425,846 $ 7,053 $ 3,645 $ 429,254 ============= ========== ========= =============
The following is a summary of available-for-sale securities as of January 31, 1999:
GROSS GROSS ESTIMATED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------------------------------------------------------------------------------- (IN THOUSANDS) Corporate debt securities $ 40,819 $ 924 $ 6 $ 41,737 ------------ ---------- --------- ----------- Common stock 13,993 3,448 1,082 16,359 Mutual funds investing in U.S. government and agencies obligations 1,929 70 - 1,999 Preferred stock 3,173 481 91 3,563 ------------- ---------- --------- ----------- Total equity securities 19,095 3,999 1,173 21,921 ------------- ---------- --------- ----------- $ 59,914 $ 4,923 $ 1,179 $ 63,658 ============= ========== ========= ===========
During the year ended January 31, 2000, the gross realized gains on sales of securities totaled approximately $11,652,000, and the gross realized losses totaled approximately $4,613,000. During the year ended January 31, 1999, the gross realized gains on sales of securities totaled approximately $1,358,000, and the gross realized losses totaled approximately $5,472,000. During the year ended December 31, 1997, the gross realized gains on sales of securities totaled approximately $4,037,000, and the gross realized losses totaled approximately $2,503,000. The basis on which cost was determined in computing realized gain or loss is by the first-in, first-out method. F-10 The amortized cost and estimated fair value of debt securities at January 31, 2000, by contractual maturity, are as follows:
ESTIMATED COST FAIR VALUE ---- ---------- (IN THOUSANDS) Due in one year or less $ 374,310 $ 374,075 Due after one year through three years 20,845 20,549 Due after three years 10,266 10,003 ------------ ------------ $ 405,421 $ 404,627 ============= =============
5. INVENTORIES Inventories consist of:
JANUARY 31, 1999 2000 ---- ---- (IN THOUSANDS) Raw materials $ 25,099 $ 41,391 Work in process 11,171 29,790 Finished goods 12,344 30,547 ------------- ------------- $ 48,614 $ 101,728 ============= ============= 6. PROPERTY AND EQUIPMENT Property and equipment consists of: JANUARY 31, 1999 2000 ---- ---- (IN THOUSANDS) Fixtures and equipment $ 121,861 $ 166,966 Land 226 26,029 Software 7,980 18,315 Transportation vehicles 2,774 1,597 Leasehold improvements 3,066 7,640 ------------- ------------- 135,907 220,547 Less accumulated depreciation and amortization (70,377) (94,446) ------------- ------------- $ 65,530 $ 126,101 ============= =============
F-11 7. OTHER ASSETS Other assets consist of:
JANUARY 31, 1999 2000 ---- ---- (IN THOUSANDS) Software development costs, net of accumulated amortization of $15,404 and $21,628 $ 16,095 $ 22,230 Debt issue costs, net of accumulated amortization of $1,078 and $1,404 9,140 5,703 Other assets 5,478 8,301 ------------- ------------- $ 30,713 $ 36,234 ============= =============
8. BUSINESS COMBINATIONS In July 2000, the Company acquired all of the outstanding stock of Loronix Information Systems, Inc. ("Loronix"), a company that develops software-based digital video recording and management systems for 1,994,806 shares of the Company's common stock and the assumption of options to purchase 370,101 shares of the Company's common stock. The combination was accounted for as a pooling of interests. The table below sets forth the separate and combined results of Comverse and Loronix for the fiscal years ended December 31, 1997 and January 31, 1999 and 2000:
CTI LORONIX COMBINED --- ------- -------- (In thousands, except share data amounts) DECEMBER 31, 1997 Sales $ 488,940 $ 9,403 $ 498,343 Net income (loss) $ 34,525 $ (2,512) $ 32,013 Earnings per share - diluted $ 0.25 $ 0.23 JANUARY 31, 1999 Sales $ 696,094 $ 12,711 $ 708,805 Net income (loss) $ 111,527 $ (2,162) $ 109,365 Earnings per share - diluted $ 0.78 $ 0.75 JANUARY 31, 2000 Sales $ 872,190 $ 37,477 $ 909,667 Net income $ 170,261 $ 2,886 $ 173,147 Earnings per share - diluted $ 1.07 $ 1.08
The consolidated statement of income data combines the historical statement of income data of the Company for the years ended December 31, 1997 and January 31, 1999 and 2000 with the historical statement of F-12 income data of Loronix for the fiscal years ended December 31, 1997, 1998 and 1999, respectively. In July 2000, the Company acquired all of the outstanding stock of Syborg Informationsysteme GmbH, ("Syborg") a company that develops software-based digital voice and internet recording and workforce management systems, for 201,251 shares of the Company's common stock. The combination was accounted for as a pooling of interests. The Company did not restate prior financial statements for this acquisition, as such restatement would not be material. In August 2000, the Company acquired all of the outstanding stock of Exalink Ltd., ("Exalink") a company specializing in router-based Wireless Application Protocol gateways and applications software for the delivery of Internet-based services to all types of wireless devices, for 5,261,211 shares of the Company's common stock and the assumption of options and warrants to purchase 810,377 shares of the Company's common stock. The combination was accounted for as a pooling of interests. The Company did not restate prior financial statements for this acquisition, as such restatement would not be material. In August 2000, the Company acquired all of the outstanding stock of Gaya Software Industries, Ltd., ("Gaya") a company specializing in software-based intelligent internet protocol ("IP") gateways and voice-over-IP technology, for 283,758 shares of the Company's common stock and the assumption of options and warrants to purchase 10,505 shares of the Company's common stock. The combination was accounted for as a pooling of interests. The Company did not restate prior financial statements for this acquisition, as such restatement would not be material. In August 1999, the Company acquired all of the outstanding stock of InTouch Systems, Inc., ("InTouch") a company that develops and markets a suite of intelligent voice-controlled software applications, for 679,202 shares of the Company's common stock and the assumption of options to purchase 79,122 shares of the Company's common stock. The combination was accounted for as a pooling of interests. The Company did not restate prior financial statements for this acquisition due to immateriality and recorded the book value of the net assets of InTouch of $(1,122,000) in the statement of stockholders' equity. In February 1999, the Company acquired all of the outstanding stock of Amarex Technology, Inc., ("Amarex"), a company that develops software-based applications for the telephone network operator and call center markets, for 692,014 shares of the Company's common stock and the assumption of options and warrants to purchase 239,286 shares of the Company's common stock. The combination was accounted for as a pooling of interests. The Company did not restate prior financial statements for this acquisition due to immateriality and recorded the book value of the net assets of Amarex of $(268,000) in the statement of stockholders' equity. In January 1998, Boston Technology, Inc., a Delaware corporation, ("BTI") merged with and into Comverse in a transaction that was accounted for as a pooling of interests. BTI designed, developed, manufactured, marketed and supported standard and customized enhanced services platforms and software applications for the telephone network operator market. Pursuant to the merger, the issued and outstanding shares of BTI at the effective date of the merger were converted into an aggregate of approximately 54,423,556 shares of Comverse's common stock and outstanding options and warrants to purchase BTI stock were converted into options and warrants to purchase an aggregate of 10,374,796 Comverse shares. BTI had a January 31 fiscal year period, accordingly, the Company's consolidated financial statements for the year ended December 31, 1997 includes the operations of BTI for the eleven months ended December 31, F-13 1997. For the eleven months ended December 31, 1997, BTI had sales of approximately $210,525,000 and a net loss of approximately $7,503,000. In 1998, the Company changed its fiscal year from the calendar year to the fiscal year ending January 31, corresponding to BTI's fiscal year. As a result of the change in fiscal year, the Company's results of operations for the one month ended January 31, 1998 have previously been reported separately as a transition period and included on a transition report on Form 10-K. Consolidated statement of operations data for the one month ended January 31, 1998 is as follows:
(In thousands, except per share amounts) Sales $ 14,401 Cost of Sales 21,146 Selling, general and administrative expenses 51,892 Research and development 13,481 Royalties and license fees 520 Merger and restructuring charges 41,877 ---------------- Loss from operations (114,515) Interest and other income, net 175 ---------------- Loss before income tax (114,340) Income tax provision (867) ----------------- Net loss $ (115,207) ================= Net loss per share $ (0.89) ================= In connection with the merger with BTI, the Company has charged $41,877,000 to operations for merger and restructuring related charges. Such charges relate to the following: Asset write-downs and impairments (In thousands) Research and development equipment $ 9,106 Capitalized software costs 2,987 Prepaid license fees 2,190 Furniture and equipment 1,474 Other 161 ------------ Total asset write-downs and impairments $ 15,918 ============ In connection with the merger with BTI, certain assets became impaired due to the closing of duplicative facilities, or the existence of duplicative technology of the merged companies. In addition, the Company decided to develop a new software platform for the combined company and to discontinue certain software enhancements under development which were previously capitalized. Accordingly, these assets were written down to their net realizable value at the time of the merger. Net realizable value was determined in accordance with the Company's accounting policies disclosed in Note 1. Severance and other restructuring charges (In thousands) Terminated employment contracts and severance $ 6,825 Terminated leases of duplicative facilities 571 Other 449 ------------ Total $ 7,845 ============
F-14 In connection with the merger with BTI, management having the requisite authority determined to close certain duplicate facilities, sever certain employees and otherwise streamline the combined operations. The Company also terminated certain employment contracts for employees that provided no future benefit to the merged companies. In connection with this plan, the Company recorded a charge for severance and related fringe benefits for 50 employees, consisting of 25 software engineers, 10 operations employees, 5 customer service employees and 10 general and administrative employees. The employees under employment contracts and employees who were terminated under the severance plan were considered redundant by the Company as a result of the merger. Prior to the merger, the Company and BTI each had sales offices in certain countries and, as a result of the merger, duplicative facilities were closed. A summary of the restructuring reserve is as follows:
One Month Ended Year Ended January 31, January 31, 1998 1999 2000 ------------------------------------------------------------- (In thousands) Balance, beginning of period $ - $ 7,356 $ 2,063 Provision 7,845 - - Payments for: Terminated employment contracts and severance (334) (4,528) (1,952) Duplicative facilities (56) (515) - Other (99) (250) - ----------- ----------- ----------- Balance, end of period $ 7,356 $ 2,063 $ 111 =========== =========== ===========
Professional fees and other direct merger expenses In connection with the merger with BTI, the Company recorded a charge of $11,040,000 for professional fees to lawyers, investment bankers and accountants, as well as other direct merger costs, such as printer fees for the proxy statement incurred directly in connection with the merger. Other merger related charges (In thousands) Penalties under product development agreements $ 5,989 Terminated development contracts 1,085 ----------- $ 7,074 In connection with the merger with BTI, the Company also terminated certain existing development contracts which provided no future benefit to the merged companies. Prior to the merger, the Company had commitments with third parties to develop technology in which it was contractually obligated. As a result of the merger, the Company decided to develop a new software platform for the combined company and to F-15 discontinue certain enhancements under development. In addition, the Company incurred penalties under product development agreements relating to transfer of technology. In addition, approximately $36,055,000 has been charged to selling, general and administrative expenses in the one month period ended January 31, 1998 relating to the impairment of receivables resulting from the merger. Included in this amount is approximately $14.9 million from an international distributor who refused to pay the Company, claiming his exclusive distribution agreement was violated as a result of the merger. Also included in this amount is approximately $21.1 million that was due from customers who had switched as customers from BTI to the Company or from the Company to BTI. In order to continue good customer relations, the Company decided to forgive the amounts owed. Approximately $7,831,000 has been charged to cost of sales in the one month ended January 31, 1998 relating to the merger. Such charge relates to the write-off of inventory that was considered obsolete and duplicative as a result of the merger. Both the Company and BTI had two enhanced services platform products. As a result of the merger, the Company decided that one product from each of the Company and BTI would no longer be sold. In February 1997, the Company acquired all of the outstanding stock of Enhanced Communications Corporation ("ECC"), a company providing outsourcing of voice messaging, for 487,500 shares of the Company's common stock. The combination has been accounted for as a pooling of interests. The Company did not restate prior financial statements for this acquisition due to immateriality and recorded the book value of the net assets of ECC of $661,000 in the statement of stockholders' equity. 9. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consist of: JANUARY 31, 1999 2000 ---- ---- (IN THOUSANDS) Accounts payable $ 64,291 $ 76,546 Accrued salaries 22,732 29,890 Accrued vacation 9,004 13,568 Accrued royalties 18,165 26,567 Other accrued expenses 71,882 89,289 ------------- ------------- $ 186,074 $ 235,860 ============= ============= 10. CONVERTIBLE SUBORDINATED DEBENTURES In June 1998, the Company issued $300,000,000 of convertible subordinated debentures bearing interest at 4-1/2% per annum, payable semi-annually. The debentures mature on July 1, 2005. The debentures are convertible into shares of the Company's common stock at a conversion price of $21.50 per share, subject to adjustment in certain events. The debentures are subordinated in right of payment to all existing and future senior indebtedness of the Company. The debentures are redeemable at the option of the Company, in whole or in part, at prices decreasing from 101.8% of the face amount on July 10, 2001 to par on July 10, 2003. F-16 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. In October 1996, the Company issued $115,000,000 of convertible subordinated debentures bearing interest at 5-3/4% per annum, payable semi-annually. In October 1999, the Company called these debentures for redemption. The debentures were converted into 7,540,916 shares of common stock. 11. LIABILITY FOR SEVERANCE PAY Liability for severance pay consists of the Company's unfunded liability for severance pay to employees of certain foreign subsidiaries and accrued severance to the Company's chief executive officer. Under Israeli law, the Company is obligated to make severance payments to employees of its Israeli subsidiaries on the basis of each individual's current salary and length of employment. These liabilities are currently provided primarily by premiums paid by the Company to insurance providers. The Company is obligated under an agreement with its chief executive officer to provide a severance payment upon the termination of his employment with the Company. Approximately $1,648,000 and $1,925,000 has been accrued as of January 31, 1999 and 2000, respectively, relating to this liability. 12. COMMON STOCK STOCK SPLITS - On April 15, 1999, the Company effected a three-for-two stock split by paying a 50% stock dividend to stockholders of record on March 31, 1999. On April 3, 2000, the Company effected a two-for-one stock split by paying a 100% stock dividend to shareholders of record on March 27, 2000. All share and per share information has been retroactively restated in the consolidated financial statements to reflect these splits. INCREASE IN AUTHORIZED COMMON SHARES - At the Annual Meeting of Shareholders held on October 8, 1999, the Company's shareholders approved an amendment to the Company's Certificate of Incorporation to increase from 100,000,000 to 300,000,000 the aggregate number of authorized common shares of the Company. At the Annual Meeting of Shareholders held on September 15, 2000, the Company's shareholders approved an amendment to the Company's Certificate of Incorporation to increase from 300,000,000 to 600,000,000 the aggregate number of authorized common shares of the Company. 