TMCnet News
COMVERSE, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read together with Item 1, "Business," Item 6, "Selected Financial Data," and the consolidated and combined financial statements and related notes included in Item 15 of this Annual Report. This discussion and analysis contains forward-looking statements based on current expectations relating to future events and our future financial performance that involve risks and uncertainties. See "Forward-Looking Statements" on page i of this Annual Report. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those set forth under Item 1A, "Risk Factors," and elsewhere in this Annual Report. Percentages and amounts within this section may not calculate due to rounding differences. EXECUTIVE SUMMARY Overview We are a leading provider of telecom business enablement solutions for communication service providers (or CSPs) through a portfolio of product-based solutions and associated services in the following domains: • Business Support Systems. We provide converged, prepaid and postpaid billing and active customer management systems (or BSS) for wireless, wireline, cable and multi-play CSPs, delivering a value proposition designed to enable an effective service and data monetization, a consistent, enhanced customer experience, reduced complexity and cost, and real-time choice and control. • Policy Solutions. We provide CSPs with the ability to better manage their data networks and to better monetize their data network investment through our Policy Management and Policy Enforcement capabilities for wireless and wireline data networks. • Digital Services. We enable voice and messaging services (including voicemail, visual voicemail, call completion, short messaging service (or SMS), and multimedia picture and video messaging (or MMS)), and digital lifestyle services and Internet Protocol (or IP) based rich communication services (including group chat, file transfer, video share, social, presence and geo-location information). • Managed and Professional Services. We offer a portfolio of services related to our solutions following the completion of the delivery of the project to the customer (referred to as managed services). Our reportable segments are: • BSS-comprised of the BSS operating segment; and • Digital Services-comprised of the Digital Services operating segment. The results of operations of our global corporate functions that support our business units is included in the column captioned "All Other" as part of our business segment presentation. For additional information see note 20 to the consolidated and combined financial statements included in Item 15 of this Annual Report. Starhome's results of operations are included in discontinued operations and therefore not presented in segment information. Historically, Mobile Internet (or Comverse MI), which was renamed Policy and is responsible for our mobile Internet and policy products, and Netcentrex, an IP-based solution that provides carrier-hosted enterprise and consumer IP services, were included in All Other. Effective in the three months ended January 31, 2014 (fourth quarter of 2013), Comverse MI and Netcentrex have been combined with the Comverse BSS and Comverse VAS segments, respectively, to form our BSS and Digital Services segments. Accordingly, the results presented under segment reporting reflect the change in segment reporting for all periods presented to conform to the current period segment reporting structure. For more information, see note 1 to our consolidated and combined financial statements included in Item 15 of this Annual Report. Significant Events During the fiscal year ended January 31, 2014 and subsequent thereto, the following additional significant events occurred: Merger of CTI and Verint. On August 12, 2012, CTI entered into an agreement and plan of merger (referred to as the Verint Merger Agreement) with Verint providing for the merger of CTI with and into a subsidiary of Verint to become a wholly-owned subsidiary of Verint (referred to as the Verint Merger). The Verint Merger was completed on February 4, 2013. 29-------------------------------------------------------------------------------- Table of Contents Under the Share Distribution Agreements we and CTI entered into in connection with the Share Distribution, we have agreed to indemnify CTI and its affiliates (including Verint after the Verint Merger) against certain losses that may arise as a result of the Verint Merger and the Share Distribution. Certain of our indemnification obligations are capped at $25.0 million and certain are uncapped. CTI placed $25.0 million in escrow to support indemnification claims to the extent made against us by Verint and any cash balance remaining in such escrow fund 18 months after the closing of the Verint Merger (referred to as Escrow Release Date), less any claims made on or prior to such date, will be released to us. The escrow funds cannot be used for claims related to the Israeli Optionholder suit. Although no indemnification claims have been filed and the Escrow Release Date is within 12 months of January 31, 2014, we continue to classify the restricted cash balance as "Long-term restricted cash" in the Consolidated Balance Sheets until it can be determined if any future claims would restrict the release of such escrow funds. We also assume all pre-Share Distribution tax obligations of each of us and CTI. For more information, see note 3 to our consolidated and combined financial statements included in Item 15 of this Annual Report. Changes in Board Composition and Agreement with Becker Drapkin. On September 11, 2013, the Board appointed Neil Montefiore to serve as a director and as a member of the Board's Audit Committee and Corporate Governance and Nominating Committee. There were no arrangements or understandings between Mr. Montefiore and any other persons pursuant to which he was selected as a director. On March 12, 2014, we entered into an agreement (or the Agreement) with Matthew Drapkin, Becker Drapkin Management, L.P., and certain of their affiliates (or, collectively, the BD Group). Under the terms of the Agreement, we agreed (a) on the date of the Agreement to (i) increase the size of the Board from seven to eight total directors; (ii) appoint Mr. Drapkin as a member of the Board; and (iii) appoint Mr. Drapkin as a member of the Compensation and Leadership Committee of the Board; (b) to nominate Mr. Drapkin for election or re-election to the Board at our 2014 and 2015 annual shareholders' meetings, subject to the nonoccurrence of certain events described in the Agreement; and (c) for so long as Mr. Drapkin is a member of the Board, (i) that Mr. Drapkin shall be a member of the Compensation and Leadership Committee and (ii) to consider Mr. Drapkin, in good faith based on Mr. Drapkin's relevant experience, for membership on any committee of the Board constituted to evaluate strategic opportunities or transactions. If Mr. Drapkin is unable or unwilling to serve as a director, the BD Group and the Board (excluding Mr. Drapkin) shall agree on a replacement. The Agreement also provides that the BD Group shall have certain obligations until the later of immediately following our 2016 shareholders' meeting and 30 days after Mr. Drapkin ceases to be a member of the Board, or such earlier date, if any, on which the Company materially breaches certain provisions of the Agreement and such breach has not been cured within ten business days following written notice, provided the breach is curable (referred to as the Standstill Period). During the Standstill Period, the BD Group has agreed to (a) cause all shares of our common stock beneficially owned by the BD Group to be present for quorum purposes at all shareholders' meetings and to be voted in favor of all directors nominated by the Board for election and against the removal of any directors whose removal is not recommended by the Board, unless and until the Board does not recommend Mr. Drapkin for re-election at the our 2016 annual shareholders' meeting; and (b) refrain from taking certain actions, including, subject to certain exceptions, to not (i) acquire beneficial ownership of more than 14.9% of our common stock; (ii) engage in activities to control or influence our governance or policies, including by submitting shareholder proposals, nominating candidates for election to the Board or opposing candidates nominated by the Board, attempting to call special meetings of our shareholders or soliciting proxies with respect to our voting securities; (iii) participate in any "group," within the meaning of Section 13(d)(3) of the Securities Exchange Act of 1934, as amended, with respect to our common stock; (iv) be involved with certain business combination or extraordinary transactions; (v) make certain unpermitted dispositions of the Company's common stock; (vi) be involved with any litigation, arbitration or other proceeding against or involving us or our directors or officers while Mr. Drapkin is a director; or (vii) engage in any short sale or derivatives transaction that derives any significant part of its value from a decline in the market price or value of our securities. Mr. Drapkin has also agreed not to serve on the board of directors of a competitor of ours while serving as our director. Notwithstanding the above, if the Board does not recommend Mr. Drapkin for re-election at the 2016 annual shareholders' meeting, the BD Group may nominate candidates for election to the Board and make public statements and solicit proxies in support of any such candidate's nomination for election at the 2016 annual shareholders' meeting. In addition, the Agreement provides that Mr. Drapkin irrevocably tender his resignation as director effective as of the date that (a) the BD Group does not have beneficial ownership of (i) 5% or more of our outstanding common stock, disregarding issuances by us of equity securities and/or issuances primarily for cash consideration or the purpose of providing compensation to our executive officers, directors, employees or consultants, or (ii) after including such issuances, 3% or more of our outstanding common stock; or (b) the BD Group materially breaches certain provisions of 30-------------------------------------------------------------------------------- Table of Contents the Agreement and such breach has not been cured within ten business days following written notice, provided such breach is curable. Consolidated and Combined Financial Highlights The following table presents certain financial highlights for the fiscal years ended January 31, 2014, 2013 and 2012, including Comverse performance and Comverse performance margin (reflecting Comverse performance as a percentage of revenue), non-GAAP financial measures, for our company on a consolidated and combined basis: Fiscal Years Ended January 31, 2014 2013 2012 (Dollars in thousands) Total revenue $ 652,501 $ 677,763 771,157 Gross margin 38.3 % 36.3 % 39.2 % Income (loss) from operations 37,699 (2,192 ) 11,442 Operating margin 5.8 % (0.3 )% 1.5 % Net income (loss) from continuing operations 18,686 (20,294 ) (20,648 ) Income from discontinued operations, net of tax - 26,542 7,761 Net income (loss) 18,686 6,248 (12,887 ) Less: Net income attributable to noncontrolling interest - (1,167 ) (2,574 ) Net income (loss) attributable to Comverse, Inc. 18,686 5,081 (15,461 ) Net cash provided by (used in) operating activities - continuing operations 6,621 28,190 (13,361 ) Non-GAAP Financial Measures - Comverse performance $ 56,649 $ 35,415 $ 73,845 Comverse performance margin 8.7 % 5.2 % 9.6 % Reconciliation of Income (Loss) from Operations to Comverse Performance We provide Comverse performance, a non-GAAP financial measure, as additional information for our operating results. This measure is not in accordance with, or an alternative for, GAAP financial measures and may be different from, or not comparable to similarly titled or other non-GAAP financial measures used by other companies. We believe that the presentation of this non-GAAP financial measure provides useful information to investors regarding certain additional financial and business trends relating to our results of operations as viewed by management in monitoring our businesses, reviewing our financial results and for planning purposes. 31-------------------------------------------------------------------------------- Table of Contents The following table provides a reconciliation of income (loss) from operations to Comverse performance for the fiscal years ended January 31, 2014, 2013, and 2012: Fiscal Years Ended January 31, 2014 2013 2012 (Dollars in thousands) Income (loss) from operations $ 37,699 $ (2,192 ) $ 11,442 Expense Adjustments: Stock-based compensation expense 10,208 7,517 3,660 Amortization of intangible assets 2,765 14,124 17,308 Compliance-related professional fees 2,144 245 10,901 Compliance-related compensation and other expenses 199 2,098 6,719 Spin-off professional fees - 933 - Italian VAT recovery recorded within operating expense (10,861 ) - - Impairment of goodwill - 5,605 - Impairment of property and equipment 482 404 2,331 Certain litigation settlements and related costs (16 ) (660 ) 804 Restructuring expenses 10,783 5,905 20,728 Gain on sale of fixed assets (41 ) (185 ) - Other 3,287 1,621 (48 ) Total expense adjustments 18,950 37,607 62,403 Comverse performance $ 56,649 $ 35,415 $ 73,845 Operating margin 5.8 % (0.3 )% 1.5 % Total expense adjustments margin 2.9 % 5.5 % 8.1 % Comverse performance margin 8.7 % 5.2 % 9.6 % Segment Performance We evaluate our business by assessing the performance of each of our operating segments. Our Chief Executive Officer is our chief operating decision maker (or CODM). The CODM uses segment performance, as defined below, as the primary basis for assessing the financial results of the operating segments and for the allocation of resources. Segment performance, as we define it in accordance with the Financial Accounting Standards Board's (or the FASB) guidance relating to segment reporting, is not necessarily comparable to other similarly titled captions of other companies. Segment performance is computed by management as income (loss) from operations adjusted for the following: (i) stock-based compensation expense; (ii) amortization of intangible assets; (iii) compliance-related professional fees; (iv) compliance-related compensation and other expenses; (v) spin-off professional fees; (vi) Italian VAT recovery recorded within operating expense; (vii) impairment of goodwill; (viii) impairment of property and equipment; (ix) certain litigation settlements and related costs; (x) restructuring expenses; and (xi) certain other gains and expenses. Compliance-related professional fees and compliance-related compensation and other expenses relate to fees and expenses recorded in connection with CTI's and our efforts to (a) complete certain financial statements and audits of such financial statements and (b) remediate material weaknesses in internal control over financial reporting. 32-------------------------------------------------------------------------------- Table of Contents Segment Financial Highlights The following table presents, for the fiscal years ended January 31, 2014, 2013 and 2012, segment revenue, gross margin, income (loss) from operations, operating margin, segment performance and segment performance margin (reflecting segment performance as a percentage of segment revenue) for each of our reportable segments and All Other: Fiscal Years Ended January 31, 2014 2013 2012 (Dollars in thousands) SEGMENT RESULTS BSS Segment revenue $ 299,561 $ 295,803 $ 388,350 Gross margin 37.0 % 33.3 % 40.4 % Income from operations 44,636 18,675 62,270 Operating margin 14.9 % 6.3 % 16.0 % Segment performance 47,557 39,283 82,415 Segment performance margin 15.9 % 13.3 % 21.2 % Digital Services Segment revenue $ 352,940 $ 378,918 $ 379,714 Gross margin 44.7 % 45.4 % 43.0 % Income from operations 127,008 130,890 118,036 Operating margin 36.0 % 34.5 % 31.1 % Segment performance 127,224 133,053 121,001 Segment performance margin 36.0 % 35.1 % 31.9 % All Other Segment revenue $ - $ 3,042 $ 3,093 Loss from operations (133,945 ) (151,757 ) (168,864 ) Segment performance (118,132 ) (136,921 ) (129,571 ) For a discussion of the results of our segments, see "-Results of Operations," and note 20 to the consolidated and combined financial statements included in Item 15 of this Annual Report. Business Trends and Uncertainties For the fiscal year ended January 31, 2014, we had income from operations compared to a loss from operations in the fiscal year ended January 31, 2013. The change was primarily a result of decreases in costs and operating expenses, which were partially offset by decreases in revenue. Comverse performance for the fiscal year ended January 31, 2014 increased compared to the fiscal year ended January 31, 2013. For more information, see "-Results of Operations-Fiscal year Ended January 31, 2014 Compared to Fiscal Year Ended January 31, 2013- Consolidated and Combined Results." The decreases in revenue were primarily attributable to decreases in revenue from customer solutions in our Digital Services segment and maintenance revenue at our BSS and Digital Services segments, partially offset by an increase in revenue from BSS customer solutions. For a discussion of the reasons for the changes in revenue at our BSS and Digital Services segments, see "-BSS," "-Digital Services," "-Results of Operations-Fiscal year Ended January 31, 2014 Compared to Fiscal Year Ended January 31, 2013- Segment Results-BSS" and "-Results of Operations- Fiscal year Ended January 31, 2014 Compared to Fiscal Year Ended January 31, 2013-Segment Results-Digital Services." Due to the decrease in deferred revenue and based on existing levels of customer orders (consisting of product bookings and maintenance revenue), we expect that revenue will decrease significantly in the fiscal year ending January 31, 2015 compared to the fiscal year ended January 31, 2014, as we currently expect the gap between customer orders and revenue to decrease significantly. Total customer orders (consisting of product bookings and maintenance revenue) decreased in the fiscal year ended January 31, 2014 compared to the fiscal year ended January 31, 2013. The decrease is primarily attributable to a significant decrease in APAC and a small decrease in EMEA, partially offset by an increase in the Americas. The increase in customer orders in the Americas reflects a reversal of a decline trend experienced in the region in prior fiscal years. In addition, the decrease in EMEA is attributable to the previously disclosed cancellation of a large maintenance 33-------------------------------------------------------------------------------- Table of Contents contract that was effective during the three months ended April 30, 2013, partially offset by an increase in product bookings. Product bookings decreased in the fiscal year ended January 31, 2014 compared to the fiscal year ended January 31, 2013, due to a significant decrease in APAC, partially offset by increases in the Americas and EMEA. The increases in the Americas and EMEA reflect a reversal of a decline trend experienced in these regions in prior fiscal years. We define "product bookings" as projected revenue from orders signed during a given fiscal period, excluding revenue from maintenance agreements. During the fiscal year ended January 31, 2014, our cash and cash equivalents and restricted cash were favorably impacted primarily by CTI's placement of $25.0 million in escrow to support indemnification claims in connection with the closing of the Verint Merger Agreement, a $10.9 million Italian VAT refund and a decline in costs, operating expenses and disbursements, partially offset by a decrease in cash collections, that resulted in positive operating cash flow in the fiscal year ended January 31, 2014. The decrease in cash collections was primarily attributable to reduced customer order activity in recent years. Our Board of Directors has adopted a program to repurchase from time to time at management's discretion up to $30 million in shares of our common stock on the open market during the 18-month period ending October 9, 2015 at prevailing market prices. Repurchases will be made under the program using our own cash