Interactive Intelligence 10-K 2008
Documents found in this filing:
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No £
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No þ
Assuming solely for the purposes of this calculation that all directors and executive officers of the registrant are “affiliates”, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant, based upon the closing sale price per share of the registrant’s common stock on June 30, 2007 as reported on The NASDAQ Global Market on that date was $270,440,796.
As of February 29, 2008, there were 17,949,496 shares outstanding of the registrant’s common stock, $0.01 par value.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the information required by Part III of this Form 10-K are incorporated by reference from portions of the registrant’s Proxy Statement for its 2008 Annual Meeting of Shareholders to be held on May 30, 2008, which will be filed with the Securities and Exchange Commission no later than 120 days after December 31, 2007.
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TABLE OF CONTENTS
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SPECIAL NOTE ABOUT FORWARD-LOOKING INFORMATION
Certain statements in this Annual Report on Form 10-K contain "forward-looking" information (as defined in the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended) that involves risks and uncertainties which may cause actual results to differ materially from those predicted in the forward-looking statements. Forward-looking statements can often be identified by their use of such verbs as “expects”, “anticipates”, “believes”, “intend”, “plan”, “may”, “should”, “will”, “would”, “will be”, “will continue”, “will likely result”, or similar verbs or conjugations of such verbs. If any of our assumptions on which the statements are based prove incorrect or should unanticipated circumstances arise, our actual results could materially differ from those anticipated by such forward-looking statements. The differences could be caused by a number of factors or combination of factors, including, but not limited to, those set forth in the Item 1A “Risk Factors” section of this Annual Report on Form 10-K.
Interactive Intelligence, Inc. (“Interactive Intelligence”, “we”, “us” or “our”) was formed in 1994 as an Indiana corporation and maintains its world headquarters and executive offices at 7601 Interactive Way, Indianapolis, IN 46278. Our telephone number is (317) 872-3000. We are located on the web at http://www.inin.com. We file annual, quarterly and current reports, proxy statements and other documents with the United States Securities and Exchange Commission (the “SEC”) under the Securities Exchange Act of 1934, as amended. These periodic and current reports and all amendments to those reports are available free of charge on the About Us – Investor Relations page located on our website.
Unified Business Communication Solutions
We are a leading provider of software applications for contact centers and we are leveraging that leadership position to provide mission-critical Voice over Internet Protocol (“VoIP”) applications to enterprises. Our solutions are installed by customers in a wide range of industries including, but not limited to, financial institutions, higher education, healthcare, retail, technology, government, business services and increasingly for the remote and mobile workforce. We also offer a pre-integrated all-software Internet Protocol Private Branch Exchange (“IP PBX”) system, a phone and communications solution for mid- to large-sized enterprises that rely on the Microsoft Corporation (“Microsoft”) platform. We offer innovative software products and services for multi-channel contact management, business communications, messaging, and VoIP solutions supported on the Session Initiation Protocol (“SIP”) global communications standard. Many of our solutions can be deployed at the customer’s site or can be provided in a Software as a Service model. See “Software as a Service as a Viable Hosted Business Communications Option” below.
Our application-based solutions are integrated on a platform developed to increase security, broaden integration to business systems and end-user devices, enhance mobility for today’s workforce, scale to thousands of users, and more wholly satisfy today’s diverse interaction needs in markets for:
By implementing our all-in-one solutions, businesses are able to unify multi-channel communications media, enhance workforce effectiveness and productivity, and more readily adapt to constantly-changing market and customer requirements. Moreover, organizations in every industry are able to reduce the cost and complexity of traditional “multi-point” legacy communications hardware systems that are seldom fully integrated.
Innovation and Value
Interactive Intelligence has long been recognized for its innovative, bundled contact center application solution, which allows contact centers to queue and manage multi-channel interactions including phone calls, faxes, e-mails and web interactions such as chats using a single integrated platform solution. Contact centers can leverage this same software platform for predictive outbound dialing, workforce management, quality monitoring, call and screen recording and agent scoring, interaction tracking, speech recognition, and other enhanced contact management and compliance capabilities.
Our principal competitors are vendors who follow traditional proprietary approaches (“legacy”) and offer a combination of hardware-centric PBX phone systems, automated call distributors (“ACD”), voice mail systems, interactive voice response (“IVR”) systems and associated equipment. Contrasting such multi-point systems, our unified platform is architected on open standards software developed to run on the Microsoft® Windows® operating system and servers certified by us, allowing businesses to reduce both the amount and cost of the historically more expensive communications hardware from proprietary vendors.
The added value of our open software approach is in the straightforward migration path it provides to VoIP via the SIP standard for networked voice and data. This open approach also supports broader integration to business systems and devices including end-user phone sets, while reducing overall costs for network management, system administration and functionality upgrades. Our application solutions also pre-integrate to popular business applications for customer relationship management (“CRM”), enterprise resource planning (“ERP”) and other processes, enabling businesses to fully integrate and automate their specific business rules with minimal interruption.
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Continued Global Success and Recognition
We market our software solutions around the globe, directly to customers and through a channel of more than 250 value-added partners. Our software applications are available in 21 languages and are installed in more than 70 countries. We began licensing our software in 1997 and have experienced ten consecutive years of continued revenue growth. Partners and customers who license our products are certified through our professional education curriculum and are supported by a global support network of our technology and implementation partners. We employ approximately 600 personnel.
We have been an ISO 9001:2000 Certified company since January 2005 and obtained our re-certification in January 2008, marking our third consecutive year of compliance. Being certified to ISO 9001:2000 gives further assurance to our customers and partners that we are able to satisfy their most stringent quality, reliability, efficiency and cost-effectiveness requirements.
Other recent company recognition includes:
Industry Overview and Current Developments
VoIP, high-speed Internet access, Internet-based commerce, process automation and the growing acceptance of data networks configured to transmit voice traffic continue to cause a major shift in business communications technologies and corporate decision-making. Organizations in many industries, and in increasing numbers, are moving from one-dimensional, hardware-based PBX phone systems to multi-channel software platforms on which phone calls and faxes as well as e-mails and web interactions, such as chats, are integrated. VoIP, IP telephony and unified communications bring networks and voice and data applications together. By doing so, businesses reduce communications equipment and administration costs, automate business processes to increase organizational efficiency and enhance workforce effectiveness, and provide better service to their customer base. The communications industry continues to experience increased demand for new application-based solutions for unified communications and multi-channel interaction management. We have followed the same open standards all-in-one software approach since 1994 to develop our industry-leading solutions for business communications requirements.
Business Process Automation
To be more efficient operationally and more proficient in meeting a customer's needs, contact centers and enterprises are looking at automation to improve the execution of their business processes, communications and customer service processes. We believe automation will improve a new or existing customer’s position in the global marketplace and strengthen their foundation for growth. Our applications have long taken an intelligence-based approach to automation, beginning with the ability to unify and handle multi-channel interactions in the same manner, and followed thereafter with features such as multimedia queuing, skills-based (agent) routing and speech-enabled interactive voice response and auto attendant processes structured according to an organization’s business rules. We are continuing this approach to automating business and interaction processes with features scheduled to be released during 2008 such as emotion detection, post-call surveys and automation of business processes using the functionality deployed in our solutions.
The Convergence of Voice and Data
In a technology trend that continues to gain acceptance worldwide, the Internet Protocol has prompted many businesses to begin moving voice traffic from circuit-switched networks and bulky hardware equipment to more agile “converged” voice and data networks, applications servers, and lower cost end-user devices based on the popular TCP/IP — a transition often referred to as the “VoIP movement.” One result of this transition is that traditional PBX phone systems hardware is being replaced by software-based solutions. This transition to software-based communications solutions is leading many businesses to look more closely at application-driven platforms that can integrate to, and work effectively with, IP-based systems for converged voice and data. We provide these software-based solutions along with other vendors including Cisco Systems, Inc. (“Cisco”), Nortel Networks Corporation (“Nortel”), Avaya Inc. (“Avaya”), 3Com Corporation (“3Com”) and others.
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According to industry analysts at Gartner, Inc., unified communications are defined as the “direct result of convergence in communication networks and applications.” Microsoft also has recently defined unified communications as a solution that “bridges the gap between telephony and computing to deliver real-time messaging, voice and conferencing to the desktop environment.” Preceding this unified approach, differing forms of communication have historically been developed, marketed and sold as individual applications. The convergence of voice and data communications on IP networks leveraging open standards software platforms is generating a new paradigm for unified communications and its impact on how people, groups and organizations communicate. Unified communications products based on software solutions, services and equipment such as servers, gateways and IP-based phones and end-user devices are proving to reduce costs over their proprietary counterparts, while at the same time enhancing organizational productivity by facilitating the integration and use of multiple enterprise communication methods. Unified communications products reflect most of their cost-effectiveness through the convergence of voice and data on a single network and at the desktop; by integrating multiple communication channels (media such as calls, faxes, e-mail and web chat), networks, systems, and business applications; and by consolidating controls and administration over these collective components. Most unified communications products are currently offered either as a stand-alone product solution or from a portfolio of integrated applications and platforms.
In addition to more traditional communications media such as the telephone, voice mail, and the fax machine, the Internet has expanded communications media to include e-mail, Internet chat sessions, web callback requests and VoIP calls. As consumers have continued to leverage these web-based contact options, companies have had to utilize the Internet as a key channel for sales, distribution and customer service. With customer service as an objective, many of these companies are deploying web applications for e-mail management, auto response, web collaboration and other online services to satisfy consumer habits and raise service levels. Though many online services are unified in an applications approach, most companies still support online media channels using separate e-mail platforms, web servers, chat servers and other disjointed equipment that can lead to inconsistencies and inefficiencies across customer touch points. If organizations have not already made the move to an applications-driven solution for online needs, many are at least re-evaluating their existing systems to determine the requirements for a more integrated environment.
Moving from Call Centers to Contact Centers
Until a few years ago, a call center consisting of phone banks and agents handling inbound and outbound calls was sufficient for businesses and their customers. While relegated to a single communications channel, these “call-only” centers nevertheless required multi-point systems consisting of a PBX, ACD, automated attendant, an IVR system, and optional systems such as a predictive outbound dialer and a call logger to handle voice-based interactions. Most call centers also were forced to spend time and money to integrate their disparate phone system devices. Increasingly, however, multi-channel communications technologies have paired e-mail and web interaction options alongside phone calls, creating the “contact center” and allowing businesses to differentiate themselves both with more contact options for customers and superior service and support as a consumer interacts. With multi-channel communications platforms now playing a broader role in customer service, as well as sales and other customer functions such as CRM, organizations are beginning to understand the value of formal contact centers. In turn, information technology leaders have begun to adopt a bundled application approach to multi-channel contact management, primarily to replace multiple hardware-centric systems and reduce costs, but also as a way to more easily migrate to network-based IP telephony.
