[June 13, 2013] COMVERSE, INC. - 10-Q - 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 the audited consolidated and combined financial statements and related notes included in Part IV, Item 15 of our Annual Report on Form 10-K for the fiscal year ended January 31, 2013 (or the 2012 Form 10-K) and the condensed consolidated and combined financial statements and related notes included in this Quarterly 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. 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 "Forward-Looking Statements" on page i of this Quarterly Report. Percentages and amounts within this section may not calculate due to rounding differences. The Share Distribution On October 31, 2012, CTI completed its 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. Immediately prior to the Share Distribution, CTI contributed to us Exalink Ltd. (or Exalink), its wholly-owned subsidiary. Other than holding certain intellectual property rights, Exalink has no operations. 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 have agreed to indemnify each other against certain liabilities arising from our respective businesses and the services that will be provided under such agreements. Following the completion of CTI's merger with Verint Systems Inc. (or Verint) discussed below, these obligations continue to apply between us and Verint. For more information, see Note 3 to our condensed consolidated and combined financial statements included in this Quarterly Report. Subsequent to the Share Distribution, we have incurred 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 31-------------------------------------------------------------------------------- Table of Contents periodic reporting obligations under federal securities laws. We believe our cash flow from operations has and will continue to be sufficient to fund these additional costs. Sale of Starhome As a result of the Starhome Disposition, the results of operations of Starhome are included in discontinued operations, less applicable income taxes, as a separate component of net income (loss) in our condensed combined statement of operations for the three months ended April 30, 2012. For more information, see Note 14 to our condensed consolidated and combined financial statements included in this Quarterly Report. 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 more information, see Note 19 to our condensed consolidated and combined financial statements included in this Quarterly Report. Starhome's results of operations are included in discontinued operations and therefore not presented in segment information. Significant Events During the three months ended April 30, 2013 and subsequent thereto, the following additional significant events occurred: 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 to 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 $25.0 million 32-------------------------------------------------------------------------------- Table of Contents and certain are uncapped. On February 4, 2013, in connection with the closing of the Verint Merger Agreement, 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 against us on or prior to such date, will be released to us. The escrow funds cannot be used for claims related to the Israeli Optionholder suits. We also assumed all pre-Share Distribution tax obligations of each of us and CTI. For more information, see Note 3 to our condensed consolidated and combined financial statements included in this Quarterly Report. Liquidity Forecast During the three months ended April 30, 2013, we had positive cash flows from operations of $9.9 million, which includes a VAT tax refund of approximately $10.9 million. 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." Condensed Consolidated and Combined Financial Highlights The following table presents certain financial highlights for the three months ended April 30, 2013 and 2012, 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: Three Months Ended April 30, 2013 2012 (Dollars in thousands) Total revenue $ 155,818 $ 137,750 Gross margin 41.6 % 30.7 % Income (loss) from operations 7,843 (22,883 ) Operating margin 5.0 % (16.6 )% Net loss from continuing operations (3,140 ) (26,597 ) Income from discontinued operations, net of tax - 429 Net loss (3,140 ) (26,168 ) Less: Net income attributable to noncontrolling interest - (154 ) Net loss attributable to Comverse Inc. (3,140 ) (26,322 ) Net cash provided by (used in) operating activities - continuing operations 9,863 (45,699 ) Non-GAAP Financial Measures Comverse performance 5,727 (16,097 ) Comverse performance margin 3.7 % (11.7 )% Reconciliation of Income (Loss) from Operations to Comverse Performance 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. 33-------------------------------------------------------------------------------- Table of Contents The following table provides a reconciliation of income (loss) from operations to Comverse performance for the three months ended April 30, 2013 and 2012: Three Months Ended April 30, 2013 2012 (Dollars in thousands) Income (loss) from operations $ 7,843 $ (22,883 ) Expense Adjustments: Stock-based compensation expense 3,094 1,431 Amortization of acquisition-related intangibles 649 4,074 Compliance-related professional fees 436 (136 ) Compliance-related compensation and other expenses 52 1,118 Impairment of property and equipment 38 22 Litigation settlements and related costs, net of recoveries (24 ) (230 ) Italian VAT refund recovery recorded within operating expenses (10,861 ) - Restructuring charges 4,221 680 Gain on sale of fixed asset (11 ) - Other, net 290 (173 ) Total expense adjustments (2,116 ) 6,786 Comverse performance $ 5,727 $ (16,097 ) 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) impairment of property and equipment; (vi) litigation settlements and related costs; (vii) Italian VAT refund recovery recorded within operating expenses; (viii) restructuring charges; and (ix) 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 and our efforts to (a) complete certain financial statements and