UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE
ACT OF 1934
For the quarterly period ended October 31, 2005
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 000-49790
Verint Systems Inc.
(Exact name of registrant as specified in its charter)
Delaware 11-3200514
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
330 South Service Road, Melville, NY 11747
(Address of principal executive offices) (Zip Code)
(631) 962-9600
(Registrant's telephone number, including area code)
Not Applicable
Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
[X] Yes [_] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
[X] Yes [_] No
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
[ ] Yes [X] No
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares of Common Stock, par value $0.001 per share,
outstanding as of December 8, 2005 was 32,186,637.
TABLE OF CONTENTS
PART I
Financial Information
Page
----
ITEM 1. Financial Statements.
1. Condensed Consolidated Balance Sheets as of January 31, 2005 and
October 31, 2005 4
2. Condensed Consolidated Statements of Income for the Three and Nine
Months Ended October 31, 2004 and October 31, 2005 5
3. Condensed Consolidated Statements of Cash Flows for the Nine Months
Ended October 31, 2004 and October 31, 2005 6
4. Notes to Condensed Consolidated Financial Statements 7
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations. 20
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk. 41
ITEM 4. Controls and Procedures. 42
PART II
Other Information
ITEM 6. Exhibits. 43
SIGNATURES 44
2
FORWARD-LOOKING STATEMENTS
From time to time, the Company makes forward-looking statements.
Forward-looking statements include financial projections, statements of plans
and objectives for future operations, statements of future economic performance,
and statements of assumptions relating thereto. Forward-looking statements are
often identified by future or conditional words such as "will," "plans,"
"expects," "believes," "seeks," "intends," "estimates," or "anticipates," or by
variations of such words or by similar expressions.
The Company may include forward-looking statements in its periodic
reports to the United States Securities and Exchange Commission on Forms 10-K,
10-Q, and 8-K, in its annual report to stockholders, in its proxy statements, in
its press releases, in other written materials, and in statements made by
employees to analysts, investors, representatives of the media, and others.
By their very nature, forward-looking statements are subject to
uncertainties, both general and specific, and risks exist that predictions,
forecasts, projections and other forward-looking statements will not be
achieved. Actual results may differ materially due to a variety of factors,
including without limitation those discussed under "Certain Trends and
Uncertainties" and elsewhere in this report. Investors and others should
carefully consider these and other uncertainties and events, whether or not the
statements are described as forward-looking.
Forward-looking statements made by the Company are intended to apply
only at the time they are made, unless explicitly stated to the contrary.
Moreover, whether or not stated in connection with a forward-looking statement,
the Company makes no commitment to revise or update any forward-looking
statements in order to reflect events or circumstances after the date any such
statement is made. If the Company were in any particular instance to update or
correct a forward-looking statement, investors and others should not conclude
that the Company would make additional updates or corrections thereafter.
PART I
ITEM 1. FINANCIAL STATEMENTS.
VERINT SYSTEMS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
JANUARY 31, OCTOBER 31,
ASSETS 2005* 2005
- ------ (Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 45,100 $ 58,035
Bank time deposits - 2,320
Short-term investments 195,314 206,210
Accounts receivable, net 39,072 48,896
Inventories 17,267 20,886
Prepaid expenses and other current assets 9,880 10,427
----------- -----------
TOTAL CURRENT ASSETS 306,633 346,774
PROPERTY AND EQUIPMENT, net 17,540 19,833
INTANGIBLE ASSETS, net 12,026 10,315
GOODWILL 49,625 59,262
OTHER ASSETS 13,154 14,957
----------- -----------
TOTAL ASSETS $ 398,978 $ 451,141
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 68,399 $ 91,507
Advance payments from customers 41,853 39,787
----------- -----------
TOTAL CURRENT LIABILITIES 110,252 131,294
LONG-TERM LIABILITIES 5,351 4,705
----------- -----------
TOTAL LIABILITIES 115,603 135,999
----------- -----------
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value - authorized, 120,000,000 shares;
issued and outstanding 31,577,587 and 32,181,356 shares 32 32
Additional paid-in capital 282,364 293,024
Unearned stock compensation (3,395) (2,656)
Retained earnings 2,155 23,133
Accumulated other comprehensive income 2,219 1,609
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 283,375 315,142
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 398,978 $ 451,141
=========== ===========
*The Condensed Consolidated Balance Sheet as of January 31, 2005 has
been summarized from the Company's audited Consolidated Balance Sheet as of
that date.
The accompanying notes are an integral part of these financial statements.
4
VERINT SYSTEMS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NINE MONTHS ENDED THREE MONTHS ENDED
OCTOBER 31, OCTOBER 31,
2004 2005 2004 2005
---- ---- ---- ----
Sales $ 180,794 $ 224,986 $ 63,989 $ 78,238
Cost of sales 82,098 99,860 29,235 34,360
---------- ---------- ---------- ----------
Gross profit 98,696 125,126 34,754 43,878
Operating expenses:
Research and development, net 23,089 29,035 8,409 10,039
Selling, general and administrative 59,704 74,217 21,290 26,272
In-process research and development 3,154 - - -
Write-down of capitalized software 1,481 - - -
---------- ---------- ---------- ----------
Income from operations 11,268 21,874 5,055 7,567
Interest and other income, net 2,379 5,361 932 1,982
---------- ---------- ---------- ----------
Income before income tax provision 13,647 27,235 5,987 9,549
Income tax provision 1,282 6,257 807 2,241
---------- ---------- ---------- ----------
Net income $ 12,365 $ 20,978 $ 5,180 $ 7,308
========== ========== ========== ==========
Earnings per share:
Basic $ 0.40 $ 0.66 $ 0.17 $ 0.23
========== ========== ========== ==========
Diluted $ 0.38 $ 0.63 $ 0.16 $ 0.22
========== ========== ========== ==========
The accompanying notes are an integral part of these financial statements.
5
VERINT SYSTEMS INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(IN THOUSANDS)
NINE MONTHS ENDED
OCTOBER 31,
2004 2005
---- ----
Cash flows from operating activities:
Net income $ 12,365 $ 20,978
Adjustment to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 9,258 11,845
In process research and development 3,154 -
Other, net 2,531 2,007
Cash flows from investing activities:
Acquisitions, net of cash acquired (45,389) (11,533)
Purchases of property and equipment (5,135) (8,073)
Proceeds from sale of property and equipment - 322
Capitalization of software development costs (3,163) (2,988)
Increase in short-term investments and bank time deposits, net (12,000) (13,269)
Other - (386)
---------- ----------
Net cash used in investing activities (65,687) (35,927)
---------- ----------
Cash flows from financing activities:
Borrowing/(Repayment) of bank loans 489 (574)
Proceeds from issuance of common stock in connection with exercise of
stock options and employee stock purchase plan 11,034 9,023
---------- ----------
Net cash provided by financing activities 11,523 8,449
---------- ----------
Net increase (decrease) in cash and cash equivalents (14,921) 12,935
Cash and cash equivalents, beginning of period 77,516 45,100
---------- ----------
Cash and cash equivalents, end of period $ 62,595 $ 58,035
========== ==========
The accompanying notes are an integral part of these financial statements.
6
VERINT SYSTEMS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
Verint Systems Inc. ("Verint" and, together with its subsidiaries, the
"Company") is engaged in providing analytic software-based solutions
for communications interception, networked video security and
surveillance, and business intelligence. The Company is a
majority-owned subsidiary of Comverse Technology, Inc. ("Comverse
Technology").
In presenting the accompanying unaudited condensed consolidated
financial statements, management makes estimates and assumptions that
affect the amounts reported and related disclosures. Estimates, by
their nature, are based on judgments and available information.
Accordingly, actual results could differ from those estimates. In
management's opinion, the condensed consolidated financial statements
contain all normal recurring adjustments necessary for a fair
presentation of interim results reported in accordance with accounting
principles generally accepted in the United States of America ("U.S.
GAAP"). The results of operations reported for interim periods are not
necessarily indicative of the results of operations for the entire
year or any subsequent interim period. Certain reclassifications have
been made to prior period amounts to conform to the current period
presentation. These financial statements should be read in conjunction
with Verint's 2004 Annual Report on Form 10-K filed on April 18, 2005.
2. STOCK-BASED EMPLOYEE COMPENSATION
The Company applies the intrinsic-value based method prescribed by
Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations. Stock-based
employee compensation cost is recognized only when employee stock
options are granted with exercise prices below the fair market value
at the date of grant, and is recognized ratably over the associated
service period, which is generally the option vesting period. The
Company recognized stock-based employee compensation cost in the
condensed consolidated statements of income of approximately $11,000
and $33,000, during each of the three month and nine month periods
ended October 31, 2004, respectively, and $0 and $22,000, during each
of the three month and nine month periods ended October 31, 2005,
respectively, relating to certain employee stock options granted with
exercise prices below the fair market value at the date of grant. As
of October 31, 2005, 11,730 employee stock options were outstanding
with exercise prices below the fair market value at the date of the
grant. All other employee stock options have been granted at exercise
prices equal to fair market value on the date of grant, and
accordingly, no compensation expense has been recognized by the
Company related to these options in the accompanying condensed
consolidated statement of income.
The Company estimated the fair value of employee stock options
utilizing the Black-Scholes option valuation model, using appropriate
assumptions, as required by U.S. GAAP. The Black-Scholes model was
developed for use in estimating the fair value of traded options and
does not consider the non-traded nature of employee stock options,
vesting and trading restrictions, lack of transferability or the
ability of employees to forfeit the options prior to expiry. In
addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because
changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of
the Company's employee stock options.
7
The following table illustrates the effect on net income and earnings
per share if the Company had applied the fair value recognition
provisions of Statement of Financial Accounting Standards ("SFAS") No.
123, "Accounting for Stock-Based Compensation," to stock-based
employee compensation for all periods:
NINE MONTHS ENDED THREE MONTHS ENDED
OCTOBER 31, OCTOBER 31,
2004 2005 2004 2005
---------- ---------- ---------- ----------
(In thousands, (In thousands,
except per share data) except per share data)
Net income, as reported $ 12,365 $ 20,978 $ 5,180 $ 7,308
Less: Stock-based employee compensation cost
determined under the fair value method,
net of related tax effects 5,613 7,038 1,855 2,417
---------- ---------- ---------- ----------
Pro forma net income $ 6,752 $ 13,940 $ 3,325 $ 4,891
========== ========== ========== ==========
Earnings per share:
Basic - as reported $ 0.40 $ 0.66 $ 0.17 $ 0.23
========== ========== ========== ==========
Basic - pro forma $ 0.22 $ 0.44 $ 0.11 $ 0.15
========== ========== ========== ==========
Diluted - as reported $ 0.38 $ 0.63 $ 0.16 $ 0.22
========== ========== ========== ==========
Diluted - pro forma $ 0.21 $ 0.42 $ 0.10 $ 0.15
========== ========== ========== ==========
3. SHORT-TERM INVESTMENTS
The Company classifies all short-term investments as available for
sale, accounted for at fair value, with the resulting unrealized gains
or losses included in accumulated other comprehensive income.
In connection with the preparation of its Annual Report on Form 10-K
for the year ended January 31, 2005, the Company concluded that it was
appropriate to classify investments in Auction Rate Securities ("ARS")
as short-term investments. ARS generally have long-term stated
maturities; however, these investments have characteristics similar to
short-term investments because at pre-determined intervals, generally
every 7 to 90 days, there is a new auction process at which these
securities are reset to current interest rates. Previously, such
investments had been classified as cash and cash equivalents due to
their liquidity and pricing reset feature. As of October 31, 2005, the
Company held approximately $183,925,000 of investments in ARS that are
classified as short-term investments. Accordingly, the Company has
revised the classification to report these securities as short-term
investments in its Condensed Consolidated Balance Sheet for all
periods prior to January 31, 2005, and has reclassified approximately
$145,053,000 of investments in ARS as of October 31, 2004, that were
previously included in cash and cash equivalents as short-term
investments.
8
The Company has also revised the presentation of the Condensed
Consolidated Statements of Cash Flows for the nine months ended
October 31, 2004 to reflect the changes in ARS as investing activities
rather than as a component of cash and cash equivalents, which is
consistent with the presentation for the year ended January 31, 2005.
In the previously reported Condensed Consolidated Statements of Cash
Flows for the nine months ended October 31, 2004, net cash provided by
investing activities related to these short-term investments of
approximately $21,853,000 were included in cash and cash equivalents.
This change in classification does not affect previously reported cash
flows from operations or from financing activities in the Consolidated
Statements of Cash Flows or previously reported Consolidated
Statements of Income for any period.
4. INVENTORIES
The composition of inventories at January 31, 2005 and October 31,
2005 is as follows:
JANUARY 31, OCTOBER 31,
2005 2005
---- ----
(In thousands)
Raw materials $ 6,067 $ 9,236
Work in process 4,179 4,791
Finished goods 7,021 6,859
----------- -----------
$ 17,267 $ 20,886
=========== ===========
5. RESEARCH AND DEVELOPMENT EXPENSES
A significant portion of the Company's research and development
operations are located in Israel, where the Company derives
substantial benefits from participation in programs sponsored by the
Government of Israel for the support of research and development
activities conducted in that country. The Company's research and
development activities include projects partially funded by the Office
of the Chief Scientist of the Ministry of Industry and Trade of the
State of Israel (the "OCS") under which the OCS reimburses a portion
of the Company's research and development expenditures under approved
project budgets. The Company is currently involved in several ongoing
research and development projects supported by the OCS. The Company
accrues royalties to the OCS for the sale of products incorporating
technology developed in these projects up to the amount of such
funding, plus interest in certain circumstances. The terms of the
applicable funding agreements limit the Company's ability to
manufacture products, or transfer technologies, outside of Israel if
such products or technologies were developed under these funding
agreements. Reimbursement from the OCS amounted to approximately
$775,000 and $2,379,000 in the three month and nine month periods
ended October 31, 2004, respectively, and approximately $1,285,000 and
$3,020,000 in the three month and nine month periods ended October 31,
2005, respectively. As of October 31, 2005, the Company has received
approximately $59.7 million in cumulative grants and has recorded
approximately $30.6 million in cumulative royalties to the OCS. The
Company recorded other reimbursements of research and development
expenses amounting to approximately $146,000 and $788,000 for the
three month and nine month periods ended October 31, 2004
respectively, and $280,000 and $810,000 for the three month and nine
month periods ended October 31, 2005, respectively.
