UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

For the quarterly period ended April 30, 2009

or

 

Commission File Number: 0-30121

 

ULTICOM, INC.

(Exact name of registrant as specified in its charter)

 

(856) 787-2700

(Registrant's telephone number, including area code)

 

Not Applicable

(Former name, former address and former fiscal year,

if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

The number of shares of Common Stock, no par value, outstanding as of October 15, 2009 was 43,926,643.

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FORWARD-LOOKING STATEMENTS

 

Certain statements by Ulticom, Inc. (referred to herein as “Ulticom,” “the Company,” “we,” “our” or “us”) appearing in the Explanatory Note, Item 2 (Management’s Discussion and Analysis of Financial Condition and the Results of Operations) and elsewhere in this Quarterly Report on Form 10-Q constitute “forward-looking statements” for purposes of the Private Securities Litigation Reform Act of 1995. In some cases, forward-looking statements can be identified by the use of terminology such as “may,” “will,” “expects,” “plans,” “anticipates,” “estimates,” “believes,” “potential” or “continue” or the negative thereof or other comparable terminology.

 

The Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2009 (“Fiscal Year 2008 Form 10-K”), which was filed with the Securities and Exchange Commission (“SEC”) on September 30, 2009, included the Company’s consolidated financial statements as of and for the fiscal years ended January 31, 2006, 2007, 2008 and 2009.

 

As described in the Fiscal Year 2008 Form 10-K, there are numerous risks and uncertainties that could cause actual results and the timing of events to differ materially from those anticipated by the forward-looking statements made therein and in this Quarterly Report on Form 10-Q and that may give rise to future claims and increase our exposure to contingent liabilities. These risks and uncertainties arise from (among other factors):

 

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significant indemnification liabilities being uninsured, which could have a material adverse effect on our business, financial position, results of operations or cash flows;

 

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These risks and uncertainties, as well as other factors, are discussed in greater detail in Item 1A (Risk Factors) in the Fiscal Year 2008 Form 10-K. The Company makes no commitment to revise or update any forward-looking statements in order to reflect events or circumstances after the date any such statement is made, except where otherwise required by law.

 

EXPLANATORY NOTE

The improper accounting practices identified by the Audit Committee in the course of the Audit Committee Investigations (as defined below) necessitated certain restatement adjustments in our consolidated financial statements. In addition, the Company’s incorrect application of the accounting guidance in AICPA Statement of Position No. 97-2, “Software Revenue Recognition” (“SOP No. 97-2”), for a portion of its revenues in each of the fiscal years from fiscal year 1998 through fiscal year 2004 and its incorrect application of accounting principles with respect to the recognition of depreciation expense required the Company to make additional restatement adjustments in its consolidated financial statements as of February 1, 2005. As a result, the Company was unable to file periodic reports with the Securities and Exchange Commission (“SEC”) during the period from December 2005 to September 30, 2009, the filing date of the Fiscal Year 2008 Form 10-K.

The Company’s fiscal year begins on February 1 and ends on January 31. The Company’s fiscal year end has been January 31 since the fiscal year ended January 31,1999 (i.e., fiscal year 1998).Prior to fiscal year 1998, the Company’s annual reporting period was on a calendar year basis (i.e., December 31 year end).

The Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2009 (“Fiscal Year 2008 Form 10-K”), which was filed with the SEC on September 30, 2009, contained, among other things:

1) the Company’s consolidated financial statements for the fiscal years ended January 31, 2006, 2007, 2008 and 2009, as well as a Management’s Discussion and Analysis of Financial Condition and Results of Operations as of and for the fiscal years presented;

2) restatement of certain financial data presented in “Selected Consolidated Financial Data” in Item 6 of the Company’s Fiscal Year 2008 Form 10-K as of and for the fiscal year ended January 31, 2005;

3) disclosures of the results of the Company’s Audit Committee Investigations regarding certain improper option grant-related accounting practices, excess expense accruals and improper deferral of revenues (collectively, the “Audit Committee Investigations”), each of which impacted certain originally reported amounts in the Company’s consolidated financial statements for each of the fiscal years beginning with the fiscal year ended December 31, 1996 and concluding with the fiscal year ended January 31, 2005, and each of which resulted in restatement adjustments; and

4) disclosures of the restatement adjustments to correct material errors resulting from incorrect application of the accounting guidance in SOP No. 97-2, for that portion of the Company’s revenues impacted by SOP No. 97-2 (i.e., certain software sales contracts with third-party customers), for each of the fiscal years from

 

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fiscal year 1998 through fiscal year 2004. Also included were disclosures of restatement adjustments to correct errors in the recognition of depreciation expense for each of the fiscal years from fiscal year 1999 through fiscal year 2004.

With the filing of the Fiscal Year 2008 Form 10-K, the Company has provided its audited annual consolidated financial statements for each of the fiscal years ended January 31, 2006, 2007, 2008 and 2009. In addition the Company, on September 30, 2009, filed its Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 2008 and is filing contemporaneously with this Quarterly Report on Form 10-Q for the fiscal quarter ended April 30, 2009, its Quarterly Report on Form 10-Q for the fiscal quarter ended July 31, 2009. The Company does not plan to file Quarterly Reports on Form 10-Q for the fiscal quarters ended April 30, 2006; July 31, 2006; October 31, 2006; April 30, 2007; July 31, 2007; October 31, 2007; April 30, 2008 and July 31, 2008.

The Company has not amended and does not plan to amend its Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q that were filed by the Company since its initial public offering on April 5, 2000 and prior to September 30, 2009, the filing date of the Fiscal Year 2008 Form 10-K and the Quarterly Report on Form 10-Q for the quarterly period ended October 31, 2008. Accordingly, as disclosed in the Company’s Current Report on Form 8-K dated April 16, 2006, the consolidated financial statements and related financial information contained in such previously filed reports should not be relied upon. For the same reason, investors also should not rely on any financial results previously reported in Current Reports on Form 8-K filed prior to September 30, 2009.

 

Background of Restatement

 

On March 13, 2006, the Company’s Audit Committee of the Board of Directors (the “Audit Committee”) was informed by the Company's Chief Executive Officer, Shawn Osborne (“Osborne”), that the Company’s majority shareholder, Comverse Technology, Inc., had determined, on a preliminary basis, that the stated dates of certain Comverse Technology, Inc. stock option grants differed from the measurement dates required to be used for purposes of determining the value of such grants, and that a similar issue might exist with respect to option grants made by the Company. That day, the Company's Audit Committee began a review of all matters relating to its historical stock option grant practices, including, but not limited to, the accuracy of the stated dates of option grants and whether proper corporate procedures had been followed with respect to those grants. The Audit Committee retained independent legal counsel, Dickstein Shapiro, LLP (“Dickstein”), who in turn retained AlixPartners, a forensic accounting firm, to analyze the impact such matters may have on our historical financial statements. The Company announced the commencement of this independent investigation on March 14, 2006 (“Phase I”).

 

Concurrent with the commencement of the investigation by the Audit Committee, on March 14, 2006, Comverse Technology, Inc. announced the creation of a Special Committee of its Board of Directors to review matters relating to Comverse Technology, Inc.’s stock option grants, including, but not limited to, the accuracy of the stated dates of option grants and whether all proper corporate procedures were followed. Once informed that Comverse Technology, Inc.’s Special Committee had determined that the stated dates of certain Comverse Technology, Inc.’s stock option grants differed from the measurement dates required to be used for purposes of determining the value of such grants and to recognize the related compensation expense in

 

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accordance with accounting principles generally accepted in the United States of America (“GAAP”), the Company was also required to record non-cash charges for stock-based compensation expenses with respect to the issuance by Comverse Technology, Inc. of options to purchase Comverse Technology, Inc.’s common stock to Company employees during periods that the Company was a wholly-owned subsidiary of Comverse Technology, Inc. Since the Company’s public offering in October 2000, Comverse Technology, Inc. has owned approximately 68% of the outstanding shares of the Company.