resources. Our costs, operating expenses and disbursements decreased during the fiscal year ended January 31, 2014 primarily due to our continued focus on closely monitoring our costs and operating expenses as part of our efforts to improve our cash position and achieve long-term improved operating performance and positive operating cash flows. During the fiscal year ended January 31, 2014, as part of our efforts to reduce costs and expenses we implemented the following primary initiatives: • Completed the first phase of the industrialization of Comverse ONE to meet or exceed our customer requirements, for ease of use and faster deployment times to reduce deployment costs; • Relocated certain delivery and research and developmentactivities to low cost centers of excellence in Eastern Europe and Asia; • Implemented a transformation plan in the Digital Services segment that included: • a reduction in research and development expenses due to a decrease in investment in traditional value added service, partially offset by an increase in research and development investment in our new Digital Services offerings, including Evolved Communications Suite, to address recent trends in the digital services market; • the deployment of new tools designed to improve efficiency in project deployment and control; and • a reduction in employee headcount facilitated by previously implemented efficiency measures; • Implemented initiatives to reduce significantly selling, general and administrative expenses that included primarily sales and marketing, finance, information technology and facilities. We believe that during the current fiscal year we realized some of the benefits of these initiatives and expect that the full cost savings associated with these initiatives will be reflected in our results of operations in future periods. We intend to continue our efforts to increase customer orders in the fiscal year ending January 31, 2015 in all regions and focus on addressing maintenance pressures. There are several key elements to our overall strategy, including: • Expand relationships with existing customers. We intend to continue to leverage our large customer base of more than 450 CSPs, by offering them a continued evolution path to new services and technologies through upgrades and expansions, enhanced maintenance plans, professional and managed services, and the cross-sale of our solution portfolio. We intend to continue to aggressively market Comverse ONE to CSPs seeking to upgrade their existing prepaid and postpaid systems to converged billing solutions. We are also continuing to offer Kenan upgrades and related professional services to our existing Kenan customer base. We will also continue to market aggressively next generation solutions to existing customers, including rich communication service, videomail, virtualized MultiVAS, our Evolved Communication Suite and other IP-based services and cloud-based solutions. • Expand customer base and market share. We intend to continue our efforts to expand our customer base and market shares by leveraging relationships with multinational CSPs seeking to acquire or establish offshore operations. We also seek engagements with newly established communication 34-------------------------------------------------------------------------------- Table of Contents service providers and will continue our efforts to displace competitors in engagements with established providers. In addition, we believe we are well positioned to replace competitors who are exiting parts of the market and intend to continue to aggressively pursue such growth opportunities. • Leverage CSPs transition to IP networks. We plan to continue to market our next generation Digital Services solutions to CSPs seeking to transition their networks to newer IP technology, such as 4G LTE. Our next generation Digital Services portfolio is designed to enable CSPs to become digital lifestyle players and capture growth opportunities through next generation digital services. We believe that our Evolved Communication Suite will enable CSPs to launch new services such as RCS, accelerate the adoption of CSP driven smartphone applications, leverage subscribers' social profiles, evolve retail and marketing to the digital world and monetize additional services, including machine to machine and Mobile Commerce. • Expand our presence and market share in the BSS market. We believe our BSS solutions offer customers several advantages over competitors' solutions, including faster time to market and lower total cost of ownership. We intend to focus on expanding our position in the converged billing market through new customer engagements. • Focus on offering managed services. We intend to continue to offer our customers managed services as part of our BSS and Digital Services offerings. Managed services enable us to assume responsibility for the operation and management of ourcustomers' systems. Our customers receive improved efficiencies relating to the operation and management of their systems, thereby allowing them to focus on their own internal business needs and strengths with reduced management distraction. Managed services alsorepresent a source of predictable revenue and foster long-term customer relationships. In order to improve operating performance and cash flow from operations, we intend to continue to implement initiatives which we believe will enhance efficiency and result in significant reductions in costs and operating expenses. The initiatives include: • Prioritizing the second phase of the industrialization of our Comverse ONE solution; • Expanding the use of low cost centers of excellence and research and development centers in Eastern Europe and Asia; and • Realigning our cost structure to our current size and business environment. During the fiscal year ended January 31, 2014, we commenced our plan to make investments relating to upgrades of systems and tools that we believe will increase operational efficiency and result in cost reductions in future fiscal periods. As part of this initiative, we plan to make additional investments in upgrades of systems and tools during the fiscal years ending January 31, 2015 and beyond. As a result of these initiatives, we expect that our costs and expenses will continue to decline in future fiscal periods. Our principal business activities are reported through the following segments: • BSS, which provides our converged, prepaid and postpaid billing and BSS for wireless, wireline, cable and multi-play CSPs, delivering a value proposition designed to enable an effective service and data monetization, a consistent, enhanced customer experience, reduced complexity and cost, and real-time choice and control; and • Digital Services, which conducts our voice and messaging services (including voicemail, visual voicemail, call completion, SMS, and MMS), and IP based rich communication services (including group chat, file transfer, video share, social, presence and geo-location information). BSS In the fiscal year ended January 31, 2014, BSS product bookings decreased compared to the fiscal year ended January 31, 2013. We believe that the decrease in BSS product bookings was primarily attributable to (i) the deferral of significant capital investments involved in deploying our BSS solutions and upgrading existing prepaid or postpaid systems to our converged BSS solution, (ii) the cancellation of projects by customers who prioritized their capital expenditures to the deployment of next generation networks, including LTE, (iii) the loss of projects to significantly larger competitors who bundled the BSS transformation with an overall network deployment project and (iv) adverse economic conditions in certain regions, including APAC (primarily India). Revenue from BSS customer solutions for the fiscal year ended January 31, 2014 increased compared to the fiscal year ended January 31, 2013. The increase in revenue from BSS customer solutions was primarily attributable to changes in scope and settlements of certain customer contracts that negatively impacted revenue in the fiscal year ended January 31, 2013 and settlements of certain other customer contracts that positively impacted revenue in the fiscal year 35-------------------------------------------------------------------------------- Table of Contents ended January 31, 2014. Revenue from BSS customer solutions continued to be adversely affected by lower volume of BSS projects in the current fiscal periods resulting from reduced product bookings in recent years. BSS maintenance revenue for the fiscal year ended January 31, 2014 decreased compared to the fiscal year ended January 31, 2013. The decrease mainly reflected the impact on maintenance revenue for the fiscal year ended January 31, 2014 attributable to the previously disclosed cancellation of a large maintenance contract that was effective during the three months ended April 30, 2013. We believe we have a leading industry position in the BSS converged billing market and believe that we are well positioned to take advantage of the growth in the converged BSS market. As part of our strategy, we are continuing our efforts to expand our presence and market share in the BSS market with BSS solutions that we believe offer several advantages over competitors' offerings, including faster time to market and lower total cost of ownership. We continue to offer our existing prepaid and postpaid customer base upgrades and an evolution path to our Comverse ONE converged billing solution, which we believe better addresses the enhanced business needs of CSPs. In addition, we continue to aggressively pursue opportunities to market our BSS solutions, primarily Comverse ONE, to new customers as part of our efforts to increase our customer base. To maintain our market leadership in BSS convergence and monetization of new business models, we continue to expend significant resources on research and development to further enhance Comverse ONE and its advanced monetization capabilities, including support for new business models such as cloud services. We continue to focus on increasing our BSS revenue and improving our margins by providing a growth and evolution path to our Kenan postpaid billing customers including upgrades and expansions. We also offer Kenan solutions to CSPs who are not prepared to commit to a full converged transformation. As part of our strategy, we recently launched a new and enhanced version of Comverse Kenan and intend to continue to invest in our Kenan solution and expect that Kenan will contribute to our growth in BSS in future periods. CSPs are experiencing growth in global wireless subscriptions and traffic and a rapid growth in the use of advanced services, such as data services and Internet browsing. In response to these market trends, CSPs require enhanced BSS system functionality to accommodate their business needs. As a result, BSS is facing increasing complexity of project deployment resulting in extended periods of time required to complete project milestones and receive customer acceptance which are generally required for revenue recognition and receipt of payment. To address these challenges, BSS continues its efforts to improve its delivery and implementation capabilities to reduce costs and expenses. In addition, project complexity impacts our customers' ability to meet their obligations as part of the delivery process which has at times also resulted in project delivery delays. Furthermore, our customers encounter issues in managing the operations of their BSS systems and tend to rely more heavily on our support services. To address our customer challenges, we are broadening our service offerings to existing and new customers, including managed services, which we expect will add to our growth potential in BSS going forward. We believe that our BSS solutions' offering has the potential to become a key driver of growth going forward. We expect that as a leader in the BSS market, we will continue to build on the strength of our Comverse ONE and Kenan solutions. We also expect that growth in mobile data traffic will increase the demand for our policy solutions, which include policy management and enforcement, deep packet inspection and smart data monetization solutions all of which are integrated into our BSS solutions. In implementing our growth strategy, we plan to focus our efforts on increasing our presence primarily in areas of growth and leveraging our customer base. Digital Services Digital Services product bookings for the fiscal year ended January 31, 2014 decreased compared to the fiscal year ended January 31, 2013. This decrease is attributable to a decline in product bookings related to Digital Services' traditional solutions, such as voicemail, SMS and MMS, which was not fully offset by an increase in product bookings for new IP based advanced offerings of our Digital Services solution portfolio. In addition, the decrease in Digital Services' product bookings was partially attributable to a decline in APAC primarily due to a delay in orders from a large customer in APAC. Revenue from Digital Services customer solutions for the fiscal year ended January 31, 2014 decreased compared to the fiscal year ended January 31, 2013 primarily due to a decrease in revenue recognized from several large percentage of completion projects that were completed in the fiscal year ended January 31, 2013, which was partially offset by an increase in revenue from customer acceptances that were completed in the fiscal year ended January 31, 2014. Digital Services maintenance revenue for the fiscal year ended January 31, 2014 decreased primarily due to the cancellation and reduction in fees of several maintenance contracts, which was partially offset by an increase in maintenance revenue attributable to maintenance services provided to customers during the initial service period. 36-------------------------------------------------------------------------------- Table of Contents We continue to maintain our market leadership in providing solutions to CSPs based on voice and messaging services, such as voicemail, call completion, SMS and MMS. However, CSPs face increasing competition from both Internet players and mobile device manufacturers, using new technologies that may provide alternatives to CSP products and services. For example, the introduction of IP-based applications on wireless devices, typically referred to as Over The Top (or OTT) services, allows end users to utilize IP-based services, such as Facebook, Facetime Google, Whatsapp, Line or Skype, to access, among other things, IP communications free of charge rather than use similar services provided by CSPs. Furthermore, these CSP services continue to face competition from low-cost competitors from emerging markets. We believe these changes have reduced demand for traditional communication products and services and increased pricing pressures, which have in turn adversely impacted our revenue and margins. At the same time, the growth in global wireless subscriptions, and high growth wireless segments, such as data services and Internet browsing are pushing CSPs to evolve to 4G/LTE IP-based network technologies, supporting the demand for several of our products. As part of our efforts to maintain our market position and leverage these recent trends, our Digital Services domain is engaged in the promotion of advanced offerings, such as visual voicemail, call management, IP messaging, our Evolved Communication Suite (which extends the industry's Rich Communication Suite (or RCS)) offered on premises or as Software-as-a-Service (SaaS) cloud-based solutions. We believe demand for advanced offerings may grow due to the increasing deployment of smartphones by CSPs and the growth in IP based 4G networks. Accordingly, we continue to expend significant resources on Digital Service research and development activities in order to enhance existing products and develop new solutions. We plan to continue to aggressively market our Digital Service products, leverage our leading market position to replace competitors and sell capacity expansions and other solutions to existing customers. Managed Services Managed through our BSS and Digital Services business units, we continue to emphasize a suite of managed services. In the fiscal year ended January 31, 2014, we invested significant resources in solidifying our managed services organization, hired senior leadership and enhanced our processes and methodologies. As a result, we experienced a significant increase in product bookings for our managed services offering for the current fiscal year compared to the prior fiscal year and we expect that managed services will continue to be an important component of our growth strategy in future periods. Our managed services offering enables us to assume responsibility for the operation and management of our customers' billing and digital services systems. Our managed services suite is designed to provide customers with improved efficiencies relating to the operation and management of their systems, thereby allowing them to focus on their own internal business needs and strengths with reduced management distraction. Managed services provide us with recurring and predictable revenue and are used by us to create and establish long-term relationships with customers as well as cross-sell additional solutions and system enhancements. We believe that the longevity of Comverse's customer relationships and the recurring revenue that such relationships generate provide us with stability and a competitive advantage in marketing our solutions to our existing customer base. Uncertainties Impacting Future Performance Mix of Revenue in Digital Services It is unclear whether our advanced Digital Services offerings will be widely adopted by existing and potential customers. Currently, we are unable to predict whether sales of advanced offerings will exceed or fully offset declines in the sale of traditional Digital Services solutions. If sales of advanced offerings do not increase or if increases in sales of advanced offerings do not exceed or fully offset any declines in sales of traditional solutions, due to adverse market trends, changes in consumer preferences or otherwise, our revenue, profitability and cash flows would likely be materially adversely affected. Change in CSP Capital Expenditure Priorities During the fiscal year ended January 31, 2014, several large-scale projects that we were pursuing were ultimately canceled by customers, who prioritized their capital expenditure budgets to the deployment of next generation networks, including LTE, rather than engage in BSS transformations. If this trend continues in future periods, our ability to achieve growth in BSS may be materially adversely affected. 37-------------------------------------------------------------------------------- Table of Contents Difficulty in Forecasting Product Bookings Our product bookings are difficult to predict. A high percentage of our product bookings have typically been generated late in fiscal quarters. In addition, based on historical industry spending patterns of CSPs, we typically forecast our highest product booking levels in our fourth fiscal quarter. This trend makes it difficult for us to forecast our annual product bookings and to implement effective measures to cover any shortfalls of prior fiscal quarters if product bookings for the fourth fiscal quarter fail to meet our expectations. Furthermore, we continue to emphasize large capacity systems in our product development and marketing strategies. Contracts for BSS and Digital Services installations typically involve a lengthy, complex and highly competitive bidding and selection process, and our ability to obtain particular contracts is inherently difficult to predict. A delay, cancellation or other factor resulting in the postponement or cancellation of significant orders may cause us to miss our projections. Share Distribution In connection with the Share Distribution, we entered into the Distribution Agreement with CTI pursuant to which, among other things, we agreed to indemnify CTI and its affiliates (including Verint after the Verint Merger) against certain losses that may arise as a result of the Verint Merger and the Share Distribution. To the extent that we are required to make payments to satisfy these indemnification obligations, our liquidity could be impacted. See Item 1A, "Risk Factors-Risks Relating to our Operation as an Independent, Publicly-Traded Company-We agreed to indemnify CTI and its affiliates and following the completion of the Verint Merger are required to indemnify Verint against certain claims or losses that may arise in connection with the Verint Merger and the Share Distribution." RESULTS OF OPERATIONS The following discussion provides an analysis of our consolidated and combined results and the results of operations of each of our segments for the fiscal periods presented. The discussion of the results of operations of each of our segments provides a more detailed analysis of the results of each segment presented. Accordingly, the discussion of our consolidated and combined results should be read in conjunction with the discussions of the results of operations of our segments. 