9
6. EARNINGS PER SHARE
The computation of basic earnings per share is based on the weighted
average number of outstanding common shares. Diluted earnings per
share further assumes the issuance of common shares for all
potentially dilutive issuances of stock. The calculation for earnings
per share for the three month and nine month periods ended October 31,
2004 and 2005, respectively, was as follows:
THREE MONTHS ENDED
-------------------------------------------------------------------------------------------------
OCTOBER 31, 2004 OCTOBER 31, 2005
------------------------------------------- -----------------------------------------------
Net Per Share Net Per Share
Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
(In thousands, except per share data)
BASIC EPS
Net Income $ 5,180 31,036 $ 0.17 $ 7,308 31,866 $ 0.23
========== ==========
EFFECT OF DILUTIVE
SECURITIES
Stock Options 1,657 1,329
Restricted shares 73 138
----------- -----------
DILUTED EPS $ 5,180 32,766 $ 0.16 $ 7,308 33,333 $ 0.22
=========== =========== =========== =========== =========== ===========
NINE MONTHS ENDED
-------------------------------------------------------------------------------------------------
OCTOBER 31, 2004 OCTOBER 31, 2005
------------------------------------------- -----------------------------------------------
Net Per Share Net Per Share
Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
(In thousands, except per share data)
BASIC EPS
Net Income $ 12,365 30,725 $ 0.40 $ 20,978 31,658 $ 0.66
========== ==========
EFFECT OF DILUTIVE
SECURITIES
Stock Options 1,683 1,345
Restricted shares 73 138
--------- -----------
DILUTED EPS $ 12,365 32,481 $ 0.38 $ 20,978 33,141 $ 0.63
=========== =========== =========== =========== =========== ===========
7. COMPREHENSIVE INCOME
Total comprehensive income was approximately $7,372,000 and $7,580,000
for the three months ended October 31, 2004 and 2005, respectively,
and approximately $14,229,000 and $20,368,000 for the nine month
periods ended October 31, 2004 and 2005, respectively. The elements of
comprehensive income include net income, unrealized gains and losses
on available for sale securities and foreign currency hedges, and
foreign currency translation adjustments.
10
8. RELATED PARTY TRANSACTIONS AND BALANCES
CORPORATE SERVICES AGREEMENT - The Company recorded expenses of
approximately $156,000 for both three month periods ended October 31,
2004 and 2005, and approximately $469,000 for both nine month periods
ended October 31, 2004 and 2005, for the services provided by the
Company's parent, Comverse Technology, under the Corporate Services
Agreement between the Company and Comverse Technology.
ENTERPRISE RESOURCE PLANNING SOFTWARE SHARING AGREEMENT - The Company
recorded approximately $36,000 and $46,000 for the three months ended
October 31, 2004 and 2005, respectively, and approximately $130,000
and $119,000 for the nine months ended October 31, 2004 and 2005,
respectively, for support services rendered by Comverse Ltd., a
subsidiary of Comverse Technology, under the Enterprise Resource
Planning Software Sharing Agreement between the Company and Comverse
Ltd.
SATELLITE SERVICES AGREEMENT - The Company recorded expenses of
approximately $866,000 and $801,000 for the three months ended October
31, 2004 and 2005, respectively, and approximately $2,341,000 and
$2,359,000 for the nine months ended October 31, 2004 and 2005,
respectively, for services rendered by Comverse, Inc., a subsidiary of
Comverse Technology, and its subsidiaries, under the Satellite
Services Agreement between the Company and Comverse, Inc.
TRANSACTIONS WITH AN AFFILIATE - The Company sold products and
services to Verint Systems (Singapore) PTE LTD, an affiliated systems
integrator in which the Company holds a 50% equity interest, amounting
to approximately $667,000 and $1,817,000, during the three months
ended October 31, 2004 and 2005, respectively, and approximately
$1,419,000 and $5,954,000, during the nine months ended October 31,
2004 and 2005, respectively. In addition, the Company was charged with
installation, support, marketing and office service fees by that
affiliate amounting to approximately $167,000 and $615,000 for the
three months ended October 31, 2004 and 2005, respectively, and
approximately $501,000 and $998,000 for the nine months ended October
31, 2004 and 2005, respectively.
TRANSACTIONS WITH OTHER SUBSIDIARIES OF COMVERSE TECHNOLOGY - The
Company charges subsidiaries of Comverse Technology for services
relating to the use of the Company's facilities and employees. Charges
to these subsidiaries were approximately $18,000 and $26,000 for the
three month periods ended October 31, 2004 and 2005, respectively, and
approximately $60,000 and $63,000 for the nine month periods ended
October 31, 2004 and 2005, respectively.
From time to time the Company sells products and services to other
subsidiaries of Comverse Technology in the ordinary course of
business. During the three and nine month periods ended October 31,
2004 the Company recorded no sales to subsidiaries of Comverse
Technology. Sales to these subsidiaries were approximately $0 and
$67,000 for the three and nine month periods ended October 31, 2005,
respectively.
RELATED PARTY BALANCES - Related party balances included in the
condensed consolidated balance sheets are as follows (in thousands):
11
JANUARY 31, OCTOBER 31,
2005 2005
---- ----
Included in accounts receivable $ - $ 1,624
Included in advance payments from customers $ 767 $ -
Included in accounts payable and accrued expenses $ 1,387 $ 1,212
9. CONVERTIBLE NOTE
On February 1, 2002, the Company acquired the business of Lanex LLC
("Lanex"). The Lanex business provides digital video recording
solutions for security and surveillance applications. The purchase
price consisted of $9,510,000 in cash and a $2,200,000 convertible
note issued by the Company. The note was non-interest bearing and
matured on February 1, 2004. Upon maturity, on February 1, 2004, the
note was converted into 136,985 shares of the Company's common stock
at a conversion price of $16.06 per share.
10. ACQUISITIONS
On September 1, 2005, the Company, through a newly-formed subsidiary,
acquired certain of the assets and liabilities of The Opus Group, LLC
("Opus"), a privately-held provider of performance analytics solutions
for contact centers and back office operations. The acquisition
extends the Company's ability to help its customers generate
actionable intelligence and enhance the effectiveness of their contact
center and back office operations. The purchase price consisted of $12
million in cash at closing and additional earn-out payments over two
years based on certain profitability targets. The Company incurred
transaction costs, consisting primarily of professional fees,
amounting to approximately $156,000, in connection with this
acquisition.
The acquisition was accounted for using the purchase method. The
purchase price was allocated to the assets and liabilities of Opus
based on the estimated fair value of those assets and liabilities as
of September 1, 2005. Identifiable intangible assets consist of sales
backlog, trade name, customer relationships and non-competition
agreements and have an estimated useful life of up to five years. The
results of operations of Opus have been included in the Company's
results of operations since September 1, 2005.
The following is a summary of the allocation of the purchase price of
the Opus acquisition:
(IN THOUSANDS)
Purchase price $ 12,000
Acquisition costs 156
------------
Total purchase price $ 12,156
============
Fair value of assets acquired $ 1,764
Fair value of liabilities assumed (1,257)
Sales backlog 965
Customer relationships 435
Trade name 740
Non-competition agreements 65
Goodwill 9,444
------------
Total purchase price $ 12,156
============
12
The value allocated to goodwill in Opus will be deducted for income
tax purposes.
On September 2, 2004, the Company, through a subsidiary, acquired all
of the outstanding stock of RP Sicherheitssysteme GmbH ("RP
Security"), a company in the business of developing and selling mobile
digital video security solutions for transportation applications. RP
Security, headquartered in Flensburg, Germany, was founded in 1999 and
has approximately 50 employees. The purchase price consisted of
approximately $9,028,000 in cash and 90,144 shares of the Company's
common stock. Shares issued as part of the purchase price were
accounted for with value of approximately $2,977,000, or $33.03 per
share. In addition, the shareholders of RP Security are entitled to
receive earn-out payments over the three year period following the
closing based on the Company's worldwide sales, profitability and
backlog of mobile video products in the transportation market during
that period. For the period ending January 31, 2005, the shareholders
of RP earned approximately $455,000. In connection with this
acquisition, the Company incurred transaction costs, consisting
primarily of professional fees, amounting to approximately $520,000.
The acquisition was accounted for using the purchase method. The
purchase price was allocated to the assets and liabilities of RP
Security based on the estimated fair value of those assets and
liabilities as of September 2, 2004. Identifiable intangible assets
consist of sales backlog, acquired technology, trade name, customer
relationships and non-competition agreements and have an estimated
useful life of up to five years. The results of operations of RP
Security have been included in the Company's results of operations
since September 2, 2004.
The following is a summary of the allocation of the purchase price of
the RP Security acquisition:
(IN THOUSANDS)
Purchase price paid in cash $ 9,028
Shares issued 2,977
Earn-out payable 455
Acquisition costs 520
-----------
Total purchase price $ 12,980
===========
Fair value of assets acquired $ 3,339
Fair value of liabilities assumed (2,536)
Sales backlog 1,673
Acquired technology 194
Customer relationships 494
Non-competition agreements 150
Trade name 47
Goodwill 9,619
-----------
Total purchase price $ 12,980
===========
The value allocated to goodwill in RP Security is not deductible for
income tax purposes.
As a result of the acquisition of RP Security, the Company wrote down
certain inventory and accounts receivable balances that became
impaired due to the existence of duplicative technology and,
accordingly, were written-down to their net realizable value at the
date of acquisition. Such write-down amounted to $899,000 and is
included in cost of sales and selling, general and administrative
expenses.
13
On March 31, 2004, the Company acquired certain assets and assumed
certain liabilities of the government surveillance business of ECtel
Ltd. ("ECtel"), which provided the Company with additional
communications interception capabilities for the mass collection and
analysis of voice and data communications. The purchase price was
approximately $35 million in cash. The Company incurred transaction
costs, consisting primarily of professional fees, amounting to
approximately $1,107,000, in connection with this acquisition.
The acquisition was accounted for using the purchase method. The
purchase price was allocated to the assets and liabilities of ECtel
based on the estimated fair value of those assets and liabilities as
of March 31, 2004. The results of operations of ECtel have been
included in the Company's results of operations since March 31, 2004.
Identifiable intangible assets consist of sales backlog, acquired
technology, customer relationships, and non-competition agreements and
have estimated useful lives of up to ten years. Purchased in-process
research and development represents the value assigned to research and
development projects of the acquired business that were commenced but
not completed at the date of acquisition, for which technological
feasibility had not been established and which have no alternative
future use in research and development activities or otherwise. In
accordance with Statement of Financial Accounting Standards No. 2,
"Accounting for Research and Development Costs," as interpreted by
FASB Interpretation No. 4, amounts assigned to purchased in-process
research and development meeting the above criteria must be charged to
expense at the acquisition date. At the acquisition date, it was
estimated that the purchased in-process research and development was
approximately 40% complete and it was expected that the remaining 60%
would be completed during the ensuing year. The fair value of the
purchased in-process research and development was determined with the
assistance of an independent appraisal specialist using the income
approach, which reflects the projected free cash flows that will be
generated by the purchased in-process research and development
projects and discounting the projected net cash flows back to their
present value using a discount rate of 21%.
As a result of the acquisition of the government surveillance business
of ECtel, the Company had certain capitalized software development
costs that became impaired due to the existence of duplicative
technology and, accordingly, were written-down to their net realizable
value at the date of acquisition. Such impairment charge amounted to
$1,481,000.
The following is a summary of the allocation of the purchase price of
the ECtel acquisition:
(IN THOUSANDS)
Purchase price $ 35,000
Acquisition costs 1,107
-----------
Total purchase price $ 36,107
===========
Fair value of assets acquired $ 1,417
Fair value of liabilities assumed (3,282)
In-process research and development 3,154
Sales backlog 854
Acquired technology 5,307
Customer relationships 1,382
Non-competition agreements 2,221
Goodwill 25,054
-----------
Total purchase price $ 36,107
===========
14
The value allocated to goodwill in ECtel will be deducted for income
tax purposes.
The summary unaudited pro forma condensed consolidated results of
operations for the three months ended October 31, 2004, assuming the
acquisitions of RP Security and Opus had occurred at the beginning of
the period, would have reflected consolidated revenues of
approximately $66,277,000, net income of approximately $4,809,000,
basic earnings per share of $0.15 and diluted earnings per share of
$0.15. The summary unaudited pro forma condensed consolidated results
of operations for the nine months ended October 31, 2004, assuming the
acquisitions of RP Security, ECtel and Opus had occurred at the
beginning of the period, would have reflected consolidated revenues of
approximately $189,752,000, net income of approximately $8,850,000,
basic earnings per share of $0.29 and diluted earnings per share of
$0.27.
The summary unaudited pro forma condensed consolidated results of
operations for the three months ended October 31, 2005, assuming the
acquisition of Opus had occurred at the beginning of the period, would
have reflected consolidated revenues of approximately $78,921,000, net
income of approximately $7,000,000, basic earnings per share of $0.22
and diluted earnings per share of $0.21. The summary unaudited pro
forma condensed consolidated results of operations for the nine months
ended October 31, 2005, assuming the acquisition of Opus had occurred
at the beginning of the period, would have reflected consolidated
revenues of approximately $233,288,000, net income of approximately
$21,880,000, basic earnings per share of $0.69 and diluted earnings
per share of $0.66.