13. STOCK OPTIONS EMPLOYEE STOCK OPTIONS - At January 31, 2000, 23,810,758 shares of common stock were reserved for issuance upon the exercise of options then outstanding and 305,062 shares were available for future grant under Comverse's Stock Option Plans, under which options may be granted to key employees, directors, and other persons rendering services to the Company. Options which are designated as "incentive stock options" under the option plans may be granted with an exercise price not less than the fair market value of the underlying shares at the date of grant and are subject to certain quantity and other limitations specified in Section F-17 422 of the Internal Revenue Code. Options which are not intended to qualify as incentive stock options may be granted at any price, but not less than the par value of the underlying shares, and without restriction as to amount. The options and the underlying shares are subject to adjustment in accordance with the terms of the plans in the event of stock dividends, recapitalizations and similar transactions. The right to exercise the options generally vests in annual increments over periods of up to four years from the date of grant or the date of commencement of the grantee's employment with the Company, up to a maximum term of ten years for all options granted. The changes in the number of options were as follows:
YEAR ENDED ------------------------------------------------------------------ DECEMBER 31, JANUARY 31, 1997 1999 2000 ---- ---- ---- Outstanding at beginning of year 17,061,447 25,184,797 21,243,496 Options from pooling of interests transactions - - 224,758 Granted during the year 3,472,716 2,788,526 8,589,990 Exercised during the year (3,772,890) (5,792,064) (5,477,611) Canceled, terminated and expired (534,150) (937,763) (769,875) --------------- --------------- ---------------- Outstanding at end of year 16,227,123 21,243,496 23,810,758 =============== =============== ================
At January 31, 2000, options to purchase an aggregate of 7,250,424 shares were vested and currently exercisable under the option plans and options to purchase an additional 16,560,334 shares vest at various dates extending through the year 2003. Weighted average option exercise price information was as follows:
YEAR ENDED ------------------------------------------------------------- DECEMBER 31, JANUARY 31, 1997 1999 2000 ---- ---- ---- Outstanding at beginning of year $ 5.62 $ 8.64 $ 9.59 Assumed from pooling of interests - - 3.16 Granted during the year 14.10 10.53 43.98 Exercised during the year 4.13 5.87 8.23 Canceled, terminated and expired 7.29 10.38 11.96 Exercisable at year end 4.08 6.87 9.05
Significant option groups outstanding at January 31, 2000 and related weighted average price and life information were as follows:
Weighted Average Weighted Weighted Range of Number Remaining Average Number Average Exercise Price Outstanding Contractual Life Exercise Price Exercisable Exercise Price -------------- ----------- ---------------- -------------- ----------- -------------- $ 0.63 - $12.99 12,180,115 7.38 $ 8.98 5,878,726 $ 7.75 $ 13.00 - $38.96 3,983,781 7.63 16.06 1,350,098 14.12 $ 38.99 - $51.95 7,644,938 9.69 46.51 21,600 46.50 $ 51.97 - $77.92 1,924 9.84 63.68 - - ---------- ---- -------- --------- -------- 23,810,758 8.16 $ 22.05 7,250,424 $ 9.05 ========== ==== ======== ========= ========
F-18 The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its option plans. Accordingly, as all options have been granted at exercise prices equal to fair market value on the date of grant, no compensation expense has been recognized by the Company in connection with its stock-based compensation plans. Had compensation cost for the Company's stock option plans been determined based upon the fair value at the grant date for awards under these plans consistent with the methodology prescribed under Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation", the Company's net income and earnings per share would have been reduced by approximately $14,058,000, $29,261,000 and $45,239,000 or $0.10, $0.20 and $0.27 per diluted share for the years ended December 31, 1997 and January 31, 1999 and 2000, respectively. The weighted average fair value of the options granted for the years ended December 31, 1997 and January 31, 1999 and 2000, respectively, is estimated at $7.67, $5.51 and $21.54 on the date of grant (using the Black-Scholes option pricing model) with the following weighted average assumptions for the years ended December 31, 1997 and January 31, 1999 and 2000, respectively: volatility of 56%, 56% and 56%; risk-free interest rate of 6.5%, 4.7% and 5.9%; and an expected life of 4.7, 5.0 and 4.1 years. OPTIONS ON SUBSIDIARY SHARES - In accordance with the requirements of his employment agreement, the chief executive officer of Comverse holds options to acquire up to 7.5% of the shares of certain subsidiaries, other than Comverse Network Systems, Inc. In addition, Comverse has granted to certain other employees of the Company options to acquire shares of certain subsidiaries, other than Comverse Network Systems, Inc. Such option issuances are not tied to the performance of the subsidiaries, but are intended to incentivize employees in the units for which they have direct responsibility. The portion of the shares of the subsidiaries upon which such options have been granted varies among the subsidiaries affected, not exceeding in any instance 20% of the shares outstanding assuming exercise in full. The options have terms of up to 15 years and become exercisable and vest over various periods ranging up to seven years from the date of initial grant. The exercise price of each option is equal to the higher of the book value of the underlying shares at the date of grant or the fair market value of such shares at that date determined on the basis of an arms'-length transaction with a third party or, if no such transactions have occurred, on a reasonable basis as determined by a committee of the Board of Directors. 14. WARRANTS In November 1995, the Company entered into an agreement to supply its products to a customer. Pursuant to this agreement, the Company issued warrants to purchase shares of its common stock at an exercise price of $7.18 per share. The warrants vest in five equal annual increments, commencing with the first anniversary of the date of grant, and remain exercisable for 30 months after first becoming exercisable. As of January 31, 2000, warrants to purchase 1,914,432 shares are outstanding, none of which are exercisable. F-19 15. EMPLOYEE STOCK PURCHASE PLAN Under the 1997 Employee Stock Purchase Plan ("ESPP"), all employees who had completed three months of employment are entitled, through payroll deductions of amounts up to 10% of their base salary, to purchase shares of the Company's common stock at 85% of the lesser of the market price at the offering commencement date or the offering termination date. The number of shares available under the ESPP is 2,000,000, of which 587,682 had been issued as of January 31, 2000. F-20 16. EARNINGS PER SHARE ("EPS") Basic earnings per share is determined by using the weighted average number of shares of common stock outstanding during each period. Diluted earnings per share further assumes the issuance of common shares for all dilutive potential common shares outstanding. The calculation for earnings per share for the years ended December 31, 1997 and January 31, 1999 and 2000 was as follows:
DECEMBER 31, 1997 JANUARY 31, 1999 JANUARY 31, 2000 --------------------------------- ------------------------------- -------------------------------- Per Share Per Share Per Share Income Shares Amount Income Shares Amount Income Shares Amount ------ ------ ------ ------ ------ ------ ------ ------ ------ (In thousands, except per share data) BASIC EPS Net Income $ 32,013 129,034 $ 0.25 $109,365 134,389 $ 0.81 $ 173,147 145,889 $ 1.19 ====== ====== ====== EFFECT OF DILUTIVE SECURITIES Options and warrants 10,668 11,050 13,905 Convertible debentures 19,399 19,192 --------- --------- ------ --------- -------- ------ --------- ---------- ------ DILUTED EPS $ 32,013 139,702 $ 0.23 $ 109,365 145,439 $ 0.75 $ 192,546 178,986 $ 1.08 ========= ======= ====== ========= ======== ====== ========= ========== ======