audits of such financial statements and (b) 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 three months ended April 30, 2013 and 2012, see Note 19 to the condensed consolidated and combined financial statements included in this Quarterly Report. Segment Financial Highlights The following table presents, for the three months ended April 30, 2013 and 2012, 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: 34-------------------------------------------------------------------------------- Table of Contents Three Months Ended April 30, 2013 2012 (Dollars in thousands) SEGMENT RESULTS Comverse BSS Segment revenue $ 71,665 $ 57,680 Gross margin 39.3 % 32.8 % Income from operations 15,002 4,397 Operating margin 20.9 % 7.6 % Segment performance 15,799 9,101 Segment performance margin 22.0 % 15.8 % Comverse VAS Segment revenue $ 76,214 $ 65,922 Gross margin 39.8 % 42.0 % Income from operations 22,678 15,840 Operating margin 29.8 % 24.0 % Segment performance 22,686 16,613 Segment performance margin 29.8 % 25.2 % Comverse Other Segment revenue $ 7,939 $ 14,148 Gross margin 80.0 % (30.4 )% Loss from operations (29,837 ) (43,120 ) Operating margin (375.8 )% (304.8 )% Segment performance (32,758 ) (41,811 ) Segment performance margin (412.6 )% (295.5 )% For a discussion of the results of our segments, see "-Results of Operations,". 35-------------------------------------------------------------------------------- Table of Contents Business Trends and Uncertainties For the three months ended April 30, 2013 compared to the three months ended April 30, 2012, we experienced increases in revenue and decreases in costs and operating expenses, resulting in income from operations for the three months ended April 30, 2013 compared to a loss from operations for the three months ended April 30, 2012. Comverse performance for the three months ended April 30, 2013 increased compared to the three months ended April 30, 2012. For more information, see Note 19 to the condensed consolidated and combined financial statements included in this Quarterly Report. The increases in revenue were primarily attributable to increases in revenue from customer solutions and maintenance revenue at our Comverse BSS and Comverse VAS segments, partially offset by a decrease in revenue from Comverse Other. 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 increases in revenue from customer solutions were primarily attributable to changes in scope and settlements of certain customer contracts. The increases in maintenance revenue were primarily attributable to an increase in maintenance services provided to customers during the initial service period and the timing of collections from certain customers from whom we recognize revenue upon collections. During the three months ended April 30, 2013, our cash and cash equivalents and restricted cash were favorably impacted primarily by (i) restricted cash received from CTI in connection with closing of the Verint Merger, and (ii) proceeds from a VAT refund in Italy and a decline in our costs, operating expenses and disbursements, that resulted in positive operating cash flow in the three months ended April 30, 2013. Our costs, operating expenses and disbursements decreased during the three months ended April 30, 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 and due to a VAT refund of approximately $10.9 million, which was recognized as a reduction of service costs. These cost reductions were partially offset by, among other factors, the increasing complexity of project deployments which resulted in higher product delivery costs. 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 favorable 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 continue 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. 36 -------------------------------------------------------------------------------- Table of Contents Comverse BSS In the three months ended April 30, 2013, customer orders for BSS customer solutions decreased compared to the three months ended April 30, 2012. The decrease in orders for BSS customer solutions was attributable mainly to delays in purchasing decisions by customers, along with a company-initiated pause in the pursuit of certain product upgrade bookings to allow for further product industrialization. We believe that BSS customer solutions order activity continued to be impacted by uncertainty in economic conditions and industry dynamics that prompted existing and potential customers to defer significant capital investments involved in deploying our BSS solutions and upgrading existing prepaid or postpaid systems to our converged BSS solution. 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 three months ended April 30, 2013 increased compared to the three months ended April 30, 2012. The increase in revenue from Comverse BSS customer solutions was primarily attributable to changes in scope and settlements of certain customer contracts that negatively impacted revenue in the three months ended April 30, 2012 with no comparable change in scope and settlements in the three months ended April 30, 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 recent years. Comverse BSS maintenance revenue for the three months ended April 30, 2013 increased compared to the three months ended April 30, 2012. The increase was primarily attributable to timing of entering into renewals of maintenance contracts with customers and the timing of collections from certain customers from whom we recognize revenue upon collections. 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. 