These pro forma results are not necessarily indicative of what would
have occurred if the acquisitions had been in effect for the period
presented. In addition, the pro forma results are not necessarily
indicative of the results that will occur in the future and do not
reflect any potential synergies that might arise from the combined
operations.
11. INTANGIBLE ASSETS
The composition of intangible assets at January 31, 2005 and October
31, 2005 is as follows:
JANUARY 31, OCTOBER 31,
USEFUL LIFE 2005 2005
----------- ---- ----
(In thousands)
Sales backlog Up to 3 years $ 3,249 $ 4,088
Acquired technology 3 to 5 years 6,902 6,917
Customer relationships 5 years 2,239 2,647
Non-competition agreements 1.5 to 10 years 3,540 3,632
Trade names 1 to 3 years 255 995
---------- ----------
16,185 18,279
Less accumulated amortization 4,159 7,964
---------- ----------
$ 12,026 $ 10,315
========== ==========
15
Amortization of intangible assets was approximately $817,000 and
$1,518,000 for the three months ended October 31, 2004 and 2005,
respectively, and approximately $1,858,000 and $3,791,000 for the nine
months ended October 31, 2004 and 2005, respectively.
Estimated amortization expense for each of the five succeeding fiscal
years is as follows:
YEAR ENDING JANUARY 31, (In thousands)
2006 $ 5,430
2007 $ 3,191
2008 $ 2,043
2009 $ 1,817
2010 $ 820
12. GOODWILL
Changes in goodwill for the year ended January 31, 2005 ("fiscal
2004"), and for the nine months ended October 31, 2005, are as
follows:
(In thousands)
BALANCE AT JANUARY 31, 2004 $ 14,364
Acquisition of ECtel 25,054
Acquisition of RP Security 9,164
Foreign exchange translation and other 1,043
----------
BALANCE AT JANUARY 31, 2005 49,625
Earn-out for RP security purchase 455
Acquisition of Opus 9,444
Foreign exchange translation and other (262)
---------
BALANCE AT OCTOBER 31, 2005 $ 59,262
==========
13. BUSINESS SEGMENT INFORMATION
The Company operates in one business segment - providing actionable
intelligence solutions. The Company's solutions collect, retain, and
analyze voice, fax, video, email, Internet and data transmissions from
voice, video and IP networks for the purpose of generating actionable
intelligence for decision makers to take more effective action. The
Company manages its business on a geographic basis. Summarized
financial information for the Company's reportable geographic segments
is presented in the following table. Sales in each geographic segment
represent sales originating from that segment.
16
UNITED UNITED RECONCILING CONSOLIDATED
STATES ISRAEL KINGDOM CANADA GERMANY OTHER ITEMS TOTALS
------ ------ ------- ------ ------- ----- ----- ------
THREE MONTHS ENDED
OCTOBER 31, 2004: (IN THOUSANDS)
-----------------
Sales $ 35,481 $ 22,144 $ 7,807 $ 4,107 $ 2,926 $ 264 $ (8,740) $ 63,989
Costs and expenses (29,098) (22,063) (8,422) (4,365) (3,879) (498) 9,391 (58,934)
----------- ----------- ----------- ----------- ----------- ----------- ---------- -----------
Operating income
(loss) $ 6,383 $ 81 $ (615) $ (258) $ (953) $ (234) $ 651 $ 5,055
=========== =========== =========== =========== =========== =========== ========== ===========
THREE MONTHS ENDED
OCTOBER 31, 2005:
-----------------
Sales $ 31,811 $ 33,255 $ 8,439 $ 7,332 $ 6,676 $ 1,248 $ (10,523) $ 78,238
Costs and expenses (30,873) (28,301) (8,905) (6,258) (6,129) (1,198) 10,993 (70,671)
----------- ----------- ----------- ----------- ----------- ----------- ---------- -----------
Operating income
(loss) $ 938 $ 4,954 $ (466) $ 1,074 $ 547 $ 50 $ 470 $ 7,567
=========== =========== =========== =========== =========== =========== ========== ===========
UNITED UNITED RECONCILING CONSOLIDATED
STATES ISRAEL KINGDOM CANADA GERMANY OTHER ITEMS TOTALS
------ ------ ------- ------ ------- ----- ----- ------
NINE MONTHS ENDED
OCTOBER 31, 2004: (IN THOUSANDS)
-----------------
Sales $ 90,975 $ 68,008 $ 22,878 $ 14,361 $ 7,904 $ 1,184 $ (24,516) $ 180,794
Costs and expenses (79,139) (68,500) (23,648) (11,557) (9,283) (1,843) 24,444 (169,526)
----------- ----------- ----------- ----------- ----------- ----------- ---------- -----------
Operating income
(loss) $ 11,836 $ (492) $ (770) $ 2,804 $ (1,379) $ (659) $ (72) $ 11,268
=========== =========== =========== =========== =========== =========== ========== ===========
NINE MONTHS ENDED
OCTOBER 31, 2005:
-----------------
Sales $ 95,297 $ 95,554 $ 24,481 $ 22,071 $ 21,158 $ 3,245 $ (36,820) $ 224,986
Costs and expenses (88,717) (83,067) (24,751) (19,243) (20,049) (3,485) 36,200 (203,112)
----------- ----------- ----------- ----------- ----------- ----------- ---------- -----------
Operating income
(loss) $ 6,580 $ 12,487 $ (270) $ 2,828 $ 1,109 $ (240) $ (620) $ 21,874
=========== =========== =========== =========== =========== =========== ========== ===========
Total assets by country of domicile consist of:
JANUARY 31, OCTOBER 31,
2005 2005
---- ----
(IN THOUSANDS)
United States $ 264,975 $ 281,534
Israel 117,017 151,944
United Kingdom 12,684 13,949
Canada 19,828 25,482
Germany 27,598 26,810
Other 2,540 1,692
Reconciling items (45,664) (50,270)
------------ ------------
$ 398,978 $ 451,141
============ ============
Reconciling items consist of the following:
Sales - elimination of inter-company revenues.
Operating income - elimination of inter-company operating income.
Total assets - elimination of inter-company receivables.
17
14. EMPLOYEE RESTRICTED STOCK
In December 2003 and 2004, the Company granted 72,700 and 65,000
shares of restricted stock, respectively, to certain key employees of
the Company. Unearned stock compensation of approximately $1,672,000
and $2,282,000 was recorded for 2003 and 2004, respectively, based on
the fair market value of the Company's common stock at the date of
grant, or $23.00 and $35.11 per share. Unearned stock compensation is
shown as a separate component of stockholders' equity and is being
amortized to expense over the four-year vesting period of the
restricted stock. Amortization of unearned stock compensation was
approximately $105,000 and $249,000 for the three months ended October
31, 2004 and 2005, respectively, and approximately $314,000 and
$739,000 for the nine months ended October 31, 2004 and 2005,
respectively, and was included in selling, general and administrative
expenses in the condensed consolidated statements of income. The
restricted stock has all the rights and privileges of the Company's
common stock, subject to certain restrictions and forfeiture
provisions. At October 31, 2005, all 137,700 shares were subject to
restriction.
15. RECENT ACCOUNTING PRONOUNCEMENTS
In April 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections," requiring retrospective application as the
required method for reporting a change in accounting principle, unless
impracticable or a pronouncement includes specific transition
provisions. This statement also requires that a change in
depreciation, amortization, or depletion method for long-lived,
non-financial assets be accounted for as a change in accounting
estimate effected by a change in accounting principle. This statement
carries forward the guidance in APB Opinion No. 20, "Accounting
Changes," for the reporting of the correction of an error and a change
in accounting estimate. This statement is effective for accounting
changes and correction of errors made in fiscal years beginning after
December 15, 2005. The adoption of SFAS No. 154 is not expected to
have a material effect on the Company's condensed consolidated
financial statements.
In December 2004, the FASB issued Statement of Financial Accounting
Standard ("SFAS") No. 123 (revised 2004), "Share-Based Payment",
("SFAS No.123(R)") which revises SFAS No. 123 and supersedes APB No.
25. In April 2005, the SEC amended Regulation S-X to modify the date
for compliance with SFAS No. 123(R). The provisions of SFAS No. 123(R)
must be applied beginning with the fiscal year beginning on or after
June 15, 2005, which for the Company is February 1, 2006 (the
"Effective Date"). SFAS No. 123(R) requires all share-based payments
to employees, including grants of employee stock options, to be valued
at fair value on the date of grant, and to be expensed over the
applicable vesting period. Pro forma disclosure of the income
statement effects of share-based payments is no longer an alternative.
Beginning on the Effective Date, the Company must (i) expense all
options granted after the Effective Date over the applicable vesting
period, and (ii) expense the non-vested portions of existing option
grants going forward over their remaining vesting period. Compensation
expense for the non-vested portions of existing option grants as of
the Effective Date will be recorded based on the fair value of the
awards previously calculated in developing the pro forma disclosures
in accordance with the provisions of SFAS No. 123. Under SFAS No.
123(R), the Company is required to adopt a fair value-based method for
measuring the compensation expense related to employee stock and stock
options awards; this will lead to substantial additional compensation
expense. Any such expense, although it will not affect the Company's
cash flows, will have a material negative impact on the Company's
reported results of operations.
18
In December 2004, the FASB issued SFAS No. 153, "Exchanges of
Non-monetary Assets - an amendment of APB Opinion No. 29." SFAS No.
153 amends APB No. 29 to eliminate the exception for non-monetary
exchanges of similar productive assets and replaces it with a general
exception for exchanges of non-monetary assets that do not have
commercial substance. A non-monetary exchange has commercial substance
if the future cash flows of the entity are expected to change
significantly as a result of the exchange. SFAS No. 153 is effective
for reporting periods beginning after June 15, 2005. The adoption of
SFAS No. 153 is not expected to have a material effect on the
Company's condensed consolidated financial statements.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - an
amendment of ARB No. 43, Chapter 4." SFAS No. 151 clarifies the
accounting for abnormal amounts of idle facility expense, freight,
handling costs, and wasted material (spoilage) by requiring that such
items be recognized as current-period charges regardless of whether
they meet the ARB No. 43, Chapter 4 criterion of "so abnormal." In
addition, SFAS No. 151 requires that allocation of fixed production
overheads to the costs of conversion be based on the normal capacity
of the production facilities. SFAS No. 151 is effective for inventory
costs incurred during fiscal years beginning after June 15, 2005. The
adoption of SFAS No. 151 is not expected to have a material effect on
the Company's condensed consolidated financial statements.
In March 2004, the Emerging Issues Task Force ("EITF") of the FASB
reached a consensus on EITF Issue No. 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments", which provides additional guidance for assessing
impairment losses on investments. Additionally, EITF 03-1 includes new
disclosure requirements for investments that are deemed to be
temporarily impaired. In September 2004, the FASB delayed the
accounting provisions of EITF 03-1; however the disclosure
requirements were effective for annual periods ending after June 15,
2004. The Company will evaluate the impact of EITF 03-1 once final
guidance is issued, however the adoption of EITF 03-1 in its current
form is not expected to have a material effect on the Company's
condensed consolidated financial statements.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
CRITICAL ACCOUNTING POLICIES
Our discussion of results of operations and financial condition relies on our
consolidated financial statements that are prepared based on certain critical
accounting policies that require management to make judgments and estimates that
are subject to varying degrees of uncertainty. We believe that investors need to
be aware of these policies and how they impact our financial statements as a
whole, as well as our related discussion and analysis presented herein. While we
believe that these accounting policies are based on sound measurement criteria,
actual future events can and often do result in outcomes that can be materially
different from these estimates or forecasts. The accounting policies and related
risks described in our Annual Report on Form 10-K for the year ended January 31,
2005 are those that depend most heavily on these judgments and estimates. As of
October 31, 2005, there have been no material changes to any of the critical
accounting policies contained therein.
RESULTS OF OPERATIONS
SUMMARY OF RESULTS
Consolidated results of operations in dollars and as a percentage of
sales for each of the three month and nine month periods ended October 31, 2004
and 2005 were as follows:
THREE MONTHS THREE MONTHS
ENDED ENDED
OCTOBER 31, OCTOBER 31,
------- -------
2004 % OF SALES 2005 % OF SALES
---- ---------- ---- ----------
Sales $ 63,989 100.0% $ 78,238 100.0%
Cost of Sales 29,235 45.7% 34,360 43.9%
---------- ---------- ---------- ----------
Gross profit 34,754 54.3% 43,878 56.1%
Operating expenses:
Research and development, net 8,409 13.1% 10,039 12.8%
Selling, general and administrative 21,290 33.3% 26,272 33.6%
---------- ---------- ---------- ----------
Income from operations 5,055 7.9% 7,567 9.7%
Interest and other income, net 932 1.5% 1,982 2.5%
---------- ---------- ---------- ----------
Income before income tax provision 5,987 9.4% 9,549 12.2%
Income tax provision 807 1.3% 2,241 2.9%
---------- ---------- ---------- ----------
Net income $ 5,180 8.1% $ 7,308 9.3%
========== ========== ========== ==========
20
NINE MONTHS NINE MONTHS
ENDED ENDED
OCTOBER 31, OCTOBER 31,
----------- -----------
2004 % OF SALES 2005 % OF SALES
---- ---------- ---- ----------
Sales $ 180,794 100.0% $ 224,986 100.0%
Cost of Sales 82,098 45.4% 99,860 44.4%
----------- ----------- ----------- -----------
Gross profit 98,696 54.6% 125,126 55.6%
Operating expenses:
Research and development, net 23,089 12.8% 29,035 12.9%
Selling, general and administrative 59,704 33.0% 74,217 33.0%
In-process research and development 3,154 1.7% - -
Write-down of capitalized software 1,481 0.8% - -
----------- ----------- ----------- -----------
Income from operations 11,268 6.2% 21,874 9.7%
Interest and other income, net 2,379 1.3% 5,361 2.4%
----------- ----------- ----------- -----------
Income before income tax provision 13,647 7.5% 27,235 12.1%
Income tax provision 1,282 0.7% 6,257 2.8%
----------- ----------- ----------- -----------
Net income $ 12,365 6.8% $ 20,978 9.3%
=========== =========== =========== ===========
NINE MONTH AND THREE MONTH PERIODS ENDED OCTOBER 31, 2005
COMPARED TO NINE MONTH AND THREE MONTH PERIODS ENDED OCTOBER 31, 2004
SALES. Sales for the nine month and three month periods ended October 31, 2005
increased by approximately $44.2 million, or 24.4%, and $14.2 million, or 22.3%,
respectively, as compared to the nine month and three month periods ended
October 31, 2004. This increase reflected an increase in both sales of products
of approximately $31.1 million and $7.9 million and service revenue of
approximately $13.1 million and $6.3 million, in the nine month and three month
periods ended October 31, 2005 as compared to the nine month and three month
periods ended October 31, 2004, respectively, and was attributable to higher
sales volume of both the Company's security and business intelligence solutions.