38-------------------------------------------------------------------------------- Table of Contents Fiscal Year Ended January 31, 2014 Compared to Fiscal Year Ended January 31, 2013 Consolidated and Combined Results Fiscal Years Ended January 31, Change 2014 2013 Amount Percent (Dollars in thousands, except per share data) Total revenue $ 652,501 $ 677,763 $ (25,262 ) (3.7 )% Costs and expenses Cost of revenue 402,476 431,644 (29,168 ) (6.8 )% Research and development, net 67,512 76,461 (8,949 ) (11.7 )% Selling, general and administrative 134,031 160,340 (26,309 ) (16.4 )% Other operating expenses 10,783 11,510 (727 ) (6.3 )% Total costs and expenses 614,802 679,955 (65,153 ) (9.6 )% Income (loss) from operations 37,699 (2,192 ) 39,891 N/M Interest income 614 829 (215 ) (25.9 )% Interest expense (847 ) (901 ) 54 (6.0 )% Interest expense on notes payable to CTI - (455 ) 455 (100.0 )% Other expense, net (9,591 ) (4,049 ) (5,542 ) 136.9 % Income tax expense (9,189 ) (13,526 ) 4,337 (32.1 )% Net income (loss) from continuing operations 18,686 (20,294 ) 38,980 N/M Income from discontinued operations, net of tax - 26,542 (26,542 ) (100.0 )% Net income 18,686 6,248 12,438 199.1 % Less: Net income attributable to noncontrolling interest - (1,167 ) 1,167 (100.0 )% Net income attributable to Comverse, Inc. $ 18,686 $ 5,081 $ 13,605 267.8 % Net income (loss) attributable to Comverse, Inc.: Net income (loss) from continuing operations $ 18,686 $ (20,294 ) $ 38,980 Income from discontinued operations, net of tax - 25,375 (25,375 ) Net income attributable to Comverse, Inc. $ 18,686 $ 5,081 $ 13,605 Earnings (loss) per share attributable to Comverse, Inc.'s stockholders: Basic earnings (loss) per share Continuing operations $ 0.84 $ (0.93 ) $ 1.77 Discontinued operations $ - $ 1.16 $ (1.16 ) Diluted earnings (loss) per share Continuing operations $ 0.83 $ (0.93 ) $ 1.76 Discontinued operations $ - $ 1.16 $ (1.16 ) Total Revenue Management analyzes our revenue by: (i) revenue generated from customer solutions, and (ii) maintenance revenue. Revenue generated from customer solutions consists primarily of the licensing of our customer solutions, hardware and related professional services and training. Professional services primarily include installation, customization and consulting services. Certain revenue arrangements that require significant customization of a product to meet the particular requirements of a customer are recognized under the percentage-of-completion method. The vast majority of the percentage-of-completion method arrangements are fixed-fee contracts. Maintenance revenue consists of post-contract customer support (or PCS), including technical software support services, unspecified software updates or upgrades to customers on a when-and-if-available basis. Revenue from customer solutions was $389.2 million for the fiscal year ended January 31, 2014, a decrease of $11.7 million, or 2.9%, compared to the fiscal year ended January 31, 2013. The decrease was attributable to a decline of $22.7 million and $3.0 million in customer solutions revenue in the Digital Services segment and All Other, respectively, partially offset by an increase of $14.0 million in the BSS segment. Revenue recognized using the percentage-of-completion method was $146.2 million and $144.4 million for the fiscal years ended January 31, 2014 and 2013, respectively. 39-------------------------------------------------------------------------------- Table of Contents Maintenance revenue was $263.3 million for the fiscal year ended January 31, 2014, a decrease of $13.5 million, or 4.9%, compared to the fiscal year ended January 31, 2013. This decrease was primarily attributable to declines of $10.2 million and $3.3 million in maintenance revenue in the BSS and Digital Services segments, respectively. Revenue by Geographic Region Revenue in the Americas, APAC and Europe, Middle East and Africa (or EMEA) represented approximately 40%, 25% and 35% of our revenue, respectively, for the fiscal year ended January 31, 2014 compared to approximately 35%, 28% and 37% of our revenue, respectively, for the fiscal year ended January 31, 2013. Foreign Currency Impact on Revenue Our functional currency for financial reporting purposes is the U.S. dollar. The majority of our revenue for the fiscal year ended January 31, 2014 was derived from transactions denominated in U.S. dollars. All other revenue was derived from transactions denominated in various foreign currencies, primarily the British pound, euro and Japanese yen. For the fiscal year ended January 31, 2014, fluctuations in the U.S. dollar relative to foreign currencies in which we conducted business unfavorably impacted revenue by $7.8 million compared to the fiscal year ended January 31, 2013, primarily due to a $6.9 million unfavorable impact of the Japanese yen. Foreign Currency Impact on Costs A significant portion of our expenses, principally personnel-related costs, is incurred in new Israeli shekel (or NIS), whereas our functional currency for financial reporting purposes is the U.S. dollar. A strengthening of the NIS against the U.S. dollar would increase the U.S. dollar value of our expenses in Israel. In order to mitigate this risk we enter into foreign currency forward contracts to hedge foreign currency exchange rate fluctuations. For the fiscal year ended January 31, 2014, fluctuations in the U.S. dollar relative to all foreign currencies in which we conducted business unfavorably impacted costs by $4.0 million compared to the fiscal year ended January 31, 2013, primarily due to a strengthening of the NIS against the U.S. dollar, net of hedging activity, resulting in a $6.5 million unfavorable impact partially offset by a $1.7 million favorable impact of the Japanese yen. Cost of Revenue Cost of revenue primarily consists of (i) material costs, (ii) compensation and related overhead expenses for personnel involved in the customization of our products, customer delivery and maintenance and professional services, (iii) contractor costs, (iv) royalties and license fees, (v) depreciation of equipment used in operations, and (vi) amortization of capitalized software costs and certain purchased intangible assets. Cost of revenue was $402.5 million for the fiscal year ended January 31, 2014, a decrease of $29.2 million, or 6.8%, compared to the fiscal year ended January 31, 2013. The decrease was attributable to declines in costs of $8.8 million, $11.6 million and $8.8 million in the BSS and Digital Services segments and All Other, respectively, for the fiscal year ended January 31, 2014 compared to the fiscal year ended January 31, 2013. Research and Development, Net Research and development expenses, net, primarily consist of personnel-related costs involved in product development and third party development and programming costs net of benefits from participation in programs sponsored by the Government of Israel for the support of research and development activities in Israel and others. Research and development expenses, net were $67.5 million for the fiscal year ended January 31, 2014, a decrease of $8.9 million, or 11.7%, compared to the fiscal year ended January 31, 2013. The decrease was primarily attributable to a decline of $11.1 million in the Digital Services segment, partially offset by an increase of $1.7 million and $0.5 million at All Other and in the BSS segment, respectively. Selling, General and Administrative Selling, general and administrative expenses consist primarily of compensation and related expenses of personnel involved in sales, marketing, finance, legal and management and professional fees related to such functions. Selling, general and administrative expenses were $134.0 million for the fiscal year ended January 31, 2014, a decrease of $26.3 million, or 16.4%, compared to the fiscal year ended January 31, 2013. The decrease was primarily attributable to declines of $18.6 million and $8.3 million at All Other and in the BSS segment, respectively, partially offset by an increase of $0.6 million in the Digital Services segment. 40-------------------------------------------------------------------------------- Table of Contents Other Operating Expenses Other operating expenses consist of operating expenses not included in research and development, net and selling, general and administrative expenses and for the fiscal periods presented primarily consist of restructuring expenses and impairment of goodwill. Other operating expenses were $10.8 million for the fiscal year ended January 31, 2014, a decrease of $0.7 million, or 6.3% compared to the fiscal year ended January 31, 2013. The decrease was attributable to a decline of $5.6 million in the BSS segment, partially offset by an increase of $4.9 million at All Other. Income (Loss) from Operations Income from operations was $37.7 million for the fiscal year ended January 31, 2014, a change of $39.9 million compared to a loss from operations of $2.2 million for the fiscal year ended January 31, 2013. The increase was primarily attributable to an increase in income from operations of $26.0 million in the BSS segment and a decrease in loss from operations of $17.8 million at All Other, partially offset by a decrease in income from operations of $3.9 million in the Digital Services segment. Interest Income Interest income was $0.6 million for the fiscal year ended January 31, 2014, a decrease of $0.2 million, or 25.9%, compared to the fiscal year ended January 31, 2013. The decrease was primarily attributable to a decrease in interest rates. Interest Expense Interest expense was $0.8 million for the fiscal year ended January 31, 2014, a decrease of $0.1 million, or 6.0%, compared to the fiscal year ended January 31, 2013. Interest Expense on Notes Payable to CTI Interest expense on notes payable to CTI consists of interest expense that was payable by us to CTI prior to the Share Distribution under a promissory note dated January 11, 2011 and a revolving loan agreement dated May 9, 2012 (referred to as the loan agreement). Interest expense on notes payable to CTI was $0.5 million for the fiscal year ended January 31, 2013. For more information about this note and the loan agreement, see note 11 of the consolidated and combined financial statements included in Item 15 of this Annual Report. Income Tax Expense Income tax expense from continuing operations was $9.2 million for the fiscal year ended January 31, 2014, representing an effective tax rate of 33.0%, compared to income tax provision from continuing operations of $13.5 million, representing an effective tax rate of (199.9)% for the fiscal year ended January 31, 2013. The effective tax rate was lower than the U.S federal statutory rate of 35% primarily due to the mix of income and losses by jurisdiction and because we did not record an income tax benefit on losses in certain jurisdictions in which we maintain valuation allowances against certain of our U.S. and foreign net deferred tax assets. The income tax expense from continuing operations for the period is comprised primarily of income tax expense recorded in non-loss jurisdictions, withholding taxes, and certain tax contingencies recorded in the fiscal years ended January 31, 2014 and 2013. We recorded a reduction in our uncertain tax provision liability and a net reduction of income tax expense of $16.5 million during the fiscal year ended January 31, 2014, primarily due to the expiration of statutes of limitations in various jurisdictions. Of the $16.5 million net reduction of income tax, approximately $3.6 million was a correction of an error recorded in the 2005 to 2012 fiscal years. For additional information, see note 19 of the consolidated and combined financial statements included in Item 15 of this Annual Report. Our tax provision is subject to significant year over year and quarter-to-quarter variability based on numerous factors noted above. For the fiscal year ending January 31, 2015, we currently expect our income tax expense to be in the range of $25.0 million to $30.0 million and our cash paid for taxes (including withholding taxes paid by our customers in various jurisdictions) to be between $13.0 million and $17.0 million. Income from Discontinued Operations, Net of Tax Income from discontinued operations represents the results of operations of Starhome, including the gain on sale of Starhome, net of tax. 41-------------------------------------------------------------------------------- Table of Contents Income from discontinued operations, net of tax, was $26.5 million for the fiscal year ended January 31, 2013, primarily attributable to $22.6 million gain on sale of Starhome. See note 16 of the consolidated and combined financial statements included in Item 15 of this Annual Report. Net Income Net income was $18.7 million for the fiscal year ended January 31, 2014, an increase of $12.4 million or 199.1% compared to the fiscal year ended January 31, 2013 due primarily to the reasons discussed above. Net Income Attributable to Noncontrolling Interest Net income attributable to noncontrolling interest in Starhome was $1.2 million for the fiscal year ended January 31, 2013. Segment Results BSS Fiscal Years Ended January 31, Change 2014 2013 Amount Percent (Dollars in thousands) Revenue: Total revenue $ 299,561 $ 295,803 $ 3,758 1.3 % Costs and expenses: Cost of revenue 188,644 197,401 (8,757 ) (4.4 )% Research and development, net 39,779 39,308 471 1.2 % Selling, general and administrative 26,502 34,814 (8,312 ) (23.9 )% Other operating expenses - 5,605 (5,605 ) (100.0 )% Total costs and expenses 254,925 277,128 (22,203 ) (8.0 )% Income from operations $ 44,636 $ 18,675 $ 25,961 139.0 % Computation of segment performance: Segment revenue $ 299,561 $ 295,803 $ 3,758 1.3 % Total costs and expenses $ 254,925 $ 277,128 $ (22,203 ) (8.0 )% Segment expense adjustments: Amortization of intangible assets 2,765 14,124 (11,359 ) (80.4 )% Compliance-related compensation and other expenses 122 877 (755 ) (86.1 )% Impairment of goodwill - 5,605 (5,605 ) (100.0 )% Impairment of property and equipment 28 2 26 N/M Other 6 - 6 N/M Segment expense adjustments 2,921 20,608 (17,687 ) (85.8 )% Segment expenses 252,004 256,520 (4,516 ) (1.8 )% Segment performance $ 47,557 $ 39,283 $ 8,274 21.1 % Revenue Revenue from BSS customer solutions was $171.5 million for the fiscal year ended January 31, 2014, an increase of $14.0 million, or 8.9%, compared to the fiscal year ended January 31, 2013. The increase in revenue from BSS customer solutions was primarily attributable to changes in scope and settlements of certain customer contracts that negatively impacted revenue in the fiscal year ended January 31, 2013 and settlements of certain other customer contracts that positively impacted revenue in the fiscal year ended January 31, 2014. BSS maintenance revenue was $128.0 million for the fiscal year ended January 31, 2014, a decrease of $10.2 million or 7.4%, compared to the fiscal year ended January 31, 2013. The decrease mainly reflected the impact on BSS maintenance revenue for the fiscal year ended January 31, 2014 attributable to the previously disclosed cancellation of a large maintenance contract that was effective during the three months ended April 30, 2013. 42-------------------------------------------------------------------------------- Table of Contents Revenue by Geographic Region Revenue in the Americas, APAC, and EMEA represented approximately 24%, 27% and 49% of BSS's revenue, respectively, for the fiscal year ended January 31, 2014 compared to approximately 25%, 27% and 48% of BSS's revenue, respectively, for the fiscal year ended January 31, 2013. The revenue percentages per geographic region remained relatively unchanged for the fiscal year ended January 31, 2014 compared to the fiscal year ended January 31, 2013. Foreign Currency Impact on Revenue For the fiscal year ended January 31, 2014, fluctuations in the U.S. dollar relative to foreign currencies in which BSS conducted business compared to the fiscal year ended January 31, 2013 unfavorably impacted revenue by $1.0 million, primarily due to a $1.5 million unfavorable impact of the Brazilian real, a $0.7 million unfavorable impact of the Australian dollar, and a $0.5 million unfavorable impact of the Indian rupee, which was offset by a favorable impact of $1.8 million of the euro. Cost of Revenue Cost of revenue was $188.6 million for the fiscal year ended January 31, 2014, a decrease of $8.8 million, or 4.4%, compared to the fiscal year ended January 31, 2013. The decrease was primarily attributable to a decrease of $11.1 million in amortization of intangible assets due to certain intangible assets becoming fully amortized in the prior year partially offset by an increase in cost of revenue due to an increase in revenue. Research and Development, Net Research and development expenses, net, were $39.8 million for the fiscal year ended January 31, 2014, an increase of $0.5 million, or 1.2%, compared to the fiscal year ended January 31, 2013. Selling, General and Administrative Selling, general and administrative expenses were $26.5 million for the fiscal year ended January 31, 2014, a decrease of $8.3 million, or 23.9%, compared to the fiscal year ended January 31, 2013. The decrease was primarily attributable to a $7.7 million decrease in agent commissions due primarily to the mix of bookings generated from certain projects and in certain geographic locations. Segment Performance Segment performance was $47.6 million for the fiscal year ended January 31, 2014 based on segment revenue of $299.6 million, representing a segment performance margin of 15.9% as a percentage of segment revenue. Segment performance was $39.3 million for the fiscal year ended January 31, 2013 based on segment revenue of $295.8 million, representing a segment performance margin of 13.3% as a percentage of segment revenue. The increase in segment performance margin was primarily attributable to increased gross margins and the decrease in selling, general and administrative expenses for the fiscal year ended January 31, 2014 compared to the fiscal year ended January 31, 2013. 