[May 16, 2013] COMVERSE, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Tweet (Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read together with Item 1, "Business," Item 6, "Selected Financial Data," and the consolidated and combined financial statements and related notes included in Item 15 of this Annual Report. This discussion and analysis contains forward-looking statements based on current expectations relating to future events and our future financial performance that involve risks and uncertainties. See "Forward-Looking Statements" on page i of this Annual Report. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those set forth under Item 1A, "Risk Factors," and elsewhere in this Annual Report. Percentages and amounts within this section may not calculate due to rounding differences. EXECUTIVE SUMMARY Overview We are a leading provider of telecom business enablement solutions for communication service providers (or CSPs) through a portfolio of product-based solutions and associated services in the following domains: • Business Support Systems. We provide converged, prepaid and postpaid billing and active customer management systems (or BSS) for wireless, wireline and cable CSPs, delivering a value proposition designed to enable an effective service monetization, a consistent customer experience, reduced complexity and cost, and real-time choice and control. • Digital and Value Added Services. We enable both network-based Value Added Services (or VAS) comprised of Voice and Messaging (that include voicemail, visual voicemail, call completion, short messaging service (or SMS), multimedia picture and video messaging (or MMS), and digital Internet Protocol (or IP) based rich communication services. • Data Management and Monetization Solutions. We provide CSPs with the ability to better manage their data networks and better monetize their data network investment through our solutions' Policy Management and Policy Enforcement capabilities for wireless and wireline data networks. • Professional and Managed Services. We offer a portfolio of services related to our solutions following the completion of the delivery of the project to the customer (referred to as post-go-live), such as system care, expert services and managed services. Our reportable segments are: • Comverse BSS-comprised of Comverse's BSS operating segment; and • Comverse VAS-comprised of Comverse's VAS operating segment. The results of operations of all of our other operations, including the Comverse Mobile Internet (or Comverse MI) operating segment, our Netcentrex operations (or Netcentrex), our global corporate functions that support our business units and Exalink Ltd., are included in the column captioned "Comverse Other" as part of our business segment presentation. For additional information see note 21 to the consolidated and combined financial statements included in 33-------------------------------------------------------------------------------- Table of Contents Item 15 of this Annual Report. Starhome's results of operations are included in discontinued operations and therefore not presented in segment information. Significant Events During the fiscal year ended January 31, 2013 and subsequent thereto, the following additional significant events occurred: Appointment of Comverse President and Chief Executive Officer. Effective May 21, 2012, Philippe Tartavull was appointed as our President, Chief Executive Officer and Director, replacing Mr. Burdick. Settlement Agreement with Cadian Capital. On May 30, 2012, CTI's Board of Directors entered into a letter agreement (referred to as Letter Agreement) with Cadian Capital Management, LLC (or Cadian Capital) and certain of its affiliates (referred to collectively as the Cadian Group) with respect to Cadian Group's solicitation for the election of CTI director nominees at CTI's Annual Meeting of Shareholders that was held on June 28, 2012 (referred to as the CTI AGM) pursuant to the proxy statement filed with the SEC on March 28, 2012. Pursuant to the terms and conditions of the Letter Agreement, the Cadian Group immediately abandoned its solicitation for the election of its or any other person's nominees as directors of CTI other than those nominees proposed by CTI in connection with the CTI AGM and agreed to vote all securities of CTI over which it has beneficial ownership in favor of the slate of directors named in CTI's proxy statement filed in connection with the CTI AGM and in favor of the Share Distribution. In addition, the parties agreed that, immediately prior to the Share Distribution, CTI would cause our Board to be comprised of seven directors, consisting of our chief executive officer, three directors designated by CTI (which were Mark Terrell, Susan Bowick and Henry Nothhaft) and three directors designated by Cadian Capital (which were James Budge, Stephen Andrews and Doron Inbar). On January 2, 2013, Mr. Andrews resigned from our Board. Mr. Andrews advised us that his resignation was prompted by the expansion of his consulting practice. Appointment of Chief Financial Officer. Effective July 24, 2012, Thomas B. Sabol was appointed as Comverse's Senior Vice President and Chief Financial Officer, replacing Mr. Legon. Separation of Chief Operating Officer. On August 5, 2012, Comverse Ltd. and Oded Golan, our former Senior Vice President and Chief Operating Officer, entered into a separation agreement in which they mutually agreed upon the terms of transition and separation of employment of Mr. Golan. Pursuant to the separation agreement, Mr. Golan continued to serve in his current capacity through January 31, 2013, at which time he resigned from his position. The Share Distribution. On October 31, 2012, CTI completed the spin-off of our company as an independent, publicly-traded company, accomplished by means of a pro rata distribution of 100% of our outstanding common shares to CTI's shareholders (referred to as the Share Distribution). Following the Share Distribution, CTI no longer holds any of our outstanding capital stock, and we are an independent publicly-traded company. Following the Share Distribution, we and CTI operate independently, and neither has any ownership interest in the other. In order to govern certain ongoing relationships between CTI and us after the Share Distribution and to provide mechanisms for an orderly transition, we and CTI entered into agreements pursuant to which certain services and rights are provided for following the Share Distribution, and we and CTI agreed to indemnify each other against certain liabilities that may arise from our respective businesses and the services that are provided under such agreements. Following the completion of CTI's merger with Verint discussed below, these obligations continue to apply between us and Verint. For more information, see note 3 to the consolidated and combined financial statements included in Item 15 of this Annual Report. Subsequent to the Share Distribution, we expect to incur increased costs as a result of becoming an independent, publicly-traded company, including compensation costs attributable to the enhancement of our senior management, compensation of non-employee directors and compensation expense and professional fees related to financial reporting and compliance with our periodic reporting obligations under federal securities laws. We believe our cash flow from operations will be sufficient to fund these additional costs. Merger of Verint and CTI. On August 12, 2012, CTI entered into an agreement and plan of merger (referred to as the Verint Merger Agreement) with Verint providing for the merger of CTI with and into a subsidiary of Verint and become a wholly-owned subsidiary of Verint (referred to as the Verint Merger). The Verint Merger was completed on February 4, 2013. Under the Share Distribution Agreement we and CTI entered into in connection with the Share Distribution, we have agreed to indemnify CTI and its affiliates (including Verint after the Verint Merger) against certain losses that may arise as a result of the Verint Merger and the Share Distribution. Certain of our indemnification obligations are capped at 34-------------------------------------------------------------------------------- Table of Contents $25.0 million and certain are uncapped. CTI placed $25.0 million in escrow to support indemnification claims to the extent made against us by Verint and any cash balance remaining in such escrow fund 18 months after the closing of the Verint Merger, less any claims made on or prior to such date, will be released to us. The escrow funds cannot be used for claims related to the Israeli Optionholder suit. We also assume all pre-Share Distribution tax obligations of each of us and CTI. For more information, see note 3 to our consolidated and combined financial statements included in Item 15 of this Annual Report. Contribution and Sale of Starhome. On August 1, 2012, CTI, certain Starhome shareholders and Starhome entered into a Share Purchase Agreement (or the Starhome Share Purchase Agreement) with Fortissimo Capital Fund II (Israel), L.P., Fortissimo Capital Fund III (Israel), L.P. and Fortissimo Capital Fund III (Cayman), L.P. (referred to collectively, as Fortissimo) pursuant to which Fortissimo agreed to purchase all of the outstanding share capital of Starhome (or the Starhome Disposition). On September 19, 2012, CTI, in order to ensure it could meet the conditions of the Verint Merger, contributed to us its interest in Starhome, including its rights and obligations under the Starhome Share Purchase Agreement. The Starhome Disposition was completed on October 19, 2012. Under the terms of the Starhome Share Purchase Agreement, Starhome's shareholders received aggregate cash proceeds of approximately $81.3 million, subject to adjustment for fees, transaction expenses and certain taxes. Of this amount, $10.5 million is held in escrow to cover potential post-closing indemnification claims, with $5.5 million being released after 18 months and the remainder released after 24 months, in each case, less any claims made on or prior to such dates. We received aggregate net cash consideration (including $4.9 million deposited in escrow at closing) of approximately $37.2 million, after payments that CTI agreed to make to certain other Starhome shareholders of up to $4.5 million. The escrow funds are available to satisfy certain indemnification claims under the Starhome Share Purchase Agreement to the extent that such claims exceed $1.0 million. As of January 31, 2013, such claims have not exceeded the $1.0 million threshold. As a result of the Starhome Disposition, the results of operations of Starhome, including the gain on sale of Starhome, net of tax, are included in discontinued operations, less applicable income taxes, as separate components of net income (loss) in our consolidated and combined statements of operations for all periods presented. The assets and liabilities of Starhome are included in discontinued operations as a separate component of our combined balance sheet as of January 31, 2012. See note 17 to the consolidated and combined financial statements included in Item 15 of this Annual Report. Liquidity Forecast During the fiscal year ended January 31, 2013, we had positive cash flows from continuing operations of $28.2 million, including a tax refund from the State of Israel of approximately $24.8 million (referred to as the Israel tax refund). We continue our efforts to aggressively market our solutions and services, improve profitability and cash collections and implement cost reduction measures. We currently forecast that available cash and cash equivalents will be sufficient to meet our liquidity needs, including capital expenditures, for at least the next 12 months. For a more comprehensive discussion of our liquidity forecast, see "-Liquidity and Capital Resources-Financial Condition-Liquidity Forecast." 35-------------------------------------------------------------------------------- Table of Contents Consolidated and Combined Financial Highlights The following table presents certain financial highlights for the fiscal years ended January 31, 2013, 2012 and 2011, including Comverse performance and Comverse performance margin (reflecting Comverse performance as a percentage of revenue), non-GAAP financial measures, for our company on a consolidated and combined basis: Fiscal Years Ended January 31, 2013 2012 2011 (Dollars in thousands) Total revenue $ 677,763 $ 771,157 862,836 Gross margin 36.3 % 39.2 % 45.1 % Loss (income) from operations (2,192 ) 11,442 (59,776 ) Operating margin (0.3 )% 1.5 % (6.9 )% Net loss from continuing operations (20,294 ) (20,648 ) (92,741 ) Income from discontinued operations, net of tax 26,542 7,761 2,826 Net income (loss) 6,248 (12,887 ) (89,915 ) Less: Net income attributable to noncontrolling interest (1,167 ) (2,574 ) (1,030 ) Net income (loss) attributable to Comverse, Inc. 5,081 (15,461 ) (90,945 ) Net cash provided by (used in) operating activities - continuing operations 28,190 (13,361 ) (107,394 ) Non-GAAP Financial Measures Comverse performance 35,415 73,845 74,007 Comverse performance margin 5.2 % 9.6 % 8.6 % Reconciliation of Income (Loss) from Operations to Comverse Performance Comverse performance, a non-GAAP financial measure, represents our operating results without the impact of significant expenditures incurred by us in connection with CTI's efforts to become or remain current in periodic reporting obligations under the federal securities laws and the remediation of material weaknesses in internal control over financial reporting, certain non-cash charges, and certain other gains and charges. We provide Comverse performance, a non-GAAP financial measure, as additional information for our operating results. This measure is not in accordance with, or an alternative for, GAAP financial measures and may be different from, or not comparable to similarly titled or other non-GAAP financial measures used by other companies. We believe that the presentation of this non-GAAP financial measure provides useful information to investors regarding certain additional financial and business trends relating to our results of operations as viewed by management in monitoring our businesses, reviewing our financial results and for planning purposes. 36-------------------------------------------------------------------------------- Table of Contents The following table provides a reconciliation of income (loss) from operations to Comverse performance for the fiscal years ended January 31, 2013, 2012, and 2011: Fiscal Years Ended January 31, 2013 2012 2011 (Dollars in thousands) (Loss) income from operations $ (2,192 ) $ 11,442 $ (59,776 ) Expense Adjustments: Stock-based compensation expense 7,517 3,660 2,439 Amortization of acquisition-related intangibles 14,124 17,308 18,505 Compliance-related professional fees 245 10,901 82,136 Compliance-related compensation and other expenses 2,098 6,719 4,542 Spin-off professional fees 933 - - Impairment of goodwill 5,605 - - Impairment of property and equipment 404 2,331 - Litigation settlements and related costs (660 ) 804 - Restructuring charges 5,905 20,728 29,934 Gain on sale of fixed assets (185 ) - (2,371 ) Other 1,621 (48 ) (1,402 ) Total expense adjustments 37,607 62,403 133,783 Comverse performance $ 35,415 $ 73,845 $ 74,007 Operating margin (0.3 )% 1.5 % (6.9 )% Total expense adjustments margin 5.5 % 8.1 % 15.5 % Comverse performance margin 5.2 % 9.6 % 8.6 % Segment Performance We evaluate our business by assessing the performance of each of our operating segments. Our Chief Executive Officer is our chief operating decision maker (or CODM). The CODM uses segment performance, as defined below, as the primary basis for assessing the financial results of the operating segments and for the allocation of resources. Segment performance, as we define it in accordance with the Financial Accounting Standards Board's (or the FASB) guidance relating to segment reporting, is not necessarily comparable to other similarly titled captions of other companies. Segment performance is computed by management as income (loss) from operations adjusted for the following: (i) stock-based compensation expense; (ii) amortization of acquisition-related intangibles; (iii) compliance-related professional fees; (iv) compliance-related compensation and other expenses; (v) spin-off professional fees; (vi) impairment of goodwill; (vii) impairment of property and equipment; (viii) litigation settlements and related costs; (ix) restructuring charges; and (x) certain other gains and charges. Compliance-related professional fees and compliance-related compensation and other expenses relate to fees and expenses recorded in connection with CTI's efforts to (a) complete certain financial statements and audits of such financial statements, (b) become current in periodic reporting obligations under the federal securities laws, and (c) remediate material weaknesses in internal control over financial reporting. For additional information on how we apply segment performance to evaluate the operating results of our segments for the fiscal years ended January 31, 2013, 2012 and 2011, see note 21 to the consolidated and combined financial statements included in Item 15 of this Annual Report. In evaluating each segment's performance, management uses segment revenue, which consists of revenue generated by the segment. Certain segment performance adjustments relate to expenses included in the calculation of income (loss) from operations, while, from time to time, certain segment performance adjustments may be presented as adjustments to revenue. We had no segment performance adjustments to revenue for the fiscal years ended January 31, 2013, 2012 and 2011. 37-------------------------------------------------------------------------------- Table of Contents Segment Financial Highlights The following table presents, for the fiscal years ended January 31, 2013, 2012 and 2011, segment revenue, gross margin, income (loss) from operations, operating margin, segment performance and segment performance margin (reflecting segment performance as a percentage of segment revenue) for each of our reportable segments and Comverse Other: Fiscal Years Ended January 31, 2013 2012 2011 (Dollars in thousands) SEGMENT RESULTS Comverse BSS Segment revenue $ 273,535 $ 365,008 $ 340,502 Gross margin 32.9 % 45.3 % 43.5 % Income from operations 36,704 77,095 56,354 Operating margin 13.4 % 21.1 % 16.6 % Segment performance 51,508 96,776 76,416 Segment performance margin 18.8 % 26.5 % 22.4 % Comverse VAS Segment revenue $ 362,434 $ 356,413 $ 460,899 Gross margin 46.9 % 45.3 % 56.7 % Income from operations 128,679 123,936 175,327 Operating margin 35.5 % 34.8 % 38.0 % Segment performance 129,595 125,963 175,657 Segment performance margin 35.8 % 35.3 % 38.1 % Comverse Other Segment revenue $ 41,794 $ 49,736 $ 61,435 Gross margin (33.2 )% (48.7 )% (33.2 )% Loss from operations (167,575 ) (189,589 ) (291,457 ) Operating margin (401.0 )% (381.2 )% (474.4 )%Segment performance (145,688 ) (148,894 ) (178,066 ) Segment performance margin (348.6 )% (299.4 )% (289.8 )% For a discussion of the results of our segments, see "-Results of Operations," and note 21 to the consolidated and combined financial statements included in Item 15 of this Annual Report. Business Trends and Uncertainties For the fiscal year ended January 31, 2013 compared to the fiscal year ended January 31, 2012, we experienced decreases in revenue, which were partially offset by decreases in costs and operating expenses, resulting in a change to loss from operations for the fiscal year ended January 31, 2013 compared to income from operations for the fiscal year ended January 31, 2012. Comverse performance for the fiscal year ended January 31, 2013 decreased compared to the fiscal year ended January 31, 2012. For more information, see note 21 to the consolidated and combined financial statements included in Item 15 of this Annual Report. The decreases in revenue were primarily attributable to decreases in revenue from Comverse BSS customer solutions and maintenance revenue at our Comverse BSS and Comverse VAS segments, partially offset by increases in revenue from Comverse VAS customer solutions. For a discussion of the reasons for the changes in revenue from customer solutions at our Comverse BSS and Comverse VAS segments, see "Comverse BSS," "Comverse VAS," "Results of Operations-Segment Results-Comverse BSS" and "Results of Operations-Segment Results-Comverse VAS." The decreases in maintenance revenue was primarily attributable to decreased collections that resulted in a delay in the recognition of revenue, timing of entering into renewals of maintenance contracts, termination of maintenance contracts and a decrease in maintenance revenue attributable to maintenance services provided to customers during the initial service period corresponding to a decline in new installed base value. 