37-------------------------------------------------------------------------------- Table of Contents 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 three months ended April 30, 2013 decreased compared to the three months ended April 30, 2012. The decrease in orders for VAS customer solutions was attributable mainly to the delays in purchasing decisions by customers. This decrease is also 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 three months ended April 30, 2013 increased compared to the three months ended April 30, 2012 .The increase in revenue from Comverse VAS customer solutions was primarily attributable to an increase in revenue resulting from customer acceptances and percentage-of-completion revenue in certain large-scale projects in the three months ended April 30, 2013, with no comparable projects in the three months ended April 30, 2012. Comverse VAS maintenance revenue for the three months ended April 30, 2013 increased compared to the three months ended April 30, 2012. The increase was primarily attributable to an increase in maintenance revenue attributable to maintenance services provided to customers during the initial service period. 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 CSPs. 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. 38-------------------------------------------------------------------------------- Table of Contents 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. Difficulty in Forecasting Customer Order Activity Our customer order activity is difficult to predict. A high percentage of our customer orders have typically been generated late in fiscal quarters. In addition, based on historical industry spending patterns of CSPs, 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 customer order projections. 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. For more information, see Note 3 to our condensed consolidated and combined financial statements included in this Quarterly Report. 39-------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS The following discussion provides an analysis of our condensed 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 condensed consolidated and combined results should be read in conjunction with the discussions of the results of operations of our segments. Three Months Ended April 30, 2013 Compared to Three Months Ended April 30, 2012 Condensed Consolidated and Combined Results Three Months Ended April 30, Change 2013 2012 Amount Percent (Dollars in thousands, except per share data) Total revenue $ 155,818 $ 137,750 $ 18,068 13.1 % Costs and expenses Cost of revenue 90,964 95,423 (4,459 ) (4.7 )% Research and development, net 16,080 19,072 (2,992 ) (15.7 )% Selling, general and administrative 36,710 45,458 (8,748 ) (19.2 )% Other operating expenses 4,221 680 3,541 520.7 % Total costs and expenses 147,975 160,633 (12,658 ) (7.9 )% Income (loss) from operations 7,843 (22,883 ) 30,726 (134.3 )% Interest income 172 222 (50 ) (22.5 )% Interest expense (188 ) (196 ) 8 (4.1 )% Interest expense on notes payable to CTI - (109 ) 109 N/M Other expense, net (6,130 ) (1,437 ) (4,693 ) 326.6 % Income tax provision (4,837 ) (2,194 ) (2,643 ) 120.5 % Net loss from continuing operations (3,140 ) (26,597 ) 23,457 (88.2 )% Income from discontinued operations, net of tax - 429 (429 ) N/M Net loss (3,140 ) (26,168 ) 23,028 (88.0 )% Less: Net income attributable to noncontrolling interest - (154 ) 154 (100.0 )% Net loss attributable to Comverse, Inc. $ (3,140 ) $ (26,322 ) $ 23,182 (88.1 )% Net loss attributable to Comverse, Inc.: Net loss from continuing operations $ (3,140 ) $ (26,597 ) $ 23,457 Income from discontinued operations, net of tax - 275 (275 ) Net income (loss) attributable to Comverse, Inc. $ (3,140 ) $ (26,322 ) $ 23,182 Loss per share attributable to Comverse, Inc.'s stockholders: Basic and diluted earnings (loss) per share(1) Continuing operations $ (0.14 ) $ (1.21 ) $ 1.07 Discontinued operations $ - $ 0.01 $ (0.01 ) (1) The computation of basic and diluted earnings (loss) per share for the three months ended April 30, 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 16 to the condensed consolidated and combined financial statements included in this Quarterly 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 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. 40-------------------------------------------------------------------------------- Table of Contents Revenue from customer solutions was $89.0 million for the three months ended April 30, 2013, an increase of $16.1 million, or 22.0%, compared to the three months ended April 30, 2012. The increase was attributable to an increase of $12.8 million and $9.1 million in customer solutions revenue at the Comverse BSS and VAS segments, respectively, partially offset by a decrease of $5.8 million at Comverse Other. Revenue recognized using the percentage-of-completion method was $34.0 million and $14.5 million for the three months ended April 30, 2013 and 2012, respectively, and comprised approximately 21.8% and 10.5% of total revenue for such periods, respectively. Maintenance revenue was $66.8 million for the three months ended April 30, 2013, an increase of $2.0 million, or 3.1%, compared to the three months ended April 30, 2012. This increase was attributable to an increase of $1.2 million in maintenance revenue at each of the Comverse BSS and Comverse VAS segments, partially offset by a decrease of $0.4 million at Comverse Other. Revenue by Geographic Region Revenue in the Americas, Asia Pacific (or APAC) and Europe, Middle East and Africa (or EMEA) represented approximately 39%, 23% and 38% of our revenue, respectively, for the three months ended April 30, 2013 compared to approximately 36%, 29% and 35% of our revenue, respectively, for the three months ended April 30, 2012. The presentation of revenue by geographic region is based on the location of customers. Foreign Currency Impact on Revenue Our currency for financial reporting purposes is the U.S. dollar. The majority of our revenue for the three months ended April 30, 2013 was derived from transactions denominated in U.S. dollars. All other revenue was derived from transactions denominated in various foreign currencies, primarily the euro, Japanese Yen, and Brazilian Real. Fluctuations in the U.S. dollar relative to foreign currencies in which we conducted business for the three months ended April 30, 2013 compared to the three months ended April 30, 2012 unfavorably impacted revenue by $1.8 million. 