VERINT SYSTEMS INC - Quarter Report: 2011 October (Form 10-Q)

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

 

 

For the quarterly period ended October 31, 2011

 

OR

 

 

For the transition period from                                to                                     .

 

Commission File No. 001-34807

 

Verint Systems Inc.

(Exact Name of Registrant as Specified in its Charter)

 

 

	(631) 962-9600
(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes þ No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

 

Large Accelerated Filer o	Accelerated Filer þ		Non-Accelerated Filer o	Smaller Reporting Company o
		(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No þ

 

There were 38,858,601 shares of the registrant’s common stock outstanding on November 15, 2011.

 

 

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CAUTIONARY NOTE ON FORWARD-LOOKING STATEMENTS		ii
PART I.	FINANCIAL INFORMATION	1
ITEM 1.	FINANCIAL STATEMENTS	1
	CONDENSED CONSOLIDATED BALANCE SHEETS	1
	CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS	2
	CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)	3
	CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS	4
	NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS	5
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	44
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	67
ITEM 4.	CONTROLS AND PROCEDURES	68
PART II.	OTHER INFORMATION	69
ITEM 1.	LEGAL PROCEEDINGS	69
ITEM 1A.	RISK FACTORS	69
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	69
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	69
ITEM 4.	REMOVED AND RESERVED	69
ITEM 5.	OTHER INFORMATION	69
ITEM 6.	EXHIBITS	70
SIGNATURES		72

 

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Cautionary Note on Forward-Looking Statements

 

Certain statements discussed in this report constitute forward-looking statements, which include financial projections, statements of plans and objectives for future operations, statements of future economic performance, and statements of assumptions relating thereto. Forward-looking statements are often identified by future or conditional words such as “will”, “plans”, “expects”, “intends”, “believes”, “seeks”, “estimates”, or “anticipates”, or by variations of such words or by similar expressions. There can be no assurances that forward-looking statements will be achieved. By their very nature, forward-looking statements involve known and unknown risks, uncertainties, and other important factors that could cause our actual results or conditions to differ materially from those expressed or implied by such forward-looking statements. Important risks, uncertainties, and other factors that could cause our actual results or conditions to differ materially from our forward-looking statements include, among others:

 

·                  uncertainties regarding the impact of general economic conditions in the United States and abroad, particularly in information technology spending and government budgets, on our business;

 

·                  risks due to aggressive competition in all of our markets, including with respect to maintaining margins and sufficient levels of investment in our business;

 

·                  risks associated with keeping pace with technological changes and evolving industry standards in our product offerings and with successfully introducing new, quality products which meet customer needs and achieve market acceptance;

 

·                  risks created by continued consolidation of competitors or introduction of large competitors in our markets with greater resources than we have;

 

·                  risks associated with successfully competing for, consummating, and implementing mergers and acquisitions, including risks associated with capital constraints, costs and expenses, management distraction, post-acquisition integration activities, and potential asset impairments;

 

·                  risks that customers or partners delay or cancel orders or are unable to honor contractual commitments due to liquidity issues, challenges in their business, or otherwise;

 

·                  risks relating to our implementation and maintenance of adequate systems and internal controls for our current and future operations and reporting needs and related risks of financial statement omissions, misstatements, restatements, or filing delays;

 

·                  risks relating to our ability to improve our infrastructure to enhance and secure our internal and external operations and to support growth;

 

·                  risks that we improperly handle sensitive or confidential information or the perception of such mishandling;

 

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·                  risks associated with Comverse Technology, Inc. (“Comverse”) controlling our board of directors and the outcome of all matters submitted for stockholder action, including the approval of significant corporate transactions, such as certain equity issuances or mergers and acquisitions, as well as speculation or announcements regarding Comverse’s strategic plans;

 

·                  risks associated with being a consolidated, controlled subsidiary of Comverse and formerly part of Comverse’s consolidated tax group, including risks of any future impact on us resulting from Comverse’s previous extended filing delay or any other future issues;

 

·                  risks that products may contain undetected defects, which could expose us to substantial liability;

 

·                  risks associated with allocating limited financial and human resources to business, development, strategic, or other opportunities that may not come to fruition or produce satisfactory returns;

 

·                  risks associated with significant foreign and international operations, including exposure to regions subject to political or economic instability and fluctuations in exchange rates;

 

·                  risks associated with complex and changing local and foreign regulatory environments;

 

·                  risks associated with our ability to recruit and retain qualified personnel in geographies in which we operate;

 

·                  challenges in accurately forecasting revenue and expenses and maintaining profitability;

 

·                  risks that our intellectual property rights may not be adequate to protect our business or assets or that others may make claims on our intellectual property or claim infringement on their intellectual property rights;

 

·                  risks associated with a significant amount of our business coming from domestic and foreign government customers, including the ability to maintain security clearances for certain projects;

 

·                  risks associated with our dependence on a limited number of suppliers or original equipment manufacturers (“OEMs”) for certain components of our products;

 

·                  risks that we are unable to maintain and enhance relationships with key resellers, partners, and systems integrators;

 

·                  risks that contract terms may expose us to unlimited liability or other unfavorable positions and risks that we may experience losses that are not covered by insurance;

 

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·                  risks that we will experience liquidity or working capital issues and related risks that financing sources will be unavailable to us on reasonable terms or at all;

 

·                  risks associated with significant leverage resulting from our current debt position, including with respect to maintaining compliance with the leverage ratio covenant under our credit facility and maintaining our credit rating;

 

·                  risks relating to timely implementation of new accounting pronouncements or new interpretations of existing accounting pronouncements and related risks of future restatements or filing delays;

 

·                  risks associated with future regulatory actions or private litigations relating to our previous extended filing delay and related circumstances; and

 

·                  risks that use of our tax benefits may be restricted or eliminated in the future.