38-------------------------------------------------------------------------------- Table of Contents During the fiscal year ended January 31, 2013, our cash and cash equivalents and restricted cash were favorably impacted primarily by CTI's cash contribution in connection with the Share Distribution, cash proceeds from the Starhome Disposition, the Israel tax refund and a decline in costs, operating expenses and disbursements, partially offset by a decrease in cash collections, that resulted in positive operating cash flow in the fiscal year ended January 31, 2013. The decrease in cash collections was primarily attributable to reduced customer order activity in recent years, the adverse impact of the timing of acceptances in certain projects and the timing of completion of project milestones. Our costs, operating expenses and disbursements decreased during the fiscal year ended January 31, 2013 primarily due to our continued focus on closely monitoring our costs and operating expenses as part of our efforts to improve our cash position and achieve long-term improved operating performance and positive operating cash flows. These cost reductions were partially offset by, among other factors, the increasing complexity of project deployment which resulted in higher product delivery costs. In addition, following the Share Distribution we incur expenses in connection with financial reporting and compliance with the federal securities laws certain of which were previously borne by CTI, our former parent company. In order to improve operating performance and cash flow from operations, we intend to continue to implement initiatives that we believe will enhance efficiency and result in significant reductions in costs and operating expenses. The initiatives include: • Prioritizing the industrialization of our BSS offerings to meet or exceed our customer requirements for ease of use and faster deployment times; • Establishing and expanding low cost centers of excellence and research and development centers in Eastern Europe and Asia; and • Realigning our cost structure to our current size and business environment by primarily reducing our selling, general and administrative expenses. We intend to implement these initiatives during the fiscal year ending January 31, 2014 and expect that some of these initiatives will continue to be implemented during the fiscal year ending January 31, 2015. In addition, for the fiscal year ending January 31, 2014, we plan to make investments relating to upgrades of systems and tools that we believe will increase operational efficiency and result in significant cost reductions in future fiscal periods. As a result of these initiatives, we expect that selling, general and administrative expenses will decline as a percentage of revenue in future fiscal periods. Our principal business activities are reported through the following segments: • Comverse BSS, which conducts our converged, prepaid and postpaid billing and active customer management systems business and includes groups engaged in product management, professional services, research and development and product sales support; and • Comverse VAS, which conducts our digital and value-added services business and includes groups engaged in VAS delivery, Rich Communication, Voice and Messaging product research and development and product sales support. Comverse BSS In the fiscal year ended January 31, 2013, customer orders for BSS customer solutions decreased compared to the fiscal year ended January 31, 2012. We believe that BSS customer solutions order activity was impacted by deferral by customers of significant capital investments involved in deploying our BSS solutions and upgrading existing prepaid or postpaid systems to our converged BSS solution partially due to the uncertainty in economic conditions. In addition, customers are more closely monitoring their operating expenses. We believe a portion of the decline was also attributable to the maturation of certain markets that historically accounted for a significant portion of our BSS growth. Revenue from BSS customer solutions for the fiscal year ended January 31, 2013 decreased significantly compared to the fiscal year ended January 31, 2012. The decrease in revenue from Comverse BSS customer solutions was primarily attributable to material modifications of contracts that allowed the recognition of additional revenue during the fiscal year ended January 31, 2012, decreases in revenue from customer acceptances and changes in scope and settlements of certain customer contracts during the fiscal year ended January 31, 2013. Revenue from Comverse BSS customer solutions continued to be adversely affected by (i) the increasing complexity of project deployment resulting in extended periods of time required to complete project milestones, delaying receipt of customer acceptance and (ii) lower volume of BSS projects in the current fiscal periods resulting from reduced customer order activity in 39-------------------------------------------------------------------------------- Table of Contents recent years. In addition, as we focus our efforts to further industrialize our BSS offerings to offer a stronger pre-packaged solution that improves ease of use and faster deployment times, near-term bookings may be impacted. Comverse BSS maintenance revenue for the fiscal year ended January 31, 2013 decreased compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to (i) timing of entering into renewals of maintenance contracts with customers (ii) decreased collections from customers for whom revenue is recognized upon collection and (iii) maintenance contracts that were terminated in the current year. For a more detailed discussion relating to revenue from Comverse BSS customer solutions, see "Results of Operations-Segment Results-Comverse BSS-Revenue." We have a leading industry position in the BSS converged billing market and believe that we are well positioned to leverage our leading market position and our BSS solution offering to take advantage of the growth in the emerging converged BSS market. As part of our strategy, Comverse BSS is continuing its efforts to expand its presence and market share in the BSS market with BSS solutions that we believe offer several advantages over competitors' offerings, including faster time to market and lower total cost of ownership. Comverse BSS continues to offer its existing prepaid and postpaid customer base upgrades to its Comverse ONE converged billing solution, which we believe better addresses the enhanced business needs of CSPs. In addition, Comverse BSS continues to aggressively pursue opportunities to market its BSS solutions, primarily Comverse ONE, to new customers as part of its efforts to increase its customer base. As a result, Comverse BSS is experiencing a shift in product mix as the portion of sales of its advanced Comverse ONE converged billing solution continues to increase and the portion of sales of its traditional stand-alone prepaid and postpaid BSS solutions continues to decrease. In addition, to maintain its market leadership in BSS convergence and monetization of new business models, Comverse BSS continues to expend significant resources on research and development to further enhance Comverse ONE and its advanced monetization capabilities, including support for new business models such as machine to machine and cloud services. CSPs are experiencing growth in global wireless subscriptions and traffic and a rapid growth in the use of advanced services, such as data services and Internet browsing. In response to these market trends, CSPs require enhanced BSS system functionality to accommodate their business needs. As a result, Comverse BSS is facing increasing complexity of project deployment resulting in extended periods of time required to complete project milestones and receive customer acceptance which are generally required for revenue recognition and receipt of payment. To address these challenges, Comverse BSS continues its efforts to improve its delivery and implementation capabilities to reduce costs and expenses. In addition, Comverse BSS continues to focus on increasing its revenue and improving its margins by broadening its customer solution and service offerings to existing and new customers. As part of its service offering, Comverse BSS offers a suite of managed services that enable it to assume responsibility for the operation and management of its customers' billing systems. Comverse's managed services suite is designed to provide customers with improved efficiencies relating to the operation and management of their systems, thereby allowing them to focus on their own internal business needs and strengths with reduced management distraction. Managed services provide Comverse with recurring and predictable revenue and are used by Comverse to create and establish long-term relationships with customers as well as cross-sell additional solutions and system enhancements. We believe that the longevity of Comverse's customer relationships and the recurring revenue that such relationships generate provide it with stability and a competitive advantage in marketing its solutions to its existing customer base. We believe that Comverse BSS's solutions offering has the potential to become a key driver of growth going forward. We expect that as a leader in the converged BSS market, we will continue to build on the strength of our Comverse ONE solution, particularly in the converged billing segment of the BSS market, which is expected to grow rapidly over the next few years. We also expect that growth in mobile data traffic will increase the demand for Comverse's mobile Internet solutions, which include policy management and enforcement, deep packet inspection, traffic management and video optimization capabilities, all of which are integrated into our BSS solution. In implementing our growth strategy, we plan to focus our efforts on increasing our presence primarily in APAC, the Middle East and certain countries in Latin America, including Brazil and Mexico and leveraging our existing customer base by offering upgrades to Comverse ONE primarily in Europe. Comverse VAS Customer orders for Comverse VAS customer solutions for the fiscal year ended January 31, 2013 decreased significantly compared to the fiscal year ended January 31, 2012. This decrease is attributable to a decline in customer order activity related to Comverse VAS' traditional solutions, such as voicemail and SMS text messaging, which was not fully offset by customer orders for Comverse VAS' advanced offerings. Revenue from Comverse VAS customer solutions for the fiscal year ended January 31, 2013 increased compared to the fiscal year ended January 31, 2012 primarily resulting from an increase in revenue recognized upon cash collection due to increased collections from certain customers and a number of customer acceptances in large-scale deployments of next generation voicemail products (including visual voicemail) during the fiscal year ended January 31, 40-------------------------------------------------------------------------------- Table of Contents 2013, partially offset by a decrease in timing of completion of project milestones and settlements. Comverse VAS maintenance revenue for the fiscal year ended January 31, 2013 decreased primarily due to the timing of entering into renewals of maintenance contracts, termination of maintenance contracts and a decrease in maintenance revenue attributable to maintenance services provided to customers during the initial service period corresponding to a decline in new installed base value. For a more detailed discussion relating to revenue from Comverse VAS customer solutions, see "Results of Operations-Segment Results-Comverse VAS-Revenue." Comverse VAS continues to maintain its market leadership in voice-based products, such as voicemail and call completion. However, in the VAS market, wireless subscriber preferences have changed in recent years as consumers transitioned to alternative messaging applications, such as SMS text messaging, in part as a substitute for voicemail usage, and increased the use of data in connection with the deployment of smartphones and other devices, such as tablets. This transition resulted in intensified competition due to the change in the business mix of Comverse VAS from the voicemail product line, in which we continue to hold a leading market position, to other applications and products in which Comverse VAS is continuing to face significant competitive challenges as part of its efforts to increase market share. In addition, Comverse VAS faces increasing competition from changing technologies that may provide alternatives to its products and services. For example, the introduction of open access to web-based applications from wireless devices allows end users to utilize web-based services, such as Facebook, Google, Yahoo or Hotmail, to access, among other things, instant messaging and electronic mail free of charge rather than use wireless carriers' service offerings. Furthermore, Comverse VAS continues to face competition from low-cost competitors from emerging markets. We believe these changes have reduced demand for Comverse VAS's products and services and increased pricing pressures, which have in turn reduced revenue and margins. At the same time, the growth in global wireless subscriptions, and emerging wireless segments, such as data services and Internet browsing, support demand for several of our products. As part of our efforts to maintain our market position and leverage these recent trends, Comverse VAS is engaged in the promotion of advanced offerings, such as visual voicemail, call management, IP messaging, a Service Enablement Middleware, Rich Communication Solutions (RCS), and Software as a Service (SaaS) cloud-based solutions. We believe demand for advanced offerings may grow due to the increasing deployment of smartphones by wireless communication service providers. Accordingly, we continue to expend significant resources on VAS research and development activities in order to enhance existing products and develop new solutions. We plan to continue to aggressively market our VAS products, leveraging our leading market position to replace competitors and sell capacity expansions and other solutions to existing customers. In addition, we believe we are in a position to benefit from recent consolidations of customers, primarily in North America. Uncertainties Impacting Future Performance Mix of Revenue It is unclear whether our advanced offerings will be widely adopted by existing and potential customers. Currently, we are unable to predict whether sales of advanced offerings will exceed or fully offset declines that we may experience in the sale of traditional solutions. If sales of advanced offerings do not increase or if increases in sales of advanced offerings do not exceed or fully offset any declines in sales of traditional solutions, due to adverse market trends, changes in consumer preferences or otherwise, our revenue, profitability and cash flows would likely be materially adversely affected. Global Economic Conditions The business of Comverse BSS and Comverse VAS is impacted by general economic conditions. The weakness in the global economy in recent years has materially and adversely affected the telecommunications industry. Many customers experienced significant declines in revenue and profitability and some customers were required to reduce excessive debt levels. In response to these challenges, many of our customers have implemented cost cutting measures, including more closely managing their operating expenses and capital investment budgets. This resulted in reduced demand for our products, services and solutions, longer customer purchasing decisions and pricing pressures. Recently, there have been adverse developments in global debt markets (including European sovereign debt) and other indications of a slowdown in the global economic recovery. These conditions have adversely impacted financial markets and have created substantial volatility and uncertainty, which we believe has had an adverse impact on the timing of certain customer spending decisions, and may continue to do so. If the recovery in the global economy is curtailed and market conditions worsen, our existing and potential customers could reduce their spending, which, in turn, could reduce the demand for our products and services. 41-------------------------------------------------------------------------------- Table of Contents Difficulty in Forecasting Operating Results Our operating results are difficult to predict. A high percentage of our customer orders has typically been generated late in fiscal quarters. In addition, based on historical industry spending patterns of communication service providers, we typically forecast our highest customer order activity to occur in our fourth fiscal quarter. This trend makes it difficult for us to forecast our annual customer order activity and to implement effective measures to cover any shortfalls of prior fiscal quarters if customer orders for the fourth fiscal quarter fail to meet our expectations. Furthermore, we continue to emphasize large capacity systems in our product development and marketing strategies. Contracts for BSS and VAS installations typically involve a lengthy, complex and highly competitive bidding and selection process, and our ability to obtain particular contracts is inherently difficult to predict. A delay, cancellation or other factor resulting in the postponement or cancellation of significant orders may cause us to miss our financial projections, which may not be discernible until the end of a financial reporting period. Share Distribution In connection with the Share Distribution, we entered into the Distribution Agreement with CTI pursuant to which, among other things, we agreed to indemnify CTI and its affiliates (including Verint after the Verint Merger) against certain losses that may arise as a result of the Verint Merger and the Share Distribution. To the extent that we are required to make payments to satisfy these indemnification obligations, our liquidity could be impacted. See Item 1A, "Risk Factors" Risks Relating to our Operation as an Independent, Publicly-Traded Company - "We agreed to indemnify CTI and its affiliates and following the completion of the Verint Merger are required to indemnify Verint against certain claims or losses that may arise in connection with the Verint Merger and the Share Distribution." RESULTS OF OPERATIONS The following discussion provides an analysis of our consolidated and combined results and the results of operations of each of our segments for the fiscal periods presented. The discussion of the results of operations of each of our segments provides a more detailed analysis of the results of each segment presented. Accordingly, the discussion of our consolidated and combined results should be read in conjunction with the discussions of the results of operations of our segments. 