UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE EXCHANGE ACT OF
1934
For the quarterly period ended April 30, 2005
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 000-49790
VERINT SYSTEMS INC.
(Exact name of registrant as specified in its charter)
DELAWARE 11-3200514
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
330 SOUTH SERVICE ROAD, MELVILLE, NY 11747
(Address of principal executive offices) (Zip Code)
(631) 962-9600
(Registrant's telephone number, including area code)
NOT APPLICABLE
Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
|X| Yes |_| No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
|X| Yes |_| No
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares of Common Stock, par value $0.001 per share,
outstanding as of June 6, 2005 was 31,710,740.
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
PAGE
----
ITEM 1. FINANCIAL STATEMENTS.
1. Condensed Consolidated Balance Sheets as of January 31, 2005 4
and April 30, 2005
2. Condensed Consolidated Statements of Income for the Three 5
Months Ended April 30, 2004 and April 30, 2005
3. Condensed Consolidated Statements of Cash Flows for the 6
Three Months Ended April 30, 2004 and April 30, 2005
4. Notes to Condensed Consolidated Financial Statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION 18
AND RESULTS OF OPERATIONS.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 35
ITEM 4. CONTROLS AND PROCEDURES. 36
PART II
OTHER INFORMATION
ITEM 6. EXHIBITS. 37
SIGNATURES 38
2
FORWARD-LOOKING STATEMENTS
From time to time, the Company makes forward-looking statements.
Forward-looking statements include financial projections, statements of plans
and objectives for future operations, statements of future economic performance,
and statements of assumptions relating thereto. Forward-looking statements are
often identified by future or conditional words such as "will," "plans,"
"expects," "believes," "seeks," "intends," "estimates," or "anticipates," or by
variations of such words or by similar expressions.
The Company may include forward-looking statements in its periodic
reports to the United States Securities and Exchange Commission on Forms 10-K,
10-Q, and 8-K, in its annual report to stockholders, in its proxy statements, in
its press releases, in other written materials, and in statements made by
employees to analysts, investors, representatives of the media, and others.
By their very nature, forward-looking statements are subject to
uncertainties, both general and specific, and risks exist that predictions,
forecasts, projections and other forward-looking statements will not be
achieved. Actual results may differ materially due to a variety of factors,
including without limitation those discussed under "Certain Trends and
Uncertainties" and elsewhere in this report. Investors and others should
carefully consider these and other uncertainties and events, whether or not the
statements are described as forward-looking.
Forward-looking statements made by the Company are intended to apply
only at the time they are made, unless explicitly stated to the contrary.
Moreover, whether or not stated in connection with a forward-looking statement,
the Company makes no commitment to revise or update any forward-looking
statements in order to reflect events or circumstances after the date any such
statement is made. If the Company were in any particular instance to update or
correct a forward-looking statement, investors and others should not conclude
that the Company would make additional updates or corrections thereafter.
3
PART I
ITEM 1. FINANCIAL STATEMENTS.
VERINT SYSTEMS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
JANUARY 31, APRIL 30,
ASSETS 2005* 2005
- ------ (Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 45,100 $ 42,573
Short-term investments 195,314 207,714
Accounts receivable, net 39,072 41,172
Inventories 17,267 21,458
Prepaid expenses and other current assets 9,880 9,905
------------ ------------
TOTAL CURRENT ASSETS 306,633 322,822
PROPERTY AND EQUIPMENT, net 17,540 18,307
INTANGIBLE ASSETS, net 12,026 10,858
GOODWILL 49,625 49,871
OTHER ASSETS 13,154 13,614
------------ ------------
TOTAL ASSETS $ 398,978 $ 415,472
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 68,399 $ 74,340
Advance payments from customers 41,853 44,347
------------- -------------
TOTAL CURRENT LIABILITIES 110,252 118,687
LONG-TERM LIABILITIES 5,351 5,087
------------- -------------
TOTAL LIABILITIES 115,603 123,774
------------- -------------
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value - authorized, 120,000,000 shares;
issued and outstanding, 31,577,587 and 31,692,182 shares 32 32
Additional paid-in capital 282,364 284,361
Unearned stock compensation (3,395) (3,154)
Retained earnings 2,155 8,688
Accumulated other comprehensive income 2,219 1,771
------------- -------------
TOTAL STOCKHOLDERS' EQUITY 283,375 291,698
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 398,978 $ 415,472
============= =============
* The Condensed Consolidated Balance Sheet as of January
31, 2005 has been summarized from the Company's audited
Consolidated Balance Sheet as of that date.
The accompanying notes are an integral part of these financial statements.
4
VERINT SYSTEMS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
APRIL 30,
2004 2005
---- ----
Sales $ 56,638 $ 72,039
Cost of sales 25,757 32,269
------------- -------------
Gross profit 30,881 39,770
Operating expenses:
Research and development, net 6,791 9,374
Selling, general and administrative 18,594 23,755
In-process research and development 3,154 -
Write-down of capitalized software 1,481 -
------------- -------------
Income from operations 861 6,641
Interest and other income, net 582 1,690
------------- -------------
Income before income tax provision (benefit) 1,443 8,331
Income tax provision (benefit) (71) 1,798
------------- -------------
Net income $ 1,514 $ 6,533
============= =============
Earnings per share:
Basic $ 0.05 $ 0.21
============= =============
Diluted $ 0.05 $ 0.20
============= =============
The accompanying notes are an integral part of these financial statements.
5
VERINT SYSTEMS INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(IN THOUSANDS)
Three months ended
April 30,
2004 2005
------------ ------------
Cash flows from operating activities:
Net cash from operations after adjustment for non-cash items $ 9,006 $ 10,843
Changes in operating assets and liabilities:
Accounts receivable (287) (2,210)
Inventories 2,876 (4,651)
Prepaid expenses and other current assets (1,297) (1,534)
Accounts payable and accrued expenses (3,310) 5,618
Advance payments from customers 7,673 2,494
Other, net (512) 979
------------ ------------
Net cash provided by operating activities 14,149 11,539
------------ ------------
Cash flows from investing activities:
Cash paid for a business combination (35,599) -
Purchases of property and equipment (1,867) (2,504)
Capitalization of software development costs (1,092) (904)
Purchase of short-term investments, net (11,319) (12,445)
------------ ------------
Net cash used in investing activities (49,877) (15,853)
------------ ------------
Cash flows from financing activities:
Net repayments of bank loans (130) (199)
Proceeds from issuance of common stock in connection with
exercise of stock options and employee stock purchase plan 4,382 1,986
------------ ------------
Net cash provided by financing activities 4,252 1,787
------------ ------------
Net decrease in cash and cash equivalents (31,476) (2,527)
Cash and cash equivalents, beginning of period 77,516 45,100
------------ ------------
Cash and cash equivalents, end of period $ 46,040 $ 42,573
============ ============
The accompanying notes are an integral part of these financial statements.
6
VERINT SYSTEMS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
Verint Systems Inc. ("Verint" and, together with its subsidiaries, the
"Company") is engaged in providing analytic software-based solutions for
communications interception, networked video security and surveillance, and
business intelligence. The Company is a majority-owned subsidiary of Comverse
Technology, Inc. ("Comverse Technology").
The accompanying financial information should be read in conjunction with the
audited financial statements, including the notes thereto, for the year ended
January 31, 2005. The condensed financial information included herein is
unaudited; however, such information reflects all adjustments (consisting solely
of normal recurring adjustments) which are, in the opinion of the Company's
management, necessary for a fair statement of the results for the interim
periods presented herein. The Company's results of operations for the three
months ended April 30, 2005 are not necessarily indicative of the Company's
results to be expected for the full year. The condensed consolidated balance
sheet as of January 31, 2005 has been summarized from the Company's audited
consolidated balance sheet as of that date. Certain amounts in prior periods
have been reclassified to conform to the manner of presentation in the current
periods.
2. STOCK-BASED EMPLOYEE COMPENSATION
The Company applies the intrinsic-value based method prescribed by Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations to account for its stock-based employee compensation.
Accordingly, stock-based employee compensation cost is recognized only when
employee stock options are granted with exercise prices below the fair market
value at the date of grant. Any resulting stock-based employee compensation cost
is recognized ratably over the associated service period, which is generally the
option vesting period. During the three months ended April 30, 2004 and 2005,
the Company recognized stock-based employee compensation cost in the condensed
consolidated statements of income of approximately $11,000 and $11,000,
respectively, relating to certain employee stock options granted with exercise
prices below the fair market value at the date of grant. As of April 30, 2005,
23,243 employee stock options were outstanding with exercise prices below the
fair market value at the date of the grant. All other employee stock options
have been granted at exercise prices equal to fair market value on the date of
grant, and accordingly, no compensation expense has been recognized by the
Company related to these options in the accompanying condensed consolidated
statement of income.
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," to stock-based employee compensation for all periods:
7
THREE MONTHS ENDED
APRIL 30,
2004 2005
---- ----
(In thousands,
except per share data)
Net income, as reported $ 1,514 $ 6,533
Less: Stock-based employee compensation cost
determined under the fair value method, net of
related tax effects 1,740 2,318
----------- -----------
Pro forma net income (loss) $ (226) $ 4,215
=========== ===========
Earnings (loss) per share:
Basic - as reported $ 0.05 $ 0.21
=========== ===========
Basic - pro forma $ (0.01) $ 0.13
=========== ===========
Diluted - as reported $ 0.05 $ 0.20
=========== ===========
Diluted - pro forma $ (0.01) $ 0.13
=========== ===========
3. SHORT-TERM INVESTMENTS
The Company classifies all short-term investments as available for sale,
accounted for at fair value, with resulting unrealized gains or losses reported
as a separate component of stockholders' equity.
In connection with the preparation of its Annual Report on Form 10-K for the
year ended January 31, 2005, the Company concluded that it was appropriate to
classify investments in Auction Rate Securities ("ARS") as short-term
investments. ARS generally have long-term stated maturities; however, these
investments have characteristics similar to short-term investments because at
pre-determined intervals, generally every 7 to 90 days, there is a new auction
process at which these securities are reset to current interest rates.
Previously, such investments had been classified as cash and cash equivalents
due to their liquidity and pricing reset feature. However, the Company has
revised the classification to report these securities as short-term investments
in the Consolidated Balance Sheets. As of April 30, 2005, the Company held
$185,400,000 of investments in ARS that are classified as short-term
investments. Accordingly, the Company has revised the classification to report
these securities as short-term investments in its Condensed Consolidated Balance
Sheet for all periods prior to January 31, 2005, and has reclassified
approximately $138,768,000 of investments in ARS as of April 30, 2004, that were
previously included in cash and cash equivalents as short-term investments.
The Company has also revised the presentation of the Condensed Consolidated
Statements of Cash Flows for the three months ended April 30, 2004 to reflect
the purchases and sales of ARS as investing activities rather than as a
component of cash and cash equivalents, which is consistent with the
presentation for the year ended January 31, 2005. In the previously reported
Condensed Consolidated Statements of Cash Flows for the three months ended April
30, 2004, net cash used in investing activities related to these short-term
investments of $15,568,000 were included in cash and cash equivalents.
8
This change in classification does not affect previously reported cash flows
from operations or from financing activities in the Consolidated Statements of
Cash Flows or previously reported Consolidated Statements of Operations for any
period.