 

In August 2006, the U. S. Securities and Exchange Commission (“SEC”) filed a civil complaint against Jacob “Kobi” Alexander (“Alexander”), Comverse Technology, Inc.’s former Chairman and Chief Executive Officer who was also the Chairman of the Board of Directors of the Company, David Kreinberg (“Kreinberg”), Comverse Technology, Inc.’s former Executive Vice President and Chief Financial Officer who was also a member of the Company’s Board of Directors and served as the Company’s Chief Financial Officer from December 1999 through early September 2001, and William Sorin (“Sorin”), formerly Comverse Technology, Inc.’s General Counsel and subsequently its Senior Counsel who was also a member of the Company’s Board of Directors and served as the Company's de facto legal counsel and Secretary until June 2004, alleging that they engaged in fraudulent practices with respect to the option grant processes of Comverse Technology, Inc. and the Company. Subsequently, Kreinberg and Sorin have pled guilty to fraud charges and there is a pending indictment against Alexander, who has fled the United States. A warrant has been issued for Mr. Alexander’s arrest and his 690,000 shares of Ulticom common stock (representing 1.57% of our issued and outstanding common stock as of October 15, 2009) are now in the possession of the U.S. Marshals Service Asset Forfeiture Office.

 

In addition to the investigation regarding past stock option grant practices, on November 16, 2006, the Company announced that its Audit Committee had commenced an investigation into past accounting practices not related to stock option grants, including the treatment of accounting reserves and the shortening of the depreciable lives of certain computer assets (“Phase II”). The investigation, which was expanded to include the improper deferral of revenue recognition on certain inter-company transactions, reviewed the fiscal years beginning in 1996 through 2004. The Audit Committee was again assisted by Dickstein and AlixPartners. The Audit Committee initiated the Phase II investigation because of certain allegations made by the former CFO of Comverse Technology, Inc. that he directed the finance and accounting officers of Comverse Technology, Inc.’s subsidiaries to make adjustments to their quarter-end expense accruals and reserve accounts.

 

During the process of correcting the errors in its consolidated financial statements resulting from the aforementioned accounting practices, the Company determined that it had incorrectly applied the provisions of SOP No. 97-2 with respect to the recognition of revenue of certain software sales contracts with third-party customers. Specifically, the Company had been providing one year of free maintenance to certain customers licensing its software, but had not been deferring any portion of the software licensing fees. On November 29, 2007, the Company announced it was conducting an evaluation of certain revenue recognition practices to determine whether, under SOP No. 97-2, it should have deferred a portion of the revenues that were recognized under certain customer contracts, amounting to the fair value of the first-year software maintenance included under such contracts, to subsequent fiscal periods in the following twelve months. In order to be able to defer only the first year maintenance value under the relevant customer contracts (rather than the entire contract value), the Company had to demonstrate that

 

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vendor specific objective evidence ("VSOE") existed for the fair value of the first year of software maintenance included under the contracts. The Company subsequently determined that VSOE of fair value existed and that the required corrective adjustments impacted the timing of revenue recognition, but did not call into question the validity of the underlying transactions or revenue. The Company also determined that revenue related to the sale of software development kits should have been deferred over the estimated period of future customer software deployments and related maintenance. The years impacted by the errors in recognizing software revenue were each of the fiscal years from 1998 to 2004.

 

Additionally, the Company determined that certain errors had been made in its recognition of depreciation expense for each of the fiscal years from 1999 to 2004. These errors primarily resulted in the Company reflecting more depreciation expense in the first year the assets were placed in service than is permitted under GAAP.

 

The cumulative impact to correct all of the aforementioned errors, net of related income tax effects, was to reduce retained earnings by approximately $6.8 million as of February 1, 2005, the commencement date of the first fiscal year covered by the Fiscal Year 2008 Form 10-K. The Company has made corrective adjustments for each of these errors, including related income tax effects, by restating its consolidated retained earnings as of February 1, 2005 as follows:

 

 

(In thousands)

Results and Conclusions of Phase I of the Audit Committee Investigations (Stock Option

Grant Practices)

 

On March 28, 2008, the Company filed a Current Report on Form 8-K announcing the findings and conclusions of the Audit Committee Investigations, together with related remedial measures.

 

In the course of Phase I of the Audit Committee Investigations, approximately 70,000 documents and data files were reviewed and analyzed and 25 interviews of current and former Comverse Technology, Inc. and Company personnel and Stock Option Committee members were conducted by Dickstein. During the course of the Phase I investigation (March through May, 2006), Dickstein had 13 in-person and telephonic meetings with the Audit Committee at which the investigation was thoroughly discussed. In addition, Dickstein provided the Audit Committee its interview memoranda and selected documents. Management cooperated fully in the investigations.

 

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The scope of Phase I of the Audit Committee Investigations encompassed the Company’s practices relating to option grants from April 2000 (the year of the Company's initial public offering) through fiscal 2005, and entailed the examination of 22 separate grants of options to purchase more than 5,806,248 shares of common stock to approximately 433 individuals.

 

The salient factual findings of Phase I were as follows:

 

On February 1, 1998, the Company entered into a Services Agreement with Comverse Technology, Inc. pursuant to which Comverse Technology, Inc. agreed to provide consulting on financial planning and reporting, routine legal services, administration of employee benefit plans, directors’ and officers’ insurance, umbrella insurance and consulting on public relations to the Company in exchange for a quarterly fee.

 

Certain former executive officers of Comverse Technology, Inc. exercised a high degree of control over the legal and financial reporting functions of the Company. From the date of Comverse Technology, Inc.'s acquisition of the Company's predecessor on August 30, 1995, until he resigned from his position on April 28, 2006, Alexander, Comverse Technology, Inc.’s former Chairman and Chief Executive Officer, was the Chairman of the Board of Directors of the Company. From at least 2000 until he resigned from his position on April 28, 2006, Kreinberg, Comverse Technology, Inc.’s former Executive Vice President and Chief Financial Officer, was a member of the Company’s Board of Directors and served as the Company’s Chief Financial Officer from December 1999 through early September 2001, when the Company’s current Chief Financial Officer, Mark Kissman (“Kissman”), joined the Company and assumed that position. From at least 2000 through May 2004, Sorin, formerly Comverse Technology, Inc.’s General Counsel and subsequently its Senior Counsel, was also a member of the Company’s Board of Directors, and served as the Company's de facto legal counsel and Secretary until June 2004.

 

Kreinberg would instruct Company employees responsible for administering the option grants to select a grant date by looking back at the closing price of the Company’s stock for a period of time and select the date on which the price was lowest during that period. Based on templates initially prepared by Sorin, a unanimous written consent (“UWC”) reflecting “as of” grant dates was prepared and circulated to the Company’s Stock Option Committee members to obtain their approval of the option grant.

 

Pursuant to Kreinberg’s direction and with the knowledge and participation of Sorin, historical grant dates were selected with respect to eight grants of stock options to the Company’s management and employees between April 2000 and April 2004; however, the selection of historical dates resulted in significantly advantageous exercise prices with respect to only the first three grants during this period, the last of which was in March 2001. None of the advantageously priced options were exercised by the Company’s CEO or current CFO.

 

The Audit Committee concluded that:

 

 

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employees during 1995 through 1997, when Ulticom was a wholly-owned subsidiary of Comverse Technology, Inc. These improper procedures resulted in a restatement adjustment of approximately $2.6 million, net of related income tax effects, to reduce retained earnings as of February 1, 2005, so as to correct the errors in the Company’s stock-based compensation expense occurring in each of the years beginning with 1996 and ending with the year ended January 31, 2005;

 

 

 

 

On March 28, 2008, the Board of Directors unanimously approved the following remedial measures recommended by the Audit Committee with respect to the improper historical stock option grant practices:

 

 

 

 

Results and Conclusions of Phase II of the Audit Committee Investigations (Non-Option Grant-Related Accounting Practices)

 

As announced by the Company on November 16, 2006, the Audit Committee expanded its investigation and adopted a comprehensive work plan, implemented with the assistance of Dickstein and AlixPartners, that focused upon two areas that, according to allegations made by Kreinberg to government prosecutors, Comverse Technology, Inc. and its subsidiaries had manipulated: (1) adjustment of accruals and reserves, and (2) improper shortening of depreciable lives on the Company’s computers in fiscal 2001. Ultimately, the depreciable lives of the Company’s computers were found to be appropriate. The Audit Committee authorized Dickstein and AlixPartners to expand the investigation into any other practices that appeared to be problematic or in violation of GAAP. One such other improper practice was in fact subsequently discovered – namely, the inappropriate deferral of recognition of certain inter-company revenues.