42-------------------------------------------------------------------------------- Table of Contents Fiscal Year Ended January 31, 2013 Compared to Fiscal Year Ended January 31, 2012 Consolidated and Combined Results Fiscal Years Ended January 31, Change 2013 2012 Amount Percent (Dollars in thousands, except per share data) Total revenue $ 677,763 $ 771,157 $ (93,394 ) (12.1 )% Costs and expenses Cost of revenue 431,644 468,867 (37,223 ) (7.9 )% Research and development, net 76,461 94,238 (17,777 ) (18.9 )% Selling, general and administrative 160,340 175,882 (15,542 ) (8.8 )% Other operating expenses 11,510 20,728 (9,218 ) (44.5 )% Total costs and expenses 679,955 759,715 (79,760 ) (10.5 )% (Loss) income from operations (2,192 ) 11,442 (13,634 ) (119.2 )% Interest income 829 1,755 (926 ) (52.8 )% Interest expense (901 ) (953 ) 52 (5.5 )% Interest expense on notes payable to CTI (455 ) (409 ) (46 ) 11.2 % Other income (expense), net (4,049 ) (7,192 ) 3,143 (43.7 )% Income tax provision (13,526 ) (25,291 ) 11,765 (46.5 )% Net loss from continuing operations (20,294 ) (20,648 ) 354 (1.7 )% Income from discontinued operations, net of tax 26,542 7,761 18,781 242.0 % Net income (loss) 6,248 (12,887 ) 19,135 (148.5 )% Less: Net income attributable to noncontrolling interest (1,167 ) (2,574 ) 1,407 (54.7 )% Net income (loss) attributable to Comverse, Inc. $ 5,081 $ (15,461 ) $ 20,542 (132.9 )% Net income (loss) attributable to Comverse, Inc.: Net loss from continuing operations $ (20,294 ) $ (20,648 ) $ 354 Income from discontinued operations, net of tax 25,375 5,187 20,188 Net income (loss) attributable to Comverse, Inc. $ 5,081 $ (15,461 ) $ 20,542 Earnings (loss) per share attributable to Comverse, Inc.'s stockholders: Basic and diluted earnings (loss) per share(1) Continuing operations $ (0.93 ) $ (0.94 ) $ 0.01 Discontinued operations $ 1.16 $ 0.23 $ 0.93 (1) The computation of basic and diluted earnings (loss) per share for the fiscal year ended January 31, 2012 is calculated using the number of shares of outstanding common stock on October 31, 2012, the completion date of the Share Distribution. See note 18 to the consolidated and combined financial statements included in Item 15 of this Annual Report. Total Revenue Management analyzes our revenue by: (i) revenue generated from customer solutions, and (ii) maintenance revenue. Revenue generated from customer solutions consists primarily of the licensing of our customer solutions, hardware and related professional services and training. Professional services primarily include installation, customization and consulting services. Certain revenue arrangements that require significant customization of a product to meet the particular requirements of a customer are recognized under the percentage-of-completion method. The vast majority of the percentage-of-completion method arrangements are fixed-fee contracts. Maintenance revenue consists primarily of post-contract customer support (or PCS), including technical software support services, unspecified software updates or upgrades to customers on a when-and-if-available basis. Revenue from customer solutions was $401.0 million for the fiscal year ended January 31, 2013, a decrease of $47.8 million, or 10.7%, compared to the fiscal year ended January 31, 2012. The decrease was attributable to a decline of $69.4 million and $6.6 million in customer solutions revenue at the Comverse BSS segment and Comverse Other, respectively, partially offset by an increase of $28.3 million at the Comverse VAS segment. Revenue recognized using the percentage-of-completion method was $144.4 million and $182.0 million for the fiscal years ended January 31, 2013 and 2012, respectively, and comprised approximately 21% and 24% of total revenue for such periods, respectively. Maintenance revenue was $276.8 million for the fiscal year ended January 31, 2013, a decrease of $45.6 million, or 14.1%, compared to the fiscal year ended January 31, 2012. This decrease was primarily attributable to declines of 43-------------------------------------------------------------------------------- Table of Contents $22.1 million and $22.3 million and $1.3 million in maintenance revenue at the Comverse BSS and Comverse VAS segments, respectively. Revenue by Geographic Region Revenue in the Americas, Europe, Middle East and Africa (or EMEA) and Asia Pacific (or APAC) represented approximately 35%, 37%, and 28% of our revenue, respectively, for the fiscal year ended January 31, 2013 compared to approximately 25%, 50%, and 25% of our revenue, respectively, for the fiscal year ended January 31, 2012. Foreign Currency Impact on Revenue Our functional currency for financial reporting purposes is the U.S. dollar. The majority of our revenue for the fiscal year ended January 31, 2013 was derived from transactions denominated in U.S. dollars. All other revenue was derived from transactions denominated in various foreign currencies, primarily the British pound, euro and Japanese yen. For the fiscal year ended January 31, 2013, fluctuations in the U.S. dollar relative to foreign currencies in which we conducted business unfavorably impacted revenue by $8.2 million compared to the fiscal year ended January 31, 2012, primarily due to a $6.9 million unfavorable impact of the Euro. Foreign Currency Impact on Costs A significant portion of our expenses, principally personnel-related costs, is incurred in new Israeli shekel (or NIS), whereas our functional currency for financial reporting purposes is the U.S. dollar. A strengthening of the NIS against the U.S. dollar would increase the U.S. dollar value of our expenses in Israel. In order to mitigate this risk we enter into foreign currency forward contracts to hedge foreign currency exchange rate fluctuations. For the fiscal year ended January 31, 2013, fluctuations in the U.S. dollar relative to all foreign currencies in which we conducted business favorably impacted costs by $9.3 million compared to the fiscal year ended January 31, 2012, primarily due to a weakening of the NIS against the U.S. dollar, net of hedging activity, resulting in a $4.6 million favorable impact. Cost of Revenue Cost of revenue primarily consists of hardware and software material costs and compensation and related expenses for personnel involved in the customization of our products for customer delivery, contractor costs, maintenance and professional services, such as installation costs and training, royalties and license fees, depreciation of equipment used in operations, amortization of capitalized software costs and certain purchased intangible assets and related overhead costs. Cost of revenue was $431.6 million for the fiscal year ended January 31, 2013, a decrease of $37.2 million, or 7.9%, compared to the fiscal year ended January 31, 2012. The decrease was attributable to declines in costs of $18.3 million, $16.2 million, and $2.7 million at Comverse Other, Comverse BSS and Comverse VAS segments, respectively, for the fiscal year ended January 31, 2013 compared to the fiscal year ended January 31, 2012. Research and Development, Net Research and development expenses, net primarily consist of personnel-related costs involved in product development, net of reimbursement under government programs. Research and development expenses also include third party development and programming costs and the amortization of purchased software code and services content used in research and development activities. Research and development expenses, net were $76.5 million for the fiscal year ended January 31, 2013, a decrease of $17.8 million, or 18.9%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to a decline of $26.6 million and $0.2 million at the Comverse BSS segment and Comverse Other, respectively, partially offset by an increase of $9.1 million at the Comverse VAS segment. Selling, General and Administrative Selling, general and administrative expenses consist primarily of compensation and related expenses of personnel, professional services, sales and marketing expenses, facility costs and unallocated overhead expenses. Selling, general and administrative expenses were $160.3 million for the fiscal year ended January 31, 2013, a decrease of $15.5 million, or 8.8%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to declines of $8.2 million, $5.1 million and $2.2 million at the Comverse BSS segment, Comverse VAS segment and Comverse Other, respectively. 44-------------------------------------------------------------------------------- Table of Contents Other Operating Expenses Other operating expenses consist of operating expenses not included in research and development, net and selling, general and administrative expenses and for the fiscal periods presented primarily consist of restructuring charges and impairments of intangible assets. Other operating expenses were $11.5 million for the fiscal year ended January 31, 2013, a decrease of $9.2 million, or 44.5% compared to the fiscal year ended January 31, 2012. The decrease was attributable to a decline at Comverse Other. (Loss) Income from Operations Loss from operations was $2.2 million for the fiscal year ended January 31, 2013, a change of $13.6 million compared to income from operations of $11.4 million for the fiscal year ended January 31, 2012. The decrease was primarily attributable to a decrease in income from operations of $40.4 million at the Comverse BSS segment, offset by a decrease in loss from operations of $22.0 million at Comverse Other and an increase in income from operations of $4.7 million at the Comverse VAS segment. Interest Income Interest income was $0.8 million for the fiscal year ended January 31, 2013, a decrease of 52.8%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to a decrease in interest rates. Interest Expense Interest expense was $0.9 million for the fiscal year ended January 31, 2013, a decrease of $0.1 million, or 5.5%, compared to the fiscal year ended January 31, 2012. Interest Expense on Notes Payable to CTI Interest expense on notes payable to CTI consists of interest expense that payable by us to CTI prior to the Share Distribution under a promissory note dated January 11, 2011 and a revolving loan agreement dated May 9, 2012 (referred to as the loan agreement). Interest expense on notes payable to CTI was $0.5 million and $0.4 million for the fiscal years ended January 31, 2013 and 2012, respectively. For more information about this note and the loan agreement, see note 11 of the consolidated and combined financial statements included in Item 15 of this Annual Report. Income Tax Provision Income tax provision from continuing operations was $13.5 million for the fiscal year ended January 31, 2013, representing an effective tax rate of (199.9)%, compared to income tax provision from continuing operations of $25.3 million, representing an effective tax rate of 544.7% for the fiscal year ended January 31, 2012. During the fiscal year ended January 31, 2013 the effective tax rate was less than the U.S. federal statutory rate of 35%. During the fiscal year ended January 31, 2013, the effective tax rate was negative and during the fiscal year ended January 31, 2012, the effective tax rate was higher than the U.S federal statutory rate of 35% primarily due to the mix of income and losses by jurisdiction and because we did not record an income tax benefit on losses in certain jurisdictions in which we maintain valuation allowances against certain of our U.S. and foreign net deferred tax assets. The income tax provision from continuing operations for the period is comprised primarily of income tax expense recorded in non-loss jurisdictions, withholding taxes, and certain tax contingencies recorded in the fiscal years ended January 31, 2013 and 2012. The change in our effective tax rate for the fiscal year ended January 31, 2013, compared to the fiscal year ended January 31, 2012 was primarily attributable to the receipt of interest income on an Israeli tax refund of $6.5 million and changes in the relative mix of income and losses across various jurisdictions. Income from Discontinued Operations, Net of Tax Income from discontinued operations represents the results of operations of Starhome, including the gain on sale of Starhome, net of tax. Income from discontinued operations, net of tax, was $26.5 million for the fiscal year ended January 31, 2013, compared to $7.8 million for the fiscal year ended January 31, 2012. The increase was primarily attributable to $22.6 million gain on sale of Starhome recorded during the fiscal year ended January 31, 2013. See note 17 of the consolidated and combined financial statements included in Item 15 of this Annual Report. 45-------------------------------------------------------------------------------- Table of Contents Net Income (Loss) Net income was $6.2 million for the fiscal year ended January 31, 2013, a change of $19.1 million compared to a net loss of $12.9 million for the fiscal year ended January 31, 2012 due primarily to the reasons discussed above. Net Income Attributable to Noncontrolling Interest Net income attributable to noncontrolling interest was $1.2 million for the fiscal year ended January 31, 2013, a decrease of $1.4 million, or 54.7%, compared to the fiscal year ended January 31, 2012. The decrease was attributable to a decrease in Starhome's net income for the fiscal year ended January 31, 2013 compared to the fiscal year ended January 31, 2012. Segment Results Comverse BSS Fiscal Years Ended January 31, Change 2013 2012 Amount Percent (Dollars in thousands) Revenue: Total revenue $ 273,535 $ 365,008 $ (91,473 ) (25.1 )% Costs and expenses: Cost of revenue 183,590 199,811 (16,221 ) (8.1 )% Research and development, net 33,833 60,473 (26,640 ) (44.1 )% Selling, general and administrative 19,408 27,629 (8,221 ) (29.8 )% Other operating expenses - - - N/M Total costs and expenses 236,831 287,913 (51,082 ) (17.7 )% Income from operations $ 36,704 $ 77,095 $ (40,391 ) (52.4 )% Computation of segment performance: Segment revenue $ 273,535 $ 365,008 $ (91,473 ) (25.1 )% Total costs and expenses $ 236,831 $ 287,913 $ (51,082 ) (17.7 )% Segment expense adjustments: Amortization of acquisition-related intangibles 14,124 17,308 (3,184 ) (18.4 )% Compliance-related compensation and other expenses 678 2,203 (1,525 ) (69.2 )% Impairment of property plan and equipment 2 170 (168 ) (98.8 )% Restructuring and integration charges - - - N/M Segment expense adjustments 14,804 19,681 (4,877 ) (24.8 )% Segment expenses 222,027 268,232 (46,205 ) (17.2 )% Segment performance $ 51,508 $ 96,776 $ (45,268 ) (46.8 )% Revenue Fiscal Year Ended January 31, 2013 compared to Fiscal Year Ended January 31, 2012. Revenue from Comverse BSS customer solutions was $140.6 million for the fiscal year ended January 31, 2013, a decrease of $69.4 million, or 33.1%, compared to the fiscal year ended January 31, 2012. The decrease in revenue for the current fiscal year compared to the prior fiscal year was partially attributable to a $29.8 million decrease in revenue recognized from material modifications of certain existing contracts as a result of the adoption of the new accounting guidance during the fiscal year ended January 31, 2012. The remaining decrease in revenue from Comverse BSS customer solutions was primarily attributable to changes in scope and settlements of certain customer contracts. Revenue from Comverse BSS customer solutions continued to be adversely affected by (i) the increasing complexity of project deployment resulting in extended periods of time required to complete project milestones and receive customer acceptance and (ii) lower volume of BSS projects in the current fiscal year resulting from lower customer order activity in recent years. Comverse BSS maintenance revenue was $133.0 million for the fiscal year ended January 31, 2013, a decrease of $22.1 million, or 14.2%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to (i) timing of entering into renewals of maintenance contracts with customers, (ii) decreased collections from customers for whom revenue is recognized upon collection and (iii) maintenance contracts that were terminated in the current year. 46-------------------------------------------------------------------------------- Table of Contents Revenue by Geographic Region Revenue in the Americas, Europe, Middle East and Africa (or EMEA) and Asia Pacific (or APAC) represented approximately 21%, 50% and 29% of Comverse BSS's revenue, respectively, for the fiscal year ended January 31, 2013 compared to approximately 19%, 53% and 28% of Comverse BSS's revenue, respectively, for the fiscal year ended January 31, 2012. Europe continued to suffer from significant weakness in market conditions and, accordingly, European customers continued to closely monitor their costs and maintain lower levels of spending. As a result, Comverse BSS's revenue from its European customers declined during the fiscal year ended January 31, 2013 compared to the fiscal year ended January 31, 2012. The decrease in total revenue for Comverse BSS in APAC was primarily attributable to a decrease in revenue recognized due to changes in scope and settlements of certain customer contracts as well as a decrease in collections from customers for whom revenue is recognized upon collection. Foreign Currency Impact on Revenue For the fiscal year ended January 31, 2013, fluctuations in the U.S. dollar relative to foreign currencies in which Comverse BSS conducted business compared to the fiscal year ended January 31, 2012 unfavorably impacted revenue by $6.5 million. Cost of Revenue Cost of revenue was $183.6 million for the fiscal year ended January 31, 2013, a decrease of $16.2 million, or 8.1%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to: • a $15.5 million decrease in material costs and overhead due to decreased revenue; • a $10.8 million decrease in personnel-related costs principally due to progress of projects accounted for under the percentage of completion method offset by a $6.5 million increase in allocation of research and development personnel to specific revenue generating projects recorded in cost of revenue in lieu of research and development expenses, net; and • a $2.8 million decrease in amortization of intangible assets due to certain intangible assets becoming fully amortized in the current year. These decreases were partially offset by a $9.7 million increase in sub-contractor costs to complete certain projects. The change in profit estimate of a Comverse BSS contract accounted for under the percentage of completion method negatively impacted income from operations by $14.8 million during the fiscal year ended January 31, 2013. Research and Development, Net Research and development expenses, net, were $33.8 million for the fiscal year ended January 31, 2013, a decrease of $26.6 million, or 44.1%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to: • a $14.3 million decrease in personnel-related costs; • a $7.2 million decrease in personnel-related costs due to allocation of research and development personnel to specific revenue generating projects recorded in cost of revenue in lieu of research and development expenses, net; and • a $4.7 million decrease in allocated overhead costs relating to research and development, principally due to workforce reductions as part of the Phase II Business Transformation in the prior year. Selling, General and Administrative Selling, general and administrative expenses were $19.4 million for the fiscal year ended January 31, 2013, a decrease of $8.2 million, or 29.8%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to: • a $3.3 million decrease in personnel-related costs; • a $1.7 million decrease in agent and employee sales commissions due to the mix of bookings generated from certain projects and in certain geographic locations; • a $1.0 million decrease in bad debt expense related to specific customers in the prior year; 47-------------------------------------------------------------------------------- Table of Contents • a $0.5 million decrease in travel costs due to overall cost reductions in the current year and the required travel needed to complete a project; and • a $0.4 million decrease in allocated overhead cost primarily due to workforce reductions as part of Phase II Business Transformation in the prior year. Segment Performance Segment performance was $51.5 million for the fiscal year ended January 31, 2013 based on segment revenue of $273.5 million, representing a segment performance margin of 18.8% as a percentage of segment revenue. Segment performance was $96.8 million for the fiscal year ended January 31, 2012 based on segment revenue of $365.0 million, representing a segment performance margin of 26.5% as a percentage of segment revenue. The decrease in segment performance margin was primarily attributable to the decrease in segment revenue partially offset by the decrease in segment expenses for the fiscal year ended January 31, 2013 compared to the fiscal year ended January 31, 2012. Comverse VAS Fiscal Years Ended January 31, Change 2013 2012 Amount Percent (Dollars in thousands) Revenue: Total revenue $ 362,434 $ 356,413 $ 6,021 1.7 % Costs and expenses: Cost of revenue 192,391 195,088 (2,697 ) (1.4 )% Research and development, net 34,467 25,416 9,051 35.6 % Selling, general and administrative 6,897 11,973 (5,076 ) (42.4 )% Other operating expenses - - - - Total costs and expenses 233,755 232,477 1,278 0.5 % Income from operations $ 128,679 $ 123,936 $ 4,743 3.8 % Computation of segment performance: Segment revenue $ 362,434 $ 356,413 $ 6,021 1.7 % Total costs and expenses $ 233,755 $ 232,477 $ 1,278 0.5 % Segment expense adjustments: Compliance-related compensation and other expenses 916 1,789 (873 ) (48.8 )% Impairment of property and equipment - 238 (238 ) (100.0 )% Segment expense adjustments 916 2,027 (1,111 ) (54.8 )% Segment expenses 232,839 230,450 2,389 1.0 % Segment performance $ 129,595 $ 125,963 $ 3,632 2.9 % Revenue Revenue from Comverse VAS customer solutions was $230.6 million for the fiscal year ended January 31, 2013, an increase of $28.3 million, or 14.0%, compared to the fiscal year ended January 31, 2012. The increase in revenue from Comverse VAS customer solutions was primarily attributable to an increase in revenue recognized upon cash collection due to increased collections from certain customers and a number of customer acceptances in large-scale deployments of next generation voicemail products (including visual voicemail) during the fiscal year ended January 31, 2013 with no comparable customer acceptances in the fiscal year ended January 31, 2012. This was partially offset by a decrease in timing of completion of project milestones and settlements. Comverse VAS maintenance revenue was $131.8 million for the fiscal year ended January 31, 2013, a decrease of $22.3 million, or 14.4%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to the timing of entering into renewals of maintenance contracts, termination of maintenance contracts and a decrease in maintenance revenue attributable to maintenance services provided to customers during the initial service period corresponding to a decline in new installed base value. 