- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported) June 30, 1998
0-15502
(Commission File Number)
----------------------------
COMVERSE TECHNOLOGY, INC.
(Exact name of registrant as specified in its charter)
New York 13-3238402
(State of Incorporation) (IRS Employer
Identification Number)
170 Crossways Park Drive, Woodbury, New York 11797
(Address of registrant's principal executive office)
(516) 677-7200
(Registrant's telephone number)
----------------------------
- --------------------------------------------------------------------------------
ITEM 5. Other Events
------------
On June 30, 1998, the registrant issued $250,000,000 aggregate
principal amount of its 4-1/2% Convertible Subordinated Debentures due 2005 (the
"Debentures"). The Debentures are convertible, at the option of the holder, into
shares of the registrant's common stock at a conversion price of $64.50. The
registrant intends to use the proceeds of this offering for working capital and
other general corporate purposes, including possible investments in, or
acquisitions of, other companies, businesses, technologies or product lines. The
Registrant's Financial Statement for the three fiscal years ended December 31,
1997 appear after page 3 of this current report.
ITEM 7. Financial Statements, Pro Forma Financial Information and Exhibits
------------------------------------------------------------------
(c) Exhibits.
--------
Exhibit Number Title
-------------- -----
4 Indenture, dated June 30, 1998, between Comverse
Technology, Inc. and The Chase Manhattan Bank,
N.A., as Trustee.
10.1 Purchase Agreement, dated June 25, 1998, between
Comverse Technology, Inc. and Lehman Brothers
Inc., as Initial Purchaser.
10.2 Registration Rights Agreement, dated June 30,
1998, between Comverse Technology, Inc. and
Lehman Brothers Inc., as Initial Purchaser.
99 Press Release dated June 25, 1998.
2
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.
COMVERSE TECHNOLOGY, INC.
By: /s/ WILLIAM F. SORIN
---------------------------
William F. Sorin
Counsel and Secretary
Date: July 2, 1998
3
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Independent Auditors' Reports............................................ F-2
Consolidated Balance Sheets as of December 31, 1996 and 1997............. F-4
Consolidated Statements of Income for the Years Ended December 31, 1995,
1996 and 1997........................................................... F-5
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31,
1995, 1996 and 1997..................................................... F-6
Consolidated Statements of Cash Flows for the Years Ended December 31,
1995, 1996 and 1997..................................................... F-7
Notes to Consolidated Financial Statements............................... F-8
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Comverse Technology, Inc.
Woodbury, New York
We have audited the accompanying consolidated balance sheets of Comverse
Technology, Inc. and subsidiaries (the "Company") as of December 31, 1996 and
1997, and the related consolidated statements of income, stockholders' equity
and cash flows for each of the three years in the period ended December 31,
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. The consolidated financial statements give
retroactive effect to the merger of the Company and Boston Technology, Inc.,
which has been accounted for as a pooling of interests as described in Note 8
to the consolidated financial statements. We did not audit the financial
statements of Boston Technology, Inc. for the years ended January 31, 1997 and
1996, respectively, which statements reflect total assets constituting 25% of
total assets as of December 31, 1996 and total sales constituting 49% and 43%
of consolidated total sales for the years ended December 31, 1996 and 1995,
respectively. Those financial statements were audited by other auditors whose
report has been furnished to us, and our opinion, insofar as it relates to the
amounts included for Boston Technology, Inc., is based solely on the report of
such other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, based on our report and the report of the other auditors, such
consolidated financial statements present fairly, in all material respects,
the financial position of Comverse Technology, Inc. and subsidiaries as of
December 31, 1996 and 1997, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1997 in
conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
New York, New York
June 17, 1998
F-2
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Boston
Technology, Inc.:
We have audited the accompanying consolidated balance sheet of Boston
Technology, Inc. as of January 31, 1997 and the related consolidated
statements of operations, stockholders' equity, and cash flows for the years
ended January 31, 1997 and 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Boston
Technology, Inc. as of January 31, 1997 and the consolidated results of its
operations and its cash flows for the years ended January 31, 1997 and 1996 in
conformity with generally accepted accounting principles.
/s/ Coopers & Lybrand L.L.P.
Boston, Massachusetts
April 24, 1997
F-3
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
(IN THOUSANDS, EXCEPT SHARE DATA)
1996* 1997*
ASSETS -------- --------
CURRENT ASSETS:
Cash and cash equivalents................................... $210,756 $188,023
Bank time deposits.......................................... 10,000 40,700
Short-term investments...................................... 39,464 60,787
Accounts receivable, net of allowance for doubtful accounts
of $7,640 and $21,846...................................... 117,945 141,922
Inventories................................................. 50,540 65,358
Prepaid expenses and other current assets................... 12,450 29,895
Deferred income tax benefits................................ 5,796 2,163
-------- --------
TOTAL CURRENT ASSETS......................................... 446,951 528,848
-------- --------
PROPERTY AND EQUIPMENT, NET.................................. 43,609 62,325
INVESTMENTS.................................................. 5,788 6,859
OTHER ASSETS................................................. 23,517 24,658
-------- --------
TOTAL ASSETS................................................. $519,865 $622,690
======== ========
1996* 1997*
LIABILITIES AND STOCKHOLDERS' EQUITY -------- --------
CURRENT LIABILITIES:
Accounts payable and accrued expenses....................... $ 79,940 $ 88,254
Bank loans.................................................. 12,195 16,970
Advance payments from customers............................. 16,479 25,074
Other current liabilities................................... 602 3,047
-------- --------
TOTAL CURRENT LIABILITIES.................................... 109,216 133,345
-------- --------
CONVERTIBLE SUBORDINATED DEBENTURES.......................... 115,000 115,000
LIABILITY FOR SEVERANCE PAY.................................. 2,708 3,515
LONG-TERM DEBT AND OTHER LIABILITIES......................... 4,391 24,669
-------- --------
TOTAL LIABILITIES............................................ 231,315 276,529
-------- --------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $0.01 par value--authorized, 2,500,000
shares; issued, none....................................... -- --
Common stock, $0.10 par value--authorized, 100,000,000
shares; issued and outstanding, 41,317,327 and 43,340,361
shares..................................................... 4,132 4,333
Additional paid-in capital.................................. 195,661 218,501
Cumulative translation adjustment........................... 338 444
Unrealized gain on available-for-sale securities, net of
tax........................................................ 1,547 1,117
Retained earnings........................................... 86,872 121,766
-------- --------
TOTAL STOCKHOLDERS' EQUITY................................... 288,550 346,161
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................... $519,865 $622,690
======== ========
- --------
* Restated for pooling of interests with Boston Technology, Inc.
See notes to consolidated financial statements.
F-4
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1995* 1996* 1997*
-------- -------- --------
REVENUES:
Sales........................................... $242,416 $389,639 $488,940
Interest and other income....................... 9,916 11,011 16,962
-------- -------- --------
TOTAL REVENUES................................... 252,332 400,650 505,902
-------- -------- --------
COSTS AND EXPENSES:
Cost of sales................................... 104,980 169,524 202,640
Selling, general and administrative............. 72,953 93,604 138,305
Research and development, net................... 41,310 66,228 96,626
Interest expense and other...................... 4,593 8,635 12,243
Royalties and license fees...................... 3,321 10,443 12,325
Minority interest and equity in affiliates...... (147) 444 (160)
Warrants and other expenses associated with AT&T
contract acquisition........................... 21,000 -- --
-------- -------- --------
TOTAL COSTS AND EXPENSES......................... 248,010 348,878 461,979
-------- -------- --------
INCOME BEFORE GAIN ON ISSUANCE OF SUBSIDIARY
SHARES AND INCOME TAX PROVISION................. 4,322 51,772 43,923
GAIN ON ISSUANCE OF SUBSIDIARY SHARES............ -- 535 --
-------- -------- --------
INCOME BEFORE INCOME TAX......................... 4,322 52,307 43,923
INCOME TAX PROVISION............................. 2,162 10,170 9,398
-------- -------- --------
NET INCOME....................................... $ 2,160 $ 42,137 $ 34,525
======== ======== ========
EARNINGS PER SHARE:
Basic........................................... $ 0.06 $ 1.10 $ 0.81
-------- -------- --------
Diluted......................................... $ 0.06 $ 1.01 $ 0.75
======== ======== ========
- --------
* Restated for pooling of interests with Boston Technology, Inc.
See notes to consolidated financial statements.
