June 6, 2002 / Internet Research Comverse Technology, Inc.

CMVT: Incremental Restructuring Appears &097 Likely 5DWLQJ 0DUNHW3HUIRUP

Marianne Wolk 646.366.4427 Investment Conclusion: Although Comverse announced numbers Malindi N. Davies 646.366.4286 loosely in line with our expectations, results have yet to show any signs of Change In... Yes/No Was Is stabilization. Weak telecom spending, coupled with a major product Rating: No MP transition across nearly all of its business lines, continues to mean Operating EPS F2003E: Yes $(0.10) $(0.28) declines in backlog, sales and earnings. With visibility to a recovery Operating EPS F2004E: Yes $0.40 $0.09 Rev F2003E: Yes $920.0 $750.2 poor, we expect the company to take rapid actions to reduce its Rev F2004E: Yes $1,065.6 $806.3 breakeven from $220MM to $190MM+/- in quarterly revenues. Trading 12-Month Price Target: No $13.00 at 0.7x CNS revenues (ex net cash of $6.85), we believe current estimate 52-Week Range () $70.50-10.00 FD Shares Outstanding 187.0 MM revisions to be largely reflected in Comverse’s shares. Market Cap $1,909.3 MM Avg Daily Volume (000) 3,700 Book Value/Share 4/02 $8.64 5yr Hist. EPS Growth Rate 44% Key Points: 5yr Proj. EPS Growth Rate 15% • COMVERSE REPORTED WEAKER-THAN-EXPECTED ROA 2003E: NA REVENUES, OFFSET SOMEWHAT BY INCREMENTAL COST Dividend/Yield NONE/ NA REDUCTIONS. Comversea reported revenues of $211MM (short of FY January F2002 A F2003 E F2004 E our $220MM forecast). The loss of ($0.04) surpassed our ($0.06) Operating EPS: estimate as the company mitigated the shortfall in revenue with a $9MM 1Q $0.43 $(0.04) A $0.00 reduction in R&D ($4MM ahead of forecasts). As with last quarter, we 2Q $0.28 $(0.11) E $0.01 estimate that interest income contributed +$0.05 to the bottom line. 3Q $0.11 $(0.11) E $0.03 4Q $0.06 $(0.02) E $0.05 DSOs grew by 22 days to an all-time high of 150 as the company Year $0.86 $(0.28) $0.09 leveraged its strong balance sheet to grant favorable financing terms to P/E NM NM NM customers. We expect to monitor these levels closely. The company’s CY EPS $(0.28) $0.09 NE reserves cover 13% of its gross receivable balance. CY P/E NM NM NM Rev (MM): F2002 A F2003 E F2004 E • 1Q $365.0 $211.2 A $192.0 DECLINE IN BUSINESS, 80% of CNS, SHOWS NO 2Q $345.1 $180.5 E $197.8 SIGN OF A BOTTOM. Voice messaging revenue for the quarter was 3Q $295.0 $167.0 E $203.7 $133MM, down 45% y/y and 25% q/q. Poor economic conditions, a soft 4Q $265.1 $191.5 E $212.9 Year $1,270.2 $750.2 $806.3 market for telecom capital spending, and increased competition are CY $750.2 $806.3 NA likely to raise pricing pressure ahead. To date, Comverse has offered Mkt Cap/Rev NM 2.5x 2.4x extended payment terms rather than succumbing to major price Mkt Cap/CY Rev 2.5x 2.4x NM reductions (thus holding gross margins above 56%). However, we also (Operating EPS before one-time items. Comverse reports a see this as a product problem. In our view, growth in traditional voice tax rate of less than 15%.) mail systems is likely to remain lackluster (low single digits) even as wireless spending recovers, as demand continues to shift to open, IP- based systems. See Figure 1.

