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COMVERSE, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(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 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, 2014 (or the 2013 Form 10-K) and the condensed consolidated 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, 31-------------------------------------------------------------------------------- Table of Contents 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. 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), these obligations continue to apply between us and Verint. For more information, see Note 3 to our condensed consolidated financial statements included in this Quarterly Report. EXECUTIVE SUMMARYOverview We are a leading provider of business enablement solutions for communication service providers (or CSPs) and enterprises 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, cable and multi-play CSPs, as well as to business-to-business (or B2B) and consumer oriented enterprises, delivering a value proposition designed to enable an effective service and data monetization, a consistent, enhanced customer experience, reduced complexity and cost, and real-time choice and control. In addition, we provide CSPs with the ability to better manage their data networks and to better monetize their data network investment through our Policy Management and Policy Enforcement capabilities for wireless and wireline data networks. • Digital Services. We enable voice and messaging services (including voicemail, visual voicemail, call completion, short messaging service (or SMS), and multimedia picture and video messaging (or MMS)), enterprise communication services, and Internet Protocol (or IP) based rich communication services (including group chat, file transfer, video, social and presence). In connection with each of these domains, we offer a portfolio of services primarily related to our solutions (referred to as managed services). Our reportable segments are: • BSS-comprised of the BSS operating segment; and • Digital Services-comprised of the Digital Services operating segment. The results of operations of our global corporate functions that support our business units are included in the column captioned "All Other" as part of our business segment presentation. Historically, Mobile Internet, which was renamed Policy and is responsible for our mobile Internet and policy products, and Netcentrex, an IP-based solution that provides carrier-hosted enterprise and consumer IP services, were included in All Other. Effective in the three months ended January 31, 2014, Policy and Netcentrex have been combined with the Comverse BSS and Comverse VAS segments, respectively, to form our BSS and Digital Services segments. Accordingly, the results presented under segment reporting for the three and six months ended July 31, 2013 reflect the change in segment reporting to conform to the current period segment reporting presentation. 32-------------------------------------------------------------------------------- Table of Contents Condensed Consolidated Financial Highlights The following table presents certain financial highlights for the three and six months ended July 31, 2014 and 2013, 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 basis: Three Months Ended July 31, Six Months Ended July 31, 2014 2013 2014 2013 (Dollars in thousands) Total revenue $ 115,320 $ 169,753 $ 234,452 $ 325,571 Gross margin 34.2 % 39.0 % 33.3 % 40.3 % (Loss) income from operations (6,747 ) 11,427 (20,499 ) 19,270 Operating margin (5.9 )% 6.7 % (8.7 )% 5.9 % Net loss (16,866 ) (17,087 ) (32,997 ) (20,227 ) Net cash (used in) provided by operating activities (13,785 ) (222 ) (49,384 ) 9,641 Non-GAAP Financial Measures Comverse performance $ 786 $ 18,129 $ (4,736 ) $ 23,856 Comverse performance margin 0.7 % 10.7 % (2.0 )% 7.3 % Reconciliation of Income 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 (loss) income from operations to Comverse performance for the three and six months ended July 31, 2014 and 2013: Three Months Ended July 31, Six Months Ended July 31, 2014 2013 2014 2013 (Dollars in thousands) (Loss) income from operations $ (6,747 ) $ 11,427 $ (20,499 ) $ 19,270 Expense Adjustments: Stock-based compensation expense 2,985 2,249 5,923 5,343 Amortization of intangible assets 700 729 1,395 1,378 Compliance-related professional fees 335 370 704 806 Compliance-related compensation and other expenses - 155 (70 ) 207 Strategic related costs 1,100 - 2,390 - Impairment of property and equipment 169 5 178 43 Certain litigation settlements and related costs 41 1 5 (23 ) Italian VAT refund recovery recorded within operating expenses - - - (10,861 ) Restructuring expenses 1,912 2,633 4,655 6,854 Gain on sale of fixed assets (14 ) (7 ) (17 ) (18 ) Other 305 567 600 857 Total expense adjustments 7,533 6,702 15,763 4,586 Comverse performance $ 786 $ 18,129 $ (4,736 ) $ 23,856 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 (loss) income from operations adjusted for the following: (i) stock-based compensation expense; (ii) amortization of intangible assets; (iii) compliance-related professional fees; (iv) compliance-related compensation and other expenses; (v) strategic-related costs (vi) impairment of property and equipment; (vii) certain litigation settlements and related costs; (viii) Italian