48-------------------------------------------------------------------------------- Table of Contents Revenue by Geographic Region Revenue in the Americas, EMEA and APAC represented approximately 44%, 28% and 28% of Comverse VAS's revenue, respectively, for the fiscal year ended January 31, 2013 compared to approximately 30%, 45% and 25% of Comverse VAS's revenue, respectively, for the fiscal year ended January 31, 2012. The increase in revenue as a percentage of total revenue for Comverse VAS in the Americas was primarily attributable to significant revenue recognized due to customer acceptances in certain large-scale projects in the fiscal year ended January 31, 2013, with no comparable customer acceptances in the fiscal year ended January 31, 2012. Conversely, the decrease in revenue as a percentage of total revenue for Comverse VAS in Europe was primarily attributable to significant revenue recognized due to customer acceptances in certain large-scale projects and settlements in the fiscal year ended January 31, 2012, with no comparable customer acceptances in the fiscal year ended January 31, 2013. The increase in revenue for Comverse VAS in APAC was primarily attributable to revenue recognized upon cash collection due to increased collections from certain customers. Foreign Currency Impact on Revenue For the fiscal year ended January 31, 2013, fluctuations in the U.S. dollar relative to foreign currencies in which Comverse VAS conducted business compared to the fiscal year ended January 31, 2012 unfavorably impacted revenue by $0.6 million. Cost of Revenue Cost of revenue was $192.4 million for the fiscal year ended January 31, 2013, a decrease of $2.7 million, or 1.4%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to: • a $4.2 million decrease in allocation of overhead costs relating to cost of revenue; • a $4.1 million decrease in material costs primarily due to lower product costs associated with revenue recognized during the period; and • a $1.8 million decrease in travel costs due to overall cost reductions in the current year and the required travel needed to complete a project. These decreases were partially offset by a $4.7 million increase in personnel-related costs principally due to progress of projects accounted for under the percentage of completion method as well as a $2.1 million increase in an allocation of research and development personnel to specific revenue generating projects recorded in cost of revenue in lieu of research and development expenses, net. Research and Development, Net Research and development expenses, net were $34.5 million for the fiscal year ended January 31, 2013, an increase of $9.1 million, or 35.6%, compared to the fiscal year ended January 31, 2012. The increase was primarily attributable to: • a $8.1 million increase in personnel-related costs mainly due to increased research and development headcount attributable to the launch of SEM and IP Messaging; and • a $2.4 million increase in allocation of overhead costs to research and development, net as a result of the higher headcount. These increases were offset by a decrease of $2.1 million in personnel-related costs due to allocation of research and development personnel to specific revenue generating projects recorded in cost of revenue in lieu of research and development expenses, net. 49-------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative Selling, general and administrative expenses were $6.9 million for the fiscal year ended January 31, 2013, a decrease of $5.1 million, or 42.4%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to: • a $1.8 million decrease in agent and employee sales commissions expense principally due to the mix of bookings generated from certain projects and in certain geographic locations with respect to which Comverse VAS pays lower sales commission; and • a $3.1 million decrease in bad debt expenses that related to a specific customer in the prior year. Segment Performance Segment performance was $129.6 million for the fiscal year ended January 31, 2013 based on segment revenue of $362.4 million, representing a segment performance margin of 35.8% as a percentage of segment revenue. Segment performance was $126.0 million for the fiscal year ended January 31, 2012 based on segment revenue of $356.4 million, representing a segment performance margin of 35.3% as a percentage of segment revenue. Comverse Other Fiscal Years Ended January 31, Change 2013 2012 Amount Percent (Dollars in thousands) Revenue: Total revenue $ 41,794 $ 49,736 $ (7,942 ) (16.0 )% Costs and expenses: Cost of revenue 55,663 73,968 (18,305 ) (24.7 )% Research and development, net 8,161 8,349 (188 ) (2.3 )% Selling, general and administrative 134,035 136,280 (2,245 ) (1.6 )% Other operating expenses 11,510 20,728 (9,218 ) (44.5 )% Total costs and expenses 209,369 239,325 (29,956 ) (12.5 )% Loss from operations $ (167,575 ) $ (189,589 ) $ 22,014 (11.6 )% Computation of segment performance: Segment revenue $ 41,794 $ 49,736 $ (7,942 ) (16.0 )% Total costs and expenses $ 209,369 $ 239,325 $ (29,956 ) (12.5 )% Segment expense adjustments: Stock-based compensation expense 7,517 3,660 3,857 105.4 % Compliance-related professional fees 245 10,901 (10,656 ) (97.8 )% Compliance-related compensation and other expenses 504 2,727 (2,223 ) (81.5 )% Spin-off professional fees 933 - 933 N/M Impairment of goodwill 5,605 - 5,605 N/M Impairment of property and equipment 402 1,923 (1,521 ) (79.1 )% Litigation settlements and related costs (660 ) 804 (1,464 ) (182.1 )% Restructuring 5,905 20,728 (14,823 ) (71.5 )% Gain on sale of fixed assets (185 ) - (185 ) N/M Other 1,621 (48 ) 1,669 N/M Segment expense adjustments 21,887 40,695 (18,808 ) (46.2 )% Segment expenses 187,482 198,630 (11,148 ) (5.6 )% Segment performance $ (145,688 ) $ (148,894 ) $ 3,206 (2.2 )% Revenue Revenue includes revenue generated primarily by Comverse MI and our Netcentrex operations (or Netcentrex). Total revenue was $41.8 million for the fiscal year ended January 31, 2013, a decrease of $7.9 million, or 16.0%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to revenue decreases in Netcentrex and MI of $9.1 million and $1.2 million, respectively, partially offset by a $2.3 million revenue increase at 50-------------------------------------------------------------------------------- Table of Contents other miscellaneous operations. For the fiscal year ended January 31, 2013 and 2012, Comverse MI's total revenue was $22.7 million and $23.9 million, respectively, and Netcentrex' total revenue was $14.3 million and $23.4 million, respectively. Foreign Currency Impact on Revenue For the fiscal year ended January 31, 2013, fluctuations in the U.S. dollar relative to foreign currencies in which Comverse Other conducted business compared to the fiscal year ended January 31, 2012 unfavorably impacted revenue by $1.2 million. Cost of Revenue Cost of revenue is primarily attributable to Comverse MI and Netcentrex. Cost of revenue also includes shared services costs associated with customer projects, including at Comverse BSS and Comverse VAS. Cost of revenue was $55.7 million for the fiscal year ended January 31, 2013, a decrease of $18.3 million, or 24.7%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to: • a $16.0 million decrease in personnel-related costs relating to employees, whose personnel-related costs were included in Comverse Other for the fiscal year ended January 31, 2012 and were transferred to specific projects at the Comverse BSS and Comverse VAS segments for the fiscal year ended January 31, 2013; • a $9.8 million decrease in allocation of research and development personnel to specific revenue generating projects recorded in cost of revenue in lieu of research and development expenses, net; and • a $1.3 million decrease in contractor costs. These decreases were partially offset by a $4.8 million increase in materials and overhead costs. Research and Development, Net Research and development expenses, net, primarily include expenses incurred by our global corporate functions in connection with shared services provided to our operations, including Comverse BSS and Comverse VAS. Research and development expenses, net, were $8.2 million for the fiscal year ended January 31, 2013, a decrease of $0.2 million, or 2.3%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to the transfer of specific projects at the Comverse BSS and Comverse VAS segments for the fiscal year ended January 31, 2013. Selling, General and Administrative Selling, general and administrative expenses consist of expenses incurred by our global corporate functions in connection with shared services provided to our operations, including, Comverse BSS and Comverse VAS that are not allocated to the segments. Selling, general and administrative expenses were $134.0 million for the fiscal year ended January 31, 2013, a decrease of $2.2 million, or 1.6%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to: • a $10.7 million decrease in compliance-related professional fees in connection with CTI's efforts to become current in its periodic reporting obligations under the federal securities laws; • a $4.7 million decrease in rent and utilities as a result of consolidation of facilities during the current fiscal period; and • a $4.2 million decrease in allocable costs from CTI primarily as a result of the Share Distribution that was completed on October 31, 2012. These decreases were partially offset by: • a $10.4 million decrease in overhead allocation relating to selling, general and administrative expenses due to a decrease in allocable cost; and • an $8.0 million increase in agent and employee sales commissions due to the mix of bookings generated from certain projects and in certain geographic locations with respect to which we pay higher commissions. 51 -------------------------------------------------------------------------------- Table of Contents Other Operating Expenses Other operating expenses were $11.5 million for the fiscal year ended January 31, 2013, a decrease of $9.2 million, or 44.5%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to a $14.8 million decrease in restructuring charges. Restructuring charges were higher during the prior year due to the implementation of the Phase II Business Transformation plan and restructuring activities related to Netcentrex. The decrease was partially offset by a $5.6 million charge for impairment of goodwill related to the Comverse MI reporting unit in the fiscal year ended January 31, 2013. Loss from Operations Loss from operations was $167.6 million for the fiscal year ended January 31, 2013, a decrease in loss of $22.0 million, or 11.6%, compared to the fiscal year ended January 31, 2012 due primarily to the reasons discussed above. For the fiscal year ended January 31, 2013, Comverse MI had income from operations of $1.5 million compared to a loss from operations of $0.7 million for the fiscal year ended January 31, 2012. The change was primarily attributable to a decrease in cost of revenue, research and development expense, selling and, general and administrative expenses. For the fiscal year ended January 31, 2013 and 2012, Netcentrex had a loss from operations of $1.1 million and $4.3 million, respectively. The decrease in loss was primarily attributable to a decrease of $11.8 million in research and development expense, cost of sales and selling, general and administrative expenses partially offset by a decrease in revenue of $9.1 million. Segment Performance Segment performance was a $145.7 million loss for the fiscal year ended January 31, 2013, a decrease in loss of $3.2 million, or 2.2%, compared to the fiscal year ended January 31, 2012. The decrease in loss was attributable to a decrease in segment expenses partially offset by a decrease in segment revenue. 52-------------------------------------------------------------------------------- Table of Contents Fiscal Year Ended January 31, 2012 Compared to Fiscal Year Ended January 31, 2011 Consolidated and Combined Results Fiscal Year Ended January 31, Change 2012 2011 Amount Percent (Dollars in thousands, except per share data) Total revenue $ 771,157 $ 862,836 $ (91,679 ) (10.6 )% Costs and expenses Cost of revenue 468,867 473,888 (5,021 ) (1.1 )% Research and development, net 94,238 148,817 (54,579 ) (36.7 )% Selling, general and administrative 175,882 269,973 (94,091 ) (34.9 )% Other operating expenses 20,728 29,934 (9,206 ) (30.8 )% Total costs and expenses 759,715 922,612 (162,897 ) (17.7 )% Income (loss) from operations 11,442 (59,776 ) 71,218 (119.1 )% Interest income 1,755 1,717 38 2.2 % Interest expense (953 ) (900 ) (53 ) 5.9 % Interest expense on notes payable to CTI (409 ) (19 ) (390 ) N/M Other expense, net (7,192 ) (3,645 ) (3,547 ) 97.3 % Income tax provision (25,291 ) (30,118 ) 4,827 (16.0 )% Net loss from continuing operations (20,648 ) (92,741 ) 72,093 (77.7 )% Income from discontinued operations, net of tax 7,761 2,826 4,935 N/M Net loss (12,887 ) (89,915 ) 77,028 (85.7 )% Less: Net income attributable to noncontrolling interest (2,574 ) (1,030 ) (1,544 ) 149.9 % Net loss attributable to Comverse, Inc. $ (15,461 ) $ (90,945 ) $ 75,484 (83.0 )% Net income (loss) attributable to Comverse, Inc.: Net loss from continuing operations $ (20,648 ) $ (92,741 ) $ 72,093 Income from discontinued operations, net of tax 5,187 1,796 3,391 Net loss attributable to Comverse, Inc. $ (15,461 ) $ (90,945 ) $ 75,484 Earnings (loss) per share attributable to Comverse, Inc.'s stockholders: Basic and diluted earnings (loss) per share(1) Continuing operations $ (0.94 ) $ (4.23 ) $ 3.29 Discontinued operations $ 0.23 $ 0.08 $ 0.15 (1) The computation of basic and diluted earnings (loss) per share for the fiscal years ended January 31, 2012 and 2011 is calculated using the number of shares of outstanding common stock on October 31, 2012, the completion date of the Share Distribution. See note 18 to the consolidated and combined financial statements included in Item 15 of this Annual Report. Total Revenue Total revenue for the fiscal year ended January 31, 2012 includes $48.9 million of additional revenue that was recognized as a result of the adoption of the new accounting guidance relating to revenue recognition. Revenue from customer solutions was $448.8 million for the fiscal year ended January 31, 2012, a decrease of $83.0 million, or 15.6%, compared to the fiscal year ended January 31, 2011. The decrease was attributable to an $82.4 million and $11.7 million decline in customer solutions revenue at the Comverse VAS segment and Comverse Other, respectively, partially offset by an $11.1 million increase in customer solutions revenue at the Comverse BSS segment. Revenue recognized using the percentage-of-completion method was $182.0 million and $140.4 million for the fiscal years ended January 31, 2012 and 2011, respectively, and comprised approximately 24% and 16% of total revenue for such periods, respectively. Maintenance revenue was $322.4 million for the fiscal year ended January 31, 2012, a decrease of $8.6 million, or 2.6%, compared to the fiscal year ended January 31, 2011. This decrease was attributable to a $22.1 million decline in maintenance revenue at the Comverse VAS segment, partially offset by a $13.4 million increase in maintenance revenue at the Comverse BSS segment. 53-------------------------------------------------------------------------------- Table of Contents Revenue by Geographic Region Revenue in the Americas, EMEA and APAC represented approximately 25%, 50%, and 25% of our revenue, respectively, for the fiscal year ended January 31, 2012 compared to approximately 33%, 44%, and 23% of our revenue, respectively, for the fiscal year ended January 31, 2011. For additional information on our revenue by geographic region, see "Business-Domestic and International Sales and Long-Lived Assets" and note 21 to the consolidated and combined financial statements included in Item 15 of this Annual Report. Foreign Currency Impact on Revenue Our functional currency for financial reporting purposes is the U.S. dollar. The majority of our revenue for the fiscal year ended January 31, 2012 was derived from transactions denominated in U.S. dollars. All other revenue was derived from transactions denominated in various foreign currencies, primarily the euro. Fluctuations in the U.S. dollar relative to foreign currencies in which we conducted business for the fiscal year ended January 31, 2012 compared to the fiscal year ended January 31, 2011 favorably impacted revenue by $10.2 million. Foreign Currency Impact on Costs A significant portion of our expenses, principally personnel-related costs, is incurred in NIS, whereas our functional currency for financial reporting purposes is the U.S. dollar. A strengthening of the NIS against the U.S. dollar would increase the U.S. dollar value of our expenses in Israel. In order to mitigate this risk, we enter into foreign currency forward contracts to hedge foreign currency exchange rate fluctuations. Cost of Revenue Cost of revenue was $468.9 million for the fiscal year ended January 31, 2012, a decrease of $5.0 million, or 1.1%, compared to the fiscal year ended January 31, 2011. The decrease was attributable to declines in costs of $4.4 million and $7.9 million at the Comverse VAS segment and Comverse Other, respectively, partially offset by an increase in costs of $7.3 million at the Comverse BSS segment for the fiscal year ended January 31, 2012 compared to the fiscal year ended January 31, 2011. Research and Development, Net Research and development expenses, net were $94.2 million for the fiscal year ended January 31, 2012, a decrease of $54.6 million, or 36.7%, compared to the fiscal year ended January 31, 2011. The decrease was primarily attributable to a decline of $34.7 million and $17.0 million at the Comverse VAS segment and Comverse Other, respectively. Selling, General and Administrative Selling, general and administrative expenses were $175.9 million for the fiscal year ended January 31, 2012, a decrease of $94.1 million, or 34.9%, compared to the fiscal year ended January 31, 2011. The decrease was primarily attributable to a decline of $79.5 million and $13.9 million at Comverse Other and the Comverse VAS segment, respectively. Other Operating Expenses Other operating expenses were $20.7 million for the fiscal year ended January 31, 2012, a decrease of $9.2 million, or 30.8% compared to the fiscal year ended January 31, 2011. The decrease was attributable to a decline at Comverse Other. Income (loss) from Operations Income from operations was $11.4 million for the fiscal year ended January 31, 2012, a change of $71.2 million compared to a loss from operations of $59.8 million for the fiscal year ended January 31, 2011. The increase was primarily attributable to a decrease in loss from operations of $101.9 million at Comverse Other and an increase in income from operations of $20.7 million at the Comverse BSS segment, partially offset by a decrease in income from operations of $51.4 million at the Comverse VAS segment. Interest Income Interest income was $1.8 million for the fiscal year ended January 31, 2012, an increase of 2.2%, compared to the fiscal year ended January 31, 2011. 54-------------------------------------------------------------------------------- Table of Contents Interest Expense Interest expense was $1.0 million for the fiscal year ended January 31, 2012, an increase of $0.1 million, or 5.9%, compared to the fiscal year ended January 31, 2011. Interest Expense on Notes Payable to CTI Interest expense on notes payable to CTI was $0.4 million for the fiscal year ended January 31, 2012, an increase of $0.4 million compared to fiscal year ended January 31, 2011. For more information about this note, see "-Liquidity and Capital Resources-Indebtedness-Note Payable to CTI." Other Expense, Net Other expense, net was $7.2 million for the fiscal year ended January 31, 2012, an increase of $3.5 million, or 97.3%, compared to the fiscal year ended January 31, 2011. The increase was primarily attributable to a $1.7 million increase in foreign currency transaction losses. Income Tax Provision Income tax provision from continuing operations was $25.3 million for the fiscal year ended January 31, 2012, representing an effective tax rate of 544.7%, compared to income tax provision from continuing operations of $30.1 million, representing an effective tax rate of (48.1)% for the fiscal year ended January 31, 2011. During the fiscal year ended January 31, 2012 the effective tax rate was higher than the U.S. federal statutory rate of 35% and during the fiscal year ended January 31, 2011 the effective tax rate was negative primarily due to the mix of income and losses by jurisdiction and because we did not record an income tax benefit on losses in certain jurisdictions in which we maintain valuation allowances against certain of our U.S. and foreign net deferred tax assets. The income tax provision from continuing operations for the period is comprised primarily of income tax expense recorded in non-loss jurisdictions, withholding taxes, and certain tax contingencies recorded in the fiscal years ended January 31, 2012 and 2011. The change in our effective tax rate for the fiscal year ended January 31, 2012, compared to the fiscal year ended January 31, 2011 was primarily attributable to changes in the relative mix of income and losses across various jurisdictions. Income from Discontinued Operations, Net of Tax Income from discontinued operations, net of tax, was $7.8 million for the fiscal year ended January 31, 2012, compared to $2.8 million for the fiscal year ended January 31, 2011. Income from discontinued operations represented the results of operations of Starhome for the fiscal years ended January 31, 2012 and 2011 less applicable income taxes. For additional discussion, see note 17 to the consolidated and combined financial statements included in Item 15 of this Annual Report. Net Loss Net loss was $12.9 million for the fiscal year ended January 31, 2012, a decrease in loss of $77.0 million, or 85.7%, compared to the fiscal year ended January 31, 2011 due primarily to the reasons discussed above. Net Income Attributable to Noncontrolling Interest Net income attributable to noncontrolling interest was $2.6 million for the fiscal year ended January 31, 2012, an increase of $1.5 million, or 149.9%, compared to the fiscal year ended January 31, 2011. The increase was attributable to an increase in Starhome's net income for the fiscal year ended January 31, 2012 compared to the fiscal year ended January 31, 2011. 