The Need to Integrate Telecommunications and Information Systems
For most businesses, telecommunications systems and information systems remain distinct components in a communications infrastructure. To more effectively interact both internally and externally, businesses must be able to access and utilize these systems in a seamless manner. To integrate various types of telecommunications devices with information technology, many vendors offer computer telephony integration (“CTI”) middleware products and services to bring the two sides together. For example in a contact center, a CTI-based “screen pop” application enables a data window to pop up on an agent’s monitor, presenting information about a call at the same time the agent’s telephone or headset rings. For customer service in particular, screen pops allow the agent to view a customer’s account information, which is usually maintained in a CRM or ERP application.
While effective for customer service, however, we believe that using CTI middleware products to integrate communications and information systems raises a number of fundamental problems. In addition to being expensive and time-consuming to implement up front, the total cost of ownership for any CTI integration over time is high due to multiple points of configuration, administration and maintenance. Modifying and managing a traditionally integrated CTI infrastructure is also difficult in that each device may be independently configured by different vendors. For instance, adding only one new agent in a contact center may require configuring a new extension in the center’s PBX phone system, defining a new mail box in its voice mail system, and creating a new agent entry in an ACD to route calls to the new agent. This process can result in the new user’s information being entered into each device inconsistently, or getting lost all together. With an emphasis on web-based objectives in particular, we believe CTI used in this traditional multi-device approach makes it more difficult for businesses to interact over the Internet.
Broader Integration to Business/Data Systems and End-user Devices
With the business world’s increasing emphasis on business process, automation is key in broadening integration between a communications platform and business applications, information systems, databases, knowledge bases and end-user devices such as phone sets, hand-held devices, cell phones and laptop computers. IP-based applications and open standards, as compared to traditional communications hardware systems and CTI, increase integration capability to a wider range of business systems, industry-standard servers and low-cost IP devices for users across an organization. More so, integration within a dispersed multi-site organization is easier to accomplish, since different locations can easily leverage IP networks to integrate business system servers, SIP connections from the same network to integrate IP phones and devices at the desktop, and wireless connections to equip their mobile workers. Again, organizations that rely on separate PBX, ACD and associated equipment for communications are not afforded the same integration flexibility. Even though many proprietary vendors are now beginning to take an applications approach to their solution, they have yet to reach the same levels of openness that more established applications vendors reached years ago. Consequently, the customers of many proprietary vendors must still utilize expensive CTI methods, third-party integration services, and higher-priced proprietary devices to update their business and communications systems.
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As IP telephony becomes more prevalent in business communications, the potential of attacks to an IP communications system makes security a critical priority for contact centers as well as for healthcare providers, financial institutions, government agencies, public companies and other organizations that manage confidential voice and data communications over an IP network. However, open standards such as SIP provide a rigorous approach to user authentication and message encryption in a VoIP environment. SIP is also the most regulated tool for security as a result of the actions of the Internet Engineering Task Force (“IETF”), which continually introduces, amends and strictly monitors SIP security specifications worldwide. Lending to stricter security measures as well are the new breed of all-in-one IP communications application suites. These suites pre-integrate applications on a single platform for all voice and data functions, and allow organizations to easily replace “multi-point” hardware systems, reduce the number of access points for potential attacks, and inherently streamline security down to a central underlying platform. Such software-based systems additionally extend security mechanisms to all critical points between an IP network and the desktop, allowing organizations to deploy virtual private networks, virtual local area networks, access lists, authentication, Transport Layer Security and Secure Real-time Transport Protocol mechanisms from the network to their IP communications system’s application server, gateway, data servers and phone devices.
Migration from Voice Mail to Unified Messaging and Enhanced Messaging
Unified messaging efficiently combines voice mail, fax and e-mail messages in an end-user’s “unified” inbox, which is often accessible through the desktop, a web browser, a handheld device, or even the telephone using Text-to-Speech technology. Though available for more than 10 years, many businesses organizations have failed to embrace unified messaging. With voice mail and fax systems reaching end-of-life status in businesses worldwide, and as e-mail continues to serve as a viable communication medium, enterprises are increasingly upgrading to unified messaging solutions that integrate with existing PBXs that are equipped for IP telephony and VoIP, and that natively support e-mail and directory servers certified by us that are already components in most technology and telecommunication infrastructures. As workers become more mobile, organizations are studying the value of enhanced messaging, which supplements unified communications with robust features such as customizable call rules and greetings for users, Follow-Me call routing, real-time presence management, speech- and browser-based voice mail access, workgroup capabilities, and more.
Software as a Service as a Viable Hosted Business Communications Option
Software as a Service (“SaaS”) is becoming a viable and increasingly recognized solution in the business communications and telecom industries. The term SaaS has generally replaced terms including “Application Service Provider”, “on-demand” and other similar notations. As an Internet-based service developed to leverage web browsers and other online technologies, SaaS business communications solutions are delivered by a software provider who may develop, customize, host and operate the applications that constitute a SaaS offering. Service offerings typically include IP PBX-based call processing, call routing, auto attendant, IVR, voice mail, e-mail, conferencing, messaging, automated notifications and other business communications services. For organizations that have substantial computing needs but that maintain little or no capability in software deployment, SaaS allows them to enjoy the same benefits of premise-based software, without on-site implementation and operation. Businesses pay only for using SaaS features and not for owning the software itself and may increase communications reliability since SaaS application servers often reside on a provider’s off-site location where disaster recovery mechanisms are provided as a part of the SaaS offering.
We have developed our solutions to meet the requirements of three distinct target markets in which our all-in-one approach delivers value. These markets also include a strong and growing demand for the inherent standards-based IP telephony, VoIP and unified communications functionality, which our application solutions offer.
We remain an industry leader in the transition from TDM (time division multiplex) and CTI-based multi-point call center technology to pre-integrated IP-based open standards application solutions for today’s multi-channel contact centers. Our scalable all-in-one contact center solution enables centers to intelligently route, monitor, record, track, and report on phone calls, as well as fax, e-mail and web interactions, whether in a single center or across multi-site contact center operations. Contact centers can also easily license our pre-integrated applications for predictive dialing, workforce management, screen and multimedia recording and agent scoring, and other enhanced functionality.
For self-service automation in the contact center environment, including speech-enabled IVR and e-mail auto response technologies, we offer a full range of solutions that help organizations support their sales and service objectives while standardizing customer service options and reducing operations costs. Among the more popular self-service applications our customers have implemented are FAQ auto response via e-mail and IVR-based processes for order status inquiries.
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Enterprise IP Telephony
Leveraging our strength in the contact center sector has enabled us to offer IP telephony to the “larger enterprise” market. In positioning our contact center solution for enterprise requirements, organizations can implement a single solution for IP PBX, ACD, IVR, multimedia queuing, messaging, mobile access and other capabilities that meet the needs of enterprise business users and workgroups as well as contact center agents. We also continue to strengthen our position in the mid-sized enterprise market with our “all-software” IP PBX phone and communications solution for companies consisting of 100 to 1,500 users, and especially that rely on the Microsoft platform. In addition to mid-sized enterprises, this market sector includes distributed organizations such as banks and credit unions, and organizations that maintain mobile and remote workforces, such as sales and service-oriented companies.
We have defined enterprise messaging as being a comprehensive yet adaptable solution for voice mail, unified messaging (voice mail, e-mail and fax in one inbox), and enhanced messaging—which builds upon unified messaging with advanced features such as Find-Me/Follow-Me, customizable call rules, real-time presence management, and other features. With many existing voice mail systems continuing to near end-of-life status, companies evaluating their messaging solutions and requirements, and the increased popularity of e-mail and mobile communications technology, we believe we are well-positioned in the enterprise messaging space.
We offer a single, highly-scalable, multi-channel messaging platform that allows organizations to route live communications to mobile phones, telephony-enabled handheld devices and desk phones, and to help users manage their inbox for e-mail, voice mail and fax messages. Our platform’s inherent IP architecture also paves a straightforward migration path to VoIP for organizations looking to make the move to IP telephony. By providing flexible choose-by-function deployment and licensing options for voice mail, unified messaging, enhanced messaging, or a combination of all three, organizations can configure and centrally administer the precise messaging environment needed, by department or enterprise-wide. Our single IP platform/adaptable applications approach has been successfully deployed by universities and large companies.
Our All-in-One Platform, Single-System Approach, Products, Customer Support and Services
All-in-One Platform, Single-System Approach
We provide a comprehensive solution of contact management and business communications applications developed to run on our pre-integrated Interaction Center Platform® multi-channel event processing platform and the Microsoft Windows operating system. Our platform-based software solutions do not require multi-point hardware or integrations to third party products or CTI middleware, and are capable of processing thousands of interactions per hour.
As a true all-in-one solution for voice and data, the Interaction Center Platform also does not require separate servers or integration, meaning contact centers and enterprises can seamlessly process telephone calls, e-mails, faxes, voice mail messages, Internet chat sessions, web collaborations and call-back requests, and IP telephony calls. Organizations can apply business rules across media types for consistent customer service and end-to-end tracking and reporting that improves workforce performance and service quality.
Our platform provides a single point of system management to simplify administration and maintenance, eliminates hardware “boxes” to reduce complexity as well as costs, and is flexibly deployed as a PBX/IP PBX or with an organization’s existing PBX/IP PBX.
These differentiating characteristics of our integrated software solutions allow businesses to more effectively communicate both internally and externally, and do so at a much lower total cost of ownership compared to legacy hardware systems and computer telephony integration products. Strategic advantages of our all-in-one, single-system approach to unified communications for business are described in the following sections.
Standards-Based All-Software Architecture and IP Capabilities
Our software applications incorporate native IP capabilities based on the international SIP communications standard developed by the IETF and adopted by a number of industry leaders including Microsoft. Unlike proprietary PBX phone systems and associated legacy hardware advertised as “IP-enabled,” our core platform and application solutions inherently incorporate SIP and open standards throughout, which eliminates the costly SIP extension “lock-ins” required when using proprietary communications hardware systems. To further reduce costs, our software runs on commodity servers with no need for expensive voice boards, allowing organizations to incrementally scale to more users and distributed office locations, and includes a built-in application generator and graphical user interface designer tools to integrate an organization’s specific business rules and required interaction processes. Combined, these open standards capabilities allow businesses to make use of a wide variety of low-cost IP soft phones and telephone devices, gateways, and other components from a number of different vendors.