43-------------------------------------------------------------------------------- Table of Contents Digital Services Fiscal Years Ended January 31, Change 2014 2013 Amount Percent (Dollars in thousands) Revenue: Total revenue $ 352,940 $ 378,918 $ (25,978 ) (6.9 )% Costs and expenses: Cost of revenue 195,219 206,807 (11,588 ) (5.6 )% Research and development, net 23,306 34,382 (11,076 ) (32.2 )% Selling, general and administrative 7,407 6,839 568 8.3 % Total costs and expenses 225,932 248,028 (22,096 ) (8.9 )% Income from operations $ 127,008 $ 130,890 $ (3,882 ) (3.0 )% Computation of segment performance: Segment revenue $ 352,940 $ 378,918 $ (25,978 ) (6.9 )% Total costs and expenses $ 225,932 $ 248,028 $ (22,096 ) (8.9 )% Segment expense adjustments: Compliance-related compensation and other expenses 216 2,314 (2,098 ) (90.7 )% Certain litigation settlements and related costs - (151 ) 151 (100.0 )% Segment expense adjustments 216 2,163 (1,947 ) (90.0 )% Segment expenses 225,716 245,865 (20,149 ) (8.2 )% Segment performance $ 127,224 $ 133,053 $ (5,829 ) (4.4 )% Revenue Revenue from Digital Services customer solutions was $217.7 million for the fiscal year ended January 31, 2014, a decrease of $22.7 million, or 9.4%, compared to the fiscal year ended January 31, 2013. The decrease in revenue from Digital Services customer solutions was primarily attributable to a decrease in revenue recognized from several large percentage of completion projects that were completed in the fiscal year ended January 31, 2013, which was partially offset by an increase in revenue from customer acceptances that were completed in the fiscal year ended January 31, 2014. Digital Services maintenance revenue was $135.2 million for the fiscal year ended January 31, 2014, a decrease of $3.3 million, or 2.4%, compared to the fiscal year ended January 31, 2013. The decrease was primarily attributable to the cancellation and reduction in fees of several maintenance contracts, which was partially offset by an increase in maintenance revenue attributable to maintenance services provided to customers during the initial service period. Revenue by Geographic Region Revenue in the Americas, APAC and EMEA represented approximately 53%, 23% and 24% of revenue, respectively, for the fiscal year ended January 31, 2014 compared to approximately 42%, 29% and 29% of revenue, respectively, for the fiscal year ended January 31, 2013. The change in regional revenue percentages was primarily attributable to an increase in customer solutions revenue for a large Americas customer and a decrease in customer solutions revenue for a large APAC customer. Foreign Currency Impact on Revenue For the fiscal year ended January 31, 2014, fluctuations in the U.S. dollar relative to foreign currencies in which Digital Services conducted business compared to the fiscal year ended January 31, 2013 unfavorably impacted revenue by $6.7 million primarily due to a $6.9 million unfavorable impact of the Japanese yen. Cost of Revenue Cost of revenue was $195.2 million for the fiscal year ended January 31, 2014, a decrease of $11.6 million, or 5.6%, compared to the fiscal year ended January 31, 2013. The decrease was primarily attributable to lower revenue. 44-------------------------------------------------------------------------------- Table of Contents Research and Development, Net Research and development expenses, net were $23.3 million for the fiscal year ended January 31, 2014, a decrease of $11.1 million, or 32.2%, compared to the fiscal year ended January 31, 2013. The decrease was primarily attributable to our continued optimization of resources between high and low cost research and development centers in Europe and Asia, as well as our increased investment in the new Digital Services offerings, that are developed on modern, virtualized platforms and are therefore more cost-efficient. Selling, General and Administrative Selling, general and administrative expenses were $7.4 million for the fiscal year ended January 31, 2014, an increase of $0.6 million, or 8.3%, compared to the fiscal year ended January 31, 2013. The increase was primarily attributable to an increase in agent commission expense principally due to the change in mix of bookings. Segment Performance Segment performance was $127.2 million for the fiscal year ended January 31, 2014 based on segment revenue of $352.9 million, representing a segment performance margin of 36.0% as a percentage of segment revenue. Segment performance was $133.1 million for the fiscal year ended January 31, 2013 based on segment revenue of $378.9 million, representing a segment performance margin of 35.1% as a percentage of segment revenue. The increase in segment performance margin was primarily attributable to the decreases in cost of revenue and in research and development expenses, net, partially offset by the decrease in revenue. All Other Fiscal Years Ended January 31, Change 2014 2013 Amount Percent (Dollars in thousands) Revenue: Total revenue $ - $ 3,042 $ (3,042 ) (100.0 )% Costs and expenses: Cost of revenue 18,611 27,436 (8,825 ) (32.2 )% Research and development, net 4,427 2,771 1,656 59.8 % Selling, general and administrative 100,124 118,687 (18,563 ) (15.6 )% Other operating expenses 10,783 5,905 4,878 82.6 % Total costs and expenses 133,945 154,799 (20,854 ) (13.5 )% Loss from operations $ (133,945 ) $ (151,757 ) $ 17,812 (11.7 )% Computation of segment performance: Segment revenue $ - $ 3,042 $ (3,042 ) (100.0 )% Total costs and expenses $ 133,945 $ 154,799 $ (20,854 ) (13.5 )% Segment expense adjustments: Stock-based compensation expense 10,208 7,517 2,691 35.8 % Compliance-related professional fees 2,144 245 1,899 775.1 % Compliance-related compensation and other expenses (139 ) (1,093 ) 954 (87.3 )% Spin-off professional fees - 933 (933 ) (100.0 )% Italian VAT recovery recorded within operating expense (10,861 ) - (10,861 ) N/M Impairment of property and equipment 454 402 52 12.9 % Certain litigation settlements and related costs (16 ) (509 ) 493 (96.9 )% Restructuring expenses 10,783 5,905 4,878 82.6 % Gain on sale of fixed assets (41 ) (185 ) 144 (77.8 )% Other 3,281 1,621 1,660 102.4 % Segment expense adjustments 15,813 14,836 977 6.6 % Segment expenses 118,132 139,963 (21,831 ) (15.6 )% Segment performance $ (118,132 ) $ (136,921 ) $ 18,789 (13.7 )% 45-------------------------------------------------------------------------------- Table of Contents Revenue Revenue for All Other represents the Company's revenue from transactions with Starhome prior to its sale on October 19, 2012. Revenue was $3.0 million for the fiscal year ended January 31, 2013. Cost of Revenue Cost of revenue is primarily attributable to unallocated shared services costs associated with customer projects in the BSS and Digital Services segments. These shared services costs relate to several organizations that provide delivery and support services to both BSS and Digital Services segments and whose costs are not allocated to BSS and Digital Services, such as our centralized call center, business operations, quality assurance infrastructure and management teams. In addition, management views certain costs as corporate expenses such as stock compensation expense and inventory write-offs, which are included in All Other. In the fiscal year ended January 31, 2014, the Italian VAT refund was also included in All Other. Cost of revenue was $18.6 million for the fiscal year ended January 31, 2014, a decrease of $8.8 million, or 32.2%, compared to the fiscal year ended January 31, 2013. The decrease was primarily attributable to a $10.9 million VAT refund received in the fiscal year ended January 31, 2014 and a $3.5 million decrease due to a decrease in inventory write-offs that occurred for the fiscal year ended January 31, 2014 compared to the fiscal year ended January 31, 2013. These decreases were partially offset by a $5.0 million increase in personnel-related costs related to the various organizations that provide services to both the BSS and Digital Services segments, such as project management, quality assurance, and support. Research and Development, Net Research and development expenses, net, primarily include expenses incurred by our centralized research and development departments that support the BSS and Digital Services segments. Research and development expenses, net, were $4.4 million for the fiscal year ended January 31, 2014, an increase of $1.7 million, or 59.8%, compared to the fiscal year ended January 31, 2013. The increase was primarily attributable to a $1.2 million increase in personnel related costs of our centralized research and development department. Selling, General and Administrative Selling, general and administrative expenses consist of expenses incurred by our global corporate functions in connection with shared services provided to the BSS and Digital Services segments. Selling, general and administrative expenses were $100.1 million for the fiscal year ended January 31, 2014, a decrease of $18.6 million, or 15.6%, compared to the fiscal year ended January 31, 2013. The decrease was primarily attributable to a $14.7 million decrease in our general and administrative global functions and a $6.6 million decrease in personnel-related costs and employee sales commissions as we continue to execute on our cost reduction initiatives. Other Operating Expenses Other operating expenses were $10.8 million for the fiscal year ended January 31, 2014, an increase of $4.9 million, or 82.6%, compared to the fiscal year ended January 31, 2013. The increase was attributable to a $4.9 million increase in restructuring expenses. Restructuring expenses were higher due to the continued implementation of our fourth quarter 2012 initiatives following the Share Distribution. See note 10 of the consolidated and combined financial statements included in Item 15 of this Annual Report. Loss from Operations Loss from operations was $133.9 million for the fiscal year ended January 31, 2014, a decrease in loss of $17.8 million, or 11.7%, compared to the fiscal year ended January 31, 2013 due primarily to the reasons discussed above. Segment Performance Segment performance was a $118.1 million loss for the fiscal year ended January 31, 2014, a decrease in loss of $18.8 million, or 13.7%, compared to the fiscal year ended January 31, 2013. The decrease in loss was attributable to a decrease in segment expenses. 46-------------------------------------------------------------------------------- Table of Contents Fiscal Year Ended January 31, 2013 Compared to Fiscal Year Ended January 31, 2012 Consolidated and Combined Results Fiscal Years Ended January 31, Change 2013 2012 Amount Percent (Dollars in thousands, except per share data) Total revenue $ 677,763 $ 771,157 $ (93,394 ) (12.1 )% Costs and expenses Cost of revenue 431,644 468,867 (37,223 ) (7.9 )% Research and development, net 76,461 94,238 (17,777 ) (18.9 )% Selling, general and administrative 160,340 175,882 (15,542 ) (8.8 )% Other operating expenses 11,510 20,728 (9,218 ) (44.5 )% Total costs and expenses 679,955 759,715 (79,760 ) (10.5 )% (Loss) income from operations (2,192 ) 11,442 (13,634 ) (119.2 )% Interest income 829 1,755 (926 ) (52.8 )% Interest expense (901 ) (953 ) 52 (5.5 )% Interest expense on notes payable to CTI (455 ) (409 ) (46 ) 11.2 % Other expense, net (4,049 ) (7,192 ) 3,143 (43.7 )% Income tax expense (13,526 ) (25,291 ) 11,765 (46.5 )% Net loss from continuing operations (20,294 ) (20,648 ) 354 (1.7 )% Income from discontinued operations, net of tax 26,542 7,761 18,781 242.0 % Net income (loss) 6,248 (12,887 ) 19,135 (148.5 )% Less: Net income attributable to noncontrolling interest (1,167 ) (2,574 ) 1,407 (54.7 )% Net income (loss) attributable to Comverse, Inc. $ 5,081 $ (15,461 ) $ 20,542 (132.9 )% Net income (loss) attributable to Comverse, Inc.: Net loss from continuing operations $ (20,294 ) $ (20,648 ) $ 354 Income from discontinued operations, net of tax 25,375 5,187 20,188 Net income (loss) attributable to Comverse, Inc. $ 5,081 $ (15,461 ) $ 20,542 Earnings (loss) per share attributable to Comverse, Inc.'s stockholders: Basic and diluted earnings (loss) per share(1) Continuing operations $ (0.93 ) $ (0.94 ) $ 0.01 Discontinued operations $ 1.16 $ 0.23 $ 0.93 (1) The computation of basic and diluted earnings (loss) per share for the fiscal year ended January 31, 2012 is calculated using the number of shares of outstanding common stock on October 31, 2012, the completion date of the Share Distribution. See note 17 to the consolidated and combined financial statements included in Item 15 of this Annual Report. Total Revenue Revenue from customer solutions was $401.0 million for the fiscal year ended January 31, 2013, a decrease of $47.8 million, or 10.7%, compared to the fiscal year ended January 31, 2012. The decrease was attributable to a decline of $71.2 million in customer solutions revenue in the BSS segment, partially offset by an increase of $23.4 million in the Digital Services segment. Revenue recognized using the percentage-of-completion method was $144.4 million and $182.0 million for the fiscal years ended January 31, 2013 and 2012, respectively. Maintenance revenue was $276.8 million for the fiscal year ended January 31, 2013, a decrease of $45.6 million, or 14.1%, compared to the fiscal year ended January 31, 2012. This decrease was primarily attributable to declines of $24.2 million and $21.4 million in maintenance revenue in the Digital Services and BSS segments, respectively. Revenue by Geographic Region Revenue in the Americas, APAC and EMEA represented approximately 35%, 28% and 37% of our revenue, respectively, for the fiscal year ended January 31, 2013 compared to approximately 25%, 25% and 50% of our revenue, respectively, for the fiscal year ended January 31, 2012. 47-------------------------------------------------------------------------------- Table of Contents Foreign Currency Impact on Revenue Our functional currency for financial reporting purposes is the U.S. dollar. The majority of our revenue for the fiscal year ended January 31, 2013 was derived from transactions denominated in U.S. dollars. All other revenue was derived from transactions denominated in various foreign currencies, primarily the British pound, euro and Japanese yen. For the fiscal year ended January 31, 2013, fluctuations in the U.S. dollar relative to foreign currencies in which we conducted business unfavorably impacted revenue by $8.2 million compared to the fiscal year ended January 31, 2012, primarily due to a $6.9 million unfavorable impact of the Euro. Foreign Currency Impact on Costs A significant portion of our expenses, principally personnel-related costs, is incurred in NIS, whereas our functional currency for financial reporting purposes is the U.S. dollar. A strengthening of the NIS against the U.S. dollar would increase the U.S. dollar value of our expenses in Israel. In order to mitigate this risk we enter into foreign currency forward contracts to hedge foreign currency exchange rate fluctuations. For the fiscal year ended January 31, 2013, fluctuations in the U.S. dollar relative to all foreign currencies in which we conducted business favorably impacted costs by $9.3 million compared to the fiscal year ended January 31, 2012, primarily due to a weakening of the NIS against the U.S. dollar, net of hedging activity, resulting in a $4.6 million favorable impact. Cost of Revenue Cost of revenue was $431.6 million for the fiscal year ended January 31, 2013, a decrease of $37.2 million, or 7.9%, compared to the fiscal year ended January 31, 2012. The decrease was attributable to declines in costs of $34.1 million and $9.8 million in the BSS and Digital Services segments, respectively, partially offset by a $6.7 million increase at All Other. Research and Development, Net Research and development expenses, net were $76.5 million for the fiscal year ended January 31, 2013, a decrease of $17.8 million, or 18.9%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to a decline of $18.0 million and $1.5 million in the BSS segment and All Other, respectively, partially offset by an increase of $1.8 million in the Digital Services segment. Selling, General and Administrative Selling, general and administrative expenses were $160.3 million for the fiscal year ended January 31, 2013, a decrease of $15.5 million, or 8.8%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to declines of $7.5 million, $5.6 million and $2.4 million at All Other and in the Digital Services and BSS segments, respectively. Other Operating Expenses Other operating expenses were $11.5 million for the fiscal year ended January 31, 2013, a decrease of $9.2 million, or 44.5% compared to the fiscal year ended January 31, 2012. The decrease was attributable to a decline $14.8 million at All Other, partially offset by an increase $5.6 million in the BSS segment. (Loss) Income from Operations Loss from operations was $2.2 million for the fiscal year ended January 31, 2013, a change of $13.6 million compared to income from operations of $11.4 million for the fiscal year ended January 31, 2012. The decrease was primarily attributable to a decrease in income from operations of $43.6 million in the BSS segment, partially offset by a decrease in loss from operations of $17.1 million at All Other and an increase in income from operations of $12.9 million in the Digital Services segment. Interest Income Interest income was $0.8 million for the fiscal year ended January 31, 2013, a decrease of 52.8%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to a decrease in interest rates. 48-------------------------------------------------------------------------------- Table of Contents Interest Expense Interest expense was $0.9 million for the fiscal year ended January 31, 2013, a decrease of $0.1 million, or 5.5%, compared to the fiscal year ended January 31, 2012. Interest Expense on Notes Payable to CTI Interest expense on notes payable to CTI consists of interest expense that was payable by us to CTI prior to the Share Distribution under a promissory note dated January 11, 2011 and a revolving loan agreement dated May 9, 2012 (referred to as the loan agreement). Interest expense on notes payable to CTI was $0.5 million and $0.4 million for the fiscal years ended January 31, 2013 and 2012, respectively. For more information about this note and the loan agreement, see note 11 of the consolidated and combined financial statements included in Item 15 of this Annual Report. Income Tax Expense Income tax expense from continuing operations was $13.5 million for the fiscal year ended January 31, 2013, representing an effective tax rate of (199.9)%, compared to income tax expense from continuing operations of $25.3 million, representing an effective tax rate of 544.7% for the fiscal year ended January 31, 2012. During the fiscal year ended January 31, 2013 the effective tax rate was less than the U.S. federal statutory rate of 35%. During the fiscal year ended January 31, 2013, the effective tax rate was negative and during the fiscal year ended January 31, 2012, the effective tax rate was higher than the U.S federal statutory rate of 35% primarily due to the mix of income and losses by jurisdiction and because we did not record an income tax benefit on losses in certain jurisdictions in which we maintain valuation allowances against certain of our U.S. and foreign net deferred tax assets. The income tax expense from continuing operations for the period is comprised primarily of income tax expense recorded in non-loss jurisdictions, withholding taxes, and certain tax contingencies recorded in the fiscal years ended January 31, 2013 and 2012. The change in our effective tax rate for the fiscal year ended January 31, 2013, compared to the fiscal year ended January 31, 2012 was primarily attributable to the receipt of interest income on an Israeli tax refund of $6.5 million and changes in the relative mix of income and losses across various jurisdictions. Income from Discontinued Operations, Net of Tax Income from discontinued operations represents the results of operations of Starhome, including the gain on sale of Starhome, net of tax. Income from discontinued operations, net of tax, was $26.5 million for the fiscal year ended January 31, 2013, compared to $7.8 million for the fiscal year ended January 31, 2012. The increase was primarily attributable to $22.6 million gain on sale of Starhome recorded during the fiscal year ended January 31, 2013. See note 16 of the consolidated and combined financial statements included in Item 15 of this Annual Report. Net Income (Loss) Net income was $6.2 million for the fiscal year ended January 31, 2013, a change of $19.1 million compared to a net loss of $12.9 million for the fiscal year ended January 31, 2012 due primarily to the reasons discussed above. Net Income Attributable to Noncontrolling Interest Net income attributable to noncontrolling interest was $1.2 million for the fiscal year ended January 31, 2013, a decrease of $1.4 million, or 54.7%, compared to the fiscal year ended January 31, 2012. The decrease was attributable to a decrease in Starhome's net income for the fiscal year ended January 31, 2013 compared to the fiscal year ended January 31, 2012. 