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. We enter into foreign currency forward contracts to mitigate risk attributable to foreign currency exchange rate fluctuations. 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 $91.0 million for the three months ended April 30, 2013, a decrease of $4.5 million, or 4.7%, compared to the three months ended April 30, 2012. The decrease was attributable to a decrease in costs of $16.9 million at Comverse Other, including a VAT refund of $10.9 million, offset by an increase in costs of $7.6 million and $4.8 million at the Comverse VAS Comverse and BSS segments, respectively, for the three months ended April 30, 2013 compared to the three months ended April 30, 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 $16.1 million for the three months ended April 30, 2013, a decrease of $3.0 million, or 15.7%, compared to the three months ended April 30, 2012. The decrease was primarily attributable to a decline of $3.5 million and $2.1 million at the Comverse VAS and Comverse BSS segments, respectively, partially offset by an increase of $2.6 million at Comverse Other. 41-------------------------------------------------------------------------------- Table of Contents 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 $36.7 million for the three months ended April 30, 2013, a decrease of $8.7 million, or 19.2%, compared to the three months ended April 30, 2012. The decrease was primarily attributable to a decline of $8.8 million and $0.6 million at Comverse Other and Comverse VAS segment, respectively, partially offset by an increase of $0.6 million at Comverse BSS segment. 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 include primarily restructuring charges and impairments of intangible assets. Other operating expenses were $4.2 million for the three months ended April 30, 2013, an increase of $3.5 million, compared to the three months ended April 30, 2012. The increase was attributable to an increase in restructuring charges at Comverse Other. Income (Loss) from Operations Income from operations was $7.8 million for the three months ended April 30, 2013, a change of $30.7 million, compared to a loss from operations of $22.9 million for the three months ended April 30, 2012. The change was primarily attributable to a decrease in loss from operations of $13.3 million at Comverse Other and an increase in income from operations of $10.6 million and $6.8 million at the Comverse BSS and Comverse VAS segments, respectively. Interest Income Interest income was $0.2 million for the three months ended April 30, 2013, a decrease of $0.1 million, or 22.5%, compared to the three months ended April 30, 2012. Interest Expense Interest expense was $0.2 million for the three months ended April 30, 2013, a decrease of 4.1%, compared to the three months ended April 30, 2012. Other Expense, Net Other expense, net was $6.1 million for the three months ended April 30, 2013, an increase of $4.7 million, or 326.6%, compared to the three months ended April 30, 2012. The increase was primarily attributable to net foreign currency transaction losses of $5.9 million, primarily relating to the exchange rates between the U.S. dollar and the NIS, for the three months ended April 30, 2013, compared to net foreign currency transaction losses of $1.2 million for the three months ended April 30, 2012. Income Tax Provision We recorded an income tax provision from continuing operations of $4.8 million for the three months ended April 30, 2013, representing an effective tax rate of 285.0%, compared with an income tax provision from continuing operations of $2.2 million, representing an effective tax rate of (9.0)% for the three months ended April 30, 2012. During the three months ended April 30, 2013 and 2012, the effective tax rates was less than the U.S. statutory rate primarily due to the fact that we did not record an income tax benefit on losses incurred in certain of our U.S. and foreign jurisdictions in which we maintain valuation allowances against our net deferred tax assets. The income tax provisions from continuing operations are comprised of income tax expense recorded in non-loss jurisdictions, withholding taxes and certain tax contingencies. The change in our effective tax rate for the three months ended April 30, 2013, compared to the three months ended April 30, 2012 is 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 represents the results of operations of Starhome, net of tax. Income from discontinued operations, net of tax, was $0.4 million for the three months ended April 30, 2012. See Note 14 of the condensed consolidated and combined financial statements included in this Quarterly Report. 42-------------------------------------------------------------------------------- Table of Contents Net Loss Net loss was $3.1 million for the three months ended April 30, 2013, a decrease in loss of $23.5 million, or 88.2%, compared to the three months ended April 30, 2012 due primarily to the reasons discussed above. Net Income Attributable to Noncontrolling Interest Noncontrolling interest represents the minority shareholders' interest in Starhome, the Company's former majority-owned subsidiary, prior to the Starhome Disposition on October 19, 2012. Net income attributable to noncontrolling interest was $0.2 million for the three months ended April 30, 2012. 