4. INVENTORIES
The composition of inventories at January 31, 2005 and April 30, 2005 is as
follows:
JANUARY 31, APRIL 30,
2005 2005
---- ----
(In thousands)
Raw materials $ 6,067 $ 8,276
Work in process 4,179 5,219
Finished goods 7,021 7,963
------------ ----------
$ 17,267 $ 21,458
============ ==========
5. RESEARCH AND DEVELOPMENT EXPENSES
A significant portion of the Company's research and development operations are
located in Israel, where the Company derives substantial benefits from
participation in programs sponsored by the Government of Israel for the support
of research and development activities conducted in that country. The Company's
research and development activities include projects partially funded by the
Office of the Chief Scientist of the Ministry of Industry and Trade of the State
of Israel (the "OCS") under which the OCS reimburses a portion of the Company's
research and development expenditures under approved project budgets. The
Company is currently involved in several ongoing research and development
projects supported by the OCS. The Company accrues royalties to the OCS for the
sale of products incorporating technology developed in these projects up to the
amount of such funding, plus interest in certain circumstances. The terms of the
applicable funding agreements limit the Company's ability to manufacture
products, or transfer technologies, outside of Israel if such products or
technologies were developed under these funding agreements. During the three
months ended April 30, 2004 and 2005, reimbursement from the OCS amounted to
$894,000 and $ 661,000, respectively. The Company recorded $187,000 and $406,000
as other reimbursements of research and development expenses for the three
months ended April 30, 2004 and 2005, respectively.
6. EARNINGS PER SHARE
The computation of basic earnings per share is based on the weighted average
number of outstanding common shares. Diluted earnings per share further assumes
the issuance of common shares for all potentially dilutive issuances of stock.
The calculation for earnings per share for the three months ended April 30, 2004
and 2005, respectively, was as follows:
9
THREE MONTHS ENDED
-------------------------------------------------------------------------
APRIL 30, 2004 APRIL 30, 2005
----------------------------------- ------------------------------------
Per Share Per Share
Net Income Shares Amount Net Income Shares Amount
(In thousands, except per share data)
BASIC EPS
Net Income $ 1,514 30,400 $ 0.05 $ 6,533 31,505 $ 0.21
======== =========
EFFECT OF DILUTIVE
SECURITIES
Stock Options 1,736 1,439
Restricted shares 73 138
--------- --------- -------- ------
DILUTED EPS $ 1,514 32,209 $ 0.05 $ 6,533 33,082 $ 0.20
========= ========= ======== ======== ====== =========
7. COMPREHENSIVE INCOME
Total comprehensive income was approximately $1,011,000 and $6,085,000 for the
three months ended April 30, 2004 and 2005, respectively. The elements of
comprehensive income include net income, unrealized gains and losses on
available for sale securities and foreign currency translation adjustments.
8. RELATED PARTY TRANSACTIONS AND BALANCES
CORPORATE SERVICES AGREEMENT - The Company recorded expenses of approximately
$156,250 and $156,250 for the three months ended April 30, 2004 and 2005,
respectively, for the services provided by the Company's parent, Comverse
Technology, under the Corporate Services Agreement between the Company and
Comverse Technology.
ENTERPRISE RESOURCE PLANNING SOFTWARE SHARING AGREEMENT - The Company recorded
$52,000 and $37,000 for the three months ended April 30, 2004 and 2005,
respectively, for support services rendered by Comverse Ltd., a subsidiary of
Comverse Technology, under the Enterprise Resource Planning Software Sharing
Agreement between the Company and Comverse Ltd.
SATELLITE SERVICES AGREEMENT - The Company recorded expenses of approximately
$643,000 and $711,000 for the three months ended April 30, 2004 and 2005,
respectively, for services rendered by Comverse, Inc., a subsidiary of Comverse
Technology, and its subsidiaries, under the Satellite Services Agreement between
the Company and Comverse, Inc.
TRANSACTIONS WITH AN AFFILIATE - The Company sold products and services to
Verint Systems (Singapore) PTE LTD, an affiliated systems integrator in which
the Company holds a 50% equity interest, amounting to approximately $730,000 and
$477,000, during the three months ended April 30, 2004 and 2005, respectively.
In addition, the Company was charged with installation, support, marketing and
office service fees by that affiliate amounting to approximately $151,000 and
$162,000 for the three months ended April 30, 2004 and 2005, respectively.
TRANSACTIONS WITH OTHER SUBSIDIARIES OF COMVERSE TECHNOLOGY - The Company
charges subsidiaries of Comverse Technology for services relating to the use of
the Company's facilities and employees. Charges to these subsidiaries were
approximately $21,000 and $22,000 for the three months ended April 30, 2004 and
2005, respectively.
10
RELATED PARTY BALANCES - Related party balances included in the condensed
consolidated balance sheets are as follows (in thousands):
JANUARY 31, APRIL 30,
2005 2005
---- ----
Included in advance payments from customers $ 767 $ 3,513
========= =========
Included in accounts payable and accrued expenses $ 1,387 $ 1,124
========= =========
9. CONVERTIBLE NOTE
On February 1, 2002, the Company acquired the business of Lanex LLC ("Lanex").
The Lanex business provides digital video recording solutions for security and
surveillance applications. The purchase price consisted of $9,510,000 in cash
and a $2,200,000 convertible note issued by the Company. The note was
non-interest bearing and matured on February 1, 2004. Upon maturity, on February
1, 2004, the note was converted into 136,985 shares of the Company's common
stock at a conversion price of $16.06 per share.
10. ACQUISITIONS
On September 2, 2004, the Company, through a subsidiary, acquired all of the
outstanding stock of RP Sicherheitssysteme GmbH ("RP Security"), a company in
the business of developing and selling mobile digital video security solutions
for transportation applications. RP Security, headquartered in Flensburg,
Germany, was founded in 1999 and has approximately 50 employees. The purchase
price consisted of approximately $9,028,000 in cash and 90,144 shares of the
Company's common stock. Shares issued as part of the purchase price were
accounted for with value of approximately $2,977,000, or $33.03 per share. In
addition, the shareholders of RP Security will be entitled to receive earn-out
payments over three years based on the Company's worldwide sales, profitability
and backlog of mobile video products in the transportation market during that
period. For the period ending January 31, 2005, the shareholders of RP earned
approximately $438,000. In connection with this acquisition, the Company
incurred transaction costs, consisting primarily of professional fees, amounting
to approximately $520,000.
The acquisition was accounted for using the purchase method. The purchase price
was allocated to the assets and liabilities of RP Security based on the
estimated fair value of those assets and liabilities as of September 2, 2004.
Identifiable intangible assets consist of sales backlog, acquired technology,
trade name, customer relationships and non-competition agreements and have an
estimated useful life of up to five years. The results of operations of RP
Security have been included in the Company's results of operations since
September 2, 2004.
11
The following is a summary of the allocation of the purchase price of the RP
Security acquisition:
(IN THOUSANDS)
Purchase price paid in cash $ 9,028
Shares issued 2,977
Earn-out payable 438
Acquisition costs 520
------------
Total purchase price $ 12,963
============
Fair value of assets acquired $ 3,339
Fair value of liabilities assumed (2,536)
Sales backlog 1,673
Acquired technology 194
Customer relationships 494
Non-competition agreements 150
Trade name 47
Goodwill 9,602
------------
Total purchase price $ 12,963
============
The value allocated to goodwill in RP Security is not deductible for income tax
purposes.
As a result of the acquisition of RP Security, the Company wrote down certain
inventory and accounts receivable balances that became impaired due to the
existence of duplicative technology and, accordingly, were written-down to their
net realizable value at the date of acquisition. Such write-down amounted to
$899,000 and is included in cost of sales and selling, general and
administrative expenses.
On March 31, 2004, the Company acquired certain assets and assumed certain
liabilities of the government surveillance business of ECtel Ltd. ("ECtel"),
which provided the Company with additional communications interception
capabilities for the mass collection and analysis of voice and data
communications. The purchase price was approximately $35 million in cash. The
Company incurred transaction costs, consisting primarily of professional fees,
amounting to approximately $1,107,000, in connection with this acquisition.
The acquisition was accounted for using the purchase method. The purchase price
was allocated to the assets and liabilities of ECtel based on the estimated fair
value of those assets and liabilities as of March 31, 2004. The results of
operations of ECtel have been included in the Company's results of operations
since March 31, 2004. Identifiable intangible assets consist of sales backlog,
acquired technology, customer relationships, and non-competition agreements and
have estimated useful lives of up to ten years. Purchased in-process research
and development represents the value assigned to research and development
projects of the acquired business that were commenced but not completed at the
date of acquisition, for which technological feasibility had not been
established and which have no alternative future use in research and development
activities or otherwise. In accordance with Statement of Financial Accounting
Standards No. 2, "Accounting for Research and Development Costs," as interpreted
by FASB Interpretation No. 4, amounts assigned to purchased in-process research
12
and development meeting the above criteria must be charged to expense at the
acquisition date. At the acquisition date, it was estimated that the purchased
in-process research and development was approximately 40% complete and it was
expected that the remaining 60% would be completed during the ensuing year. The
fair value of the purchased in-process research and development was determined
with the assistance of an independent appraisal specialist using the income
approach, which reflects the projected free cash flows that will be generated by
the purchased in-process research and development projects and discounting the
projected net cash flows back to their present value using a discount rate of
21%.
As a result of the acquisition of the government surveillance business of ECtel,
the Company had certain capitalized software development costs that became
impaired due to the existence of duplicative technology and, accordingly, were
written-down to their net realizable value at the date of acquisition. Such
impairment charge amounted to $1,481,000.
The following is a summary of the allocation of the purchase price of the ECtel
acquisition:
(IN THOUSANDS)
Purchase price $ 35,000
Acquisition costs 1,107
------------
Total purchase price $ 36,107
============
Fair value of assets acquired $ 1,417
Fair value of liabilities assumed (3,282)
In-process research and development 3,154
Sales backlog 854
Acquired technology 5,307
Customer relationships 1,382
Non-competition agreements 2,221
Goodwill 25,054
------------
Total purchase price $ 36,107
============
The value allocated to goodwill in ECtel will be deducted for income tax
purposes.
The summary unaudited pro forma condensed consolidated results of operations for
the three months ended April 30, 2004, assuming the acquisitions of RP Security
and ECtel had occurred at the beginning of the period, would have reflected
consolidated revenues of approximately $58,576,000, net loss of approximately
$233,000, basic loss per share of $0.01 and diluted loss per share of $0.01.
These pro forma results are not necessarily indicative of what would have
occurred if the acquisitions had been in effect for the period presented. In
addition, the pro forma results are not necessarily indicative of the results
that will occur in the future and do not reflect any potential synergies that
might arise from the combined operations.