F-5
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS, EXCEPT SHARE DATA)
COMMON STOCK TREASURY STOCK
----------------- ADDITIONAL ------------------ CUMULATIVE UNREALIZED
NUMBER OF PAR PAID-IN TRANSLATION GAINS RETAINED
SHARES VALUE CAPITAL SHARES AMOUNT ADJUSTMENT (LOSSES) EARNINGS TOTAL
---------- ------ ---------- -------- -------- ----------- ---------- -------- --------
BALANCE, January 1,
1995, as previously
reported............... 20,981,456 $2,098 $ 73,300 $(118) $ 15 $ 26,318 $101,613
Pooling of interests.... 16,093,546 1,609 33,510 (16) -- 21,689 56,792
---------- ------ -------- ----- ------ -------- --------
BALANCE, as restated.... 37,075,002 3,707 106,810 (134) 15 48,007 158,405
Unrealized gain on
available-for-sale
securities............. -- -- -- -- $ -- -- 631 -- 631
Common stock purchased.. (487,500) (10,663) -- -- -- (10,663)
Issuance of treasury
stock upon exercise of
stock options.......... -- -- -- 71,067 1,649 (1,146) 503
Issuance of treasury
stock for employee
stock purchase plan.... -- -- -- 17,906 415 -- -- (96) 319
Exercise of stock
options................ 733,125 73 4,007 -- -- -- -- -- 4,080
Employee stock purchase
plan................... 17,904 2 294 -- -- -- -- -- 296
Acquisition of
additional interest in
majority-owned
subsidiary............. 10,696 1 154 -- -- -- -- -- 155
Tax benefit of
dispositions of stock
options................ -- -- 1,313 -- -- -- -- -- 1,313
Stock warrants issued... -- -- 18,600 -- -- -- -- -- 18,600
Translation adjustment.. -- -- -- -- -- 281 -- -- 281
Net income year ended
December 31, 1995...... -- -- -- -- -- -- -- 2,160 2,160
---------- ------ -------- -------- -------- ----- ------ -------- --------
BALANCE, DECEMBER 31,
1995*.................. 37,836,727 3,783 131,178 (398,527) (8,599) 147 646 48,925 176,080
Unrealized gain on
available-for-sale
securities............. -- -- -- -- -- -- 901 -- 901
Issuance of treasury
stock upon exercise of
stock options.......... -- -- -- 352,596 7,534 (3,993) 3,541
Issuance of treasury
stock for employee
stock purchase plan.... -- -- -- 45,931 1,065 -- -- (197) 868
Exercise of stock
options................ 378,332 38 2,817 -- -- -- -- -- 2,855
Conversion of
debentures............. 3,096,768 310 58,335 -- -- -- -- -- 58,645
Acquisition of
additional interest in
majority-owned
subsidiary............. 5,500 1 148 -- -- -- -- -- 149
Tax benefit of
dispositions of stock
options................ -- -- 3,183 -- -- -- -- -- 3,183
Translation adjustment.. -- -- -- -- -- 191 -- -- 191
Net income year ended
December 31, 1996...... -- -- -- -- -- -- -- 42,137 42,137
---------- ------ -------- -------- -------- ----- ------ -------- --------
BALANCE, DECEMBER 31,
1996*.................. 41,317,327 4,132 195,661 -- -- 338 1,547 86,872 288,550
Unrealized gain on
available-for-sale
securities............. -- -- -- -- -- -- (430) -- (430)
AT&T warrant exercises.. 552,144 55 (55) -- -- -- -- -- -
Common stock issued for
acquisition............ 162,500 16 -- -- -- -- -- -- 16
Retained earnings of
acquired company....... -- -- -- -- -- -- -- 661 661
Common stock issued for
employee stock purchase
plan................... 50,921 5 1,301 -- -- -- -- -- 1,306
Issuance of treasury
stock upon exercise of
stock options.......... -- -- -- -- -- -- -- (292) (292)
Exercise of stock
options................ 1,257,469 125 14,664 -- -- -- -- -- 14,789
Tax benefit of
dispositions of stock
options................ -- -- 6,930 -- -- -- -- -- 6,930
Translation adjustment.. -- -- -- -- -- 106 -- -- 106
Net income year ended
December 31, 1997...... -- -- -- -- -- -- -- 34,525 34,525
---------- ------ -------- -------- -------- ----- ------ -------- --------
BALANCE, DECEMBER 31,
1997*.................. 43,340,361 $4,333 $218,501 -- $ -- $ 444 $1,117 $121,766 $346,161
========== ====== ======== ======== ======== ===== ====== ======== ========
- -------
* Restated for pooling of interests with Boston Technology, Inc.
See notes to consolidated financial statements.
F-6
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS)
1995* 1996* 1997*
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income...................................... $ 2,160 $ 42,137 $ 34,524
Adjustments to reconcile net income to net cash
provided
by operating activities:
Depreciation and amortization................. 10,696 15,493 22,000
Non-cash charge for warrants issued........... 18,600 -- --
Changes in assets and liabilities:
Accounts receivable.......................... (17,244) (46,044) (23,977)
Inventories.................................. (11,999) (17,816) (14,818)
Prepaid expenses and other current assets.... (5,077) (1,503) (17,802)
Accounts payable and accrued expenses........ 12,723 35,459 8,314
Advance payments from customers.............. (46) 5,130 8,595
Liability for severance pay.................. 947 409 807
Other........................................ 549 (305) 3,658
-------- -------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES........ 11,309 32,960 21,301
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Maturities and sales (purchases) of bank time
deposits and
investments, net............................... 68,663 (27,792) (53,524)
Purchase of property and equipment.............. (12,102) (32,227) (36,532)
Capitalization of software development costs.... (4,697) (4,466) (6,008)
Other........................................... (597) (1,331) --
-------- -------- --------
NET CASH PROVIDED BY (USED IN) INVESTING
ACTIVITIES...................................... 51,267 (65,816) (96,064)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of debentures........ -- 111,899 --
Proceeds from issuance of common stock in
connection with exercise
of stock options, warrants, and employee stock
purchase plan.................................. 5,198 7,412 23,041
Net proceeds from bank loans and other debt..... (767) 10,510 28,989
Purchases of treasury stock..................... (10,663) -- --
Other........................................... (1,493) -- --
-------- -------- --------
NET CASH (USED IN) PROVIDED BY FINANCING
ACTIVITIES...................................... (7,725) 129,821 52,030
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS..................................... 54,851 96,965 (22,733)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR..... 58,940 113,791 210,756
-------- -------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR........... $113,791 $210,756 $188,023
======== ======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid during the year for interest.......... $ 3,677 $ 3,276 $ 9,184
======== ======== ========
Cash paid during the year for income taxes...... $ 5,897 $ 5,116 $ 10,811
======== ======== ========
- --------
* Restated for pooling of interests with Boston Technology, Inc.
See notes to consolidated financial statements.
F-7
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
1.ORGANIZATION AND BUSINESS
Comverse Technology, Inc. ("Comverse" and, together with its subsidiaries,
"CTI" or the "Company") was organized as a New York corporation in October
1984. The Company is engaged in the design, development, manufacture,
marketing and support of special purpose computer and telecommunications
systems and software for multimedia communications and information
processing applications.
2.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION--The consolidated financial statements include
the accounts of Comverse and its wholly-owned and majority-owned
subsidiaries. All material intercompany balances and transactions have been
eliminated.
CASH, CASH EQUIVALENTS AND BANK TIME DEPOSITS--The Company considers all
highly liquid investments purchased with original maturities of three
months or less to be cash equivalents. Bank deposits with maturities in
excess of three months are classified as bank time deposits.
SHORT-TERM INVESTMENTS--The Company classifies all of its short-term
investments (including U.S. treasury bills) as available-for-sale,
accounted for at fair value, with resulting unrealized gains or losses
reported as a separate component of stockholders' equity, on a net-of-tax
basis.
CONCENTRATION OF CREDIT RISK--Financial instruments which potentially
expose the Company to concentration of credit risk, consist primarily of
cash investments and accounts receivable. The Company places its cash
investments with high-credit quality financial institutions and currently
invests primarily in bank time deposits, money market funds placed with
major banks and financial institutions, corporate commercial paper,
corporate medium-term notes, and U.S. government obligations that have
maturities of one year or less. Accounts receivable are generally
diversified due to the number of commercial and government entities
comprising the Company's customer base and their dispersion across many
geographical regions. The Company believes no significant concentration of
credit risk exists with respect to these cash investments and accounts
receivable.
INVENTORIES--Inventories are stated at the lower of cost or market. Cost is
determined by the first-in, first-out method.
PROPERTY AND EQUIPMENT--Property and equipment are carried at cost less
accumulated depreciation and amortization. The Company depreciates its
property and equipment on a straight-line basis over periods ranging from
three to seven years. The cost of maintenance and repairs is charged to
operations as incurred. Significant renewals and betterments are
capitalized.
INCOME TAXES--The Company accounts for its income using the asset and
liability method. Under this method, deferred tax assets and liabilities
are determined based on differences between financial reporting and tax
bases of assets and liabilities, and are measured using the enacted tax
rates and laws that are expected to be in effect when the differences are
expected to reverse.
REVENUE AND EXPENSE RECOGNITION--Revenues from product sales are generally
recognized upon shipment. Products shipped for customer trials are carried
in finished goods inventory until customer acceptance is obtained, at which
time revenue is recognized.
Revenues from certain contracts are recognized under the percentage-of-
completion method on the basis of physical completion to date or using
actual costs incurred to total expected costs under the contract.
F-8
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
Amounts received from customers in excess of revenues earned under the
percentage-of-completion method are recorded as advance payments from
customers. Related contract costs include all direct material and labor
costs and those indirect costs related to contract performance, and are
included in cost of sales in the consolidated statements of income.
Expenses incurred in connection with research and development activities,
other than certain software development costs that are capitalized, and
selling, general and administrative expenses are charged to operations as
incurred.
SOFTWARE DEVELOPMENT COSTS--Software development costs are capitalized upon
the establishment of technological feasibility and are amortized over the
estimated useful life of the software, which to date has been four years or
less. Amortization begins in the period in which the related product is
available for general release to customers. Amortization expenses amounted
to $2,453,000, $3,079,000 and $3,546,000 in 1995, 1996 and 1997,
respectively.