 

These risks, uncertainties and challenges, as well as other factors, are discussed in greater detail under Item 1A of our Annual Report on Form 10-K for the year ended January 31, 2011.  You are cautioned not to place undue reliance on forward-looking statements, which reflect our management’s view only as of the date of this report. We make no commitment to revise or update any forward-looking statements in order to reflect events or circumstances after the date any such statement is made, except as otherwise required under the federal securities laws. If we were in any particular instance to update or correct a forward-looking statement, investors and others should not conclude that we would make additional updates or corrections thereafter except as otherwise required under the federal securities laws.

 

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PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements.

 

VERINT SYSTEMS INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

October 31, 2011 and January 31, 2011

(Unaudited)

 

		October 31,			January 31,
(in thousands, except share and per share data)		2011			2011
Assets
Current Assets:
Cash and cash equivalents		$	112,413		$	169,906
Restricted cash and bank time deposits		8,018			13,639
Accounts receivable, net		153,749			150,769
Inventories		14,814			16,987
Deferred cost of revenue		6,368			6,269
Prepaid expenses and other current assets		57,002			44,374
Total current assets		352,364			401,944
Property and equipment, net		27,549			23,176
Goodwill		817,744			738,674
Intangible assets, net		190,189			157,071
Capitalized software development costs, net		5,828			6,787
Long-term deferred cost of revenue		14,575			21,715
Other assets		37,855			26,760
Total assets		$	1,446,104		$	1,376,127
Liabilities, Preferred Stock, and Stockholders’ Equity
Current Liabilities:
Accounts payable		$	36,126		$	36,861
Accrued expenses and other current liabilities		169,099			163,029
Current maturities of long-term debt		6,208			—
Deferred revenue		134,454			142,465
Liabilities to affiliates		1,791			1,847
Total current liabilities		347,678			344,202
Long-term debt		592,695			583,234
Long-term deferred revenue		29,623			40,424
Other liabilities		65,256			45,038
Total liabilities		1,035,252			1,012,898
Preferred Stock - $0.001 par value; authorized 2,500,000 shares.  Series A convertible preferred stock; 293,000 shares issued and outstanding; aggregate liquidation preference and redemption value of $348,629 at October 31, 2011.		285,542			285,542
Commitments and Contingencies
Stockholders’ Equity:
Common stock - $0.001 par value; authorized 120,000,000 shares.  Issued 39,130,000 and 37,349,000 shares; outstanding 38,847,000 and 37,089,000 shares, as of October 31, 2011 and January 31, 2011, respectively.		39			38
Additional paid-in capital		547,354			519,834
Treasury stock, at cost - 283,000 and 260,000 shares as of October 31, 2011 and January 31, 2011, respectively.		(7,466		)	(6,639		)
Accumulated deficit		(374,943		)	(394,757		)
Accumulated other comprehensive loss		(43,783		)	(42,069		)
Total Verint Systems Inc. stockholders’ equity		121,201			76,407
Noncontrolling interest		4,109			1,280
Total stockholders’ equity		125,310			77,687
Total liabilities, preferred stock, and stockholders’ equity		$	1,446,104		$	1,376,127

 

See notes to condensed consolidated financial statements.

 

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VERINT SYSTEMS INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

Three and Nine Months Ended October 31, 2011 and 2010

(Unaudited)

 

		Three Months Ended October 31,						Nine Months Ended October 31,
(in thousands, except per share data)		2011			2010			2011			2010
Revenue:
Product		$	101,164		$	97,769		$	284,865		$	282,942
Service and support		98,200			88,872			285,790			256,988
Total revenue		199,364			186,641			570,655			539,930
Cost of revenue:
Product		33,623			26,615			89,368			83,333
Service and support		33,091			30,070			96,469			87,052
Amortization of acquired technology		3,425			2,256			8,760			6,709
Total cost of revenue		70,139			58,941			194,597			177,094
Gross profit		129,225			127,700			376,058			362,836
Operating expenses:
Research and development, net		28,464			24,063			81,640			72,544
Selling, general and administrative		76,536			67,868			218,988			224,029
Amortization of other acquired intangible assets		5,943			5,376			16,904			16,053
Total operating expenses		110,943			97,307			317,532			312,626
Operating income		18,282			30,393			58,526			50,210
Other income (expense), net:
Interest income		153			109			447			309
Interest expense		(7,905		)	(8,941		)	(24,556		)	(20,825		)
Loss on extinguishment of debt		—			—			(8,136		)	—
Other income (expense), net		(1,313		)	2,159			437			(3,987		)
Total other expense, net		(9,065		)	(6,673		)	(31,808		)	(24,503		)
Income before provision for (benefit from) income taxes		9,217			23,720			26,718			25,707
Provision for (benefit from) income taxes		(704		)	5,332			3,968			10,544
Net income		9,921			18,388			22,750			15,163
Net income attributable to noncontrolling interest		470			1,214			2,936			2,722
Net income attributable to Verint Systems Inc.		9,451			17,174			19,814			12,441
Dividends on preferred stock		(3,747		)	(3,592		)	(11,003		)	(10,549		)
Net income attributable to Verint Systems Inc. common shares		$	5,704		$	13,582		$	8,811		$	1,892
Net income per share attributable to Verint Systems Inc.
Basic		$	0.15		$	0.38		$	0.23		$	0.06
Diluted		$	0.15		$	0.36		$	0.22		$	0.05
Weighted-average common shares outstanding
Basic		38,807			35,368			38,263			33,785
Diluted		39,263			47,679			39,267			36,525