For the nine month and three month periods ended October 31, 2005, the Company
generated approximately 47% and 48%, respectively, of its sales from the
Americas region, 35% for both periods from the Europe, Middle East and Africa
region ("EMEA"), and 18% and 17%, respectively, from the Asia Pacific region
("APAC").
The Company sells its products in multiple configurations and the price of any
particular product varies depending on the configuration of the product sold.
Due to the variety of customized configurations for each product that the
Company sells, it is unable to quantify the effects of a change in the price of
any particular product and/or a change in the number of products sold on its
revenues. Sales to international customers as a percentage of total sales
represented approximately 58% and 59%, respectively, for the nine month and
three month periods ended October 31, 2005, as compared to approximately 51% and
48%, respectively, for the nine month and three month periods ended October 31,
2004.
21
COST OF SALES. Cost of sales consists primarily of material and overhead costs,
operation and service personnel costs, amortization of capitalized software and
purchased intangible assets, and royalties. Cost of sales for the nine month and
three month periods ended October 31, 2005 increased by approximately $17.8
million, or 21.6%, and $5.1 million, or 17.5%, respectively, as compared to the
nine month and three month periods ended October 31, 2004. This increase was
attributable to an increase in material and overhead costs of approximately $9.7
million and $1.4 million, respectively, due to higher sales volumes, an increase
in personnel related costs of approximately $1.7 million and $0.8 million,
respectively, primarily as a result of an increase in the number of service
department personnel and increased personnel compensation, an increase in
subcontracting expenses of approximately $2.8 million and $0.8 million,
respectively, an increase in depreciation and amortization expenses of
approximately $1.8 million and $0.6 million, and an increase in other expenses
of approximately $1.8 million and $1.5 million, respectively, mainly due to
increased travel and royalties expenses. Gross margins increased to 55.6% and
56.1%, respectively, in the nine month and three month periods ended October 31,
2005, from 54.6% and 54.3%, respectively, in the nine month and three month
periods ended October 31, 2004.
RESEARCH AND DEVELOPMENT EXPENSES, NET. Research and development ("R&D")
expenses consist primarily of personnel and subcontracting expenses and
allocated overhead, net of certain software development costs that are
capitalized as well as reimbursement under government and other programs.
Software development costs are capitalized upon the establishment of
technological feasibility and until related products are available for general
release to customers. Research and development expenses, net, for the nine month
and three month periods ended October 31, 2005 increased by approximately $5.9
million and $1.6 million, respectively, or 25.8% and 19.4%, respectively, as
compared to the nine month and three month periods ended October 31, 2004. The
increase was attributable to an increase in personnel related costs amounting to
approximately $3.9 million and $1.0 million, respectively, and an increase of
approximately $2.0 million and $0.6 million, respectively, in other expenses.
Capitalization of software development costs amounted to approximately $3.2
million and $1.1 million for the nine month and three month periods ended
October 31, 2004 respectively, and approximately $3.0 million and $0.9 million
for the nine month and three month periods ended October 31, 2005, respectively.
Reimbursement of research and development expenses amounted to approximately
$3.2 million and $0.9 million for the nine month and three month periods ended
October 31, 2004 respectively, and $3.8 million and $1.6 million for the nine
month and three month periods ended October 31, 2005, respectively. Research and
development expenses, net, as a percentage of sales, was 12.9% and 12.8% for the
nine month and three month periods ended October 31, 2005, respectively,
compared to 12.8% and 13.1% , respectively, for the nine month and three month
periods ended October 31, 2004.
Historically, the Company has received more reimbursement for R&D expenses
partially funded by the Office of the Chief Scientist of the Ministry of
Industry and Trade of the State of Israel (the "OCS") in a given fiscal year
than it has had to pay to the OCS in royalties during that fiscal year. More
recently, however, the Company has been paying, and continues to expect to pay,
more in royalties to the OCS than it receives in reimbursement from the OCS for
R&D expenses in a given fiscal year. In fiscal year 2004 and in the nine months
ended October 31, 2005, the Company recorded a net expense of $1.6 million and
$1.1 million, respectively, representing the difference between OCS royalties
accrued and reimbursement received from OCS. As of October 31, 2005, the Company
has received approximately $59.7 million in cumulative grants and has recorded
approximately $30.6 million of cumulative royalties to the OCS. The Company
continues to evaluate whether to participate in a program offered by the OCS to
pay a lump sum royalty amount for past amounts received from the OCS and has
started preliminary discussions with the OCS in that regard. The Company
believes it could reach agreement with the OCS regarding participating in such
program as early as the first calendar quarter of 2006. Assuming the Company
elects to participate in this program it may be required to pay as much as the
difference between the cumulative grants received and the cumulative royalties
paid plus interest and other charges. This would significantly reduce or
eliminate the Company's net income for a given fiscal year and might cause the
Company to report a loss for the fiscal year in which the program is entered
into which would have a material adverse effect on the Company's operating
results.
22
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses consist primarily of personnel costs and related
expenses, sales and marketing expenses, including travel and agent commission,
and other administrative expenses. Selling, general and administrative expenses
for the nine month and three month periods ended October 31, 2005 increased by
approximately $14.5 million, or 24.3% and $5.0 million, or 23.4%, respectively,
as compared to the nine month and three month periods ended October 31, 2004.
This increase was attributable to an increase in compensation and benefits for
existing personnel and increase in headcount to support the increased level of
sales amounting to approximately $8.5 million and $3.0 million, respectively, an
increase in agent commissions of approximately $2.1 million and $1.7 million,
respectively, an increase in rent and utility expenses of approximately $1.5
million and $0.8 million, respectively, and an increase (decrease) in other
expenses of approximately $2.4 million and ($0.5 million), respectively.
Selling, general and administrative expenses as a percentage of sales increased
to 33.0% and 33.6%, for the nine month and three month periods ended October 31,
2005, from 33.0% and 33.3% for the nine month and three month periods ended
October 31, 2004.
IN-PROCESS RESEARCH AND DEVELOPMENT. In the nine month period ended October 31,
2004, purchased in-process research and development of approximately $3.2
million, resulting from the purchase of ECtel's government surveillance
business, was charged to expense at the date of acquisition (see also Note 10 of
the Notes to the Condensed Consolidated Financial Statements).
WRITE-DOWN OF CAPITALIZED SOFTWARE. As a result of the acquisition of ECtel's
government surveillance business, the Company had certain capitalized software
development costs that became impaired due to the existence of duplicative
technology and, accordingly, were written-down to their net realizable value at
the date of acquisition. Such impairment charge amounted to approximately $1.5
million, and was recorded in the three months ended April 30, 2004.
INTEREST AND OTHER INCOME, NET. Net interest and other income for the nine month
and three month periods ended October 31, 2005 increased by approximately $3.0
million and $1.0 million, respectively, as compared to the nine month and three
month periods ended October 31, 2004. This increase was attributable to
increased interest income of approximately $3.6 million and $1.2 million,
respectively, due to an increase in interest rates and an increase in interest
bearing short-term investments, partially offset by a decrease in income from
the Company's minority interest in its Singapore affiliate of $0.3 million and
$0.1 million, an increase in foreign currency losses and other items of
approximately $0.3 million and $0.1 million.
INCOME TAX PROVISION. Income tax provision of approximately $6.3 million and
$2.2 million, respectively, was recorded for the nine month and three month
periods ended October 31, 2005 as compared to approximately $1.3 million and
$0.8 million recorded in the nine month and three month periods ended October
31, 2004, respectively. The overall effective tax rate increased to 23.0% and
23.5%, for the nine month and three month periods ended October 31, 2005,
respectively, as compared to an effective tax rate of 9.4% and 13.5% for the
nine month and three month periods ended October 31, 2004, respectively. The
increase in tax provision for the nine month and three month periods ended
October 31, 2005 was mainly attributable to the significant reduction of the
Company's net operating loss carry forwards in the United States by the end of
fiscal 2004, which caused the Company to record income tax provision for the
profits of its U.S. operations. The Company expects its effective tax rate for
the fiscal year ended January 31, 2006 ("fiscal 2005") to increase significantly
as compared to fiscal 2004. The Company's effective tax rate for fiscal 2005 is
expected to remain relatively low as compared to the U.S. federal tax rate. This
reflects the use of net operating loss carry-forwards in certain tax
23
jurisdictions as well as the tax benefits associated with qualified activities
of the Company's Israeli subsidiary, which is entitled to favorable income tax
rates under a program of the Israeli Government for "Approved Enterprise"
investments in that country. To the extent that the Company continues to be
profitable in certain tax jurisdictions, it will continue to use net operating
loss carry forwards in these jurisdictions. When the Company ceases to have net
operating loss carry forwards available to it in a tax jurisdiction, the
Company's effective tax rate would increase in that jurisdiction.
NET INCOME. Net income for the nine month and three month periods ended October
31, 2005 increased by approximately $8.6 million, or 70%, and $2.1 million, or
41%, as compared to the nine month and three month periods ended October 31,
2004, respectively. As a percentage of sales, net income was approximately 9.3%
in both the nine month and three month periods ended October 31, 2005, as
compared to approximately 6.8% and 8.1% in the nine month and three month
periods ended October 31, 2004, respectively. The change resulted primarily from
the factors described above.
LIQUIDITY AND CAPITAL RESOURCES
As of October 31, 2005, the Company had cash and cash equivalents of
approximately $58.0 million, bank time deposits of approximately $2.3 million,
short-term investments of $206.2 million and working capital of approximately
$215.5 million. As of January 31, 2005, the Company had cash and cash
equivalents of approximately $45.1 million, short-term investments of $195.3
million and working capital of approximately $196.4 million.
Operating activities for the nine month period ended October 31, 2004 and 2005,
after adjustment for non-cash items, provided cash of approximately $27.3
million and $34.8 million, respectively. Other changes in operating assets and
liabilities provided cash of approximately $11.9 million and $5.6 million for
the nine months ended October 31, 2004 and 2005, respectively. This resulted in
cash provided by operating activities of approximately $39.2 million and $40.4
million for the nine months ended October 31, 2004 and 2005, respectively.
Investing activities for the nine months ended October 31, 2004 and 2005 used
cash of approximately $65.7 million and $35.9 million, respectively. For the
nine months ended October 31, 2004, these amounts include cash paid for the
acquisition of ECtel's government surveillance business of approximately $36.1
million, cash paid for the acquisition of RP Security of approximately $9.3
million, purchase of property and equipment of approximately $5.1 million,
capitalization of software development costs of approximately $3.2 million and
net purchases of short-term securities of approximately $12.0 million. For the
nine months ended October 31, 2005, these amounts include cash paid for the
acquisition of Opus (net of cash acquired of approximately $0.6 million) of
approximately $11.5 million, net purchases of short-term securities and bank
time deposits of approximately $13.3 million, purchase of property and equipment
of approximately $8.1 million, capitalization of software development costs of
approximately $3.0 million, and other investments of approximately $0.4 million,
net of proceeds from sale of property and equipment of approximately $0.3
million.
Financing activities for the nine month periods ended October 31, 2004 and 2005
provided cash of approximately $11.5 million and $8.4 million, respectively. For
the nine month periods ended October 31, 2004 and 2005, proceeds from the
issuances of common stock provided cash of approximately $11.0 million and $9.0
million, respectively. Net borrowings (repayments) of bank loans and other debt
provided (used) cash of approximately $0.5 million and ($0.6) million in the
nine month periods ended October 31, 2004 and 2005, respectively.
On September 1, 2005, the Company, through a newly-formed subsidiary, acquired
certain of the assets and liabilities of The Opus Group, LLC, a privately-held
provider of performance analytics solutions for contact centers and back office
operations. The acquisition extends the Company's ability to help its customers
generate actionable intelligence and enhance the effectiveness of their contact
center and back office operations. The purchase price consisted of $12 million
in cash at closing and additional earn-out payments over two years based on
certain profitability targets.
24
On September 2, 2004, the Company, through a subsidiary, acquired all of the
outstanding stock of RP Security, a company in the business of developing and
selling mobile digital video security solutions for transportation applications.
The Company paid approximately $9,028,000 in cash and 90,144 shares of the
Company's common stock for RP Security. In addition, the shareholders of RP are
entitled to receive earn-out payments over the three year period following the
closing based on the Company's worldwide sales, profitability and backlog of
mobile video products in the transportation market during that period. For the
period ending January 31, 2005, the shareholders of RP earned approximately
$455,000.