VAT recovery recorded within operating expense; (ix) restructuring expenses; and (x) certain other gains and expenses. Compliance-related professional fees relate to fees and expenses recorded in connection with our efforts to remediate material weaknesses in internal control over financial reporting for the fiscal year ended January 31, 2014. Segment Financial Highlights The following table presents, for the three and six months ended July 31, 2014 and 2013, 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 loss from operations and segment performance for All Other: 34-------------------------------------------------------------------------------- Table of Contents Three Months Ended July 31, Six Months Ended July 31, 2014 2013 2014 2013 (Dollars in thousands) SEGMENT RESULTS BSS Segment revenue $ 60,155 $ 74,158 $ 117,027 $ 150,422 Gross margin 45.3 % 35.4 % 41.8 % 37.8 % Income from operations 14,900 7,087 21,355 22,788 Operating margin 24.8 % 9.6 % 18.2 % 15.1 % Segment performance 15,600 7,820 22,752 24,318 Segment performance margin 25.9 % 10.5 % 19.4 % 16.2 % Digital Services Segment revenue $ 55,165 $ 95,595 $ 117,425 $ 175,149 Gross margin 33.7 % 51.5 % 37.1 % 45.5 % Income from operations 11,107 40,970 29,499 63,812 Operating margin 20.1 % 42.9 % 25.1 % 36.4 % Segment performance 11,109 41,131 29,503 64,030 Segment performance margin 20.1 % 43.0 % 25.1 % 36.6 % All Other Loss from operations $ (32,754 ) $ (36,630 ) $ (71,353 ) $ (67,330 ) Segment performance (25,923 ) (30,822 ) (56,991 ) (64,492 ) For a discussion of the results of our segments, see "-Results of Operations." Business Trends and Uncertainties For the three and six months ended July 31, 2014 compared to the three and six months ended July 31, 2013 our consolidated revenue decreased and our costs and operating expenses decreased. The decrease in revenue exceeded the decrease in our costs and operating expenses, resulting in loss from operations for the three and six months ended July 31, 2014 compared to income from operations for the three and six months ended July 31, 2013. Comverse performance for the three months ended July 31, 2014 decreased compared to the three months ended July 31, 2013. Comverse performance for the six months ended July 31, 2014 reflected a loss compared to a gain for the six months ended July 31, 2013. The decrease in revenue was primarily attributable to a decrease in revenue from customer solutions and maintenance revenue in our BSS and Digital Services segments. For a discussion of the reasons for the changes in revenue at our BSS and Digital Services segments, see "-BSS," "-Digital Services," "-Results of Operations-Segment Results-BSS" and "-Results of Operations-Segment Results-Digital Services." Our costs and operating expenses decreased during the three and six months ended July 31, 2014 primarily due to a decrease in cost of revenue due to lower revenue in the BSS and Digital Services segments and lower project loss provisions compared to the prior year periods. Cost of revenue for the six months ended July 31, 2013 was favorably impacted by a $10.9 million Italian VAT refund that we received during the three months ended April 30, 2013. The decrease in operating expenses was also attributable to a decrease in selling, general and administrative expenses primarily attributable to a decrease in commission expenses due to lower product bookings and a decrease in personnel-related costs primarily due to lower bonus costs. During the three months ended July 31, 2014, our cash and cash equivalents and restricted cash decreased primarily due to negative operating cash flow, payments made in connection with restructuring activities, repurchase of common stock in the open market and the deposit in escrow of the purchase price for the acquisition of Solaiemes, S.L. (or Solaiemes), which closed on August 1, 2014. As previously disclosed, our Board of Directors adopted a program to repurchase from time to time at management's discretion up to $30.0 million in shares of our common stock on the open market during the 18-month period ending October 9, 2015 at prevailing market prices. Repurchases are made under the program using our own cash resources. During the three 35-------------------------------------------------------------------------------- Table of Contents months ended July 31, 2014, we repurchased in the open market under this program 143,580 shares of common stock for an aggregate purchase price of approximately $3.6 million, at an average purchase price of $24.88 per share. On August 1, 2014, we acquired Spain-based Solaiemes for approximately $2.7 million and the assumption of $1.5 million of debt. Solaiemes is an innovator focused on enabling the creation and monetization of CSPs' digital services. Solutions from Solaiemes complement our Evolved Communication Suite offering and the combined portfolio creates an end-to-end platform for service monetization of IP-based digital services. As previously disclosed, 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 (the "Escrow Release Date"), less any claims made on or prior to such date, was to be released to us. On August 6, 2014, the escrow was released in accordance with its terms and we received the escrow amount of approximately $25.0 million. During the three months ended July 31, 2014, as part of our efforts to