13
11. INTANGIBLE ASSETS
The composition of intangible assets at January 31, 2005 and April 30, 2005 is
as follows:
JANUARY 31, APRIL 30,
USEFUL LIFE 2005 2005
----------- ---- ----
(In thousands)
Sales backlog Up to 3 years $ 3,249 $ 3,221
Acquired technology 3 to 5 years 6,902 6,890
Customer relationships 5 years 2,239 2,228
Non-competition agreements 3 to 10 years 3,540 3,526
Trade names 1 to 3 years 255 253
------------ ------------
16,185 16,118
Less accumulated amortization 4,159 5,260
------------ ------------
$ 12,026 $ 10,858
============ ============
Amortization of intangible assets was $314,000 and $1,131,000 for the three
months ended April 30, 2004 and 2005, respectively.
Estimated amortization expense for each of the five succeeding fiscal years is
as follows:
YEAR ENDING JANUARY 31, (In thousands)
2006 $4,625
2007 $2,219
2008 $1,954
2009 $1,734
2010 $ 738
12. GOODWILL
Changes in goodwill for the year ended January 31, 2005 ("fiscal 2004"), and for
the three months ended April 30, 2005, are as follows:
(In thousands)
BALANCE AT JANUARY 31, 2004 $ 14,364
Acquisition of ECtel 25,054
Acquisition of RP Security 9,164
Other 1,043
----------
BALANCE AT JANUARY 31, 2005 49,625
Earn-out for RP Security Purchase 438
Other (192)
----------
BALANCE AT APRIL 30, 2005 $ 49,871
==========
14
13. BUSINESS SEGMENT INFORMATION
The Company operates in one business segment - providing actionable intelligence
solutions. The Company's solutions collect, retain, and analyze voice, fax,
video, email, Internet and data transmissions from voice, video and IP networks
for the purpose of generating actionable intelligence for decision makers to
take more effective action. The Company manages its business on a geographic
basis. Summarized financial information for the Company's reportable geographic
segments is presented in the following table. Sales in each geographic segment
represent sales originating from that segment.
UNITED UNITED RECONCILING CONSOLIDATED
STATES ISRAEL KINGDOM CANADA GERMANY OTHER ITEMS TOTALS
------ ------ ------- ------ ------- ----- ----- ------
THREE MONTHS ENDED
APRIL 30, 2004: (IN THOUSANDS)
---------------
Sales $ 25,950 $ 21,612 $ 7,511 $ 4,718 $ 2,872 $ 483 $ (6,508) $ 56,638
Costs and expenses (23,857) (23,952) (7,649) (3,376) (2,968) (606) 6,631 (55,777)
-------- -------- ------- -------- -------- -------- -------- ---------
Operating income
(loss) $ 2,093 $ (2,340) $ (138) $ 1,342 $ (96) $ (123) $ 123 $ 861
======== ======== ======= ======== ======== ======== ======== =========
THREE MONTHS ENDED
APRIL 30, 2005:
---------------
Sales $ 30,751 $ 31,264 $ 7,731 $ 8,138 $ 5,804 $ 1,324 $ (12,973) $ 72,039
Costs and expenses (28,487) (27,072) (7,068) (7,185) (6,108) (1,413) 11,935 (65,398)
-------- -------- ------- -------- -------- -------- -------- ---------
Operating income
(loss) $ 2,264 $ 4,192 $ 663 $ 953 $ (304) $ (89) $ (1,038) $ 6,641
======== ======== ======= ======== ======== ======== ======== =========
Total assets by country of domicile consist of:
JANUARY 31, APRIL 30,
2005 2005
---- ----
(IN THOUSANDS)
United States $ 264,975 $ 262,026
Israel 117,017 136,777
United Kingdom 12,684 12,435
Canada 19,828 21,438
Germany 27,598 25,199
Other 2,540 2,204
Reconciling items (45,664) (44,607)
------------ ----------
$ 398,978 $ 415,472
============ ==========
15
Reconciling items consist of the following:
Sales - elimination of inter-company revenues.
Operating income - elimination of inter-company operating income.
Total assets - elimination of inter-company receivables.
14. EMPLOYEE RESTRICTED STOCK
In December 2003 and 2004, the Company granted 72,700 and 65,000 shares of
restricted stock, respectively, to certain key employees of the Company.
Unearned stock compensation of approximately $1,672,000 and $2,282,000 was
recorded for 2003 and 2004, respectively, based on the fair market value of the
Company's common stock at the date of grant, or $23.00 and $35.11 per share.
Unearned stock compensation is shown as a separate component of stockholders'
equity and is being amortized to expense over the four-year vesting period of
the restricted stock. Amortization of unearned stock compensation was
approximately $103,000 and $241,000 for the three months ended April 30, 2004
and 2005, respectively, and was included in selling, general and administrative
expenses in the condensed consolidated statements of income. The restricted
stock has all the rights and privileges of the Company's common stock, subject
to certain restrictions and forfeiture provisions. At April 30, 2005, all
137,700 shares were subject to restriction.
15. RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued Statement of Financial Accounting Standard
("SFAS") No. 123 (revised 2004), "Share-Based Payment", ("SFAS No.123(R)") which
revises SFAS No. 123 and supersedes APB No. 25. In April 2005, the SEC amended
Regulation S-X to modify the date for compliance with SFAS No. 123(R). The
provisions of SFAS No. 123(R) must be applied beginning with the fiscal year
beginning on or after June 15, 2005, which for the Company is February 1, 2006
(the "Effective Date"). SFAS No. 123(R) requires all share-based payments to
employees, including grants of employee stock options, to be valued at fair
value on the date of grant, and to be expensed over the applicable vesting
period. Pro forma disclosure of the income statement effects of share-based
payments is no longer an alternative. Beginning on the Effective Date, the
Company must (i) expense all options granted after the Effective Date over the
applicable vesting period, and (ii) expense the non-vested portions of existing
option grants going forward over their remaining vesting period. Compensation
expense for the non-vested portions of existing option grants as of the
Effective Date will be recorded based on the fair value of the awards previously
calculated in developing the pro forma disclosures in accordance with the
provisions of SFAS No. 123. Under SFAS No. 123(R), the Company is required to
adopt a fair value-based method for measuring the compensation expense related
to employee stock and stock options awards; this will lead to substantial
additional compensation expense. Any such expense, although it will not affect
the Company's cash flows, will have a material negative impact on the Company's
reported results of operations.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - an amendment
of ARB No. 43, Chapter 4." SFAS No. 151 clarifies the accounting for abnormal
amounts of idle facility expense, freight, handling costs, and wasted material
(spoilage) by requiring that such items be recognized as current-period charges
regardless of whether they meet the ARB No. 43, Chapter 4 criterion of "so
abnormal." In addition, SFAS No. 151 requires that allocation of fixed
production overheads to the costs of conversion be based on the normal capacity
of the production facilities. SFAS No. 151 is effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS
No. 151 is not expected to have a material effect on the Company's condensed
consolidated financial statements.
16
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets
- - an amendment of APB Opinion No. 29." SFAS No. 153 amends APB No. 29 to
eliminate the exception for nonmonetary exchanges of similar productive assets
and replaces it with a general exception for exchanges of nonmonetary assets
that do not have commercial substance. A nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. SFAS No. 153 is effective for
reporting periods beginning after June 15, 2005. The adoption of SFAS No. 153 is
not expected to have a material effect on the Company's condensed consolidated
financial statements.
In March 2004, the Emerging Issues Task Force ("EITF") of the FASB reached a
consensus on EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments", which provides
additional guidance for assessing impairment losses on investments.
Additionally, EITF 03-1 includes new disclosure requirements for investments
that are deemed to be temporarily impaired. In September 2004, the FASB delayed
the accounting provisions of EITF 03-1; however the disclosure requirements were
effective for annual periods ending after June 15, 2004. The Company will
evaluate the impact of EITF 03-1 once final guidance is issued, however the
adoption of EITF 03-1 in its current form is not expected to have a material
effect on the Company's condensed consolidated financial statements.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
CRITICAL ACCOUNTING POLICIES
Our discussion of results of operations and financial condition relies on our
consolidated financial statements that are prepared based on certain critical
accounting policies that require management to make judgments and estimates that
are subject to varying degrees of uncertainty. We believe that investors need to
be aware of these policies and how they impact our financial statements as a
whole, as well as our related discussion and analysis presented herein. While we
believe that these accounting policies are based on sound measurement criteria,
actual future events can and often do result in outcomes that can be materially
different from these estimates or forecasts. The accounting policies and related
risks described in our Annual Report on Form 10-K for the year ended January 31,
2005 are those that depend most heavily on these judgments and estimates. As of
April 30, 2005, there have been no material changes to any of the critical
accounting policies contained therein.
RESULTS OF OPERATIONS
SUMMARY OF RESULTS
Consolidated results of operations in dollars and as a percentage of sales
for each of the three months ended April 30, 2004 and 2005 were as follows:
THREE MONTHS THREE MONTHS
ENDED ENDED
APRIL 30, 2004 % OF SALES APRIL 30, 2005 % OF SALES
-------------- ---------- -------------- ----------
Sales $ 56,638 100.0% $ 72,039 100.0%
Cost of Sales 25,757 45.5% 32,269 44.8%
-------------- ---------- -------------- -----------
Gross profit 30,881 54.5% 39,770 55.2%
Operating expenses:
Research and development, net 6,791 12.0% 9,374 13.0%
Selling, general and administrative 18,594 32.8% 23,755 33.0%
In-process research and development 3,154 5.6% -- --
Write-down of capitalized software 1,481 2.6% -- --
-------------- ---------- -------------- -----------
Income from operations 861 1.5% 6,641 9.2%
Interest and other income, net 582 1.0% 1,690 2.3%
-------------- ---------- -------------- -----------
Income before income tax provision (benefit) 1,443 2.5% 8,331 11.6%
Income tax provision (benefit) (71) (0.1)% 1,798 2.5%
-------------- ---------- -------------- -----------
Net income $ 1,514 2.7% $ 6,533 9.1%
============== ========== ============== ===========
18
THREE MONTHS ENDED APRIL 30, 2005
COMPARED TO THREE MONTHS ENDED APRIL 30, 2004
SALES. Sales for three months ended April 30, 2005 increased by approximately
$15.4 million, or 27%, as compared to the three month period ended April 30,
2004. This increase reflected an increase in both sales of products of
approximately $11.5 million and service revenue of approximately $3.9 million,
and was attributable to higher sales volume of both the Company's security and
business intelligence solutions. For the three months ended April 30, 2005, the
Company generated approximately 46% of its sales from the Americas region, 35%
from the Europe, Middle East and Africa region ("EMEA"), and 19% from the Asia
Pacific region ("APAC").
The Company sells its products in multiple configurations and the price of any
particular product varies depending on the configuration of the product sold.
Due to the variety of customized configurations for each product that the
Company sells, it is unable to quantify the effects of a change in the price of
any particular product and/or a change in the number of products sold on its
revenues. Sales to international customers represented approximately 56% of
sales for the three months ended April 30, 2005, as compared to approximately
54% for the three months ended April 30, 2004.
COST OF SALES. Cost of sales consists primarily of material and overhead costs,
operation and service personnel costs, amortization of capitalized software and
royalties. Cost of sales for the three months ended April 30, 2005 increased by
approximately $6.5 million, or 25%, as compared to the three months ended April
30, 2004. This increase was attributable to an increase in materials and
overhead costs of approximately $4.1 million, due to higher sales volumes, an
increase in personnel related costs of approximately $1.0 million, primarily as
a result of an increase in the number of service department personnel and
increased personnel compensation, and an increase in other expenses of
approximately $1.4 million, mainly due to increased subcontracting expenses,
amortization and travel expenses. Gross margins increased to 55.2% in the three
months ended April 30, 2005, from 54.5% in the three months ended April 30,
2004.