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Broader Range of Functions
Traditional legacy communications systems require contact center and business enterprise operations to purchase separate multi-point products to attain the voice and data functionality they need, such as a PBX for phone calls, a web server for chat, and others. Our pre-integrated application suites instead offer the following communications features in one software solution: PBX/IP PBX, telephony, e-mail processing, ACD, IVR, web interaction event processing, inbound and outbound fax, conferencing, multimedia recording and screen recording, quality monitoring and more. Our solutions also include supervisory features to view communications statistics in real time, supplemented by workforce management, coaching features, interaction tracking and end-to-end reporting to improve performance. Collectively, these capabilities allow our customers to improve customer satisfaction and increase internal efficiency.
No Need to Integrate Disparate Technologies
Traditional communications systems generally require multiple components for voice and data. To work together, these multi-point systems in turn require significant, and often complex, integration efforts that can require expensive hardware, middleware and services. Our software application suites pre-integrate all necessary components for converged voice and data and unified communications, allowing businesses to concentrate their efforts on improving business operations instead of maintaining disparate communications technologies. Additionally to protect system investments, businesses can use our software applications to supplement an existing PBX with web-based interaction management, unified messaging, IVR, departmental contact center services, and other phone system functions.
Greater Ability to Utilize the Internet
With online initiatives playing a significant sales and marketing role in many businesses, our solutions provide customers a number of web-based interaction options. These options include e-mail, FAQ auto response, web chat and callback requests, online forms, and VoIP calls. Such options are increasingly important for effective e-commerce, e-Services and online customer service as consumers continue to use the Internet to conduct business transactions.
Open Architecture and Greater Compatibility with Leading Technologies
To accommodate our standards-based approach to business communications, we developed our Interaction Center Platform on an open architecture that is completely different from traditional telecommunications systems that are based on a proprietary, closed architecture. Traditional systems limit an organization’s ability to readily adapt to change or customize communications processes. With proprietary systems, even simple changes such as adding a new employee or changing an employee’s location can require costly vendor services. Our solutions are built using industry-standard server, networking and software components such as Intel Corporation’s (“Intel”) microprocessors, the Microsoft Windows operating system, Dialogic Corporation’s (“Dialogic”) Host Media Processing (“HMP”) software, and gateways from a select list of certified vendors (including our own Interaction Gateway™). Our open platform architecture allows organizations to easily configure our applications to meet precise communications requirements and to flexibly make hardware or software modifications as necessary. Our products also easily interact with popular technology products that include:
Lower Total Cost of Ownership
We believe that our pre-integrated applications-based solutions result in a lower total cost of ownership compared to traditional multi-point communications systems with similar functionality. Our all-in-one platform and application solutions are developed specifically to reduce configuration and administration while delivering enhanced multi-channel communications features, by deploying applications on a single interaction server and licensing users rather than procuring products and incurring high integration costs from several different vendors. Adding to a lower total cost of ownership is the fact that our intuitive Windows-driven solutions reduce end-user training, along with the time and expense typically required to manage changes in a multi-component business communications system.
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Greater Ability to Customize Communications to Meet Specific Needs
Our core Interaction Center Platform includes the built-in Interaction Designer® application generator and graphical user interface that enables an organization to integrate specific business rules and required interaction processes. In addition to deploying applications quickly with minimal configuration, organizations can use the pre-built tool sets in Interaction Designer to customize nearly any aspect of their communications processing. This customization capability allows organizations to tailor communications processes for their customers, employees and other users using only a single tool to structure dial plans, call distribution rules, IVR menus, web services, voice mail system menus, fax applications and other communications applications.
We intend to leverage our leadership position in the contact center marketplace to continue expanding our multi-channel IP telephony solutions into the enterprise market. Our strategy for achieving this mission has multiple elements as described below.
Innovation and Enhancing Our Core Product Offerings
Forward-thinking has been the cornerstone of our company. Since incorporating in 1994, we have gained significant experience and expertise in contact center, telecommunications, software, and Internet technologies. We will continue to leverage this knowledge to improve our solutions with enhanced functionality, maintainability, security, mobility, scalability and broader integration capability to differentiate our offerings in the markets we serve. We also will continue to improve and add to our global offerings for VoIP and unified communications by leveraging the international SIP communications standard. Currently, this combination of industry experience and our technological approach allows us to offer a single, open software solution for a variety of IP-based business communications needs in contact centers, enterprises and for the mobile workforce. We continue to invest in research and development of new and existing products for contact centers and enterprises, as well as for VoIP infrastructures. We are continually improving our technology to address the requirements of large-scale organizations with thousands of users for voice mail (including voice mail system replacement), unified messaging, and enhanced messaging. Our company was built on innovation, and we expect to continue breaking new ground with our solutions. New applications or functionality scheduled to be released by us in 2008 include integration with Microsoft's Office Communication Server, our Interaction Mobile Office application for remote enterprise messaging, post-call cusotmer surveys, real-time "emotion detection" and the ability to automate business processes leveraging our communications platform.
Expand in Our Markets
For all markets we serve, our strategy is to appeal to a broader audience of customers and partners by providing “whole solutions” for business communications.
We have leveraged the already strong position of our Customer Interaction Center® (“CIC”) IP application suite to appeal to larger single- and multi-site contact center operations with 50 to 5,000 ACD agents. The single-platform CIC solution utilizes VoIP via the international SIP communications standard, and offers a pre-integrated “all-in-one” application suite for multi-channel interaction management, CRM integration, screen pop, self-service automation, multi-lingual support, and communications features for enterprise business users as well as contact center agents, remote agents and supervisors.
We have positioned our pre-integrated Vonexus Enterprise Interaction Center™ IP PBX offering (“Vonexus EIC”) for enterprises from 100 to 1,500 users. As a whole product model for businesses using the Microsoft platform, Vonexus EIC is delivered complete with the Vonexus EIC server and application solution, SIP proxy, gateways and IP phones. We are positioning the Vonexus EIC solution to a global audience of mid-sized enterprises, and especially to those that employ growing mobile workforces, that require increased contact center and workgroup capabilities, and that see the need for a more unified communications infrastructure using VoIP.
We have also enhanced our Messaging Interaction Center™ ("MIC") enterprise messaging solution by positioning it as a combined application server/telephony user interface solution to deliver advanced voice and IP capabilities alongside its robust messaging features. With a number of notable enhancements in the past year, we believe MIC offers a clear path to VoIP messaging through a cost-effective, easy to use system that is easy to install and administer.
Promote Our Services Offerings
Led by our Customer Support and Services teams, we continue to add to the list of implementation and customization services we provide for our new and existing customers and partners. As hosted communications services become more popular among businesses, we plan to expand our SaaS offerings for contact centers and enterprises, which we launched in the first quarter of 2007, along with our business development and marketing efforts for our icNotify hosted notification services, which we introduced in the first quarter of 2006. We believe these combined services offerings will more firmly and effectively position us against our competitors.
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Leverage Industry-Specific Solutions
We have experienced an increasing number of customers in higher education, healthcare, financial services (i.e. banks, credit unions and insurance companies) and other industry-specific markets. Our strategy is to leverage our existing business relationships with our customers and partners to further penetrate these markets. To supplement our vertical market offerings, we will continue to work with our partners with expertise in specific industries to create custom applications and solutions, most notably in the financial services sector, and will present such offerings throughout our entire partner channel.
Go “Up-Market” Through Increased Scalability and Reliability
We are able to meet the demand of larger business organizations by increasing security, reliability, functionality and mobility, as well as by offering broader integration. In our most recent Customer Interaction Center® (“CIC”) product release, version 3.0 (“CIC 3.0”), we have made significant enhancements in the following areas:
Security – CIC 3.0 includes new support features for secure real-time transport protocol and transport layer security to encrypt audio and call control information. CIC 3.0 also includes recording encryption via our Interaction Recorder® solution, improved password generation requirements, the use of public/private key certificates, and the ability to handle communications between secure and non-secure devices. CIC 3.0’s data security measures are also specialized for VoIP, with the benefit being reduced costs and increased customer satisfaction through improved compliance with regulatory, payment card industry and privacy standards, along with reduced opportunities for eavesdropping, impersonation, theft, and the manipulation of audio and data.
Broader integration – CIC 3.0 includes new integration to Microsoft’s Office Communications Server, which embeds call control capabilities into the Microsoft Office Communicator client. CIC 3.0 also delivers integration to Microsoft Exchange 2007 Unified Messaging to provide server-based tools for access anywhere to voice, fax, and e-mail data, along with the ability to use the phone to manage e-mail, calendar, and personal contacts. The benefits of such wide-ranging integration are reduced costs associated with less integration and increased productivity through CIC 3.0’s single interface for end-users. CIC 3.0 also includes an upgraded application programming interface (“API”) and software development kit called Interaction Center Extension Library (“IceLib”). The benefits of CIC 3.0’s API and IceLib features are lower costs via faster development times, and increased revenue opportunities that results from more flexible integration options for call control functions into third-party applications and back-end systems.
Simplified deployment – CIC 3.0 includes new auto-provisioning for Polycom® phones, additional automated e-mail routing options, and a new Report Assistant that simplifies custom reporting. The benefits in this case are a faster return on investment and lower total cost of ownership, resulting from shorter deployment times for telephone device provisioning, e-mail routing configuration and custom report forms.
Enhanced mobility – CIC 3.0 adds Microsoft Exchange calendar integration to existing functionality in our Interaction Mobile Office™ application, which includes speech-enabled auto-attendant, voice mail and e-mail message retrieval, status changes, and company directory access. The Interaction Client® Mobile Edition is a new graphical client interface that supports Windows Mobile 5.0 and 6.0 and the Smartphone operating systems to make “Interaction Center” IP telephony functionality accessible via mobile devices such as the Microsoft Windows-Powered Pocket PC and the Windows Mobile Smartphone. The benefits are increased access to voice and data for mobile workers, resulting in increased productivity.
We have developed a comprehensive product solution to serve the contact management and business communications needs of organizations in our three target markets:
It is important to note that our pre-integrated application solutions, as well as the core Interaction Center Platform that supports them, are designed expressly to work with one another as fully-integrated all-in-one solutions that require no third party products or computer telephony integration. Because our products are not acquired from other vendors, our customers avoid the complexities and costs of trying to integrate disparate multi-point systems that were not originally designed to work together.
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Customer Interaction Center® (“CIC”)
Unified Communications from a Single Integrated Platform for the Contact Center and Enterprise IP Telephony for the Larger Enterprise
CIC gives contact centers and enterprises a single platform and a pre-integrated all-in-one application solution for IP telephony, highlighted by multimedia ACD to uniformly manage phone calls, faxes, e-mails and web interactions. CIC’s inherent PBX/IP PBX call processing, voice mail, fax server and unified messaging further enhance performance and customer service for agents, supervisors and business users. The SIP-architected CIC provides a straightforward migration path for VoIP, and is well-suited for contact centers, including remote agents. CIC also serves as a communication solution for enterprises and multi-site organizations, including mobile workers. CIC can be deployed as an on-premise product or provided through a SaaS deployment model.