55-------------------------------------------------------------------------------- Table of Contents Segment Results Comverse BSS Fiscal Years Ended January 31, Change 2012 2011 Amount Percent (Dollars in thousands) Revenue: Total revenue $ 365,008 $ 340,502 $ 24,506 7.2 % Costs and expenses: Cost of revenue 199,811 192,516 7,295 3.8 % Research and development, net 60,473 63,357 (2,884 ) (4.6 )% Selling, general and administrative 27,629 28,275 (646 ) (2.3 )% Total costs and expenses 287,913 284,148 3,765 1.3 % Income from operations $ 77,095 $ 56,354 $ 20,741 36.8 % Computation of segment performance: Segment revenue $ 365,008 $ 340,502 $ 24,506 7.2 % Total costs and expenses $ 287,913 $ 284,148 $ 3,765 1.3 % Segment expense adjustments: Amortization of acquisition-related intangibles 17,308 18,505 (1,197 ) (6.5 )% Compliance-related compensation and other expenses 2,203 1,557 646 41.5 % Impairment of property plan and equipment 170 - 170 N/M Segment expense adjustments 19,681 20,062 (381 ) (1.9 )% Segment expenses 268,232 264,086 4,146 1.6 % Segment performance $ 96,776 $ 76,416 $ 20,360 26.6 % Revenue Total revenue for the fiscal year ended January 31, 2012 includes $42.7 million of additional revenue that was recognized as a result of the adoption of the new accounting guidance relating to revenue recognition. Revenue from Comverse BSS customer solutions was $210.0 million for the fiscal year ended January 31, 2012, an increase of $11.1 million, or 5.6%, compared to the fiscal year ended January 31, 2011. The increase in revenue from Comverse BSS customer solutions was primarily attributable to $42.7 million of additional revenue that was recognized as a result of the adoption of the new accounting guidance relating to revenue recognition. The increase was partially offset by lower volume of customer acceptances for the fiscal year ended January 31, 2012 compared to the fiscal year ended January 31, 2011. Revenue from customer acceptances decreased by approximately 13% for the fiscal year ended January 31, 2012 compared to the fiscal year ended January 31, 2011. Comverse BSS maintenance revenue was $155.0 million for the fiscal year ended January 31, 2012, an increase of $13.4 million, or 9.4%, compared to the fiscal year ended January 31, 2011. The increase was primarily attributable to an increase in the installed base of Comverse BSS customer solutions and increased collections that resulted in the recognition of additional revenue. Revenue by Geographic Region Revenue in the Americas, EMEA and APAC represented approximately 19%, 53%, and 28% of Comverse BSS's revenue, respectively, for the fiscal year ended January 31, 2012 compared to approximately 17%, 60%, and 23% of Comverse BSS's revenue, respectively, for the fiscal year ended January 31, 2011. The increase in revenue as a percentage of the total revenue for Comverse BSS in APAC was primarily attributable to significant revenue recognized due to customer acceptances in certain large-scale projects in the fiscal year ended January 31, 2012, with no comparable customer acceptances in the fiscal year ended January 31, 2011. Europe continued to suffer from significant weakness in market conditions and, accordingly, European customers continued to closely monitor their costs and maintain lower levels of spending. As a result, Comverse BSS's revenue from its European customers declined during the fiscal year ended January 31, 2012 compared to the fiscal year ended January 31, 2011. 56-------------------------------------------------------------------------------- Table of Contents Foreign Currency Impact on Revenue Fluctuations in the U.S. dollar relative to foreign currencies in which Comverse BSS conducted business for the fiscal year ended January 31, 2012 compared to the fiscal year ended January 31, 2011 favorably impacted revenue by $4.7 million. Cost of Revenue Cost of revenue was $199.8 million for the fiscal year ended January 31, 2012, an increase of $7.3 million, or 3.8%, compared to the fiscal year ended January 31, 2011. The increase was primarily attributable to: • an $18.8 million increase in material costs and overhead due to increased revenue and lower margin projects; and • a $1.9 million increase in travel and entertainment expenses. These increases were partially offset by: • a $10.8 million decrease in contractor costs due to increased use of company employees in lieu of contractors as part of cost savings initiatives; and • a $3.5 million decrease in allocated overhead costs relating to cost of revenue. Research and Development, Net Research and development expenses, net were $60.5 million for the fiscal year ended January 31, 2012, a decrease of $2.9 million, or 4.6%, compared to the fiscal year ended January 31, 2011. The decrease was primarily attributable to a $2.7 million decrease in personnel-related costs principally due to workforce reductions and a decline in compensation levels. Selling, General and Administrative Selling, general and administrative expenses were $27.6 million for the fiscal year ended January 31, 2012, a decrease of $0.6 million, or 2.3%, compared to the fiscal year ended January 31, 2011. The decrease was primarily attributable to workforce reductions and an overall reduction in sales commissions due to lower bookings. Income from Operations Income from operations was $77.1 million for the fiscal year ended January 31, 2012, an increase of $20.7 million, or 36.8%, compared to the fiscal year ended January 31, 2011 due primarily to the reasons described above. Segment Performance Segment performance was $96.8 million for the fiscal year ended January 31, 2012 based on segment revenue of $365.0 million, representing a segment performance margin of 26.5% as a percentage of segment revenue. Segment performance was $76.4 million for the fiscal year ended January 31, 2011 based on segment revenue of $340.5 million, representing a segment performance margin of 22.4% as a percentage of segment revenue. The increase in segment performance margin was primarily attributable to the increase in segment revenue partially offset by the increase in segment expenses for the fiscal year ended January 31, 2012 compared to the fiscal year ended January 31, 2011. 57-------------------------------------------------------------------------------- Table of Contents Comverse VAS Fiscal Years Ended January 31, Change 2012 2011 Amount Percent (Dollars in thousands) Revenue: Total revenue $ 356,413 $ 460,899 $ (104,486 ) (22.7 )% Costs and expenses: Cost of revenue 195,088 199,537 (4,449 ) (2.2 )% Research and development, net 25,416 60,156 (34,740 ) (57.7 )% Selling, general and administrative 11,973 25,879 (13,906 ) (53.7 )% Total costs and expenses 232,477 285,572 (53,095 ) (18.6 )% Income from operations $ 123,936 $ 175,327 $ (51,391 ) (29.3 )% Computation of segment performance: Segment revenue $ 356,413 $ 460,899 $ (104,486 ) (22.7 )% Total costs and expenses $ 232,477 $ 285,572 $ (53,095 ) (18.6 )% Segment expense adjustments: Compliance-related compensation and other expenses 1,789 330 1,459 N/M Impairment of property and equipment 238 - 238 N/M Segment expense adjustments 2,027 330 1,697 N/M Segment expenses 230,450 285,242 (54,792 ) (19.2 )% Segment performance $ 125,963 $ 175,657 $ (49,694 ) (28.3 )% Revenue Total revenue for the fiscal year ended January 31, 2012 includes $5.8 million of additional revenue that was recognized as a result of the adoption of the new accounting guidance relating to revenue recognition. Revenue from Comverse VAS customer solutions was $202.3 million for the fiscal year ended January 31, 2012, a decrease of $82.4 million, or 28.9%, compared to the fiscal year ended January 31, 2011. The decrease in revenue from Comverse VAS customer solutions was primarily attributable to a number of customer acceptances of large-scale deployments of next generation voicemail products (including visual voicemail) in connection with the launch of new smartphones and increasing use of smartphones by subscribers during the fiscal year ended January 31, 2011 with no comparable customer acceptances in the fiscal year ended January 31, 2012. In addition, revenue was impacted by the timing of customer acceptances in certain projects and the timing of completion of project milestones. Further, the implementation of Comverse's strategy to pursue higher margin Comverse VAS projects led, as expected, to lower revenue. Comverse VAS maintenance revenue was $154.1 million for the fiscal year ended January 31, 2012, a decrease of $22.1 million, or 12.5%, compared to the fiscal year ended January 31, 2011. The decrease was mainly due to a decline in maintenance revenue attributable to maintenance services provided to customers during the initial service period corresponding to the decline in revenue from VAS customer solutions and a decline in installed base value. Revenue by Geographic Region Revenue in the Americas, EMEA and APAC represented approximately 30%, 45%, and 25% of Comverse VAS's revenue, respectively, for the fiscal year ended January 31, 2012 compared to approximately 41%, 34%, and 25% of Comverse VAS's revenue, respectively, for the fiscal year ended January 31, 2011. The decrease in revenue as a percentage of total revenue for Comverse VAS in the Americas was primarily attributable to (i) significant revenue recognized due to customer acceptances in certain large-scale projects in the fiscal year ended January 31, 2011, with no comparable customer acceptances in the fiscal year ended January 31, 2012, and (ii) the implementation of our strategy to pursue higher margin Comverse VAS projects which, as expected, led to lower revenue. The increase in revenue for Comverse VAS in EMEA was primarily attributable to timing of certain acceptances. 58-------------------------------------------------------------------------------- Table of Contents Foreign Currency Impact on Revenue Fluctuations in the U.S. dollar relative to foreign currencies in which Comverse VAS conducted business for the fiscal year ended January 31, 2012 compared to the fiscal year ended January 31, 2011 favorably impacted revenue by $4.2 million. Cost of Revenue Cost of revenue was $195.1 million for the fiscal year ended January 31, 2012, a decrease of $4.4 million, or 2.2%, compared to the fiscal year ended January 31, 2011. The decrease was primarily attributable to: • a $14.7 million decrease in material costs and overhead primarily as a result of decreased revenue and inventory obsolescence; and • a $1.3 million decrease in travel and entertainment expenses as a result of cost saving initiatives. The decrease was partially offset by increases in cost of revenue due to the transfer of certain research and development personnel to specific projects in connection with processes to improve operational efficiency as part of the implementation of the Phase II Business Transformation with the costs attributable to such personnel being recorded as cost of revenue in lieu of research and development expenses, net. These increases included: • a $9.0 million increase in allocated overhead costs relating to cost of revenue; • a $2.5 million increase in contractor costs recorded based on progress of projects related to customer solutions; and • a $0.8 million increase in personnel-related costs. Research and Development, Net Research and development expenses, net were $25.4 million for the fiscal year ended January 31, 2012, a decrease of $34.7 million, or 57.7%, compared to the fiscal year ended January 31, 2011. Research and development expenses, net were impacted by the transfer of certain research and development personnel to specific projects in connection with processes to improve operational efficiency as part of the implementation of the Phase II Business Transformation with the costs attributable to such personnel being recorded as cost of revenue in lieu of research and development expenses, net. The decrease in research and development expenses, net was primarily attributable to: • a $20.9 million decrease in personnel-related costs primarily due to workforce reductions, a decline in compensation levels and a decrease in research and development activity; • a $7.9 million decrease in allocated overhead costs relating to research and development due to a workforce reduction; and • a $4.0 million decrease in contractor costs due to a decrease in research and development activity. Selling, General and Administrative Selling, general and administrative expenses were $12.0 million for the fiscal year ended January 31, 2012, a decrease of $13.9 million, or 53.7%, compared to the fiscal year ended January 31, 2011. The decrease was primarily attributable to: • a $12.4 million decrease in personnel-related costs primarily due to workforce reductions and a decline in compensation levels; and • a $2.4 million decrease in overhead allocations related to selling, general and administrative expenses. Income from Operations Income from operations was $123.9 million for the fiscal year ended January 31, 2012, a decrease of $51.4 million, or 29.3% compared to the fiscal year ended January 31, 2011 due primarily to the reasons described above. Segment Performance Segment performance was $126.0 million for the fiscal year ended January 31, 2012 based on segment revenue of $356.4 million, representing a segment performance margin of 35.3% as a percentage of segment revenue. Segment performance was $175.7 million for the fiscal year ended January 31, 2011 based on segment revenue of $460.9 million, 59-------------------------------------------------------------------------------- Table of Contents representing a segment performance margin of 38.1% as a percentage of segment revenue. The decrease in segment performance margin was primarily attributable to the decrease in segment revenues partially offset by the decrease in segment expenses for the fiscal year ended January 31, 2012 compared to the fiscal year ended January 31, 2011. Comverse Other Fiscal Years Ended January 31, Change 2012 2011 Amount Percent (Dollars in thousands) Revenue: Total revenue $ 49,736 $ 61,435 $ (11,699 ) (19.0 )% Costs and expenses: Cost of revenue 73,968 81,835 (7,867 ) (9.6 )% Research and development, net 8,349 25,304 (16,955 ) (67.0 )% Selling, general and administrative 136,280 215,819 (79,539 ) (36.9 )% Other operating expenses 20,728 29,934 (9,206 ) (30.8 )% Total costs and expenses 239,325 352,892 (113,567 ) (32.2 )% Loss from operations $ (189,589 ) $ (291,457 ) $ 101,868 (35.0 )% Computation of segment performance: Segment revenue $ 49,736 $ 61,435 $ (11,699 ) (19.0 )% Total costs and expenses $ 239,325 $ 352,892 $ (113,567 ) (32.2 )% Segment expense adjustments: Stock-based compensation expense 3,660 2,439 1,221 50.1 % Compliance-related professional fees 10,901 82,136 (71,235 ) (86.7 )% Compliance-related compensation and other expenses 2,727 2,655 72 2.7 % Impairment of property and equipment 1,923 - 1,923 N/M Litigation settlements and related costs 804 - 804 N/M Restructuring 20,728 29,934 (9,206 ) (30.8 )% Gain on sale of fixed assets - (2,371 ) 2,371 N/M Other (48 ) (1,402 ) 1,354 (96.6 )% Segment expense adjustments 40,695 113,391 (72,696 ) (64.1 )% Segment expenses 198,630 239,501 (40,871 ) (17.1 )% Segment performance $ (148,894 ) $ (178,066 ) $ 29,172 (16.4 )% Revenue Total revenue was $49.7 million for the fiscal year ended January 31, 2012, a decrease of $11.7 million, or 19.0%, compared to the fiscal year ended January 31, 2011. The decrease was primarily attributable to a $13.2 million revenue decline at Comverse MI partially offset by an increase in revenue of $3.3 million at Netcentrex. The decrease in revenue at Comverse MI was primarily attributable to a large customer acceptance of Comverse MI solutions during the fiscal year ended January 31, 2011 with no comparable customer acceptance in the fiscal year ended January 31, 2012. For the fiscal years ended January 31, 2012 and 2011, Comverse MI's total revenue were $23.9 million and $37.1 million, respectively, and Netcentrex' total revenue were $23.4 million and $20.1 million, respectively. Total revenue of Comverse MI for the fiscal year ended January 31, 2012 includes $0.4 million of additional revenue that was recognized as a result of the adoption of the new accounting guidance relating to revenue recognition. Cost of Revenue Cost of revenue was $74.0 million for the fiscal year ended January 31, 2012, a decrease of $7.9 million, or 9.6%, compared to the fiscal year ended January 31, 2011. The decrease was primarily attributable to: • a $6.7 million decrease in material costs primarily due to a decrease in provision for contract loss compared to the fiscal year ended January 31, 2011; • a $1.7 million decrease in contractor costs; • a $1.6 million decrease in allocated overhead costs relating to cost of revenue; and • a $1.5 million decrease in travel and entertainment expenses as a result of cost saving initiatives. 60-------------------------------------------------------------------------------- Table of Contents The decrease was partially offset by a $5.5 million increase in personnel-related costs due to the transfer of certain research and development personnel to specific projects in connection with processes to improve operational efficiency as part of the implementation of the Phase II Business Transformation with the personnel-related costs attributable to such personnel being recorded as cost of revenue in lieu of research and development expenses, net. Research and Development, Net Research and development expenses, net, were $8.3 million for the fiscal year ended January 31, 2012, a decrease of $17.0 million, or 67.0%, compared to the fiscal year ended January 31, 2011. The decrease was primarily attributable to: • a $6.2 million decrease in personnel-related costs due to a decrease in research and development activity, resulting in the transfer of certain research and development personnel to specific projects in connection with processes to improve operational efficiency as part of the implementation of the Phase II Business Transformation with the personnel-related costs attributable to such personnel being recorded in cost of revenue in lieu of research and development expenses, net; and • a $9.0 million decrease in personnel-related costs primarily due to a workforce reduction. Selling, General and Administrative Selling, general and administrative expenses were $136.3 million for the fiscal year ended January 31, 2012, a decrease of $79.5 million, or 36.9%, compared to the fiscal year ended January 31, 2011. The decrease was primarily attributable to a $71.2 million decrease in compliance-related professional fees. During the fiscal year ended January 31, 2012, compliance-related professional fees were incurred primarily in connection with the preparation of CTI's 2010 Form 10-K (which was filed with the SEC on May 31, 2011), the Quarterly Report on Form 10-Q for the fiscal quarter ended April 30, 2011 (which was filed with the SEC on June 22, 2011), the Quarterly Reports on Form 10-Q for the fiscal quarters ended April 30, 2010, July 31, 2010 and October 31, 2010 (which were filed with the SEC on July 28, 2011), the Quarterly Report on Form 10-Q for the fiscal quarter ended July 31, 2011 (which was filed timely with the SEC on September 8, 2011) and the Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 2011 (which was filed timely with the SEC on December 12, 2011). Such fees were lower than the compliance-related professional fees incurred during the fiscal year ended January 31, 2011 in connection with CTI's efforts to complete adjustments to its consolidated historical financial statements and evaluations of the application of U.S. GAAP, which were ultimately concluded with the filing of the Comprehensive Form 10-K with the SEC on October 4, 2010. Other Operating Expenses Other operating expenses were $20.7 million for the fiscal year ended January 31, 2012, a decrease of $9.2 million, or 30.8%. The decrease was primarily attributable to a decrease in restructuring charges due to higher personnel-related expenses incurred during the fiscal year ended January 31, 2011. Loss from Operations Loss from operations was $189.6 million for the fiscal year ended January 31, 2012, a decrease in loss of $101.9 million, or 35.0%, compared to the fiscal year ended January 31, 2011 due primarily to the reasons discussed above. For the fiscal year ended January 31, 2012, Comverse MI had a loss from operations of $0.7 million compared to income from operations of $15.5 million for the fiscal year ended January 31, 2011. The change was attributable to a $13.2 million decrease in total revenue and increases in cost of revenue and research and development expense, net. For the fiscal years ended January 31, 2012 and 2011, Netcentrex had a loss from operations of $4.3 million and $19.6 million, respectively. The decrease in loss was primarily attributable to a $3.3 million increase in total revenue, and $8.7 million decrease in selling general and administrative expenses, and a $5.3 million decrease in research and development expenses, net. Segment Performance Segment performance was a $148.9 million loss for the fiscal year ended January 31, 2012, a decrease in loss of $29.2 million, or 16.4%, compared to the fiscal year ended January 31, 2011. The decrease in loss was attributable to a decrease in segment expenses partially offset by a decrease in segment revenue. 