• BACKLOG, NEW BUSINESS ORDERS, CONTINUE TO DEMONSTRATE COMVERSE’S DIFFICULTIES. Backlog fell by $26MM, or nearly 12%, from last quarter, suggesting order flow of $185MM, down from $189MM. We believe Comverse is seeing a freeze on prior orders (currently in backlog), slowing the implementation of Comverse solutions and the recognition of revenues. We believe such a halt to be in place at AT&T Wireless on the previously anticipated upgrade to Comverse voice mail for its GSM/GPRS base in conjunction with a move to Unified Messaging. (Please refer to our October 11, 2001, report on Comverse’s problems at AT&T Wireless.) A similar freeze may be in place at Verizon (please refer to our December 17 report forecasting slow implementations here). • WE CONTINUE TO BELIEVE COMVERSE HAS A PRODUCT AND POSITIONING PROBLEM THAT MAY NOT RECOVER IN LINE WITH WIRELESS SPENDING OR THE 1X/GPRS CYCLE. Comverse’s three largest revenue generators include: (1) voice mail, (2) SMS and (3) prepaid services. We believe these three lines account for 80%, 12%, and 7.5% of Comverse Network Systems revenues, respectively. In our view, all three major product lines are in product transition to: (1) open, IP-based voice mail (standard message format, distributed storage throughout the network on Suna, Ciscoa, etc.) and Unified Communications; (2) MMS; and (3) prepaid-post-pay integrated systems. It is easy to refer to the weak economy, delays in the deployment of GPRS/1X, or the dearth in immediate consumer and enterprise interest as the culprit for poor demand. However, we continue to raise concerns that Comverse may not see a strong recovery with an improvement in these factors. In our view, its offerings are not well positioned to take advantage of the shift to newer IP technologies. The leader in closed, proprietary voice mail (50%-60% share of wireless), Comverse has been slow to move to open its systems fully. The No. 3 player in MMS, Comverse’s deals to date in MMS suggest it has lost market share to , Ericssona and others. Lastly, we suspect weak prepaid billing sales may reflect rising competition from integrated systems offered by Amdocsb and Convergys.

• STRONG CASH BALANCES CONTINUE TO PROVIDE SUPPORT LEVEL FOR STOCK PRICE. Comverse ended the quarter with net cash of $1.285B, or approximately $6.85 a share. At this level, interest income continues to bolster the bottom-line results and provides a theoretical floor for the stock price. Although a truer floor may reflect Comverse’s cash position after the de-consolidation of cash balances held by VRNTab and ULCM, leaving CNS with approximately $989MM, or approximately $5.30 per share. In any case, we expect the net cash balance to fall over the next several quarters and the Company will continue to leverage its balance sheet to provide favorable financing terms to customers, make select technology acquisitions and support negative cash flows from operations.

DETAILS:

WE BELIEVE COMVERSE’S PERFORMANCE WILL REMAIN HEAVILY DEPENDENT ON VOICE MESSAGING IN THE NEAR-TERM WHERE THE OUTLOOK REMAINS WEAK.

• Voice messaging has represented the lion’s share of CNS’s revenue over the last few years (CY00 81%, CY01 76%), and we project it will represent an increasing portion of revenues in the near-term.

• Comverse’s voice messaging business fell by 25% q/q and 45% y/y. With limited big win opportunities in this space and continued conservative spending environment for telcos, we believe that Comverse may see some pricing pressure and that this business will continue to decline.

• We do not believe that the falloff here is a pure function of the telecom spending glut and we are uncertain if the GPRS/1X cycle will provide any upside relief. The network upgrade cycle would only provide a positive impact if new data services (a) attract new wireless subscribers or (b) ultimately spur converged communications storage (i.e., a single inbox for voice, email and SMS/MMS messages) AND Comverse is able to secure that business. Neither looks like a shoe-in at this time.

Figure 1. Comverse Voice Mail Business Has Not Stabilized Oct01 Jan02 Apr02 Jul02E Oct02E Jan03E C01A C02E Voice 177 177 133 109 95 110 823 447 Mail Revenues Y/Y (17.0)% (23.7)% (45.4)% (51.7)% (46.3)% (37.8)% (2)% (46)% Growth Source: Company reports and Robertson Stephens estimates.