FUNCTIONAL CURRENCY AND FOREIGN CURRENCY TRANSACTION GAINS AND LOSSES--The
United States dollar (the "dollar") is the functional currency of the major
portion of the Company's foreign operations. Most of the Company's sales,
and materials purchased for manufacturing, are denominated in or linked to
the dollar. Certain operating costs, principally salaries, of foreign
operations are denominated in local currencies. In those instances where a
foreign subsidiary has a functional currency other than the dollar, the
Company records any necessary foreign currency translation adjustment,
reflected in stockholders' equity, at the end of each reporting period.
Net losses from foreign currency transactions, included in the consolidated
statements of income, approximated $258,000, $1,012,000 and $2,192,000 in
1995, 1996 and 1997, respectively.
The Company occasionally enters into foreign exchange forward contracts and
options on foreign currencies. The purpose of the Company's foreign
currency hedging activities is to protect the Company from the risk that
the eventual dollar cash flows resulting from the sale of products to
international customers will be adversely affected by changes in exchange
rates. Any gain or loss on a foreign exchange contract which hedges a firm
commitment is deferred until the underlying transaction is realized, at
which time it is included in the consolidated statement of income. At
December 31, 1997, there were outstanding forward contracts to purchase
approximately $22,680,000 in Western European and Japanese currencies. The
Company also purchases foreign exchange options which permit, but do not
require, the Company to exchange foreign currencies at a future date with
another party at a contracted exchange rate. To finance premiums paid on
such options, from time to time the Company may also write offsetting
options at exercises prices which limit, but do not eliminate, the effect
of purchased options as a hedge. As of December 31, 1997, the Company had
purchased foreign exchange options of $8,000,000 and written foreign
exchange options of $8,000,000 in Western European currencies.
OTHER ASSETS--Licenses of patent rights and acquired "know-how" are
recorded at cost and amortized using the straight-line method over the
estimated useful lives of the related technology, not exceeding five years.
Goodwill and other intangible assets associated with acquired subsidiaries
are amortized over periods ranging from five to twelve years. Debt issue
costs are amortized over the ten-year term of the related debt, on a
straight-line basis.
LONG-LIVED ASSETS--The Company reviews for the impairment of long-lived
assets and certain identifiable intangibles whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. An impairment loss would be recognized when estimated future
cash flows expected to result from the use of the asset and its eventual
disposition are less than its carrying amount.
F-9
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
PERVASIVENESS OF ESTIMATES--The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
3.RESEARCH AND DEVELOPMENT
A significant portion of the Company's research and development operations
are located in Israel where the Company derives substantial benefits from
participation in programs sponsored by the Government of Israel for the
support of research and development activities conducted in that country.
For the years 1995, 1996 and 1997, the Company's research and development
activities included projects partially funded by the Office of the Chief
Scientist of the Ministry of Industry and Trade of the State of Israel (the
"OCS") under which the funding organization reimbursed 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 is required to pay
royalties to the OCS based on the sale of products incorporating technology
developed in these projects. In addition, under the terms of the applicable
funding agreements, products resulting from projects funded by the OCS may
not be manufactured outside of Israel without government approval. The
amounts reimbursed by the OCS for the years 1995, 1996 and 1997 were
$7,735,000, $9,172,000 and $16,276,000, respectively.
The Company has been involved in several software research and development
programs that were funded in whole or in part by its customers. Customer
funding was recognized as a reduction to research and development expense,
and was recognized as development activities occur. Amounts received from
customers for research and development funding were included in the balance
sheet as advance payments from customers until they are recognized.
Customer funding offsets against research and development expense for the
years ended December 31, 1995, 1996 and 1997 amounted to approximately
$5,051,000, $3,349,000 and $5,148,000, respectively.
4.SHORT-TERM INVESTMENTS
The Company classifies all of its short-term investments as available-for-
sale securities. The following is a summary of available-for-sale
securities as of December 31, 1997:
GROSS GROSS ESTIMATED
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------- ---------- ---------- ---------
(IN THOUSANDS)
U.S. treasury notes................ $ 248 $ 4 $ -- $ 252
Corporate debt securities.......... 35,685 50 -- 35,735
U.S. Government agency bonds....... 749 -- -- 749
------- ------ ------ -------
Total debt securities.............. 36,682 54 -- 36,736
------- ------ ------ -------
Common stock....................... 14,359 2,787 1,687 15,459
Mutual funds investing in U.S.
government and agencies
obligations....................... 1,929 35 -- 1,964
Preferred stock.................... 5,981 880 233 6,628
------- ------ ------ -------
Total equity securities............ 22,269 3,702 1,920 24,051
------- ------ ------ -------
$58,951 $3,756 $1,920 $60,787
======= ====== ====== =======
F-10
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
The following is a summary of available-for-sale securities as of December
31, 1996:
GROSS GROSS ESTIMATED
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------- ---------- ---------- ---------
(IN THOUSANDS)
U.S. treasury notes................ $ 347 $ 4 $ -- $ 351
Corporate debt securities.......... 12,493 5 -- 12,498
U.S. government agency bonds....... 746 2 -- 748
------- ------ ------ -------
Total debt securities.............. 13,586 11 -- 13,597
------- ------ ------ -------
Common stock....................... 15,300 2,878 986 17,192
Mutual funds investing in U.S.
government and agencies
obligations....................... 1,929 10 -- 1,939
Preferred stock.................... 6,431 349 44 6,736
------- ------ ------ -------
Total equity securities............ 23,660 3,237 1,030 25,867
------- ------ ------ -------
$37,246 $3,248 $1,030 $39,464
======= ====== ====== =======
During 1997, the gross realized gains on sales of securities totaled
approximately $4,037,000 and the gross realized losses totaled
approximately $2,503,000.
The amortized cost and estimated fair value of debt securities at December
31, 1997, by contractual maturity, are as follows:
ESTIMATED
COST FAIR VALUE
------- ----------
(IN THOUSANDS)
Due in one year or less................................... $15,041 $15,047
Due after one year through three years.................... 21,591 21,638
Due after three years..................................... 50 51
------- -------
$36,682 $36,736
======= =======
5.INVENTORIES
Inventories consist of:
DECEMBER 31,
---------------
1996 1997
------- -------
(IN THOUSANDS)
Raw materials................................................ $25,416 $32,379
Work in process.............................................. 17,438 18,104
Finished goods............................................... 7,686 14,875
------- -------
$50,540 $65,358
======= =======
F-11
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
6.PROPERTY AND EQUIPMENT
Property and equipment consists of:
DECEMBER 31,
-----------------
1996 1997
------- --------
(IN THOUSANDS)
Fixtures and equipment.................................... $76,388 $112,625
Transportation vehicles................................... 3,237 2,845
Leasehold improvements.................................... 1,387 2,072
------- --------
81,012 117,542
Less accumulated depreciation and amortization............ (37,403) (55,217)
------- --------
$43,609 $ 62,325
======= ========
7.OTHER ASSETS
Other assets consist of:
DECEMBER 31,
---------------
1996 1997
------- -------
(IN THOUSANDS)
Software development costs, net of accumulated amortization
of
$9,103 and $12,649......................................... $10,143 $12,605
Other assets................................................ 13,374 12,053
------- -------
$23,517 $24,658
======= =======
8.ACQUISITIONS
On January 14, 1998, Boston Technology, Inc., a Delaware corporation,
("BTI") merged with and into Comverse in a transaction that has been
accounted for as a pooling of interests. BTI designs, develops,
manufactures, markets and supports standard and customized enhanced
services platforms and software applications for the telephone network
operator market. Pursuant to the merger, the issued and outstanding shares
of BTI at the effective date of the merger were converted into an aggregate
of approximately 18,141,185 shares of Comverse's common stock and
outstanding options and warrants to purchase BTI stock were converted into
options and warrants to purchase an aggregate of 3,458,265 Comverse shares.
F-12
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
The table below sets forth the unaudited separate and combined results of
CTI and BTI for the fiscal years ended December 31, 1995, 1996 and 1997:
CTI BTI ADJUSTMENTS COMBINED
---------- ---------- ------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1995
Sales....................... $ 137,149 $ 105,267 $ 242,416
Net income (loss)........... $ 17,050 $ (14,890) $ 2,160
Earnings per share--
diluted.................... $ 0.75 $ 0.06
1996
Sales....................... $ 197,181 $ 192,458 $ 389,639
Net income.................. $ 27,988 $ 14,149 $ 42,137
Earnings per share--
diluted.................... $ 1.16 $ 1.01
1997
Sales....................... $ 280,281 $ 210,525 $ (1,866) $ 488,940
Net income (loss)........... $ 43,500 $ (7,503) $ (1,472) $ 34,525
Earnings per share--
diluted.................... $ 1.61 $ 0.75
BTI had a January fiscal year end. Accordingly, the consolidated statement
of income data combines the historical statement of income data of the
Company for the years ended December 31, 1995, 1996 and 1997 with the
historical statement of income data of BTI for the fiscal years ended
January 31, 1996 and 1997 and the eleven months ended December 31, 1997,
respectively.
On February 20, 1997, the Company acquired all of the outstanding stock of
Enhanced Communications Corporation ("ECC"), a company providing
outsourcing of voice messaging, for 162,500 shares of the Company's common
stock. The combination has been accounted for as a pooling of interests.