achieve revenue growth we conducted a comprehensive review of the markets and opportunities of our two businesses and refined our growth strategy. For more information, see "-BSS" and "-Digital Services." As part of our efforts to reduce costs and expenses, improve our cash position and achieve long-term improved operating performance and positive operating cash flows, we continued to implement the following initiatives during the three months ended July 31, 2014: • The industrialization of Comverse ONE to meet or exceed our customer requirements, for ease of use and faster deployment times to reduce deployment costs; • The relocation of certain delivery and research and development activities to low cost centers of excellence in Eastern Europe and Asia; • Initiatives to reduce selling, general and administrative expenses that included primarily sales and marketing, finance, information technology and facilities. On September 9, 2014, we commenced an expansion of our previously disclosed 2014 restructuring plan. We expect that as a result of the restructuring plan (as expanded), our global workforce will be reduced by approximately 14% and that our annual cost of revenue and operating expenses will decrease by approximately $30 million to $40 million. The restructuring plan has been facilitated by efficiencies gained through initiatives implemented in recent fiscal periods and the expectation that software will account for a higher portion of our revenue in future periods. The restructuring is designed to align operating costs and expenses with currently anticipated revenue. The restructuring plan (as expanded) is expected to include reduction of workforce included in cost of revenue, research and development and selling, general and administrative expenses. The aggregate total cost of the 2014 restructuring plan (as expanded) is currently expected to be approximately $15.0 million to $17.0 million, primarily related to severance costs which are expected to be accrued and paid by January 31, 2015. As previously disclosed, the aggregate total cost of the 2014 restructuring plan (prior to expansion) was expected to be approximately $9.0 million. In relation to this restructuring plan, we recorded severance-related costs of $5.0 million and paid $3.5 million during the six months ended July 31, 2014. Our principal business activities are reported through the following segments: • BSS, which provides our converged, prepaid and postpaid billing and BSS for wireless, wireline, cable and multi-play CSPs as well as B2B and consumer oriented enterprises, delivering a value proposition designed to enable an effective service and data monetization, a consistent, enhanced customer experience, reduced complexity and cost, and real-time choice and control. In addition, we provide CSPs with the ability to better manage their data networks and to better monetize their data network investment through our Policy Management and Policy Enforcement capabilities for wireless and wireline data networks; and • Digital Services, which conducts our voice and messaging services (including voicemail, visual voicemail, call completion, SMS, and MMS), enterprise communication services, and IP-based rich communication services (including group chat, file transfer, video, social and presence). In connection with each of these segments, we offer a portfolio of services primarily related to our solutions (referred to as managed services). For more information, see "-Managed Services." 36-------------------------------------------------------------------------------- Table of Contents BSS Revenue from BSS customer solutions for the three and six months ended July 31, 2014 decreased compared to the three months ended July 31, 2013. The decrease in revenue for the three months periods was primarily attributable to the decrease in collections from certain customers whose revenue is limited to collections, a decrease in license only sales and a lower volume of BSS projects in the current period resulting from lower bookings over the past year. The decrease in revenue for the six months period was primarily attributable to a lower volume of BSS projects in the current period resulting from lower bookings in the past year, a decrease in collections from certain customers whose revenue is limited to collections and due to a decrease in license only sales. BSS maintenance revenue for the three and six months ended July 31, 2014 decreased compared to the three and six months ended July 31, 2013. The decrease in revenue for the three and six months period was primarily attributable to a decrease in revenue allocated to the initial warranty period of projects due to lower volume of deliveries for the initial warranty period of projects and due to the timing of entering into renewals of maintenance contracts with customers, partially offset by an increase in collections from certain customers whose revenue is limited to collections. As noted above, we conducted a comprehensive review of our BSS markets and opportunities and refined our growth strategy. We plan to focus our efforts in the BSS segment on providing converged BSS solutions, through our Comverse ONE solutions and enterprise and cloud billing through our Kenan solution. We believe we have a leading industry position in the BSS converged billing market and believe that we are well