Vonexus Enterprise Interaction Center™ (“Vonexus EIC”)
Enterprise IP Telephony for the Mid-sized Enterprise
Vonexus EIC is a complete all-software IP PBX phone and communications system built on the Microsoft platform and architected for SIP-supported VoIP. The Vonexus EIC solution is targeted at mid-sized businesses from 100 to 1,500 users, whether in one location, in distributed branch offices or in mobile workgroups. In one system, Vonexus EIC includes IP PBX call processing, ACD, automated attendant, voice mail, operator console, Find-Me/Follow-Me, built-in fax server, and web chat and web callback. The Vonexus EIC software additionally offers features including real-time presence management and remote access, with pre-integrated unified messaging, IVR and Interaction Client integrations for Microsoft’s most popular applications optionally available.
Messaging Interaction Center™ (“MIC”)>
Voice Mail, Unified Messaging, Enhanced Enterprise Messaging, SIP-supported VoIP
MIC personifies enterprise messaging with its “choose by function” capability on one integrated platform. Users on the same system can have different capabilities ranging from voice mail to unified messaging to enhanced messaging features that include one-number Find-Me/Forward, universal web-based message access and system administration, message notification options, personal settings options, and calendar and contact management capabilities. MIC also offers call screening, user-defined call handling rules, automatic callback, and desktop faxing and fax “navigation.” MIC allows organizations of up to hundreds of thousands of users to replace legacy voice mail, implement unified messaging, take advantage of VoIP using the SIP standard, or leverage all of these capabilities in one solution.
Pre-integrated add-on modules for CIC are identified in the following sections.
Interaction Dialer leverages the CIC platform for outbound and blended predictive dialing, and provides call scripting, multi-site campaign management, intelligent campaign staging, compliance options, and more. Version 2.4 of the Interaction Dialer application also works with our Interaction Gateway for SIP-based outbound dialing that scales to higher call levels per hour.
Interaction EasyScripter integrates to Interaction Dialer for easy web-based scripting at all user levels, including for “non-technical” users.
Interaction Optimizer supports workforce management forecasting, scheduling and real-time adherence for contact centers.
Interaction Director pre-integrates to multiple CIC servers to route calls to the location that can best handle those calls at that time. A single Interaction Director server can process hundreds of thousands of calls per hour.
Pre-integrated add-on modules for CIC and Vonexus EIC are identified in the following sections.
Interaction Supervisor pre-integrates to CIC and to the Vonexus EIC solution to provide a single real-time interface for monitoring agent, user and workgroup activities, along with interaction events and Interaction Center system and queue statistics.
Interaction Tracker is a full interaction/contact history management application that works with CIC and Vonexus EIC to track multimedia interactions and allows authorized users to resolve new contacts and search for and view historical interaction-based information. Interaction Tracker can function as a customer interaction tracking system, but can also be integrated with packaged CRM solutions and/or special purpose customer information management systems.
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Interaction Recorder offers complete quality assessment control in one environment for recording and archiving phone calls, e-mails, faxes and web chats. In addition, CIC users can capture interactions with Interaction Recorder’s screen recording capability. Scoring features in the Interaction Recorder application simplify quality processes and out-of-the-box reports facilitate measuring individual and group scoring results for performance.
For self-service automation:
e-FAQ provides users across enterprises and contact centers a seamless, integrated gateway to vital up-to-date information that employees and customers alike can query for as needed, using their choice of communication channels to ensure rapid data delivery. The e-FAQ application uses linguistic analysis to clarify incoming questions, search for matches, and instantly reply when an appropriate match is found. e-FAQ’s web-based e-FAQ Knowledge Manager™ simplifies authoring and centralizes administration, reporting, and testing. e-FAQ’s built-in editor interface and sample response templates further streamline the authoring and implementation process.
For the mobile workforce:
Interaction Mobile Office™
Interaction Mobile Office integrates to the CIC, Vonexus EIC and MIC application solutions to extend each system to mobile users. By leveraging the Interaction Mobile Office application’s speech-enabled telephone user interface, users can change presence management settings and access Microsoft Exchange-based voice mails, e-mails, faxes, corporate directories, and calendars from wherever they are located.
For voice mail and unified messaging enhancement:
Interaction Message Indicator™ ("IMI")
IMI monitors Microsoft Exchange Server 2007 Unified Messaging mailboxes for the presence of voice mail messages. IMI initiates the message waiting indicator on a user’s desktop phone and discontinues the message waiting indicator when new voice mails have been reviewed. IMI is engineered to work with all third-party phone systems, and with our Vonexus EIC and CIC application solutions.
We also have developed SIP and VoIP solutions that enhance our software offerings, including the following:
Interaction Gateway makes it possible to configure Interaction Dialer (version 2.4 and higher) and CIC for SIP-supported outbound predictive dialing, increased call volume capacity, and advanced call analysis for outbound dialing. By supporting the high-volume outbound capacities of multiple Interaction Dialer servers, the Interaction Gateway appliance is targeted to teleservices firms and businesses that offer blended inbound/outbound dialing services to their customers.
Interaction Media Server™ and Interaction SIP Proxy™
The Interaction Media Server and Interaction SIP Proxy for CIC and Vonexus EIC is available in version 2.4 and version 3.0 and increases Interaction Center system performance by moving audio recording, processing and compression to this appliance. Interaction Media Server features, which utilize our next-generation ION™ technology, also allow organizations to support supervisory monitoring, recording at remote sites, and the playback of recorded music during ACD wait states. Interaction SIP Proxy likewise allows organizations employing the SIP communications standard for VoIP to support all SIP methods and status codes, comply with SIP specifications, and more effectively balance and route SIP-based messages.
As part of our Vonexus EIC solution we sell servers, gateways and telephone handsets. Some customers licensing our CIC software require that we deliver certain hardware, such as servers and telephone handsets, and occasionally including networking hardware, as part of the solution. In addition, we have developed our Interaction Media Server, Interaction SIP Proxy and Interaction Gateway appliances as a combination of hardware and our software.
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Research and Development
Leveraging technology is part of our strategic position, and we continue to invest a substantial percentage of our revenue in research and development. Our research and development group is comprised of professionals with backgrounds in telecommunications, software, and hardware. This combination of diverse technical and communications expertise contributes to our competitive advantage with a differentiated technology approach. A series of packaged customer solutions are available from this group, such as integration to SAP, Siebel, and Microsoft MS-CRM. These solutions allow partners to quickly install sophisticated applications for customers.
We are both a Microsoft Certified Developer as well as a Microsoft Certified Solutions Provider. These designations provide us early access to Microsoft technology and the opportunity to develop products more quickly and which effectively interoperate with Microsoft products.
Research and development expenses were $17.0 million, $13.6 million and $12.4 million in 2007, 2006 and 2005, respectively. Our research and development group is structured as technical teams, each of which follows formal processes for enhancements, release management, technical reviews and quality assurance. We continue to make research and development a priority in our business in order to remain on the forefront of innovation.
Customer Support and Services
We recognize the importance of offering quality service and support to our partners and customers. Our partners provide valuable initial support and services to many of our customers. We provide a wide range of services and support to both partners and customers including worldwide support services, educational services, and professional services. These services are described in more detail in the following sections.
Our Professional Services Team offers project management, implementation services and consulting services. This team handles strategic accounts and enhances partner expertise on advanced offerings such as predictive dialing, speech recognition and third-party CRM integrations. They also offer a variety of packaged and ad-hoc consulting services to ensure the customer has the solution that drives their business to success. This team works closely with our new partners as they implement our products at their sites. Our Professional Services Team is involved with the early release of products to assist in new release implementations. We are investing in this team as we provide more consultative services and implementation services for strategic customers globally.
Support and Managed Services
Our Support Services Team offers global technical support for our partners and customers 24 hours a day, seven days a week by phone, fax, e-mail, web chat and from our website. We have support centers at our world headquarters in Indianapolis, Indiana, and in the United Kingdom and Malaysia, and we have other secondary support resources in California, Virginia, the Netherlands, Australia, Japan and Korea. We utilize our CIC products, leveraged with technologies such as knowledge base, CRM and the Internet, to maximize the effectiveness of our support services.
Our Support Services Team is divided into regions that align with our worldwide sales teams. Interactions are routed to the respective region based on the customer location. This enables our Support Services Team to better know their customers and offer quality support services. The engineers on our Support Services Team are also specialists. They focus their efforts on very specific areas of our offerings, allowing them to develop a deeper knowledge set. We use Interaction Director to route incidents globally in a “follow-the–sun” manner.
With our growing base of strategic partners and end customers, we now offer a Managed Care Program where our Managed Services Team provides not only off-site support but also SaaS support and day-to-day support on-site within our customers’ locations. Currently, our Managed Services Team is divided into regions in North America that align with our worldwide sales teams.
Our Educational Services Team is also divided into regions that align with our worldwide sales teams and provides technical certification and advanced instruction through on-site courses, classroom presentations, and web-based training. This team develops and maintains course curriculum for formal certification programs such as sales, product installation, troubleshooting, system administration and custom design. Web-based training courses offer enhanced topics such as reporting, system administration, and computer-based user training. All of our partners are required to maintain updated certifications to license and support our products. Classes are also offered to all of our end customers to encourage the most effective use of the applications. We have moved our classroom sessions to a VoIP structure and focused our education resources on the IP-based Interaction Center. This enables our partners and our end customers to build a deeper understanding of the networking infrastructure and telephony technology of the future.
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Our marketing team is organized by five departments: Product Management, Solutions Marketing, Market Communications, Lead Management, and Marketing Services Group.
Our Product Management Team is responsible for coordinating activities with our development teams to define product requirements and to manage the process for market requirements, product development approvals, pricing definitions, release scheduling and beta test coordination. This Product Management Team oversees the product management process from product concept through the end of the beta test cycle.
Members of our Solutions Marketing Team focus on the marketing and promotion of our solutions to customers, prospective customers and partners as well as to industry analysts. Their responsibilities include product promotional activities, market positioning of new and updated products, internet content and other solutions-related events and actions.
Our Market Communications Team manages media and industry analyst relations, primarily through regularly-scheduled briefings with magazine editors and industry analysts and by participating in various media events such as tradeshows and seminars.
Our Lead Management Team handles all lead-generation activities resulting from tradeshows, seminars, and web-based marketing programs. This team leverages local and regional seminars with strategic partners such as Intel, Microsoft and Polycom to generate qualified leads for partners as well as our Territory Managers and Channel Sales Managers. This Lead Management Team additionally organizes our annual User Forum customer conference and Partner Conference.