Debentures convertible into 7,540,984 shares and 21,494,472 shares were outstanding as of December 31, 1997 and January 31, 1999, respectively, but were not included in the computation of diluted EPS because the effect of including them would be antidilutive. 17. INTEREST AND OTHER INCOME, NET Interest and other income, net, consists of the following: YEAR ENDED DECEMBER 31, JANUARY 31, 1997 1999 2000 ---- ---- ---- (IN THOUSANDS) Interest and dividend income $ 15,847 $ 25,552 $ 36,872 Interest expense (9,761) (16,141) (19,423) Other, net (1,129) (1,096) (854) ------------ ------------ ------------- $ 4,957 $ 8,315 $ 16,595 ============ ============ ============= F-21 18. INCOME TAXES The provision for income taxes consists of the following: YEAR ENDED DECEMBER 31, JANUARY 31, 1997 1999 2000 ---- ---- ---- (IN THOUSANDS) Current: Federal $ 3,471 $ - $ 171 State 703 127 769 Foreign 2,216 11,664 14,743 ----------- ------------ ------------ 6,390 11,791 15,683 ----------- ------------ ------------ Deferred (benefit): Federal 2,835 (430) (49) State 222 13 5 Foreign (17) 409 59 ------------ ------------ ------------ 3,040 (8) 15 ----------- ------------- ------------ $ 9,430 $ 11,783 $ 15,698 =========== ============ ============ The reconciliation of the U.S. Federal statutory tax rate to the Company's effective tax rate is as follows: YEAR ENDED DECEMBER 31, JANUARY 31, 1997 1999 2000 ---- ---- ---- U.S. Federal statutory rate 35% 35% 35% Consolidated worldwide income in excess of U.S. income (33) (38) (36) Foreign income taxes 5 9 8 Other 16 4 1 -------- -------- -------- Company's effective tax rate 23% 10% 8% ======== ======== ======== Deferred income taxes reflect the net tax effects of (a) temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and (b) operating loss carryforwards. The tax effects of significant items comprising the Company's deferred tax asset and liability at January 31, 1999 and 2000 is as follows: F-22
JANUARY 31, 1999 2000 ---- ---- (IN THOUSANDS) Deferred tax liability: Expenses deductible for tax purposes and not for financial reporting purposes $ 633 $ 722 Unrealized gain on available-for-sale securities 1,301 1,154 ----------- ------------ $ 1,934 $ 1,876 =========== ============ Deferred tax asset: Reserves not currently deductible $ 23,028 $ 19,690 Tax loss carryforwards 26,824 105,378 Inventory capitalization 365 504 ----------- ------------ 50,217 125,572 Less: valuation allowance (48,018) (123,335) ------------ ------------- Total deferred tax asset $ 2,199 $ 2,237 =========== ============
At January 31, 2000, the Company had net operating loss carryforwards for Federal income tax purposes of approximately $284.7 million, which begin to expire in 2012. Income tax has not been provided on unrepatriated earnings of foreign subsidiaries as currently it is the intention of the Company to reinvest such foreign earnings in their operations. 19. BUSINESS SEGMENT INFORMATION The Company has historically operated its business based on different geographical regions. During the year ended January 31, 2000, the Company changed the manner in which it operates into its various product business units. The Company's reporting segments are as follows: Enhanced Services Platform Products - Enables telecommunications network operators to offer a variety of revenue-generating services, including a broad range of integrated messaging, information distribution and personal assistant services, such as call answering, voice mail, fax mail, unified messaging, pre-paid services, wireless data and Internet-based services. Signaling Software Products - Interconnects the complex switching, database and messaging systems and manage the vital number, routing and billing information that form the backbone of today's communication networks. These products also enable voice and data networks to interoperate, or converge, allowing service providers to offer such converged network services as voice over the Internet and Internet call waiting. Digital Monitoring Systems Products - Supports the voice, fax, data and video recording and analysis activities of call centers and a variety of other commercial and governmental organizations and supports the monitoring, recording, surveillance, and information gathering and analysis activities of law enforcement and intelligence agencies. All Other - Includes other miscellaneous operations. F-23 The table below presents information about operating income/loss and segment assets as of and for the year ended January 31, 2000:
Enhanced Digital Services Signaling Monitoring Platform Software Systems All Reconciling Consolidated Products Products Products Other Items Totals -------------------------------------------------------------------------------------------------------- (In thousands) Sales $ 755,597 $ 25,831 $ 115,551 $ 19,494 $ (6,806) $ 909,667 Operating Income (Loss) $ 182,836 $ 2,809 $ (9,530) $ (2,043) $ (1,822) $ 172,250 Total Assets $ 694,872 $ 17,794 $ 99,183 $ 39,512 $ 521,486 $ 1,372,847
Reconciling items consist of the following: Sales - elimination of intersegment revenues Operating Income - elimination of intersegment operating income and corporate operations. Total Assets - elimination of intersegment receivables and unallocated corporate assets. Historical operating information could not be reasonably restated for prior years based on the Company's new operating structure. Historical condensed operating information based on geographical regions for the years ended December 31, 1997 and January 31, 1999 were as follows:
UNITED STATES ISRAEL OTHER ELIMINATIONS TOTAL ------ ------ ----- ------------ ----- (IN THOUSANDS) YEAR ENDED DECEMBER 31, 1997 Sales $ 352,005 $ 203,636 $ 19,067 $ (76,365) $ 498,343 Costs and expenses (353,759) (163,847) (18,292) 74,041 (461,857) ------------- -------------- ----------- ----------- ------------- Operating income (loss) $ (1,754) $ 39,789 $ 775 $ (2,324) $ 36,486 ============= ============== =========== =========== ============= YEAR ENDED JANUARY 31, 1999 Sales $ 354,407 $ 407,809 $ 33,510 $ (86,921) $ 708,805 Costs and expenses (379,890) (274,218) (31,009) 89,145 (595,972) ------------- -------------- ----------- ----------- ------------- Operating income (loss) $ (25,483) $ 133,591 $ 2,501 $ 2,224 $ 112,833 ============= ============== =========== =========== =============
F-24 Sales by country, based on end-user location, as a percentage of total sales, for the years ended December 31, 1997 and January 31, 1999 and 2000 were as follows: DECEMBER 31, JANUARY 31, ------------ ----------- 1997 1999 2000 ---- ---- ---- United States 34% 27% 24% Germany 4% 11% 10% Japan 13% 8% 9% Other foreign 49% 54% 57% ------- ------ -------- Total 100% 100% 100% ======= ====== ======== No customer accounted for 10% or more of sales for the years ended December 31, 1997, January 31, 1999 or January 31, 2000. Long-lived assets by country of domicile consist of: JANUARY 31, 1999 2000 ---- ---- (IN THOUSANDS) United States $ 52,784 $ 72,494 Israel 41,826 95,275 Other 2,462 10,570 ----------- ------------- $ 97,072 $ 178,339 =========== ============= 20. COMMITMENTS AND CONTINGENCIES LEASES - The Company leases office, manufacturing, and warehouse space under non-cancelable operating leases. Rent expense for all leased premises approximated $11,785,000, $15,168,000 and $22,500,000 in the years ended December 31, 1997 and January 31, 1999 and 2000, respectively. As of January 31, 2000, the minimum annual rent obligations of the Company were approximately as follows: TWELVE MONTHS ENDED JANUARY 31, AMOUNT (IN THOUSANDS) 2001 $ 22,633 2002 18,018 2003 16,537 2004 15,323 2005 and thereafter 41,026 ------------- $ 113,537 ============= F-25 EMPLOYMENT AGREEMENTS - The Company is obligated under employment contracts with its chief executive officer to provide salary, bonuses, and fringe benefits through January 31, 2004. Minimum salary payments under the contracts currently amount to $642,000 per year. The executive is entitled to annual bonuses equal to at least 2.75% of the Company's consolidated after-tax net income during each year, determined without regard to acquisition-related expenses and charges. Following termination or expiration of the term of employment, the executive is entitled to receive a severance payment equal to $112,736 times the number of years from the beginning of his employment with the Company, the amount of which payment increases at the rate of 10% per annum compounded for each year of employment following December 31, 2000, plus continued fringe benefits for three years and insurance coverage for up to 10 years. If the executive's employment is terminated by the Company without "cause", or by the executive for "good reason" (as those terms are defined in the agreement), the executive is entitled to additional payments attributable to the salary, bonus and the monetary equivalence of other benefits which he otherwise would have expected to receive for a period of three years or the balance of the agreement term, whichever is longer. If such termination occurs following a change in control of the Company, the required additional payment is three times the executive's annual salary and bonus, and the executive is additionally entitled to the accelerated vesting of all retirement benefits and stock options, and payments sufficient to reimburse any associated excise tax liability and income tax resulting from such reimbursement. The agreements also provide for the executive to receive options