43-------------------------------------------------------------------------------- Table of Contents Segment Results Comverse BSS Three Months Ended April 30, Change 2013 2012 Amount Percent (Dollars in thousands) Revenue: Total revenue $ 71,665 $ 57,680 $ 13,985 24.2 % Costs and expenses: Cost of revenue 43,511 38,733 4,778 12.3 % Research and development, net 7,738 9,829 (2,091 ) (21.3 )% Selling, general and administrative 5,362 4,721 641 13.6 % Other operating expenses 52 - 52 N/M Total costs and expenses 56,663 53,283 3,380 6.3 % Income from operations $ 15,002 $ 4,397 $ 10,605 241.2 % Computation of segment performance: Segment revenue $ 71,665 $ 57,680 $ 13,985 24.2 % Total costs and expenses $ 56,663 $ 53,283 $ 3,380 6.3 % Segment expense adjustments: Amortization of acquisition-related intangibles 649 4,074 (3,425 ) (84.1 )% Compliance-related compensation and other expenses 122 630 (508 ) N/M Impairment of property and equipment 26 - 26 N/M Segment expense adjustments 797 4,704 (3,907 ) (83.1 )% Segment expenses 55,866 48,579 7,287 15.0 % Segment performance $ 15,799 $ 9,101 $ 6,698 73.6 % Revenue Revenue from Comverse BSS customer solutions was $39.6 million for the three months ended April 30, 2013, an increase of $12.8 million, or 47.7%, compared to the three months ended April 30, 2012. The increase in revenue was primarily attributable to changes in scope and settlements of certain customer contracts that negatively impacted revenue in the three months ended April 30, 2012 with no comparable change in scope and settlements in the three months ended April 30, 2013. Comverse BSS maintenance revenue was $32.0 million for the three months ended April 30, 2013, an increase of $1.2 million, or 3.9%, compared to the three months ended April 30, 2012. The increase was primarily attributable to timing of entering into renewals of maintenance contracts with customers and the timing of collections for certain customers whose revenue is limited to collections. Revenue by Geographic Region Revenue in the Americas, Europe, APAC and EMEA represented approximately 23%, 27% and 50% of Comverse BSS's revenue, respectively, for the three months ended April 30, 2013 compared to approximately 24%, 41% and 35% of Comverse BSS's revenue, respectively, for the three months ended April 30, 2012. The increase in EMEA revenue as a percentage of total revenue for Comverse BSS was primarily attributable to changes in scope and settlements of certain customer contracts that negatively impacted revenue in the three months ended April 30, 2012 with no comparable change in scope and settlements in the three months ended April 30, 2013. Foreign Currency Impact on Revenue Fluctuations in the U.S. dollar relative to foreign currencies in which Comverse BSS conducted business for the three months ended April 30, 2013 compared to the three months ended April 30, 2012 unfavorably impacted revenue by $0.2 million. 44-------------------------------------------------------------------------------- Table of Contents Cost of Revenue Cost of revenue was $43.5 million for the three months ended April 30, 2013, an increase of $4.8 million, or 12.3%, compared to the three months ended April 30, 2012. The increase was primarily attributable to: • a $3.8 million increase in material costs and overhead due to increased revenue; • a $1.9 million increase in assignment 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 $1.9 million increase in subcontractor costs to complete certain projects. These increases were partially offset by a $3.2 million decrease in amortization of intangible assets due to certain intangible assets becoming fully amortized in the prior year. Research and Development, Net Research and development expenses, net, were $7.7 million for three months ended April 30, 2013, a decrease of $2.1 million, or 21.3%, compared to the three months ended April 30, 2012. The decrease is primarily attributable to more personnel-related costs used in specific revenue generating projects recorded in cost of revenue in lieu of research and development expenses, net during the three months ended April 30, 2013 compared to the three months ended April 30, 2012. Selling, General and Administrative Selling, general and administrative expenses were $5.4 million for the three months ended April 30, 2013, an increase of $0.6 million, or 13.6%, compared to the three months ended April 30, 2012. The increase was primarily attributable to recoveries of bad debt expense related to specific customers for the three months ended April 30, 2012 with no comparable recoveries for the three months ended April 30, 2013. Segment Performance Segment performance was $15.8 million for the three months ended April 30, 2013 based on segment revenue of $71.7 million, representing a segment performance margin of 22.0% as a percentage of segment revenue. Segment performance was $9.1 million for the three months ended April 30, 2012 based on segment revenue of $57.7 million, representing a segment performance margin of 15.8% as a percentage of segment revenue. The increase in segment performance margin was primarily attributable to an increase in segment revenue and a decrease in research and development expense partially offset by an increase in cost of revenue for the three months ended April 30, 2013 compared to the three months ended April 30, 2012. 45-------------------------------------------------------------------------------- Table of Contents Comverse VAS Three Months Ended April 30, Change 2013 2012 Amount Percent (Dollars in thousands) Revenue: Total revenue $ 76,214 $ 65,922 $ 10,292 15.6 % Costs and expenses: Cost of revenue 45,862 38,245 7,617 19.9 % Research and development, net 6,086 9,632 (3,546 ) (36.8 )% Selling, general and administrative 1,587 2,205 (618 ) (28.0 )% Other operating expenses 1 - 1 N/M Total costs and expenses 53,536 50,082 3,454 6.9 % Income from operations $ 22,678 $ 15,840 $ 6,838 43.2 % Computation of segment performance: Segment revenue $ 76,214 $ 65,922 $ 10,292 15.6 % Total costs and expenses $ 53,536 $ 50,082 $ 3,454 6.9 % Segment expense adjustments: Compliance-related compensation and other expenses 7 773 (766 ) N/M Impairment of property and equipment 1 - 1 N/M Segment expense adjustments 8 773 (765 ) (99.0 )% Segment expenses 53,528 49,309 4,219 8.6 % Segment performance $ 22,686 $ 16,613 $ 6,073 36.6 % Revenue Revenue from Comverse VAS customer solutions was $44.2 million for the three months ended April 30, 2013, an increase of $9.1 million, or 26.0%, compared to the three months ended April 30, 2012. The increase in revenue from Comverse VAS customer solutions was primarily attributable to an increase in revenue resulting from customer acceptances and percentage-of-completion revenue in certain large-scale projects in the three months ended April 30, 2013, with no