Our Marketing Services Group is responsible for all print collateral and associated materials for tradeshows, marketing seminars, promotions, advertising, brand awareness, customer and partner relations and other company functions. Field Marketing Managers throughout Europe, the Middle East and Africa (“EMEA”) and the Asia-Pacific (“APAC”) regions are aligned with our Marketing Services Group and are responsible for similar brand awareness, marketing and advertising functions in their respective areas.
Global Distribution and Sales
We distribute our products through partners and direct arrangements with end-user customers. In 2007 product orders we received through partners were 65% of total orders.
We assign geographic or account responsibilities to Territory Managers/Channel Sales Managers who manage partners and direct customer opportunities.
As of December 31, 2007, we had 51 Territory Managers/Channel Sales Managers and maintained a global channel network of more than 250 partners with a presence in over 70 countries.
For the growing VoIP and IP telephony market, our distribution channel is anchored by knowledgeable and experienced “converged” partners who understand voice and data networking. We continue to expand this partner network to cover new geographic and product markets worldwide.
In the Americas, we license and distribute mainly through our partners. However, in the United States and Canada we also maintain certain direct customers, primarily with major corporations or in areas lacking adequate partner relationships. In such cases, we utilize our Territory Managers, supplemented by lead generation and inside sales groups that generate potential opportunities. In EMEA and APAC, we license and distribute our solutions principally through a joint strategy between our Master Distributors and partners at the Elite and Premier Partner levels. Our EMEA headquarters are located near London, England and our APAC headquarters are located in Kuala Lumpur, Malaysia.
Our partners are supported by Program Managers, regional Channel Enablement Managers, Licensing Specialists and other roles related to sales, support services and education/certification.
Within our program framework, our principal partner level designations include:
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We also have a Channel Ready Team that extends beyond the software aspects of our solution to the hardware. Our Channel Ready Team takes the final product and then produces an image that enables the partner to install faster and easier, back-up and recover for normal maintenance, and reduce the cost of ongoing support. Our Channel Ready Team works with hardware providers globally and has built relationships that enable us to provide a full solution for our partners. This team also develops appliances that use our software, such as the Interaction Media Server and Interaction Gateway.
Our Technical Sales Team is responsible for demonstration facilities, systems and services at our Indianapolis, Indiana headquarters and regional offices throughout the U.S. and around the world. This team builds and maintains demonstration scripts and provides training to partners and internal Interactive Intelligence sales teams. All of our partners are granted access to our systems and services for live customer demonstrations on a global basis, and are assisted by our Technical Sales Team as needed to perform demonstrations. Our Technical Sales Team further assists with marketing efforts and presentations at industry tradeshows, regional seminars, and events including our annual partner conference and global user forum.
Customers and Geographic Areas of Operations
As of December 31, 2007, we licensed our products to more than 2,500 active customers in the Americas, EMEA and APAC. No customer or partner accounted for 10% or more of our revenues or accounts receivable in 2007, 2006 and 2005. As such, no material part of our business is dependent upon a single customer or partner or a small group of customers or partners. Therefore, the loss of any one customer or partner would not have a material adverse effect on our operations.
See Note 11 of Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for financial information about each of the geographic areas in which we operate.
The markets for our application-based solutions are highly competitive. Our competition varies depending on the different market segments in which we license our software applications: Contact Centers, Enterprise IP Telephony, and Enterprise Messaging. Unlike those solutions from several of our competitors, customers can choose to deploy many of our solutions on-premise or leverage them in a SaaS model. In the contact center sector our main competitors are Aspect Software (formerly Aspect Communications Corporation), Avaya, Cisco and Nortel. Significant enterprise IP telephony competitors include Alcatel, Avaya, Cisco, Nortel, Siemens AG and ShoreTel, Inc. For enterprise messaging we compete mainly with Avaya, Cisco, Intervoice, Inc., Nortel and Applied Voice & Speech Technologies. We compete, on a smaller scale, with many other established and recent entrants in each marketplace.
Intellectual Property and Other Proprietary Rights
We own numerous patents and patent applications that we consider valuable components of our business. To protect our proprietary rights, we rely primarily on a combination of:
As of December 31, 2007, we and our subsidiaries held 11 patents and have filed other patent applications relating to technology embodied in our software products. In addition, we and our subsidiaries hold 23 United States and 76 foreign trademark registrations and have numerous other trademark applications pending worldwide, as well as common law rights in other trademarks and service marks. We and our subsidiaries also hold 16 registered copyrights and have numerous other applications pending.
As of February 29, 2008, we had 595 employees worldwide, including 163 in research and development, 183 in client services, 155 in sales and marketing and 94 in administration. Our future performance depends in significant part upon the continued service of our key sales, marketing, technical and senior management personnel and our continuing ability to attract and retain highly qualified personnel. Competition for these personnel is intense and we may not be successful in attracting or retaining these personnel in the future.
We believe that we have a corporate culture that attracts highly qualified and motivated employees. We emphasize teamwork, flexible work arrangements, local decision-making and open communications. Many employees have been granted stock options. None of our employees are represented by a labor union. We have not experienced any work stoppages. We consider our relations with our current employees to be good.
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The following factors, among others, could cause actual results to differ materially from those contained in forward-looking statements made in this Annual Report on Form 10-K and presented elsewhere by management from time to time. Such factors, among others, may have a material adverse effect on our business, financial condition, and results of operations and you should carefully consider them. It is not possible to predict or identify all such factors. Consequently, you should not consider any such list to be a complete statement of all our potential risks or uncertainties. Because of these and other factors, past performance should not be considered an indication of future performance.
The Overall Economic Climate May Weaken Which Could Result in Decreased Demand for Our Products and Lower Revenues
Our products typically represent substantial capital commitments by customers and involve a potentially long sales cycle. As a result, customer purchase decisions may be significantly affected by a variety of factors, including general economic trends in the allocation of capital spending budgets to communication software, services and systems, lengthened sales cycles, customer approval processes, and market conditions, which may result in our customers delaying and/or reducing their capital spending related to information systems. If the economy weakens, demand for our products could decrease, resulting in lower revenues.
We May Not Sustain Profitability
We have been profitable for the past four consecutive years. Prior to 2004, we historically incurred losses and may do so again in the future. At December 31, 2007, we had accumulated net losses since inception of $31.0 million. We intend to continue to make significant investments in our research and development, marketing, services, and sales operations.
Our Quarterly Operating Results Have Varied Significantly
Our operating results have varied significantly from quarter to quarter and may continue to do so in the future depending on a number of factors affecting us or our industry, including many that are beyond our control. As a result, we believe that period-to-period comparisons of our operating results are not necessarily meaningful, and you should not rely on them as an indication of our future performance. In addition, our operating results in a future quarter or quarters may fall below expectations of securities analysts or investors and, as a result, the price of our common stock may fluctuate.
Because we do not know if or when our partners and current or potential customers will place orders and finalize licenses, and because it is difficult to predict the mix of annually renewable licenses and perpetual licenses in a quarter, we cannot always accurately forecast our licensing activity, our revenues and our operating results for future quarters. We recognize revenues from different licenses over different periods depending on the satisfaction of the requirements of relevant accounting literature, including American Institute of Certified Public Accountants (“AICPA”) Statement of Position 97-2, AICPA Statement of Position 98-9, SEC Staff Accounting Bulletin (“SAB”) No. 104, and all related AICPA Technical Practice Aids (5100.38 - 5100.76). As a result, our quarterly revenues and operating results depend on many factors, including the type of license, the size, quantity and timing of orders received for our products during each quarter, the delivery of the related software or hardware and our expectations regarding collection. If a large number of orders or several large orders do not occur or are deferred or delayed, our revenues in a quarter could be substantially reduced. This risk is heightened by the significant investment and executive level decision-making typically involved in our customers’ decisions to license our products. Since a large portion of our operating expenses, including salaries and rent, is fixed and difficult to reduce or modify in a short time period, our business, financial condition or results of operations could be materially adversely affected if revenues do not meet our expectations.
Our limited number of products, changes in pricing policies, the timing of development completion, and announcement and sale of new or upgraded versions of our products are some of the additional factors that could cause our revenues and operating results to vary significantly from period to period.
We Have a Lengthy Product Sales Cycle Which Has Contributed and May Continue to Contribute to the Variability of Quarterly Operating Results
We have generally experienced a lengthy initial sales cycle, averaging approximately six to nine months. The lengthy sales cycle is one of the factors that has caused, and may in the future continue to cause, our product revenues and operating results to vary significantly from quarter to quarter, which could affect the market price of our common stock. The lengthy sales cycle also makes it difficult for us to forecast product license revenues. Because of the unique characteristics of our products and our prospective customers’ internal evaluation processes, decisions to license our products often require significant time and executive-level decision making. We believe that many companies currently are not aware of the benefits of interaction management software of the type that we license or of our products and capabilities. For this reason, we must provide a significant level of education to prospective customers about the use and benefits of our products, which can cause potential customers to take many months to make these decisions. As a result, sales cycles for customer orders vary substantially from customer to customer. Excessive delay in product sales could materially adversely affect our business, financial condition or results of operations.
The length of the sales cycle for customer orders depends on a number of other factors over which we have little or no control, including:
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Our Inability to Successfully Manage Our Increasingly Complex Third Party Relationships Could Adversely Affect Us
As the complexity of our product technology and our partner and other third party relationships have increased, the management of those relationships and the negotiation of contractual terms sufficient to protect our rights and limit our potential liabilities have become more complicated, and we expect this trend to continue in the future. In addition, because we now offer, through suppliers, a whole product solution, this has added complexity to those third party relationships. As a result, our inability to successfully manage these relationships or negotiate sufficient contractual terms could have a material adverse effect on us.
We May Not be Able to Grow Our Business If We Do Not Maintain Successful Relationships With Our Partners and Continue to Recruit and Develop Additional Successful Partners
Our ability to achieve revenue growth in the future will depend in part on our success in maintaining successful relationships with our existing and future partners and in recruiting and training additional partners. We rely primarily on partners to market and support our products and plan on continuing to rely heavily on such partners in the future. We are still expanding our partner and distribution networks and may be unable to attract additional partners with both voice and data expertise or appropriate partners that will be able to market our products effectively and that will be qualified to provide timely and cost-effective customer support and service. We generally do not have long-term or exclusive agreements with our partners, and the loss of specific larger partners or a significant number of partners could materially adversely affect our business, financial condition or results of operations.