The Company did not restate prior financial statements for this acquisition
due to immateriality and recorded the book value of the net assets of ECC
of $661,000 in the statement of stockholders' equity.
On August 30, 1995, the Company acquired DGM&S, a corporation that develops
and markets telecommunications software products. To effect the
acquisition, the Company issued 1,078,944 shares of common stock for all of
the outstanding common stock of DGM&S. The acquisition has been accounted
for as a pooling of interests; therefore, prior financial statements and
information have been restated to include DGM&S, as if the companies had
been combined for all periods presented.
9.ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of:
DECEMBER 31,
---------------
1996 1997
------- -------
(IN THOUSANDS)
Accounts payable............................................ $35,164 $42,462
Accrued payroll and vacation................................ 14,103 20,300
Accrued royalties........................................... 3,426 6,049
Other accrued expenses...................................... 27,247 19,443
------- -------
$79,940 $88,254
======= =======
F-13
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
10.BANK LOANS
As of December 31, 1997, a subsidiary of Comverse has a bank loan of
$16,500,000. The loan has an interest rate of 6% and is repayable in July
1998. The loan is secured by a $16,500,000 deposit with the bank.
As of December 31, 1997, the Company maintained a $60,000,000 revolving
credit facility with four banks. Borrowings are collateralized by the
Company's accounts receivable and inventories and bear interest at the
prime rate (8.5% at December 31, 1997) or the LIBOR rate plus 175 basis
points. The credit facility is scheduled to expire on July 17, 1999. This
revolving credit facility also has a .25% annual commitment fee on the
unused portion. This facility contains quarterly covenants which, among
other things, require the Company to maintain certain financial ratios,
specified levels of equity and other restrictions. The Company had
outstanding cash borrowings of $17,000,000 at December 31, 1997. In January
1998, the borrowings were repaid and the credit facility was cancelled.
11.CONVERTIBLE SUBORDINATED DEBENTURES
In October 1996, the Company issued $115,000,000 of convertible
subordinated debentures bearing interest at 5 3/4% per annum, payable semi-
annually. The debentures mature on October 1, 2006. The debentures are
convertible into shares of the Company's common stock at a conversion price
of $45.75 per share, subject to adjustment in certain events. The
debentures are subordinated in right of payment to all existing and future
senior indebtedness of the Company. The debentures are redeemable at the
option of the Company, in whole or in part, at prices decreasing from 102%
of the face amount on October 12, 1999 to par on October 1, 2001. The
debenture holders may require the Company to repurchase the debentures at
par in the event that the common stock ceases to be publicly traded and, in
certain instances, upon a change in control of the Company.
In November 1993, the Company issued $60,000,000 of convertible
subordinated debentures bearing interest at 5 1/4% per annum, payable semi-
annually. In November 1996, the Company called these debentures for
redemption. All of the debentures were converted into 3,096,768 shares of
common stock.
12.LIABILITY FOR SEVERANCE PAY
Liability for severance pay consists of the Company's unfunded liability
for severance pay to employees of certain foreign subsidiaries and accrued
severance to the Company's chief executive officer.
The Company's statutory obligation for severance pay to employees of its
Israeli subsidiaries is determined on the basis of each individual's
current salary and length of employment. Funding is currently provided
primarily by premiums paid by the Company to insurance providers.
The Company is obligated under an agreement with its chief executive
officer to provide a severance payment upon the termination of his
employment with the Company. Approximately $1,186,000 and $1,398,000 has
been accrued as of December 31, 1996 and 1997, respectively, relating to
this liability.
13.RELATED PARTIES
The Company paid or accrued legal fees to one of its directors in the
amounts of $298,000, $254,000, and $422,000 in 1995, 1996 and 1997,
respectively.
F-14
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
14.STOCK OPTIONS
EMPLOYEE STOCK OPTIONS--At December 31, 1997, 5,277,904 shares of common
stock were reserved for issuance upon the exercise of options then
outstanding and 1,478,899 options were available for future grant under
Comverse's Stock Option Plans, under which options may be granted to key
employees, directors, and other persons rendering services to the Company.
Options which are designated as "incentive stock options" under the option
plans may be granted with an exercise price not less than the fair market
value of the underlying shares at the date of grant and are subject to
certain quantity and other limitations specified in Section 422 of the
Internal Revenue Code. Options which are not intended to qualify as
incentive stock options may be granted at any price, but not less than the
par value of the underlying shares, and without restriction as to amount.
The options and the underlying shares are subject to adjustment in
accordance with the terms of the plans in the event of stock dividends,
recapitalizations and similar transactions. The right to exercise the
options generally vests in annual increments over periods of up to four
years from the date of grant or the date of commencement of the grantee's
employment with the Company.
The changes in the number of options were as follows:
YEAR ENDED DECEMBER 31,
--------------------------------
1995 1996 1997
--------- --------- ----------
Outstanding at beginning of year........... 4,346,902 4,620,225 5,572,961
Granted during the year.................... 1,234,756 1,892,136 1,104,750
Exercised during the year.................. (804,192) (730,928) (1,257,469)
Canceled, terminated and expired........... (157,241) (208,472) (142,338)
--------- --------- ----------
Outstanding at end of year................. 4,620,225 5,572,961 5,277,904
========= ========= ==========
At December 31, 1997, options to purchase an aggregate of 2,136,339 shares
were vested and currently exercisable under the option plans and options to
purchase an additional 3,141,565 shares vest at various dates extending
through the year 2001.
Weighted average option exercise price information for the years 1995, 1996
and 1997 was as follows:
1995 1996 1997
------ ------ ------
Outstanding at beginning of year....................... $ 8.57 $11.25 $16.62
Granted during the year................................ 17.38 27.11 43.04
Exercised during the year.............................. 5.71 8.92 12.38
Canceled, terminated and expired....................... 13.70 17.55 26.97
Exercisable at year end................................ 7.56 9.77 11.68
Significant option groups outstanding at December 31, 1997 and related
weighted average price and life information were as follows:
WEIGHTED AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE PRICE OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
-------------- ----------- ---------------- -------------- ----------- --------------
$ 1.40-
$10.00 1,463,194 5.24 $ 7.11 1,321,943 $ 6.79
$10.20-
$23.75 2,165,585 7.74 19.57 748,968 18.23
$25.47-
$44.25 1,362,795 8.95 39.79 63,028 34.93
$45.09-
$51.83 286,330 9.06 47.00 2,400 45.25
--------- ---- ------ --------- ------
5,277,904 7.43 $22.81 2,136,339 $11.68
========= ==== ====== ========= ======
F-15
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations in accounting
for its option plans. Accordingly, as all options have been granted at
exercise prices equal to fair market value on the date of grant, no
compensation expense has been recognized by the Company in connection with
its stock-based compensation plans. Had compensation cost for the Company's
stock option plans been determined based upon the fair value at the grant
date for awards under these plans consistent with the methodology
prescribed under Statement of Financial Accounting Standards ("SFAS") No.
123, "Accounting for Stock-Based Compensation", the Company's net income
and earnings per share would have been reduced by approximately $2,254,000,
$4,962,000 and $13,505,000 or $.06, $.11 and $.29 per diluted share in
1995, 1996 and 1997, respectively. The weighted average fair value of the
options granted during 1995, 1996 and 1997 is estimated at $9.63, $14.20
and $23.21 on the date of grant (using the Black-Scholes option pricing
model) with the following weighted average assumptions for 1995, 1996 and
1997, respectively: volatility of 63%, 56% and 54%, risk-free interest rate
of 6.7%, 6.3% and 6.5%, and an expected life of 4.6, 4.6 and 4.7 years in
1995, 1996 and 1997, respectively.
OPTIONS ON SUBSIDIARY SHARES--Comverse has granted to its chief executive
officer, under the terms of his employment agreement, options to acquire
7.5% of the equity of Comverse's subsidiaries, other than Efrat Future
Technology, Ltd. ("Efrat"). In addition, Comverse has granted to certain
other key executives of the Company options to acquire shares of certain
subsidiaries, other than Efrat, as a means of providing incentives directly
tied to the performance of those subsidiaries for which different
executives have direct responsibility. Such options, which upon exercise
would represent in the aggregate up to 23.6% of the outstanding shares of
each subsidiary, have terms of ten years and become exercisable and vest in
equal ratable annual increments over periods ranging from three to five
years from the first anniversary of the date of initial grant. The exercise
price of each option is equal to the higher of the book value of the
underlying shares at the date of grant or the fair market value of such
shares at that date determined on the basis of an arms'-length transaction
with a third party or, if no such transactions have occurred, on a
reasonable basis as determined by a committee of the Board of Directors.
Upon the exercise, in whole or in part, of any option, Comverse will
receive an irrevocable proxy to vote the underlying shares and a right of
first refusal to purchase the shares upon any proposed sale, transfer or
other disposition, until such time as the shares shall have been sold in a
bona fide open market transaction.
15.WARRANTS
In November 1995, the Company entered into an agreement to supply its
products to AT&T. Pursuant to this agreement, the Company issued warrants
to purchase shares of its common stock at an exercise price of $21.54 per
share. The warrants vest in five equal annual increments, commencing with
the first anniversary of the date of grant, and remain exercisable for 30
months after first becoming exercisable. Any stock issued as a result of
the exercise of the warrants would be for the customer's investment
purposes only, and would be "restricted securities" under Rule 144 of the
Securities Act of 1933. As of December 31, 1997, warrants to purchase
1,914,432 shares are outstanding, none of which are exercisable.