 

See notes to condensed consolidated financial statements.

 

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VERINT SYSTEMS INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholders’ Equity (Deficit)

Nine Months Ended October 31, 2011 and 2010

(Unaudited)

 

		Verint Systems Inc. Stockholders’ Equity (Deficit)
		Common Stock					Additional									Accumulated Other			Total Verint Systems Inc.						Total
(in thousands)		Shares		Par Value			Paid-in Capital			Treasury Stock			Accumulated Deficit			Comprehensive Loss			Stockholders’ Equity (Deficit)			Noncontrolling Interest			Stockholders’ Equity (Deficit)
Balances as of January 31, 2010		32,584		$	33		$	451,166		$	(2,493	)	$	(420,338	)	$	(43,134	)	$	(14,766	)	$	199		$	(14,567	)
Comprehensive income:
Net income		—		—			—			—			12,441			—			12,441			2,722			15,163
Unrealized gains on derivative financial instruments, net		—		—			—			—			—			755			755			—			755
Foreign currency translation adjustments		—		—			—			—			—			1,112			1,112			270			1,382
Total comprehensive income		—		—			—			—			12,441			1,867			14,308			2,992			17,300
Stock-based compensation expense		—		—			22,856			—			—			—			22,856			—			22,856
Exercises of stock options		1,695		1			30,911			—			—			—			30,912			—			30,912
Common stock issued for stock awards		2,493		2			(2		)	—			—			—			—			—			—
Purchases of treasury stock		(157	)	—			—			(4,146		)	—			—			(4,146		)	—			(4,146		)
Tax effects from stock award plans		—		—			(482		)	—			—			—			(482		)	—			(482		)
Balances as of October 31, 2010		36,615		$	36		$	504,449		$	(6,639	)	$	(407,897	)	$	(41,267	)	$	48,682		$	3,191		$	51,873
Balances as of January 31, 2011		37,089		$	38		$	519,834		$	(6,639	)	$	(394,757	)	$	(42,069	)	$	76,407		$	1,280		$	77,687
Comprehensive income:
Net income		—		—			—			—			19,814			—			19,814			2,936			22,750
Unrealized losses on derivative financial instruments, net		—		—			—			—			—			(241		)	(241		)	—			(241		)
Foreign currency translation adjustments		—		—			—			—			—			(1,473		)	(1,473		)	(107		)	(1,580		)
Total comprehensive income		—		—			—			—			19,814			(1,714		)	18,100			2,829			20,929
Stock-based compensation expense		—		—			17,211			—			—			—			17,211			—			17,211
Exercises of stock options		487		—			9,710			—			—			—			9,710			—			9,710
Common stock issued for stock awards		1,294		1			(1		)	—			—			—			—			—			—
Stock options issued in business combination		—		—			60			—			—			—			60			—			60
Purchases of treasury stock		(23	)	—			—			(827		)	—			—			(827		)	—			(827		)
Tax effects from stock award plans		—		—			540			—			—			—			540			—			540
Balances as of October 31, 2011		38,847		$	39		$	547,354		$	(7,466	)	$	(374,943	)	$	(43,783	)	$	121,201		$	4,109		$	125,310

 

See notes to condensed consolidated financial statements.

 

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VERINT SYSTEMS INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

Nine Months Ended October 31, 2011 and 2010

(Unaudited)

 