Our Inability to Source Hardware Could Harm Our Business
For certain of our orders, we supply hardware to support the implementation of our software. We are dependent on third parties for the supply of hardware components to our customers. If these hardware distributors experience financial, operational or quality assurance difficulties, or if there is any other disruption in our relationships, we may be required to locate alternative hardware sources. We are also subject to the following risks related to our hardware distribution system:
We cannot assure you that we would be able to locate alternative hardware sources in a timely manner, on terms favorable to us, or at all. Even if we and/or our distributors are successful in locating alternative sources of supply, alternative suppliers could increase prices significantly. In addition, alternative components may malfunction or interact with existing components in unexpected ways. The use of new suppliers and the modification of our products to function with new systems would require testing and may require further modifications, which may result in additional expense, diversion of management attention and other resources, inability to fulfill customer orders or delay in fulfillment, reduction in quality and reliability, customer dissatisfaction, and other adverse effects on our reputation, business and operating results.
We Face Competitive Pressures, Which May Have a Material Adverse Affect on Us
The market for our software applications is highly competitive and, because there are relatively low barriers to entry in the software market, we expect competitive pressures to continue to be a risk to our ongoing success in the market. In addition, because our industry is evolving and characterized by rapid technological change, it is difficult for us to predict whether, when and by whom new competing technologies or new competitors may be introduced into our markets. Currently, our competition comes from several different market segments, including computer telephony platform developers, computer telephony applications software developers and telecommunications equipment vendors. We cannot provide assurance that we will be able to compete effectively against current and future competitors. In addition, increased competition or other competitive pressures may result in price reductions, reduced margins or loss of market share, any of which could have a material adverse effect on our business, financial condition or results of operations.
Many of our current and potential competitors have longer operating histories, significantly greater resources, greater name recognition and a larger installed base of customers than we do. As a result, these competitors may be able to respond to new or emerging technologies and changes in customer requirements more effectively than we can, or to devote greater resources to the development, promotion and sale of products than we can. In addition, for a number of our larger competitors, the product segment in which they currently compete with us is a small portion of their overall offering. These competitors might be willing and able to dramatically cut prices in our segment in order to protect or grow other segments that are more important to their overall business. Current and potential competitors have established, and may in the future establish, cooperative relationships among themselves or with third parties, including mergers or acquisitions, to increase the ability of their products to address the needs of our current or prospective customers. If these competitors were to acquire significantly increased market share, it could have a material adverse effect on our business, financial condition or results of operations.
Our Markets Are Characterized by Rapid Technological Change Which May Cause Us to Incur Significant Development Costs and Prevent Us from Attracting New Customers
The market for our products is characterized by rapid technological change, frequent new product introductions and enhancements, uncertain product life cycles and changing customer demands. The introduction of products embodying new technologies and the emergence of new industry standards could render existing products obsolete or unmarketable and cause us to incur significant development costs and prevent us from attracting new customers.
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A Decline in Market Acceptance for Microsoft Technologies on Which Our Products Rely Could Have a Material Adverse Affect on Us
Our products currently run on Microsoft Windows operating systems. Our web client interfaces are supported on certain browsers which run on Windows, Mac and Linux. A decline in market acceptance for Microsoft technologies or the increased acceptance of other server technologies could cause us to incur significant development costs and could have a material adverse effect on our ability to market our current products. Although we believe that Microsoft technologies will continue to be widely used by businesses, we cannot assure you that businesses will adopt these technologies as anticipated or will not in the future migrate to other computing technologies that we do not currently support. In addition, our products and technologies must continue to be compatible with new developments in Microsoft technologies. We cannot assure you that we can maintain that compatibility or that we will not incur significant expenses in connection therewith.
If We Are Unable to Maintain the Compatibility of Our Software With Certain Other Products and Technologies, Our Future Business Would be Adversely Affected
Our software must integrate with software and hardware solutions provided by a number of our existing and potential competitors. For example, our products must integrate with phone switches made by the telephone switch vendors and computer telephony software applications offered by other software providers. These competitors or their business partners could alter their products so that our software no longer integrates well with them, or they could delay or deny our access to software releases that allow us to timely adapt our software to integrate with their products. If we cannot adapt our software to changes in necessary technology, it may significantly impair our ability to compete effectively, particularly if our software must integrate with the software and hardware solutions of our competitors.
Our Future Business Prospects Depend in Part on Our Ability to Maintain and Improve Our Current Products and Develop New Products
We believe that our future business prospects depend in large part on our ability to maintain and improve our current software applications and to develop new software applications on a timely basis. Our software applications will have to continue to achieve market acceptance, maintain technological competitiveness and meet an expanding range of customer requirements. As a result of the complexities inherent in our applications, major new applications and application enhancements require long development and testing periods. We may not be successful in developing and marketing, on a timely and cost effective basis, application enhancements or new software applications that respond to technological change, evolving industry standards or customer requirements. We may also experience difficulties that could delay or prevent the successful development, introduction or marketing of application enhancements, and our new applications and application enhancements may not achieve market acceptance. Significant delays in the general availability of new releases of our software applications or significant problems in the installation or implementation of new releases of our applications could have a material adverse effect on our business, financial condition or results of operations.
Slow Growth, or a Decline in Demand for Interaction Management Software of the Type We License, Could Materially Adversely Affect Our Financial Results and Growth Prospects
If the demand for interaction management software of the type we license does not grow within each of our three targeted markets, our financial results and ability to grow our business could be materially adversely affected. All of our revenues have been generated from licenses of our Interaction Center Platform software or complementary products, and related support, educational and professional services. We expect these products and services to account for the majority of our revenues for the foreseeable future. Although we believe demand for the functions performed by our products is high, the market for our products and services is still emerging. Further, our growth plans require us to successfully attract enterprise and service provider customers in significantly larger numbers than we have historically achieved.
If Our Customers Do Not Perceive Our Products or the Related Services Provided by Us or Our Partners to Be Effective or of High Quality, Our Brand and Name Recognition Will Suffer
We believe that establishing and maintaining brand and name recognition is critical for attracting, retaining and expanding customers in our target markets. We also believe that the importance of reputation and name recognition will increase as competition in our market increases. Promotion and enhancement of our name will depend on the effectiveness of our marketing and advertising efforts and on our success in providing high-quality products and related services, neither of which can be assured. If our customers do not perceive our products or related services to be effective or of high quality, our brand and name recognition would suffer which could have a material adverse effect on our business, financial condition or results of operations.
Our Products Could Have Defects for Which We Are Potentially Liable and Which Could Result in Loss of Revenue, Increased Costs, Loss of Our Credibility, Harm Our Reputation or Delay in Acceptance of Our Products in the Market
Our products, including components supplied by others, may contain errors or defects, especially when first introduced or when new versions are released. Despite internal product testing, we have in the past discovered software errors in some of our products after their introduction. Errors in new products or releases could be found after commencement of commercial shipments, and this could result in additional development costs, diversion of technical and other resources from our other development efforts, or the loss of credibility with current or future customers. This could result in a loss of revenue or delay in market acceptance of our products, which could have a material adverse effect on our business, financial condition or results of operations.
Our license agreements with our customers typically contain provisions designed to limit our exposure to potential product liability and some contract claims. However, not all of these agreements contain these types of provisions and, where present, these provisions vary as to their terms and may not be effective under the laws of some jurisdictions. A product liability, warranty, or other claim brought against us could have a material adverse effect on our business, financial condition or results of operations.
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Our software runs on a Windows 2000 or Windows 2003 server and for telephone call processing uses voice processing boards or third party VoIP media processing software such as Intel HMP software. Our server software also operates in a complex network environment with database servers, email servers and other third party systems. Because of this complexity, our software may be more prone to performance interruptions for our customers than traditional hardware-based products. Performance interruptions at our customer sites, many of which currently do not have back-up systems, could affect demand for our products or give rise to claims against us.
If We Do Not Provide Installation Services or Training Courses Effectively and Efficiently, Our Partners and End Customers May Not Use Our Installation Services, May Not Attend Our Training Courses or May Stop Using Our Software
Our partners and end customers ordinarily purchase installation, training and maintenance services together with our products. The functionality of our products is not dependent on our installation and training services. We believe that the speed and quality of installation services are competitive factors in our industry. If our installation services are not satisfactory, our partners and end customers may choose not to use our installation services, or attend our training courses or may not license our software in the future. As a result, we would lose product licensing and services revenue, and it could harm our reputation. In addition, our revenues realized from the performance of maintenance services are material to our operating results, and a failure to provide adequate maintenance support to our partners and end customers would result in reduced maintenance revenues and have an adverse effect on our operating results.
We May Not Be Able to Protect Our Proprietary Rights Adequately, Which Could Allow Third Parties to Copy or Otherwise Obtain and Use Our Technology Without Authorization
We regard our software products as proprietary. In an effort to protect our proprietary rights, we rely primarily on a combination of copyright, trademark and trade secret laws, as well as patents, licensing and other agreements with consultants, suppliers, partners and customers, and employee and third-party non-disclosure agreements. These laws and agreements provide only limited protection of our proprietary rights. It may be possible for a third party to copy or otherwise obtain and use our technology without authorization. A third party could also develop similar technology independently. In addition, the laws of some countries in which we license our products do not protect our software and intellectual property rights to the same extent as the laws of the United States. Unauthorized copying, use or reverse engineering of our products could materially adversely affect our business, results of operations or financial condition.
Certain Provisions in Agreements That We Have Entered Into May Expose Us to Liability for Breach That Is Not Limited In Amount By the Terms of the Contract
Certain contract provisions, principally confidentiality and indemnification obligations in certain of our license agreements, could expose us to risks of loss that, in some cases, are not limited by contract to a specified maximum amount. If we fail to perform to the standards required by these contracts, we could be subject to additional liability and our business, financial condition and results of operations could be materially and adversely affected.
Termination of Certain Third Party Licenses for Technology Embedded in Our Products Could Adversely Affect Us
We license from third parties technology that is embedded in our products. Some of these third parties that license technology to us are our competitors, or could become competitive with us in the future. Certain license agreements permit either party to terminate all or a portion of the license without cause at any time. Further, some of the license agreements provide that upon acquisition of us by certain other third parties, we would have to pay a significant fee to continue the license. If one or more of these licenses terminates or cannot be renewed on satisfactory terms, we would have to modify our affected products to use alternative technology, which may not be available, or eliminate the affected product function, either of which could have a material adverse effect on us.
Infringement Claims Could Adversely Affect Us
Third parties have claimed and may in the future claim that our technology infringes their proprietary rights. As the number of software products in our target markets increases and the functionality of these products overlap, we believe that software developers may face additional infringement claims.
Infringement claims, even if without merit, can be time consuming and expensive to defend. A third party asserting infringement claims against us or our customers with respect to our current or future products may require us to enter into costly royalty arrangements or litigation, or otherwise materially adversely affect us.