At commencement of the contract, the Company estimated that compliance with
the terms of the agreement would result in a $21,000,000 loss, which was
recognized in the year ended December 31, 1995. Included in the $21,000,000
was a charge of $18,600,000 relating to the value of the warrants issued to
AT&T, based on an evaluation performed by an independent investment banking
firm.
F-16
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
16.EARNINGS PER SHARE ("EPS")
In 1997, the Company adopted SFAS No. 128, "Earnings Per Share". Basic
earnings per share is determined by using the weighted average number of
shares of common stock outstanding during each period. Diluted earnings per
share further assumes the issuance of common shares for all dilutive
potential common shares outstanding. The calculation for earnings per share
for each of the three years ended December 31, 1997 was as follows:
1995 1996 1997
----------------------- ------------------------ ------------------------
PER SHARE PER SHARE PER SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT INCOME SHARES AMOUNT
------ ------ --------- ------- ------ --------- ------- ------ ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
BASIC EPS
Net Income.............. $2,160 37,281 $0.06 $42,137 38,223 $1.10 $34,525 42,413 $0.81
===== ===== =====
EFFECT OF DILUTIVE
SECURITIES
Options................. 1,479 3,453 3,556
Convertible debentures.. 2,586 2,701
------ ------ ----- ------- ------ ----- ------- ------ -----
DILUTED EPS............. $2,160 38,760 $0.06 $44,723 44,377 $1.01 $34,525 45,969 $0.75
====== ====== ===== ======= ====== ===== ======= ====== =====
Debentures convertible into 3,096,768 shares, 2,513,661 shares and
2,513,661 shares were outstanding as of December 31, 1995, 1996 and 1997,
respectively, but were not included in the computation of diluted EPS
because the effect of including them would be antidilutive.
17.FOREIGN OPERATIONS
Condensed net assets, exclusive of intercompany balances, applicable to all
foreign operations, principally located in Israel, included in the
consolidated balance sheets, are summarized as follows:
DECEMBER 31,
----------------
1996 1997
------- --------
(IN THOUSANDS)
Current assets............................................. $85,841 $131,262
Property and equipment, net................................ 13,548 19,523
Software development costs, net............................ 9,394 12,134
Other assets............................................... 80 1,757
------- --------
Total assets............................................. 108,863 164,676
------- --------
Current liabilities........................................ 32,323 43,942
Other liabilities.......................................... 2,258 2,849
------- --------
Total liabilities........................................ 34,581 46,791
------- --------
Net assets............................................. $74,282 $117,885
======= ========
F-17
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
Condensed operating information, exclusive of intercompany transactions,
applicable to all foreign operations, principally located in Israel,
included in the consolidated statements of income, is summarized as
follows:
YEAR ENDED DECEMBER 31,
--------------------------
1995 1996 1997
------- -------- --------
(IN THOUSANDS)
Total revenues.................................. $72,843 $ 95,766 $156,337
Costs and expenses.............................. 71,430 112,056 166,726
------- -------- --------
Operating income (loss)......................... $ 1,413 $(16,290) $(10,389)
======= ======== ========
The operating results shown above reflect the inclusion in costs and
expenses of fixed charges incurred by Comverse's foreign subsidiaries
necessary to support a level of activity which is greater than that shown
in the table due to the exclusion of intercompany revenue. Foreign
operations in 1996 and 1997 were profitable when intercompany transactions
are included.
18.INCOME TAXES
The provision for income taxes consists of the following:
YEAR ENDED DECEMBER 31,
--------------------------
1995 1996 1997
------- -------- -------
(IN THOUSANDS)
Current:
Federal......................................... $ 2,218 $ 9,885 $ 3,471
State........................................... 585 1,235 703
Foreign......................................... 1,022 1,950 2,216
------- -------- -------
3,825 13,070 6,390
------- -------- -------
Deferred (benefit):
Federal......................................... (1,559) (2,716) 2,810
State........................................... (325) (206) 215
Foreign......................................... 221 22 (17)
------- -------- -------
(1,663) (2,900) 3,008
------- -------- -------
$ 2,162 $ 10,170 $ 9,398
======= ======== =======
The reconciliation of the U.S. Federal statutory tax rate to the Company's
effective tax rate is as follows:
YEAR ENDED
DECEMBER 31,
----------------
1995 1996 1997
---- ---- ----
U.S. Federal statutory rate............................... 35% 35% 35%
Consolidated worldwide income in excess of U.S. income.... (136) (18) (31)
Foreign income taxes...................................... 29 4 5
AT&T warrants............................................. 151 -- --
Other..................................................... (29) (2) 12
---- --- ---
Company's effective tax rate.............................. 50% 19% 21%
==== === ===
Deferred income taxes reflect the net tax effects of (a) temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes
and
F-18
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(b) operating loss carryforwards. The tax effects of significant items
comprising the Company's deferred tax asset and liability at December 31,
1996 and 1997 are as follows:
1996 1997
------ -------
(IN THOUSANDS)
Deferred tax liability:
Expenses deductible for tax purposes and not for
financial reporting purposes............................ $1,681 $ 846
Unrealized gain on available-for-sale securities......... 674 679
------ -------
$2,355 $ 1,525
------ -------
Deferred tax asset:
Reserves not currently deductible........................ $8,308 $15,827
Tax loss carryforwards................................... 1,091 482
Inventory capitalization................................. (263) 420
Other.................................................... 474 94
------ -------
9,610 16,823
Less: valuation allowance................................. (3,814) (14,660)
------ -------
Total deferred tax asset................................ $5,796 $ 2,163
====== =======
Income tax has not been provided on unrepatriated earnings of foreign
subsidiaries as currently it is the intention of the Company to reinvest
such foreign earnings in their operations.
19.BUSINESS SEGMENT INFORMATION
The Company is engaged in one business segment: the design, development,
manufacture, marketing and support of special purpose computer and
telecommunications systems and software for multimedia communications and
information processing applications.
Sales by geographic regions, as a percentage of total sales, for the years
ended December 31, 1995, 1996 and 1997 were as follows:
1995 1996 1997
---- ---- ----
United States................................................ 34% 49% 33%
Canada....................................................... 2% 2% 1%
Europe....................................................... 18% 20% 26%
Far East/Australia........................................... 36% 23% 30%
Latin America................................................ 3% 1% 6%
Other........................................................ 7% 5% 4%
--- --- ---
Total........................................................ 100% 100% 100%
=== === ===
In 1996, sales to AT&T constituted 11% of total sales. No customer
accounted for 10% of sales in 1995 or 1997.
20.COMMITMENTS AND CONTINGENCIES
LEASES--The Company leases office, manufacturing, and warehouse space under
non-cancelable operating leases. Rent expense for all leased premises
approximated $5,889,000, $7,839,000 and $11,705,000 in 1995, 1996, and
1997, respectively.
F-19
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
As of December 31, 1997, the minimum rent obligations of the Company were
approximately as follows:
AMOUNT
--------------
(IN THOUSANDS)
1998....................................................... $ 13,568
1999....................................................... 12,090
2000....................................................... 9,944
2001....................................................... 9,779
2002 and thereafter........................................ 64,948
--------
$110,329
========
EMPLOYMENT AGREEMENTS--The Company is obligated under employment contracts
with its chief executive officer to provide salary, bonuses, and fringe
benefits through June 30, 2000. Minimum salary payments under the contracts
currently amount to $350,000 per year and aggregate $875,000 through June
30, 2000. The executive is entitled to annual bonuses equal to at least 3%
of the Company's consolidated after-tax net income during each year. Upon
termination or expiration of the term of employment, the executive is
entitled to receive a severance payment equal to $93,170 for each year of
his previous and current employment with the Company, which is increased by
the rate of 10% per annum compounded for each year of employment, plus
continued employment-related benefits for the period of 36 months
thereafter. If the termination of employment results from a unilateral
termination or fundamental breach of the agreement by the Company, or the
resignation of the executive within six months following a change in
control of the Company not approved by the executive in his capacity as a
director of Comverse, the executive is entitled to an additional payment
equal to 299% of the average annual cash compensation, including salary and
any bonus payments, received by the executive from the Company during the
three immediately preceding fiscal years, plus an amount equal to the
income tax resulting from such payment. The agreements also provide for the
executive to receive options entitling him to purchase 7 1/2% of the equity
of Comverse's subsidiaries, other than Efrat, at prices equal to the higher
of book value of the underlying shares at the date of option grant or the
fair market value of such shares at that date determined on the basis of an
arms'-length transaction with a third party or, if no such transactions
have occurred, on a reasonable basis as determined by the Board of
Directors.
Most other employment agreements of the Company are terminable with or
without cause with prior notice of 60 days or less. In certain instances,
the termination of employment agreements without cause entitles the
employees to certain benefits, including acceleration of the vesting of
stock options and severance payment of as much as one year's compensation.
LICENSES AND ROYALTIES--The Company licenses certain technology, "know-
how," software and related rights for use in the manufacture and marketing
of its products, and pays royalties to third parties under such licenses
and under other agreements entered into in connection with research and
product development activities. The Company currently pays royalties on the
sale of substantially all of its product lines in varying amounts based
upon the revenues attributed to the various components of such products.