positioned to take advantage of the growth in the converged BSS market. However, as previously disclosed, our BSS product bookings were adversely affected in recent fiscal periods by (i) the deferral of significant capital investments involved in deploying our BSS solutions and upgrading existing prepaid or postpaid systems to our converged BSS solution, (ii) the cancellation of projects by customers who prioritized their capital expenditures to the deployment of next generation networks, including LTE, and (iii) the loss of projects to significantly larger competitors who bundled the BSS transformation with an overall network deployment project. In addition, CSPs are experiencing significant industry change and a shifting ecosystem which includes device manufacturers and over-the-top (or OTT) software and content providers. In response to these market trends, CSPs require enhanced BSS system functionality to accommodate their business needs. As a result, 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. In addition, project complexity impacts our customers' ability to meet their obligations as part of the delivery process which has at times also resulted in project delivery delays. Furthermore, our customers encounter issues in managing the operations of their BSS systems and tend to rely more heavily on our support services. To address our customer challenges, we invested significant resources in industrializing our Comverse ONE solutions and during the three months ended July 31, 2014, launched a new version of Comverse ONE that we believe improves efficiency, shortens deployment periods and reduces project implementation costs in deployments utilizing the new version. In addition, in fiscal 2013, we have established a Managed Services offering designed to allow us to manage Comverse One operations, as well as other BSS-related IT functions. The key elements to our converged BSS strategy, include: • Emphasizing Managed Services. The ecosystem of CSPs' Networks, Services and support systems is becoming more complex and requires higher levels of experience and expertise to operate efficiently. We believe this represents a significant growth potential in the BSS market. We have entered into important managed services engagements with existing BSS customers and intend to offer managed services to existing and new potential BSS customers. We plan to focus our efforts on tier 3 and 4 CSPs who operate the systems using their in-house IT departments. In addition, we may expand our managed services portfolio and customer base through opportunistic acquisitions; • Continuing focusing on Emerging Mobile CSPs. As the Networks and Services are becoming more complex, we are expanding the prebuilt capabilities and business processes within our converged BSS solution to address CSPs' needs. In addition, we are pre-integrating our policy offering into our converged BSS solution to offer a comprehensive data monetization solution for CSPs' growing data networks, reducing the footprint required to optimize operational costs, improving the delivery process and enhancing functionality to address the emerging needs for Customer Relationship Management (or CRM) and support for their Enterprise segments; 37-------------------------------------------------------------------------------- Table of Contents • Expanding in mature markets. We plan to expand our efforts in mature markets primarily through the expansion of our indirect sales channels, including the use of systems integrators and third party point solutions. To address this market, we are making the Comverse ONE product open, modular and extendable while enhancing its enterprise support capabilities; and • Evolving Enterprise Billing. We plan to expand our efforts in the enterprise billing software and cloud markets with a combined direct sales force and through third party distribution channels. To address this market, we are enhancing our Kenan product to support complex global billing requirements, cloud environment, SaaS business model, and an open eco-system. In addition, we continue to focus on increasing our BSS revenue and improving our margins by providing a growth and evolution path to our Kenan postpaid billing customers, including upgrades and expansions. We are also pursuing aggressively new Kenan engagements and offer Kenan solutions to CSPs who are not prepared to commit to a full converged transformation and to enterprise businesses with complex billing requirements. We believe that our BSS solutions' offering has the potential to become a key driver of growth going forward. We expect that as a leader in the BSS market, we will continue to build on the strength of our Comverse ONE and Kenan solutions as well as managed services. We also expect that growth in mobile data traffic will increase the demand for our policy solutions, which include policy management and enforcement, deep packet inspection and smart data monetization solutions all of which are integrated into our BSS solutions. In addition to the CSP market, we intend to focus on the enterprise, eCommerce and subscription base billing market. This market is expected to experience significant growth and we believe it will surpass the size of the more traditional billing market currently targeted by Comverse One. We believe that there has been a significant shift in the billing needs