61-------------------------------------------------------------------------------- Table of Contents LIQUIDITY AND CAPITAL RESOURCES Overview Our principal sources of liquidity historically have consisted of cash and cash equivalents, cash flows from operations, including changes in working capital, borrowings from CTI, and the sale of investments and assets. We believe that our future sources of liquidity will include cash and cash equivalents and cash flows from operations, and may include new borrowings, or proceeds from the issuance of equity or debt securities. During the fiscal year ended January 31, 2013, our principal uses of liquidity were to fund operating expenses, make capital expenditures and pay significant professional fees and other expenses in connection with CTI's efforts to continue to meet its periodic reporting obligations under, the federal securities laws. In addition, we expended resources and made investments to improve our internal control over financial reporting through the hiring of additional experienced finance and accounting personnel, redesigning of processes, implementing accounting and finance systems and performing additional business analytics. These expenses declined significantly for the fiscal year ended January 31, 2013 compared to the fiscal year ended January 31, 2012. Following the Share Distribution, we did not incur expenses in connection with CTI's periodic reporting requirements. However, following the Share Distribution, our accounting, tax and legal fees associated with compliance with our periodic reporting obligations under, federal securities laws and maintenance of internal control over financial reporting increased. We currently expect to incur costs associated with the remediation of our material weakness relating to income tax reporting ranging from $1.0 million to $3.0 million. Financial Condition Cash and Cash Equivalents As of January 31, 2013, we had cash, cash equivalents, bank time deposits and restricted cash of approximately $305.4 million, compared to approximately $199.4 million as of January 31, 2012. In connection with the completion of the Share Distribution, we received from CTI a cash capital contribution of $38.5 million and all indebtedness payable by us to CTI was settled through a capital contribution to our equity by CTI. In addition, we received $37.2 million of cash consideration from the Starhome Disposition, including $4.9 million held in escrow pursuant to the terms of the Starhome Share Purchase Agreement to cover potential post-closing indemnification claims. Any cash balance remaining following the escrow period will be released to us. Furthermore, we received the Israel tax refund of approximately $24.8 million. The amounts presented exclude $25.0 million placed by CTI in escrow on February 4, 2013 as discussed below, and a $10.9 million Italian VAT refund received on April 30, 2013. During the fiscal year ended January 31, 2013 we made the following significant disbursements: • approximately $4.3 million paid for special retention bonuses; and • approximately $4.0 million in restructuring payments, including for workforce reduction initiatives. Restricted Cash Restricted cash short-term and long-term aggregated $42.5 million and $38.6 million as of January 31, 2013 and January 31, 2012, respectively. Restricted cash includes compensating cash balances related to existing lines of credit and deposits that are pledged as collateral or restricted for use to settle specified performance guarantees to customers and vendors, letters of credit, foreign currency transactions in the ordinary course of business and pending tax judgments. On February 4, 2013, in connection with the closing of the Verint Merger, CTI placed $25.0 million in escrow to support indemnification claims to the extent made against us by Verint and any cash balance remaining in such escrow fund 18 months after the closing of the Verint Merger, less any claims made on or prior to such date, will be released to us. We expect that such amount will be included in restricted cash in future fiscal periods. Liquidity Forecast We currently forecast that available cash and cash equivalents will be sufficient to meet our liquidity needs, including capital expenditures, for at least the next 12 months. 62-------------------------------------------------------------------------------- Table of Contents Management's current forecast is based upon a number of assumptions including, among others: continued implementation of initiatives to reduce operating costs; no significant degradation in operating margins; increased spending on certain investments in the business; slight reductions in the unrestricted cash levels required to support the working capital needs of the business; reductions in compliance-related costs and other professional fees; and intra-quarter working capital fluctuations consistent with historical trends. Management believes that the above-noted assumptions are reasonable. However, should one or more of the assumptions prove incorrect, or should one or more of the risks or uncertainties described in Item 1A, "Risk Factors" materialize, we may experience a shortfall in the cash required to support working capital needs. Sources of Liquidity The following is a discussion that highlights our primary sources of liquidity, cash and cash equivalents, and changes in those amounts due to operations, financing, and investing activities and the liquidity of our investments. Cash Flows Fiscal Year Ended January 31, 2013 Compared to Fiscal Year Ended January 31, 2012 Fiscal Year Ended January 31, 2013 2012 (In thousands) Net income (loss) $ 6,248 $ (12,887 ) Net income from discontinued operations (26,542 ) (7,761 ) Non-cash charges 41,122 49,808 Net income after non-cash charges add-back 20,828 29,160 Changes in operating assets and liabilities 7,362 (42,521 ) Net cash provided by (used in) operating activities - continuing operations 28,190 (13,361 ) Net cash (used in) provided by operating activities - discontinued operations (1,277 ) 11,807 Net cash used in investing activities (4,482 ) (8,735 ) Net cash provided by (used in) financing activities 49,252 (12,417 ) Effects of exchange rates on cash and cash equivalents (1,954 ) 2,860 Net increase (decrease) in cash and cash equivalents 69,729 (19,846 ) Cash and cash equivalents, beginning of period including cash of discontinued operations 193,192 213,038 Cash and cash equivalents, end of period including cash of discontinued operations 262,921 193,192 Less: Cash and cash equivalents of discontinued operations, end of period - (32,466 ) Cash and cash equivalents, end of period $ 262,921 $ 160,726 Operating Cash Flows During the fiscal year ended January 31, 2013, net cash of $28.2 million was provided by operating activities from continuing operations. Net cash provided by operating activities from continuing operations was primarily attributable to: • a $36.1 million decrease in deferred cost of revenue; • a $35.9 million increase in accounts payable and accrued expenses; • a $20.8 million of net income after non-cash charges add-back; • a $14.9 million decrease in prepaid expense and other current assets; and • a $9.5 million decrease in accounts receivable. Cash provided by operating activities was partially offset by: • a $85.0 million decrease in deferred revenue. 63-------------------------------------------------------------------------------- Table of Contents Investing Cash Flows During the fiscal year ended January 31, 2013, net cash used in investing activities was $4.5 million. Net cash used in investing activities was primarily attributable to a $4.7 million increase in restricted cash and bank time deposits and $5.4 million of cash used for purchases of property and equipment partially offset by $6.3 million in proceeds from the sale of Starhome. Financing Cash Flows During the fiscal year ended January 31, 2013, net cash provided by financing activities was $49.3 million. Net cash provided by financing activities was primarily attributable to a $38.5 million cash capital contribution from CTI and $9.5 million of borrowings under the note payable to CTI. Effects of Exchange Rates on Cash and Cash Equivalents The majority of our cash and cash equivalents are denominated in U.S. dollars. However, due to the nature of our global business, we also hold cash denominated in other currencies, primarily the euro, the NIS and the British pound. For the fiscal year ended January 31, 2013, the fluctuation in foreign currency exchange rates had an unfavorable impact of $2.0 million on cash and cash equivalents. Fiscal Year Ended January 31, 2012 Compared to Fiscal Year Ended January 31, 2011 Fiscal Years Ended January 31, 2012 2011 (In thousands) Net loss $ (12,887 ) $ (89,915 ) Net income from discontinued operations (7,761 ) (2,826 ) Non-cash charges 49,808 50,549 Net income (loss) after non-cash charges add-back 29,160 (42,192 ) Changes in operating assets and liabilities (42,521 ) (65,202 ) Net cash used in operating activities - continuing operations (13,361 ) (107,394 ) Net cash provided by operating activities - discontinued operations 11,807 7,638 Net cash (used in) provided by investing activities (8,735 ) 39,579 Net cash used in financing activities (12,417 ) (59,177 ) Effects of exchange rates on cash and cash equivalents 2,860 2,981 Net decrease in cash and cash equivalents (19,846 ) (116,373 ) Cash and cash equivalents, beginning of year including cash of discontinued operations 213,038 329,411 Cash and cash equivalents, end of year including cash of discontinued operations 193,192 213,038 Less: Cash and cash equivalents of discontinued operations, end of year (32,466 ) (21,209 ) Cash and cash equivalents, end of year $ 160,726 $ 191,829 Operating Cash Flows During the fiscal year ended January 31, 2012, we used net cash of $13.4 million for operating activities from continuing operations. Net cash used in operating activities from continuing operations was primarily attributable to: • a $70.9 million decrease in deferred revenue; and • a $33.4 million decrease in accounts payable and accrued expenses. Cash used in operating activities was partially offset by: • a $37.8 million decrease in deferred cost of revenue; • $29.2 million of net income after non-cash charges add-back; and • a $22.2 million decrease in accounts receivable. 64-------------------------------------------------------------------------------- Table of Contents Investing Cash Flows During the fiscal year ended January 31, 2012, net cash used in investing activities was $8.7 million. Net cash used in investing activities was primarily attributable to (i) $5.4 million of cash used for capital expenditures and (ii) $4.4 million net increase in restricted cash and bank time deposits. These cash outflows were partially offset by asset sale proceeds of $1.4 million. Financing Cash Flows During the fiscal year ended January 31, 2012, net cash used in financing activities was $12.4 million. Net cash used in financing activities was primarily attributable to (i) a $7.9 million decrease in net investment of CTI, and (ii) $6.0 million of repayment of borrowings under a line of credit. These cash outflows were partially offset by $1.5 million of borrowing under a note payable to CTI. Effects of Exchange Rates on Cash and Cash Equivalents The majority of our cash and cash equivalents are denominated in the U.S. dollar. However, due to the nature of our global business, we also hold cash denominated in other currencies, primarily the euro, the NIS and the British pound. For the fiscal year ended January 31, 2012, the fluctuation in foreign currency exchange rates had a favorable impact of $2.9 million on cash and cash equivalents. Sale of Starhome On August 1, 2012, CTI, certain other Starhome shareholders and Starhome entered into the Starhome Share Purchase Agreement with Fortissimo pursuant to which Fortissimo agreed to purchase all of the outstanding share capital of Starhome as part of the Starhome Disposition. On September 19, 2012, CTI, in order to ensure it could meet the conditions of the Verint Merger, contributed to us its interest in Starhome, including its rights and obligations under the Starhome Share Purchase Agreement. The Starhome Disposition was completed on October 19, 2012. Under the terms of the Starhome Share Purchase Agreement, Starhome's shareholders received aggregate cash proceeds of approximately $81.3 million, subject to adjustment for fees, transaction expenses and certain taxes. Of this amount, $10.5 million is held in escrow to cover potential post-closing indemnification claims, with $5.5 million being released after 18 months and the remainder released after 24 months, in each case, less any claims made on or prior to such dates. We received aggregate net cash consideration (including $4.9 million deposited in escrow at closing) of approximately $37.2 million, after payments that CTI agreed to make to certain other Starhome shareholders of approximately $4.5 million. The escrow funds are available to satisfy certain indemnification claims under the Starhome Share Purchase Agreement to the extent that such claims exceed $1.0 million. As of January 31, 2013, such claims have not exceeded the $1.0 million threshold. Merger of CTI and Verint Under the Share Distribution Agreement we and CTI entered into in connection with the Share Distribution, we have agreed to indemnify CTI and its affiliates (including Verint after the Verint Merger) against certain losses that may arise as a result of the Verint Merger and the Share Distribution. Certain of our indemnification obligations are capped at $25.0 million and certain are uncapped. CTI placed $25.0 million in escrow to support indemnification claims to the extent made against us by Verint and any cash balance remaining in such escrow fund 18 months after the closing of the Verint Merger, less any claims made on or prior to such date, will be released to us. The escrow funds cannot be used for claims related to the Israeli Optionholder suit. We also assumed all pre-Share Distribution tax obligations of each of us and CTI. For more information, see note 3 to our consolidated and combined financial statements included in Item 15 of this Annual Report. Indebtedness Comverse Ltd. Lines of Credit As of January 31, 2013 and 2012, Comverse Ltd., our wholly-owned Israeli subsidiary, had a $20.0 million line of credit with a bank to be used for various performance guarantees to customers and vendors, letters of credit and foreign currency transactions in the ordinary course of business. This line of credit is not available for borrowings. The line of credit bears no interest and is subject to renewal on an annual basis. Comverse Ltd. is required to maintain cash balances with the bank of no less than the capacity under the line of credit at all times regardless of amounts utilized under the line of credit. As of January 31, 2013 and 2012, Comverse Ltd. had utilized $17.2 million and $17.8 million, respectively, of capacity under the line of credit for guarantees and foreign currency transactions. 65-------------------------------------------------------------------------------- Table of Contents As of January 31, 2013 and 2012, Comverse Ltd. had an additional line of credit with a bank for $8.0 million, to be used for borrowings, various performance guarantees to customers and vendors, letters of credit and foreign currency transactions in the ordinary course of business. The line of credit bears no interest other than on borrowings thereunder and is subject to renewal on an annual basis. Borrowings under the line of credit bear interest at an annual rate of London Interbank Offered Rate (or LIBOR) plus a variable margin determined based on the bank's underlying cost of capital. Comverse Ltd. is required to maintain cash balances with the bank of no less than the capacity under the line of credit at all times regardless of amounts borrowed or utilized under the line of credit. As of January 31, 2013 and 2012, Comverse Ltd. had no outstanding borrowings under the line of credit. As of January 31, 2013 and 2012, Comverse Ltd. had utilized $8.0 million and $3.3 million, respectively, of capacity under the line of credit for guarantees and foreign currency transactions. Other than Comverse Ltd.'s requirement to maintain cash balances with the banks as discussed above, the lines of credit have no financial covenants. These cash balances required to be maintained with the banks were classified as "Restricted cash and bank time deposits" and long-term restricted cash included in "Other assets" within the consolidated and combined balance sheets as of January 31, 2013 and 2012. Note Payable to CTI On January 11, 2011, we entered into a promissory note to borrow up to $10.0 million from CTI, with the note scheduled to mature on January 11, 2016. Borrowings could be prepaid by us without penalty. The contractual interest rate applicable to borrowings under this promissory note was LIBOR plus 4.0%. The interest expense was $0.5 million and $0.4 million for the fiscal years ended January 31, 2013 and 2012. The amount owed to CTI as of January 31, 2012, including accrued interest, was approximately $8.5 million. The note payable balance to CTI of $9.4 million as of October 31, 2012 was settled through a capital contribution to our equity by CTI concurrently with the Share Distribution. Loan Agreement with CTI On May 9, 2012, we entered into a revolving loan agreement (referred to as the loan agreement) with CTI, pursuant to which CTI extended us a $25.0 million revolving credit facility. Borrowings under the loan agreement were used to fund our operating expenses and working capital needs. The borrowings of approximately $9.0 million under the loan agreement with CTI were settled through a capital contribution to our equity by CTI concurrently with the Share Distribution on October 31, 2012, at which time the loan agreement was terminated. The interest expense was $0.1 million for the fiscal year ended January 31, 2013. Borrowings under the loan agreement bore interest at the one-month LIBOR plus 4.00%. The loan agreement provided for the mandatory prepayment of the principal and interest outstanding under the loan agreement with all cash swept from our bank accounts from time to time in accordance with our cash management operations with CTI. Our obligations under the loan agreement were unsecured. The loan agreement did not contain any restrictive covenants but did contain customary events of default. 66-------------------------------------------------------------------------------- Table of Contents Restructuring Initiatives We review our business, manage costs and align resources with market demand. As a result, we have taken several actions to improve our cash position, reduce fixed costs, eliminate redundancies, strengthen operational focus and better position us to respond to market pressures or unfavorable economic conditions. While such restructuring initiatives are expected to have positive impact on our operating cash flows in the long term, they also have led and will lead to some charges. During the fiscal years ended January 31, 2013 and 2012, we recorded severance and facility-related costs attributable to existing restructuring initiatives of $5.9 million and $20.7 million, respectively, and paid $4.0 million and $22.9 million, respectively. The remaining severance and facility-related costs relating to existing restructuring initiatives of $3.9 million and $1.7 million are expected to be substantially paid by January, 2014 and May, 2017, respectively. For more information relating to our restructuring initiatives, including our financial obligations in respect thereof, see note 10 to the consolidated and combined financial statements included in Item 15 of this Annual Report. Guarantees and Restrictions on Access to Subsidiary Cash Guarantees We provide certain customers in the ordinary course of business with financial performance guarantees, which in certain cases are backed by standby letters of credit or surety bonds, the majority of which are cash collateralized and accounted for as restricted cash and bank time deposits. We are only liable for the amounts of those guarantees in the event of our nonperformance, which would permit the customer to exercise the guarantee. As of January 31, 2013 and 2012, we believe that we were in compliance with our performance obligations under all contracts for which there is a financial performance guarantee, and that any liabilities arising in connection with these guarantees will not have a material adverse effect on our consolidated and combined results of operations, financial position or cash flows. We also obtained bank guarantees primarily to provide customer assurance relating to the performance of certain obligations required by customer agreements for the guarantee of certain payment obligations. These guarantees, which aggregated $31.1 million and $27.2 million as of January 31, 2013 and 2012, respectively, are generally scheduled to be released upon our performance of specified contract milestones, a majority of which are scheduled to be completed at various dates through January 31, 2016. Dividends from Subsidiaries The ability of our Israeli subsidiaries to pay dividends is governed by Israeli law, which provides that dividends may be paid by an Israeli corporation only out of earnings as defined in accordance with the Israeli Companies Law of 1999, provided that there is no reasonable concern that such payment will cause such subsidiary to fail to meet its current and expected liabilities as they come due. Cash and cash equivalents held by foreign subsidiaries. We operate our business internationally. A significant portion of our cash and cash equivalents of is held by various foreign subsidiaries. As of January 31, 2013 and 2012, we had $149.4 million and $142.3 million or 57% and 89%, respectively, of our cash and cash equivalents held by our foreign subsidiaries. If cash and cash equivalents held outside the United States are distributed to the United States resident corporate parents in the form of dividends or otherwise, we may be subject to additional U.S. income taxes (subject to an adjustment for foreign tax credits) and foreign withholding taxes. We may incur substantial withholding taxes if we repatriate our cash from certain foreign subsidiaries. We expect a portion of our foreign subsidiaries cash to be repatriated to the U.S. As this amount has been previously subject to U.S. tax, the non-U.S. withholding taxes that would be imposed on an actual triggering of a dividend of $149.0 million has been accrued in the amount of $20.1 million. OFF-BALANCE SHEET ARRANGEMENTS As of January 31, 2013, we had no material off-balance sheet arrangements, other than performance guarantees disclosed in "-Liquidity and Capital Resources-Guarantees and Restrictions on Access to Subsidiary Cash-Guarantees" and except as disclosed in note 25 to the consolidated and combined financial statements included in Item 15 of this Annual Report. There were no material changes in our off-balance sheet arrangements since January 31, 2012. 