 

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During the course of Phase II of the Audit Committee Investigations (December 2006 through August 2007), approximately 20,000 documents and data files were reviewed and analyzed and 19 interviews of current and former Company personnel were conducted by Dickstein and AlixPartners. Dickstein had well over 20 in-person and telephonic meetings with the Audit Committee at which the investigation was thoroughly discussed and provided the Audit Committee its interview memoranda and selected documents. Management cooperated fully in the investigations.

 

Phase II of the Audit Committee Investigations resulted in a net restatement adjustment of approximately $19,000, net of related income tax effects, to increase retained earnings as of February 1, 2005, as a consequence of correcting errors made to various accrued expenses for each of the years beginning with 1996 and ending with the fiscal year ended January 31, 2004.

 

The Audit Committee found that the accounting practices at issue (excess accruals and improper deferral of revenue) were implemented at the Company under the direction of Kreinberg, who was Chief Financial Officer of Comverse Technology, Inc. throughout the period at issue and Chief Financial Officer of the Company from December 1999 through early September 2001, for the purpose of achieving an upward trend of growth in the Company’s revenue and income. From fiscal 1996 (year ended December 31, 1996) through early September 2001, Kreinberg managed and controlled the financial reporting process at the Company. All quarterly reporting packages were reviewed and approved by Kreinberg, who directed Lisa Roberts (“Roberts”), the Company’s highest ranking finance officer from late 1996 through late 1999 and second highest ranking finance officer during Kreinberg’s tenure as Chief Financial Officer at the Company, to make any changes and to resubmit the reporting packages to him. The Audit Committee and the Company’s independent registered public accounting firm had no knowledge of the practices at issue.

 

The Audit Committee found that the Company’s Chief Executive Officer, Osborne, reasonably relied upon Kreinberg’s accounting expertise and control over the financial reporting process at the Company and did not participate in and was not aware of any of the Phase II–covered accounting practices at the time these practices were occurring.

 

With respect to the allegations of excess/unsupported accruals described above, the Audit Committee found that:

 

 

 

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substantial downward revisions to certain accrual accounts during the fourth quarter of fiscal 2001, but did not entirely eliminate excess/unsupported accruals and reserves;

 

 

 

With respect to improper deferral of revenue, the Audit Committee found that:

 

 

 

 

The Company’s Board of Directors unanimously approved various remedial measures recommended by the Audit Committee with respect to the accounting practices investigation including:

 

 

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In response to the above remedial measures approved by the Board, the Company has implemented the following changes to address these issues:

 

 

 

 

 

 

 

 

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Results and Conclusions of Revenue Recognition Practices Evaluation

 

In connection with the preparation of its financial statements, and independent of the Audit Committee’s Investigations, in November, 2007, the Company commenced an evaluation of its software revenue recognition practices for complex contractual arrangements under SOP No. 97-2. The results of the Company’s evaluation were disclosed to the Audit Committee and the Audit Committee specifically considered the Company’s revenue recognition practices under SOP No. 97-2. Directed by the Audit Committee, Dickstein and AlixPartners LLP, reviewed documentary evidence and interviewed Lisa Roberts, who served as Ulticom’s highest ranking and second highest ranking financial officer during the period when the accounting treatment was first developed and implemented. The Audit Committee concluded that if Ulticom misapplied SOP No. 97-2 with respect to the recognition of revenue on the third-party software contracts at issue, the misapplication was a good faith mistake and not part of any attempt to manipulate or distort the Company’s financial results.

 

The Company determined that under SOP No. 97-2, it should have deferred a portion of the revenues that were recognized under certain customer contracts; specifically, the fair value of the first-year software maintenance included under such contracts should have been deferred and amortized to revenues over the initial maintenance period, generally twelve months. The Company has also determined that revenue related to the sale of software development kits should have been deferred and amortized to revenues over the estimated period of future customer software deployments and related maintenance. The errors resulting from improper application of SOP No. 97-2 impacted fiscal years beginning with the fiscal year ended January 31, 1999 and ending with the fiscal year ended January 31, 2005. The cumulative effect of these errors for these fiscal years resulted in overstatements of revenues and cost of revenues of approximately $7.5 million and $0.4 million, respectively, or a net overstatement of income before income tax expense of approximately $7.1 million. Including related income tax effects, the net cumulative adjustment to properly reflect the deferral of revenue and costs in accordance with SOP No. 97-2 was a reduction of retained earnings as of February 1, 2005 of approximately $4.4 million.

 

Results and Conclusions of Depreciation Expense Recognition Evaluation

 

During the fourth quarter of fiscal year 2007, independent of the Audit Committee’s Investigations, the Company determined that certain errors had been made in its recognition of depreciation expense for each of the fiscal years from 1999 to 2004. These errors primarily resulted in the Company reflecting more depreciation expense in the first year the assets were placed in service than is permitted under GAAP and their correction required a cumulative increase of approximately $141,000, net of related income tax effects, in the Company’s retained earnings as of February 1, 2005.

 

SEC Enforcement Settlement and Final Judgment

 

On June 18, 2009 the SEC announced that it had filed a civil injunctive action against the Company, in the U.S. District Court for the Eastern District of New York (the “Court”), for violations of:

 

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Simultaneous with the filing of the Complaint, without admitting or denying the allegations therein, the Company consented to the issuance of a Final Judgment (the “Final Judgment”). The Court imposed the Final Judgment on July 22, 2009, ordering that the Company and its agents are permanently restrained and enjoined from violations, directly or indirectly, of Section 17(a) of the Securities Act of 1933, Sections 13(a), 13(b)(2)(A) and (B) and 14(a) of the Securities Exchange Act of 1934 and SEC Rules 13a-1, 13a-11, 13a-13 and 14a-9. The Final Judgment also orders the Company to become current in its reporting obligations under Section 13(a) of the Securities Exchange Act of 1934 on or before November 9, 2009.

 

 

 

 

 

 

 

 

 

 

 

 

 

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PART I – FINANCIAL INFORMATION

 

 

ULTICOM, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except share data)

 

 

* The Condensed Consolidated Balance Sheet as of January 31, 2009 has been derived from the Company’s audited Consolidated Balance Sheet as of that date.

 

The accompanying notes are an integral part of these unaudited financial statements.

 

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ULTICOM, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these unaudited financial statements.

 

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ULTICOM, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

 

 

 

 

The accompanying notes are an integral part of these unaudited financial statements.

 

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ULTICOM, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Company Business and Background - Ulticom, Inc. (together with its subsidiaries, the “Company"), a New Jersey corporation and a majority-owned subsidiary of Comverse Technology, Inc., designs, develops, markets, licenses, and supports service enabling signaling software for fixed, mobile, and internet communications software and hardware for use in the communications industry.

 

Basis of Presentation - The accompanying financial information should be read in conjunction with the consolidated financial statements, including the notes thereto, contained in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2009. The condensed consolidated financial information included herein is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments), which are, in the opinion of management, necessary for a fair statement of results for the interim periods. The results of operations for the three months ended April 30, 2008 and 2009 are not necessarily indicative of the results to be expected for the full year.