RESEARCH AND DEVELOPMENT EXPENSES, NET. Research and development ("R&D")
expenses consist primarily of personnel and subcontracting expenses and
allocated overhead, net of certain software development costs that are
capitalized as well as reimbursement under government and other programs.
Software development costs are capitalized upon the establishment of
technological feasibility and until related products are available for general
release to customers. Research and development expenses, net, for the three
months ended April 30, 2005 increased by approximately $2.6 million, or 38%, as
compared to the three months ended April 30, 2004. The increase was attributable
to an increase in personnel related costs amounting to approximately $1.8
million and an increase of approximately $0.8 million in other expenses.
Capitalization of software development costs amounted to approximately $1.1
million and approximately $0.9 million in the three months ended April 30, 2004
and 2005, respectively. Reimbursement of research and development expenses
amounted to approximately $1.1 million for each of the three months ended April
30, 2004, and 2005. Research and development expenses, net, as a percentage of
sales, increased to 13% for the three months ended April 30, 2005 from 12% for
the three months ended April 30, 2004.
Historically, the Company has received more reimbursement under government
programs for R&D expenses in a given fiscal year than it has had to pay to the
appropriate government agency in royalties during that fiscal year. In fiscal
2005 and in future fiscal years, the Company expects to pay more in royalties to
these government agencies than it receives in reimbursement from these
government agencies for R&D expenses in a given fiscal year.
19
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses consist primarily of personnel costs and related
expenses, sales and marketing expenses, including travel and agent commission,
and other administrative expenses. Selling, general and administrative expenses
for the three months ended April 30, 2005 increased by approximately $5.2
million, or 28% as compared to the three months ended April 30, 2004. This
increase was attributable to an increase in compensation and benefits for
existing personnel and increase in headcount to support the increased level of
sales amounting to approximately $3.1 million, an increase in marketing expenses
of approximately $0.7 million, an increase in rent and utility expenses of
approximately $0.4 million, and an increase in other expenses of approximately
$1.0 million. Selling, general and administrative expenses as a percentage of
sales increased to 33.0%, for the three months ended April 30, 2005, from 32.8%
for the three months ended April 30, 2004.
IN-PROCESS RESEARCH AND DEVELOPMENT. In the three months ended April 30, 2004,
purchased in-process research and development of approximately $3.2 million,
resulting from the purchase of ECtel's government surveillance business, was
charged to expense at the acquisition (see also Note 10 of the Notes to the
Condensed Consolidated Financial Statements).
WRITE-DOWN OF CAPITALIZED SOFTWARE. As a result of the acquisition of ECtel's
government surveillance business, the Company had certain capitalized software
development costs that became impaired due to the existence of duplicative
technology and, accordingly, were written-down to their net realizable value at
the date of acquisition. Such impairment charge amounted to approximately $1.5
million, and was recorded in the three months ended April 30, 2004.
INTEREST AND OTHER INCOME, NET. Net interest and other income for the three
months ended April 30, 2005 increased by approximately $1.1 million, as compared
to the three months ended April 30, 2004. This increase was attributable to
increased interest income of approximately $0.9 million, due to an increase in
interest rates and an increase in interest bearing short-term investments, and
an increase in other income of approximately $0.2 million.
INCOME TAX PROVISION. Income tax provision of approximately $1.8 million was
recorded for the three months ended April 30, 2005 as compared to an income tax
benefit of approximately $0.1 million recorded in the three months ended April
30, 2004. The overall effective tax rate increased to 21.6% for the three months
ended April 30, 2005 as compared to an effective tax rate of (4.9)% for the
three months ended April 30, 2004. The increase in tax provision for the three
month period ended April 30, 2005 was mainly attributable to the significant
reduction of the Company's net operating loss carry forwards in the United
States by the end of fiscal 2004, which caused the Company to record income tax
provision for the profits of its U.S. operations. The Company expects that its
effective tax rate for the fiscal year ended January 31, 2006 ("fiscal 2005") to
increase significantly as compared to fiscal 2004. The Company's effective tax
rate for fiscal 2005 is expected to remain relatively low as compared to the
U.S. federal tax rate. This reflects the use of net operating loss
carry-forwards in certain tax jurisdictions as well as the tax benefits
associated with qualified activities of the Company's Israeli subsidiary, which
is entitled to favorable income tax rates under a program of the Israeli
Government for "Approved Enterprise" investments in that country. The income tax
benefit recorded in the three months ended April 30, 2004 was mainly due to
one-time charges recorded as a result of the purchase of ECtel's government
surveillance business and the use of net operating loss carry forwards in
certain tax jurisdictions. To the extent that the Company continues to be
profitable in certain tax jurisdictions, it will continue to use net operating
loss carry forwards in these jurisdictions. When the Company ceases to have net
operating loss carry forwards available to it in a tax jurisdiction, the
Company's effective tax rate would increase in that jurisdiction.
20
NET INCOME. Net income for the three months ended April 30, 2005 increased by
approximately $5.0 million, or 331%, as compared to the three months ended April
30, 2004. As a percentage of sales, net income was approximately 9.1%, in the
three months ended April 30, 2005, as compared to approximately 2.7% in the
three months ended April 30, 2004. The change resulted primarily from the
factors described above.
LIQUIDITY AND CAPITAL RESOURCES
As of April 30, 2005, the Company had cash and cash equivalents of approximately
$42.6 million, short-term investments of $207.7 million and working capital of
approximately $204.1 million. As of January 31, 2005, the Company had cash and
cash equivalents of approximately $45.1 million, short-term investments of
$195.3 million and working capital of approximately $196.4 million.
Operating activities for the three months ended April 30, 2004 and 2005, after
adjustment for non-cash items, provided cash of approximately $9.0 million and
$10.8 million, respectively. Other changes in operating assets and liabilities
provided cash of approximately $5.1 million and $0.7 million for the three
months ended April 30, 2004 and 2005, respectively. This resulted in cash
provided by operating activities of approximately $14.1 million and $11.5
million for the three months ended April 30, 2004 and 2005, respectively.
Investing activities for the three months ended April 30, 2004 and 2005 used
cash of approximately $49.9 million and $15.9 million, respectively. For the
three months ended April 30, 2004, these amounts include cash paid for the
acquisition of ECtel's government surveillance business of approximately $35.6
million, net purchases of short-term securities of approximately $11.3 million,
additions to property and equipment of approximately $1.9 million and
capitalization of software development costs of approximately $1.1 million. For
the three months ended April 30, 2005, these amounts include net purchases of
short-term securities of approximately $12.4 million, purchase of property and
equipment of approximately $2.5 million, and capitalization of software
development costs of approximately $0.9 million.
Financing activities for the three months ended April 30, 2004 and 2005 provided
cash of approximately $4.3 million and $1.8 million, respectively. For the three
months ended April 30, 2004 and 2005, proceeds from the issuances of common
stock provided cash of approximately $4.4 million and $2.0 million,
respectively. Net repayments of bank loans and other debt used cash of
approximately $0.1 million and $0.2 million in the three months ended April 30,
2004 and 2005, respectively.
On March 31, 2004, the Company acquired certain assets and assumed certain
liabilities of the government surveillance business of ECtel. The purchase price
consisted of $35 million in cash. In connection with this acquisition, the
Company incurred transaction costs, consisting primarily of professional fees,
amounting to approximately $1.1 million (see also Note 10 of the Notes to the
Condensed Consolidated Financial Statements).
On September 2, 2004, the Company, through a subsidiary, acquired all of the
outstanding stock of RP Security, a company in the business of developing and
selling mobile digital video security solutions for transportation applications.
The Company paid approximately $9,028,000 in cash and 90,144 shares of the
Company's common stock for RP Security. In addition, the shareholders of RP will
be entitled to receive earn-out payments over three years based on the Company's
worldwide sales, profitability and backlog of mobile video products in the
transportation market during that period. For the period ending January 31,
2005, the shareholders of RP earned approximately $438,000.
21
On August 20, 2004, the Company entered into a lease agreement for the lease of
approximately 125,000 square feet of office and storage space for manufacturing,
development, support and sales facilities in Herzlia, Israel. Under the lease
agreement, occupancy of the new building and rent payments are expected to
commence in October 2005, for a period of ten years. Annual rent payments are
expected to be approximately $2.3 million. The new lease agreement replaces the
lease agreement for the Company's existing building in Israel.
The ability of the Company's Israeli subsidiary to pay dividends is governed by
Israeli law, which provides that dividends may be paid by an Israeli corporation
only out of its earnings as defined in accordance with the Israeli Companies Law
of 1999, provided that there is no reasonable concern that such payment will
cause such subsidiary to fail to meet its current and expected liabilities as
they come due. In the event of a devaluation of the Israeli currency against the
U.S. dollar, the amount in U.S. dollars available for payment of cash dividends
out of prior years' earnings will decrease accordingly. Cash dividends paid by
an Israeli corporation to U.S. resident corporate parents are subject to the
Convention for the Avoidance of Double Taxation between Israel and the United
States. Under the terms of the Convention, such dividends are subject to
taxation by both Israel and the United States and, in the case of Israel, such
dividends out of income derived in respect of a period for which an Israeli
company is entitled to the reduced tax rate applicable to an Approved Enterprise
are generally subject to withholding of Israeli income tax at source at a rate
of 15%. The Israeli company is also subject to additional Israeli taxes in
respect of such dividends, generally equal to the tax benefits previously
granted in respect of the underlying income by virtue of the Approved Enterprise
status.
The Company believes that its current cash balances and potential cash flows
from operations will be sufficient to meet the Company's anticipated cash needs
for working capital, capital expenditures and other activities for at least the
next 12 months. Thereafter, if current sources are not sufficient to meet the
Company's needs, the Company may seek additional debt or equity financing. In
addition, although there is no present understanding, commitment or agreement
with respect to any acquisition of other businesses, products, or technologies,
the Company may in the future consider such transactions. In the event the
Company pursues such acquisitions, its current cash balances and potential cash
flow from operations may not be sufficient to consummate such acquisitions. As a
result, the Company may require additional debt or equity financing and could
have a decrease of its working capital.
CERTAIN TRENDS AND UNCERTAINTIES
The Company's primary business is providing analytic software-based solutions
for communications interception, networked video security and surveillance, and
business intelligence. Recent legislative and regulatory actions have provided
greater surveillance powers to law enforcement agencies, imposed strict
requirements on communications service providers to facilitate interception of
communications over public networks, and increased the security measures being
implemented at public facilities such as airports. However, the Company cannot
be assured that these legislative and regulatory actions will result in
increased demand for or purchasing of solutions such as those offered by the
Company or, if it does, that such solutions will be purchased from the Company.
If demand for or purchasing of the Company's solutions does not increase as
anticipated, the Company may not be able to sustain or increase profitability on
a quarterly or annual basis.