67-------------------------------------------------------------------------------- Table of Contents CONTRACTUAL OBLIGATIONS The following table presents our contractual obligations as of January 31, 2013: Payments due by period Contractual obligations Total < 1 year 1-3 years 3-5 years > 5 years (In thousands) Capital lease obligations $ 12 $ 8 $ 4 $ - $ - Operating lease obligations - real estate 82,021 17,363 25,202 12,664 26,792 Operating lease obligations - other (equipment, etc) 1,286 811 454 21 - Purchase obligations(1) 17,237 15,805 1,432 - - Other current and long-term liabilities 181 - - - 181 Total(2) $ 100,737 $ 33,987 $ 27,092 $ 12,685 $ 26,973 (1) Purchase obligations include agreements to purchase goods or services that are enforceable, legally binding and specify all significant terms, including fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions, and the approximate timing of the transaction. Purchase obligations exclude agreements that are cancelable without penalty. (2) Our consolidated balance sheet as of January 31, 2013 includes $114.2 million of non-current tax liabilities for uncertain tax positions. The specific timing of any cash payments, if any, relating to this obligation cannot be projected with reasonable certainty and, therefore, no amounts for this obligation are included in the table set forth above. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The accounting estimates and judgments discussed in this section are those that we consider to be most critical to understand our combined financial statements (or the financial statements), because they involve significant judgments and uncertainties. More specifically, the accounting estimates and judgments outlined below are critical because they can materially affect our operating results and financial condition, inasmuch as they require management to make difficult and subjective judgments regarding uncertainties. Many of these estimates include determinations of fair value. All of these estimates reflect our best judgment about current and, for some estimates, future, economic and market conditions and effects based on information available to us as of the date of the accompanying financial statements. As a result, the accuracy of these estimates and the likelihood of future changes depend on a range of possible outcomes and a number of underlying variables, some of which are beyond our control. See also note 1 to the consolidated and combined financial statements included in Item 15 of this Annual Report for additional information on the significant accounting estimates and judgments underlying the financial results disclosed in our combined financial statements. Revenue Recognition We report our revenue in two categories: (i) product revenue, including hardware and software products; and (ii) service revenue, including revenue from professional services, training services and post-contract customer support (or PCS). Professional services primarily include installation, customization and consulting services. Revenue arrangements may include one of these single elements, or may incorporate one or more elements in a single transaction or combination of related transactions. In September 2009, the FASB issued revenue recognition guidance applicable to multiple element arrangements, which: • applies to multiple element revenue arrangements that contain both software and hardware elements, focusing on determining which revenue arrangements are within the scope of the software revenue guidance; and • addresses how to separate consideration related to each element in a multiple element arrangement, excluding software arrangements, and establishes a hierarchy for determining the selling price of an element. It also eliminates the residual method of allocation by requiring that arrangement consideration be allocated at the inception of the arrangement to all elements using the relative selling price method. We adopted this guidance on a prospective basis for revenue arrangements entered into, or materially modified, on or after February 1, 2011. 68-------------------------------------------------------------------------------- Table of Contents Multiple element arrangements entered into or materially modified on or after February 1, 2011 that include hardware which functions together with software to provide the essential functionality of the product are accounted under the FASB's new guidance applicable to multiple element arrangements. Multiple element arrangements entered into prior to February 1, 2011 and not materially modified on or after February 1, 2011 are accounted for in accordance with the FASB's guidance relating to revenue recognition for software arrangements as the software component of most of our multiple element arrangements is more than incidental to the products being sold. For arrangements that do not require significant customization of the underlying software, we recognize revenue when we have persuasive evidence of an arrangement, the product has been shipped and the services have been provided to the customer, the sales price is fixed or determinable, collectability is probable, and all pertinent criteria are met as required by the FASB's guidance. For multiple element arrangements entered into prior to February 1, 2011 and not materially modified on or after February 1, 2011, we allocate revenue to the delivered elements of the arrangement using the residual method, whereby revenue is allocated to the undelivered elements based on vendor specific objective evidence (or VSOE) of fair value of the undelivered elements with the remaining arrangement fee allocated to the delivered elements and recognized as revenue assuming all other revenue recognition criteria are met. If we are unable to establish VSOE of fair value for the undelivered elements of the arrangement, revenue recognition is deferred for the entire arrangement until all elements of the arrangement are delivered. However, if the only undelivered element is PCS, we recognize the arrangement fee ratably over the PCS period. For multiple element arrangements entered into or materially modified after February 1, 2011 that include hardware which functions together with software to provide the essential functionality of the product, we allocate revenue to each element based on its selling price. The selling price used for each element is based on VSOE of fair value, if available, third party evidence ("TPE") of fair value if VSOE is not available, or our best estimate of selling price ("BESP") if neither VSOE nor TPE is available. In determining the units of accounting for these arrangements, we evaluate whether each element has stand-alone value as defined in the FASB's guidance. Given that the hardware and software function together to provide the essential functionality of the product and each element is critical to the overall tangible product sold, neither the software nor the hardware has stand-alone value. Professional services performed prior to the product's acceptance do not have stand-alone value and are therefore combined with the related hardware and software as one non-software deliverable. After determining the fair value for each deliverable, the arrangement consideration is allocated using the relative selling price method. Revenue is recognized accordingly for each deliverable once the respective revenue recognition criteria are met for that deliverable. The majority of multiple element arrangements contain at least two of the following elements: (1) tangible product (hardware, software, and professional services performed prior to the product's acceptance), (2) post-contract support (PCS), (3) training, and (4) post acceptance services. Our tangible products are rarely sold separately. In addition, our tangible products are complex, and contain a high degree of customizations such that we are unable to demonstrate pricing within a pricing range to establish BESP as very few contracts are comparable. Therefore, we have concluded that cost plus a target gross profit margin provides the best estimate of the selling price. PCS, training, and post acceptance services have various pricing practices based on several factors, including the geographical region of the customer, the size of the customer's installed base, the volume of services being sold and the type or class of service being performed. As noted above, we have VSOE of PCS for a portion of our arrangements. For PCS, we use our minimum substantive VSOE thresholds by region plus a reasonable margin as the basis to estimate BESP of PCS for transactions that do not meet the VSOE criteria. For training and post-acceptance services, we perform an annual study of stand-alone training and post-acceptance sales to arrive at BESP. While the study does not result in VSOE, it is useful in determining our BESP. The timing of recognition for our revenue transactions involves numerous judgments, estimates and policy determinations. The most significant are summarized as follows: PCS revenue is derived primarily from providing technical software support services, unspecified software updates and upgrades to customers on a when and if available basis. PCS revenue is recognized ratably over the term of the PCS period. When PCS is included within a multiple element arrangement and the arrangement is within the scope of the software revenue guidance, we primarily utilize the substantive renewal rate to establish VSOE of fair value for the PCS. When using the substantive renewal rate method, we may be unable to establish VSOE of fair value for PCS because the renewal rate is deemed to be non-substantive or there are no contractually-stated renewal rates. If the stated renewal rate is non-substantive, the entire arrangement fee is recognized ratably over the estimated economic life of the product (five to eight years) beginning upon delivery of all elements other than PCS. We believe that the estimated economic life of the product is the best estimate of how long the customer will renew PCS. If there is no contractually 69-------------------------------------------------------------------------------- Table of Contents stated renewal rate, the entire arrangement fee is recognized ratably over the relevant contractual PCS term beginning upon delivery of all elements other than PCS. For arrangements that include a stated renewal rate, determining whether the actual renewal rate is substantive is a matter of judgment. For each group of our products, we stratify our customers based on the size of the installed base and the geographic location of the customer. Based on our historical negotiations and contract experience we believe that our customers behave differently and perceive different values for PCS based on these two main factors. We evaluate many factors in determining the estimated economic life of our products, including the support period of the product, technological obsolescence, average time between new product releases and upgrade activity by customers. We have concluded that the estimated economic lives of our key software products range from five to eight years. Our policy for establishing VSOE of fair value for professional services and training is based upon an analysis of separate sales of services, which are then compared with the fees charged when the same elements are included in a multiple element arrangement. Comverse has not yet established VSOE of fair value for any element other than PCS. In certain multiple element arrangements, we are obligated to provide training services to customers related to the operation of our software products. These training services are either provided to the customer on a "defined" basis (limited to a specified number of days or training classes) or on an "as-requested" basis (unlimited training over a contractual period). For multiple element arrangements containing as-requested training obligations that are within the scope of the software revenue guidance, we recognize the total arrangement consideration ratably over the contractual period during which we are required to "stand ready" to perform such training, provided that all other criteria for revenue recognition have been met. For multiple element arrangements containing defined training obligations, the training services are typically provided to the customer prior to the completion of the installation services. For arrangements that are within the scope of the software revenue guidance, because revenue recognition does not commence until the completion of installation, the defined training obligations do not impact the timing of recognition of revenue. In certain circumstances in which training is provided after the end of the installation period, we commence revenue recognition upon the completion of training, provided that all other criteria for revenue recognition have been met. Some of our arrangements require significant customization of the product to meet the particular requirements of the customer. For these arrangements, revenue is recognized, in accordance with the FASB's guidance for long-term construction type contracts using the percentage-of-completion (or POC) method. The determination of whether services entail significant customization requires judgment and is primarily based on alterations to the features and functionality to the standard release, complex or unusual interfaces as well as the amount of hours necessary to complete the customization solution relative to the size of the contract. Revenue from these arrangements is recognized on the POC method based on the ratio of total hours incurred to date compared to estimated total hours to complete the contract. We are required to make judgments to estimate the total estimated costs and progress to completion. Changes to such estimates can impact the timing of the revenue recognition period to period. We use historical experience, project plans, and an assessment of the risks and uncertainties inherent in the arrangement to establish these estimates. Uncertainties in these arrangements include implementation delays or performance issues that may or may not be within our control. If some level of profitability is assured, but the related revenue and costs cannot be reasonably estimated, then revenue is recognized to the extent of costs incurred until such time that the project's profitability can be estimated or the services have been completed. If VSOE of fair value of PCS does not exist, all revenue will be deferred until completion of the professional services and recognized ratably over the respective PCS period. If we determine that based on our estimates our costs exceed the sales price, the entire amount of the estimated loss is accrued in the period that such losses become known. When revenue is recognized over multiple periods in accordance with our revenue recognition policies, the material cost, including hardware and third party software license fees are deferred and amortized over the same period that product revenue is recognized. These costs are recognized as "Deferred cost of revenue" on the combined balance sheets. However, we have made an accounting policy election whereby the cost for installation and other service costs are expensed as incurred, except for arrangements recognized in accordance with the FASB's guidance for long-term construction type contracts. In the combined statements of operations, we classify revenue as product revenue or service revenue as prescribed by SEC Rules and Regulations. For multiple element arrangements that include both product and service elements, management evaluates various available indicators of fair value and applies its judgment to reasonably classify the arrangement fee between product revenue and service revenue. The amount of multiple element arrangement fees 70-------------------------------------------------------------------------------- Table of Contents classified as product and service revenue based on management estimates of fair value when VSOE of fair value for all elements of an arrangement does not exist could differ from amounts classified as product and service revenue if VSOE of fair value of all elements existed. The allocation of multiple element arrangement fees between product revenue and service revenue, when VSOE of fair value of all elements does not exist, is for combined financial statement presentation purposes only and does not affect the timing or amount of revenue recognized. In determining the amount of a multiple element arrangement fee that should be classified between product revenue and service revenue, we first allocate the arrangement fee to product revenue and PCS (PCS is classified as service revenue) based on management's estimate of fair value for those elements. The remainder of the arrangement fee, which is comprised of all other service elements, is allocated to service revenue. The estimate of fair value of the product element is based primarily on management's evaluation of direct costs and reasonable profit margins on those products. This was determined to be the most appropriate methodology as we have historically been product oriented with respect to pricing policies which facilitates the evaluation of product costs and related margins in arriving at a reasonable estimate of the product element fair value. Management's estimate of reasonable profit margins requires significant judgment and consideration of various factors, such as the impact of the economic environment on margins, the complexity of projects, the stability of product profit margins and the nature of products. The estimate of fair value for PCS is based on management's evaluation of weighted average PCS rates for arrangements for which VSOE of fair value of PCS exists. Extended Payment Terms One of the critical judgments that we make, related to revenue recognition, is the assessment that collectability is probable. Our recognition of revenue is based on our assessment of the probability of collecting the related accounts receivable balance at the onset of a sales arrangement. Certain of our arrangements include payment terms that depart from our customary practice. In these situations, if a customer does not have an adequate history of abiding by its contractual payment terms without concessions, the sales price is not considered fixed or determinable and revenue is recognized upon collection provided all other revenue recognition criteria have been met. We consider payment terms where more than 5% of the arrangement fees are due 120 days from customer acceptance to be extended. If the arrangement is with a new customer and the payment terms are extended, there is no evidence of collecting under the original payment terms without making concessions and therefore the presumption that the fee is not fixed and determinable cannot be overcome. If this arrangement is with an existing customer, an evaluation of the customer's payment history will take place to determine if the fee is fixed. Percentage-of-Completion Accounting We have a standard quarterly process in which management reviews the progress and performance of our significant contracts. As part of this process, management reviews include, but are not limited to, any outstanding key contract matters, progress towards completion and the related program schedule, identified risks and opportunities, and the related changes in estimates of revenues and costs. These risks and opportunities include management's judgment about the ability and costs to achieve the schedule requirements, technical requirements (for example, a newly-developed product versus a mature product) and other specific contract requirements. Management must make assumptions regarding labor productivity and availability, the complexity of the work to be performed, the availability of materials, the length of time to complete the contract (to estimate increases in wages and prices for materials and related support cost allocations), performance by our subcontractors, and the availability and timing of funding from our customer, among other variables. Based on this analysis, any adjustments to net sales, costs of sales and the related impact to operating income are recorded as necessary in the period they become known. These adjustments may result in an increase in operating profit during the performance of a contract to the extent we determine we will be successful in mitigating risks for schedule and technical requirements in addition to other specific contract risks or we will realize related opportunities. Likewise, these adjustments may decrease operating profit if we determine we will not be successful in mitigating these risks or we will not realize related opportunities. Changes in estimates of net sales, costs of sales, and the related impact to operating income are recognized using a cumulative catch-up, which recognizes in the current period the cumulative effect of the changes on current and prior periods. A significant change in one or more of these estimates could affect the profitability of one or more of our contracts. Expense Allocations CTI provided a variety of services to us. CTI directly assigned, where possible, certain general and administrative costs to us based on actual use of those services. Where direct assignment of costs is not possible, or practical, CTI used other indirect methods, to estimate the allocation of costs. Allocated costs include general support services such as information technology, legal services, human resource services, general accounting and finance, and executive support. 