MMS MOMENTUM A MAJOR WILD CARD FOR COMVERSE, THOUGH NEAR-TERM PERFORMANCE HAS BEEN WEAK. The evolution to GPRS/1X, which should be a catalyst for industry-wide MMS sales, could help Comverse’s longer-term results IF the company successfully transitions its SMS platforms to newer multimedia technologies. Though the transition to MMS is off to a slow start in 2002 (See our June 4 report and comments on weakness at Logica), most forecasts assume a rapid shift to MMS as new networks and handsets become more available starting later this year. To this end, Mobile Streams forecasts the number of the MMS messages may outpace SMS messaging by 2007 (See Figure 2). While these figures may be on the aggressive side, they demonstrate the expected shift in demanded services.

Robertson Stephens, Inc. 1 Figure 2. MMS Growth Outlook Worldwide – Number of Monthly Message Sent 2002E 2007E CAGR SMS 62.4 B 40.0 B (8.5%) MMS 0.3 B 50.0 B 340.9% Total 62.7 B 90.0 B 7.5% Notes: Based on December. Source: Mobile Streams.

The big question is whether Comverse (the No. 3 player in SMS) will land any of the big deals that are appearing in the market to provide these services. This transition is already underway in Europe and Asia and Comverse is yet to participate in any of the deals that we have identified (See Figure 3). Management acknowledged that increased competition from other players as well as handset makers, such as Nokia and Ericsson, are making it difficult to forecast major wins. To this end, Comverse indicated it would attempt to take part in the MMS market as a second source – not a resounding indicator of potential future revenues.

Figure 3. Announced European MMS Deals Do Not Include Comverse Carrier Vendor Timing Geography TIM Nokia / Ericsson June 2002 Italy T-Mobile Ericsson May 2002 United Kingdom Optimus CMG May 2002 Portugal CSL Nokia April 2002 Hong Kong Westel Ericsson April 2002 Hungary KPN CMG April 2002 The Netherlands TMN CMG April 2002 Portugal Hutchison CMG February 2002 United Kingdom Vodafone Ericsson January 2002 Germany, Greece, Ireland, Italy, the Netherlands, Portugal, Spain, Sweden and the United Kingdom Source: Company reports.

QUARTERLY PERFORMANCE METRICS:

Figure 4. BACKLOG ANALYSIS

Q1:02 Actual Q1:02 Estimate Q4:01 Actual

Backlog ($MM) $195MM $190MM +/- $221MM Q/Q Growth (11.9)% (14.0)% 1.4% Forward 4Q Visibility 26.7% 19.9% 24.0%

Implied Order Flow $185MM $189MM $268MM (Reported Revenues Adjusted for Increase in Backlog)

Deferred Revenues $37MM $33MM $39MM Q/Q Growth (5.5)% (15.4)% (4.3)% Pct of Backlog 19.2% 17.6% 17.9%

No. of Carrier Customers 390 390 390

Revenue Mix Voice Mail 80% 78.8% 80% Enhanced Services 20% 21.2% 20% Comverse Network Systems 100% 100% 100% Source: Company reports, Robertson estimates.

Robertson Stephens, Inc. 2 Figure 5. BALANCE SHEET CONTINUES TO LOOK STRONG

Q1:02 A Q4:01 A Q3:01 A Cash $MM 1885 1893 1794 Net Cash $MM 1285 1293 1194 Net Cash/Share 6.89 6.80 6.30 Deferred Revenues $MM 37.4 39.6 41.3 Inventories 59 56 67 Avg Inventory Turns 14.7 17.2 15.9 Q End DSOs 150 128 130 Notes: (1) Net Cash less VRNT and ULCM cash holdings divided by average shares outstanding. Source: Company reports, Robertson Stephens estimates.