 

Adoption of Accounting Pronouncements - Effective February 1, 2009, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”) that relate to nonfinancial assets and nonfinancial liabilities. SFAS No. 157 applies to other accounting pronouncements that require or permit fair value measurements, defines fair value based upon an exit price model, establishes a framework for measuring fair value and expands the applicable disclosure requirements. SFAS No. 157 establishes a fair value hierarchy disclosure framework that prioritizes and ranks the level of market price observability used in measuring assets and liabilities at fair value. Market price observability is impacted by a number of factors, including the type of asset or liability and their characteristics. This hierarchy prioritizes the inputs into three broad levels as follows:

 

Level 1 – Quoted prices in active markets for identical instruments;

 

Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model derived valuations in which all significant inputs and significant value drivers are observable in active markets; and

 

Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

 

The application of SFAS No. 157 to the Company’s nonfinancial assets and nonfinancial liabilities as of February 1, 2009 did not have a material effect on the Company’s financial position, results of operations or cash flows.

 

 

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Effective February 1, 2009, the Company adopted SFAS No. 141(R), "Business Combinations" ("SFAS No. 141(R)"). SFAS No. 141(R) replaces SFAS No. 141, "Business Combinations,” but retains the requirement that the purchase method of accounting for acquisitions be used for all business combinations. As it relates to the Company, SFAS No. 141(R) became effective for any business combination with an acquisition date occurring on or after February 1, 2009. As the Company did not complete an acquisition during the three months ended April 30, 2009, the adoption of SFAS No. 141(R) has had no impact on the Company’s consolidated financial statements.

 

Effective February 1, 2009, the Company adopted FASB Staff Position (“FSP”) FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP EITF 03-6-1”). FSP EITF 03-6-1 provides that all outstanding unvested share-based payment awards that contain rights to non-forfeitable dividends participate in the undistributed earnings with the common shareholders and are therefore participating securities. Companies with participating securities are required to apply the two-class method in calculating basic and diluted earnings per share, the effects of which must be applied retrospectively. The effect of applying the guidance of FSP EITF 03-6-1 did not have a material effect on the Company’s basic and diluted earnings per share for all periods presented in the condensed consolidated statements of operations.

 

Recent Accounting Pronouncements - In April 2009, the Financial Accounting Standards Board (“FASB”) issued the following three FSPs that are intended to provide additional application guidance and enhance disclosures about fair value measurements and impairments of securities:

FSP FAS 157-4 clarifies the objective and method of fair value measurement even when there has been a significant decrease in market activity for the asset being measured. FSP FAS 115-2 establishes a new model for measuring other-than-temporary impairments for debt securities, including establishing criteria for when to recognize a write-down through earnings versus other comprehensive income. FSP FAS 107-1 expands the fair value disclosures required for all financial instruments within the scope of SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” to interim periods. All of these FSPs are effective as of the beginning of the Company’s fiscal quarter ended July 31, 2009 and their adoption is not expected to have a material impact on the Company consolidated financial statements and related disclosures.

 

In May 2009, the FASB issued SFAS No. 165, "Subsequent Events" ("SFAS No. 165"). SFAS No. 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. Effective as of the beginning of the Company’s fiscal quarter ended July 31, 2009, the Company’s adoption of SFAS No. 165 is

 

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not expected to have a material impact on the Company consolidated financial statements and notes thereto.

 

In September 2009, the FASB ratified the consensuses reached by the Emerging Issues Task Force (“EITF”) regarding the following issues involving revenue recognition:

 

EITF No. 08-1 applies to multiple-deliverable revenue arrangements that are currently within the scope of EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF No. 08-1 also:

 

EITF No. 09-3 applies to multiple-deliverable revenue arrangements that contain both software and hardware elements, focusing on determining which revenue arrangements are within the scope of the software revenue guidance in AICPA Statement of Position No. 97-2, “Software Revenue Recognition.” EITF No. 09-3 removes tangible products from the scope of the software revenue guidance and provides guidance on determining whether software deliverables in an arrangement that includes a tangible product are within the scope of the software revenue guidance. The accounting guidance in EITF No. 08-1 and EITF No. 09-3 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Alternatively, an entity can elect to adopt the provisions of these issues on a retrospective basis. The Company is assessing the potential impact that the application of EITF No. 08-1 and EITF No. 09-3 may have on its consolidated financial statements and disclosures.

 

 

On April 20, 2009, the Company paid a special cash dividend of $4.58 per share to its shareholders of record as of the close of business on April 13, 2009, totaling approximately $199.6 million. The total amount of the dividend was approximately $199.8 million, which includes approximately $0.2 million of dividends to be paid to holders of deferred stock units awarded under the Company’s equity incentive plan upon each issuance of common stock

 

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subject to such awards. The Company’s retained earnings as of the date of the dividend was approximately $66.0 million. As the amount of the dividend exceeded the Company’s retained earnings as of the date of the dividend, the remaining portion of the dividend, approximately $133.8 million, reduced additional paid-in capital. The Company’s retained earnings as of April 30, 2009 represents the net income of the Company since the date of the dividend.

 

 

As of April 30, 2009, all of the Company’s short-term investments were marketable debt securities that were classified as available-for-sale and summarized in the following table:

 

The Company’s measurements of the fair values of these financial instruments are performed on a recurring basis and, as of April 30, 2009, were based on non-binding market consensus prices that can be corroborated with observable market data. Accordingly, the fair value measurements of these financial instruments were classified as Level 2 in accordance with SFAS No. 157.

 

Interest and other income, net consisted of the following:

 

 

For the three months ended April 30, 2008 and 2009, comprehensive income (loss) consisted of the following:

 

 

Upon the sale of an available-for-sale investment security, the cumulative unrealized gain or loss associated with the sold security that was previously recorded in accumulated other

 

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comprehensive income (loss) is reclassified into the condensed consolidated statement of operations as a realized gain (loss). For each of the three months ended April 30, 2008 and 2009, realized gains, net of applicable income taxes, reclassified into net income were less than $0.1 million.

 

 

Basic earnings (loss) per share is determined by using the weighted average number of shares of common stock outstanding during each period. Diluted earnings per share further assumes the issuance of common shares for all dilutive potential shares outstanding. The share amounts used in the computations of basic and diluted earnings (loss) per share are as follows:

 

 

For purposes of computing basic earnings (loss) per share, any nonvested shares of restricted stock that have been issued by the Company and which vest solely on the basis of a service condition are excluded from the weighted average number of shares of common stock outstanding. Incremental potential common shares from stock options and nonvested restricted stock and deferred stock units (“DSUs”) are included in the computation of diluted earnings per share, except when the effect would be antidilutive. Accordingly, diluted loss per share for the three months ended April 30, 2008 and 2009 excluded outstanding stock options totaling approximately 3.1 million and 3.0 million, respectively, as these potential common shares would have had an antidilutive effect. Also excluded from the computation of diluted loss per share for each of the three month periods ended April 30, 2008 and 2009 were potential common shares of approximately 0.1 million associated with nonvested restricted stock and DSUs, as these potential common shares would have had an antidilutive effect.

 

 

The Company sells products and provides services to other subsidiaries of Comverse Technology, Inc. For the three months ended April 30, 2008 and 2009, included in the Company’s revenues were sales to subsidiaries of Comverse Technology, Inc. of approximately $1.1 million and $0.4 million, respectively.

 

As of January 31, 2009 and April 30, 2009, the amount due from subsidiaries of Comverse Technology, Inc. was approximately $0.1 million and $0.3 million, respectively.

 

 

Stock Option Modifications

 

Effective as of April 21, 2009, the exercise prices of outstanding options to purchase 2,982,104 shares of the Company’s common stock held by 237 current and former employees were reduced

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in connection with the payment of the special cash dividend of $4.58 per share. For the purpose of determining the amount of any incremental share-based compensation cost that may have resulted from the modification of the exercise prices, the Company re-measured the fair value of each modified award immediately prior and subsequent to the modification and determined that none of the modifications required the recognition of additional share-based payment expense.

The table below summarizes the reductions in the exercise prices of the unexercised stock options:

 

 

For the options with an original exercise price of $3.97 per share, a full reduction of $4.58 per share was not possible in order to preserve the option’s characterization under federal income tax law. The exercise price for these options was therefore reduced by $3.47 to $0.50 per share.