		Nine Months Ended October 31,
(in thousands)		2011			2010
Cash flows from operating activities:
Net income		$	22,750		$	15,163
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		39,152			36,100
Stock-based compensation		17,211			22,856
Non-cash losses on derivative financial instruments, net		1,225			4,271
Loss on extinguishment of debt		8,136			—
Other non-cash items, net		4,049			1,626
Changes in operating assets and liabilities, net of effects of business combinations:
Accounts receivable		(1,698		)	(9,719		)
Inventories		1,629			(3,369		)
Deferred cost of revenue		7,824			12,957
Prepaid expenses and other assets		2,354			(405		)
Accounts payable and accrued expenses		(22,996		)	(1,585		)
Deferred revenue		(24,583		)	(56,177		)
Other, net		(9,822		)	(3,252		)
Net cash provided by operating activities		45,231			18,466
Cash flows from investing activities:
Cash paid for business combinations, net of cash acquired		(98,698		)	(15,292		)
Purchases of property and equipment		(9,238		)	(5,845		)
Settlements of derivative financial instruments not designated as hedges		(1,183		)	(32,640		)
Cash paid for capitalized software development costs		(2,542		)	(1,604		)
Changes in restricted cash and bank time deposits and other investing activities		5,893			(12,878		)
Net cash used in investing activities		(105,768		)	(68,259		)
Cash flows from financing activities:
Proceeds from borrowings, net of original issuance discount		597,000			—
Repayments of borrowings and other financing obligations		(585,514		)	(22,960		)
Payments of debt issuance and other debt-related costs		(15,280		)	(4,039		)
Proceeds from exercises of stock options		9,394			30,572
Purchases of treasury stock		(827		)	(4,146		)
Other financing activities		(2,004		)	—
Net cash provided by (used in) financing activities		2,769			(573		)
Effect of exchange rate changes on cash and cash equivalents		275			37
Net decrease in cash and cash equivalents		(57,493		)	(50,329		)
Cash and cash equivalents, beginning of period		169,906			184,335
Cash and cash equivalents, end of period		$	112,413		$	134,006
Supplemental disclosures of cash flow information:
Cash paid for interest		$	22,374		$	13,014
Cash paid for income taxes, net of refunds received		$	12,064		$	5,533
Non-cash investing and financing transactions:
Accrued but unpaid purchases of property and equipment		$	1,241		$	929
Inventory transfers to property and equipment		$	555		$	372
Liabilities for contingent consideration in business combinations		$	33,704		$	3,224
Stock options exercised, proceeds received subsequent to period end		$	364		$	340
Purchases under supplier financing arrangements, including capital leases		$	1,090		$	1,858

 

See notes to condensed consolidated financial statements.

 

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VERINT SYSTEMS INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.              BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

 

Condensed Consolidated Financial Statements Preparation

 

The condensed consolidated financial statements included herein have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and on the same basis as the audited consolidated financial statements included in our Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) for the year ended January 31, 2011.  The condensed consolidated statements of operations, stockholders’ equity (deficit) and cash flows for the periods ended October 31, 2011 and 2010, and the condensed consolidated balance sheet as of October 31, 2011, are not audited but reflect all adjustments that are of a normal recurring nature and that are considered necessary for a fair presentation of the results for the periods shown.  The condensed consolidated balance sheet as of January 31, 2011 is derived from the audited consolidated financial statements presented in our Annual Report on Form 10-K for the year ended January 31, 2011.  Certain information and disclosures normally included in annual consolidated financial statements have been omitted pursuant to the rules and regulations of the SEC.  Because the condensed consolidated interim financial statements do not include all of the information and disclosures required by GAAP for a complete set of financial statements, they should be read in conjunction with the audited consolidated financial statements and notes included in our Annual Report on Form 10-K filed with the SEC for the year ended January 31, 2011.  The results for interim periods are not necessarily indicative of a full year’s results.

 

Unless the context otherwise requires, the terms “Verint”, “we”, “our”, and “us” and words of similar import as used in these notes to the condensed consolidated financial statements include Verint Systems Inc. and its consolidated subsidiaries.

 

Principles of Consolidation

 

The accompanying condensed consolidated financial statements include the accounts of Verint Systems Inc., our wholly owned subsidiaries, and a joint venture in which we hold a 50% equity interest.  This joint venture functions as a systems integrator for Asian markets and is a variable interest entity in which we are the primary beneficiary.  Investments in companies in which we have less than a 20% ownership interest and do not exercise significant influence are accounted

 

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for at cost.  We include the results of operations of acquired companies from the date of acquisition.  All significant intercompany transactions and balances are eliminated.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires our management to make estimates and assumptions, which may affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from those estimates.

 

Reclassifications

 

The classification of certain costs within the condensed consolidated statements of operations for the three and nine months ended October 31, 2010 has been corrected to conform to the presentation for the three and nine months ended October 31, 2011.  The reclassification reflects $1.5 million and $5.1 million of cost of service and support revenue for the three and nine months ended October 31, 2010, respectively, which had previously been presented as a component of cost of product revenue.  This correction was not material to the condensed consolidated financial statements for the three and nine months ended October 31, 2010 and did not impact our total cost of revenue, gross profit, operating income, income before provision for income taxes, net income, condensed consolidated balance sheet, or condensed consolidated statements of cash flows for those periods.

 

Significant Accounting Policies

 

We describe our significant accounting policies in Note 1 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended January 31, 2011.  As discussed below, on February 1, 2011 we adopted new authoritative accounting guidance on multiple-deliverable revenue arrangements. There were no other changes to our significant accounting policies during the three and nine months ended October 31, 2011.

 

Revenue Recognition

 

In October 2009, the Financial Accounting Standards Board (“FASB”) issued amended revenue recognition accounting standards that removed tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry-specific software revenue recognition guidance.  Also in October 2009, the FASB amended the accounting standards for multiple-deliverable revenue arrangements to:

 

	(i)	provide updated guidance on when and how the deliverables in a multiple-deliverable arrangement should be separated, and how the consideration should be allocated;
	(ii)	require an entity to allocate revenue in an arrangement that has separate units of accounting, using estimated selling prices (“ESP”) of deliverables if a vendor does not have vendor-specific objective evidence (“VSOE”) of selling price, or third-party evidence of selling price (“TPE”); and

 

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(iii)

eliminate the use of the residual method and require an entity to allocate revenue using   the relative selling price method to the separate units of accounting.