entitling him to purchase 7-1/2% of the equity of Comverse's subsidiaries, other than Comverse Network Systems, Inc., at prices equal to the higher of the book value of the underlying shares at the date of option grant or the fair market value of such shares at that date determined on the basis of an arms'-length transaction with a third party or, if no such transactions have occurred, on a reasonable basis as determined by the Board of Directors. These options, as well as any options granted the executive under the Company's stock option or stock incentive plans, become fully vested, exercisable and nonforfeitable in the event of a change in control of the Company, the termination of the executive's employment by the Company without cause or by the executive for good reason, or the executive's death or disability. Most other employment agreements of the Company are terminable with or without cause with prior notice of 90 days or less. In certain instances, the termination of employment agreements without cause entitles the employees to certain benefits, including acceleration of the vesting of stock options and severance payments of as much as one year's compensation. LICENSES AND ROYALTIES - The Company licenses certain technology, "know-how," software and related rights for use in the manufacture and marketing of its products, and pays royalties to third parties under such licenses and under other agreements entered into in connection with research and product development activities. The Company currently pays royalties on the sale of most of its product lines in varying amounts based upon the revenues attributed to the various components of such products. Royalties typically range up to 6% of net sales of the related products and, in the case of royalties due to government funding sources in respect of research and development projects, are required to be paid until the funding organization has received total royalties ranging from 100% to 150% of the amounts received by the Company under the approved project budgets. DIVIDEND RESTRICTIONS - The ability of Comverse's Israeli subsidiaries to pay dividends is governed by Israeli law, which provides that cash dividends may be paid by an Israeli corporation only out of retained earnings as determined for statutory purposes in Israeli currency. In the event of a devaluation of the Israeli currency against the dollar, the amount in dollars available for payment of cash dividends out of prior years' earnings will decrease accordingly. Cash dividends paid by an Israeli corporation to United States residents are subject to withholding of Israeli income tax at source at a rate of up to 25%, depending on the particular facilities which have generated the earnings that are the source of the dividends. F-26 INVESTMENTS - In 1997, wholly-owned subsidiaries of Comverse and Quantum Industrial Holdings Ltd. organized two new companies to make investments primarily relating to Israel, including investments in high technology ventures. Each participant committed a total of $37,500,000 to the capital of the new companies, for use as suitable investment opportunities are identified. Quantum Industrial Holdings Ltd. is the principal direct investment vehicle of the Quantum Group, a group of investment funds managed by Soros Fund Management LLC. As of January 31, 1999 and 2000, the Company has invested approximately $3,100,000 and $11,300,000, respectively, related to these ventures which are included in the caption "Investments" in the accompanying balance sheets. GUARANTIES - The Company has obtained bank guaranties primarily for performance of certain obligations under contracts with customers. These guaranties, which aggregated approximately $58,405,000 at January 31, 2000, are to be released by the Company's performance of specified contract milestones, which are scheduled to be completed primarily during 2000. LITIGATION - The Company is subject to certain legal actions arising in the normal course of business. After taking into consideration legal counsel's evaluation of such actions, management is of the opinion that their final resolution will not have any significant adverse effect upon the Company's financial position or results of operations. 21. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair value amounts have been determined by the Company, using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
JANUARY 31, -------------------------------------------------------------------------- 1999 2000 ---- ---- CARRYING ESTIMATED CARRYING ESTIMATED AMOUNT FAIR VALUE AMOUNT FAIR VALUE ------ ---------- ------ ---------- (IN THOUSANDS) Liabilities: Convertible subordinated debentures $ 415,000 $ 646,475 $ 300,000 $ 1,313,400 Off-balance sheet financial instruments: Foreign exchange forward contracts and options used for hedging purposes $ - $ (909) $ - $ -
CASH AND CASH EQUIVALENTS, BANK TIME DEPOSITS, SHORT-TERM INVESTMENTS, ACCOUNTS RECEIVABLE, INVESTMENTS, AND ACCOUNTS PAYABLE - The carrying amounts of these items are a reasonable estimate of their fair value. CONVERTIBLE SUBORDINATED DEBENTURES AND FOREIGN EXCHANGE FORWARD CONTRACTS - The fair value of these securities is estimated based on quoted market prices or recent sales for those or similar securities. F-27 The fair value estimates presented herein are based on pertinent information available to management as of January 31, 2000. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date, and current estimates of fair value may differ significantly from the amounts presented herein. 22. EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS During 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 requires that all derivative financial instruments be recognized as either assets or liabilities in the balance sheet. Measurement is at fair value, and if the derivative is not designed as a hedging instrument, changes in fair value (i.e., gains and losses) are to be recognized in earnings in the period of change. If certain conditions are met, a derivative may be designed as a hedge, in which case the accounting for changes in fair value will depend on the specific exposure being hedged. The method that will be used for assessing the effectiveness of a hedging derivative, as well as the measurement approach for determining the ineffective aspects of the hedge, must be established at the inception of the hedge. The methods must be consistent with the Company's approach to managing risk. SFAS 133, as amended by Statement of Financial Accounting Standards No. 137, will be effective for fiscal years beginning after June 15, 2000. The Company is currently evaluating the impact that the adoption of SFAS 133 will have on its financial statements. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements". SAB 101 summarizes certain of the SEC's views in applying generally accepted accounting principals to revenue recognition in financial statements. The Company is required to adopt SAB 101 in the fourth quarter of fiscal 2000. The Company is currently evaluating the impact that the adoption of SAB 101 will have on its financial statements. F-28 23. QUARTERLY INFORMATION (UNAUDITED) The following table shows selected results of operations for each of the quarters during the years ended January 31, 1999 and 2000:
FISCAL QUARTER ENDED APRIL 30, JULY 31, OCT. 31, JAN. 31, APRIL 30, JULY 31, OCT. 31, JAN. 31 1998 1998 1998 1999 1999 1999 1999 2000 ---------------------------------------------------------------------------------------------------------------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Sales $ 162,385 $ 169,389 $ 183,444 $ 193,587 $ 207,897 $ 216,810 $ 232,893 $ 252,067 Gross profit 95,169 100,294 109,145 116,084 125,936 132,971 142,970 155,042 Net income 23,301 25,179 29,225 31,660 36,192 41,023 44,035 51,897 Diluted earnings per share $ 0.16 $ 0.17 $ 0.20 $ 0.21 $ 0.24 $ 0.26 $ 0.27 $ 0.30 ========== ========= ========= ========= ========== ========= ========= =========