Equity Award Grants

 

In February 2009, each independent director of the Company’s Board of Directors was awarded 5,500 deferred stock units (“DSUs”) for their service during the fiscal year ended January 31, 2010. The DSUs vest 25% on April 30, 2009; 25% on July 31, 2009; 25% on October 31, 2009; and 25% on January 31, 2010. Shares of the Company’s common stock equal to the number of vested DSUs will be issued to these directors on or before January 3, 2011. Based on the fair market value of the Company’s common stock at the date of the grant, share-based payment expense related to the grants of these DSUs totaled approximately $0.1 million and was recognized in the condensed consolidated statement of operations for the three months ended April 30, 2009 on a pro rata basis in proportion to the number of vested DSUs as of April 30, 2009.

 

 

The Company and its subsidiaries are subject to U.S. federal income tax, as well as income tax of multiple foreign and state jurisdictions. For all periods presented in the condensed consolidated statements of operations, the Company’s income tax expense (benefit) reflects current and deferred income taxes associated with each of these taxing jurisdictions. In June 2009, the Company reached a settlement with the Internal Revenue Service regarding federal income tax audits for the years ended January 31, 2005 and 2006. Accordingly, the amount of unrecognized income tax benefit obligation that is included in accrued expenses in the condensed consolidated balance sheet as of April 30, 2009 is expected to decrease by approximately $1.0 million in the second fiscal quarter of 2009. Additional changes in the Company’s unrecognized income tax benefit obligation within the next twelve months are not expected to be material.

 

Subject to certain limitations, the Company has agreed to indemnify its current and former directors, officers and employees in connection with any regulatory or litigation matter relating to the improper stock option granting practices described in the Explanatory Note immediately

 

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preceding Part I, Item 1 of this Quarterly Report on Form 10-Q. Such obligations may arise under the terms of the Company’s articles of incorporation, as amended, the Company’s amended and restated bylaws, applicable agreements and New Jersey law. An obligation to indemnify generally means that the Company is required to pay or reimburse the individual’s reasonable legal expenses and possibly damages and other liabilities that may be incurred. The Company’s insurance policies for periods prior to June 29, 2007 are unlikely to provide adequate coverage for expenses resulting from the historical stock option granting practices and any such coverage may have to be shared with related parties. Factors that may affect such coverage are minimum retention requirements and exceptions for certain non-qualifying expenses. Additionally, our current director and officer liability insurance does not provide coverage with respect to our historical stock option granting practices.

 

 

SEC Enforcement Settlement and Final Judgment

 

On June 18, 2009, the SEC announced that it had filed a civil injunctive action against the Company, in the U.S. District Court for the Eastern District of New York (the “Court”), for violations of:

 

 

 

 

 

Simultaneous with the filing of the Complaint, without admitting or denying the allegations therein, the Company consented to the issuance of a Final Judgment (the “Final Judgment”). The Court imposed the Final Judgment on July 22, 2009, ordering that the Company and its agents are permanently restrained and enjoined from violations, directly or indirectly, of Section 17(a) of the Securities Act of 1933, Sections 13(a), 13(b)(2)(A) and (B) and 14(a) of the Securities Exchange Act of 1934 and SEC Rules 13a-1, 13a-11, 13a-13 and 14a-9. The Final Judgment also orders the Company to become current in its reporting obligations under Section 13(a) of the Securities Exchange Act of 1934 on or before November 9, 2009.

 

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The following management’s discussion and analysis should be read in conjunction with the consolidated financial statements and related notes included in the Fiscal Year 2008 Form 10-K. The discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from the results contemplated in these forward-looking statements as a result of factors including, but not limited to, those described under “Item 1A – Risk Factors” of the Fiscal Year 2008 Form 10-K.

 

OVERVIEW OF COMPANY’S OPERATIONS

 

The Company designs, develops, markets, licenses and supports network signaling solutions. Its products are sold primarily through direct sales to network equipment manufacturers, application developers, and service providers who include the Company’s products within their systems or services. Product revenues consist primarily of sales of software licenses and interface boards. Service revenues consist primarily of software maintenance fees related to previously deployed licenses of the Company’s products and fees for support services. Service revenues are expected to show less volatility than product revenues. The key drivers of the Company’s financial results are:

 

 

During the third quarter of fiscal year 2008, the Company’s financial results began to be adversely affected by the ongoing slowdown of infrastructure spending by communication service providers and by declines in technology expenditures. In response to these circumstances, during the fourth fiscal quarter of 2008, the Company took measures to reduce selling, general and administrative expenses, consisting primarily of making reductions in the number of sales and marketing personnel. As a result of implementing these measures, personnel and other labor-related costs charged to selling, general and administrative expenses for fiscal year 2009 is expected to be approximately $1.3 million lower than the comparable amount for fiscal year 2008.

 

Revenues for the three months ended April 30, 2009 declined 27%, as compared to the same period in fiscal year 2008. While the Company has seen modest improvement in quarterly revenues subsequent to the third quarter of fiscal year 2008, management believes that the timing or extent of any recovery in quarterly revenues is uncertain. In September 2009, the Company took additional actions to lower its costs to operate more effectively at these lower sales levels, principally consisting of reductions in the numbers of personnel in substantially all areas of its operations. On an annualized basis, operating expenses are expected to decrease by approximately $2.2 million as a result of the actions taken in September 2009.

 

For the three months ended April 30, 2008 and 2009, the Company’s financial results were also negatively impacted by the substantial expenses related to investigation, restatement and

 

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corporate development activities, as well as employee retention and workforce reduction payments. These expenses are expected to decrease during the fourth quarter of fiscal year 2009.

 

On April 20, 2009, the Company paid a special cash dividend of $4.58 per share to its shareholders of record as of the close of business on April 13, 2009. The total amount of the dividend was approximately $200 million. The Company currently has no plans to pay any additional dividends on its equity securities and believes it has sufficient capital for meeting operational needs, paying liabilities and funding strategic initiatives. The payment of the special dividend reduced the Company’s invested cash by approximately $200 million, and, as a result, interest income will be significantly lower in fiscal quarters subsequent to the first fiscal quarter of 2009.

 

The Company continues to focus on the key elements of its strategy to expand its role as a premium provider of signaling solutions to the telecommunications industry. These elements include the Company leveraging its strengths to maintain and expand its market share in the wireless broadband services and communication infrastructure markets. Specifically, the Company is currently focusing on further developing the following strengths of its business:

 

 

RESULTS OF OPERATIONS

 

Three Months Ended April 30, 2009 Compared to Three Months Ended April 30, 2008

 

Revenues.

 

 

The decrease in the Company’s product revenues was due primarily to decreases in the sales of boards and licenses totaling approximately $4.1 million, most of which was attributable to one of the Company’s largest customers. Additionally, product revenues declined as a result of lower sales to affiliates of Comverse Technology, Inc. of approximately $0.7 million. The Company believes that the demand for its products has been negatively impacted by declines in capital spending by companies operating in the communications industry in recent years. The decline in industry-wide capital spending began to make its most significant adverse impact on the Company’s revenues beginning in the third quarter of fiscal year 2008. Service revenues increased as the installed base of software licenses continued to grow, consequently generating higher levels of fees for software maintenance and support.

 

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Cost of Revenues.

 

 

Lower materials and production costs from the lower volume of sales orders resulted in an approximate $0.4 million decrease in cost of product revenues. Excluding payments to compensate holders of certain expired options of approximately $0.2 million charged to cost of revenues in the first fiscal quarter of 2008, personnel and other labor-related expenses included in total cost of revenues were lower by approximately $0.4 million, primarily as a result of the Company employing fewer production personnel during the three months ended April 30, 2009, as compared to the same period in fiscal year 2008.

 

Research and Development Expenses.

 

 

Personnel and other labor-related costs charged to research and development expenses were lower by approximately $0.7 million, primarily as a result of the Company employing fewer research and development personnel during the three months ended April 30, 2009, as compared to the same period in fiscal year 2008. Additionally, research and development expenses for the three months ended April 30, 2008 included cash payments to compensate holders of expired options in February 2008 of approximately $0.3 million.