of the enterprise and subscription markets. We believe that (i) B2B enterprises require a global complex billing layer and agile software, (ii) that business-to-consumer (or B2C) business using subscription services require a carrier-grade and complex software support and (iii) that customers in a wide array of industries are seeking cloud-based billing solutions. We believe that no other vendor currently can adequately addresses all customer needs as legacy vendors have focused on their closed suites and new Software-as-a-Service (or SaaS) providers have focused on simple recurring billing models. We believe we can compete for business in a large portion of this market by leveraging our Kenan product expertise, large installed base, existing Kenan enterprise customer base and reputation. This market includes our traditional CSP customers as well as media, eCommerce, retail service providers and other digital players who use a subscription-type business model. As part of our strategy, we continue to enhance our Kenan solution by making it available as a cloud-based service (in a SaaS business model). We believe that enterprise, cloud-based and subscription billing solutions could contribute to our growth in BSS in future periods through the ability to address a broader base of customers that are growing at a rapid pace. Digital Services Revenue from Digital Services customer solutions for the three and six months ended July 31, 2014 decreased compared to the three and six months ended July 31, 2013. The decrease in revenue from Digital Services customer solutions for both periods was primarily attributable to a lower number and size of acceptances in the three and six months ended July 31, 2014 compared to the three and six months ended July 31, 2013. Digital Services maintenance revenue for the three and six months ended July 31, 2014 decreased compared to the three and six months ended July 31, 2013. The decrease for both periods was primarily attributable to the termination of several maintenance agreements, the reduction in maintenance fees charged to certain customers and due to the timing of entering into renewals of maintenance contracts with customers. We continue to maintain our market leadership in the traditional value added services (or VAS) market by providing solutions to CSPs based on voice and messaging services, such as voicemail, call completion, SMS and MMS. However, CSPs face increasing competition from both Internet players and mobile device manufacturers, using new technologies that may provide alternatives to CSP products and services. For example, the introduction of IP-based applications on wireless devices by Over The Top (or OTT) providers, allows end users to utilize IP-based services, such as Facebook, Facetime, Google, Whatsapp, Line or Skype, to access, among other things, IP communications free of charge rather than use similar services provided by CSPs. Furthermore, these CSP services continue to face competition from low-cost competitors from emerging markets. We believe these changes have reduced demand for traditional communication products and services and increased pricing pressures, which have in turn adversely impacted our revenue and margins and we expect this trend to continue. 38-------------------------------------------------------------------------------- Table of Contents At the same time, the growth in global wireless subscriptions, and high growth wireless segments, such as data services and Internet browsing are pushing CSPs to evolve to 4G/LTE IP-based network technologies, supporting the demand for several of our products. In addition, a key need for CSPs is to increase their relevance in the digital lifestyle of their subscribers. To address these market trends and the needs of our customers, we are implementing our strategy in respect of traditional VAS, IP-based solutions and unified communications. The key elements to our Digital Services strategy, include: • Continuing to leverage our leading market position in traditional VAS. As a market leader in the traditional VAS market we plan to focus on the following initiatives: • Leveraging existing customer base. We continue to maintain our existing VAS customer base by enhancing our existing products and services and offering new products and services that facilitate total cost reduction of CSPs system operations and allow CSPs to launch new services; • Gain market share through virtualization and cloud-based offering. We are currently pursuing aggressively new opportunities with new and existing customers by offering virtualized and cloud-based solutions which are designed to simplify CSPs' current systems, improve efficiencies and reduce total cost of ownership; and • Centralize the systems of multi-country large CSPs. We are currently pursuing and intend to continue to pursue opportunities to consolidate the systems of large, multi-country CSPs by moving their traditional VAS deployments from a per-country operation to a centralized cloud infrastructure that either they can operate or we could operate for them. This proposition is designed to create a significant reduction in the total cost of ownership for CSPs and also provides them with a platform for launching new digital services for their markets. • Focusing on IP-Based Evolved Communication Services (or ECS): Our ECS solution is