It is difficult for the Company to forecast the timing of revenues from product
sales because customers often need a significant amount of time to evaluate its
products before purchasing them and, in the case of governmental customers,
sales are dependent on budgetary and other bureaucratic processes. The period
between initial customer contact and a purchase by a customer may vary from
three months to more than a year. During the evaluation period, customers may
defer or scale down proposed orders of the Company's products for various
reasons, including: (i) changes in budgets and purchasing priorities; (ii)
reduced need to upgrade existing systems; (iii) deferrals in anticipation of
enhancements or new products; (iv) introduction of products by the Company's
competitors; and (v) lower prices offered by the Company's competitors.
22
The Company faces aggressive competition from numerous and varied competitors in
all areas of its business. Because of this aggressive competition and the fact
that many of the Company's customers and potential customers make decisions to
purchase largely based on price, the Company may have to lower prices of many of
its products and services or increase efficiencies and capacity. This can affect
the Company because:
o the Company may not be able to maintain or improve revenue and
gross margin with its current cost structure, and therefore its
profitability could be materially and adversely affected.
o in the face of increased pricing pressure and an effort to
maintain or improve revenue and gross margin, the Company may
have to reduce costs. For example, the Company invests a
significant amount in research and development, which the Company
views as necessary for its long-term competitiveness. If, to
decrease its cost structure, the Company reduces its investment
in research and development, the Company may adversely impact its
long-term competitiveness in an effort to maintain or improve its
revenue and income in the short-term.
Even if the Company is able to maintain or increase market share for a
particular product, revenue could decline due to increased competition from
other types of products or because the product is in a maturing industry.
Because of the intensely competitive markets in which the Company operates, the
Company's competitors may simply execute better than the Company and,
resultantly, reduce the Company's market share. Some of the Company's
competitors have, in relation to it, longer operating histories, larger customer
bases, longer standing relationships with customers, greater name recognition
and significantly greater financial, technical, marketing, customer service,
public relations, distribution and other resources. Further, there has been
significant consolidation among the Company's competitors, improving the
competitive position of several of its competitors. If the Company's competitors
are able to achieve a competitive position superior to that of the Company, the
Company's market share and, therefore, results of operations may be materially
and adversely affected.
The Company's competitors may be able to more quickly develop or adapt to new or
emerging technologies or respond to changes in customer requirements, or to
devote greater resources to the development, promotion and sale of their
products. New competitors continue to emerge and there continues to be
consolidation among existing competitors which may reduce the Company's market
share. In addition, some of the Company's customers and partners may in the
future decide to internally develop their own solutions instead of purchasing
them from the Company. Increased competition could force the Company to lower
its prices or take other actions to differentiate its products.
The Company derives a significant amount of its revenues from various government
contracts worldwide. The Company expects that government contracts will continue
to be a significant source of its revenues for the foreseeable future. The
Company's business generated from government contracts may be materially and
adversely affected if: (i) its reputation or relationship with government
agencies is impaired; (ii) it is suspended or otherwise prohibited from
contracting with a domestic or foreign government or any significant law
enforcement agency; (iii) levels of government expenditures and authorizations
for law enforcement and security related programs decrease, remain constant or
23
shift to programs in areas where it does not provide products and services; (iv)
it is prevented from entering into new government contracts or extending
existing government contracts based on violations or suspected violations of
laws or regulations, including those related to procurement; (v) it is not
granted security clearances that are required to sell its products to domestic
or foreign governments or such security clearances are revoked; (vi) there is a
change in government procurement procedures; or (vii) there is a change in
political climate that adversely affects the Company's existing or prospective
relationships.
The Company's quarterly operating results are difficult to predict and may
fluctuate significantly in the future, which in turn may result in volatility in
its stock price. The following factors, among others, many of which are outside
the Company's control, can cause fluctuations in the Company's operating results
and stock price volatility: (i) the size, timing, terms and conditions of orders
from and shipments to its customers; (ii) unanticipated delays or problems in
releasing new products; (iii) the timing and success of its customers'
deployment of its products and services; (iv) the amount and timing of its
investments in research and development activities; (v) costs associated with
providing the Company's goods and services; (vi) the fluctuation of foreign
currency exchange rates; and (vii) the impairment or devaluation of the
Company's assets (for instance, intangibles or goodwill).
To the extent that the Company continues to be profitable in certain tax
jurisdictions, it will continue to use available net operating loss carry
forwards in these jurisdictions. When the Company ceases to have net operating
loss carry forwards available to it in a tax jurisdiction, the Company's
effective tax rate would increase in that jurisdiction. The Company's effective
tax rate is expected to increase substantially in 2005 as compared to fiscal
2004, which could materially and adversely affect the Company's results of
operations.
The Company has continued to expand its gross margins primarily as a result of
reducing hardware as a part of its product offerings. This gross margin
expansion has contributed to the growth of the Company's net income at a rate
greater than the growth of its revenue. The Company's ability to continue to
expand gross margins in this manner is contingent upon a variety of factors,
principally that its customers obtain the hardware necessary to operate the
Company's software solutions from another vendor. If customers insist that the
Company provide all necessary hardware, the Company may not be able to continue
to expand gross margins at the rate that it has or at all, which would reduce
the rate of growth of the Company's net income. If the rate of growth of the
Company's net income is reduced, it could materially and adversely affect the
share price of its Common Stock.
While it has no single customer that is material, the Company has many
significant customers and receives multi-million dollar orders from time to
time. The deferral or loss of one or more significant orders or a delay in an
expected implementation of such an order could materially and adversely affect
the Company's operating results in any fiscal quarter, particularly if there are
significant sales and marketing expenses associated with the deferred, lost or
delayed sales. The Company bases its current and future expense levels on its
internal operating plans and sales forecasts, and its operating costs are, to a
large extent, fixed. As a result, the Company may not be able to sufficiently
reduce its costs in any quarter to compensate for an unexpected near-term
shortfall in revenues.
The Company has historically derived a significant portion of its sales from
contracts for large system installations with major customers. The Company
continues to emphasize sales to larger customers in its product development and
marketing strategies. Contracts for large installations typically involve a
lengthy and complex bidding and selection process, and the ability of the
Company to obtain particular contracts is inherently difficult to predict. The
timing and scope of these opportunities are difficult to forecast, and the
pricing and margins may vary substantially from transaction to transaction. The
Company's future operating results may accordingly exhibit a high degree of
volatility, and also may be more volatile than the Company has experienced in
prior periods. The degree of dependence by the Company on large system orders,
and the investment required to enable the Company to perform such orders,
without assurance of continuing order flow from the same customers, increases
the risk associated with its business.
24
The market for the Company's business intelligence solutions has been adversely
affected by the global economic slowdown and the decline in information
technology spending, which has caused many companies to reduce or, in extreme
cases, entirely eliminate, information technology spending. While there exists
some evidence in the market that information technology spending is increasing,
the rate of this spending by the Company's customers in the near term remains
unclear and the Company is uncertain whether it will be able to increase or
maintain its revenues. If sales do not increase as anticipated or if expenses
increase at a greater pace than revenues, the Company may not be able to sustain
or increase profitability on a quarterly or annual basis.
The markets for the Company's products are characterized by rapidly changing
technology and evolving industry standards. The introduction of products
embodying new technology and the emergence of new industry standards can render
the Company's existing products obsolete and unmarketable and can exert price
pressures on existing products. It is critical to the Company's success that it
be able to:
o anticipate changes in technology or in industry standards;
o successfully develop and introduce new, enhanced and competitive
products; and
o introduce these new and enhanced products on a timely basis with
high quality.
The Company may not be able to successfully develop new products or introduce
new applications for existing products. For example, the market for the
Company's communications interception solutions has been characterized by new
protocols as well as by increased use encryption, and the Company's ability to
compete in this market is dependent on its ability to introduce products that
address these new developments. In addition, new products and applications
introduced by the Company - such as the Company's content analytic software -
may not achieve market acceptance or the introduction of new products or
technological developments by its competitors may render the Company's products
obsolete. If the Company is unable to introduce new products that address the
needs of its customers or that achieve market acceptance, there may be a
material and adverse impact on the Company's reputation with its customers and
its financial results.
The Company's products are complex and involve sophisticated technology that
performs critical functions to highly demanding standards. The Company's
existing and future products may develop operational problems. In addition, when
the Company introduces a product to the market or as it releases new versions of
an existing product, the product may contain undetected defects or errors. The
Company may not discover such defects, errors or other operational problems
until after a product has been released and used by the customer. Significant
costs may be incurred to correct undetected defects, errors or other operational
problems in the Company's products, including product liability claims. In
addition, defects or errors in the Company's products may result in questions
regarding the integrity of its products, which could cause adverse publicity and
impair their market acceptance, resulting in lost future sales.
The global market for analytic solutions for security and business applications
is intensely competitive, both in the number and breadth of competing companies
and products and the manner in which products are sold. For example, the Company
often competes for customer contracts through a competitive bidding process that
subjects it to risks associated with: (i) the frequent need to bid on programs
in advance of the completion of their design, which may result in unforeseen
technological difficulties and cost overruns; and (ii) the substantial time and
effort, including design, development and marketing activities, required to
prepare bids and proposals for contracts that may not be awarded to the Company.
25
The Company's products are often used by customers to compile and analyze highly
sensitive or confidential information and data, including information or data
used in intelligence gathering or law enforcement activities. The Company may
come into contact with such information or data when it performs support or
maintenance functions for its customers. While the Company has internal
policies, procedures and training for employees in connection with performing
these functions, even the perception that such potential contact may pose a
security risk or that any of the Company's employees has improperly handled
sensitive or confidential information and data of a customer could harm its
reputation and could inhibit market acceptance of its products.
The markets for the Company's security and business intelligence products are
still emerging. The Company's growth is dependent on, among other things, the
size and pace at which the markets for its products develop. If the markets for
its products decrease, remain constant or grow slower than the Company
anticipates, the Company will not be able to maintain its growth. In addition,
in markets where the Company is a sole source supplier, the Company's growth may
be adversely impacted if customers seek to and succeed in developing alternative
sources for the Company's products. Continued growth in the demand for the
Company's products is uncertain as, among other reasons, its existing customers
and potential customers may: (i) not achieve a return on their investment in its
products; (ii) experience technical difficulty in utilizing its products; or
(iii) use alternative solutions to achieve their security, intelligence or
business objectives. In addition, as the Company's business intelligence
products are sold primarily to contact centers, slower than anticipated growth
or a contraction in the number of contact centers will have a material adverse
effect on the Company's ability to maintain its growth.
A significant portion of the Company's revenues are generated by sales made
through strategic and technology partners, distributors, value added resellers
and systems integrators. In addition, many of these sales channels also partner
with the Company's competitors and may even offer the products of the Company
and its competitors when presenting bids to certain customers. The Company's
ability to achieve revenue growth depends to some extent on maintaining and
adding to these sales channels. If the Company's relationships with these sales
channels deteriorate or terminate, the Company may lose important sales and
marketing opportunities.
On September 2, 2004, the Company acquired RP Security. If the Company is unable
to successfully integrate RP Security with its business, it may be unable to
realize the anticipated benefits of this acquisition. The Company may experience
technical difficulties that could delay the integration of RP Security's
products into the Company's solutions, resulting in business disruptions.