comparable customer projects in the three months ended April 30, 2012. Comverse VAS maintenance revenue was $32.0 million for the three months ended April 30, 2013, an increase of $1.2 million, or 3.9%, compared to the three months ended April 30, 2012. The increase was primarily attributable to an increase in maintenance revenue attributable to maintenance services provided to customers during the initial service period. Revenue by Geographic Region Revenue in the Americas, APAC and EMEA represented approximately 55%, 18% and 27% of Comverse VAS's revenue, respectively, for the three months ended April 30, 2013 compared to approximately 47%, 20% and 33% of Comverse VAS's revenue, respectively, for the three months ended April 30, 2012. The increase in revenue as a percentage of total revenue for Comverse VAS in the Americas and corresponding decline in EMEA was primarily attributable to significant revenue recognized due to customer acceptances and percentage-of-completion revenue in certain large-scale projects in Americas in the three months ended April 30, 2013, with no comparable customer acceptances in the three months ended April 30, 2012. 46-------------------------------------------------------------------------------- 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 three months ended April 30, 2013 compared to the three months ended April 30, 2012 unfavorably impacted revenue by $0.8 million primarily due to transactions denominated in Japanese yen. Cost of Revenue Cost of revenue was $45.9 million for the three months ended April 30, 2013, an increase of $7.6 million, or 19.9%, compared to the three months ended April 30, 2012. The increase was primarily attributable a $5.8 million increase in personnel-related costs and a $2.8 million increase in material costs due to increased revenue. These increases were partially offset by a $2.5 million decrease in the assignment of research and development personnel to specific revenue generating projects recorded in cost of revenue. Research and Development, Net Research and development expenses, net, were $6.1 million for the three months ended April 30, 2013, a decrease of $3.5 million, or 36.8%, compared to the three months ended April 30, 2012. The decrease is primarily attributable to a decrease in personnel as a result of restructuring initiatives partially offset by a decrease in the assignment of research and development personnel to specific revenue generating projects recorded in cost of revenue during the three months ended April 30, 2013 compared to the three months ended April 30, 2012. Selling, General and Administrative Selling, general and administrative expenses were $1.6 million for the three months ended April 30, 2013, a decrease of $0.6 million, or 28.0%, compared to the three months ended April 30, 2012. The decrease was primarily attributable to a decrease in personnel-related costs of $0.3 million and a reduction in bad debt expense of $0.2 million for the three months ended April 30, 2013 compared to the three months ended April 30, 2012. Segment Performance Segment performance was $22.7 million for the three months ended April 30, 2013 based on segment revenue of $76.2 million, representing a segment performance margin of 29.8% as a percentage of segment revenue. Segment performance was $16.6 million for the three months ended April 30, 2012 based on segment revenue of $65.9 million, representing a segment performance margin of 25.2% as a percentage of segment revenue. The increase in segment performance margin was primarily attributable to an increase in segment revenue and a decrease in research and development expense, partially offset by an increase in cost of revenue for the three months ended April 30, 2013 compared to the three months ended April 30, 2012. 47-------------------------------------------------------------------------------- Table of Contents Comverse Other Three Months Ended April 30, Change 2013 2012 Amount Percent (Dollars in thousands) Revenue: Total revenue $ 7,939 $ 14,148 $ (6,209 ) (43.9 )% Costs and expenses: Cost of revenue 1,591 18,445 (16,854 ) (91.4 )% Research and development, net 2,256 (389 ) 2,645 N/M Selling, general and administrative 29,734 38,532 (8,798 ) (22.8 )% Other operating expenses 4,195 680 3,515 N/M Total costs and expenses 37,776 57,268 (19,492 ) (34.0 )% Loss from operations $ (29,837 ) $ (43,120 ) $ 13,283 (30.8 )% Computation of segment performance: Segment revenue $ 7,939 $ 14,148 $ (6,209 ) (43.9 )% Total costs and expenses $ 37,776 $ 57,268 $ (19,492 ) (34.0 )% Segment expense adjustments: Stock-based compensation expense 3,094 1,431 1,663 116.2 % Compliance-related professional fees 436 (136 ) 572 N/M Compliance-related compensation and other expenses (77 ) (285 ) 208 (73.0 )% Impairment of property and equipment 11 22 (11 ) (50.0 )% Litigation settlements and related costs, net of recoveries (24 ) (230 ) 206 (89.6 )% Italian VAT refund recovery recorded within operating expenses (10,861 ) - (10,861 ) N/M Restructuring 4,221 680 3,541 520.7 % Gain on sale of fixed assets (11 ) - (11 ) N/M Other 290 (173 ) 463 (267.6 )% Segment expense adjustments (2,921 ) 1,309 (4,230 ) (323.1 )% Segment expenses 40,697 55,959 (15,262 ) (27.3 )% Segment performance $ (32,758 ) $ (41,811 ) $ 9,053 (21.7 )% Revenue Revenue includes revenue generated primarily by Comverse MI and our Netcentrex operations (or Netcentrex). Total revenue was $7.9 million for the three months ended April 30, 2013, a decrease of $6.2 million, or 43.9%, compared to the three months ended April 30, 2012. The decrease was primarily attributable to revenue decreases at Netcentrex and Comverse MI of $2.9 million and $1.6 million, respectively. For the three months ended April 30, 2013 and 2012, Comverse MI's total revenue was $4.8 million and $6.4 million, respectively, and Netcentrex' total revenue was $3.0 million and $5.9 million, respectively. Cost of Revenue Cost of revenue is primarily attributable to Comverse MI and Netcentrex. Cost of revenue also includes shared services costs associated with percentage-of-completion projects, including at Comverse BSS and Comverse VAS. 48-------------------------------------------------------------------------------- Table of Contents Cost of revenue was $1.6 million for the three months ended April 30, 2013, a decrease of $16.9 million, or 91.4%, compared to the three months ended April 30, 2012. The decrease was primarily attributable to a VAT refund of $10.9 million the three months ended April 30, 2013 and a decrease in material costs of $4.3 million associated with the decrease in revenue. 