Robertson Stephens, Inc. 3 Company Info

The Company Comverse Technology is a leading vendor of communication and messaging solutions with over 370 carrier customers in 100 countries. Comverse Network Systems (> 80% of revenues) provides voice mail systems and other messaging solutions. Its Enhanced Services platform (ESP) enables carriers to offer value-added services to endusers including Short Messaging Services (SMS), prepaid services, Unified Messaging, voice- recognition applications, and wireless data gateways. Approximately 25% of Ulticom, a division of Comverse, has been spun out of Comverse and is publicly traded under the ticker ULCM. Comverse derives less than 5% of revenues from Ulticom, which provides middleware solutions to allow equipment manufacturers and application developers to create new services and applications (such as local number portability, 800 number services, and personal number services) more quickly and easily across both circuit-based and IP networks. Comverse is based in Woodbury, New York, with major offices in , .

Investment Thesis Though Comverse's voice mail opportunity remains substantial, short-term pressure from the slowdown in the economy and intermediate pressure from the introduction of revolutionary new messaging architectures (real or FUD) could slow the share gains that have historically led Comverse's growth. Without voice mail wins to smooth the transition to IP infrastructure and applications, Comverse's margins are likely to remain under pressure.

Investment Risks Among the risks are (1) a pending shift in messaging architectures to open IP-based standards that could pressure Comverse's growth and margins; (2) reliance on favorable tax benefits in Israel which contribute to a below-average 10% tax rate; (3) integration of future acquisitions. Our rating system is based upon 12-month price targets that assume a flat market.

For stocks with market cap of $2 billion or greater: Strong Buy describes stocks that we expect to appreciate by 25% or more. Buy describes stocks that we expect to appreciate by 10-25%. Market Perform describes stocks that we expect to change plus or minus 10%. Market Underperform describes stocks that we expect to decline by more than 10%.

For stocks with market cap of less than $2 billion: Strong Buy describes stocks that we expect to appreciate by 50% or more. Buy describes stocks that we expect to appreciate by 20-50%. Market Perform describes stocks that we expect to change plus or minus 20%. Market Underperform describes stocks that we expect to decline by more than 20%.

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Copyright  2002 Robertson Stephens Marianne Wolk Marianne, a managing director, specializes in technology solutions for the converging communications industry. Her areas of expertise include communication software and services such as wireless data and telecom operation support systems. Marianne has had a decade of buy- and sell-side research experience in the technology industry. Marianne is a Wall Street Journal All-Star Analyst and has been ranked by Greenwich Associates as a leading industry analyst. Marianne received a BA in applied mathematics from Northwestern University and an MBA in finance and economics from the University of Chicago.

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UREHUWVRQVWHSKHQVFRP COMVERSE TECHNOLOGY Robertson Stephens Earnings Model Marianne Wolk June 6, 2002 (646) 366-4427

------C2000------C2001------C2002E------C2003E FY JAN 4/00 7/00 10/00 1/01 Year 4/01 7/01 10/01 1/02 Year 4/02 7/02 10/02 1/03 Year Year

Enhanced Svcs Platforms (CNS) 228.678 246.642 266.614 290.926 1,032.860 313.346 295.357 251.102 220.889 1,080.694 166.843 135.500 120.000 142.800 565.143 586.586 Svc Enabling NW Software (Ulticom) 8.826 10.591 12.823 15.201 47.441 17.033 17.926 13.013 10.184 58.156 7.097 7.000 7.500 8.403 30.000 43.612

Revenues 268.469 292.070 317.966 346.553 1,225.058 365.037 345.090 295.032 265.059 1,270.218 211.194 180.500 166.963 191.507 750.163 806.312 Trailing 970 1,045 4Q 1,131 1,225 1,322 1,375 1,352 1,270 1,116 952 824 750 Sequential Growth 6.5% 8.8% 8.9% 9.0% 34.7% 5.3% -5.5% -14.5% -10.2% 3.7% -20.3% -14.5% -7.5% 14.7% -40.9% 7.5%

Cost of Revenues 102.051 109.989 119.024 129.566 460.630 136.438 141.289 120.875 110.997 509.599 91.777 78.518 73.464 83.305 327.063 349.681