F-29 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. RESULTS OF OPERATIONS INTRODUCTION In July 2000, Comverse acquired all of the outstanding stock of Loronix Information Systems, Inc., a Nevada corporation ("Loronix"), in a transaction accounted for as a pooling of interests. The Company's financial statements for the years ended January 31, 2000 and 1999 and December 31, 1997 include the operations of Loronix for the years ended December 31, 1999, 1998 and 1997 respectively. In January 1998, Comverse consummated a merger (the "Merger") with Boston Technology, Inc., a Delaware corporation ("Boston"), in a transaction accounted for as a pooling of interests. The Company's financial statements for the year ended December 31, 1997 include the operations of Boston for the eleven months ended December 31, 1997. Cost of sales include material costs, subcontractor costs, salary and related benefits for the operations and service departments, depreciation and amortization of equipment used in the operations and service departments, amortization of capitalized software costs and an overhead allocation. Research and development costs include salaries and related benefits as well as travel, depreciation and amortization of research and development equipment, an overhead allocation, as well as other costs associated with research and development activities. Selling, general and administrative costs include salary and related benefits, travel, depreciation and amortization, marketing and promotional materials, recruiting expenses, professional fees, facility costs, as well as other costs associated with sales, marketing, finance and administrative departments. YEAR ENDED JANUARY 31, 2000 COMPARED TO YEAR ENDED JANUARY 31, 1999 Sales. Sales for the fiscal year ended January 31, 2000 ("fiscal 1999") increased by approximately $200.9 million, or 28%, compared to fiscal year ended January 31, 1999 ("fiscal 1998"). This increase is primarily attributable to an increase in sales of ESP products of approximately $161.5 million. Such increase was principally due to increased sales to European customers. In addition, sales of multimedia digital monitoring systems and network signaling software products increased by approximately $31.3 million and $6.3 million, respectively. Cost of Sales. Cost of sales for fiscal 1999 increased by approximately $64.6 million, or 22%, as compared to fiscal 1998. The increase in cost of sales is primarily attributable to increased materials and production costs of approximately $40 million due to the increase in sales and increased personnel-related costs of approximately $23 million due to hiring of additional personnel and increased compensation and benefits for existing personnel. Gross margins increased from approximately 59% in fiscal 1998 to approximately 61% in fiscal 1999. F-30 Selling, General and Administrative Expenses. Selling, general and administrative expenses for fiscal 1999 increased by approximately $36.9 million, or 23%, compared to fiscal 1998, but as a percentage of sales decreased from approximately 22% in fiscal 1998 to approximately 21% in fiscal 1999. The increase was primarily due to hiring of additional personnel and increased compensation and benefits for existing personnel to support the increased level of sales during fiscal 1999. Research and Development. Net research and development expenses for fiscal 1999 increased by approximately $35.6 million, or 27%, compared to fiscal 1998 due to overall growth of research and development operations and the initiation of significant new research and development projects. The increase was primarily due to hiring of additional personnel and increased compensation and benefits for existing personnel to support the higher volume of research and development activities. Royalties and License Fees. Royalties and license fees for fiscal 1999 increased by approximately $2.3 million, or 14%, compared to fiscal 1998. The increase was primarily a result of the growth in sales of royalty bearing products. Interest and Other Income, Net. Interest and other income, net, for fiscal 1999 increased by approximately $8.3 million as compared to fiscal 1998. The principal reasons for the increase are increased interest and dividend income of approximately $11.3 million and increased realized gains on the Company's investments of approximately $11.2 million. These increases were partially offset by increased interest expense of approximately $3.3 million and a change in foreign currency gains/losses of approximately $12.3 million. The increase in interest and dividend income and interest expense is primarily a result of the inclusion for a full year in fiscal 1999 of the Company's $300 million convertible subordinated debentures issued in June 1998. Income Tax Provision. Provision for income taxes increased from fiscal 1998 to fiscal 1999 by approximately $3.9 million, or 33%, due to increased pre-tax income. Our overall effective tax rate decreased from approximately 10% during fiscal 1998 to approximately 8% in fiscal 1999. 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. Net income increased by approximately $63.8 million, or 58%, in fiscal 1999 compared to fiscal 1998, while as a percentage of sales increased from approximately 15% in fiscal 1998 to approximately 19% in fiscal 1999. The increase resulted primarily from the factors described above. YEAR ENDED JANUARY 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1997 Sales. Sales for fiscal 1998 increased by approximately $210.5 million, or 42%, compared to fiscal year ended December 31, 1997 ("fiscal 1997"). This increase is primarily attributable to an increase in sales of ESP products of approximately $176.8 million. Such increase was principally due to F-31 increased sales to European customers. In addition, sales of multimedia digital monitoring systems increased by approximately $28.3 million. Cost of Sales. Cost of sales for fiscal 1998 increased by approximately $78.8 million, or 38%, as compared to fiscal 1997. The increase in cost of sales is primarily attributable to increased materials and production costs of approximately $48 million due to the increase in sales, increased personnel-related costs of approximately $14 million due to hiring of additional personnel and increased compensation and benefits for existing personnel, and an increase in overhead costs of approximately $8.5 million. Gross margins increased from approximately 58% in fiscal 1997 to approximately 59% in fiscal 1998. Selling, General and Administrative Expenses. Selling, general and administrative expenses for fiscal 1998 increased by approximately $15.1 million, or 11%, compared to fiscal 1997, but as a percentage of sales decreased from approximately 29% in fiscal 1997 to approximately 22% in fiscal 1998. The increase was primarily due to hiring of additional personnel and increased compensation and benefits for existing personnel to support the increased level of sales during fiscal 1998. Research and Development. Net research and development expenses for fiscal 1998 increased by approximately $36.0 million, or 37%, compared to fiscal 1997 due to overall growth of research and development operations and the initiation of significant new research and development projects. The increase was primarily due to hiring of additional personnel and increased compensation and benefits for existing personnel to support the higher volume of research and development activities. Royalties and License Fees. Royalties and license fees for fiscal 1998 increased by approximately $4.2 million, or 34%, compared fiscal 1997. The increase was primarily a result of the growth in sales of royalty bearing products. Interest and Other Income, Net. Interest and other income, net, for fiscal 1998 increased by approximately $3.4 million as compared to fiscal 1997. The principal reasons for the increase are increased interest and dividend income of approximately $9.7 million and a change in foreign currency gains/losses of approximately $5.0 million. These increases were partially offset by increased interest expense of approximately $6.4 million and net realized losses on the Company's investments of approximately $5.6 million. The increase in interest and dividend income and interest expense in fiscal 1998 is primarily a result of the issuance by the Company of $300 million convertible subordinated debentures issued in June 1998. Income Tax Provision. Provision for income taxes increased from fiscal 1997 to fiscal 1998 by approximately $2.4 million, or 25%, due to increased pre-tax income. Our overall effective tax rate decreased from approximately 23% during fiscal 1997 to approximately 10% in fiscal 1998. 