 

This guidance was effective for fiscal years beginning on or after June 15, 2010, although early adoption was permitted.  We elected to prospectively adopt the provisions of this new guidance as of February 1, 2011, for new and materially modified transactions entered into on or after that date.  Since we have been able to establish VSOE for a significant amount of our service and support offerings included in multiple-element arrangements, we do not consider the impact of implementing the guidance to be significant for the three and nine months ended October 31, 2011.  For the three and nine months ended October 31, 2011, we recognized $1.7 million and $7.6 million of additional revenue and $1.0 million and $3.6 million of additional  income before provision for income taxes, respectively, as a result of adopting the new guidance. We believe that the adoption of this guidance may still materially increase revenue for the year ending January 31, 2012, but we are not able to reasonably estimate the amount of the revenue increase, as the impact will vary based on the nature and volume of new or materially modified arrangements during the three months ending January 31, 2012.

 

Our updated policy for revenue recognition, reflecting the impact of the new guidance, is described below.

 

We derive and report our revenue in two categories: (a) product revenue, including hardware products (which include software that works together with the hardware to deliver the product’s essential functionality) and licensing of software products, and (b) service and support revenue, including revenue from installation services, post-contract customer support (“PCS”), project management, hosting services, product warranties, and training services.

 

Our revenue recognition policy is a critical component of determining our operating results and is based on a complex set of accounting rules that require us to make significant judgments and estimates.  Our customer arrangements typically include several elements, including products, services, and support.  Revenue recognition for a particular arrangement is dependent upon such factors as the level of customization within the solution and the contractual delivery, acceptance, payment, and support terms with the customer.  Significant judgment is required to conclude whether collectability of fees is reasonably assured and whether fees are fixed and determinable.

 

For arrangements that do not require significant modification or customization of the underlying products, we recognize revenue when we have persuasive evidence of an arrangement, the product has been delivered or the services have been provided to the customer, the sales price is fixed or determinable and collectability is reasonably assured.  In addition, our multiple-element arrangements must be carefully reviewed to determine the selling price of each element.

 

Our multiple-element arrangements consist of a combination of our product and service offerings that may be delivered at various points in time.  For arrangements within the scope of the new revenue accounting guidance, a deliverable constitutes a separate unit of accounting when it has stand-alone value and there are no customer-negotiated refunds or return rights for the delivered elements. For multiple-element arrangements comprised only of hardware products and related services, we allocate revenue to each element in an arrangement based on a selling price hierarchy. The selling price for a deliverable is based on its VSOE, if available, TPE, if VSOE is

 

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not available, or ESP, if neither VSOE nor TPE is available.  The total transaction revenue is allocated to the multiple elements based on each element’s relative selling price compared to the total selling price.

 

Our policy for establishing VSOE for installation, consulting, and training is based upon an analysis of separate sales of services.  We utilize either the substantive renewal rate approach or the bell-shaped curve approach to establish VSOE for our PCS offerings, depending upon the business segment, geographical region, or product line.

 

TPE of selling price is established by evaluating largely similar and interchangeable competitor products or services in stand-alone sales to similarly situated customers.

 

If we are unable to determine the selling price because VSOE or TPE does not exist, we determine ESP for the purposes of allocating the arrangement by considering several external and internal factors including, but not limited to, pricing practices, similar product offerings, margin objectives, geographies in which we offer our products and services, internal costs, competition, and product lifecycle.  The determination of ESP is made through consultation with and approval by our management, taking into consideration our go-to-market strategies.  ESP for each element is updated, when appropriate, to ensure that it reflects recent pricing experience.

 

For multiple-element arrangements comprised only of software products and related services, a portion of the total purchase price is allocated to the undelivered elements, primarily installation services, PCS, and training, using VSOE of fair value of the undelivered elements. The remaining portion of the total transaction value is allocated to the delivered software, referred to as the residual method.  If we are unable to establish VSOE 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 software arrangements for which we are unable to establish VSOE of one or more elements, and where such arrangements are recognized ratably, we use various available indicators of fair value and apply our best judgment to reasonably classify the arrangement’s revenue into product revenue and service revenue for financial reporting purposes.  For these arrangements, we review our VSOE for training, installation, and PCS services from similar transactions and stand-alone services arrangements and prepare comparisons to peers, in order to determine reasonable and consistent approximations of fair values of service revenue for statement of operations classification purposes with the remaining amount being allocated to product revenue.  Installation services associated with our Communications Intelligence arrangements are included within product revenue as such amounts are not material.

 

For new or materially modified multiple-element arrangements entered into on or after February 1, 2011 that are comprised of a combination of hardware and software elements, the total transaction value is bifurcated between the hardware elements and the software elements that are not essential to the functionality of the hardware, based on the relative selling prices of the hardware elements and the software elements as a group. Revenue is then recognized for the hardware and hardware-related services following the hardware revenue recognition methodology outlined above and revenue for the software and software-related services is

 

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recognized following the residual method or ratably over the PCS period if VSOE for PCS does not exist.