Gross Profit 166.418 182.081 198.942 216.987 764.428 228.599 203.801 174.157 154.062 760.619 119.417 101.983 93.499 108.201 423.100 456.630 Gross 62.0%Margin 62.3% 62.6% 62.6% 62.4% 62.6% 59.1% 59.0% 58.1% 59.9% 56.5% 56.5% 56.0% 56.5% 56.4% 56.6%

Research and Development 50.717 55.128 60.461 65.892 232.198 70.198 74.990 76.198 71.910 293.296 62.923 61.000 57.000 55.000 235.923 222.030 Selling, General and Administrative 56.512 61.705 67.549 73.841 259.607 78.189 80.985 83.312 80.550 323.036 73.513 70.000 66.000 65.000 274.513 252.250 Royalties and License Fees 4.880 5.327 5.757 6.064 22.028 6.184 5.362 4.335 0.000 15.881 0.000 0.000 0.000 0.000 0.000 0.000 Operating Expenses 112.109 122.160 133.767 145.797 513.833 154.571 161.337 163.845 152.460 632.213 136.436 131.000 123.000 120.000 510.436 474.280 Opex Pct of Revenues 41.8% 41.8% 42.1% 42.1% 41.9% 42.3% 46.8% 55.5% 57.5% 49.8% 64.6% 72.6% 73.7% 62.7% 68.0% 58.8%

Enhanced Svcs Platforms (CNS) 56.241 60.729 63.924 70.854 251.748 71.585 39.926 12.117 3.285 126.913 -15.016 -25.068 -27.000 -13.350 -80.433 -33.046 Svc Enabling NW Software (Ulticom) 1.333 1.720 2.294 3.009 8.356 3.834 4.231 0.357 0.101 8.523 -2.903 -2.900 -2.111 -1.565 -9.479 -1.551

Operating Income 54.309 59.921 65.175 71.190 250.595 74.028 42.464 10.312 1.602 128.406 -17.019 -29.018 -29.501 -11.799 -87.336 -17.650 Operating 20.2%Margin 20.5% 20.5% 20.5% 20.5% 20.3% 12.3% 3.5% 0.6% 10.1% -8.1% -16.1% -17.7% -6.2% -11.6% -2.2%

Interest Income (Expense) 6.545 7.405 8.300 11.089 33.339 10.380 11.441 11.935 10.339 44.095 10.149 9.950 9.750 9.550 39.399 39.200 Other Income 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

Pretax Income 60.854 67.326 73.475 82.279 283.934 84.408 53.905 22.247 11.941 172.501 -6.870 -19.068 -19.751 -2.249 -47.937 21.550 Taxes 4.648 4.837 4.765 5.414 19.664 5.452 3.893 2.125 1.314 12.784 1.313 1.313 1.313 1.313 5.252 4.146 Net Income--Operating 56.206 62.489 68.710 76.865 264.270 78.956 50.012 20.122 10.627 159.717 -8.183 -20.381 -21.064 -3.562 -53.189 17.404

Extraordinary Items 0.000 -10.786 -4.348 0.000 -15.134 0.000 -22.028 -18.427 -64.643 -105.098 -15.393 0.000 0.000 0.000 -15.393 0.000 Reported Net Income 56.206 51.703 64.362 76.865 249.136 78.956 27.984 1.695 -54.016 54.619 -23.576 -20.381 -21.064 -3.562 -68.582 17.404

Earnings per Share Operating* $0.32 $0.36 $0.38 $0.41 $1.50 $0.43 $0.28 $0.11 $0.06 $0.88 -$0.04 -$0.11 -$0.11 -$0.02 -$0.28 $0.09 Reported* $0.32 $0.30 $0.35 $0.41 $1.42 $0.43 $0.16 $0.01 -$0.28 $0.29 -$0.13 -$0.11 -$0.11 -$0.02 -$0.37 $0.09

Avg Shares Outstanding 172.283 172.054 177.820 181.500 175.914 179.900 181.242 189.600 194.994 186.434 186.600 186.600 186.600 186.850 186.663 187.475 * EPS adusted for convertible dilution; Operating EPS before 1x charges.

Source: Robertson Stephens estimates and Company Reports