We Depend on Key Personnel and Will Need to Retain and Recruit Skilled Personnel, for Which Competition Is Intense, to Conduct and Grow Our Business Effectively
Our success depends in large part on the continued service of our key personnel, particularly Dr. Donald E. Brown, our Chief Executive Officer and principal stockholder. The loss of the services of Dr. Brown or other key personnel could have a material adverse effect on our business, financial condition or results of operations. Our future success also depends on our ability to attract, train, assimilate and retain additional qualified personnel. Competition for persons with skills in the software industry is intense, particularly for those with relevant technical and/or sales experience. We cannot assure you that we will be able to retain our key employees or that we can attract, train, assimilate or retain other highly qualified personnel in the future.
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We May Pursue Acquisitions That by Their Nature Present Risks and That May Not be Successful
In the future we may pursue acquisitions to diversify our product offerings and customer base or for other strategic purposes. We have limited prior history of making acquisitions and we cannot assure you that any future acquisitions will be successful. The following are some of the risks associated with acquisitions that could have a material adverse effect on our business, financial condition or results of operations:
Our International Operations Involve Financial and Operational Risks Which May Adversely Affect Our Business and Operating Results
Our international operations require significant management attention and financial resources to establish and operate, including hiring appropriate personnel and recruiting effective international partners. Non-North American revenues accounted for 25%, 25% and 24% of our total revenues for the years ended December 31, 2007, 2006 and 2005, respectively. We have marketing efforts in the Americas, EMEA and APAC. We intend to continue to emphasize our international operations and we may enter additional international markets. Revenues from international operations may be inadequate to cover the expenses of those operations. In addition to foreign currency fluctuation risks, other risks inherent in our international business activities may include the following:
Fluctuations in the Value of Foreign Currencies Could Result in Losses
Our international revenues are generally denominated in United States dollars with, principally, the exception of some European partners and customers. Our international expenses are generally denominated in local foreign currencies. Although foreign currency translation gains and losses have been immaterial to date, fluctuations in exchange rates between the United States dollar and other currencies could have a material adverse effect on our business, financial condition or results of operations, and particularly on our operating margins. To date, we have not sought to actively hedge the risks associated with fluctuations in exchange rates, but we may more actively undertake to do so in the future. Any hedging techniques we implement in the future may not be successful. Exchange rate fluctuations could also make our products more expensive than competitive products not subject to these fluctuations, which could adversely affect our revenues and profitability in international markets.
We May Not Be Able to Obtain Adequate Financing to Implement Our Strategy and Any Equity Financing Would Dilute Our Existing Shareholders
Successful implementation of our strategy may require continued access to capital. If we do not generate sufficient cash from operations, our growth could be limited unless we are able to obtain capital through additional debt or equity financings. We cannot assure you that debt or equity financings will be available as required for acquisitions or other needs. Even if financing is available, it may not be on terms that are favorable to us or sufficient for our needs. If we are unable to obtain sufficient financing, we may be unable to fully implement our growth strategy. In addition, if we complete an equity financing, the issuance of shares of our common stock would dilute your ownership interest in our company.
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Our Stock Price Has Been and Could Continue to Be Highly Volatile
Our stock price has been and could continue to be highly volatile due to a number of factors, including:
This risk may be heightened because our industry is continually evolving, characterized by rapid technological change and susceptible to the introduction of new competing technologies or competitors.
In addition, the stock market has experienced significant price and volume fluctuations that have particularly affected the trading prices of equity securities of many technology companies, including us. These price and volume fluctuations often have been unrelated to the operating performance of the affected companies. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has sometimes been instituted against that company. This type of litigation, regardless of the outcome, could result in substantial costs and a diversion of management’s attention and resources, which could materially and adversely affect our business, financial condition or results of operations.
Our Common Stock is Subject to Various Listing Requirements
The various markets operated by The NASDAQ Stock Market LLC (“NASDAQ”) have quantitative maintenance criteria for continued listing of common stock. We may be delisted from one or more NASDAQ markets if we fail to comply with the criteria. While we believe that we currently meet criteria for listing on a market operated by NASDAQ, we can offer no assurance that our common stock will continue to meet the various criteria for continued listing on any market operated by NASDAQ. Any delisting may result in a reduction in the liquidity of our common stock, which may have a material adverse effect on the price of our common stock.
Regulatory Changes Made to Generally Accepted Accounting Principles, Tax Accounting Principles or Corporate Governance Matters May Impact Our Business
Revisions to generally accepted accounting principles will require us to review our accounting and financial reporting procedures in order to ensure continued compliance with required policies. From time to time, such changes may have a short-term impact on our reporting, and these changes may impact market perception of our financial condition. In addition, legislative changes, and the perception these changes create, can have a material, adverse effect on our business. For example:
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We are Required to Recognize Stock-Based Compensation Expense Related to Employee Stock Options, and There is No Assurance that the Expense that We are Required to Recognize is Indicative of the Accurate Value of Our Share-Based Payment Awards
The application of SFAS 123R requires the use of an option-pricing model to determine the fair value of share-based payment awards on the day they are granted. As a result of adopting SFAS 123R, beginning with 2006, our earnings were lower than they would have been had we not been required to adopt SFAS 123R. This will continue to be the case for future periods as long as we have either new grants or unvested stock-based payment awards. We cannot predict the effect that this adverse impact on our reported operating results will have on the trading price of our common stock.
This determination of fair value is affected by our stock price as well as a number of assumptions regarding a number of highly complex and subjective variables. If factors change and we use different assumptions for estimating stock-based compensation expense in future periods, stock-based compensation expense may differ materially in the future from that recorded in 2007. Although the fair value of employee stock options is determined in accordance with SFAS 123R and Staff Accounting Bulletin No. 107, Share-Based Payment (“SAB 107”), as amended by SAB No. 110, Share-Based Payment (“SAB 110”), using an option-pricing model such as Black-Scholes, that value may not be indicative of the fair value observed in a willing buyer and willing seller market transaction.
Failure to Maintain Effective Internal Controls in Accordance with Section 404 of the Sarbanes-Oxley Act of 2002 Could Have a Material Adverse Effect on Our Business, Operating Results and Stock Price
The Sarbanes-Oxley Act of 2002 imposes certain duties on us and our executives and directors. We are also required to comply with the internal control over financial reporting requirements of Section 404 of the Sarbanes-Oxley Act. Our efforts to comply with the requirements of Section 404 have resulted in increased general and administrative expense and a diversion of management time and attention from revenue-generating activities to compliance activities, and we expect these efforts to require the continued commitment of significant resources.
If we fail to maintain the adequacy of our internal controls, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting. Failure to maintain effective internal control over financial reporting could result in investigation and/or sanctions by regulatory authorities, and could have a material adverse effect on our business and operating results, investor confidence in our reported financial information, and the market price of our common stock.
Anti-Takeover Provisions in Our Organizational Documents and Indiana Law Make Any Change in Control of Us More Difficult, May Discourage Bids at a Premium over the Market Price and May Adversely Affect the Market Price of Our Stock
Our Restated Articles of Incorporation and By-Laws contain provisions that may have the effect of delaying, deferring or preventing a change in control of us, may discourage bids at a premium over the market price of our common stock and may adversely affect the market price of our common stock, and the voting and other rights of the holders of our common stock. These provisions include:
The Indiana corporation law contains business combination provisions that, in general, prohibit for five years any business combination with a beneficial owner of 10% or more of our common stock unless the holder’s acquisition of the stock was approved in advance by our board of directors. The Indiana corporation law also contains control share acquisition provisions that limit the ability of certain shareholders to vote their shares unless their control share acquisition is approved.
We Cannot Predict Every Event and Circumstance That May Impact Our Business and, Therefore, the Risks and Uncertainties Discussed Above May Not Be the Only Ones You Should Consider
The risks and uncertainties discussed above are in addition to those that apply to most businesses generally. In addition, as we continue to grow our business, we may encounter other risks of which we are not aware at this time. These additional risks may cause serious damage to our business in the future, the impact of which we cannot estimate at this time.
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Our world headquarters are located in a 120,000 square foot office building in Indianapolis, Indiana. We lease the building under an operating lease agreement. As of December 31, 2007, the operating lease required payments of $25.5 million over the remaining term of the lease, which expires on March 31, 2018. On March 1, 2005, we sublet 8,980 square feet of our world headquarters building and on January 30, 2006, we sublet an additional 3,000 square feet of our headquarters building to the same tenant. The total remaining sublease payments as of December 31, 2007 were approximately $33,000. The term of the sublease expired on February 29, 2008, and we and the tenant did not renew the sublease. As a result of the sublease expiring, the tenant moved out of our world headquarters building, and we began utilizing the sublet space to accommodate our expansion needs.
In June 2007, we entered into an amendment of our world headquarters operating lease under which our current leased space is to be expanded in three installments through March 2009 totaling approximately 79,000 square feet in a 154,000 square foot office building adjacent to our world headquarters. Rent payments for the expanded space are expected to commence in March 2008. In consideration for entering into the amendment, the landlord agreed to pay us a discretionary allowance of $450,000. The allowance, which we intend to use for certain costs associated with our world headquarters building and/or the additional space, as defined in the amendment, will be recognized as a reduction of rent expense over the term of the world headquarters operating lease. This amendment did not have any financial statement impact during 2007.
In addition to our world headquarters, we occupy a satellite office and two regional headquarters offices in the United States and lease headquarters offices for each of our EMEA and APAC operations. As a sublessee, we sublet 31,000 square feet of office space for our satellite office that we began occupying in October 2006 located near our world headquarters. This sublease will expire in July 2008 and we do not intend to renew the sublease. Our eastern regional headquarters are located in a leased 4,200 square foot office in Herndon, Virginia that we also opened in October 2006, and our western regional headquarters are located in a leased 7,500 square foot office in Irvine, California that we opened in September 2006 and expanded in August 2007.
We also lease space for our various sales, services and development offices located throughout the United States. All of these leases are short-term operating leases. We have various offices located internationally, with our EMEA headquarters located in Berkshire, United Kingdom and our APAC headquarters located in Kuala Lumpur, Malaysia. These international leases have varying terms and lengths of contract.
We believe that all of our facilities, including our world headquarters, regional headquarters and international headquarters in EMEA and APAC, are adequate and well suited to accommodate our business operations. We continuously review space alternatives to ensure we have adequate room for growth in the future.
The information set forth in Note 12 of Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K is incorporated herein by reference.
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Our common stock is traded on The NASDAQ Global Market under the ticker symbol ININ. The following table sets forth, for the quarterly periods indicated, the high and low common stock prices per share as reported by The NASDAQ Global Market:
As of February 29, 2008, there were 129 registered holders of record of our common stock.