On August 20, 2004, the Company entered into a lease agreement for the lease of
approximately 145,000 square feet of office and storage space for manufacturing,
development, support and sales facilities in Herzlia, Israel for a term of ten
years. Occupancy of the new building and rent payments commenced in October
2005. Annual rent payments are expected to be approximately $2.5 million. The
new lease agreement replaced the lease agreement for the Company's prior
building in Israel.
On March 31, 2004, the Company acquired certain assets and assumed certain
liabilities of the government surveillance business of ECtel. The purchase price
consisted of $35 million in cash. In connection with this acquisition, the
Company incurred transaction costs, consisting primarily of professional fees,
amounting to approximately $1.1 million (see also Note 10 of the Notes to the
Condensed Consolidated Financial Statements).
The ability of the Company's Israeli subsidiary to pay dividends is governed by
Israeli law, which provides that dividends may be paid by an Israeli corporation
only out of its 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. In the event of a devaluation of the Israeli currency against the
U.S. dollar, the amount in U.S. dollars available for payment of cash dividends
out of prior years' earnings will decrease accordingly. Cash dividends paid by
an Israeli corporation to U.S. resident corporate parents are subject to the
Convention for the Avoidance of Double Taxation between Israel and the United
States. Under the terms of the Convention, such dividends are subject to
taxation by both Israel and the United States and, in the case of Israel, such
dividends out of income derived in respect of a period for which an Israeli
company is entitled to the reduced tax rate applicable to an Approved Enterprise
are generally subject to withholding of Israeli income tax at source at a rate
of 15%. The Israeli company is also subject to additional Israeli taxes in
respect of such dividends, generally equal to the tax benefits previously
granted in respect of the underlying income by virtue of the Approved Enterprise
status.
The Company believes that its current cash balances and potential cash flows
from operations will be sufficient to meet the Company's anticipated cash needs
for working capital, capital expenditures and other activities for at least the
next 12 months. Thereafter, if current sources are not sufficient to meet the
Company's needs, the Company may seek additional debt or equity financing. In
addition, although there is no present understanding, commitment or agreement
with respect to any acquisition of other businesses, products, or technologies
(other than with respect to MultiVision as described elsewhere herein), the
Company may in the future consider such transactions. In the event the Company
pursues such acquisitions, its current cash balances and potential cash flow
from operations may not be sufficient to consummate such acquisitions. As a
result, the Company may require additional debt or equity financing and could
have a decrease of its working capital.
25
RECENT DEVELOPMENTS
On September 7, 2005, the Company entered into a definitive agreement with
MultiVision Intelligent Surveillance Limited ("MultiVision") to acquire
substantially all of its networked video security business. Under the agreement,
the Company would pay approximately $48 million, subject to certain adjustments.
The consideration will consist of cash, provided that, the definitive agreement
allows the Company, at its sole option, to substitute shares of Company common
stock for up to 70% of the adjusted purchase price paid at closing. On November
1, 2005, the Company provided irrevocable notice to MultiVision that it would
not issue shares of its common stock as part of the purchase price. The Company
will therefore pay the full purchase price in cash. The acquisition is expected
to close in January 2006, subject to a number of conditions, including approval
by MultiVision's shareholders.
CERTAIN TRENDS AND UNCERTAINTIES
The Company's primary business is providing analytic software-based solutions
for communications interception, networked video security and surveillance, and
business intelligence. Recent legislative and regulatory actions have provided
greater surveillance powers to law enforcement agencies, imposed strict
requirements on communications service providers to facilitate interception of
communications over public networks, and increased the security measures being
implemented at public facilities such as airports. However, the Company cannot
be assured that these legislative and regulatory actions will result in
increased demand for or purchasing of solutions such as those offered by the
Company or, if it does, that such solutions will be purchased from the Company.
If demand for or purchasing of the Company's solutions does not increase as
anticipated, the Company may not be able to sustain or increase profitability on
a quarterly or annual basis.
It is difficult for the Company to forecast the timing of revenues from product
sales because customers often need a significant amount of time to evaluate its
products before purchasing them and, in the case of governmental customers,
sales are dependent on budgetary and other bureaucratic processes. The period
between initial customer contact and a purchase by a customer may vary from
three months to more than a year. During the evaluation period, customers may
defer or scale down proposed orders of the Company's products for various
reasons, including: (i) changes in budgets and purchasing priorities; (ii)
reduced need to upgrade existing systems; (iii) deferrals in anticipation of
enhancements or new products; (iv) introduction of products by the Company's
competitors; and (v) lower prices offered by the Company's competitors.
The Company faces aggressive competition from numerous and varied competitors in
all areas of its business. Because of this aggressive competition and the fact
that many of the Company's customers and potential customers make decisions to
purchase largely based on price, the Company may have to lower the prices of
many of its products and services or increase efficiencies and capacity. This
can affect the Company because:
o the Company may not be able to maintain or improve revenue and gross
margin with its current cost structure, and therefore its
profitability could be materially and adversely affected.
o in the face of increased pricing pressure and an effort to maintain or
improve revenue and gross margin, the Company may have to reduce
costs. For example, the Company invests a significant amount in
research and development, which the Company views as necessary for its
long-term competitiveness. If, to decrease its cost structure, the
Company reduces its investment in research and development, the
Company may adversely impact its long-term competitiveness in an
effort to maintain or improve its revenue and income in the
short-term.
26
Even if the Company is able to maintain or increase market share for a
particular product, revenue could decline due to increased competition from
other types of products or because the product is in a maturing industry.
Because of the intensely competitive markets in which the Company operates, the
Company's competitors may simply execute better than the Company and,
resultantly, reduce the Company's market share. Some of the Company's
competitors have, in relation to it, longer operating histories, larger customer
bases, longer standing relationships with customers, greater name recognition
and significantly greater financial, technical, marketing, customer service,
public relations, distribution and other resources. Further, there has been
significant consolidation among the Company's competitors, improving the
competitive position of several of its competitors. If the Company's competitors
are able to achieve a competitive position superior to that of the Company, the
Company's market share and, therefore, results of operations, may be materially
and adversely affected.
The Company's competitors may be able to more quickly develop or adapt to new or
emerging technologies or respond to changes in customer requirements, or to
devote greater resources to the development, promotion and sale of their
products. New competitors continue to emerge and there continues to be
consolidation among existing competitors which may reduce the Company's market
share. In addition, some of the Company's customers and partners may in the
future decide to internally develop their own solutions instead of purchasing
them from the Company. Increased competition could force the Company to lower
its prices or take other actions to differentiate its products.
The global market for analytic solutions for security and business applications
is competitive not only in the number and breadth of competing companies and
products, but also in the manner in which products are sold. For example, the
Company often competes for customer contracts through a competitive bidding
process that subjects it to risks associated with: (i) the frequent need to bid
on programs in advance of the completion of their design, which may result in
unforeseen technological difficulties and cost overruns; and (ii) the
substantial time and effort, including design, development and marketing
activities, required to prepare bids and proposals for contracts that may not be
awarded to the Company. Even where the Company is not involved in a competitive
bidding process, due to the intense competition in the Company's markets and
increasing customer demand for shorter delivery periods, the Company must in
some cases begin implementation of a project before the corresponding order has
been finalized, increasing the risk that the Company will have to write off
expenses associated with orders that do not come to fruition.
Approximately half of the Company's revenues are generated by sales made through
strategic and technology partners, distributors, value added resellers and
systems integrators. In addition, many of these sales channels also partner with
the Company's competitors and may even offer the products of both the Company
and its competitors when presenting bids to customers. Further, competitors
often seek to establish exclusive relationships with these sales channels or, at
a minimum, to become a preferred partner for these channels. The Company's
ability to achieve revenue growth depends to a significant extent on maintaining
and adding to these sales channels. If the Company's relationships with these
sales channels deteriorate or terminate, the Company may lose important sales
and marketing opportunities.
The Company derives a significant amount of its revenues from various government
contracts worldwide. The Company expects that government contracts will continue
to be a significant source of its revenues for the foreseeable future. The
Company's business generated from government contracts may be materially and
adversely affected if: (i) its reputation or relationship with government
agencies is impaired; (ii) it is suspended or otherwise prohibited from
contracting with a domestic or foreign government or any significant law
27
enforcement agency; (iii) levels of government expenditures and authorizations
for law enforcement and security related programs decrease, remain constant or
shift to programs in areas where the Company does not provide products and
services; (iv) it is prevented from entering into new government contracts or
extending existing government contracts based on violations or suspected
violations of laws or regulations, including those related to procurement; (v)
it is not granted security clearances that are required to sell its products to
domestic or foreign governments or such security clearances are revoked; (vi)
there is a change in government procurement procedures; or (vii) there is a
change in political climate that adversely affects the Company's existing or
prospective relationships.
The Company's quarterly operating results are difficult to predict and may
fluctuate significantly in the future, which in turn may result in volatility in
its stock price. The following factors, among others, many of which are outside
the Company's control, can cause fluctuations in the Company's operating results
and volatility in the Company's stock price: (i) the size, timing, terms and
conditions of orders from and shipments to the Company's customers; (ii)
unpredictability in the growth in the security and business intelligence
markets; (iii) unanticipated delays or problems in releasing new products; (iv)
continued fluctuation in the Company's tax rate; (v) the timing and success of
its customers' deployment of the Company's products and services; (vi) the
amount and timing of the Company's investments in research and development
activities; (vii) costs associated with providing the Company's goods and
services; (viii) the fluctuation of foreign currency exchange rates; and (ix)
the impairment or devaluation of the Company's assets (for instance, intangibles
or goodwill).
To the extent that the Company continues to be profitable in certain tax
jurisdictions, it will continue to use available net operating loss carry
forwards in these jurisdictions. When the Company ceases to have net operating
loss carry forwards available to it in a tax jurisdiction, the Company's
effective tax rate would increase in that jurisdiction. The Company's effective
tax rate is expected to increase substantially for fiscal 2005 as compared to
fiscal 2004, which could materially and adversely affect the Company's results
of operations.
The Company has continued to expand its gross margins primarily as a result of
reducing hardware as a part of its product offerings. This gross margin
expansion has contributed to the growth of the Company's net income at a rate
greater than the growth of its revenue. The Company's ability to continue to
expand gross margins in this manner is contingent upon a variety of factors,
principally that its customers obtain the hardware necessary to operate the
Company's software solutions from another vendor and that the Company not have
to significantly reduce its prices to remain competitive. If customers insist
that the Company provide all necessary hardware for its solutions, the Company
may not be able to continue to expand gross margins at the rate that it has or
at all, which would reduce the rate of growth of the Company's net income. If
the rate of growth of the Company's net income is reduced, it could materially
and adversely affect the share price of its Common Stock.
While it has no single customer that is material, the Company has many
significant customers and receives multi-million dollar orders from time to
time. The deferral or loss of one or more significant orders or customers or a
delay in an expected implementation of such an order could materially and
adversely affect the Company's operating results in any fiscal quarter,
particularly if there are significant sales and marketing expenses associated
with the deferred, lost or delayed sales. The Company bases its current and
future expense levels on its internal operating plans and sales forecasts, and
its operating costs are, to a large extent, fixed. As a result, the Company may
not be able to sufficiently reduce its costs in any quarter to compensate for an
unexpected near-term shortfall in revenues.
28
The Company has historically derived a significant portion of its sales from
contracts for large system installations with major customers. The Company
continues to emphasize sales to larger customers in its product development and
marketing strategies. Contracts for large installations typically involve a
lengthy and complex bidding and selection process, and the ability of the
Company to obtain particular contracts is inherently difficult to predict. The
timing and scope of these opportunities are difficult to forecast, and the
pricing and margins may vary substantially from transaction to transaction. The
Company's future operating results may accordingly exhibit a high degree of
volatility and may also be more volatile than the Company has experienced in
prior periods. The degree of dependence by the Company on large system orders,
and the investment required to enable the Company to perform such orders,
without assurance of continuing order flow from the same customers, increases
the risk associated with the Company's business. In particular, in pursuit of
major customers, the Company often engages in research and development
activities specifically for these potential customers. If these potential
customers ultimately decide not to purchase the Company's products, the Company
may obtain little or no benefit from these research and development activities,
as they may not be applicable to other customers. As a result, these costs may
not be recovered by the Company and may materially and adversely affect the
Company's financial results.
The Company's recent growth has strained its managerial and operational
resources. The Company's continued growth may further strain its resources,
which could hurt its business and results of operations. There can be no
assurance that the Company's managers will be able to manage growth effectively.
To manage future growth, the Company's management must continue to improve the
Company's operational, IT and financial systems, procedures and controls and
expand, train, retain and manage its employee base. If the Company's systems,
procedures and controls are inadequate to support its operations, the Company's
expansion could slow or come to a halt, and it could lose its opportunity to
gain significant market share. Any inability to manage growth effectively could
materially harm the Company's business, results of operations and financial
condition.
The markets for the Company's products are characterized by rapidly changing
technology and evolving industry standards. The introduction of products
embodying new technology and the emergence of new industry standards can render
the Company's existing products obsolete and unmarketable and can exert pricing
pressure on existing products. It is critical to the Company's success that it
is able to:
o anticipate changes in technology or in industry standards;
o successfully develop and introduce new, enhanced and competitive
products; and
o introduce these new and enhanced products on a timely basis with
high quality.
The Company may not be able to successfully develop new products or introduce
new applications for existing products. For example, the market for the
Company's communications interception solutions has been characterized by new
protocols as well as by increased use of encryption, and the Company's ability
to compete in this market is dependent on its ability to introduce products that
address these new developments. In addition, new products and applications
introduced by the Company - such as the Company's content analytics software -
may not achieve market acceptance or the introduction of new products or
technological developments by its competitors may render the Company's products
obsolete. If the Company is unable to introduce new products that address the
needs of its customers or that achieve market acceptance, there may be a
material and adverse impact on the Company's reputation with its customers and
its financial results.