On March 31, 2004, the Company completed its acquisition of certain assets and
liabilities of ECtel comprising its communications interception business. As a
result of this acquisition, the Company and ECtel have a variety of ongoing
contractual relationships related to providing certain resources to one another
and fulfillment of certain obligations to former ECtel customers. If ECtel does
not perform its post-acquisition contractual obligations to the Company, the
Company may not continue to realize the benefits of the acquisition realized by
the Company or have a negative impact on the Company's operations and the
transitioning of ECtel's customers to the Company.
The Company is required to obtain export licenses from the U.S., Israeli and
German and other governments to export some of the products that it develops or
manufactures in these countries, and comply with applicable export control laws.
The Company cannot be assured that it will be successful in obtaining or
maintaining the licenses and other authorizations required to export its
products from applicable governmental authorities. In addition, export laws and
regulations are revised from time to time; if the Company is found not to have
26
complied with applicable export control laws, the Company may be penalized by,
among other things, having its ability to receive export licenses curtailed or
eliminated possibly for an extended period of time. The Company's failure to
receive or maintain any required export license or authorization would hinder
its ability to sell its products and could materially and adversely affect its
business, financial condition and results of operations.
Many of the Company's government contracts contain provisions that give the
governments party to those contracts rights and remedies not typically found in
private commercial contracts, including provisions enabling the governments to:
(i) terminate or cancel existing contracts for convenience; (ii) in the case of
the U.S. Government, suspend the Company from doing business with a foreign
government or prevent the Company from selling its products in certain
countries; (iii) audit and object to the Company's contract-related costs and
expenses, including allocated indirect costs; and (iv) change specific terms and
conditions in the Company's contracts, including changes that would reduce the
value of its contracts. In addition, many jurisdictions have laws and
regulations that deem government contracts in those jurisdictions to include
these types of provisions, even if the contracts themselves do not contain them.
If a government terminates a contract with the Company for convenience, the
Company may not recover its incurred or committed costs, any settlement expenses
or profit on work completed prior to the termination. If a government terminates
a contract for default, the Company may not recover these amounts, and, in
addition, may be liable for any costs incurred by a government in procuring
undelivered items and services from another source. Further, an agency within a
government may share information regarding the Company's termination with other
government agencies. As a result, the Company's on-going or prospective
relationships with such other government agencies could be impaired.
The Company must comply with domestic and foreign laws and regulations relating
to the formation, administration and performance of government contracts. These
laws and regulations affect how the Company does business with government
agencies in various countries and may impose added costs on its business. For
example, in the United States the Company is subject to the Federal Acquisition
Regulations, which comprehensively regulate the formation, administration and
performance of federal government contracts, and to the Truth in Negotiations
Act, which requires certification and disclosure of cost and pricing data in
connection with contract negotiations. The Company is subject to similar
regulations in foreign countries as well.
In August 2005, the European Parliament Directive 2002/96/EC (dated 27 January
2003) on Waste Electrical and Electronic Equipment Directive (the "WEEE
Directive") will become effective in the European Union. The WEEE Directive
requires producers of certain electrical and electronic equipment to be
financially responsible for the future disposal costs of this equipment sold
within the European Union. In July 2006, the European Parliament Directive
2002/95/EC (dated 27 January 2003) on Restriction of the Use of Certain
Hazardous Substances in Electrical and Electronic Equipment (the "RoHS
Directive") will become effective in the European Union. The RoHS Directive
restricts the use of certain hazardous substances, including mercury, lead,
cadmium, hexavalent chromium, and certain flame retardants, in the construction
of component parts of certain electrical and electronic equipment sold within
the European Union. The Company is currently making preparations to comply with
these directives to the extent applicable to the hardware portion of its
solutions. As part of this process, the Company will need to ensure that it has
a supply of compliant components from its suppliers. Ensuring compliance with
these directives and integrating compliance activities with suppliers will
result in additional costs to the Company and may result in disruptions to
operations. The Company cannot currently estimate the extent of such additional
costs or potential disruptions. However, to the extent that any such costs or
disruptions are substantial, the Company's financial results could be materially
and adversely affected.
27
If a government review or investigation uncovers improper or illegal activities,
depending on the nature of the activity, the Company may be subject to civil and
criminal penalties and administrative sanctions, including termination of
contracts, forfeiture of profits, suspension of payments, fines and suspension
or debarment from doing business with government agencies, and curtailment of
the Company's ability to obtain export licenses, which could materially and
adversely affect its business, financial condition and results of operations. In
addition, a government may reform its procurement practices or adopt new
contracting rules and regulations that could be costly to satisfy or that could
impair the Company's ability to obtain new contracts.
The Company's recent growth has strained its managerial and operational
resources. The Company's continued growth may further strain its resources,
which could hurt its business and results of operations. There can be no
assurance that the Company's managers will be able to manage growth effectively.
To manage future growth, the Company's management must continue to improve the
Company's operational, IT and financial systems, procedures and controls and
expand, train, retain and manage its employee base. If the Company's systems,
procedures and controls are inadequate to support its operations, the Company's
expansion could slow or come to a halt, and it could lose its opportunity to
gain significant market share. Any inability to manage growth effectively could
materially harm the Company's business, results of operations and financial
condition.
The Company depends on the continued services of its executive officers and
other key personnel. In addition, in order to continue to grow effectively, the
Company expects to need to attract and retain a substantial number of new
employees, including managers, sales and marketing personnel and technical
personnel, who understand and have experience with its products and services.
The market for such personnel is intensely competitive in most if not all of the
geographies in which the Company operates, and on occasion it has had to
relocate personnel to fill positions in locations where it could not attract
qualified experienced personnel. Further, competition for personnel for certain
positions in the Company's industry is intense, and the Company has in the past
and may in the future experience difficulty in recruiting qualified personnel
due to the market demand for their services. If the Company is unable to attract
and retain qualified employees, its ability to grow could be impaired. Further,
if the costs of attracting and retaining qualified personnel increase
significantly, the Company's financial results could be materially and adversely
affected.
The Company has significant operations in foreign countries, including sales,
research and development, customer support and administrative service. The
countries in which the Company has its most significant foreign operations
include Israel, Germany, the United Kingdom and Canada, and the Company intends
to continue to expand its operations internationally. The Company's business may
suffer if it is unable to successfully expand and maintain foreign operations.
The Company's foreign operations are, and any future foreign expansion will be,
subject to a variety of risks, many of which are beyond its control, including
risks associated with: (i) foreign currency fluctuations; (ii) political and
economic instability in foreign countries; (iii) changes in and compliance with
local laws and regulations, including tax laws, labor laws, employee benefits,
currency restrictions and other requirements; (iv) differences in tax regimes
and potentially adverse tax consequences of operating in foreign countries; (v)
customizing products for foreign countries; (vi) legal uncertainties regarding
liability, export and import restrictions, tariffs and other trade barriers;
(vii) hiring qualified foreign employees; and (viii) difficulty in accounts
receivable collection and longer collection periods. In addition, the tax
authorities in the various jurisdictions in which the Company operates may
review from time to time the pricing arrangements between the Company and its
subsidiaries. An adverse determination by one or more tax authorities in this
regard may have a material and adverse effect on the Company's financial
results.
28
The Company's subsidiary, Verint Technology Inc. ("Verint Technology"), which
markets, sells and supports its communications interception solutions to various
U.S. government agencies, is required by the National Industrial Security
Program to maintain facility security clearances and to be insulated from
foreign ownership, control or influence. To comply with the National Industrial
Security Program requirements, in January 1999 the Company, Verint Technology,
Comverse Technology and the Department of Defense entered into a proxy agreement
with respect to the ownership and operations of Verint Technology, which
agreement was superseded in May 2001 to comply with the Department of Defense's
most recent requirements. Under the proxy agreement, the Company, among other
things, appointed three individuals, who are U.S. citizens, holding the
requisite security clearances as holders of proxies to vote the Verint
Technology stock. The proxy holders have the power to exercise all prerogatives
of ownership of Verint Technology. These three individuals are responsible for
the oversight of Verint Technology's security arrangements.
The proxy agreement may be terminated and Verint Technology's facility security
clearance may be revoked in the event of a breach of the proxy agreement, or if
it is determined by the Department of Defense that termination is in the
national interest. If Verint Technology's facility security clearance is
revoked, the Company may lose all or a substantial portion of its sales to U.S.
government agencies and its business, financial condition and results of
operations would be harmed. In addition, concerns about the security of the
Company or its products can materially and adversely affect Verint Technology's
sales to U.S. government agencies.
As the communications industry continues to evolve, governments may increasingly
regulate products that monitor and record voice, video and data transmissions
over public communications networks, such as the solutions that the Company
offers. For example, products which the Company sells in the United States to
law enforcement agencies and which interface with a variety of wireline,
wireless and Internet protocol networks, must comply with the technical
standards established by the Federal Communications Commission pursuant to the
Communications Assistance for Law Enforcement Act and products that it sells in
Europe must comply with the technical standards established by the European
Telecommunications Standards Institute. The adoption of new laws or regulations
governing the use of the Company's products or changes made to existing laws or
regulations could cause a decline in the use of its products and could result in
increased expenses for the Company, particularly if the Company is required to
modify or redesign its products to accommodate these new or changing laws or
regulations.
As part of the Company's growth strategy, it intends to pursue new strategic
alliances. The Company considers and engages in strategic transactions from time
to time and may be evaluating alliances or joint ventures at any time. The
Company competes with other analytic solution providers for these opportunities.
The Company cannot be assured that it will be able to effect these transactions
on commercially reasonable terms or at all. If the Company enters into these
transactions, there is also no assurance that it will realize the benefits it
anticipates.
The Company incorporates software that it licenses from third parties into the
vast majority of its products. If the Company loses or is unable to maintain any
software licenses, it could incur additional costs or experience unexpected
delays until equivalent software can be developed or licensed and integrated
into its products.
While the Company occasionally files patent applications, it cannot be assured
that patents will be issued on the basis of such applications or that, if such
patents are issued, they will be sufficiently broad to protect its technology.
In addition, the Company cannot be assured that any patents issued to it will
not be challenged, invalidated or circumvented.
In order to safeguard its unpatented proprietary know-how, trade secrets and
technology, the Company relies primarily upon trade secret protection and
non-disclosure provisions in agreements with employees and others having access
to confidential information. The Company cannot be assured that these measures
will adequately protect it from improper disclosure or misappropriation of its
proprietary information.
29
While the Company implements sophisticated security measures, third parties may
attempt to breach its security or inappropriately use its products through
computer viruses, electronic break-ins and other disruptions. If successful,
confidential information, including passwords, financial information or other
personal information may be improperly obtained and the Company may be subject
to lawsuits and other liability. Even if the Company is not held liable, such
security breaches could harm its reputation, and even the perception of security
risks, whether or not valid, could inhibit market acceptance of its products
with both government and commercial purchasers.