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. F-32 Net Income. Net income increased by approximately $77.4 million, or 242%, in fiscal 1998 compared to fiscal 1997, while as a percentage of sales increased from approximately 6% in fiscal 1997 to approximately 15% in fiscal 1998. The increase resulted primarily from the factors described above. TRANSITION PERIOD In 1998, the Company changed its fiscal year from the calendar year to the fiscal year ending January 31, corresponding to Boston's fiscal year. As a result of the change in fiscal year, the Company's results of operations for the one month ended January 31, 1998 have previously been reported separately as a transition period and included on a transition report on Form 10-K. The Company had sales of approximately $14.4 million, costs and expenses of approximately $129.6 million, and a net loss of approximately $115.2 million for the one month ended January 31, 1998. In connection with the Merger, the Company has charged $41,877,000 to operations for merger and restructuring related charges. Such charges relate to the following: Asset write-downs and impairments (In thousands) Research and development equipment $ 9,106 Capitalized software costs 2,987 Prepaid license fees 2,190 Furniture and equipment 1,474 Other 161 ------------ Total asset write-downs and impairments $ 15,918 ============= In connection with the Merger, certain assets became impaired due to the closing of duplicative facilities, or the existence of duplicative technology of the merged companies. In addition, the Company decided to develop a new software platform for the combined company and to discontinue certain software enhancements under development which were previously capitalized. Accordingly, these assets were written down to their net realizable value at the time of the merger. Severance and other restructuring charges (In thousands) Terminated employment contracts and severance $ 6,825 Terminated leases of duplicative facilities 571 Other 449 ------------ Total $ 7,845 ============ F-33 In connection with the Merger, management having the requisite authority determined to close certain duplicate facilities, sever certain employees and otherwise streamline the combined operations. The Company also terminated certain employment contracts for employees that provided no future benefit to the merged companies. In connection with this plan, the Company recorded a charge for severance and related fringe benefits for 50 employees, consisting of 25 software engineers, 10 operations employees, 5 customer service employees and 10 general and administrative employees. The employees under employment contracts and employees who were terminated under the severance plan were considered redundant by the Company as a result of the Merger. Prior to the Merger, the Company and Boston each had sales offices in certain countries and, as a result of the Merger, duplicative facilities were closed. Professional fees and other direct merger expenses In connection with the Merger, the Company recorded a charge of $11,040,000 for professional fees to lawyers, investment bankers and accountants, as well as other direct merger costs, such as printer fees for the proxy statement incurred directly in connection with the merger. Other merger related charges (In thousands) Penalties under product development agreements $ 5,989 Terminated development contracts 1,085 ----------- $ 7,074 =========== In connection with the Merger, the Company also terminated certain existing development contracts which provided no future benefit to the merged companies. Prior to the Merger, the Company had commitments with third parties to develop technology in which it was contractually obligated. As a result of the Merger, the Company decided to develop a new software platform for the combined company and to discontinue certain enhancements under development. In addition, the Company incurred penalties under product development agreements relating to transfer of technology. In addition, approximately $36,055,000 has been charged to selling, general and administrative expenses in the one month period ended January 31, 1998 relating to the impairment of receivables resulting from the Merger. Included in this amount is approximately $14.9 million from an international distributor who refused to pay the Company, claiming his exclusive distribution agreement was violated as a result of the Merger. Also included in this amount is approximately $21.1 million that was due from customers who had switched as customers from Boston to the Company or from the Company to Boston. In order to continue good customer relations, the Company decided to forgive the amounts owed. Approximately $7,831,000 has been charged to cost of sales in the one month ended January 31, 1998 relating to the Merger. Such charge relates to the write-off of inventory that was considered obsolete and duplicative as a result of the Merger. Both the Company and Boston had two ESP products. As a result of the Merger, the Company decided that one product from each of the Company and Boston would no longer be sold. F-34 LIQUIDITY AND CAPITAL RESOURCES The Company's working capital at January 31, 2000 and 1999 was approximately $858.3 million and $712.2 million, respectively. Operations for the years ended January 31, 2000 and 1999 and December 31, 1997, after adding back non-cash items, provided cash of approximately $208.1 million, $131.5 million and $55.1 million, respectively. During such years, other changes in working capital used cash of approximately $30.8 million, $27.8 million and $36.1 million, respectively, resulting in cash being provided by operating activities of approximately $177.4 million, $103.6 million and $19.0 million, respectively. Investment activities for the years ended January 31, 2000 ("Fiscal 1999") and 1999 ("Fiscal 1998") and December 31, 1997 ("Fiscal 1997") used cash of approximately $475.7 million, $10.5 million and $97.2 million, respectively. These amounts include (i) additions to property in Fiscal 1999, Fiscal 1998 and Fiscal 1997 of approximately $85.6 million, $25.6 million and $37.3 million, respectively; (ii) maturities and sales (purchases) of bank time deposits and investments, net, of approximately ($377.6) million, $24.3 million and ($53.5) million, respectively; and (iii) capitalization of software development costs of approximately $12.5 million, $9.1 million and $6.5 million, respectively. The property additions in Fiscal 1999 include the increase of the Company's fixtures and equipment as a result of the growth of the Company and the purchase of land by the Company of approximately $25.8 million for future construction purposes. In addition, in Fiscal 1999 the Company increased the amount of its bank time deposits and investments to better utilize the net proceeds of the 1998 issuance of convertible debentures. Financing activities for Fiscal 1999, Fiscal 1998 and Fiscal 1997 provided cash of approximately $53.6 million, $308.3 million and $52.7 million, respectively. These amounts include (i) the net proceeds from the issuance of convertible debentures in Fiscal 1998 of approximately $292.7 million; (ii) proceeds from the issuance of common stock in connection with the exercise of stock options, warrants and employee stock purchase plan of approximately $50.6 million, $36.2 million and $23.0 million, respectively; and (iii) net proceeds (repayments) of bank loans and other debt of approximately $3.1 million, ($20.6) million and $29.7 million, respectively. As of January 31, 2000, the Company had outstanding convertible subordinated debentures of $300 million. 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. 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. F-35 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 has benefited from the growth in its business and capital base over the past several years to make significant new investment in its operations and infrastructure intended to enhance its opportunities for future growth and profitability. The Company intends to continue to make significant investments in the growth of its business, and to examine opportunities for additional growth through acquisitions and strategic investments. The impact of these decisions on future profitability cannot be predicted with assurance, and the Company's commitment to growth may increase its vulnerability to unforeseen downturns in its markets, technology changes and shifts in competitive conditions. However, the Company believes that significant opportunities exist in the markets for each of its main product lines, and that continued strong investment in its technical, product development, marketing and sales capabilities will enhance its opportunities for long term growth and profitability. The telecommunications industry is subject to rapid technological change. The introduction of new technologies in the telecommunications market 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 revenue stream 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. 