 

Selling, General and Administrative Expenses.

 

 

Included in selling, general and administrative expenses were various costs associated with investigation and restatement activities, corporate development, payments made in February 2008 to compensate holders of expired stock options, workforce reductions and employee retention, as summarized in the following table:

 

 

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The investigative activities were completed in early 2008, while restatement related activities have continued into fiscal year 2009 as the Company completes its financial statements and related SEC filings. The Company’s corporate development related activities consisted primarily of exploring various strategic options during the first three months of fiscal 2008 and, for the three months ended April 30, 2009, the evaluation of the special dividend that was paid in April 2009. During each of the fourth fiscal quarters of 2007 and 2008, the Company made reductions in sales, marketing and administrative staff. As a result, workforce reduction costs were incurred during fiscal years 2008 and 2009.

 

Excluding the expenses summarized in the paragraph and table above, selling, general and administrative expenses decreased by approximately $1.4 million during the three months ended April 30, 2009, as compared to the same fiscal period in 2008. Personnel and other labor-related expenses were lower by approximately $0.9 million, primarily as a result of reductions in the Company’s sales, marketing and administrative staff and related travel expenses.

 

Interest and Other Income, net. Interest and other income, net decreased $1.2 million to approximately $0.9 million for the three months ended April 30, 2009, as compared to the same period in fiscal year 2008, primarily due to lower interest income of approximately $1.3 million. The decrease in interest income was primarily due to the significant declines in interest rates on the Company’s cash equivalents and short-term investments occurring throughout fiscal year 2008 and the first quarter of fiscal year 2009. The payment of the special dividend on April 20, 2009 lowered the Company’s total cash equivalents and short-term investments by approximately $200 million and will result in lower interest income in future fiscal quarters.

 

Income Tax Expense (Benefit). For the three months ended April 30, 2008 and 2009, the Company recorded income tax benefits of approximately $0.7 million and $0.5 million, respectively. The Company’s overall effective tax rate was 34% and 37% for the three months ended April 30, 2008 and 2009, respectively.

 

LIQUIDITY AND CAPITAL RESOURCES

 

At January 31, 2009 and April 30, 2009, the Company’s cash and cash equivalents and short-term investments totaled approximately $282.0 million and $81.8 million, respectively. On April 20, 2009, the Company paid a special cash dividend of $4.58 per share to its shareholders of record as of the close of business on April 13, 2009. The total amount of the dividend payment was approximately $200 million. The Company has no current plans to pay additional cash dividends on its equity securities. Any future determination as to the declaration and payment of dividends will be made by the Board of Directors in its discretion and will depend upon the Company’s earnings, financial condition, capital requirements, and other relevant factors.

 

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The Company believes that its cash, cash equivalent and short-term investment balances retained after payment of the special dividend will be sufficient to meet anticipated cash needs for working capital, capital expenditures, research and development and other activities for the foreseeable future. However, if current sources are not sufficient to meet the Company’s needs, it may seek additional debt or equity financing.

 

Although there are no present understandings, commitments, or agreements with respect to acquisitions of other businesses, products, or technologies, the Company may, in the future, consider such transactions, which may require debt or additional equity financing. The issuance of debt or equity securities may have a dilutive impact on the Company’s shareholders, and any acquired business may not contribute positive operating results commensurate with the associated investment.

 

Analysis of Cash Flows

 

Operations for the three months ended April 30, 2008 and 2009 used cash of approximately $3.0 million, and $0.5 million, respectively. The reduction in the amount of cash used in operating activities was primarily attributable to decreases in the use of cash for expenses associated with investigation and restatement activities, corporate development, and payments to compensate employees for certain expired options.

 

The Company’s cash provided by or used in investing activities generally reflected the Company’s shifts between cash equivalents and short-term investments. For fiscal year 2009, the Company has committed to spending less for capital expenditures than it had in fiscal year 2008.

 

For the three months ended April 30, 2009, the Company’s financing activities consisted solely of the payment of the special dividend in April 2009. For the three months ended April 30, 2008, there were no cash flows from financing activities.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Critical accounting policies are those that are both most important to the portrayal of a company’s financial position and results of operations and require management to make difficult, subjective, or complex judgments.

 

The Company’s accounting policies that require a significant amount of estimation or judgment in their application include:

 

 

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Revenue Recognition

 

Product revenues, which include software license and hardware revenue, are generally recognized in the period in which persuasive evidence of a sale or service arrangement exists, the products are delivered and accepted by the customer, the fee is fixed and determinable, and collection is considered probable. When the Company has significant obligations subsequent to shipment, revenues are not recognized until the obligations are fulfilled. Revenues from arrangements that include significant acceptance terms are not recognized until acceptance has occurred. The Company provides its customers with post-contract support services, which generally consist of bug-fixing and telephone access to the Company’s technical personnel, but may also include the right to receive unspecified product updates, upgrades, and enhancements, when and if available. Revenue from these services is recognized ratably over the contract period. Post-contract support services included in the initial licensing fee are allocated from the total contract amount based on the relative fair value of vendor specific objective evidence (“VSOE”). For multiple element software arrangements, the fair value of any undelivered element is determined using VSOE. The Company allocates revenue based on VSOE to the undelivered elements and the residual revenue to the delivered elements. Where VSOE of the undelivered element cannot be determined, the Company defers revenue for the delivered elements until the undelivered elements are delivered.

 

Sales of development kits are deferred and recognized as revenue over the estimated period of future customer software deployments and related maintenance, which the Company considers to be the economic life of the development kit. Additional development license fees are deferred and recognized as revenue over the remaining estimated economic life of the development kit. The estimation of the economic life of the development kit requires significant management judgment and is based on our customer’s historical project experience. Any change in the estimated economic life of the development kit would affect the amount of revenue recognized in future periods.

 

Allowance for Doubtful Accounts Receivable

 

The collectability of the Company’s accounts receivable requires a considerable amount of judgment when assessing the realization of these receivables, including reviewing the current creditworthiness, current and historical collection history, and the related aging of past due balances of each customer. The Company evaluates specific accounts when it becomes aware of information indicating that a customer may not be able to meet its financial obligations due to deterioration of its financial condition, lower credit ratings, bankruptcy, or other factors affecting the ability to render payment. Reserve requirements are based on the facts available and are re-evaluated and adjusted each accounting period as additional information is received.

 

Reserve for Obsolete or Excess Inventory

 

Inventory reserves for excess and obsolete inventory are determined primarily by future demand forecasts and charges are recorded to cost of revenues. Demand forecasts are assessed on at least a quarterly basis. Charges are recorded to reduce inventory to its estimated net realizable value and there is no increase in its carrying value due to subsequent changes in demand forecasts. Accordingly, if inventory previously reserved for is subsequently sold, improved gross profit margins may be realized on those transactions in the period the related revenue is recognized.

 

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Accounting for Share-based Payment Transactions

 

Stock options have been awarded to employees and directors under the Company’s equity incentive plans during fiscal years prior to fiscal year 2006. The cost of each option award was measured based on the fair value of the option as of the date of the award. For purposes of calculating each stock option’s fair value, the Company uses the Black-Scholes option pricing model, which involves the determination of assumptions that become inputs into the model. The primary inputs are expected volatility, expected term of the option, risk-free interest rate and dividend yield. Expected volatility is based on the historical performance of the Company’s common stock. Historical data of exercise behavior is used to estimate the average number of years that an option will remain outstanding prior to its exercise, factoring in the vesting period, contractual life of the option and post-vesting employment termination behavior, including the anticipated effects on employee exercises of the blackout periods restricting employee transactions involving the Company’s common stock. The risk-free interest rate is the implied yield available as of the grant date on U.S. Treasury zero-coupon issues with a remaining term equal to the option’s expected term. Prior to the Company’s special cash dividend paid on April 20, 2009, the Company had not paid dividends and had not declared any intentions of doing so. Accordingly, the dividend yield was assumed to be zero.