The information technology industry is characterized by frequent allegations of
intellectual property infringement. In the past, third parties have asserted
that certain of the Company's products infringe their intellectual property, and
similar claims may be made in the future. Any allegation of infringement against
the Company could be time consuming and expensive to defend or resolve, result
in substantial diversion of management resources, cause product shipment delays,
or force it to enter into royalty or license agreements rather than dispute the
merits of such allegation. If patent holders or other holders of intellectual
property initiate legal proceedings against the Company, it may be forced into
protracted and costly litigation. The Company may not be successful in defending
such litigation and may not be able to procure any required royalty or license
agreements on terms acceptable to it, or at all. The Company generally
indemnifies its customers with respect to infringement by its products of the
proprietary rights of third parties. Third parties may assert infringement
claims against the Company's customers. These claims may require the Company to
initiate or defend protracted and costly litigation, regardless of the merits of
these claims. If any of these claims succeed, the Company may be forced to pay
damages or may be required to obtain licenses for the products its customers
use. If the Company cannot obtain all necessary licenses on commercially
reasonable terms, its customers may be forced to stop using, or, in the case of
value added resellers, stop selling, its products.
Although the Company generally uses standard parts and components in its
products, it does use some non-standard parts and equipment. The Company relies
on non-affiliated suppliers for the supply of certain standard and non-standard
components and on manufacturers of assemblies that are incorporated in all of
its products. The Company does not have long term supply or manufacturing
agreements with all of these suppliers and manufacturers. If these suppliers or
manufacturers (a) experience financial, operational, manufacturing capacity or
quality assurance difficulties, or cease production and sale of such products at
the end of their life cycle; or (b) if there is any other disruption in its
relationships with these suppliers or manufacturers, the Company will be
required to locate alternative sources of supply. The Company's inability to
obtain sufficient quantities of these components, if and as required in the
future, entails the following risks: (i) delays in delivery or shortages in
components could interrupt and delay manufacturing and result in cancellations
of orders for its products; (ii) alternative suppliers could increase component
prices significantly and with immediate effect; (iii) it may not be able to
develop alternative sources for product components; (iv) it may be required to
modify its products, which may cause delays in product shipments, increased
manufacturing costs and increased product prices; and (v) it may be required to
hold more inventory than it otherwise might in order to avoid problems from
shortages or discontinuance, which may result in write-offs if the Company is
unable to use all such products in the future.
The Company has in the past and may in the future pursue acquisitions of
businesses, products and technologies, or the establishment of joint venture
arrangements. The negotiation of potential acquisitions or joint ventures as
well as the integration of an acquired or jointly developed business, technology
or product could result in a substantial diversion of management resources.
Future acquisitions could result in potentially dilutive issuances of equity
securities, the incurrence of debt and contingent liabilities, amortization of
30
certain identifiable intangible assets, research and development write-offs and
other acquisition-related expenses. These investments may be made in immature
businesses with unproven track records and technologies. Such investments have a
high degree of risk, with the possibility that the Company may lose the total
amount of its investments, or more than its total investment if such businesses
have liabilities not identified by the Company. The Company may not be able to
identify suitable investment candidates, and, even if it does, it may not be
able to make those investments on acceptable terms, or at all. In addition, the
Company also may fail to successfully integrate acquired businesses with its
operations or successfully realize the intended benefits of any acquisition,
either of which could affect the Company's continued growth and profitability.
And, the integration process may further strain the Company's existing financial
and managerial controls and reporting systems and procedures. Due to rapidly
changing market conditions, the Company may find the value of its acquired
technologies and related intangible assets, such as goodwill, as recorded in its
financial statements, to be impaired, resulting in charges to operations. The
Company may also fail to retain the acquired or merged company's key employees
and customers.
Currently, the Company accounts for employee stock options in accordance with
Accounting Principles Board ("APB") Opinion No. 25 and related Interpretations,
which provide that any compensation expense relative to employee stock options
be measured based on intrinsic value of the stock options. As a result, when
options are priced at or above fair market value of the underlying stock on the
date of the grant, as is currently the Company's practice, the Company incurs no
compensation expense.
In December 2004, the FASB issued Statement of Financial Accounting Standard
("SFAS") No. 123 (revised 2004), "Share-Based Payment", ("SFAS No.123(R)") which
revises SFAS No. 123 and supersedes APB No. 25. In April 2005, the SEC amended
Regulation S-X to modify the date for compliance with SFAS No. 123(R). The
provisions of SFAS No. 123(R) must be applied beginning with the fiscal year
beginning on or after June 15, 2005, which for the Company is February 1, 2006
(the "Effective Date"). SFAS No. 123(R) requires all share-based payments to
employees, including grants of employee stock options, to be valued at fair
value on the date of grant, and to be expensed over the applicable vesting
period. Pro forma disclosure of the income statement effects of share-based
payments is no longer an alternative. Beginning on the Effective Date, the
Company must (i) expense all options granted after the Effective Date over the
applicable vesting period, and (ii) expense the non-vested portions of existing
option grants going forward over their remaining vesting period. Compensation
expense for the non-vested portions of existing option grants as of the
Effective Date will be recorded based on the fair value of the awards previously
calculated in developing the pro forma disclosures in accordance with the
provisions of SFAS No. 123. Under SFAS No. 123(R), the Company is required to
adopt a fair value-based method for measuring the compensation expense related
to employee stock and stock options awards; this will lead to substantial
additional compensation expense. Any such expense, although it will not affect
the Company's cash flows, will have a material negative impact on the Company's
reported results of operations.
The Company receives conditional grants from the Government of Israel through
the Office of the Chief Scientist of the Ministry of Industry and Trade, or the
OCS, for the financing of a portion of its research and development expenditures
in Israel. The terms of these conditional grants limit the Company's ability to
manufacture products outside of Israel if such products or technologies were
developed using these grants. On March 30, 2005, the Israeli parliament approved
an amendment to Israeli Law for Encouragement of Industrial Research and
Development, which permits the transfer of such technology outside of Israel
under certain conditions. If the Company receives approval to manufacture
products, or to transfer technology, developed using these conditional grants
outside of Israel, it may be required to pay a significantly increased amount of
royalties on an accelerated basis to the Government of Israel, depending on the
manufacturing volume that is performed outside of Israel, or in respect of a
transfer of technology it may be required, prior to such transfer, to pay a
redemption price to be determined under regulations that have not yet been
promulgated. This restriction may impair the Company's ability to outsource
manufacturing or engage in similar arrangements for those products or
technologies. In addition, if the Company fails to comply with any of the
conditions imposed by the OCS, it may be required to refund any grants
previously received together with interest and penalties, and it may be subject
31
to criminal charges. Further, from time to time the Government of Israel may
audit the sales of products incorporating technology partially funded through
OCS programs which, while not increasing the aggregate amount of royalties that
may be due from the Company, may cause the Company to have to pay royalties on
additional products, effectively accelerating the pace at which it pays
royalties to the Government of Israel in repayment of the benefits received
under such programs. In recent years, the Government of Israel has accelerated
the rate of repayment of OCS grants and may further accelerate them in the
future. The Company currently pays royalties of between 3% and 5% (or 6% under
certain circumstances) of associated product revenues (including service and
other related revenues) to the Government of Israel in consideration of benefits
received under this program. Such royalty payments by the Company are currently
required to be made until the government has been reimbursed the amounts
received by it, linked to the U.S. dollar, plus, for amounts received under
projects approved by the OCS after January 1, 1999, interest on such amounts at
a rate equal to the 12-month LIBOR rate in effect on January 1st of the year in
which approval is obtained. As of April 30, 2005, the Company has received
approximately $56.6 million in cumulative grants and has recorded approximately
$27.7 million in cumulative royalties to the OCS. Further, the Government of
Israel has reduced the benefits available under these programs in recent years
and these programs may be discontinued or curtailed in the future. In addition,
the Company expects that OCS grants as a percentage of its consolidated research
and development expenses will decrease in future periods due to an expected
increase in the portion of research and development activities that will not be
reimbursed by the OCS and an expected increase in research and development
activities outside of Israel. The continued reduction in these benefits or the
termination of the Company's eligibility to receive these benefits may
materially and adversely affect the Company's business, financial condition and
results of operations. Alternatively to paying royalties over time, there may be
circumstances in which a company would repay all or substantially all of the
amounts due to the OCS in a single payment. From time to time, the Company
evaluates whether to pursue repayment of amounts due to OCS in a single payment.
If the Company were to repay all or substantially all of the amounts due to the
OCS in a single payment, it would significantly reduce or eliminate the
Company's net income for a given fiscal year and might cause the Company to
report a loss for the fiscal year in which such a payment is made.
To date, most of the Company's sales have been denominated in U.S. dollars,
while a significant portion of its expenses, primarily labor expenses in Israel,
Germany, the United Kingdom and Canada, are incurred in the local currencies of
these countries. As a result, the Company is exposed to the risk that
fluctuations in the value of these currencies relative to the U.S. dollar could
increase the dollar cost of its operations in Israel, Germany, the United
Kingdom or Canada, and would therefore have a material adverse effect on its
results of operations.
In addition, since a portion of the Company's sales are made in foreign
currencies, primarily the British pound and the euro, fluctuation in the value
of these currencies relative to the U.S. dollar could decrease its revenues and
materially and adversely affect its results of operations. In addition, the
Company's costs of operations have at times been negatively affected by changes
in the cost of its operations in Israel, Germany and Canada, resulting from
changes in the value of the relevant local currency relative to the U.S. dollar.
Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors, which in the
past and may in the future, lead to security and economic problems for Israel.
Current and future conflicts and political, economic and/or military conditions
in Israel and the Middle East region can directly affect the Company's
operations in Israel. From October 2000, until recently, terrorist violence in
Israel increased significantly, primarily in the West Bank and Gaza Strip, and
Israel has experienced terrorist incidents within its borders. There can be no
assurance that the recent relative calm and renewed discussions with the
Palestinian representatives will continue. The Company could be materially
adversely affected by hostilities involving Israel, the interruption or
32
curtailment of trade between Israel and its trading partners, or a significant
downturn in the economic or financial condition of Israel. In addition, the sale
of products manufactured in Israel may be materially adversely affected in
certain countries by restrictive laws, policies or practices directed toward
Israel or companies having operations in Israel. The continuation or
exacerbation of violence in Israel or the outbreak of violent conflicts
involving Israel may impede the Company's ability to sell its products or
otherwise adversely affect the Company. In addition, many of the Company's
Israeli employees in Israel are required to perform annual compulsory military
service in Israel and are subject to being called to active duty at any time
under emergency circumstances. The absence of these employees may have an
adverse effect upon the Company's operations.
The Company's investment programs in manufacturing equipment and leasehold
improvements at its facility in Israel has been granted approved enterprise
status and it is therefore eligible for tax benefits under the Israeli Law for
Encouragement of Capital Investments. The Government of Israel may reduce or
eliminate the tax benefits available to approved enterprise programs such as the
programs provided to the Company. The Company cannot be assured that these tax
benefits will be continued in the future at their current levels or at all. If
these tax benefits are reduced or eliminated, the amount of taxes that the
Company pays in Israel will increase. In addition, if the Company fails to
comply with any of the conditions and requirements of the investment programs,
the tax benefits it has received may be rescinded and it may be required to
refund the amounts it received as a result of the tax benefits, together with
interest and penalties.
The Company's business is subject to evolving corporate governance and public
disclosure regulations that have increased both costs and the risk of
noncompliance, which could have an adverse effect on the Company's stock price.