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 $2.3 million for the three months ended April 30, 2013, an increase of $2.6 million, compared to the three months ended April 30, 2012. The increase is primarily attributable to more personnel-related costs used in developing products during the three months ended April 30, 2013 compared to the three months ended April 30, 2012. 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. Selling, general and administrative expenses were $29.7 million for the three months ended April 30, 2013, a decrease of $8.8 million, or 22.8%, compared to the three months ended April 30, 2012. The decrease was primarily attributable to lower sales agent commission expenses of $7.1 million due to a decrease in bookings and mix of bookings generated from certain projects, as not all projects involve sales agents. Other Operating Expenses Other operating expenses were $4.2 million for the three months ended April 30, 2013, an increase of $3.5 million, compared to the three months ended April 30, 2012. The increase was attributable to an increase of $3.5 million in restructuring charges. See Note 8 of the condensed consolidated and combined financial statements included in this Quarterly Report. Loss from Operations Loss from operations was $29.8 million for the three months ended April 30, 2013, a decrease in loss of $13.3 million, or 30.8%, compared to the three months ended April 30, 2012 due primarily to the reasons discussed above. For the three months ended April 30, 2013, Comverse MI had income from operations of $1.3 million compared to a loss of $0.4 million for the three months ended April 30, 2012. The change was primarily attributable to a decrease in cost of revenue research and development and selling, general and administrative expenses. For the three months ended April 30, 2013, Netcentrex had a loss from operations of $0.5 million compared to income from operations of $1.3 million for the three months ended April 30, 2012. The change was primarily attributable to a decrease in total revenue. Segment Performance Segment performance was a $32.8 million loss for the three months ended April 30, 2013, a decrease in loss of $9.1 million, or 21.7%, compared to the three months ended April 30, 2012. The decrease in loss in segment performance was primarily attributable to a decrease in selling, general and administrative expenses and cost of revenue partially offset by a decrease in segment revenue for the three months ended April 30, 2013 compared to the three months ended April 30, 2012. 49-------------------------------------------------------------------------------- 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 may include new borrowings or proceeds from the issuance of equity or debt securities. During the three months ended April 30, 2013, our principal uses of liquidity were to fund operating expenses, make capital expenditures and pay 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. Financial Condition Cash and Cash Equivalents As of April 30, 2013, we had cash, cash equivalents, bank time deposits and restricted cash of approximately $336.0 million, compared to approximately $305.4 million as of January 31, 2013. During the three months ended April 30, 2013, we received $25.0 million from CTI in connection with the closing of the Verint Merger and approximately $10.9 million in proceeds from a VAT refund in Italy. Restricted Cash Restricted cash aggregated $67.5 million and $42.5 million as of April 30, 2013 and January 31, 2013, 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, indemnification claims, foreign currency transactions in the ordinary course of business and pending tax judgments. 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. 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 Part I, Item 1A, "Risk Factors" of the 2012 Form 10-K 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. 50-------------------------------------------------------------------------------- Table of Contents Cash Flows Three Months Ended April 30, 2013 Compared to Three Months Ended April 30, 2012 Three Months Ended April 30, 2013 2012 (In thousands)Net cash provided by (used in) operating activities - continuing operations $ 9,863 $ (45,699 ) Net cash used in operating activities - discontinued operations - (1,336 ) Net cash used in investing activities - continuing operations (27,991 ) (1,405 ) Net cash provided by (used in) financing activities - continuing operations 24,396 (257 ) Effects of exchange rates on cash and cash equivalents (687 ) 545 Net increase (decrease) in cash and cash equivalents 5,581 (48,152 ) Cash and cash equivalents, beginning of period including cash of discontinued operations 262,921 193,192 Cash and cash equivalents, end of period including cash of discontinued operations 268,502 145,040 Less: Cash and cash equivalents of discontinued operations, end of period - (31,055 ) Cash and cash equivalents, end of period $ 268,502 $ 113,985 Operating Cash Flows During the three months ended April 30, 2013, operating activities provided net cash of $9.9 million, including a VAT tax refund of approximately $10.9 million. Net cash provided by operating activities was primarily attributable to a decrease in deferred cost of revenue, a decrease in accounts receivable and in net income after non-cash charges add-back partially offset by a decrease in deferred revenue and a decrease in accounts payable and accrued expenses for the three months ended April 30, 2013. Investing Cash Flows