71-------------------------------------------------------------------------------- Table of Contents Substantially all of these allocations are reflected in "Selling, general, and administrative" expenses in our combined statements of operations. Employee compensation and overhead expenses were allocated utilizing a time study of CTI employees' percentage of time spent on matters related to us. External vendor expenses were allocated based on information provided by the vendor or an internal analysis of benefits derived by us from the services incurred by CTI. We considered these expense allocations to be a reasonable reflection of the utilization of services provided. The allocations may not, however, reflect the expense we would have incurred as an independent company. Actual costs which may have been incurred if we had been a stand-alone company for the fiscal years ended January 31, 2013, 2012 and 2011 would depend on a number of factors, including how we chose to organize ourself, and what, if any, functions were outsourced or performed by our employees. Stock-Based Compensation We account for share-based payment awards, including employee stock options, restricted stock, restricted stock units and employee stock purchases, made to employees and directors in accordance with the FASB's guidance for share-based payment and related interpretative guidance, which requires the measurement and recognition of compensation expense for all such awards based on estimated fair value. Comverse estimates the fair value of share-based payment awards on the date of grant using an option-pricing model. Under the FASB's guidance, stock-based compensation expense is measured at the grant date based on the fair value of the award, and the cost is recognized as expense ratably over the award's vesting period. Comverse uses the Black-Scholes option-pricing model to measure fair value of these stock option awards. The Black-Scholes model requires judgments regarding the assumptions used within the model, the most significant of which are the stock price volatility assumption over the term of the awards and the expected life of the option award based on the actual and projected employee stock option behaviors. The inputs noted below that are factored into the option valuation model we use to measure the fair value of our stock awards are subjective estimates. Changes to these estimates could cause the fair value of our stock awards and related stock-based compensation expenses to vary materially. Except as noted below, the following key assumptions are used for all of Comverse stock-based compensation awards: • The risk-free interest rate assumption we use is based upon U.S. Treasury interest rates appropriate for the expected life of the awards. • Comverse's expected dividend rate is zero since Comverse does not currently pay cash dividends on their common stock and do not anticipate doing so in the foreseeable future. • Until Comverse establishes enough stock history the volatility will be calculated based on peer companies volatility. Comverse is also required to estimate expected forfeitures of stock-based awards at the grant date and recognize compensation cost only for those awards expected to vest. Although Comverse estimates forfeitures based on historical experience while a subsidiary of CTI and future expectation, actual forfeitures may differ. The forfeiture assumption is adjusted to the actual forfeitures that occur. During the fiscal years ended January 31, 2013, 2012 and 2011, our stock-based compensation expense, including prior to the Share Distribution, was $7.5 million, $3.7 million and, $2.4 million, respectively. Recoverability of Goodwill Goodwill represents the excess of the fair value of consideration transferred in the business combination over the fair value of tangible and intangible assets acquired net of the fair value of liabilities assumed and the fair value of any noncontrolling interest in the acquiree. We apply the FASB's guidance when testing goodwill for impairment which permits management to make a qualitative assessment of whether goodwill is impaired, or opt to bypass the qualitative assessment, and proceed directly to performing the first step of the two-step impairment test. If management performs a qualitative assessment and concludes it is more likely than not that the fair value of a reporting unit exceeds its carrying value, goodwill is not considered impaired and the two-step impairment test is unnecessary. However, if management concludes otherwise, it is then required to perform the first step of the two-step impairment test. For reporting units where we decide to perform a qualitative assessment, our management assesses and makes judgments regarding a variety of factors which potentially impact the fair value of a reporting unit, including general economic conditions, industry and market-specific conditions, customer behavior, cost factors, our financial performance 72-------------------------------------------------------------------------------- Table of Contents and trends, our strategies and business plans, capital requirements, management and personnel issues, and our stock price, among others. Management then considers the totality of these and other factors, placing more weight on the events and circumstances that are judged to most affect a reporting unit's fair value or the carrying amount of its net assets, to reach a qualitative conclusion regarding whether it is more likely than not that the fair value of a reporting unit exceeds its carrying amount. For reporting units where we perform the two-step goodwill impairment test, the first step requires us to compare the fair value of each reporting unit to the carrying value of its net assets. Management considers both an income-based approach using projected discounted cash flows and a market-based approach using multiples of comparable companies to determine the fair value of its reporting units. Management's estimate of fair value of each reporting unit is based on a number of subjective factors, including: (i) the appropriate weighting of valuation approaches (income-based approach and market-based approach), (ii) estimates of the future revenue and cash flows, (iii) discount rate for estimated cash flows, (iv) selection of peer group companies for the market-based approach, (v) required levels of working capital, (vi) assumed terminal value, (vii) the time horizon of cash flow forecasts, and (viii) control premium. We use the work of an independent third party appraisal firm to assist us in considering our determination of the implied fair value of our goodwill. The fair values are calculated using the income approach and a market approach based on comparable companies. The income approach, more commonly known as the discounted cash flow approach, estimates fair value based on the cash flows that an asset can be expected to generate over its useful life. If the carrying value of a reporting unit's goodwill exceeds its implied fair value, then an impairment charge equal to the difference is recorded. Assumptions and estimates about future values of our reporting units and implied goodwill are complex and subjective. They can be affected by a variety of factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our internal forecasts. Although we believe the historical assumptions and estimates we have made are reasonable and appropriate, different assumptions and estimates could materially impact our reported financial results. The determination of reporting units also requires management judgment. We assess whether a reporting unit exists within a reportable segment by identifying the unit, determining whether the unit qualifies as a business under U.S. GAAP, and assessing the availability and regular review by segment management of discrete financial information for the unit. We recorded a goodwill impairment charge of approximately $5.6 million for the Comverse MI reporting unit for the fiscal year ended January 31, 2013. For more information, see note 1 and note 6 to the consolidated and combined financial statements included in Item 15 of this Annual Report. Management's forecasts and estimates are based on assumptions that are consistent with the plans and estimates used to manage the business. Changes in these estimates could change the conclusion regarding an impairment of goodwill. Impairment of Long-Lived and Intangible Assets We review the recoverability of our long-lived assets, such as property and equipment, and intangible assets with finite lives, whenever events or changes in circumstances occur that indicate that the carrying value of the asset may not be recoverable. Any impairment of these assets must be considered prior to our impairment review of goodwill. The assessment of impairment is based on our ability to recover the carrying value of the asset by analyzing the expected future undiscounted pre-tax cash flows specific to the asset or asset group. Circumstances which could trigger a review include, but are not limited to, significant decreases in the market price of the asset, significant adverse changes in the business climate or legal factors, accumulation of costs significantly in excess of the amount expected for the acquisition of a long-lived asset, current period negative cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with the use of the asset. We assess the recoverability of the carrying value of long-lived assets at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. If these undiscounted cash flows are less than the carrying value of such asset or asset group, an impairment loss is measured based on the difference between estimated fair value and carrying value. Assets to be disposed of are written-down to the greater of their fair value or salvage value. Estimated fair values are based on assumptions regarding the amount and timing of estimated future cash flows and appropriate discount rates to reflect varying degrees of perceived risk. Significant management judgment is involved in estimating these factors, and they include inherent uncertainties. Measurement of the recoverability of these assets is dependent upon the accuracy of the assumptions used in making these estimates, as well as how the estimates compare to the eventual future operating performance of the specific reporting unit to which the assets are attributed. 73-------------------------------------------------------------------------------- Table of Contents Allowance for Doubtful Accounts We estimate the collectability of our accounts receivable balances for each accounting period and adjust the allowance for doubtful accounts accordingly. We exercise judgment in assessing the collectability of accounts receivable, including consideration of the current economic conditions, creditworthiness of customers, their collection history and the related aging of past due receivables balances. We evaluate specific accounts when we become aware that a customer may be experiencing a deterioration of its financial condition due to lower credit ratings, bankruptcy or other factors that may affect such customer's ability to meet its payment obligations. Management has used all available information subsequent to the balance sheet date to evaluate the reasonableness of its estimates. We charge off uncollectible trade receivables when all collection efforts have been exhausted and we believe the amount will not be collected. As of January 31, 2013 and 2012, the accounts receivable balance was $123.6 million and $132.0 million, respectively, net of allowance for doubtful accounts of $8.8 million and $9.2 million, respectively. Unanticipated events and circumstances may occur that affect the accuracy or validity of such assumptions, estimates or actual results. Income Taxes Income taxes are provided using the asset and liability method, such that income taxes (i.e., deferred tax assets, deferred tax liabilities, taxes currently payable/refunds receivable and tax expense/benefit) are recorded based on amounts refundable or payable in the current year and include the results of any difference between U.S. GAAP and tax reporting. Deferred income taxes reflect the tax effect of net operating losses, capital losses and general business credit carryforwards and the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial statement and income tax purposes, as determined under enacted tax laws and rates. Valuation allowances are established when management determines that it is more-likely-than-not that some portion or all of the deferred tax asset will not be realized. The financial effect of changes in tax laws or rates is accounted for in the period of enactment. The subsequent realization of net operating loss and general business credit carryforwards acquired in acquisitions accounted for using the acquisition method of accounting is recognized in the combined statement of operations. We were included in the CTI consolidated federal and certain combined state income tax returns. As such, we were not a separate taxable entity for U.S. federal and certain state income tax purposes. In addition, we did not have a written tax sharing agreement with CTI. Our provisions for income taxes and related balance sheet accounts were presented as if we were a separate taxpayer ("separate return method"). This method of allocating the CTI consolidated current and deferred income taxes was systematic, rational and consistent with the asset and liability method. The separate return method represented a hypothetical computation assuming that our reported revenue and expenses were incurred by a separate taxable entity. Accordingly, the reported provision for income taxes and the related balance sheet account balances (including but not limited to the NOL deferred tax assets) did not equal the amounts that were allocable to us under the applicable consolidated federal and state tax laws. Further, as we did not have a tax-sharing agreement with CTI in place, the expected payable was treated as a dividend to the parent. Immediately following our separation from CTI, the consolidated CTI tax attributes were allocated between CTI and us based on the applicable tax laws. From time to time, we have business transactions in which the tax consequences are uncertain. Significant judgment is required in assessing and estimating the tax consequences of these transactions. We prepare and file tax returns based on our interpretation of tax laws. In the normal course of business, our tax returns are subject to examination by various taxing authorities. Such examinations may result in future tax, interest and penalty assessments. In determining our tax provision for financial reporting purposes, we establish a liability for uncertain tax positions unless such positions are determined to be more-likely-than-not of being sustained upon examination, based on their technical merits. That is, for financial reporting purposes, we only recognize tax benefits that we believe are more-likely-than-not of being sustained and then recognize the largest amount of benefit that is greater than 50 percent likely to be realized upon settlement. There is considerable judgment involved in determining whether positions taken on the tax return are more-likely-than-not of being sustained and determining the likelihood of various potential settlement outcomes. We adjust our estimated liability for uncertain tax positions periodically because of new information discovered as a function of ongoing examinations by, and settlements with, the various taxing authorities, as well as changes in tax laws, regulations and interpretations. The combined tax provision of any given year includes adjustments to prior year income tax accruals that are considered appropriate as well as any related estimated interest. Our policy is to recognize all appropriately accrued interest and penalties on uncertain tax positions as part of income tax expense. For further information, see note 20 to the consolidated and combined financial statements included in Item 15 of this Annual Report. 74-------------------------------------------------------------------------------- Table of Contents As part of our accounting for business combinations, some of the purchase price is allocated to goodwill and intangible assets. Impairment charges associated with goodwill are generally not tax deductible and will result in an increased effective income tax rate in the fiscal period any impairment is recorded. Amortization expenses associated with acquired intangible assets are generally not tax deductible pursuant to our existing tax structure; however, deferred taxes have been recorded for non-deductible amortization expenses as a part of the purchase price allocation process. We have taken into account the allocation of these identified intangibles among different taxing jurisdictions, including those with nominal or zero percent tax rates, in establishing the related deferred tax liabilities. Under the FASB's guidance, the income tax benefit from future releases of the acquisition date valuation allowances or income tax contingencies, if any, are reflected in the income tax provision in the combined statements of operations, rather than as an adjustment to the purchase price allocation. Litigation and Contingencies Contingencies by their nature relate to uncertainties that require management to exercise judgment both in assessing the likelihood that a liability has been incurred as well as in estimating the amount of potential loss, if any. We accrue for costs relating to litigation, claims and other contingent matters when such liabilities become probable and reasonably estimable. We expense legal fees associated with consultations with outside counsel and defense of lawsuits as incurred. Such estimates may be based on advice from third parties or solely on management's judgment, as appropriate. Actual amounts paid may differ materially from amounts estimated, and such differences will be charged to operations in the period in which the final determination of the liability is made. From time to time, we receive notices that our products or processes may be infringing the patent or intellectual property rights of others; and notices of other lawsuits or other claims against us. We assess each matter in order to determine if a contingent liability should be recorded. In making this determination, management may, depending on the nature of the matter, consult with internal and external legal counsel. Based on the information obtained combined with management's judgment regarding all the facts and circumstances of each matter, we determine whether a contingent loss is probable and whether the amount of such loss can be estimated. Should a loss be probable and estimable, we record a contingent loss. Should the judgments and estimates made by management not coincide with future events, such as a judicial action against us where we expected no merit on the part of the party bringing the action against us, we may need to record additional contingent losses that could materially adversely impact our results of operations. Alternatively, if the judgments and estimates made by management are incorrect and a particular contingent loss does not occur, the contingent loss recorded would be reversed thereby favorably impacting our results of operations. Accounting Standards Applicable to Emerging Growth Companies We are an emerging growth company as defined under the JOBS Act. Emerging growth companies can delay adopting new or revised accounting standards that have different effective dates for public and private companies until such time as those standards apply to private companies. We intend to take advantage of such extended transition period. Since we will not be required to comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies, our financial statements may not be comparable to the financial statements of companies that comply with public company effective dates. If we were to elect to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act. RECENT ACCOUNTING PRONOUNCEMENTS TO BE IMPLEMENTED None [ Back To TMCnet.com's Homepage ]