49-------------------------------------------------------------------------------- Table of Contents Segment Results BSS Fiscal Years Ended January 31, Change 2013 2012 Amount Percent (Dollars in thousands) Revenue: Total revenue $ 295,803 $ 388,350 $ (92,547 ) (23.8 )% Costs and expenses: Cost of revenue 197,401 231,511 (34,110 ) (14.7 )% Research and development, net 39,308 57,308 (18,000 ) (31.4 )% Selling, general and administrative 34,814 37,261 (2,447 ) (6.6 )% Other operating expenses 5,605 - 5,605 N/M Total costs and expenses 277,128 326,080 (48,952 ) (15.0 )% Income from operations $ 18,675 $ 62,270 $ (43,595 ) (70.0 )% Computation of segment performance: Segment revenue $ 295,803 $ 388,350 $ (92,547 ) (23.8 )% Total costs and expenses $ 277,128 $ 326,080 $ (48,952 ) (15.0 )% Segment expense adjustments: Amortization of intangible assets 14,124 17,308 (3,184 ) (18.4 )% Compliance-related compensation and other expenses 877 2,447 (1,570 ) (64.2 )% Impairment of goodwill 5,605 - 5,605 N/M Impairment of property and equipment 2 390 (388 ) (99.5 )% Segment expense adjustments 20,608 20,145 463 2.3 % Segment expenses 256,520 305,935 (49,415 ) (16.2 )% Segment performance $ 39,283 $ 82,415 $ (43,132 ) (52.3 )% Revenue Revenue from BSS customer solutions was $157.5 million for the fiscal year ended January 31, 2013, a decrease of $71.2 million, or 31.1%, compared to the fiscal year ended January 31, 2012. The decrease in revenue for the current fiscal year compared to the prior fiscal year was partially attributable to a $29.8 million decrease in revenue recognized from material modifications of certain existing contracts as a result of the adoption of the new accounting guidance during the fiscal year ended January 31, 2012. The remaining decrease in revenue from BSS customer solutions was primarily attributable to changes in scope and settlements of certain customer contracts. Revenue from BSS customer solutions continued to be adversely affected by (i) the increasing complexity of project deployment resulting in extended periods of time required to complete project milestones and receive customer acceptance and (ii) lower volume of BSS projects in the current fiscal year resulting from lower product bookings levels in recent years. BSS maintenance revenue was $138.3 million for the fiscal year ended January 31, 2013, a decrease of $21.4 million, or 13.4%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to (i) timing of entering into renewals of maintenance contracts with customers, (ii) decreased collections from customers for whom revenue is recognized upon collection and (iii) maintenance contracts that were terminated in the current year. Revenue by Geographic Region Revenue in the Americas, APAC and EMEA represented approximately 25%, 27% and 48% of BSS's revenue, respectively, for the fiscal year ended January 31, 2013 compared to approximately 21%, 27% and 52% of BSS's revenue, respectively, for the fiscal year ended January 31, 2012. Europe continued to suffer from significant weakness in market conditions and, accordingly, European customers continued to closely monitor their costs and maintain lower levels of spending. As a result, BSS's revenue from its European customers declined during the fiscal year ended January 31, 2013 compared to the fiscal year ended January 31, 2012. 50-------------------------------------------------------------------------------- Table of Contents Foreign Currency Impact on Revenue For the fiscal year ended January 31, 2013, fluctuations in the U.S. dollar relative to foreign currencies in which BSS conducted business compared to the fiscal year ended January 31, 2012 unfavorably impacted revenue by $6.6 million primarily due to a $3.8 million unfavorable impact of the euro and $1.7 million unfavorable impact of the Brazilian Real. Cost of Revenue Cost of revenue was $197.4 million for the fiscal year ended January 31, 2013, a decrease of $34.1 million, or 14.7%, compared to the fiscal year ended January 31, 2012, resulting in a decrease in gross margin of $58.4 million. The decrease in gross margin was primarily attributable to: • a $37.4 million decrease due to decreased revenue; • a $2.8 million decrease in amortization of intangible assets due to certain intangible assets becoming fully amortized; and • a $16.9 million decrease primarily due to several project and commercial issues related to changes in scope and settlements for our Comverse ONE implementations in the fiscal year ended January 31, 2013. The change in profit estimate of a BSS contract accounted for under the percentage of completion method negatively impacted income from operations by $14.8 million during the fiscal year ended January 31, 2013. Research and Development, Net Research and development expenses, net, were $39.3 million for the fiscal year ended January 31, 2013, a decrease of $18.0 million, or 31.4%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to a $20.0 million decrease in personnel-related costs and associated overhead allocated costs principally due to workforce reductions as part of the Phase II Business Transformation in the prior year. Selling, General and Administrative Selling, general and administrative expenses were $34.8 million for the fiscal year ended January 31, 2013, a decrease of $2.4 million, or 6.6%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to: • a $5.9 million decrease in personnel-related costs and associated allocated costs and employee sales commissions principally due to workforce reductions as part of the Phase II Business Transformation in the prior year; and • a $1.0 million decrease in bad debt expense related to specific customers in the prior year. These decreases were partially offset by a $5.5 million increase in agent commissions due to the mix of bookings generated from certain projects and in certain geographic locations. Segment Performance Segment performance was $39.3 million for the fiscal year ended January 31, 2013 based on segment revenue of $295.8 million, representing a segment performance margin of 13.3% as a percentage of segment revenue. Segment performance was $82.4 million for the fiscal year ended January 31, 2012 based on segment revenue of $388.4 million, representing a segment performance margin of 21.2% as a percentage of segment revenue. The decrease in segment performance margin was primarily attributable to the decrease in segment revenue partially offset by the decrease in segment expenses for the fiscal year ended January 31, 2013 compared to the fiscal year ended January 31, 2012. 51-------------------------------------------------------------------------------- Table of Contents Digital Services Fiscal Years Ended January 31, Change 2013 2012 Amount Percent (Dollars in thousands) Revenue: Total revenue $ 378,918 $ 379,714 $ (796 ) (0.2 )% Costs and expenses: Cost of revenue 206,807 216,619 (9,812 ) (4.5 )% Research and development, net 34,382 32,621 1,761 5.4 % Selling, general and administrative 6,839 12,438 (5,599 ) (45.0 )% Total costs and expenses 248,028 261,678 (13,650 ) (5.2 )% Income from operations $ 130,890 $ 118,036 $ 12,854 10.9 % Computation of segment performance: Segment revenue $ 378,918 $ 379,714 $ (796 ) (0.2 )% Total costs and expenses $ 248,028 $ 261,678 $ (13,650 ) (5.2 )% Segment expense adjustments: Compliance-related compensation and other expenses 2,314 2,205 109 4.9 % Impairment of property and equipment - 741 (741 ) (100.0 )% Certain litigation settlements and related costs (151 ) - (151 ) N/M Other - 19 (19 ) (100.0 )% Segment expense adjustments 2,163 2,965 (802 ) (27.0 )% Segment expenses 245,865 258,713 (12,848 ) (5.0 )% Segment performance $ 133,053 $ 121,001 $ 12,052 10.0 % Revenue Revenue from Digital Services customer solutions was $240.4 million for the fiscal year ended January 31, 2013, an increase of $23.4 million, or 10.8%, compared to the fiscal year ended January 31, 2012. The increase in revenue from Digital Services customer solutions was primarily attributable to an increase in the amount of revenue from percentage-of-completion projects and an increase in the number of customer acceptances in large-scale deployments of next generation voicemail products (including visual voicemail) during the fiscal year ended January 31, 2013 with no comparable customer acceptances in the fiscal year ended January 31, 2012. Digital Services maintenance revenue was $138.6 million for the fiscal year ended January 31, 2013, a decrease of $24.2 million, or 14.9%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to the reduction and termination of several maintenance contracts and a decrease in maintenance revenue attributable to maintenance services provided to customers during the initial service period. Revenue by Geographic Region Revenue in the Americas, APAC and EMEA represented approximately 42%, 29% and 29% of Digital Services revenue, respectively, for the fiscal year ended January 31, 2013 compared to approximately 28% 25% and 47% of Digital Services revenue, respectively, for the fiscal year ended January 31, 2012. The increase in revenue as a percentage of total revenue for Digital Services in the Americas was primarily attributable to significant revenue recognized due to customer acceptances in certain large-scale projects in the fiscal year ended January 31, 2013, with no comparable customer acceptances in the fiscal year ended January 31, 2012. Conversely, the decrease in revenue as a percentage of total revenue for Digital Services in Europe was primarily attributable to significant revenue recognized due to customer acceptances in certain large-scale projects and settlements in the fiscal year ended January 31, 2012, with no comparable customer acceptances in the fiscal year ended January 31, 2013. The increase in revenue for Digital Services in APAC was primarily attributable to revenue recognized upon cash collection due to increased collections from certain customers. 52-------------------------------------------------------------------------------- Table of Contents Foreign Currency Impact on Revenue For the fiscal year ended January 31, 2013, fluctuations in the U.S. dollar relative to foreign currencies in which Digital Services conducted business compared to the fiscal year ended January 31, 2012 unfavorably impacted revenue by $2.1 million primarily due to a $3.1 million unfavorable impact of the euro offset by a $1.0 million favorable impact of the Japanese yen. Cost of Revenue Cost of revenue was $206.8 million for the fiscal year ended January 31, 2013, a decrease of $9.8 million, or 4.5%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to the mix in revenue, as a larger percentage of the revenue in the fiscal year ended January 31, 2013 came from higher margin projects. Research and Development, Net Research and development expenses, net were $34.4 million for the fiscal year ended January 31, 2013, an increase of $1.8 million, or 5.4%, compared to the fiscal year ended January 31, 2012. The increase was primarily attributable to a $3.0 million increase in personnel-related costs mainly due to increased research and development headcount attributable to the launch of SEM and IP Messaging. The increase was offset by a decrease of $1.6 million in personnel-related costs due to allocation of research and development personnel to specific revenue generating projects recorded in cost of revenue in lieu of research and development expenses, net. Selling, General and Administrative Selling, general and administrative expenses were $6.8 million for the fiscal year ended January 31, 2013, a decrease of $5.6 million, or 45.0%, compared to the fiscal year ended January 31, 2012. The decrease was primarily attributable to: • a $3.1 million decrease in bad debt expenses that related to a specific customer in the prior year; and • a $2.4 million decrease in agent sales commissions expense principally due to the mix of bookings generated from certain projects and in certain geographic locations. Segment Performance Segment performance was $133.1 million for the fiscal year ended January 31, 2013 based on segment revenue of $378.9 million, representing a segment performance margin of 35.1% as a percentage of segment revenue. Segment performance was $121.0 million for the fiscal year ended January 31, 2012 based on segment revenue of $379.7 million, representing a segment performance margin of 31.9% as a percentage of segment revenue. 53-------------------------------------------------------------------------------- Table of Contents All Other Fiscal Years Ended January 31, Change 2013 2012 Amount Percent (Dollars in thousands) Revenue: Total revenue $ 3,042 $ 3,093 $ (51 ) (1.6 )% Costs and expenses: Cost of revenue 27,436 20,737 6,699 32.3 % Research and development, net 2,771 4,309 (1,538 ) (35.7 )% Selling, general and administrative 118,687 126,183 (7,496 ) (5.9 )% Other operating expenses 5,905 20,728 (14,823 ) (71.5 )% Total costs and expenses 154,799 171,957 (17,158 ) (10.0 )% Loss from operations $ (151,757 ) $ (168,864 ) $ 17,107 (10.1 )% Computation of segment performance: Segment revenue $ 3,042 $ 3,093 $ (51 ) (1.6 )% Total costs and expenses $ 154,799 $ 171,957 $ (17,158 ) (10.0 )% Segment expense adjustments: Stock-based compensation expense 7,517 3,660 3,857 105.4 % Compliance-related professional fees 245 10,901 (10,656 ) (97.8 )% Compliance-related compensation and other expenses (1,093 ) 2,067 (3,160 ) (152.9 )% Strategic evaluation related costs 933 - 933 N/M Impairment of property and equipment 402 1,200 (798 ) (66.5 )% Certain litigation settlements and related costs (509 ) 804 (1,313 ) N/M Restructuring expenses 5,905 20,728 (14,823 ) (71.5 )% Gain on sale of fixed assets (185 ) - (185 ) N/M Other 1,621 (67 ) 1,688 N/M Segment expense adjustments 14,836 39,293 (24,457 ) (62.2 )% Segment expenses 139,963 132,664 7,299 5.5 % Segment performance $ (136,921 ) $ (129,571 ) $ (7,350 ) 5.7 % Revenue Revenue was $3.0 million for the fiscal year ended January 31, 2013, a decrease of $0.1 million, or 1.6%, compared to the fiscal year ended January 31, 2012. Cost of Revenue Cost of revenue was $27.4 million for the fiscal year ended January 31, 2013, an increase of $6.7 million, or 32.3%, compared to the fiscal year ended January 31, 2012. The increase was primarily attributable to a $5.0 million change in inventory write-offs. Research and Development, Net Research and development expenses, net, were negative $2.8 million for the fiscal year ended January 31, 2013, a decrease of $1.5 million, or 35.7%, compared to the fiscal year ended January 31, 2012. The decrease was primarily due to a $1.4 million decrease in personnel-related and associated allocated costs. Selling, General and Administrative Selling, general and administrative expenses were $118.7 million for the fiscal year ended January 31, 2013, a decrease of $7.5 million, or 5.9%, compared to the fiscal year ended January 31, 2012. The increase was primarily attributable to: • a $10.7 million decrease in compliance-related professional fees in connection with CTI's efforts to become current in its periodic reporting obligations under the federal securities laws; and • a $2.1 million increase in stock compensation expense. These decreases were partially offset by: 54-------------------------------------------------------------------------------- Table of Contents • a $2.9 million increase in personnel-related costs in the sales and marketing departments due to an increase in headcount; and • a $2.2 million increase in employee sales commissions due to stronger sales performance in the fiscal year ended January 31, 2012. Other Operating Expenses Other operating expenses were $5.9 million for the fiscal year ended January 31, 2013, a decrease of $14.8 million, or 71.5%, compared to the fiscal year ended January 31, 2012. The decrease was attributable to a $14.8 million decrease in restructuring expenses. Restructuring expenses were higher during the prior year due to the implementation of the Phase II Business Transformation plan and restructuring activities related to Netcentrex. Loss from Operations Loss from operations was $151.8 million for the fiscal year ended January 31, 2013, a decrease in loss of $17.1 million, or 10.1%, compared to the fiscal year ended January 31, 2012 due primarily to the reasons discussed above. Segment Performance Segment performance was a $136.9 million loss for the fiscal year ended January 31, 2013, an increase in loss of $7.4 million, or 5.7%, compared to the fiscal year ended January 31, 2012. The increase in net loss was primarily attributable to an increase in cost of revenue expenses as described above. LIQUIDITY AND CAPITAL RESOURCES Overview Our principal sources of liquidity historically have consisted of cash and cash equivalents, cash flows from operations, including changes in working capital, borrowings from CTI, and the sale of investments and assets. We believe that our future sources of liquidity will include cash and cash equivalents and cash flows from operations, and may include new borrowings, or proceeds from the issuance of equity or debt securities. During the fiscal year ended January 31, 2014, our principal uses of liquidity were to fund operating expenses, implement restructuring initiatives and make capital expenditures. In addition, we expended resources and made investments to improve our internal control over financial reporting through the hiring of additional experienced finance and accounting personnel, redesigning of processes, implementing accounting and finance systems and performing additional business analytics. These expenses declined significantly for the fiscal year ended January 31, 2014 compared to the fiscal year ended January 31, 2013. Following the Share Distribution, we did not incur expenses in connection with CTI's periodic reporting requirements. However, following the Share Distribution, our accounting, tax and legal fees associated with compliance with our periodic reporting obligations under, federal securities laws and maintenance of internal control over financial reporting increased. Financial Condition Cash and Cash Equivalents and Restricted Cash As of January 31, 2014, we had cash, cash equivalents, bank time deposits and restricted cash of approximately $322.7 million, compared to approximately $305.4 million as of January 31, 2013. In connection with the completion of the Verint Merger Agreement on February 4, 2013, CTI placed $25.0 million in escrow to support indemnification claims to the extent made against us by Verint as discussed below, and a $10.9 million Italian VAT refund received on April 30, 2013. During the fiscal year ended January 31, 2014 in connection with our restructuring initiatives we made approximately $10.2 million in restructuring payments, which were primarily severance-related. Restricted Cash Restricted cash short-term and long-term aggregated $68.2 million and $42.5 million as of January 31, 2014 and January 31, 2013, respectively. Restricted cash includes compensating cash balances related to existing lines of credit and deposits that are pledged as collateral or restricted for use specified performance guarantees to customers and vendors, letters of credit, indemnification claims, foreign currency transactions in the ordinary course of business and pending tax judgments. On February 4, 2013, in connection with the closing of the Verint Merger, CTI placed $25.0 million in escrow to support indemnification claims to the extent made against us by Verint and any cash balance remaining in such escrow 55-------------------------------------------------------------------------------- Table of Contents fund 18 months after the closing of the Verint Merger, less any claims made on or prior to such date, will be released to us. Although no indemnification claims have been filed and the Escrow Release Date is within 12 months of January 31, 2014, we continue to classify the restricted cash balance as "Long-term restricted cash" in the Consolidated Balance Sheets until it can be determined if any future claims would restrict the release of such escrow funds. Common Stock Repurchase Our Board of Directors has adopted a program to repurchase from time to time at management's discretion up to $30 million in shares of our common stock on the open market during the 18-month period ending October 9, 2015 at prevailing market prices. Repurchases will be made under the program using our own cash resources. Liquidity Forecast We currently forecast that available cash and cash equivalents will be sufficient to meet our liquidity needs, including capital expenditures, for at least the next 12 months. Management's current forecast is based upon a number of assumptions, including, among