 

PCS revenue is derived from providing technical software support services and unspecified software updates and upgrades to customers on a when-and-if-available basis.  PCS revenue is recognized ratably over the term of the maintenance period, which in most cases is one year.

 

Under the substantive renewal rate approach, we believe it is necessary to evaluate whether both the support renewal rate and term are substantive and whether the renewal rate is being consistently applied to subsequent renewals for a particular customer.  We establish VSOE under this approach through analyzing the renewal rate stated in the customer agreement and determining whether that rate is above the minimum substantive VSOE renewal rate established for that particular PCS offering.  The minimum substantive VSOE rate is determined based upon an analysis of renewal rates associated with historical PCS contracts.  For multiple-element software arrangements that do not contain a stated renewal rate, revenue associated with the entire bundled arrangement is recognized ratably over the PCS term.  Multiple-element software arrangements that have a renewal rate below the minimum substantive VSOE rate are deemed to contain a more than insignificant discount element, for which VSOE cannot be established.  We recognize aggregate contractual revenue for these arrangements over the period that the customer is entitled to renew its PCS at the discounted rate, but not to exceed the estimated economic life of the product.  We evaluate many factors in determining the estimated economic life of our products, including the support period of the product, technological obsolescence, and customer expectations.  We have concluded that our software products have estimated economic lives ranging from five to seven years.

 

Under the bell-shaped curve approach of establishing VSOE, we perform VSOE compliance tests to ensure that a substantial majority of our actual PCS renewals are within a narrow range of pricing.

 

For certain of our products, we do not have an explicit obligation to provide PCS but as a matter of business practice have provided implied PCS.  The implied PCS is accounted for as a separate element for which VSOE does not exist.  Arrangements comprised of software only elements that contain implied PCS are recognized over the period the implied PCS is provided, but not to exceed the estimated economic life of the product.

 

Some of our arrangements require significant customization of the product to meet the particular requirements of the customer.  For these arrangements, revenue is recognized under contract accounting methods, typically using the percentage-of-completion (“POC”) method.  Under the POC method, revenue recognition is generally based upon the ratio of hours incurred to date to the total estimated hours required to complete the contract.  Profit estimates on long-term contracts are revised periodically based on changes in circumstances, and any losses on contracts are recognized in the period that such losses become evident.  If the range of profitability cannot be estimated, but some level of profit is assured, 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.  In the event some level of profitability on a contract cannot be assured, the completed-contract method of revenue recognition is applied.

 

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If an arrangement includes customer acceptance criteria, revenue is not recognized until we can objectively demonstrate that the software or services meet the acceptance criteria, or the acceptance period lapses, whichever occurs earlier.  If an arrangement containing software elements obligates us to deliver specified future software products or upgrades, revenue related to the software elements under the arrangement is initially deferred and is recognized only when the specified future software products or upgrades are delivered, or when the obligation to deliver specified future software products expires, whichever occurs earlier.

 

We record provisions for estimated product returns in the same period in which the associated revenue is recognized.  We base these estimates of product returns upon historical levels of sales returns and other known factors.  Actual product returns could be different from our estimates, and current or future provisions for product returns may differ from historical provisions.  Concessions granted to customers are recorded as reductions to revenue in the period in which they were granted.  The vast majority of our contracts are successfully completed, and concessions granted to customers are minimal in both dollar value and frequency.

 

Product revenue derived from shipments to resellers and original equipment manufacturers (“OEMs”) who purchase our products for resale are generally recognized when such products are shipped (on a “sell-in” basis).  We have historically experienced insignificant product returns from resellers and OEMs, and our payment terms for these customers are similar to those granted to our end-users.  If a reseller or OEM develops a pattern of payment delinquency, or seeks payment terms longer than generally accepted, we defer the recognition of revenue until the receipt of cash.  Our arrangements with resellers and OEMs are periodically reviewed as our business and products change.

 

In instances where revenue is derived from sale of third-party vendor services and we are a principal in the transaction, we generally record revenue at gross and record costs related to a sale in cost of revenue.  In those cases where we are acting as an agent between the customer and the vendor, revenue is recorded net of costs.

 

We record reimbursements from customers for out-of-pocket expenses as revenue.  Shipping and handling fees and expenses that are billed to customers are recognized in revenue and the costs associated with such fees and expenses are recorded in cost of revenue.  Historically, these fees and expenses have not been material.  Taxes collected from customers and remitted to government authorities are excluded from revenue.

 

Other Accounting Pronouncements Implemented — Three and Nine Months Ended October 31, 2011:

 

In January 2010, the FASB issued amended standards that require additional fair value disclosures.  These disclosure requirements were effective in two phases.  The initial phase, which was effective for us as of February 1, 2010, requires enhanced disclosures about inputs and valuation techniques used to measure fair value as well as disclosures about significant transfers.  The second phase, which was effective for us as of February 1, 2011, requires presentation of disaggregated activity within the reconciliation for fair value measurements using significant unobservable inputs (Level 3).  The adoption of these standards did not have a material impact on our condensed consolidated financial statements.