29
The Company's products are complex and involve sophisticated technology that
performs critical functions to highly demanding standards. The Company's
existing and future products may develop operational problems. In addition, when
the Company introduces a product to the market or as it releases new versions of
an existing product, the product may contain undetected defects or errors. The
Company may not discover such defects, errors or other operational problems
until after a product has been released and used by the customer. Significant
costs may be incurred to correct undetected defects, errors or other operational
problems in the Company's products, including product liability claims. In
addition, defects or errors in the Company's products may result in questions
regarding the integrity of its products, which could cause adverse publicity and
impair their market acceptance, resulting in lost future sales.
The market for the Company's business intelligence solutions has been adversely
affected in the past by significant declines in information technology spending
and continues to be affected by fluctuations in information technology spending.
Continued fluctuations in information technology spending may cause companies to
reduce or, in extreme cases, eliminate, information technology spending. The
rate of information technology spending by the Company's customers in the near
term remains unclear and the Company is uncertain whether it will be able to
increase or maintain its revenues. If sales do not increase as anticipated or if
expenses increase at a greater pace than revenues, the Company may not be able
to sustain or increase profitability on a quarterly or annual basis.
The Company's products are often used by customers to compile and analyze highly
sensitive or confidential information and data, including information or data
used in intelligence gathering or law enforcement activities. The Company may
come into contact with such information or data when it performs support or
maintenance functions for its customers. While the Company has internal
policies, procedures and training for employees in connection with performing
these functions, even the perception that such potential contact may pose a
security risk or that any of the Company's employees has improperly handled
sensitive or confidential customer information or data could harm the Company's
reputation and could inhibit market acceptance of its products.
The Company depends on the continued services of its executive officers and
other key personnel. In addition, in order to continue to grow effectively, the
Company expects to need to attract and retain a substantial number of new
employees, including managers, sales and marketing personnel and technical
personnel, who understand and have experience with its products and services.
The market for such personnel is intensely competitive in most if not all of the
geographies in which the Company operates, and on occasion the Company has had
to relocate personnel to fill positions in locations where it could not attract
qualified experienced personnel. Further, the Company has in the past and may in
the future experience difficulty in recruiting or retaining qualified personnel
due to, for example, the market demand for their services or constraints on the
Company's ability to use equity compensation due to recent changes in accounting
rules. If the Company is unable to attract and retain qualified employees, its
ability to grow could be impaired. Further, if the costs of attracting and
retaining qualified personnel increase significantly, the Company's financial
results could be materially and adversely affected.
The markets for the Company's security and business intelligence products are
still emerging. The Company's growth is dependent on, among other things, the
size and pace at which the markets for its products develop. If the markets for
its products decrease, remain constant or grow slower than the Company
anticipates, the Company will not be able to maintain its growth. In addition,
in markets where the Company is a sole source supplier, the Company's growth may
be adversely impacted if customers seek to and succeed in developing alternative
sources for the Company's products. Continued growth in the demand for the
Company's products is uncertain as, among other reasons, its existing customers
and potential customers may: (i) not achieve a return on their investment in its
products; (ii) experience technical difficulty in utilizing its products; or
(iii) use alternative solutions to achieve their security or business
intelligence objectives. In addition, as the Company's business intelligence
products are sold primarily to contact centers, slower than anticipated growth
or a contraction in the number or size of contact centers will have a material
adverse effect on the Company's ability to maintain its growth.
30
On September 7, 2005, the Company entered into a definitive agreement with
MultiVision to acquire substantially all of its networked video security
business. The acquisition is subject to a number of conditions, including
approval by MultiVision's shareholders. The Company anticipates that the
acquisition will close in January 2006, however, there is no assurance that the
transaction will be consummated by such time or at all. Failure to consummate
the acquisition for any reason or significant delay in closing may cause the
value of the Company's common stock to decline. In addition, if the transaction
does not close, significant management time and effort will have been expended,
and costs related to the transaction, such as legal and accounting fees, will
still have to be paid, with no corresponding benefit to the Company.
On September 1, 2005, the Company, through a newly-formed subsidiary, acquired
certain of the assets and liabilities of The Opus Group, LLC, representing the
Company's first acquisition of a services-based business and its first
acquisition in the contact center market.
There is no assurance that the Company will be able to:
o successfully integrate this business into the Company's business,
including operations, facilities and related matters
o retain and integrate employees joining the Company with the
acquired business, including maintaining employee morale
o continue to successfully operate its own business while
management time and attention is diverted to integrating this
business
o improve upon the financial results of this business, or even
perform as well, or ensure that this business will not materially
and adversely affect the Company's financial results
o ensure that the customers of this business or the Company's own
customers will be confident in the Company's ability to
adequately deliver products and services.
On September 2, 2004, the Company acquired RP Security. If the Company is unable
to successfully integrate RP Security with its business, it may be unable to
realize the anticipated benefits of this acquisition. The Company may experience
technical difficulties that could delay the integration of RP Security's
products into the Company's solutions, resulting in business disruptions.
On March 31, 2004, the Company completed its acquisition of certain assets and
liabilities of ECtel comprising its communications interception business. As a
result of this acquisition, the Company and ECtel have a variety of ongoing
contractual relationships related to providing certain resources to one another
and fulfillment of certain obligations to former ECtel customers. If ECtel does
not perform its post-acquisition contractual obligations to the Company, the
Company may not continue to realize the benefits of the acquisition realized by
the Company or have a negative impact on the Company's operations and the
transitioning of ECtel's customers to the Company.
The Company's subsidiary, Verint Technology Inc. ("Verint Technology"), which
markets, sells and supports its communications interception solutions to, among
others, various U.S. government agencies, is required by the National Industrial
Security Program to maintain facility security clearances and to be insulated
from foreign ownership, control or influence. To comply with the National
Industrial Security Program requirements, in January 1999, the Company, Verint
Technology, Comverse Technology and the Department of Defense entered into a
proxy agreement with respect to the ownership and operations of Verint
Technology, which agreement was superseded in May 2001 to comply with the
Department of Defense's most recent requirements. Under the proxy agreement, the
Company, among other things, appointed three individuals, who are U.S. citizens,
holding the requisite security clearances as holders of proxies to vote the
Verint Technology stock. The proxy holders have the power to exercise all
prerogatives of ownership of Verint Technology. These three individuals are
responsible for the oversight of Verint Technology's security arrangements. The
proxy agreement may be terminated and Verint Technology's facility security
clearance may be revoked in the event of a breach of the proxy agreement, or if
it is determined by the Department of Defense that termination is in the
national interest. If Verint Technology's facility security clearance is
revoked, the Company may lose all or a substantial portion of its sales to U.S.
government agencies and its business, financial condition and results of
operations would be harmed. In addition, concerns about the security of the
Company or its products can materially and adversely affect Verint Technology's
sales to U.S. government agencies.
In addition to the clearances of Verint Technology, some of the Company's other
subsidiaries maintain clearances in certain other countries in connection with
the development, marketing and sale of its communications interception
solutions. These clearances are reviewed from time to time by the applicable
government agencies in these countries, and following review, these clearances
are either maintained or deactivated. These clearances can be deactivated for
many reasons, including that the clearing agencies in certain countries may
object to the fact that the Company does business in certain other countries or
the fact that the Company itself is a foreign corporation subject to foreign
influence. If the Company's clearances are deactivated in any particular
country, the Company may lose the ability to directly sell its communications
interception solutions in that country for projects that require security
clearances. Further, in order to continue to do classified business in that
country, the Company may have to sell through local systems integrators or
distributors with clearances. Additionally, any inability to obtain or maintain
clearances in a particular country may affect the Company's ability to sell its
communications interception solutions generally. Recently, a federal agency in a
particular country deactivated the federal-level security clearances of the
Company's subsidiary in that country, in part, because the subsidiary is
controlled by a company and personnel not from that country. Any inability to
obtain or maintain clearances can materially and adversely affect the Company's
financial performance.
Whether or not the Company is able to maintain security clearances, law
enforcement and intelligence agencies in certain countries may decline to
purchase communications interception solutions not developed or manufactured in
that country. As a result, because the Company's communications interception
solutions are developed and manufactured either in Israel or Germany, there may
be certain countries where some or all of the law enforcement and intelligence
agencies are unwilling to purchase the Company's communications interception
solutions. If the Company is unable to sell its communication interception
solutions in certain countries for this reason, its business and results of
operations could be materially and adversely affected.
The Company is required to obtain export licenses from the U.S., Israeli, German
and other governments to export some of the products that it develops or
manufactures in these countries, and to comply with applicable export control
laws generally. The Company cannot be assured that it will be successful in
obtaining or maintaining the licenses and other authorizations required to
export its products from applicable governmental authorities. In addition,
export laws and regulations are revised from time to time and can be extremely
complex in their application; if the Company is found not to have complied with
31
applicable export control laws, the Company may be penalized by, among other
things, having its ability to receive export licenses curtailed or eliminated
possibly for an extended period of time. The Company's failure to receive or
maintain any required export license or authorization or its penalization for
failure to comply with applicable export control laws would hinder its ability
to sell its products and could materially and adversely affect its business,
financial condition and results of operations.
Many of the Company's government contracts contain provisions that give the
governments party to those contracts rights and remedies not typically found in
private commercial contracts, including provisions enabling the governments to:
(i) terminate or cancel existing contracts for convenience; (ii) in the case of
the U.S. Government, suspend the Company from doing business with a foreign
government or prevent the Company from selling its products in certain
countries; (iii) audit and object to the Company's contract-related costs and
expenses, including allocated indirect costs; and (iv) change specific terms and
conditions in the Company's contracts, including changes that would reduce the
value of its contracts. In addition, many jurisdictions have laws and
regulations that deem government contracts in those jurisdictions to include
these types of provisions, even if the contracts themselves do not contain them.
If a government terminates a contract with the Company for convenience, the
Company may not recover its incurred or committed costs, any settlement
expenses, or profit on work completed prior to the termination. If a government
terminates a contract for default, the Company may not recover these amounts,
and, in addition, may be liable for any costs incurred by a government in
procuring undelivered items and services from another source. Further, an agency
within a government may share information regarding the Company's termination
with other government agencies. As a result, the Company's on-going or
prospective relationships with such other government agencies could be impaired.
The Company must comply with domestic and foreign laws and regulations relating
to the formation, administration and performance of government contracts. These
laws and regulations affect how the Company does business with government
agencies in various countries and may impose added costs on its business. For
example, in the United States, the Company is subject to the Federal Acquisition
Regulations, which comprehensively regulate the formation, administration and
performance of federal government contracts, and to the Truth in Negotiations
Act, which requires certification and disclosure of cost and pricing data in
connection with contract negotiations. The Company is subject to similar
regulations in foreign countries as well.
In August 2005, the European Parliament Directive 2002/96/EC (dated 27 January
2003) on Waste Electrical and Electronic Equipment Directive (the "WEEE
Directive") became effective in the European Union. The WEEE Directive requires
producers of certain electrical and electronic equipment to be financially
responsible for the future disposal costs of this equipment sold within the
European Union. In July 2006, the European Parliament Directive 2002/95/EC
(dated 27 January 2003) on Restriction of the Use of Certain Hazardous
Substances in Electrical and Electronic Equipment (the "RoHS Directive") will
become effective in the European Union. The RoHS Directive restricts the use of
certain hazardous substances, including mercury, lead, cadmium, hexavalent
chromium, and certain flame retardants, in the construction of component parts
of certain electrical and electronic equipment sold within the European Union.
The Company is currently assessing the applicability of these Directives, and
has begun implementing the WEEE Directive and making preparations and
arrangements to comply with the RoHS Directive, in each case, to the extent
applicable to the hardware portion of its solutions. As part of this process,
the Company will need to ensure that it has a supply of compliant components
from its suppliers. Ensuring compliance with these directives and coordinating
compliance activities with suppliers will result in additional costs to the
Company and may result in disruptions to operations. The Company cannot
currently estimate the extent of such additional costs or potential disruptions.
However, to the extent that any such costs or disruptions are substantial, the
Company's financial results could be materially and adversely affected.
32
If a government review or investigation uncovers improper or illegal activities,
depending on the nature of the activity, the Company may be subject to civil and
criminal penalties and administrative sanctions, including termination of
contracts, forfeiture of profits, suspension of payments, fines and suspension
or debarment from doing business with government agencies, and curtailment of
the Company's ability to obtain export licenses, which could materially and
adversely affect its business, financial condition and results of operations. In
addition, a government may reform its procurement practices or adopt new
contracting rules and regulations that could be costly to satisfy or that could
impair the Company's ability to obtain new contracts.
The Company has significant operations in foreign countries, including sales,
research and development, customer support and administrative service. The
countries in which the Company has its most significant foreign operations
include Israel, Germany, the United Kingdom and Canada, and the Company intends
to continue to expand its operations internationally. The Company's business may
suffer if it is unable to successfully expand and maintain foreign operations.
The Company's foreign operations are, and any future foreign expansion will be,
subject to a variety of risks, many of which are beyond its control, including
risks associated with: (i) foreign currency fluctuations; (ii) political,
security, and economic instability in foreign countries; (iii) changes in and
compliance with local laws and regulations, including tax laws, labor laws,
employee benefits, currency restrictions and other requirements; (iv)
differences in tax regimes and potentially adverse tax consequences of operating
in foreign countries; (v) customizing products for foreign countries; (vi) legal
uncertainties regarding liability, export and import restrictions, tariffs and
other trade barriers; (vii) hiring qualified foreign employees; and (viii)
difficulty in accounts receivable collection and longer collection periods. Any
or all of these factors could materially affect the Company's business or
results of operations. In addition, the tax authorities in the various
jurisdictions in which the Company operates may review from time to time the
pricing arrangements between the Company and its subsidiaries. An adverse
determination by one or more tax authorities in this regard may have a material
and adverse effect on the Company's financial results.