Royalties typically range up to 6% of net sales of the related products
and, in the case of royalties due to government funding sources in respect
of research and development projects, are required to be paid until the
funding organization has received total royalties ranging from 100% to 150%
of the amounts received by the Company under the approved project budgets.
DIVIDEND RESTRICTIONS--The ability of Comverse's Israeli subsidiaries to
pay dividends is governed by Israeli law, which provides that cash
dividends may be paid by an Israeli corporation only out of retained
F-20
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
earnings as determined for statutory purposes in Israeli currency. In the
event of a devaluation of the Israeli currency against the dollar, the
amount in dollars available for payment of cash dividends out of prior
years' earnings will decrease accordingly. Cash dividends paid by an
Israeli corporation to United States residents are subject to withholding
of Israeli income tax at source at a rate of up to 25%, depending on the
particular facilities which have generated the earnings that are the source
of the dividends.
INVESTMENTS--In 1997, wholly-owned subsidiaries of Comverse and Quantum
Industrial Holdings Ltd. organized two new companies to make investments
primarily relating to Israel, including investments in high technology
ventures. Each participant committed a total of $25,000,000 to the capital
of the new companies, for use as suitable investment opportunities are
identified. Quantum Industrial Holdings Ltd. is the principal direct
investment vehicle of the Quantum Group, a group of investment funds
managed by Soros Fund Management LLC.
GUARANTIES--The Company has obtained bank guaranties primarily for
performance of certain obligations under contracts with customers. These
guaranties, which aggregated approximately $13,142,000 at December 31,
1997, are to be released by the Company's performance of specified contract
milestones, which are scheduled to be completed primarily during 1998.
LITIGATION--On February 2, 1998, Computel Computadores e Telecommunicacoes
S.A. ("Computel") filed a Request for Arbitration with the International
Chamber of Commerce ("ICC") in Paris, France (No. 9858/FMS), claiming
breaches by BTI and its wholly-owned subsidiary, Boston Technology
Investments, Inc., in respect of agreements with Computel and its
affiliates for the distribution of BTI's systems in Brazil. On March 10,
1998, the Company commenced an action against Computel and an affiliate in
the Middlesex Superior Court of Massachusetts (Civil Action No. 98-1155)
seeking declaratory judgments as to arbitrability and the continuing
validity of the Purchase and Sale Agreement between the parties, Computel's
specific performance of such agreement and injunctions to prevent Computel
from proceeding with the ICC arbitration. In this action, the Company seeks
damages in excess of $3,767,500 as a result of Computel's failure to pay
monies owed under the Purchase and Sale Agreement, as well as costs and
attorneys' fees. The defendants have filed a counterclaim in that action
alleging, among other things, that BTI breached its obligations to Computel
by merging with Comverse and thereby competing with a company jointly
established by the parties in connection with such distribution activities,
by delivering equipment that did not conform to specifications, and by
failing to support this equipment. On April 21, 1998, the Company served on
Computel and its affiliate a motion to stay and to compel arbitration and
to dismiss certain counts of defendants' Counterclaim. On March 11, 1998,
the Company filed a Demand for Arbitration with the American Arbitration
Association in Boston, Massachusetts, against Computel and certain of its
affiliates claiming breach of a Distribution Agreement between the parties
and unfair and deceptive trade practices. In this arbitration, the Company
seeks to recover damages in excess of $12,000,000, plus interest, for
systems shipped to respondents, and additional damages for respondents'
repudiation and anticipatory breach of contract and unfair and deceptive
trade practices. On April 3, 1998, the Middlesex Superior Court issued a
temporary injunction prohibiting Computel from proceeding with its ICC
arbitration request.
The Company is subject to certain other legal actions arising in the normal
course of business. After taking into consideration legal counsel's
evaluation of such actions, management is of the opinion that their final
resolution will not have any significant adverse effect upon the Company's
business or its consolidated financial statements.
F-21
COMVERSE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
21.FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Company, using
available market information and appropriate valuation methodologies.
However, considerable judgment is necessarily required in interpreting
market data to develop the estimates of fair value. Accordingly, the
estimates presented herein are not necessarily indicative of the amounts
that the Company could realize in a current market exchange. The use of
different market assumptions and/or estimation methodologies may have a
material effect on the estimated fair value amounts.
DECEMBER 31, 1996 DECEMBER 31, 1997
------------------- -------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
(IN THOUSANDS)
Liabilities:
Convertible subordinated
debentures....................... $115,000 $119,456 $115,000 $122,188
Off-balance sheet financial
instruments:
Foreign exchange forward contracts
used for hedging purposes........ $ -- $ 64 $ -- $ 1,407
CASH AND CASH EQUIVALENTS, BANK TIME DEPOSITS, SHORT-TERM INVESTMENTS,
ACCOUNTS RECEIVABLE, LONG-TERM RECEIVABLES, INVESTMENTS, AND ACCOUNTS
PAYABLE--The carrying amounts of these items are a reasonable estimate of
their fair value.
CONVERTIBLE SUBORDINATED DEBENTURES AND FOREIGN EXCHANGE FORWARD
CONTRACTS--The fair value of these securities is estimated based on quoted
market prices or recent sales for those or similar securities.
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 1997. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since that date, and
current estimates of fair value may differ significantly from the amounts
presented herein.
22.QUARTERLY INFORMATION (UNAUDITED)
The following table shows selected results of operations for each of the
quarters during 1996 and 1997.
FISCAL QUARTER ENDED
---------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1996 1996 1996 1996 1997 1997 1997 1997
--------- -------- --------- -------- --------- -------- --------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Sales................... $76,161 $88,084 $104,710 $120,684 $126,848 $133,012 $140,327 $ 88,753
Gross profit............ $41,231 $51,065 $ 58,772 $ 69,047 $ 74,221 $ 80,101 $ 85,081 $ 46,897
Net income (loss)....... $ 7,337 $ 9,642 $ 11,406 $ 13,752 $ 15,494 $ 17,050 $ 18,246 $(16,265)
Diluted earnings per
share.................. $ 0.18 $ 0.23 $ 0.27 $ 0.32 $ 0.34 $ 0.37 $ 0.39 $ (0.35)
======= ======= ======== ======== ======== ======== ======== ========
The difference between income per share for the years and the sum of the
income per share for the quarters comprising the years is due to
differences in the calculation of the weighted average number of shares
outstanding over the respective periods and rounding adjustments.
F-22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
INTRODUCTION
On January 14, 1998, Comverse Technology, Inc. ("Comverse" and, together
with its subsidiaries, the "Company") consummated a merger (the "Merger") with
Boston Technology, Inc., a Delaware corporation ("Boston") in a transaction in
which former shareholders of Boston received an aggregate of 18,141,185 shares
of Comverse's Common Stock. The Merger has been accounted for as a pooling of
interests. This Discussion and Analysis reviews the financial statements of the
Company for the three years ended December 31, 1997 restated to include the
operations of Boston for its fiscal years ended January 31, 1996 and 1997 and
the eleven months ended December 31, 1997.
RESULTS OF OPERATIONS
The following discussion and analysis of the Company's results of
operations covers the operating results of Comverse and its consolidated
subsidiaries for the fiscal years included in the foregoing selected financial
data.
COMPARISON OF 1996 AND 1997 OPERATIONS
Total Revenues. Total revenues increased from 1996 to 1997 by
approximately $105,252,000 (26%). The increase is attributable primarily to a
higher volume of sales of systems and parts. Sales increased from 1996 to 1997
by approximately $99,301,000 (25%), primarily resulting from increased sales of
Comverse Network Systems' products. Interest and other income increased from
1996 to 1997 by approximately $5,951,000 (54%), resulting primarily from
increased interest and dividend income, the investment of funds generated
through the issuance of convertible subordinated debentures in October 1996, and
realized gains on sales of investments.
Cost of Sales. Cost of sales increased by approximately $33,116,000
(20%) from 1996 to 1997 primarily as a result of the increase in sales. Gross
margins increased from approximately 56.5% in 1996 to approximately 58.6% in
1997.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased from 1996 to 1997 by approximately $44,701,000
(48%) and as a percentage of total revenues increased from approximately 23% in
1996 to approximately 27% in 1997. The increased amount was a result of
increased sales, marketing and administrative activities associated with the
overall growth of the Company's operations, and particularly with the expansion
of direct sales and marketing activities.
Research and Development Expenses. Net research and development expenses
during 1997 increased by approximately $30,398,000 (46%) over 1996 due to
overall growth of research and development operations, the initiation of
significant new research and development projects and increases in salaries and
other costs associated with research and development operations in Israel.
Royalties and License Fees. Royalties and license fees increased from
1996 to 1997 by approximately $1,882,000 (18%) due primarily to growth in sales
of royalty-bearing products.
Income Tax Provision. Provision for income taxes decreased from 1996 to
1997 by approximately $772,000 (8%), while the Company's overall effective tax
rate increased from approximately 19% during 1996 to approximately 21% in 1997.
The Company's overall rate of tax is reduced significantly by the tax benefits
associated with qualified activities of one of its Israeli subsidiaries, which
is entitled to favorable income tax rates under a program of the Israeli
Government for "Approved Enterprise" investments in that country.
Net Income. Net income after taxes decreased from approximately
$42,137,000 in 1996 to approximately $34,525,000 in 1997, a decrease of
approximately $7,612,000 (18%), while net
F-23
income after taxes as a percentage of total revenues decreased from
approximately 10.5% in 1996 to approximately 6.8% in 1997. The decreases
resulted primarily from the factors described above.