 

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In December 2010, the FASB issued updated accounting guidance to clarify that pro forma disclosures should be presented as if a business combination occurred at the beginning of the prior annual period for purposes of preparing both the current reporting period and the prior reporting period pro forma financial information.  These disclosures should be accompanied by a narrative description about the nature and amount of material, nonrecurring pro forma adjustments.  This new accounting guidance is effective for business combinations consummated in periods beginning after December 15, 2010 and should be applied prospectively as of the date of adoption, although early adoption is permitted.  We adopted this new guidance effective February 1, 2011.  The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.

 

In December 2010, the FASB issued updated accounting guidance related to the calculation of the carrying amount of a reporting unit when performing the first step of a goodwill impairment test.  This update modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts.  For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists.  In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider and assess whether there are any adverse qualitative factors indicating that impairment may exist.  For public entities, this new accounting guidance is effective for impairment tests performed during fiscal years (and interim periods within those years) that began after December 15, 2010.  We adopted this new guidance effective February 1, 2011. We do not believe that the adoption of this guidance will have a material impact on our future tests for goodwill impairment.

 

New Pronouncements to be Implemented:

 

In May 2011, the FASB issued updated accounting guidance to amend existing requirements for fair value measurements and disclosures.  The guidance expands the disclosure requirements around fair value measurements categorized in Level 3 of the fair value hierarchy and requires disclosure of the level in the fair value hierarchy of items that are not measured at fair value but whose fair value must be disclosed.  It also clarifies and expands upon existing requirements for fair value measurements of financial assets and liabilities as well as instruments classified in stockholders’ equity.  The guidance is effective for us beginning with our three-month period ending April 30, 2012.  We are assessing the impact that the application of this guidance may have on our consolidated financial statements.

 

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In June 2011, the FASB issued amended standards regarding the presentation of comprehensive income.  These amendments eliminate the option to present components of other comprehensive income as part of the statement of stockholders’ equity and requires the presentation of comprehensive income, the components of net income, and the components of other comprehensive income in either a single continuous statement of comprehensive income or in two separate but consecutive statements.  The items that must be reported within other comprehensive income and the criteria for determining when an item of other comprehensive income must be reclassified to net income were not changed.  These amended standards are effective for us beginning with our three-month period ending April 30, 2012 and must be applied retrospectively.  Other than the change in presentation, these changes will not have an impact on our consolidated financial statements.

 

In September 2011, the FASB issued amended standards intended to simplify how tests for potential goodwill impairment are performed.  These amended standards permit an assessment of qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit in which goodwill resides is less than its carrying value.  For reporting units in which this assessment concludes it is more likely than not that the fair value is more than its carrying value, these amended standards eliminate the requirement to perform further goodwill impairment testing as required under the previous standards.  These amended standards are effective for us beginning with our three-month period ending April 30, 2012; however, we plan to early adopt these standards in our three-month period ending January 31, 2012, as permitted by the amended standards.  We do not expect these new standards to significantly impact our consolidated financial statements.

 

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2.              NET INCOME PER SHARE ATTRIBUTABLE TO VERINT SYSTEMS INC.

 

The following table summarizes the calculation of basic and diluted net income per share attributable to Verint Systems Inc. for the three and nine months ended October 31, 2011 and 2010:

 

		Three Months Ended October 31,						Nine Months Ended October 31,
(in thousands, except per share amounts)		2011			2010			2011			2010
Net income		$	9,921		$	18,388		$	22,750		$	15,163
Net income attributable to noncontrolling interest		470			1,214			2,936			2,722
Net income attributable to Verint Systems Inc.		9,451			17,174			19,814			12,441
Dividends on preferred stock		(3,747		)	(3,592		)	(11,003		)	(10,549		)
Net income attributable to Verint Systems Inc. for basic net income per share		5,704			13,582			8,811			1,892
Dilutive effect of dividends on preferred stock		—			3,592			—			—
Net income attributable to Verint Systems Inc. for diluted net income per share		$	5,704		$	17,174		$	8,811		$	1,892
Weighted-average shares outstanding
Basic		38,807			35,368			38,263			33,785
Dilutive effect of employee equity award plans		456			2,040			1,004			2,740
Dilutive effect of assumed conversion of preferred stock		—			10,271			—			—
Diluted		39,263			47,679			39,267			36,525
Net income per share attributable to Verint Systems Inc.
Basic		$	0.15		$	0.38		$	0.23		$	0.06
Diluted		$	0.15		$	0.36		$	0.22		$	0.05

 

We excluded the following weighted-average shares underlying stock-based awards and convertible preferred stock from the calculations of diluted net income per share because their inclusion would have been anti-dilutive:

 

		Three Months Ended October 31,				Nine Months Ended October 31,
(in thousands)		2011		2010		2011		2010
Shares excluded from calculation:
Stock options and restricted stock-based awards		1,404		1,215		984		1,429
Convertible preferred stock		10,675		—		10,573		10,173

 

3.              INVENTORIES

 

Inventories consisted of the following as of October 31, 2011 and January 31, 2011:

 

		October 31,			January 31,
(in thousands)		2011			2011
Raw materials		$	4,712		$	7,112
Work-in-process		6,174			5,112
Finished goods		3,928			4,763
Total inventories		$	14,814		$	16,987

 

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4.              BUSINESS COMBINATIONS

 

For the Nine Months Ended October 31, 2011

 

Vovici Corporation

 

On August 4, 2011, we acquired all of the outstanding shares of Vovici Corporation (“Vovici”), a U.S.-based, privately held provider of online survey management and enterprise feedback solutions.  This acquisition enhances our Enterprise Intelligence product suite to include comprehensive Voice of the Customer (“VoC”) software and services offerings, designed to help organizations implement a single-vendor solution set for collecting, analyzing, and acting on customer insights.  We have included the financial results of Vovici in our consolidated financial statements since August 4, 2011.