33
As the communications industry continues to evolve, governments may increasingly
regulate products that monitor and record voice, video and data transmissions
over public communications networks, such as the solutions that the Company
offers. For example, products which the Company sells in the United States to
law enforcement agencies and which interface with a variety of wireline,
wireless and Internet protocol networks, must comply with the technical
standards established by the Federal Communications Commission pursuant to the
Communications Assistance for Law Enforcement Act and products that the Company
sells in Europe must comply with the technical standards established by the
European Telecommunications Standards Institute. The adoption of new laws or
regulations governing the use of the Company's products or changes made to
existing laws or regulations could cause a decline in the use of its products
and could result in increased expenses for the Company, particularly if the
Company is required to modify or redesign its products to accommodate these new
or changing laws or regulations.
The Company incorporates software that it licenses from third parties into the
vast majority of its products. If the Company loses or is unable to maintain any
such software licenses, it could incur additional costs or experience unexpected
delays until equivalent software can be developed or licensed and integrated
into its products.
While the Company occasionally files patent applications, it cannot be assured
that patents will be issued on the basis of such applications or that, if such
patents are issued, they will be sufficiently broad to protect its technology.
In addition, the Company cannot be assured that any patents issued to it will
not be challenged, invalidated or circumvented.
In order to safeguard its unpatented proprietary know-how, trade secrets and
technology, the Company relies primarily upon trade secret protection and
non-disclosure provisions in agreements with employees and others having access
to confidential information. The Company cannot be assured that these measures
will adequately protect it from improper disclosure or misappropriation of its
proprietary information.
While the Company implements sophisticated security measures, third parties may
attempt to breach its security or inappropriately use its products through
computer viruses, electronic break-ins and other disruptions. If successful,
confidential information, including passwords, financial information or other
personal information may be improperly obtained and the Company may be subject
to lawsuits and other liability. Even if the Company is not held liable, such
security breaches could harm its reputation, and even the perception of security
risks, whether or not valid, could inhibit market acceptance of the Company's
products with both government and commercial purchasers.
34
The information technology industry is characterized by frequent allegations of
intellectual property infringement. In the past, third parties have asserted
that certain of the Company's products infringe their intellectual property, and
similar claims may be made in the future. Any allegation of infringement against
the Company could be time consuming and expensive to defend or resolve, result
in substantial diversion of management resources, cause product shipment delays,
or force the Company to enter into royalty or license agreements rather than
dispute the merits of such allegation. If patent holders or other holders of
intellectual property initiate legal proceedings against it, the Company may be
forced into protracted and costly litigation. The Company may not be successful
in defending such litigation and may not be able to procure any required royalty
or license agreements on terms acceptable to it, or at all. The Company
generally indemnifies its customers with respect to infringement by its products
of the proprietary rights of third parties. Third parties may assert
infringement claims against the Company's customers. These claims may require
the Company to initiate or defend protracted and costly litigation, regardless
of the merits of these claims. If any of these claims succeed, the Company may
be forced to pay damages or may be required to obtain licenses for the products
its customers use. If the Company cannot obtain all necessary licenses on
commercially reasonable terms, its customers may be forced to stop using, or, in
the case of value added resellers, stop selling, its products.
Although the Company generally uses standard parts and components in its
products, it does use some non-standard parts and equipment. The Company relies
on non-affiliated suppliers for the supply of certain standard and non-standard
components and on manufacturers of assemblies that are incorporated in all of
its products. The Company does not have long term supply or manufacturing
agreements with all of these suppliers and manufacturers. If these suppliers or
manufacturers (a) experience financial, operational, manufacturing capacity or
quality assurance difficulties, or cease production and sale of such products at
the end of their life cycle; or (b) if there is any other disruption in its
relationships with these suppliers or manufacturers, the Company will be
required to locate alternative sources of supply. The Company's inability to
obtain sufficient quantities of these components, if and as required in the
future, entails the following risks: (i) delays in delivery or shortages in
components could interrupt and delay manufacturing and result in cancellations
of orders for its products; (ii) alternative suppliers could increase component
prices significantly and with immediate effect; (iii) the Company may not be
able to develop alternative sources for product components; (iv) the Company may
be required to modify its products, which may cause delays in product shipments,
increased manufacturing costs and increased product prices; and (v) the Company
may be required to hold more inventory than it otherwise might in order to avoid
problems from shortages or discontinuance, which may result in write-offs if the
Company is unable to use all such products in the future.
As part of the Company's growth strategy, it intends to pursue new strategic
alliances. The Company considers and engages in strategic transactions from time
to time and may be evaluating alliances or joint ventures at any time. The
Company competes with other similar solutions providers for these opportunities.
The Company cannot be assured that it will be able to effect these transactions
on commercially reasonable terms or at all. If the Company enters into these
transactions, there is also no assurance that it will realize the benefits it
anticipates.
The Company has in the past and may in the future pursue acquisitions of
businesses, products and technologies, or the establishment of joint venture
arrangements. The negotiation of potential acquisitions or joint ventures as
well as the integration of an acquired or jointly developed business, technology
or product could result in a substantial diversion of management resources.
Future acquisitions could result in potentially dilutive issuances of equity
35
securities, the incurrence of debt and contingent liabilities, amortization of
certain identifiable intangible assets, research and development write-offs and
other acquisition-related expenses. These investments may be made in immature
businesses with unproven track records and technologies. Such investments have a
high degree of risk, with the possibility that the Company may lose the total
amount of its investments, or more than its total investment if such businesses
have liabilities not identified by the Company. The Company may not be able to
identify suitable investment candidates, and, even if it does, it may not be
able to make those investments on acceptable terms, or at all. In addition, the
Company also may fail to successfully integrate acquired businesses with its
operations or successfully realize the intended benefits of any acquisition,
either of which could affect the Company's continued growth and profitability.
And, the integration process may further strain the Company's existing financial
and managerial controls and reporting systems and procedures. Due to rapidly
changing market conditions, the Company may find the value of its acquired
technologies and related intangible assets, such as goodwill, as recorded in its
financial statements, to be impaired, resulting in charges to operations. The
Company may also fail to retain the acquired or merged company's key employees
and customers.
Currently, the Company accounts for employee stock options in accordance with
Accounting Principles Board ("APB") Opinion No. 25 and related Interpretations,
which provide that any compensation expense relative to employee stock options
be measured based on intrinsic value of the stock options. As a result, when
options are priced at or above fair market value of the underlying stock on the
date of the grant, as is currently the Company's practice, the Company incurs no
compensation expense.
In December 2004, the FASB issued Statement of Financial Accounting Standard
("SFAS") No. 123 (revised 2004), "Share-Based Payment", ("SFAS No.123(R)") which
revises SFAS No. 123 and supersedes APB No. 25. In April 2005, the SEC amended
Regulation S-X to modify the date for compliance with SFAS No. 123(R). The
provisions of SFAS No. 123(R) must be applied beginning with the fiscal year
beginning on or after June 15, 2005, which for the Company is February 1, 2006
(the "Effective Date"). SFAS No. 123(R) requires all share-based payments to
employees, including grants of employee stock options, to be valued at fair
value on the date of grant, and to be expensed over the applicable vesting
period. Pro forma disclosure of the income statement effects of share-based
payments is no longer an alternative. Beginning on the Effective Date, the
Company must (i) expense all options granted after the Effective Date over the
applicable vesting period, and (ii) expense the non-vested portions of existing
option grants going forward over their remaining vesting period. Compensation
expense for the non-vested portions of existing option grants as of the
Effective Date will be recorded based on the fair value of the awards previously
calculated in developing the pro forma disclosures in accordance with the
provisions of SFAS No. 123. Under SFAS No. 123(R), the Company is required to
adopt a fair value-based method for measuring the compensation expense related
to employee stock and stock options awards; this will lead to substantial
additional compensation expense. Any such expense, although it will not affect
the Company's cash flows, will have a material negative impact on the Company's
reported results of operations.
The Company receives conditional grants from the Government of Israel through
the Office of the Chief Scientist of the Ministry of Industry and Trade, or the
OCS, for the financing of a portion of its research and development expenditures
in Israel. Until recently, the terms of these conditional grants limited the
Company's ability to manufacture products outside of Israel if such products or
technologies were developed using these grants. On March 30, 2005, the Israeli
parliament approved an amendment to Israeli Law for the Encouragement of
Industrial Research and Development, which permits the transfer of such
technology outside of Israel under certain conditions. If the Company seeks and
receives approval to manufacture products developed using these conditional
grants outside of Israel, it may be required to pay a significantly increased
amount of royalties, which may be up to 300% of the grant amount, plus interest,
on an accelerated basis depending on the manufacturing volume that is performed
outside of Israel. If the Company seeks and receives approval to transfer
technology developed using these conditional grants outside of Israel, it may be
required, prior to such transfer, to pay a redemption price to be determined
under regulations that have not yet been promulgated. These restrictions may
impair the Company's ability to outsource manufacturing or engage in similar
36
arrangements for those products or technologies. In addition, if the Company
fails to comply with any of the conditions imposed by the OCS, it may be
required to refund any grants previously received together with interest and
penalties, and it may be subject to criminal charges. Further, from time to time
the Government of Israel may audit the sales of products incorporating
technology partially funded through OCS programs which, while not increasing the
aggregate amount of royalties that may be due from the Company, may cause the
Company to have to pay royalties on additional products, effectively
accelerating the pace at which it pays royalties to the Government of Israel in
repayment of the benefits received under such programs.
In recent years, the Government of Israel has accelerated the rate of repayment
of OCS grants and may further accelerate them in the future. The Company
currently pays royalties of between 3% and 5% (or 6% under certain
circumstances) of associated product revenues (including service and other
related revenues) to the Government of Israel based upon the sale of products
incorporating technology developed under OCS grants. Such royalty payments by
the Company are currently required to be made until the government has been
reimbursed up to the amounts received by the Company, linked to the U.S. dollar,
plus, for amounts received under projects approved by the OCS after January 1,
1999, interest on such amounts at a rate equal to the 12-month LIBOR rate in
effect on January 1st of the year in which approval is obtained. Further, the
Government of Israel has reduced the benefits available under these programs in
recent years and these programs may be discontinued or curtailed in the future.
The Company expects that OCS grants as a percentage of its consolidated research
and development expenses will decrease in future periods due to an expected
increase in the portion of research and development activities that will not be
reimbursed by the OCS and an expected increase in research and development
activities outside of Israel. The continued reduction in these benefits or the
termination of the Company's eligibility to receive these benefits may
materially and adversely affect the Company's business, financial condition and
results of operations.
Historically, the Company has received more reimbursement for R&D expenses
partially funded by the OCS in a given year than it has had to pay to the OCS in
royalties during that fiscal year. More recently, however, the Company has been
paying, and continues to expect to pay, more in royalties to the OCS than it
receives in reimbursement from the OCS for R&D expenses in a given fiscal year.
For example, in the nine months ended October 31, 2005, the Company recorded a
net expense of $1.1 million representing the difference between royalties
recorded for the OCS and reimbursement received from the OCS.
As of October 31, 2005, the Company has received approximately $59.7 million in
cumulative grants and has recorded approximately $30.6 million in cumulative
royalties to the OCS. The Company continues to evaluate whether to participate
in a program offered by the OCS to pay a lump sum royalty amount for past
amounts received from the OCS and has started preliminary discussions with the
OCS in that regard. The Company believes it could reach agreement with the OCS
regarding participating in such program as early as the first calendar quarter
of 2006. Assuming the Company elects to participate in this program it may be
required to pay as much as the difference between the cumulative grants received
and the cumulative royalties paid plus interest and other charges. This would
significantly reduce or eliminate the Company's net income for a given fiscal
year and might cause the Company to report a loss for the fiscal year in which
the program is entered into which would have a material adverse effect on the
Company's operating results.
To date, most of the Company's sales have been denominated in U.S. dollars,
while a significant portion of its expenses, primarily labor expenses in Israel,
Germany, the United Kingdom and Canada, are incurred in the local currencies of
these countries. As a result, the Company is exposed to the risk that
fluctuations in the value of these currencies relative to the U.S. dollar could
increase the dollar cost of its operations in Israel, Germany, the United
Kingdom or Canada, and would therefore have a material adverse effect on its
results of operations.
In addition, since a portion of the Company's sales are made in foreign
currencies, primarily the British pound and the euro, fluctuation in the value
of these currencies relative to the U.S. dollar could decrease its revenues and
materially and adversely affect its results of operations. In addition, the
Company's costs of operations have at times been negatively affected by changes
in the cost of its operations in Israel, Germany and Canada, resulting from
changes in the value of the relevant local currency relative to the U.S. dollar.
37
Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors, which in the
past and may in the future, lead to security and economic problems for Israel.
Current and future conflicts and political, economic and/or military conditions
in Israel and the Middle East region can directly affect the Company's
operations in Israel. From October 2000 until recently, terrorist violence in
Israel increased significantly, primarily in the West Bank and Gaza Strip, and
Israel has experienced terrorist incidents within its borders. There can be no
assurance that the recent relative calm will continue nor can the Company
anticipate what the impact will be on Israel or the region following the recent
Israeli withdrawals from the Gaza Strip and portions of the West Bank. The
Company could be materially adversely affected by hostilities involving Israel,
the interruption or curtailment of trade between Israel and its trading
partners, or a significant downturn in the economic or financial condition of
Israel. In addition, the sale of products manufactured in Israel may be
materially adversely affected in certain countries by restrictive laws, policies
or practices directed toward Israel or companies having operations in Israel.