COMPARISON OF 1995 AND 1996 OPERATIONS
Total Revenues. Total revenues increased from 1995 to 1996 by
approximately $148,318,000 (59%). The increase is attributable primarily to a
higher volume of sales of systems and parts. Sales increased from 1995 to 1996
by approximately $147,223,000 (61%), primarily resulting from increased sales
of Comverse Network Systems' products. Interest and other income increased
from 1995 to 1996 by approximately $1,095,000 (11%), resulting primarily from
increased interest and dividend income, the investment of funds generated
through the issuance of convertible subordinated debentures in October 1996, and
realized gains on sales of short-term investments.
Cost of Sales. Cost of sales increased by approximately $64,544,000
(61%) from 1995 to 1996 primarily as a result of the increase in sales. Gross
margins decreased from approximately 56.7% in 1995 to approximately 56.5% in
1996.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased from 1995 to 1996 by approximately $20,651,000
(28%) and as a percentage of total revenues decreased from approximately 29% in
1995 to approximately 23% in 1996. The increased amount was a result of
increased sales, marketing and administrative activities associated with the
overall growth of the Company's operations, and particularly with the expansion
of direct sales and marketing activities.
Research and Development Expenses. Net research and development expenses
during 1996 increased by approximately $24,918,000 (60%) over 1995 due to
overall growth of research and development operations, the initiation of
significant new research and development projects and increases in salaries and
other costs associated with research and development operations in Israel.
Royalties and License Fees. Royalties and license fees increased from
1995 to 1996 by approximately $7,122,000 (214%) due primarily to growth in sales
of royalty-bearing products, as well as a new licensing agreement.
Warrants and Other Expenses Associated with AT&T Contract Acquisition.
In 1995, the Company entered into an agreement with AT&T Corporation ("AT&T")
for the supply of the Company's Access NP Network Services Platform and its
AccessMAX object-oriented software. Pursuant to the agreement, the Company
issued to AT&T warrants to purchase the Company's common stock. In conjunction
with the issuance of the warrants and the start-up costs associated with the
agreement, the Company took a non-cash, non-tax deductible charge of $21,000,000
to earnings. The $21,000,000 charge was due primarily to the valuation placed
on the warrants.
Income Tax Provision. Provision for income taxes increased from 1995 to
1996 by approximately $8,008,000 (370%), while the Company's overall effective
tax rate decreased from approximately 50% during 1995 to approximately 19% in
1996. The Company's overall rate of tax is reduced significantly by the tax
benefits associated with qualified activities of one of its Israeli
subsidiaries, which is entitled to favorable income tax rates under a program of
the Israeli Government for "Approved Enterprise" investments in that country.
F-24
Net Income. Net income after taxes increased from approximately
$2,160,000 in 1995 to approximately $42,137,000 in 1996, an increase of
approximately $39,977,000 (1,851%), while net income after taxes as a percentage
of total revenues increased from approximately 0.9% in 1995 to approximately
10.5% in 1996. The increases resulted primarily from the factors described
above.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had cash and cash equivalents of
approximately $188,023,000, bank time deposits of approximately $40,700,000,
short-term investments of approximately $60,787,000 and working capital of
approximately $395,503,000. In addition, in June 1998, the Company issued
$250,000,000 of 4-1/2% Convertible Subordinated Debentures due 2005. The
Company believes that its existing working capital, together with funds
generated from operations, will be sufficient to provide for its planned
operations at least through December 31, 1998.
The Company regularly examines opportunities for strategic acquisitions
of other companies or lines of business, and anticipates that it may from time
to time issue additional debt and/or equity securities either as direct
consideration for such acquisitions or to raise additional funds to be used (in
whole or in part) in payment for acquired securities or assets. The issuance of
such securities can be expected to have a dilutive impact on the Company's
shareholders, and there can be no assurance as to whether or when any acquired
business would contribute positive operating results commensurate with the
associated acquisition cost.
The Company's liquidity and capital resources have not been, and are not
anticipated to be, materially affected by restrictions pertaining to the ability
of its subsidiaries in Israel to pay dividends or by withholding taxes
associated with any such dividend payments. Cash dividends paid by an Israeli
corporation to United States residents are subject to withholding of Israeli
income tax at source at rates of up to 25%, depending on the particular
facilities that have generated the earnings that are the source of the
dividends.
YEAR 2000
The Company has taken actions to understand the nature and extent of the
work required to make its systems, products and infrastructure Year 2000
compliant and has begun work to prepare its products and its financial,
information and other computer-based systems for the Year 2000, including
replacing and/or updating existing legacy systems. The Company continues to
evaluate the estimated costs associated with these efforts. While these efforts
will involve additional costs, the Company believes, based on available
information, that it will be able to manage its total Year 2000 transition
without any material adverse effect on its business operations, products or
financial prospects.
CERTAIN TRENDS AND UNCERTAINTIES
The Company has benefited from the growth in its business and capital base
over the past several years to make significant new investment in its operations
and infrastructure intended to
F-25
enhance its opportunities for future growth and profitability. The Company's
results of operations reflect the significant increase in its investment in
operations over the past three years. The Company intends to continue to make
significant investments in the growth of its business, and to examine
opportunities for additional growth through acquisitions and strategic
investments. The impact of these decisions on future profitability cannot be
predicted with assurance, and the Company's commitment to growth may increase
its vulnerability to unforeseen downturns in its markets, technology changes and
shifts in competitive conditions. However, the Company believes that significant
opportunities exist in the markets for each of its main product lines, and that
continued strong investment in its technical, product development, marketing and
sales capabilities will enhance its opportunities for long term growth and
profitability.
The Merger involves the integration of two companies that have previously
operated independently. The combination of two sizable technology-based
companies involves significant complexities, and no assurance can be given that
the combined Company will be able to integrate the operations of Boston into the
Company without encountering difficulties or experiencing the loss of key
Comverse or Boston personnel or that the benefits expected from such integration
will be realized. The integration of two companies across geographically
dispersed operations can create the risk of disruption in operations of the
combined company, and neither company's management has substantial experience in
managing such integration or the operations of an entity the size of the
combined company. The Company does not expect to realize cost savings in the
near future as a result of the Merger, and no assurance can be given that any
savings can be achieved in future periods. Furthermore, there can be no
certainty that the Merger will not adversely affect the relationships with key
customers or key vendors of either company. As a result of its significantly
greater concentration on a small number of large telephone company customers,
Boston's business has historically been considerably more volatile than that of
Comverse, and the operations of the combined company are likely to be less
predictable and subject to greater risks from actions of individual customers
than the operations of Comverse in recent years.
The telecommunications industry is subject to rapid technological change.
The Company's revenue stream will depend on its ability to enhance its existing
products and to introduce new products on a timely and cost-effective basis.
This includes any customer-requested custom software enhancements required in
the normal course of product delivery and customer demands for the technological
convergence of the Company's products. The Company's products involve
sophisticated hardware and software technology that performs critical functions
to highly demanding standards. There can be no assurance that the Company's
current or future products will not develop operational problems, which could
have a material adverse effect on the Company. In addition, if the Company were
to delay the introduction of new products, or to delay the delivery of specific
custom software enhancements, the Company's operating results could be adversely
affected. The Company sells a majority of its products to companies in the
telecommunications industry. This industry is undergoing significant change as
a result of deregulation and privatization worldwide, reducing restrictions on
competition in the industry. Unforeseen changes in the regulatory environment
may have an impact on the Company's revenues and/or costs in any given part of
the world. The worldwide enhanced services systems industry is already highly
competitive and the Company expects competition to intensify. The Company
believes that existing competitors will continue to present substantial
competition, and that other companies, many with considerably greater financial,
marketing and sales resources than the Company, may enter the enhanced services
systems markets. The 1997 acquisition of Octel Communications Corporation, a
significant competitor of the Company, by Lucent
F-26
Technologies, Inc. may intensify the competitive environment in the industry,
and there can be no assurance that similar business combinations or industry
consolidation will not occur in the future.
The enhanced services platforms industry has experienced a continuing
evolution of product offerings and alternatives for delivery of services. These
trends have affected and may be expected to have a significant continuing
influence on conditions in the industry, although the impact on the industry
generally and on the Company's position in the industry cannot be predicted with
assurance. Significant changes in the industry make planning decisions more
difficult and increase the risk inherent in the planning process.
The market for telecommunications monitoring systems is also in a period of
significant transition. Budgetary constraints, uncertainties resulting from the
introduction of new technologies in the telecommunications environment and
shifts in the pattern of government expenditures resulting from geopolitical
events have increased uncertainties in the market, resulting in certain
instances in the attenuation of government procurement programs beyond their
originally expected performance periods and an increased incidence of delay,
cancellation or reduction of planned projects. The continuing delay and
uncertainties surrounding the Communications Assistance for Law Enforcement Act
("CALEA") have had a significant impact on acquisition plans of law enforcement
agencies in North America engaged in monitoring activities, and no assurances
can be given as to the timing or ultimate content of the proposed legislation.
Competitive conditions in this sector have also been affected by the increasing
use by certain potential government customers of their own internal development
resources rather than outside vendors to provide certain technical solutions.