 

We acquired Vovici for approximately $56.1 million in cash at closing, including $0.4 million to repay Vovici’s bank debt.  In addition, the consideration also included the exchange of certain unvested Vovici stock options for options to acquire approximately 42,000 shares of Verint common stock with fair values totaling $1.0 million, of which $0.1 million represents compensation for pre-acquisition services and is included in the consideration transferred and $0.9 million is being recognized as stock-based compensation expense over the remaining future vesting periods of the awards.  We also agreed to make potential additional cash payments of up to approximately $19.1 million, contingent upon the achievement of certain performance targets over the period ending January 31, 2013.  The fair value of this contingent obligation was estimated to be $9.9 million at August 4, 2011.

 

The $9.9 million acquisition date fair value of the contingent consideration obligation was estimated based on the probability adjusted present value of the consideration expected to be transferred  using significant inputs that are not observable in the market.  Key assumptions used in this estimate include probability assessments with respect to the likelihood of achieving the performance targets and discount rates consistent with the level of risk of achievement.  At each reporting date, we revalue the contingent consideration obligation to its fair value and record increases and decreases in fair value within selling, general and administrative expenses in our condensed consolidated statements of operations.  Increases or decreases in the fair value of the contingent consideration obligation may result from changes in discount periods and rates, and changes in probability assumptions with respect to the likelihood of achieving the performance targets.  We recorded expense of approximately $0.3 million for the three months ended October 31, 2011, reflecting the impact of revised assessments of the probability of payment, as well as the decrease in the discount period since the acquisition date.  As of October 31, 2011, the fair value of this contingent consideration obligation was approximately $10.2 million.

 

The purchase price was allocated to the tangible assets and intangible assets acquired and liabilities assumed based on their estimated fair values on the acquisition date, with the remaining unallocated purchase price recorded as goodwill.  The fair values assigned to identifiable intangible assets acquired was determined primarily by using the income approach, which discounts expected future cash flows to present value using estimates and assumptions determined by management.  The acquired identifiable intangible assets are being amortized on a

 

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straight-line basis, which we believe approximates the pattern in which the assets are utilized, over their estimated useful lives.

 

Among the factors contributing to the recognition of goodwill in this transaction were synergies in products and technologies, and the addition of a skilled, assembled workforce.  This goodwill has been assigned to our Enterprise Intelligence segment and is not deductible for income tax purposes.

 

In connection with the purchase price allocation, the estimated fair value of support obligations assumed from Vovici was determined utilizing a cost build-up approach. The cost build-up approach calculates fair value by estimating the costs relating to fulfilling these obligations plus a normal profit margin, which approximates the amount that we believe would be required to pay a third party to assume the support obligations.  The estimated costs to fulfill the support obligation were based on the historical direct costs related to providing support services.  These estimated costs did not include any costs associated with selling efforts or research and development or the related margins on these costs.  Profit associated with selling efforts is excluded because the selling effort on the support contracts concluded prior to the August 4, 2011 acquisition date.  The estimated profit margin was 15%, which we believe best approximates our operating profit margin to fulfill support obligations.  As a result, in allocating the purchase price, we recorded an adjustment to reduce the $5.3 million carrying value of Vovici’s deferred revenue to $2.3 million, representing the estimated fair value of the support obligations assumed.  As former Vovici customers renew their support contracts, we will recognize revenue at the full contract value over the remaining term of the contracts.

 

Revenue attributable to Vovici from August 4, 2011 through October 31, 2011 was $2.3 million.  The impact of Vovici on net income for this period was not significant.

 

Transaction and related costs, consisting primarily professional fees and integration expenses, directly related to the acquisition of Vovici, totaled $2.5 million for the nine months ended October 31, 2011, including $1.3 million incurred during the three months ended October 31, 2011, and were expensed as incurred.

 

Global Management Technologies

 

On October 7, 2011, we acquired all of the outstanding shares of Global Management Technologies (“GMT”), a U.S.-based, privately held provider of workforce management solutions whose software and services are widely used by organizations, particularly in retail branch banking environments.  This acquisition adds key functionality to our Enterprise Intelligence product suite.  We have included the financial results of GMT in our consolidated financial statements since October 7, 2011.

 

We acquired GMT for approximately $24.6 million in cash at closing.  We also agreed to make potential additional cash payments of up to approximately $17.4 million, contingent upon the achievement of certain performance targets over the period ending January 31, 2014.  The fair value of this contingent obligation was estimated to be $12.0 million at October 7, 2011.

 

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