Because the Company's Common Stock is publicly traded on the NASDAQ National
Market, the Company is subject to rules and regulations promulgated by a number
of governmental and self-regulated organizations, including the Securities and
Exchange Commission, NASDAQ and the Public Company Accounting Oversight Board,
which monitors the accounting practices of public companies. Many of these
regulations have only recently been enacted, and continue to evolve, making
compliance more difficult and uncertain. In addition, the Company's efforts to
comply with these new regulations have resulted in, and are likely to continue
to result in, increased general and administrative expenses and a diversion of
management time and attention from revenue-generating activities to compliance
activities. In particular, Section 404 of the Sarbanes-Oxley Act of 2002 and
related regulations require the Company to include a management assessment of
its internal controls over financial reporting and auditor attestation of that
assessment in its annual report, which the Company included for in its annual
report for fiscal 2004. While the Company was able to assert, in the management
certifications filed with its Annual Report on Form 10-K, that the Company's
internal control over financial reporting is effective as of January 31, 2005
and that no material weaknesses were identified, the Company must continue to
monitor and assess the internal control over financial reporting. The Company
cannot provide any assurances that material weaknesses will not be discovered in
the future. If the Company is unable to assert that the internal control over
financial reporting is effective for any given reporting period (or if the
Company's auditors are unable to attest that the management's report is fairly
stated or are unable to express an opinion on the effectiveness of the internal
controls), the Company could lose investor confidence in the accuracy and
completeness of the Company's financial reports, which would have an adverse
effect on the Company's stock price. The effort regarding Section 404 has
required, and continues to require, the commitment of significant financial and
managerial resources.
Comverse Technology beneficially owns a majority of the Company's outstanding
shares of Common Stock. Consequently, Comverse Technology effectively controls
the outcome of all matters submitted for stockholder action, including the
composition of the Company's board of directors and the approval of significant
corporate transactions. Through its representation on the Company's board of
33
directors, Comverse Technology has a controlling influence on the Company's
management, direction and policies, including the ability to appoint and remove
its officers. As a result, Comverse Technology may cause the Company to take
actions which may not be aligned with the Company's interests or those of its
other stockholders. For example, Comverse Technology may prevent or delay any
transaction involving a change in control or in which stockholders might receive
a premium over the prevailing market price for their shares. In particular, as a
result of Comverse Technology's majority ownership, the Company has relied on
the "controlled company" exemption from certain requirements under Rule
4350(c)(5) of the listing standards of the National Association of Securities
Dealers, Inc., and does not have an independent Compensation Committee or
Nominating Committee, as non-controlled companies are required to have.
The Company receives insurance, legal and certain administrative services from
Comverse Technology under a corporate services agreement. The Company's
enterprise resource planning software is maintained and supported by Comverse
Ltd., a subsidiary of Comverse Technology, under an enterprise resource planning
software sharing agreement. The Company also obtains personnel and facility
services from Comverse, Inc. under a satellite services agreement. If these
agreements are terminated, the Company may be required to obtain similar
services from other entities or, alternatively, it may be required to hire
qualified personnel and incur other expenses to obtain these services. The
Company may not be able to hire such personnel or to obtain comparable services
at prices and on terms as favorable as it currently has under these agreements.
The Company has entered into a business opportunities agreement with Comverse
Technology that addresses potential conflicts of interest between Comverse
Technology and the Company. This agreement allocates between Comverse Technology
and the Company opportunities to pursue transactions or matters that, absent
such allocation, could constitute corporate opportunities of both companies. As
a result, the Company may lose valuable business opportunities. In general, the
Company is precluded from pursuing opportunities offered to officers or
employees of Comverse Technology who may also be its directors, officers or
employees unless Comverse Technology fails to pursue these opportunities.
Seven of the Company's thirteen directors are officers and/or directors or
employees of Comverse Technology, or otherwise affiliated with Comverse
Technology. These directors have fiduciary duties to both companies and may have
conflicts of interest on matters affecting both the Company and Comverse
Technology and in some circumstances may have interests adverse to the Company.
The Company's Chairman, Kobi Alexander, is the chairman of Comverse Technology.
This position with Comverse Technology imposes significant demands on Mr.
Alexander's time and presents potential conflicts of interest.
Prior to the Company's initial public offering in May 2002, it was included in
the Comverse Technology consolidated group for federal income tax purposes and
did not file its own federal income tax return. Following the Company's initial
public offering, it ceased to be included in the Comverse Technology
consolidated group for federal income tax purposes. To the extent Comverse
Technology or other members of the group fail to make any federal income tax
payments required of them by law in respect of years for which Comverse
Technology filed a consolidated federal income tax return which included the
Company, the Company would be liable for the shortfall. Similar principles apply
for state income tax purposes in many states. In addition, by virtue of its
controlling ownership and its tax sharing agreement with the Company, Comverse
Technology effectively controls all of the Company's tax decisions for periods
ending prior to the completion of its initial public offering. For periods
during which the Company was included in the Comverse Technology consolidated
group for federal income tax purposes, Comverse Technology has sole authority to
respond to and conduct all federal income tax proceedings and audits relating to
the Company, to file all federal income tax returns on its behalf and to
determine the amount of its liability to, or entitlement to payment from,
Comverse Technology under its tax sharing agreement. Despite this agreement,
federal law provides that each member of a consolidated group is liable for the
group's entire tax obligation and the Company could, under certain
circumstances, be liable for taxes of other members of the Comverse Technology
consolidated group.
34
The trading price of the Company's shares of Common Stock has been affected by
the factors disclosed in this section as well as prevailing economic and
financial trends and conditions in the public securities markets. Share prices
of companies in technology-related industries, such as the Company's, tend to
exhibit a high degree of volatility. The announcement of financial results that
fall short of the results anticipated by the public markets could have an
immediate and significant negative effect on the trading price of the Company's
shares in any given period. Such shortfalls may result from events that are
beyond the Company's immediate control, can be unpredictable and, since a
significant proportion of its sales during each fiscal quarter tend to occur in
the latter stages of the quarter, may not be discernible until the end of a
financial reporting period. These factors may contribute to the volatility of
the trading value of the Company's shares regardless of its long-term prospects.
The trading price of the Company's shares may also be affected by developments,
including reported financial results and fluctuations in trading prices of the
shares of other publicly-held companies in its industry generally, and its
business segment in particular, which may not have any direct relationship with
its business or prospects.
In the past, securities class action litigation has often been brought against a
company following periods of volatility in the market price of its securities.
The Company could be the target of similar litigation in the future. Securities
litigation could result in the expenditure of substantial costs, divert
management's attention and resources, harm the Company's reputation in the
industry and the securities markets and reduce its profitability.
Terrorist attacks and other acts of war, and any response to them, may lead to
armed hostilities and such developments would likely cause instability in
financial markets. Armed hostilities and terrorism may directly impact the
Company's facilities, personnel and operations which are located in the United
States, Canada, Israel, Europe, the Far East, Australia and South America, as
well as those of its clients. Furthermore, severe terrorist attacks or acts of
war may result in temporary halts of commercial activity in the affected
regions, and may result in reduced demand for its products. These developments
could have a material adverse effect on the Company's business and the trading
price of its Common Stock.
The Company's board of directors' ability to designate and issue up to 2,500,000
shares of preferred stock and to issue additional shares of Common Stock could
adversely affect the voting power of the holders of Common Stock, and could have
the effect of making it more difficult for a person to acquire, or could
discourage a person from seeking to acquire, control of the Company. If this
occurs, investors could lose the opportunity to receive a premium on the sale of
their shares in a change of control transaction.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to market risk from changes in foreign currency exchange
rates that could impact its results of operations and financial condition. The
Company considers the foreign currency exchange rate risk, in particular that of
the U.S. dollar versus the British pound, the euro and the Israeli shekel, to be
its primary market risk exposure. To date, the Company has not used any material
foreign currency exchange contracts or other derivative instruments to reduce
its exposure to the foreign currency exchange risks. In the future, the Company
may use foreign currency exchange contracts and other derivative instruments to
reduce its exposure to this risk.
The Company is exposed to market risk from changes in interest rates. Various
financial instruments held by the Company are sensitive to changes in interest
rates. Interest rate changes could result in an increase or decrease in interest
35
income as well as in gains or losses in the market value of the Company's debt
security investments due to differences between the market interest rates and
rates at the date of purchase of these investments.
The Company places its cash investments with high credit-quality financial
institutions and currently invests primarily in money market funds placed with
major banks and financial institutions, bank time deposits, Auction-Rate
Securities ("ARS"), corporate debt securities and United States government,
corporation and agency obligations and/or mutual funds investing in the like.
The Company has investment guidelines relative to diversification and maturities
designed to maintain safety and liquidity. As of April 30, 2005, the Company had
cash and cash equivalents, which generally have a maturity of three months or
less, totaling approximately $42.6 million and had short-term investments,
totaling approximately $207.7 million, which primarily consist of Auction Rate
Securities.
These ARS have maturities ranging up to thirty years; however, these investments
have characteristics similar to short-term investments because at pre-determined
intervals, generally every 7 to 90 days, there is a new auction process at which
these securities are reset to current interest rates. If, during the year ended
January 31, 2006, average short-term interest rates increase or decrease by 50
basis points relative to average rates realized during the year ended January
31, 2005, the Company's projected interest income from cash and cash equivalents
and short-term investments would increase or decrease by approximately $1.2
million, assuming a similar level of investments in the year ended January 31,
2006.
Due to the short-term nature of the Company's cash and cash equivalents, the
carrying values approximates market value and are not generally subject to price
risk due to fluctuations in interest rates. The Company's short-term investments
are subject to price risk due to fluctuations in interest rates. Neither a 10%
increase nor decrease in prices would have a material effect on the Company's
financial position, results of operations or cash flows. All short-term
investments are considered to be available-for-sale, accounted for at fair
value, with resulting unrealized gains or losses reported as a separate
component of shareholders' equity. If these available-for-sale securities
experience declines in fair value that are considered other-than-temporary, an
additional loss would be reflected in net income (loss) in the period when the
subsequent impairment becomes apparent. See Note 3 of the notes to the Condensed
Consolidated Financial Statements and Note 4 of the notes to the consolidated
financial statement in the Company's Annual Report on Form 10-K for more
information regarding the Company's short-term investments.
ITEM 4. CONTROLS AND PROCEDURES.
The Company's management evaluated, with the participation of the Company's
principal executive and principal financial officers, the effectiveness of the
Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act")), as of April 30, 2005. Based on their evaluation, the Company's principal
executive and principal financial officers concluded that the Company's
disclosure controls and procedures were effective as of April 30, 2005.
There has been no change in the Company's internal control over financial
reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)
that occurred during the Company's fiscal quarter ended April 30, 2005, that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
36
PART II
Other Information
-----------------
ITEM 6. EXHIBITS.
(a) Exhibit Index.
-------------
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) and 15d-14(a) of the Exchange Act, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) and 15d-14(a) of the Exchange Act, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
37
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VERINT SYSTEMS INC.
Dated: June 9, 2005 By: /s/ Dan Bodner
------------------------------------------
Dan Bodner
President and Chief Executive Officer
Principal Executive Officer
Dated: June 9, 2005 By: /s/ Igal Nissim
------------------------------------------
Igal Nissim
Vice President and Chief Financial Officer
Principal Financial Officer
38