 

The Black-Scholes model was developed for use in estimating the fair value of traded options and does not consider the non-traded nature of employee stock options, vesting and trading restrictions, lack of transferability or the ability of employees to forfeit the options prior to expiration. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in subjective input assumptions can materially affect the fair value estimate, the Black-Scholes model may not necessarily provide a reliable single measure of the fair value of the Company’s employee stock options.

 

Prior to the vesting of the Company’s share-based payment awards, which, in addition to stock options, have included awards of restricted stock (stock that is subject to forfeiture upon the happening of specified events) and deferred stock units (awards that represent the right to receive common stock at the end of a specified deferral period), share-based payment expense is based on the fair value of the grants that are expected to vest. Accordingly, the Company develops expectations with respect to forfeitures of awards, based on historical experience regarding employee turnover or, in the case of awards that vest upon the satisfaction of predetermined performance conditions, on the probable outcome of the performance conditions. Upon vesting of awards, the Company’s share-based payment expense is adjusted to reflect the effects of actual forfeitures.

 

Accounting for Income Taxes

 

The Company accounts for income taxes using an asset and liability approach, which requires estimates of taxes payable or refunds for the current period and estimates of deferred tax assets and liabilities for the future tax consequences attributable to differences between the carrying amounts of assets and liabilities for financial reporting purposes and the corresponding amounts used for income tax purposes. Current and deferred tax assets and liabilities are based on

 

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provisions of the enacted tax laws and are measured using the enacted tax rates and laws that are expected to be in effect when the future tax events are expected to reverse. The effects of future changes in tax laws or rates are not anticipated.

 

Significant judgment is required in evaluating the Company's tax positions and measuring any related future benefit that may result from such positions. In its determination of income tax expense, the Company does not recognize any benefit from tax positions it considers to be uncertain. Only benefits that may result from tax positions that are more likely than not of being sustained on audit, based on the technical merits of the position, are recognized. Further, the effect on the Company’s income tax provision of these tax positions is measured at the largest amount of benefit that is greater than 50% likely of being realized upon the ultimate settlement. Differences between the amount of benefits taken or expected to be taken in the Company’s income tax returns and the amount of benefits recognized based on the evaluation and measurement of the related tax positions represent unrecognized income tax benefits, the total of which is reflected as a liability in the consolidated balance sheet.

 

The portion of any deferred tax asset for which it is more likely than not that a tax benefit will not be realized is offset by recording a valuation allowance. Future realization of the tax benefit of an existing deductible temporary difference or carryforward ultimately depends on the existence of sufficient taxable income of the appropriate character (for example, ordinary income or capital gain) within the carryforward period available under the tax law. The Company’s policy is to consider the following sources of taxable income, which may be available under the tax law to realize a tax benefit for deductible temporary differences and carryforwards:

 

(1) accelerate taxable amounts to utilize expiring carryforwards;

(2) change the character of taxable or deductible amounts from ordinary income or loss to capital gain or loss; and 

(3) switch from tax-exempt to taxable investments.

 

Evidence available about each of those possible sources of taxable income will vary between tax jurisdictions and, possibly, from year to year. To the extent evidence about one or more sources of taxable income is sufficient to support a conclusion that a valuation allowance is not necessary, the Company’s policy is that other sources need not be considered. Consideration of each source is required, however, to determine the amount of the valuation allowance that may be required to be recognized for deferred tax assets.

 

For any specific jurisdiction where a history of three years of cumulative losses has occurred or where there has been a substantial change in the business, the Company does not rely on projections of future taxable income as described above. Instead, the Company determines its need for a valuation allowance on deferred tax assets, if any, by determining an average steady-state normalized taxable income amount over the last three years. The Company will also consider the following positive evidence in the above scenarios, if present:

 

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ADOPTION OF ACCOUNTING PRONOUNCEMENTS

 

Effective February 1, 2009, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”) that relate to nonfinancial assets and nonfinancial liabilities. SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. While SFAS No. 157 does not require any new fair value measurements, it applies under other accounting pronouncements that require fair value measurements. SFAS No. 157 clarifies the definition of fair value as an exit price and emphasizes that fair value is a market-based measurement. The application of SFAS No. 157 to the Company’s nonfinancial assets and nonfinancial liabilities as of February 1, 2009 did not have a material effect on the Company’s financial position, results of operations or cash flows.

 

Effective February 1, 2009, the Company adopted SFAS No. 141(R), "Business Combinations" ("SFAS No. 141(R)"). SFAS No. 141(R) replaces SFAS No. 141, "Business Combinations,” but retains the requirement that the purchase method of accounting for acquisitions be used for all business combinations. As it relates to the Company, SFAS No. 141(R) became effective for any business combination with an acquisition date occurring on or after February 1, 2009. As the Company did not complete an acquisition during the three months ended April 30, 2009, the adoption of SFAS No. 141(R) has had no impact on the Company’s consolidated financial statements.

 

Effective February 1, 2009, the Company adopted FASB Staff Position (“FSP”) FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP EITF 03-6-1”). FSP EITF 03-6-1 provides that all outstanding unvested share-based payment awards that contain rights to non-forfeitable dividends participate in the undistributed earnings with the common shareholders and are therefore participating securities. Companies with participating securities are required to apply the two-class method in calculating basic and diluted earnings per share, the effects of which must be applied retrospectively. The effect of applying the guidance of FSP EITF 03-6-1 did not have a material effect on the Company’s basic and diluted earnings per share for all periods presented in the condensed consolidated statements of operations.

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

In April 2009, the Financial Accounting Standards Board (“FASB”) issued the following three FSPs that are intended to provide additional application guidance and enhance disclosures about fair value measurements and impairments of securities:

 

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FSP FAS 157-4 clarifies the objective and method of fair value measurement even when there has been a significant decrease in market activity for the asset being measured. FSP FAS 115-2 establishes a new model for measuring other-than-temporary impairments for debt securities, including establishing criteria for when to recognize a write-down through earnings versus other comprehensive income. FSP FAS 107-1 expands the fair value disclosures required for all financial instruments within the scope of SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” to interim periods. All of these FSPs are effective as of the beginning of the Company’s fiscal quarter ended July 31, 2009 and their adoption is not expected to have a material impact on the Company consolidated financial statements and related disclosures.

 

In May 2009, the FASB issued SFAS No. 165, "Subsequent Events" ("SFAS No. 165"). SFAS No. 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. Effective as of the beginning of the Company’s fiscal quarter ended July 31, 2009, the Company’s adoption of SFAS No. 165 is not expected to have a material impact on the Company consolidated financial statements and notes thereto.

 

In September 2009, the FASB ratified the consensuses reached by the Emerging Issues Task Force (“EITF”) regarding the following issues involving revenue recognition:

 

EITF No. 08-1 applies to multiple-deliverable revenue arrangements that are currently within the scope of EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF No. 08-1 also:

 

 

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EITF No. 09-3 applies to multiple-deliverable revenue arrangements that contain both software and hardware elements, focusing on determining which revenue arrangements are within the scope of the software revenue guidance in AICPA Statement of Position No. 97-2, “Software Revenue Recognition.” EITF No. 09-3 removes tangible products from the scope of the software revenue guidance and provides guidance on determining whether software deliverables in an arrangement that includes a tangible product are within the scope of the software revenue guidance. The accounting guidance in EITF No. 08-1 and EITF No. 09-3 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Alternatively, an entity can elect to adopt the provisions of these issues on a retrospective basis. The Company is assessing the potential impact that the application of EITF No. 08-1 and EITF No. 09-3 may have on its consolidated financial statements and disclosures.

 

 

The Company is exposed to financial market risks, primarily from changes in interest rates that may impact the fair values of the Company’s short-term investments in marketable debt securities. Derivative financial instruments have not been used to manage these risks.