The continuation or exacerbation of violence in Israel or the outbreak of
violent conflicts involving Israel may impede the Company's ability to sell its
products or otherwise adversely affect the Company. In addition, many of the
Company's Israeli employees in Israel are required to perform annual compulsory
military service in Israel and are subject to being called to active duty at any
time under emergency circumstances. The absence of these employees may have an
adverse effect upon the Company's operations.
The Company's investment programs in manufacturing equipment and leasehold
improvements at its facility in Israel has been granted approved enterprise
status and it is therefore eligible for tax benefits under the Israeli Law for
Encouragement of Capital Investments. The Government of Israel may reduce or
eliminate the tax benefits available to approved enterprise programs such as the
programs provided to the Company. The Company cannot be assured that these tax
benefits will be continued in the future at their current levels or at all. If
these tax benefits are reduced or eliminated, the amount of taxes that the
Company pays in Israel will increase. In addition, if the Company fails to
comply with any of the conditions and requirements of the investment programs,
the tax benefits it has received may be rescinded and it may be required to
refund the amounts it received as a result of the tax benefits, together with
interest and penalties.
The Company's business is subject to evolving corporate governance and public
disclosure regulations that have increased both the costs and the risk of
noncompliance, either of which could have an adverse effect on the Company's
stock price. Because the Company's Common Stock is publicly traded on the NASDAQ
National Market, the Company is subject to rules and regulations promulgated by
a number of governmental and self-regulated organizations, including the
Securities and Exchange Commission, NASDAQ and the Public Company Accounting
Oversight Board, which monitors the accounting practices of public companies.
Many of these regulations have only recently been enacted, and continue to
evolve, making compliance more difficult and uncertain. In addition, the
Company's efforts to comply with these new regulations have resulted in, and are
likely to continue to result in, increased general and administrative expenses
and a diversion of management time and attention from revenue-generating
activities to compliance activities. In particular, Section 404 of the
Sarbanes-Oxley Act of 2002 and related regulations require the Company to
include a management assessment of its internal controls over financial
reporting and auditor attestation of that assessment in its annual report, which
the Company included for in its annual report for fiscal 2004. While the Company
was able to assert, in the management certifications filed with its Annual
Report on Form 10-K, that the Company's internal control over financial
reporting is effective as of January 31, 2005 and that no material weaknesses
were identified, the Company must continue to monitor and assess the internal
control over financial reporting.
38
The Company cannot provide any assurances that material weaknesses will not be
discovered in the future. If the Company is unable to assert that the internal
control over financial reporting is effective for any given reporting period (or
if the Company's auditors are unable to attest that the management's report is
fairly stated or are unable to express an opinion on the effectiveness of the
internal controls), the Company could lose investor confidence in the accuracy
and completeness of the Company's financial reports, which would have an adverse
effect on the Company's stock price. The effort regarding Section 404 has
required, and continues to require, the commitment of significant financial and
managerial resources.
Comverse Technology beneficially owns a majority of the Company's outstanding
shares of Common Stock. Consequently, Comverse Technology effectively controls
the outcome of all matters submitted for stockholder action, including the
composition of the Company's board of directors and the approval of significant
corporate transactions. Through its representation on the Company's board of
directors, Comverse Technology has a controlling influence on the Company's
management, direction and policies, including the ability to appoint and remove
its officers. As a result, Comverse Technology may cause the Company to take
actions which may not be aligned with the Company's interests or those of its
other stockholders. For example, Comverse Technology may prevent or delay any
transaction involving a change in control or in which stockholders might receive
a premium over the prevailing market price for their shares. In particular, as a
result of Comverse Technology's majority ownership, the Company has relied on
the "controlled company" exemption from certain requirements under Rule
4350(c)(5) of the listing standards of the National Association of Securities
Dealers, Inc., and does not have an independent Compensation Committee or
Nominating Committee, as non-controlled companies are required to have.
The Company receives insurance, legal and certain administrative services from
Comverse Technology under a corporate services agreement. The Company's
enterprise resource planning software is maintained and supported by Comverse
Ltd., a subsidiary of Comverse Technology, under an enterprise resource planning
software sharing agreement. The Company also obtains personnel and facility
services from Comverse, Inc. under a satellite services agreement. If these
agreements are terminated, the Company may be required to obtain similar
services from other entities or, alternatively, it may be required to hire
qualified personnel and incur other expenses to obtain these services. The
Company may not be able to hire such personnel or to obtain comparable services
at prices and on terms as favorable as it currently has under these agreements.
The Company has entered into a business opportunities agreement with Comverse
Technology that addresses potential conflicts of interest between Comverse
Technology and the Company. This agreement allocates between Comverse Technology
and the Company opportunities to pursue transactions or matters that, absent
such allocation, could constitute corporate opportunities of both companies. As
a result, the Company may lose valuable business opportunities. In general, the
Company is precluded from pursuing opportunities offered to officers or
employees of Comverse Technology who may also be directors, officers or
employees of the Company unless Comverse Technology fails to pursue these
opportunities.
Seven of the Company's thirteen directors are officers and/or directors or
employees of Comverse Technology, or otherwise affiliated with Comverse
Technology. These directors have fiduciary duties to both companies and may have
conflicts of interest on matters affecting both the Company and Comverse
Technology and in some circumstances may have interests adverse to the Company.
The Company's Chairman, Kobi Alexander, is the chairman of Comverse Technology.
This position with Comverse Technology imposes significant demands on Mr.
Alexander's time and presents potential conflicts of interest.
39
Prior to the Company's initial public offering in May 2002, the Company was
included in the Comverse Technology consolidated group for federal income tax
purposes and did not file its own federal income tax return. Following the
Company's initial public offering, it ceased to be included in the Comverse
Technology consolidated group for federal income tax purposes. To the extent
Comverse Technology or other members of the group fail to make any federal
income tax payments required of them by law in respect of years for which
Comverse Technology filed a consolidated federal income tax return which
included the Company, the Company would be liable for the shortfall. Similar
principles apply for state income tax purposes in many states. In addition, by
virtue of its controlling ownership and its tax sharing agreement with the
Company, Comverse Technology effectively controls all of the Company's tax
decisions for periods ending prior to the completion of its initial public
offering. For periods during which the Company was included in the Comverse
Technology consolidated group for federal income tax purposes, Comverse
Technology has sole authority to respond to and conduct all federal income tax
proceedings and audits relating to the Company, to file all federal income tax
returns on its behalf and to determine the amount of its liability to, or
entitlement to payment from, Comverse Technology under its tax sharing
agreement. Despite this agreement, federal law provides that each member of a
consolidated group is liable for the group's entire tax obligation and the
Company could, under certain circumstances, be liable for taxes of other members
of the Comverse Technology consolidated group.
The trading price of the Company's shares of Common Stock has been affected by
the factors disclosed in this section as well as prevailing economic and
financial trends and conditions in the public securities markets. Share prices
of companies in technology-related industries, such as the Company's, tend to
exhibit a high degree of volatility. The announcement of financial results that
fall short of the results anticipated by the public markets could have an
immediate and significant negative effect on the trading price of the Company's
shares in any given period. Such shortfalls may result from events that are
beyond the Company's immediate control, can be unpredictable and, since a
significant proportion of its sales during each fiscal quarter tend to occur in
the latter stages of the quarter, may not be discernible until the end of a
financial reporting period. These factors may contribute to the volatility of
the trading value of the Company's shares regardless of its long-term prospects.
The trading price of the Company's shares may also be affected by developments,
including reported financial results and fluctuations in trading prices of the
shares of other publicly-held companies in its industry generally, and its
business segment in particular, which may not have any direct relationship with
its business or prospects.
In the past, securities class action litigation has often been brought against a
company following periods of volatility in the market price of its securities.
The Company could be the target of similar litigation in the future. Securities
litigation could result in the expenditure of substantial costs, divert
management's attention and resources, harm the Company's reputation in the
industry and the securities markets and reduce its profitability.
Terrorist attacks and other acts of war, and any response to them, may lead to
armed hostilities and such developments would likely cause instability in
financial markets. Armed hostilities and terrorism may directly impact the
Company's facilities, personnel and operations which are located in the United
States, Canada, Israel, Europe, the Far East, Australia and South America, as
well as those of its clients. Furthermore, severe terrorist attacks or acts of
war may result in temporary halts of commercial activity in the affected
regions, and may result in reduced demand for its products. These developments
could have a material adverse effect on the Company's business and the trading
price of its Common Stock.
The ability of the Company's board of directors to designate and issue up to
2,500,000 shares of preferred stock and to issue additional shares of Common
Stock could adversely affect the voting power of the holders of Common Stock,
and could have the effect of making it more difficult for a person to acquire,
or could discourage a person from seeking to acquire, control of the Company. If
this occurs, investors could lose the opportunity to receive a premium on the
sale of their shares in a change of control transaction.
40
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to market risk from changes in foreign currency exchange
rates that could impact its results of operations and financial condition. The
Company considers the foreign currency exchange rate risk, in particular that of
the U.S. dollar versus the British pound, the euro and the Israeli shekel, to be
its primary market risk exposure. To date, the Company has not used any material
foreign currency exchange contracts or other derivative instruments to reduce
its exposure to foreign currency exchange risks. In the future, the Company may
use foreign currency exchange contracts and other derivative instruments to
reduce its exposure to this risk.
The Company is also exposed to market risk from changes in interest rates.
Various financial instruments held by the Company are sensitive to changes in
interest rates. Interest rate changes could result in an increase or decrease in
interest income as well as in gains or losses in the market value of the
Company's debt security investments due to differences between the market
interest rates and rates at the date of purchase of these investments.
The Company places its cash investments with high credit-quality financial
institutions and currently invests primarily in money market funds placed with
major banks and financial institutions, bank time deposits, Auction-Rate
Securities ("ARS"), corporate debt securities and United States government,
corporation and agency obligations and/or mutual funds investing in the like.
The Company has investment guidelines relative to diversification and maturities
designed to maintain safety and liquidity. As of October 31, 2005, the Company
had cash and cash equivalents, which generally have a maturity of three months
or less, totaling approximately $58 million, bank time deposits totaling
approximately $2.3 million and short-term investments totaling approximately
$206.2 million, which primarily consist of Auction Rate Securities. Auction Rate
Securities have maturities ranging up to thirty years; however, these
investments have characteristics similar to short-term investments because at
pre-determined intervals, generally every 7 to 90 days, there is a new auction
process at which these securities are reset to current interest rates.
If, during the year ended January 31, 2006, average short-term interest rates
increase or decrease by 50 basis points relative to average rates realized
during the year ended January 31, 2005, the Company's projected interest income
from cash and cash equivalents and short-term investments would increase or
decrease by approximately $1.3 million, assuming a similar level of investments
in the year ended January 31, 2006.
Due to the short-term nature of the Company's cash and cash equivalents, the
carrying values approximate market values and are not generally subject to price
risk due to fluctuations in interest rates. The Company's short-term investments
are subject to price risk due to fluctuations in interest rates. Neither a 10%
increase nor decrease in prices would have a material effect on the Company's
financial position, results of operations or cash flows. All short-term
investments are considered to be available-for-sale, accounted for at fair
value, with resulting unrealized gains or losses reported as a separate
component of shareholders' equity. If these available-for-sale securities
experience declines in fair value that are considered other-than-temporary, an
additional loss would be reflected in net income (loss) in the period when the
subsequent impairment becomes apparent. See Note 3 of the notes to the Condensed
Consolidated Financial Statements and Note 4 of the notes to the consolidated
financial statement in the Company's Annual Report on Form 10-K for more
information regarding the Company's short-term investments.
41
ITEM 4. CONTROLS AND PROCEDURES.
(a) Evaluation of Disclosure Controls and Procedures
The Company's management evaluated, with the participation of the Company's
principal executive and principal financial officers, the effectiveness of the
Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act")), as of October 31, 2005. Based on their evaluation, the Company's
principal executive and principal financial officers concluded that the
Company's disclosure controls and procedures were effective as of October 31,
2005.
(b) Changes in Internal Control Over Financial Reporting
During the Company's fiscal quarter ended October 31, 2005, the Company
continued to add several members to its finance organization worldwide, in
particular at its principal executive offices in Melville, New York as part of
an effort to consolidate and improve certain financial reporting functions. In
addition, the Company continued an upgrade of certain of its information systems
used to accumulate financial data for financial reporting. The additional
personnel and the upgrade are part of an ongoing effort by the Company to
continue to improve its internal control over financial reporting. Although
these improvements are ongoing, the Company used its new personnel and system to
generate some of the financial information used in its financial statements for
this fiscal quarter. Improvements such as these present several risks, including
straining existing resources and errors in data migrated from the Company's
existing information systems to its new information systems. The Company
believes that, notwithstanding the risks of these improvements, as of October
31, 2005, its internal control over financial reporting has been designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. However, because these
improvements are ongoing and the Company has not yet completed its testing of
the internal process improvements made to date, there is no assurance that
errors resulting from these improvements will not be found at a later date.
42
PART II
OTHER INFORMATION
-----------------
ITEM 6. EXHIBITS.
(a) Exhibit Index.
-------------
10.1 Stock Purchase Agreement, dated as of September 7, 2005, by
and among Verint Systems Inc., MultiVision Holdings Limited,
and MultiVision Intelligent Surveillance Limited
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) and 15d-14(a) of the Exchange Act, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) and 15d-14(a) of the Exchange Act, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
32.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
43
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VERINT SYSTEMS INC.
Dated: December 12, 2005 By: /s/ Dan Bodner
------------------------------------------
Dan Bodner
President and Chief Executive Officer
Principal Executive Officer
Dated: December 12, 2005 By: /s/ Igal Nissim
------------------------------------------
Igal Nissim
Vice President and Chief Financial Officer
Principal Financial Officer
44