During the three months ended April 30, 2013, net cash used in investing activities was $28.0 million. Net cash used in investing activities was primarily attributable to a $25.0 million increase in restricted cash in bank time deposits received from CTI in connection with the closing of the Verint Merger and $3.0 million of cash used for purchases of property and equipment. Financing Cash Flows During the three months ended April 30, 2013, net cash provided by financing activities was $24.4 million. Net cash provided by financing activities was primarily attributable to a $25.0 million cash capital contribution from CTI. Effects of Exchange Rates on Cash and Cash Equivalents The majority of our cash and cash equivalents is 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 three months ended April 30, 2013, the fluctuation in foreign currency exchange rates had an unfavorable impact of $0.7 million on cash and cash equivalents. Merger of CTI and Verint On August 12, 2012, CTI entered into an agreement and plan of merger with Verint providing for the merger of CTI with and into a subsidiary of Verint to become a wholly-owned subsidiary of Verint. 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 $25.0 million and certain are uncapped. On February 4, 2013, in connection with the closing of the Verint Merger Agreement, CTI placed $25.0 million in escrow to support indemnification claims to the extent made against us by Verint and any cash balance 51-------------------------------------------------------------------------------- Table of Contents 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 suits. We also assume all pre-Share Distribution tax obligations of each of us and CTI. For more information, see Note 3 to our condensed consolidated and combined financial statements included in this Quarterly Report. Indebtedness Comverse Ltd. Lines of Credit As of April 30, 2013 and January 31, 2013, 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 April 30, 2013 and January 31, 2013, Comverse Ltd. had utilized $15.7 million and $17.2 million, respectively, of capacity under the line of credit for guarantees and foreign currency transactions. As of April 30, 2013 and January 31, 2013, 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 April 30, 2013 and January 31, 2013, Comverse Ltd. had no outstanding borrowings under the line of credit. As of April 30, 2013 and January 31, 2013, Comverse Ltd. had utilized $8.0 million and $8.0 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 balance sheets as of April 30, 2013 and January 31, 2013. 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 three months ended April 30, 2013 and 2012, we recorded severance and facility-related costs attributable to existing restructuring initiatives of $4.2 million and $0.7 million, respectively, and paid $3.3 million and $1.1 million, respectively. The remaining severance and facility-related costs relating to existing restructuring initiatives of $2.0 million and $5.5 million are expected to be substantially paid by January 2014 and October 2019, respectively. For additional information relating to our financial obligations in respect of restructuring initiatives, see Note 8 to the condensed consolidated and combined financial statements included in this Quarterly 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 April 30, 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 condensed 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 52-------------------------------------------------------------------------------- Table of Contents guarantee of certain payment obligations. These guarantees, which aggregated $29.9 million and $31.1 million as of April 30, 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 November 30, 2015. 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 are held by various foreign subsidiaries. As of April 30, 2013 and January 31, 2013, cash and cash equivalents held by our foreign subsidiaries was $109.6 million and $149.4 million, respectively. 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. OFF-BALANCE SHEET ARRANGEMENTS As of April 30, 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." There were no material changes in our off-balance sheet arrangements since January 31, 2013. For a more comprehensive discussion of our off-balance sheet arrangements as of January 31, 2013, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Part II, Item 7 of our 2012 Form 10-K. CONTRACTUAL OBLIGATIONS There were no material changes in our contractual obligations as of January 31, 2013. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Part II, Item 7 of our 2012 Form 10-K. 53-------------------------------------------------------------------------------- Table of Contents CRITICAL ACCOUNTING POLICIES AND ESTIMATES We described the significant accounting policies and methods used in the preparation of our consolidated and combined financial statements in Note 1 to the consolidated and combined financial statements included in Part IV, Item 15 of our 2012 Form 10-K. The accounting policies that reflect our more significant estimates, judgments and assumptions in the preparation of our consolidated and combined financial statements are described in "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Part II, Item 7 of our 2012 Form 10-K, and include the following: • revenue recognition; • extended payment terms; • percentage-of-completion accounting; • expense allocation; • stock-based compensation; • recoverability of goodwill; • impairment of long-lived and intangible assets; • allowance for doubtful accounts; • income taxes; and • litigation and contingencies. We do not believe that there were any significant changes in our critical accounting policies during the three months ended April 30, 2013. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS For information related to recently issued accounting pronouncements, see Note 2 to the condensed consolidated and combined financial statements included in this Quarterly Report. [ Back To TMCnet.com's Homepage ]