others: assumed levels of customer order activity, revenue and collections; continued implementation of initiatives to reduce operating costs; no significant degradation in operating margins; increased spending on certain investments in the business; slight reductions in the unrestricted cash levels required to support the working capital needs of the business and other professional fees; intra-quarter working capital fluctuations consistent with historical trends; and assumed levels of repurchases of our common stock. Management believes that the above-noted assumptions are reasonable. However, should one or more of the assumptions prove incorrect, or should one or more of the risks or uncertainties described in Item 1A, "Risk Factors" materialize, we may experience a shortfall in the cash required to support working capital needs. Capital Expenditures During the fiscal year ended January 31, 2014, we commenced our plan to make investments relating to upgrades of systems and tools that we believe will increase operational efficiency and result in cost reductions in future fiscal periods. As part of this initiative, we plan to make significant additional investments in the fiscal years ending January 31, 2015 and 2016. In addition, we plan to make capital expenditures in respect of leasehold improvements related to our new facility in Ra'anana, Israel and other planned office moves. We currently expect that the aggregate amount of the capital expenditure for these upgrades of systems and tools and leasehold improvements to be made during the next two fiscal years should range between $30.0 million to $35.0 million, the exact timing of which is subject to numerous factors. In addition, we have typically had annual capital expenditures between $5.0 million to $8.0 million that would be in addition to the above items. Sources of Liquidity The following is a discussion that highlights our primary sources of liquidity, cash and cash equivalents, and changes in those amounts due to operations, financing, and investing activities and the liquidity of our investments. Cash Flows Fiscal Year Ended January 31, 2014 Compared to Fiscal Year Ended January 31, 2013 Fiscal Year Ended January 31, 2014 2013 (In thousands)Net cash provided by operating activities - continuing operations $ 6,621 $ 28,190 Net cash used in operating activities - discontinued operations - (1,277 ) Net cash used in investing activities (38,297 ) (4,482 ) Net cash provided by financing activities 25,118 49,252 Effects of exchange rates on cash and cash equivalents (1,783 ) (1,954 ) Net (decrease) increase in cash and cash equivalents (8,341 ) 69,729 Cash and cash equivalents, beginning of period including cash of discontinued operations 262,921 193,192 Cash and cash equivalents, end of period $ 254,580 $ 262,921 56-------------------------------------------------------------------------------- Table of Contents Operating Cash Flows Net cash provided by operating activities from continuing operations was $6.6 million during the fiscal year ended January 31, 2014, a decrease of $20.3 million compared to the fiscal year ended January 31, 2013. This decrease was primarily attributable to: • a decrease of $25.8 million in deferred revenue mainly due to revenue recognition being higher than invoicing for the twelve months ended January 31, 2014 when compared to the twelve months ended January 31, 2013; and • a decrease of $41.9 million in tax contingencies as a result of revaluation of uncertain tax position liabilities. These decreases were partially offset by increases in net income and non-cash items of $49.2 million, which includes a $10.9 million VAT refund received in fiscal 2013. Investing Cash Flows Net cash used in investing activities was $38.3 million during the fiscal year ended January 31, 2014, an increase in cash used of $33.8 million compared to the fiscal year ended January 31, 2013. The increase in cash used was attributable to a $22.2 million increase in restricted cash mainly due to $25.0 million in bank time deposits received from CTI in connection with the closing of the Verint Merger, a $6.9 million increase in cash used for purchases of property and equipment and $6.3 million in net proceeds received from the sale of Starhome in the fiscal year ended January 31, 2013. Financing Cash Flows Net cash used in financing activities was $25.1 million during the fiscal year ended January 31, 2014, a decrease in cash provided by financing activities of $24.1 million compared to the fiscal year ended January 31, 2013. The decrease was primarily attributable to a $38.5 million cash capital contribution from CTI and $9.5 million of borrowings under the note payable to CTI during the fiscal year ended January 31, 2013, compared to a $25.0 million cash capital contribution from CTI during the fiscal year ended January 31, 2014. Effects of Exchange Rates on Cash and Cash Equivalents The majority of our cash and cash equivalents are denominated in U.S. dollars. However, due to the nature of our global business, we also hold cash denominated in other currencies, primarily the Euro, the NIS and the British pound. For the fiscal year ended January 31, 2014, the fluctuation in foreign currency exchange rates had an unfavorable impact of $1.8 million on cash and cash equivalents. Fiscal Year Ended January 31, 2013 Compared to Fiscal Year Ended January 31, 2012 Fiscal Years Ended January 31, 2013 2012 (In thousands)Net cash used in (provided by) operating activities - continuing operations 28,190 (13,361 ) Net cash (used in) provided by operating activities - discontinued operations (1,277 ) 11,807 Net cash used in investing activities (4,482 ) (8,735 ) Net cash provided by (used in) financing activities 49,252 (12,417 ) Effects of exchange rates on cash and cash equivalents (1,954 ) 2,860 Net increase (decrease) in cash and cash equivalents 69,729 (19,846 ) Cash and cash equivalents, beginning of year including cash of discontinued operations 193,192 213,038 Cash and cash equivalents, end of year including cash of discontinued operations 262,921 193,192 Less: Cash and cash equivalents of discontinued operations, end of year - (32,466 ) Cash and cash equivalents, end of year $ 262,921 $ 160,726 57-------------------------------------------------------------------------------- Table of Contents Operating Cash Flows During the fiscal year ended January 31, 2013, net cash of $28.2 million was provided by operating activities from continuing operations. Net cash provided by operating activities from continuing operations was primarily attributable to: • a $36.1 million decrease in deferred cost of revenue; • a $35.9 million increase in accounts payable and accrued expenses; • a $20.8 million of net income after non-cash charges add-back; • a $14.9 million decrease in prepaid expense and other current assets; and • a $9.5 million decrease in accounts receivable. Cash provided by operating activities was partially offset by a $85.0 million decrease in deferred revenue. Investing Cash Flows During the fiscal year ended January 31, 2013, net cash used in investing activities was $4.5 million. Net cash used in investing activities was primarily attributable to a $4.7 million increase in restricted cash and bank time deposits and $5.4 million of cash used for purchases of property and equipment partially offset by $6.3 million in proceeds from the sale of Starhome. Financing Cash Flows During the fiscal year ended January 31, 2013, net cash provided by financing activities was $49.3 million. Net cash provided by financing activities was primarily attributable to a $38.5 million cash capital contribution from CTI and $9.5 million of borrowings under the note payable to CTI. Effects of Exchange Rates on Cash and Cash Equivalents The majority of our cash and cash equivalents is denominated in U.S. dollars. However, due to the nature of our global business, we also hold cash denominated in other currencies, primarily the euro, the NIS and the British pound. For the fiscal year ended January 31, 2013, the fluctuation in foreign currency exchange rates had an unfavorable impact of $2.0 million on cash and cash equivalents. Sale of Starhome On August 1, 2012, CTI, certain other Starhome shareholders and Starhome entered into the Starhome Share Purchase Agreement with Fortissimo pursuant to which Fortissimo agreed to purchase all of the outstanding share capital of Starhome as part of the Starhome Disposition. On September 19, 2012, CTI, in order to ensure it could meet the conditions of the Verint Merger, contributed to us its interest in Starhome, including its rights and obligations under the Starhome Share Purchase Agreement. The Starhome Disposition was completed on October 19, 2012. Under the terms of the Starhome Share Purchase Agreement, Starhome's shareholders received aggregate cash proceeds of approximately $81.3 million, subject to adjustment for fees, transaction expenses and certain taxes. Of this amount, $10.5 million is held in escrow to cover potential post-closing indemnification claims, with $5.5 million being released after 18 months and the remainder released after 24 months, in each case, less any claims made on or prior to such dates. We received aggregate net cash consideration (including $4.9 million deposited in escrow at closing) of approximately $37.2 million, after payments that CTI agreed to make to certain other Starhome shareholders of approximately $4.5 million. The escrow funds are available to satisfy certain indemnification claims under the Starhome Share Purchase Agreement to the extent that such claims exceed $1.0 million. As of January 31, 2014, such claims have not exceeded the $1.0 million threshold. Merger of CTI and Verint Under the Share Distribution Agreements we and CTI entered into in connection with the Share Distribution, we have agreed to indemnify CTI and its affiliates (including Verint after the Verint Merger) against certain losses that may arise as a result of the Verint Merger and the Share Distribution. Certain of our indemnification obligations are capped at $25.0 million and certain are uncapped. CTI placed $25.0 million in escrow to support indemnification claims to the extent made against us by Verint and any cash balance remaining in such escrow fund 18 months after the closing of the Verint Merger, less any claims made on or prior to such date, will be released to us. The escrow funds cannot be used for claims related to the Israeli Optionholder suit. Although no indemnification claims have been filed and the Escrow Release Date is within 12 months of January 31, 2014, we continue to classify the restricted cash balance as "Long-term 58-------------------------------------------------------------------------------- Table of Contents restricted cash" in the Consolidated Balance Sheets until it can be determined if any future claims would restrict the release of such escrow funds. We also assumed all pre-Share Distribution tax obligations of each of us and CTI. For more information, see note 3 to our consolidated and combined financial statements included in Item 15 of this Annual Report. Indebtedness Comverse Ltd. Lines of Credit As of January 31, 2014 and 2013, Comverse Ltd., our wholly-owned Israeli subsidiary, had a $20.0 million line of credit with a bank to be used for various performance guarantees to customers and vendors, letters of credit and foreign currency transactions in the ordinary course of business. This line of credit is not available for borrowings. The line of credit bears no interest and is subject to renewal on an annual basis. Comverse Ltd. is required to maintain cash balances with the bank of no less than the capacity under the line of credit at all times regardless of amounts utilized under the line of credit. As of January 31, 2014 and 2013, Comverse Ltd. had utilized $20.0 million and $17.2 million, respectively, of capacity under the line of credit for guarantees and foreign currency transactions. In February 2014, Comverse Ltd. increased the line of credit from $20.0 million to $25.0 million with a corresponding increase in the cash balances Comverse Ltd. was required to maintain with the bank to $25.0 million. As of January 31, 2014 and 2013, Comverse Ltd. had an additional line of credit with a bank for $8.0 million, to be used for borrowings, various performance guarantees to customers and vendors, letters of credit and foreign currency transactions in the ordinary course of business. The line of credit bears no interest other than on borrowings thereunder and is subject to renewal on an annual basis. Borrowings under the line of credit bear interest at an annual rate of London Interbank Offered Rate (or LIBOR) plus a variable margin determined based on the bank's underlying cost of capital. Comverse Ltd. is required to maintain cash balances with the bank of no less than the capacity under the line of credit at all times regardless of amounts borrowed or utilized under the line of credit. As of January 31, 2014 and 2013, Comverse Ltd. had no outstanding borrowings under the line of credit. As of each of January 31, 2014 and 2013, Comverse Ltd. had utilized $8.0 million of capacity under the line of credit for guarantees and foreign currency transactions. In February 2014, Comverse Ltd. increased the additional line of credit from $8.0 million to $10.0 million with a corresponding increase in the cash balances Comverse Ltd. was required to maintain with the bank to $10.0 million. Other than Comverse Ltd.'s requirement to maintain cash balances with the banks as discussed above, the lines of credit have no financial covenants. These cash balances required to be maintained with the banks were classified as "Restricted cash and bank time deposits" and "Long-term restricted cash" included within the consolidated balance sheets as of January 31, 2014 and 2013. Restructuring Initiatives We review our business, manage costs and align resources with market demand. As a result, we have taken several actions to improve our cash position, reduce fixed costs, eliminate redundancies, strengthen operational focus and better position us to respond to market pressures or unfavorable economic conditions. While such restructuring initiatives are expected to have positive impact on our operating cash flows in the long term, they also have led and will lead to some expenses. During the fiscal years ended January 31, 2014 and 2013, we recorded severance and facility-related costs attributable to existing restructuring initiatives of $10.8 million and $5.9 million, respectively, and paid $10.2 million and $4.0 million, respectively. The remaining severance and facility-related costs relating to existing restructuring initiatives of $1.1 million and $6.1 million are expected to be substantially paid by April, 2014 and October, 2019, respectively. For more information relating to our restructuring initiatives, including our financial obligations in respect thereof, see note 10 to the consolidated and combined financial statements included in Item 15 of this Annual Report. We expect to commence certain initiatives in the fiscal year ended January 31, 2015, with a plan to further restructure our operations towards aligning operating costs and expenses with anticipated revenue. The restructuring plan is expected to include reduction of workforce included in cost of revenue, research and development and selling, general and administrative expenses. The aggregate cost of the plan is currently expected to be approximately $9.0 million primarily related to severance costs which is expected to be accrued and paid by January 31, 2015. 59-------------------------------------------------------------------------------- Table of Contents Guarantees and Restrictions on Access to Subsidiary Cash Guarantees We provide certain customers in the ordinary course of business with financial performance guarantees, which in certain cases are backed by standby letters of credit or surety bonds, the majority of which are cash collateralized and accounted for as restricted cash and bank time deposits. We are only liable for the amounts of those guarantees in the event of our nonperformance, which would permit the customer to exercise the guarantee. As of January 31, 2014 and 2013, we believe that we were in compliance with our performance obligations under all contracts for which there is a financial performance guarantee, and that any liabilities arising in connection with these guarantees will not have a material adverse effect on our consolidated and combined results of operations, financial position or cash flows. We also obtained bank guarantees primarily to provide customer assurance relating to the performance of certain obligations required by customer agreements for the guarantee of certain payment obligations. These guarantees, which aggregated $33.4 million and $31.1 million as of January 31, 2014 and 2013, respectively, are generally scheduled to be released upon our performance of specified contract milestones, a majority of which are scheduled to be completed at various dates through December 31, 2015. Dividends from Subsidiaries The ability of our Israeli subsidiaries to pay dividends is governed by Israeli law, which provides that dividends may be paid by an Israeli corporation only out of earnings as defined in accordance with the Israeli Companies Law of 1999, provided that there is no reasonable concern that such payment will cause such subsidiary to fail to meet its current and expected liabilities as they come due. Cash and cash equivalents held by foreign subsidiaries. We operate our business internationally. A significant portion of our cash and cash equivalents is held by various foreign subsidiaries. As of January 31, 2014 and 2013, we had $97.2 million and $149.4 million or 38% and 57%, respectively, of our cash and cash equivalents held by our foreign subsidiaries. If cash and cash equivalents held outside the United States are distributed to the United States resident corporate parents in the form of dividends or otherwise, we may be subject to additional U.S. income taxes (subject to an adjustment for foreign tax credits) and foreign withholding taxes. We may incur substantial withholding taxes if we repatriate our cash from certain foreign subsidiaries. We expect a portion of our foreign subsidiaries cash to be repatriated to the U.S. As this amount has been previously subject to U.S. tax, the non-U.S. withholding taxes that would be imposed on an actual triggering of a dividend of $149.0 million has been accrued in the amount of $20.1 million. OFF-BALANCE SHEET ARRANGEMENTS As of January 31, 2014, we had no material off-balance sheet arrangements, other than performance guarantees disclosed in "-Liquidity and Capital Resources-Guarantees and Restrictions on Access to Subsidiary Cash-Guarantees" and except as disclosed in note 24 to the consolidated and combined financial statements included in Item 15 of this Annual Report. There were no material changes in our off-balance sheet arrangements since January 31, 2013. 60-------------------------------------------------------------------------------- Table of Contents CONTRACTUAL OBLIGATIONS The following table presents our contractual obligations as of January 31, 2014: Payments due by period Total < 1 year 1-3 years 3-5 years > 5 years (In thousands) Capital lease obligations $ 16 $ 10 $ 6 $ - $ - Operating lease obligations - real estate 78,772 17,420 21,127 12,969 27,256 Operating lease obligations - other (equipment, etc.) 338 218 120 - - Purchase obligations (1)(2) 16,199 11,527 4,672 - - Other current and long-term liabilities 164 - - - 164 Total(3) $ 95,489 $ 29,175 $ 25,925 $ 12,969 $ 27,420 (1) Purchase obligations include agreements to purchase goods or services that are enforceable, legally binding and specify all significant terms, including fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions, and the approximate timing of the transaction. Purchase obligations exclude agreements that are cancelable without penalty. (2) The purchase obligations set forth above, includes approximately $44.1 million in expected lease payments over a 10 year term for 218,912 square feet of leased office space in Ra'anana, Israel which is expected to be available in October, 2014. (3) Our consolidated balance sheet as of January 31, 2014 includes $90.3 million of non-current tax liabilities for uncertain tax positions. The specific timing of any cash payments, if any, relating to this obligation cannot be projected with reasonable certainty and, therefore, no amounts for this obligation are included in the table set forth above. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The accounting estimates and judgments discussed in this section are those that we consider to be most critical to understand our combined financial statements (or the financial statements), because they involve significant judgments and uncertainties. More specifically, the accounting estimates and judgments outlined below are critical because they can materially affect our operating results and financial condition, inasmuch as they require management to make difficult and subjective judgments regarding uncertainties. Many of these estimates include determinations of fair value. All of these estimates reflect our best judgment about current and, for some estimates, future, economic and market conditions and effects based on information available to us as of the date of the accompanying financial statements. As a result, the accuracy of these estimates and the likelihood of future changes depend on a range of possible outcomes and a number of underlying variables, some of which are beyond our control. See also note 1 to the consolidated and combined financial statements included in Item 15 of this Annual Report for additional information on the significant accounting estimates and judgments underlying the financial results disclosed in our combined financial statements. Revenue Recognition We report our revenue in two categories: (i) product revenue, including hardware and software products; and (ii) service revenue, including revenue from professional services, training services and post-contract customer support (or PCS). Professional services primarily include installation, customization and consulting services. Revenue arrangements may include one of these single elements, or may incorporate one or more elements in a single transaction or combination of related transactions. In September 2009, the FASB issued revenue recognition guidance applicable to multiple element arrangements, which: • applies to multiple element revenue arrangements that contain both software and hardware elements, focusing on determining which revenue arrangements are within the scope of the software revenue guidance; and • addresses how to separate consideration related to each element in a multiple element arrangement, excluding software arrangements, and establishes a hierarchy for determining the selling price of an element. It also eliminates the residual method of allocation by requiring that arrangement consideration be allocated at the inception of the arrangement to all elements using the relative selling price method. We adopted this guidance on a prospective basis for revenue arrangements entered into, or materially modified, on or after February 1, 2011. Multiple element arrangements entered into or materially modified on or after February 1, 2011 that include hardware which functions together with software to provide the essential functionality of the product are accounted 61-------------------------------------------------------------------------------- Table of Contents under the FASB's new guidance applicable to multiple element arrangements. Multiple element arrangements entered into prior to February 1, 2011 and not materially modified on or after February 1, 2011 are accounted for in accordance with the FASB's guidance relating to revenue recognition for software arrangements as the software component of most of our multiple element arrangements is more than incidental to the products being sold. For arrangements that do not require significant customization of the underlying software, we recognize revenue when we have persuasive evidence of an arrangement, the product has been shipped and the services have been provided to the customer, the sales price is fixed or determinable, collectability is probable, and all pertinent criteria are met as required by the FASB's guidance. For multiple element arrangements entered into prior to February 1, 2011 and not materially modified on or after February 1, 2011, we allocate revenue to the delivered elements of the arrangement using the residual method, whereby revenue is allocated to the undelivered elements based on vendor specific objective evidence (or VSOE) of fair value of the undelivered elements with the remaining arrangement fee allocated to the delivered elements and recognized as revenue assuming all other revenue recognition criteria are met. If we are unable to establish VSOE of fair value for the undelivered elements of the arrangement, revenue recognition is deferred for the entire arrangement until all elements of the arrangement are delivered. However, if the only undelivered element is PCS, we recognize the arrangement fee ratably over the PCS period. For multiple element arrangements entered into or materially modified after February 1, 2011 that include hardware which functions together with software to provide the essential functionality of the product, we allocate revenue to each element based on its selling price. The selling price used for each element is based on VSOE of fair value, if available, third party evidence (or TPE) of fair value if VSOE is not available, or our best estimate of selling price (or BESP) if neither VSOE nor TPE is available. In determining the units of accounting for these arrangements, we evaluate whether each element has stand-alone value as defined in the FASB's guidance. Given that the hardware and software function together to provide the essential functionality of the product and each element is critical to the overall tangible product sold, neither the software nor the hardware has stand-alone value. Professional services performed prior to the product's acceptance do not have stand-alone value and are therefore combined with the related hardware and software as one non-software deliverable. After determining the fair value for each deliverable, the arrangement consideration is allocated using the relative selling price method. Revenue is recognized accordingly for each deliverable once the respective revenue recognition criteria are met for that deliverable. The majority of multiple element arrangements contain at least two of the following elements: (1) tangible product (hardware, software, and professional services performed prior to the product's acceptance), (2) post-contract support (PCS), (3) training, and (4) post acceptance services. Our tangible products are rarely sold separately. In addition, our tangible products are complex, and contain a high degree of customizations such that we are unable to demonstrate pricing within a pricing range to establish BESP as very few contracts are comparable. Therefore, we have concluded that cost plus a target gross profit margin provides the best estimate of the selling price. PCS, training, and post acceptance services have various pricing practices based on several factors, including the geographical region of the customer, the size of the customer's installed base, the volume of services being sold and the type or class of service being performed. As noted above, we have VSOE of PCS for a portion of our arrangements. For PCS, we use our minimum substantive VSOE thresholds by region plus a reasonable margin as the basis to estimate BESP of PCS for transactions that do not meet the VSOE criteria. For training and post-acceptance services, we perform an annual study of stand-alone training and post-acceptance sales to arrive at BESP. While the study does not result in VSOE, it is useful in determining our BESP. The timing of recognition for our revenue transactions involves numerous judgments, estimates and policy determinations. The most significant are summarized as follows: PCS revenue is derived primarily from providing technical software support services, unspecified software updates and upgrades to customers on a when and if available basis. PCS revenue is recognized ratably over the term of the PCS period. When PCS is included within a multiple element arrangement and the arrangement is within the scope of the software revenue guidance, we primarily utilize the substantive renewal rate to establish VSOE of fair value for the PCS. When using the substantive renewal rate method, we may be unable to establish VSOE of fair value for PCS because the renewal rate is deemed to be non-substantive or there are no contractually-stated renewal rates. If the stated renewal rate is non-substantive, the entire arrangement fee is recognized ratably over the estimated economic life of the product (five to eight years) beginning upon delivery of all elements other than PCS. We believe that the estimated economic life of the product is the best estimate of how long the customer will renew PCS. If there is no contractually stated renewal rate, the entire arrangement fee is recognized ratably over the relevant contractual PCS term beginning upon delivery of all elements other than PCS. 62-------------------------------------------------------------------------------- Table of Contents For arrangements that include a stated renewal rate, determining whether the actual renewal rate is substantive is a matter of judgment. For each group of our products, we stratify our customers based on the size of the installed base and the geographic location of the customer. Based on our historical negotiations and contract experience we believe that our customers behave differently and perceive different values for PCS based on these two main factors. We evaluate many factors in determining the estimated economic life of our products, including the support period of the product, technological obsolescence, average time between new product releases and upgrade activity by customers. We have concluded that the estimated economic lives of our key software products range from five to eight years. Our policy for establishing VSOE of fair value for professional services and training is based upon an analysis of separate sales of services, which are then compared with the fees charged when the same elements are included in a multiple element arrangement. Comverse has not yet established VSOE of fair value for any element other than PCS. In certain multiple element arrangements, we are obligated to provide training services to customers related to the operation of our software products. These training services are either provided to the customer on a "defined" basis (limited to a specified number of days or training classes) or on an "as-requested" basis (unlimited training over a contractual period). For multiple element arrangements containing as-requested training obligations that are within the scope of the software revenue guidance, we recognize the total arrangement consideration ratably over the contractual period during which we are required to "stand ready" to perform such training, provided that all other criteria for revenue recognition have been met. For multiple element arrangements containing defined training obligations, the training services are typically provided to the customer prior to the completion of the installation services. For arrangements that are within the scope of the software revenue guidance, because revenue recognition does not commence until the completion of installation, the defined training obligations do not impact the timing of recognition of revenue. In certain circumstances in which training is provided after the end of the installation period, we commence revenue recognition upon the completion of training, provided that all other criteria for revenue recognition have been met. Some of our arrangements require significant customization of the product to meet the particular requirements of the customer. For these arrangements, revenue is recognized, in accordance with the FASB's guidance for long-term construction type contracts using the percentage-of-completion (or POC) method. The determination of whether services entail significant customization requires judgment and is primarily based on alterations to the features and functionality to the standard release, complex or unusual interfaces as well as the amount of hours necessary to complete the customization solution relative to the size of the contract. Revenue from these arrangements is recognized on the POC method based on the ratio of total hours incurred to date compared to estimated total hours to complete the contract. We are required to make judgments to estimate the total estimated costs and progress to completion. Changes to such estimates can impact the timing of the revenue recognition period to period. We use historical experience, project plans, and an assessment of the risks and uncertainties inherent in the arrangement to establish these estimates. Uncertainties in these arrangements include implementation delays or performance issues that may or may not be within our control. If some level of profitability is assured, but the related revenue and costs cannot be reasonably estimated, then revenue is recognized to the extent of costs incurred until such time that the project's profitability can be estimated or the services have been completed. If VSOE of fair value of PCS does not exist, all revenue will be deferred until completion of the professional services and recognized ratably over the respective PCS period. If we determine that based on our estimates our costs exceed the sales price, the entire amount of the estimated loss is accrued in the period that such losses become known. When revenue is recognized over multiple periods in accordance with our revenue recognition policies, the material cost, including hardware and third party software license fees are deferred and amortized over the same period that product revenue is recognized. These costs are recognized as "Deferred cost of revenue" on the combined balance sheets. However, we have made an accounting policy election whereby the cost for installation and other service costs are expensed as incurred, except for arrangements recognized in accordance with the FASB's guidance for long-term construction type contracts. In the combined statements of operations, we classify revenue as product revenue or service revenue as prescribed by SEC Rules and Regulations. For multiple element arrangements that include both product and service elements, management evaluates various available indicators of fair value and applies its judgment to reasonably classify the arrangement fee between product revenue and service revenue. The amount of multiple element arrangement fees classified as product and service revenue based on management estimates of fair value when VSOE of fair value for all elements of an arrangement does not exist could differ from amounts classified as product and service revenue if VSOE of fair value of all elements existed. The allocation of multiple element arrangement fees between product revenue and 63-------------------------------------------------------------------------------- Table of Contents service revenue, when VSOE of fair value of all elements does not exist, is for combined financial statement presentation purposes only and does not affect the timing or amount of revenue recognized. In determining the amount of a multiple element arrangement fee that should be classified between product revenue and service revenue, we first allocate the arrangement fee to product revenue and PCS (PCS is classified as service revenue) based on management's estimate of fair value for those elements. The remainder of the arrangement fee, which is comprised of all other service elements, is allocated to service revenue. The estimate of fair value of the product element is based primarily on management's evaluation of direct costs and reasonable profit margins on those products. This was determined to be the most appropriate methodology as we have historically been product oriented with respect to pricing policies which facilitates the evaluation of product costs and related margins in arriving at a reasonable estimate of the product element fair value. Management's estimate of reasonable profit margins requires significant judgment and consideration of various factors, such as the impact of the economic environment on margins, the complexity of projects, the stability of product profit margins and the nature of products. The estimate of fair value for PCS is based on management's evaluation of weighted average PCS rates for arrangements for which VSOE of fair value of PCS exists. Extended Payment Terms One of the critical judgments that we make, related to revenue recognition, is the assessment that collectability is probable. Our recognition of revenue is based on our assessment of the probability of collecting the related accounts receivable balance at the onset of a sales arrangement. Certain of our arrangements include payment terms that depart from our customary practice. In these situations, if a customer does not have an adequate history of abiding by its contractual payment terms without concessions, the sales price is not considered fixed or determinable and revenue is recognized upon collection provided all other revenue recognition criteria have been met. We consider payment terms where more than 5% of the arrangement fees are due 120 days from customer acceptance to be extended. If the arrangement is with a new customer and the payment terms are extended, there is no evidence of collecting under the original payment terms without making concessions and therefore the presumption that the fee is not fixed and determinable cannot be overcome. If this arrangement is with an existing customer, an evaluation of the customer's payment history will take place to determine if the fee is fixed. Percentage-of-Completion Accounting We have a standard quarterly process in which management reviews the progress and performance of our significant contracts. As part of this process, management reviews include, but are not limited to, any outstanding key contract matters, progress towards completion and the related program schedule, identified risks and opportunities, and the related changes in estimates of revenues and costs. These risks and opportunities include management's judgment about the ability and costs to achieve the schedule requirements, technical requirements (for example, a newly-developed product versus a mature product) and other specific contract requirements. Management must make assumptions regarding labor productivity and availability, the complexity of the work to be performed, the availability of materials, the length of time to complete the contract (to estimate increases in wages and prices for materials and related support cost allocations), performance by our subcontractors, and the availability and timing of funding from our customer, among other variables. Based on this analysis, any adjustments to net sales, costs of sales and the related impact to operating income are recorded as necessary in the period they become known. These adjustments may result in an increase in operating profit during the performance of a contract to the extent we determine we will be successful in mitigating risks for schedule and technical requirements in addition to other specific contract risks or we will realize related opportunities. Likewise, these adjustments may decrease operating profit if we determine we will not be successful in mitigating these risks or we will not realize related opportunities. Changes in estimates of net sales, costs of sales, and the related impact to operating income are recognized using a cumulative catch-up, which recognizes in the current period the cumulative effect of the changes on current and prior periods. A significant change in one or more of these estimates could affect the profitability of one or more of our contracts. Stock-Based Compensation We account for share-based payment awards, including employee stock options, restricted stock, restricted stock units and employee stock purchases, made to employees and directors in accordance with the FASB's guidance for share-based payment and related interpretative guidance, which requires the measurement and