In addition, a number of established government contractors, particularly
developers and integrators of technology products, have taken steps to redirect
their marketing strategies and product plans in reaction to cut-backs in their
traditional areas of focus, resulting in an increase in the number of
competitors and the range of products offered in response to particular requests
for proposals. The lack of predictability in the timing and scope of government
procurements have similarly made planning decisions more difficult and have
increased the associated risks.
The Company has historically derived a significant portion of its sales and
operating profit from a relatively small number of contracts for large system
installations with major customers. Boston's operating results, in particular,
have often been characterized by volatility and lack of predictability,
reflecting its traditional customer concentration among major telecommunications
services providers such as the Regional Bell Operating Companies. The Company
continues to emphasize large capacity systems in its product development and
marketing strategies. Contracts for large installations typically involve a
lengthy and complex bidding and selection process, and the ability of the
Company to obtain particular contracts is inherently difficult to predict. The
Company believes that opportunities for large installations will continue to
grow in both its commercial and government markets, and intends to continue to
expand its research and development, manufacturing, sales and marketing and
product support capabilities in anticipation of such growth. However, the
timing and scope of these opportunities and the pricing and margins associated
with any eventual contract award are difficult to forecast, and may vary
substantially from transaction to transaction. The Company's future operating
results may accordingly exhibit a higher degree of volatility than the operating
results of other companies in its industries that have adopted different
strategies, and than the Company has experienced in prior periods. Although the
Company is actively pursuing a number of significant procurement opportunities
in the United States and internationally, both the timing of any eventual
procurements and the probability of the Company's receipt of significant
contract awards are uncertain. The degree of dependence by the Company on large
orders, and the investment
F-27
required to enable the Company to perform such orders, without assurance of
continuing order flow from the same customers and predictability of gross
margins on any future orders, increase the risk associated with its business.
The Company has significantly increased its expenditures in all areas of
its operations during recent periods, including the areas of research and
development and marketing and sales, and the Company plans to further increase
these expenditures in the foreseeable future. The increase in research and
development expenditures reflects the Company's concentration on enhancing the
range of features and capabilities of its existing product lines and developing
new generations of its products. The Company believes that these efforts are
essential for the continuing competitiveness of its product offerings and for
positioning itself to participate in future growth opportunities in both the
commercial and government sectors. The increase in sales and marketing
expenditures primarily results from the Company's decision to expand its
activities and direct presence in a growing number of world markets. The
Company's costs of operations have also been affected by increases in the cost
of its operations in Israel, resulting both from general inflation and increases
in the cost of attracting and retaining qualified scientific, engineering and
technical personnel in Israel, where the demand for such personnel is growing
rapidly with the expansion of technology-based industries in that country. The
increase in these costs in recent periods has not been offset by proportional
devaluation of the Israeli shekel against the United States dollar, and
accordingly has had a negative impact on the Company's overall results of
operations. Continuation of such trends may have a material adverse effect on
the Company's future results of operations.
A significant portion of the Company's research and development and
manufacturing operations are located in Israel and may be affected by
regulatory, political, military and economic conditions in that country. The
Company's historical operating results reflect substantial benefits from
programs sponsored by the Israeli government for the support of research and
development, as well as favorable tax rates available to "Approved Enterprises"
in Israel. The Israeli government has indicated its intention to reexamine
certain of its policies in these areas. In 1996, the Israeli government acted to
increase, from between 2% and 3% of associated product sales to between 3% and
5% of associated product revenues (including service and other related
revenues), the annual rate of royalties to be applied to repayment of benefits
under the conditional grant program administered by the Office of the Chief
Scientist of the Ministry of Industry and Trade, a program in which the Company
has regularly participated and under which it continues to receive significant
benefits through reimbursement of qualified research and development
expenditures. The Company's repayment of amounts received under the program will
be accelerated through these higher royalty rates until repayment is completed.
In addition, permission from the government of Israel is required for the
Company to manufacture outside of Israel products resulting from research and
development activities funded under such programs, or to transfer outside of
Israel related technology rights, and in order to obtain such permission the
Company may be required to increase the royalties to the applicable funding
agencies and/or repay certain amounts received as reimbursement of research and
development costs. The Company expects to incur additional royalty expenses
and/or repayment obligations as a result of the Merger and the location of
certain manufacturing and research and development operations pertaining to its
TRILOGUE product line at its Boston facilities. The Israeli authorities have
also indicated that these research and development funding programs will be
further reduced in the future, particularly for larger entities such as the
Company. The Israeli government has also shortened the period of the tax
moratorium applicable to "Approved Enterprises" from four years to two years.
Although this change has not affected the tax status of the Company's projects
that were eligible for the moratorium prior to 1997, it applies to the
subsequent "Approved Enterprises" of the Company.
F-28
If further changes in the law or government policies regarding those programs
were to result in their termination or adverse modification, or if the Company
were to become unable to participate in or take advantage of those programs, the
cost to the Company of its operations in Israel would materially increase and
there would be an adverse effect on the results of the Company's operations as a
whole. To the extent the Company increases its activities outside Israel, which
will result from the Merger and possible future acquisitions, such increased
activities will not be eligible for programs sponsored by Israel. Most of the
Company's research and development and manufacturing operations attributable to
Boston are expected to continue to be located in the United States and thus will
not be eligible for the benefits of those programs. Accordingly, the effective
cost to the Company of its future research and development activities in
particular, and its operations in general, could significantly increase relative
to that of Comverse, historically.
The Company currently derives a significant portion of its total sales from
customers outside of the United States. International transactions involve
particular risks, including political decisions affecting tariffs and trade
conditions, rapid and unforeseen changes in economic conditions in individual
countries, turbulence in foreign currency and credit markets, and increased
costs resulting from lack of proximity to the customer. Volatility in
international currency exchange rates may have a significant impact on the
Company's operating results. The Company has, and anticipates that it will
continue to receive, significant contracts denominated in foreign (primarily
Western European and Japanese) currencies. As a result of the unpredictable
timing of purchase orders and payments under such contracts and other factors,
it is often not practicable for the Company to effectively hedge the risk of
significant changes in currency rates during the contract period. Since the
Company will hedge the exchange rate risks associated with long-term contracts
denominated in foreign currencies only to a limited extent, operating results
can be affected by the impact of currency fluctuations as well as the cost of
such hedging.
Prevailing economic conditions in the Far East and Southeast Asia have
reduced the demand for the Company's systems in certain countries. The Company
cannot currently predict the effect on its business should regional economic
conditions fail to improve.
The trading price of the Company's shares may be affected by the factors
noted above as well as prevailing economic and financial trends and conditions
in the public securities markets. Share prices of companies in technology and
government contracting businesses, and particularly smaller and medium-sized
publicly traded companies such as the Company, tend to exhibit a high degree of
volatility. The Company's revenues and earnings may be more volatile than those
of Comverse historically as a result of the greater concentration of Boston's
business on a limited number of large customers. Shortfalls in revenues or
earnings from the levels anticipated by the public markets could have an
immediate and significant effect on the trading price of the Company's shares in
any given period. Such shortfalls may result from events that are beyond the
Company's immediate control, can be unpredictable and, since a significant
proportion of the Company's sales during each fiscal quarter tend to occur in
the latter stages of the quarter, may not be discernible until the end of a
financial reporting period. These factors contribute to the volatility of the
trading value of its shares regardless of the Company's long-term prospects.
The trading price of the Company's shares may also be affected by developments,
including reported financial results and fluctuations in trading prices of the
shares of other publicly-held companies in the telecommunications equipment
industry in general, and the enhanced services platform industry in particular,
which may not have any direct relationship with the Company's business or
prospects.
F-29
FORWARD-LOOKING STATEMENTS
From time to time, the Company makes forward-looking statements.
Forward-looking statements include financial projections, statements of plans
and objectives for future operations, statements of future economic performance,
and statements of assumptions relating thereto.
The Company may include forward-looking statements in its periodic
reports to the Securities and Exchange Commission on Forms 10-K, 10-Q, and 8-K,
in its annual report to shareholders, in its proxy statements, in its press
releases, in other written materials, and in statements made by employees to
analysts, investors, representatives of the media, and others.
By their very nature, forward-looking statements are subject to
uncertainties, both general and specific, and risks exist that predictions,
forecasts, projections and other forward-looking statements will not be
achieved. Actual results may differ materially due to a variety of factors,
including without limitation those discussed under "Certain Trends and
Uncertainties" and elsewhere in this report. Investors and others should
carefully consider these and other uncertainties and events, whether or not the
statements are described as forward-looking.
Forward-looking statements made by the Company are intended to apply only
at the time they are made, unless explicitly stated to the contrary. Moreover,
whether or not stated in connection with a forward-looking statement, the
Company undertakes no obligation to correct or update a forward-looking
statement should the Company later become aware that it is not likely to be
achieved. If the Company were in any particular instance to update or correct a
forward-looking statement, investors and others should not conclude that the
Company will make additional updates or corrections thereafter.
F-30
Exhibit Index
Exhibit Number Title Page
- -------------- ----- ----
4 Indenture, dated June 30, 1998, between Comverse
Technology, Inc. and The Chase Manhattan Bank,
N.A., as Trustee.
10.1 Purchase Agreement, dated June 25, 1998, between
Comverse Technology, Inc. and Lehman Brothers
Inc., as Initial Purchaser.
10.2 Registration Rights Agreement, dated June 30,
1998, between Comverse Technology, Inc. and
Lehman Brothers Inc., as Initial Purchaser.
99 Press Release dated June 25, 1998.