 

As discussed in Note 3 to the Condensed Consolidated Financial Statements, short-term investments as of April 30, 2009 consisted of marketable debt securities, principally U.S. government agency obligations, which the Company deems available-for-sale. The Company’s investment policy provides guidelines relative to diversification and maturities designed to maintain safety and liquidity. Historically, the Company’s investment purchases consisted primarily of corporate and municipal short and medium-term notes, U. S. government obligations, U. S. government agency obligations and/or mutual funds investing in the like. At any given time, the Company’s mix of investments held as cash and cash equivalents versus short-term investments is dependent upon the Company’s view of each prospective investment’s price risk relative to the attainment of potentially higher yields or returns on its invested cash. A 10% increase or decrease in the fair values of the Company’s short-term investments held at April 30, 2009 would have a material effect on the Company's consolidated financial position.

 

As of the end of each reporting period, the Company adjusts the carrying amount of each short-term investment to its fair value. For each of the Company’s marketable debt securities held as of April 30, 2009, the Company’s measurements of fair value were based on non-binding market consensus prices that can be corroborated with observable market data.

 

As of April 30, 2009, cash and cash equivalents and short-term investments totaled approximately $81.8 million. If, during the fiscal year ending January 31, 2010, average short-term interest rates increase or decrease by 50 basis points relative to average rates realized during the year ended January 31, 2009, the Company’s projected interest income from cash and cash equivalents and short-term investments would increase or decrease by approximately $0.4 million, assuming a similar level of investments as held at April 30, 2009.

 

The Company’s cash equivalents primarily consist of investments in institutional money market funds placed with high credit-quality financial institutions. Due to the short-term nature of the Company’s cash and cash equivalents, the carrying amounts are not generally subject to price risk due to fluctuations in interest rates.

 

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EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

 

Disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are controls and other procedures designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified by the rules and forms promulgated by the SEC. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that such information is accumulated and communicated to management, including the chief executive officer and the chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.

 

In connection with the preparation of this Quarterly Report on Form 10-Q, the Company completed an evaluation, as of April 30, 2009, under the supervision of and with participation from the Company’s management, including the Chief Executive and Chief Financial Officers, as to the effectiveness of the Company’s disclosure controls and procedures. Based upon the evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, because of the material weaknesses in its internal control over financial reporting described in its Annual Report on Form 10-K for the fiscal year ended January 31, 2009 (the “Fiscal Year 2008 Form 10-K”), and its inability to file this report within the required time period, the Company’s disclosure controls and procedures were not effective as of April 30, 2009.

 

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

Under applicable SEC rules (Exchange Act Rules 13a-15(c) and 15d-15(c)), management (with the participation of the Chief Executive Officer and the Chief Financial Officer) is only required to evaluate the effectiveness of the Company’s internal control over financial reporting as of the end of each fiscal year. However, Exchange Act Rules 13a-15(c) and 15d-15(c) require management (with the participation of the Chief Executive Officer and the Chief Financial Officer) to evaluate any change in the Company’s internal control over financial reporting that occurred during each fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. In evaluating whether there were any reportable changes in the Company’s internal control over financial reporting during the quarter ended April 30, 2009, management determined (with the participation of the Chief Executive Officer and the Chief Financial Officer) that there was such a change in the form of additional remedial procedures either commenced or enhanced during this quarter to address the material weaknesses in the Company’s internal control over financial reporting identified in the Fiscal Year 2008 Form 10-K.

 

As explained in greater detail under Item 9A of the Fiscal Year 2008 Form 10-K, the Company and its management undertook a broad range of remedial procedures prior to September 30, 2009, the filing date of the Fiscal Year 2008 Form 10-K, most of which had been instituted before the interim period ended April 30, 2009, to address the material weaknesses in the Company’s internal control over financial reporting identified by management in its Report on Internal Control Over Financial Reporting in such Form 10-K (under Item 9A). With respect to the material weaknesses that are identified in the Fiscal Year 2008 Form 10-K, during the fiscal

 

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quarter ended April 30, 2009, management instituted a procedure for the review of complex software revenue arrangements on a quarterly basis pursuant to which (i) the Chief Financial Officer reviews any new customer contracts or amendments to existing contracts for terms that impose significant obligations on the Company subsequent to shipment of the product to the customer and (ii) management reviews all customer purchase orders to ensure that all revenue arrangements containing multiple elements are detected and communicated to personnel responsible for determining the proper revenue recognition for these arrangements. The Company believes this action constitutes a change in internal control over financial reporting during the fiscal quarter ended April 30, 2009 that either has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

While the Company’s management believes that it has addressed the material weaknesses identified in its Fiscal Year 2008 Form 10-K through the implementation of remedial procedures as of the date of the filing of the Fiscal Year 2008 Form 10-K, the material weaknesses cannot be considered remediated until the controls have been operational for a period of time that is adequate to permit testing. Accordingly, the Company has performed additional manual procedures and analysis and other post-closing procedures in order to prepare the consolidated financial statements included in this Quarterly Report on Form 10-Q. As a result of these expanded procedures, the Company believes the consolidated financial statements contained in this report present fairly, in all material respects, the Company’s financial condition, results of operation and cash flows for the fiscal years covered thereby in conformity with GAAP.

 

For a more comprehensive discussion of the material weaknesses in internal control over financial reporting identified by management as of January 31, 2009, and the remedial measures undertaken to address these material weaknesses, which remedial measures continued during the fiscal period covered by this Quarterly Report on Form 10-Q, investors are encouraged to review Item 9A, Controls and Procedures, of the Fiscal Year 2008 Form 10-K filed on September 30, 2009.

 

 

 

 

 

 

 

 

 

 

 

 

 

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PART II

 

Settled SEC Civil Injunctive Action

Subsequent to the fiscal quarter ended April 30, 2009, on June 18, 2009 the SEC announced that it had filed a civil injunctive action against the Company, in the U.S. District Court for the Eastern District of New York (the “Court”), for violations of:

Simultaneous with the filing of the Complaint, without admitting or denying the allegations therein, the Company consented to the issuance of a Final Judgment (the “Final Judgment”). The Court imposed the Final Judgment on July 22, 2009, ordering that the Company and its agents are permanently restrained and enjoined from violations, directly or indirectly, of Section 17(a) of the Securities Act of 1933, Sections 13(a), 13(b)(2)(A) and (B) and 14(a) of the Exchange Act and SEC Rules 13a-1, 13a-11, 13a-13 and 14a-9. The Final Judgment also orders the Company to become current in its reporting obligations under Section 13(a) of the Exchange Act on or before November 9, 2009.

From time to time, the Company is subject to claims in legal proceedings arising in the normal course of its business. The Company does not believe that it is currently party to any pending legal actions that could reasonably be expected to have a material adverse effect on its business, financial condition, results of operations or cash flows.

 

We have previously disclosed risk factors in Part I, Item 1A of our Annual Report on Form 10-K for the period ended January 31, 2009 (the “Fiscal Year 2008 Form 10-K”), which was filed with the Securities and Exchange Commission on September 30, 2009. There are no additions to or changes in our risk factors for the quarter ended April 30, 2009 from those disclosed in the Part I, Item 1A of our Fiscal Year 2008 Form 10-K.

 

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During the fiscal quarter ended April 30, 2009, the Company issued unregistered securities to independent directors as more fully described in Part III, Item 11 of the Company’s Fiscal Year 2008 Form 10-K under the heading “Director Compensation.”

 

Such unregistered securities were issued pursuant to an exemption from registration afforded by Section 4(2) of the Securities Act of 1933, as amended. Each issuance was to a director deemed an “Accredited Investor” that was approved by a Committee of the Board of Directors of the Company solely for compensation purposes and the Company did not receive any cash consideration for such securities. Each certificate issued for such unregistered securities contained a legend stating that such securities have not been registered under the Securities Act of 1933, as amended, and setting forth the restrictions on the transferability and sale of such securities.

 

The following unregistered securities were issued to the Company’s independent directors during the fiscal quarter ended April 30, 2009:

 

 

 

 

None.

 

 

None.

 

 

None.

 

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31.1     Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2     Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1     Certification of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

 

 

 

 

 

 

 

 

 

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