designed to modernize the Traditional VAS deployments by extending current services to IP endpoints, as well as upgrade the CSP's voice and messaging offer to a comprehensive communication package that is based on Rich Communication Standards (or RCS), including voice, multi-device visual voicemail, messaging to IP-based devices, video, presence and chat. Our connectivity layer uses multiple access technologies to bridge traditional endpoints, web endpoints, and IP Multimedia System Session Initiation Protocol (SIP) endpoints. In order to enhance our solution, we recently acquired Solaiemes, whose WebRTC, RCS Monetization API Gateway and Presence solutions complement our ECS offering, with the combined portfolio creating a platform for service monetization of IP-based digital services. We plan to continue to enhance our ECS solution internally and through acquisitions or third party engagements; and • Pursuing Enterprise Unified Communications Opportunities. We offer a portfolio of IP Trunking and Unified Communications services that CSPs can extend to their enterprise customers. Our objective is to sell these solutions through the CSP, and become the CSP's Unified Communication solution of choice. The strength of our portfolio lies in its ability to provide convergence between the "at-work" Unified Communication experience and the "outside-work" ECS experience for CSPs' end customers. This capability leverages our existing broad customer base which we believe provides us with a competitive advantage. Managed Services Through our BSS and Digital Services business units, we continue to emphasize a suite of managed services. In the fiscal year ended January 31, 2014 and the six months ended July 31, 2014, we invested significant resources in solidifying our managed services organization, hired senior leadership and enhanced our processes and methodologies. As a result, we expect that managed services will continue to be an important component of our growth strategy in future periods. Our managed services' offering enables us to assume responsibility for the operation and management of our customers' billing and digital services systems. Our 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 us with recurring and predictable revenue and are used by us 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 us with stability and a competitive advantage in marketing our solutions to our existing customer base. Our current initiatives in respect of managed services include: 39-------------------------------------------------------------------------------- Table of Contents •Leading with Managed Services. As part of strategy, we are currently leading engagements with our managed services offering with the objective of providing value to our customers by increasing their efficiency and system utilization and reducing their operating costs; and •Leveraging our existing customer base. We are currently approaching our existing customer base and offering our managed services, primarily to Tier 2, 3 and 4 CSPs and are seeking alliances with system integrators in respect of Tier 1 CSPs. Uncertainties Impacting Future Performance Mix of Revenue in Digital Services It is unclear whether our advanced Digital Services offerings will be widely adopted by existing and potential customers. We expect that sales of advanced offerings will not fully offset declines in the sale of traditional VAS solutions in fiscal 2014. Currently, we are unable to predict whether sales of advanced offerings will fully offset declines in the sale of traditional VAS solutions in subsequent fiscal periods. 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. Change in CSP Capital Expenditure Priorities During the fiscal year ended January 31, 2014 and the six months ended July 31, 2014, several large-scale projects that we were pursuing were ultimately canceled or postponed by customers, who prioritized their capital expenditure budgets to the deployment of next generation networks, including LTE, rather than engage in BSS transformations. In addition, the sales cycle for such large scale projects continues to lengthen and the number of large scale projects have decreased due to pressure on CSPs' capital expenditure spending which in turn is adversely impacting our future revenue growth. We expect this trend to continue in future periods, and accordingly our ability to achieve growth in BSS may be materially adversely affected. Difficulty in Forecasting Product Bookings Our product bookings are difficult to predict. A high percentage of our product bookings have typically been generated late in fiscal quarters. In addition, based on historical industry spending patterns of CSPs, we typically forecast our highest product booking levels in our fourth fiscal quarter. This trend makes it difficult for us to forecast our annual product bookings and to implement effective measures to cover any shortfalls of prior fiscal quarters if product bookings 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 Digital Services 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 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 additional information, see Note 3 to our condensed consolidated financial statements included in this Quarterly Report. 40-------------------------------------------------------------------------------- Table of Contents |