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. In addition, if the Company were to delay the introduction of new products, the Company's operating results could be adversely affected. The telecommunications industry is undergoing significant change as a result of deregulation and privatization worldwide, reducing restrictions on competition in the industry. Unforeseen changes in the regulatory environment may have an impact on the Company's revenues and/or costs in any given part of the world. The worldwide ESP 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 ESP system markets. Moreover, as the Company enters into new markets for enhanced services as a result of its own research and development efforts or acquisitions, it is likely to encounter new competitors. The market for telecommunications monitoring systems is also in a period of significant transition. Budgetary constraints, uncertainties resulting from the introduction of new technologies in the telecommunications environment and shifts in the pattern of government expenditures resulting from geopolitical events have increased uncertainties in the market, resulting in certain F-36 instances in the attenuation of government procurement programs beyond their originally expected performance periods and an increased incidence of delay, cancellation or reduction of planned projects. The delays and uncertainties surrounding the Communications Assistance for Law Enforcement Act ("CALEA") have had a significant negative impact on acquisition plans of law enforcement agencies in North America engaged in monitoring activities. Competitive conditions in this sector have also been affected by the increasing use by certain potential government 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 lack of predictability in the timing and scope of government procurements have similarly made planning decisions more difficult and have increased the associated risks. 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 Company believes that opportunities for large installations will continue to grow in both its commercial and government markets, and intends to continue to expand its research and development, manufacturing, sales and marketing and product support capabilities in anticipation of such growth. However, 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 than the Company has experienced in prior periods. Although the Company is actively pursuing a number of significant procurement opportunities, both the timing of any eventual procurements and the probability of the Company's receipt of significant contract awards are uncertain. 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 has significantly increased its expenditures in all areas of its operations during recent periods, including the areas of research and development and marketing and sales, and the Company plans to further increase these expenditures in the foreseeable future. The increase in research and development expenditures reflects the Company's concentration on enhancing the range of features and capabilities of its existing product lines, developing new generations of its products and expanding into new product areas. The Company believes that these efforts are essential for the continuing competitiveness of its product offerings and for positioning itself to participate in future growth opportunities in both the commercial and government sectors. The increase in sales and marketing expenditures primarily results from the Company's decision to expand its activities and direct presence in a growing number of world markets. The Company's costs of operations have also been affected by increases in the cost of its operations in Israel, resulting both from appreciation of the Israeli shekel relative to the United States dollar in certain periods and devaluation of the Israeli shekel at rates insufficient to offset cost increases F-37 in others, and from increases in the cost of attracting and retaining qualified scientific, engineering and technical personnel in Israel, where the demand for such personnel is growing rapidly with the expansion of high technology industries in that country. Continuation of such trends could have a material adverse effect on the Company's future results of operations. A significant portion of the Company's research and development and manufacturing operations are located in Israel. 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. To be eligible for these programs and 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. These programs and tax benefits may not be continued in the future at the current levels or at any level. 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 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 a conditional grant program administered by the Office of the Chief Scientist of the Ministry of Industry and Trade, a program in which the Company has regularly participated and under which it continues to receive significant benefits through reimbursement of up to 50% of qualified research and development expenditures. For amounts received under programs which have been, or will be, approved by the Office of the Chief Scientist after January 1, 1999, repayment of the amount received (calculated in U.S. Dollars), plus interest on such amount at a rate equal to the 12-month LIBOR rate in effect at the time of the approval of the program, is required through the application of royalty payments. 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 Israeli authorities have also indicated that this funding program will be further reduced significantly or eliminated in the future, particularly for larger companies such as the Company. The termination or reduction of these programs could adversely affect the Company's operating results. The Israeli government has also shortened the period of the tax moratorium applicable to Approved Enterprises from four years to two years. Although this change has not affected the tax status of the Company's projects that were eligible for the moratorium prior to 1997, it applies to subsequent "Approved Enterprise" projects. Recently, the government announced a proposal to impose additional limitations on the tax benefits associated with Approved Enterprise projects for certain categories of taxpayers, which would include the Company, although it has not submitted legislation to the Israeli Parliament. 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 F-38 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. To the extent that the Company increases its activities outside Israel, which could result from, among other things, future acquisitions, such increased activities will not be eligible for programs sponsored by Israel. 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. 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 (primarily Western European) currencies. 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. Since it is the Company's practice to hedge the exchange rate risks associated with contracts denominated in foreign currencies only to a limited extent, if at all, it's operating results have been and may in the future be negatively 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. The Company's future operating results and financial condition will be adversely affected should economic weakness result in widespread slowdown or recessionary conditions in major world markets, or in severe trade or currency disruptions. The trading price of the Company's shares may be affected by the factors noted above as well as prevailing economic and financial trends and conditions in the public securities markets. Share prices of companies in technology and government contracting businesses, and particularly publicly traded companies such as the Company, tend to exhibit a high degree of volatility. Shortfalls in revenues or earnings from the levels anticipated by the public markets could have an immediate and significant 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 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. F-39 EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS During 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 requires that all derivative financial instruments be recognized as either assets or liabilities in the balance sheet. Measurement is at fair value, and if the derivative is not designed as a hedging instrument, changes in fair value (i.e., gains and losses) are to be recognized in earnings in the period of change. If certain conditions are met, a derivative may be designed as a hedge, in which case the accounting for changes in fair value will depend on the specific exposure being hedged. The method that will be used for assessing the effectiveness of a hedging derivative, as well as the measurement approach for determining the ineffective aspects of the hedge, must be established at the inception of the hedge. The methods must be consistent with the Company's approach to managing risk. SFAS 133, as amended by Statement of Financial Accounting Standards No. 137, will be effective for fiscal years beginning after June 15, 2000. The Company is currently evaluating the impact that the adoption of SFAS 133 will have on its financial statements. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements". SAB 101 summarizes certain of the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements. The Company is required to adopt SAB 101 in the fourth quarter of fiscal 2000. The Company is currently evaluating the impact that the adoption of SAB 101 will have on its financial statements. 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. F-40 MARKET RISK DISCLOSURES. 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. F-41 -----END PRIVACY-ENHANCED MESSAGE-----