recognition of compensation expense for all such awards based on estimated fair value. Comverse estimates the fair value of share-based payment awards on the date of grant using an option-pricing model. Under the FASB's guidance, stock-based compensation expense is measured at the grant date based on the fair value of the award, and the cost is recognized as expense ratably over the award's vesting period. Comverse uses the 64-------------------------------------------------------------------------------- Table of Contents Black-Scholes option-pricing model to measure fair value of stock option awards. The Black-Scholes model requires judgments regarding the assumptions used within the model, the most significant of which are the stock price volatility assumption over the term of the awards and the expected life of the option award based on the actual and projected employee stock option behaviors. The inputs noted below that are factored into the option valuation model we use to measure the fair value of our stock awards are subjective estimates. Changes to these estimates could cause the fair value of our stock awards and related stock-based compensation expenses to vary materially. Except as noted below, the following key assumptions are used for all of Comverse stock-based compensation awards: • The risk-free interest rate assumption we use is based upon U.S. Treasury interest rates appropriate for the expected life of the awards. • Comverse's expected dividend rate is zero since Comverse does not currently pay cash dividends on their common stock and do not anticipate doing so in the foreseeable future. • Until Comverse establishes enough stock history the volatility will be calculated based on peer companies' volatility. Comverse is also required to estimate expected forfeitures of stock-based awards at the grant date and recognize compensation cost only for those awards expected to vest. Although Comverse estimates forfeitures based on historical experience while a subsidiary of CTI and future expectation, actual forfeitures may differ. The forfeiture assumption is adjusted to the actual forfeitures that occur. During the fiscal years ended January 31, 2014, 2013 and 2012, our stock-based compensation expense, including prior to the Share Distribution, was $10.2 million, $7.5 million and $3.7 million, respectively. Recoverability of Goodwill Goodwill represents the excess of the fair value of consideration transferred in the business combination over the fair value of tangible and intangible assets acquired net of the fair value of liabilities assumed and the fair value of any noncontrolling interest in the acquiree. We apply the FASB's guidance when testing goodwill for impairment which permits management to make a qualitative assessment of whether goodwill is impaired, or opt to bypass the qualitative assessment, and proceed directly to performing the first step of the two-step impairment test. If management performs a qualitative assessment and concludes it is more-likely-than-not that the fair value of a reporting unit exceeds its carrying value, goodwill is not considered impaired and the two-step impairment test is unnecessary. However, if management concludes otherwise, it is then required to perform the first step of the two-step impairment test. For reporting units where we decide to perform a qualitative assessment, our management assesses and makes judgments regarding a variety of factors which potentially impact the fair value of a reporting unit, including general economic conditions, industry and market-specific conditions, customer behavior, cost factors, our financial performance and trends, our strategies and business plans, capital requirements, management and personnel issues, and our stock price, among others. Management then considers the totality of these and other factors, placing more weight on the events and circumstances that are judged to most affect a reporting unit's fair value or the carrying amount of its net assets, to reach a qualitative conclusion regarding whether it is more-likely-than-not that the fair value of a reporting unit exceeds its carrying amount. For reporting units where we perform the two-step goodwill impairment test, the first step requires us to compare the fair value of each reporting unit to the carrying value of its net assets. Management considers both an income-based approach using projected discounted cash flows and a market-based approach using multiples of comparable companies to determine the fair value of its reporting units. Management's estimate of fair value of each reporting unit is based on a number of subjective factors, including: (i) the appropriate weighting of valuation approaches (income-based approach and market-based approach), (ii) estimates of the future revenue and cash flows, (iii) discount rate for estimated cash flows, (iv) selection of peer group companies for the market-based approach, (v) required levels of working capital, (vi) assumed terminal value, (vii) the time horizon of cash flow forecasts, and (viii) control premium. We use the work of an independent third party appraisal firm to assist us in considering our determination of the implied fair value of our goodwill. The fair values are calculated using the income approach and a market approach based on comparable companies. The income approach, more commonly known as the discounted cash flow approach, estimates fair value based on the cash flows that an asset can be expected to generate over its useful life. If the carrying value of a reporting unit's goodwill exceeds its implied fair value, then an impairment charge equal to the difference is recorded. Assumptions and estimates about future values of our reporting units and implied goodwill are complex and subjective. They can be affected by a variety of factors, including external factors such as industry and economic trends, 65-------------------------------------------------------------------------------- Table of Contents and internal factors such as changes in our business strategy and our internal forecasts. Although we believe the historical assumptions and estimates we have made are reasonable and appropriate, different assumptions and estimates could materially impact our reported financial results. The determination of reporting units also requires management judgment. We assess whether a reporting unit exists within a reportable segment by identifying the unit, determining whether the unit qualifies as a business under U.S. GAAP, and assessing the availability and regular review by segment management of discrete financial information for the unit. We recorded a goodwill impairment charge of approximately $5.6 million for the Comverse MI reporting unit for the fiscal year ended January 31, 2013. For more information, see note 1 and note 6 to the consolidated and combined financial statements included in Item 15 of this Annual Report. Management's forecasts and estimates are based on assumptions that are consistent with the plans and estimates used to manage the business. Changes in these estimates could change the conclusion regarding an impairment of goodwill. Income Taxes Income taxes are provided using the asset and liability method, such that income taxes (i.e., deferred tax assets, deferred tax liabilities, taxes currently payable/refunds receivable and tax expense/benefit) are recorded based on amounts refundable or payable in the current year and include the results of any difference between U.S. GAAP and tax reporting. Deferred income taxes reflect the tax effect of net operating losses, capital losses and general business credit carryforwards and the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial statement and income tax purposes, as determined under enacted tax laws and rates. Valuation allowances are established when management determines that it is more-likely-than-not that some portion or all of the deferred tax asset will not be realized. The financial effect of changes in tax laws or rates is accounted for in the period of enactment. The subsequent realization of net operating loss and general business credit carryforwards acquired in acquisitions accounted for using the acquisition method of accounting is recognized in the combined statement of operations. We were included in the CTI consolidated federal and certain combined state income tax returns until completion of the Share Distribution. As such, we were not a separate taxable entity for U.S. federal and certain state income tax purposes until completion of the Share Distribution. In addition, we did not have a written tax sharing agreement with CTI. Our provisions for income taxes and related balance sheet accounts were presented as if we were a separate taxpayer ("separate return method"). This method of allocating the CTI consolidated current and deferred income taxes was systematic, rational and consistent with the asset and liability method. The separate return method represented a hypothetical computation assuming that our reported revenue and expenses were incurred by a separate taxable entity. Accordingly, the reported provision for income taxes and the related balance sheet account balances (including but not limited to the NOL deferred tax assets) did not equal the amounts that were allocable to us under the applicable consolidated federal and state tax laws. Further, as we did not have a tax-sharing agreement with CTI in place, the expected payable was treated as a dividend to the parent. Immediately following our separation from CTI, the consolidated CTI tax attributes were allocated between CTI and us based on the applicable tax laws. From time to time, we have business transactions in which the tax consequences are uncertain. Significant judgment is required in assessing and estimating the tax consequences of these transactions. We prepare and file tax returns based on our interpretation of tax laws. In the normal course of business, our tax returns are subject to examination by various taxing authorities. Such examinations may result in future tax, interest and penalty assessments. In determining our tax provision for financial reporting purposes, we establish a liability for uncertain tax positions unless such positions are determined to be more-likely-than-not of being sustained upon examination, based on their technical merits. That is, for financial reporting purposes, we only recognize tax benefits that we believe are more-likely-than-not of being sustained and then recognize the largest amount of benefit that is greater than 50 percent likely to be realized upon settlement. There is considerable judgment involved in determining whether positions taken on the tax return are more-likely-than-not of being sustained and determining the likelihood of various potential settlement outcomes. We adjust our estimated liability for uncertain tax positions periodically because of new information discovered as a function of ongoing examinations by, and settlements with, the various taxing authorities, as well as changes in tax laws, regulations and interpretations. The combined tax provision of any given year includes adjustments to prior year income tax accruals that are considered appropriate as well as any related estimated interest. Our policy is to recognize all appropriately accrued interest and penalties on uncertain tax positions as part of income tax expense. For further information, see note 19 to the consolidated and combined financial statements included in Item 15 of this Annual Report. 66-------------------------------------------------------------------------------- Table of Contents As part of our accounting for business combinations, some of the purchase price is allocated to goodwill and intangible assets. Impairment expenses associated with goodwill are generally not tax deductible and will result in an increased effective income tax rate in the fiscal period any impairment is recorded. Amortization expenses associated with acquired intangible assets are generally not tax deductible pursuant to our existing tax structure; however, deferred taxes have been recorded for non-deductible amortization expenses as a part of the purchase price allocation process. We have taken into account the allocation of these identified intangibles among different taxing jurisdictions, including those with nominal or zero percent tax rates, in establishing the related deferred tax liabilities. Under the FASB's guidance, the income tax benefit from future releases of the acquisition date valuation allowances or income tax contingencies, if any, are reflected in the income tax provision in the combined statements of operations, rather than as an adjustment to the purchase price allocation. Litigation and Contingencies Contingencies by their nature relate to uncertainties that require management to exercise judgment both in assessing the likelihood that a liability has been incurred as well as in estimating the amount of potential loss, if any. We accrue for costs relating to litigation, claims and other contingent matters when such liabilities become probable and reasonably estimable. We expense legal fees associated with consultations with outside counsel and defense of lawsuits as incurred. Such estimates may be based on advice from third parties or solely on management's judgment, as appropriate. Actual amounts paid may differ materially from amounts estimated, and such differences will be charged to operations in the period in which the final determination of the liability is made. From time to time, we receive notices that our products or processes may be infringing the patent or intellectual property rights of others; and notices of other lawsuits or other claims against us. We assess each matter in order to determine if a contingent liability should be recorded. In making this determination, management may, depending on the nature of the matter, consult with internal and external legal counsel. Based on the information obtained combined with management's judgment regarding all the facts and circumstances of each matter, we determine whether a contingent loss is probable and whether the amount of such loss can be estimated. Should a loss be probable and estimable, we record a contingent loss. Should the judgments and estimates made by management not coincide with future events, such as a judicial action against us where we expected no merit on the part of the party bringing the action against us, we may need to record additional contingent losses that could materially adversely impact our results of operations. Alternatively, if the judgments and estimates made by management are incorrect and a particular contingent loss does not occur, the contingent loss recorded would be reversed thereby favorably impacting our results of operations. Israel Employees Severance Pay Under Israeli law, we are obligated to make severance payments under certain circumstances to employees of our Israeli subsidiaries on the basis of each individual's current salary and length of employment. Our liability for severance pay is calculated pursuant to Israel's Severance Pay Law based on the most recent monthly salary of the employee multiplied by the number of years of employment, as of the balance sheet date. The liability for severance pay is recognized as compensation benefits in the consolidated and combined statements of operations. Employees are entitled to one month's salary for each year of employment or a portion thereof. We record the obligation as if it was payable at each balance sheet date ("shut-down method"). A portion of such severance liability is funded by monthly deposits into insurance policies, which are restricted to only be used to satisfy such severance payments. Any change in the fair value of the asset is recognized as an adjustment to compensation expense in the consolidated and combined statements of operations. The asset and liability are recognized gross and not offset on the consolidated balance sheet. Upon involuntary termination, employees will receive the balance from deposited funds from the insurance policies with the remaining balance paid by us. For voluntarily termination the employees are entitled, based on Company's policy, to the balance in the deposited funds. Any remaining net liability balance is reversed as compensation benefits in the consolidated and combined statements of operations. For employees in Israel hired after January 2011, we make regular deposits with certain insurance companies for accounts controlled by each applicable employee in order to secure the employee's rights upon termination. We are relieved from any severance pay liability with respect to deposits made on behalf of each employee. As such, the severance plan is only defined by the monthly contributions made by us, the liability accrued in respect of these employees and the amounts funded are not reflected in the consolidated and combined balance sheets. The portion of liability not funded is included in Other liabilities in the consolidated balance sheets. Probability assessment of performance based stock units vesting We grant share-based payment awards as compensation to certain employees. A substantial portion of these awards vest only if we achieve pre-established performance targets. The amount and timing of compensation expense 67-------------------------------------------------------------------------------- Table of Contents recognized for such performance-based awards is dependent upon management's quarterly assessment of the likelihood and timing of achieving these future profitability targets. Accordingly, if the projections used by management in its assessment prove, with the benefit of hindsight, to be inaccurate, the amount of life-to-date and future compensation expense related to share-based payments could significantly increase or decrease. The share-based awards have a total potential compensation expense impact of up to $3.4 million within a two year vesting period. Expense Allocations Prior to the spin-off, CTI provided a variety of services to us. CTI directly assigned, where possible, certain general and administrative costs to us based on actual use of those services. Where direct assignment of costs is not possible, or practical, CTI used other indirect methods, to estimate the allocation of costs. Allocated costs include general support services such as information technology, legal services, human resource services, general accounting and finance, and executive support. Substantially all of these allocations are reflected in "Selling, general, and administrative" expenses in our combined statements of operations. Employee compensation and overhead expenses were allocated utilizing a time study of CTI employees' percentage of time spent on matters related to us. External vendor expenses were allocated based on information provided by the vendor or an internal analysis of benefits derived by us from the services incurred by CTI. We considered these expense allocations to be a reasonable reflection of the utilization of services provided. The allocations may not, however, reflect the expense we would have incurred as an independent company. Actual costs which may have been incurred if we had been a stand-alone company for the fiscal years ended January 31, 2013 and 2012 would depend on a number of factors, including how we chose to organize ourself, and what, if any, functions were outsourced or performed by our employees. Accounting Standards Applicable to Emerging Growth Companies We are an emerging growth company as defined under the JOBS Act. Emerging growth companies can delay adopting new or revised accounting standards that have different effective dates for public and private companies until such time as those standards apply to private companies. We intend to take advantage of such extended transition period. Since we will not be required to comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies, our financial statements may not be comparable to the financial statements of companies that comply with public company effective dates. If we were to elect to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act. RECENT ACCOUNTING PRONOUNCEMENTS See note 2, Recent Accounting Pronouncements, to the consolidated and combined financial statements included in Item 15 of this Annual Report. |