We have never declared or paid cash dividends on our capital common stock and do not expect to declare or pay any cash dividends in the foreseeable future. We currently intend to retain future earnings, if any, to finance operations and to expand our business. Any future determination to declare or pay cash dividends will be at the discretion of our Board of Directors and will depend upon our financial condition, operating results, capital requirements and other factors that our Board of Directors deem relevant.
We did not repurchase any of our equity securities during 2007.
The remaining information required by this Item concerning securities authorized for issuance under our equity compensation plans is set forth in or incorporated by reference to Part III, Item 12 of this Annual Report on Form 10-K.
The following selected consolidated financial data (in thousands, except per share amounts) >is qualified in its entirety by, and should be read in conjunction with, Management’s Discussion and Analysis of Financial Condition and Results of Operations and our Consolidated Financial Statements and the Notes thereto contained in Items 7 and 8, respectively, of this Annual Report on Form 10-K.
Consolidated Statements of Operations Data:
Consolidated Balance Sheet Data:
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The following Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to provide investors with an understanding of our past performance, our financial condition and our prospects and should be read in conjunction with other sections of this Annual Report on Form 10-K, including Part I, Item 1 “Business”; Part II, Item 6 “Selected Financial Data”; and Part II, Item 8 “Financial Statements and Supplementary Data”. Investors should carefully review the information contained in this report under Part I, Item 1A “Risk Factors”. The following will be discussed and analyzed:
Interactive Intelligence, Inc. (“Interactive Intelligence”, “we”, “us” or “our”) was formed in 1994 as an Indiana corporation and maintains its world headquarters and executive offices at 7601 Interactive Way, Indianapolis, IN 46278. Our telephone number is (317) 872-3000. You can find our website at http://www.inin.com. We file annual, quarterly and current reports, proxy statements and other documents with the SEC under the Securities Exchange Act of 1934, as amended. These periodic and current reports and all amendments to those reports are available free of charge on the About Us – Investor Relations page located on our website.
We are a leading provider of software applications for contact centers and we are leveraging that leadership position to provide mission critical VoIP applications to enterprises. Our solutions are installed by customers in a wide range of industries including, but not limited to, financial institutions, higher education, healthcare, retail, technology, government, business services and increasingly for the remote and mobile workforce. We also offer a pre-integrated all-software IP PBX, a phone and communications solution for mid-sized enterprises that relies on the Microsoft platform. We offer innovative software products and services for multi-channel contact management, business communications, and messaging using SIP-supported VoIP. Our application-based solutions are built as a single pre-integrated platform that scales to thousands of users, and are developed to satisfy today’s diverse interaction needs in markets for:
By implementing our all-in-one solutions, businesses are able to unify communications, enhance workforce effectiveness and productivity, and readily adapt to constantly changing market and customer requirements. Moreover, organizations in every industry are able to reduce the cost and complexity of traditional “multi-point” legacy communications hardware systems that are seldom fully integrated.
In the coming year, we intend to leverage our position as an industry-leading software solutions provider to a full-service solution provider for contact center automation, enterprise business communications and VoIP foundation technologies. Our strategy for achieving this mission is:
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Critical Accounting Policies and Estimates
We believe our accounting policies listed below are important to understanding our historical and future performance, as these policies affect our reported amounts of revenues and expenses and are applied to significant areas involving management’s judgments and estimates. These policies, and our procedures related to these policies, are described below. See also Note 2 of Notes to Consolidated Financial Statements for a further summary of our significant accounting policies and methods used in the preparation of our consolidated financial statements.
The accounting policies described below are significantly affected by critical accounting estimates. Such accounting policies require significant judgments, assumptions and estimates used in the preparation of our consolidated financial statements, and actual results could differ materially from the amounts reported based on these policies.
Sources of Revenues and Revenue Recognition Policy
We generate product revenues from licensing the right to use our software applications and in certain instances providing hardware as a component of our solution, and we generate services revenues primarily from annual support fees, annual renewal fees, professional services and educational services.
Our license agreements are either perpetual or annually renewable. For any revenues to be recognized from a license agreement, the following criteria must be met:
For a perpetual license agreement, upon meeting the revenue recognition criteria above, we immediately recognize as product revenues the amount of initial license fees if sufficient vendor specific objective evidence of fair value (“VSOE”) exists to support allocating a portion of the total fee to the undelivered elements of the arrangement. If sufficient VSOE of the undelivered elements does not exist, we recognize the initial license fee as product revenues ratably over the initial term of the support agreement once support is the only undelivered element. The support period is generally 12 months but may be up to 18 months for initial orders because support begins when the licenses are downloaded, when support commences, or no more than six months following the contract date. We determine VSOE of support in perpetual agreements based on substantive renewal rates the customer must pay to renew the support. The VSOE of other services is based on amounts charged when the services are sold in stand-alone sales.
For an annually renewable license agreement, upon meeting the revenue recognition criteria above, we recognize a majority of the initial license fees under these agreements as product revenues ratably over the initial license period, which is generally 12 months, and the remainder of the initial license fees are recognized as services revenues over the same time period.
We recognize revenues related to any hardware sales when the hardware is delivered and all other revenue recognition criteria are met.
Services revenues are primarily recognized for renewal fees and support related to annually renewable license agreements and support fees for perpetual license agreements. For annually renewable agreements, the allocation of the initial order between product revenues and services revenues is based on an average renewal rate for our time based contracts. We apply the allocation of product revenues and services revenues consistently to all annually renewable agreements. Under annually renewable license agreements, after the initial license period, our customers may renew their license agreement for an additional period, typically 12 months, by paying a renewal fee. The revenue from annual renewal fees is classified under services revenue and the revenue is recognized ratably over the contract period. Under perpetual license agreements, we recognize annual support fees as services revenues ratably over the post-contract support period, which is typically 12 months.
We also generate revenues from other services that we provide to our partners and customers. These additional revenues include fees for professional services and educational services. Revenues from professional services, which include implementing our products for a customer, and educational services, which consist of training courses for partners and customers, are recognized as the related services are performed.
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Stock-Based Compensation Expense
We account for our employee and director stock options in accordance with SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”) and the guidance of Staff Accounting Bulletin No. 107, Share-Based Payment ("SAB 107"), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, based on fair values. On December 21, 2007, the SEC released SAB No. 110, Share-Based Payment (“SAB 110”), which extended the permissibility of the simplified method, in certain circumstances, under SAB 107, for options granted after December 31, 2007.
As permitted by SFAS 123R, we continue to use the Black-Scholes option-pricing model as our method of valuation for share-based payment awards. Our determination of fair value of share-based payment awards on the date of grant using the Black-Scholes option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards and an expected risk-free rate of return. If factors change and we use different assumptions for estimating stock-based compensation expense in future periods, stock-based compensation expense may differ materially in the future from that recorded in the current period.
We adopted SFAS 123R using the modified prospective transition method, which required the application of the accounting standard as of January 1, 2006. Our consolidated financial statements for periods beginning after January 1, 2006 reflect the impact of SFAS 123R. In accordance with the modified prospective transition method, as permitted by the standard, our consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R.
For additional information, refer to Note 6 of Notes to Consolidated Financial Statements. Stock-based compensation expense for employee and director stock options recognized under SFAS 123R for the years ended December 31, 2007 and 2006 was $3.1 million and $2.1 million, respectively.
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
SFAS No. 109, Accounting for Income Taxes (“SFAS 109”), establishes financial accounting and reporting standards for the effect of income taxes. We are subject to income taxes in both the United States and numerous foreign jurisdictions. Significant judgment is required in evaluating our tax positions and determining our provision for income taxes. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our financial position, results of operations, or cash flows.
In assessing the recoverability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon generation of future taxable income during the periods in which temporary differences such as loss carryforwards and tax credits become deductible. Management considers projected future taxable income and tax planning strategies in making this assessment and ensuring that the deferred tax asset valuation allowance is adjusted as appropriate.
At December 31, 2007, we had $45.5 million of tax net operating loss carryforwards and $1.6 million in tax credit carryforwards. In the fourth quarter of 2007 and third quarter of 2006, we recorded a tax benefit of $8.1 million and $5.0 million, respectively, to reduce the valuation allowance for the deferred tax assets. There was no valuation allowance at December 31, 2007. We will continue to evaluate the recorded deferred tax assets in accordance with the requirements of SFAS 109.
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Allowance for Doubtful Accounts Receivable
The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We evaluate bad debt expense based on a percentage of revenue reported each period. We then review the allowance for doubtful accounts each reporting period based on a detailed analysis of our accounts receivable. In the analysis, we primarily consider the age of the customer’s or partner’s receivable and also consider the creditworthiness of the customer or partner, the economic conditions of the customer’s or partner’s industry, and general economic conditions, among other factors. If any of these factors change, we may also change our original estimates, which could impact the level of our future allowance for doubtful accounts.
If payment is not made timely, we will contact the customer or partner to try to obtain payment. If this is not successful, we will institute other collection practices such as generating collection letters, involving our sales personnel and ultimately terminating the customer’s or partner’s access to future upgrades, licenses and technical support. Once all collection efforts are exhausted, the receivable is written off against the allowance for doubtful accounts.
Research and Development
For the years ending December 31, 2007, 2006 and 2005, all research and development expenditures have been expensed as incurred. Based on our product development process and technological feasibility, the date at which capitalization of development costs may begin is established upon completion of a working model. Costs incurred between completion of the working model and the point at which the product is ready for general release have been insignificant.
Liabilities for loss contingencies arising from claims, assessments, litigation, fines, and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment and/or remediation can be reasonably estimated. Legal costs incurred in connection with loss contingencies are expensed as incurred.
For the year ended December 31, 2007, as compared to 2006, we achieved 32% annual revenue growth, a 61% increase in operating income and over $20 million of operating cash flow. Factors that affect revenues in any particular year include a customer’s or partner’s budget constraints, personnel resources to implement our solutions, historical product order patterns and willingness to implement a critical telecommunications system. Revenues in any particular period can greatly fluctuate from other periods.
The amount of orders we receive, while impacting product revenues, does not have an exact correlation to recognized revenues because the terms in the contracts, a customer’s or partner’s collection history, and any other contractual conditions affect whether we can recognize the order during the period or in subsequent periods. Consequently, product revenues for any particular period are impacted not only by orders received in the current period but also by orders received in previous periods that are being recognized in the current period.
The following table sets forth information about our total revenues (in millions) and the annual growth percentage over the previous year for the past five years (including the impact of the reclassifications and adjustments discussed in Note 2 of Notes to Consolidated Financial Statements).
Product revenues increased during the year ended December 31, 2007, compared to the same period in 2006, as a result of increased demand for our software and appliances, third party products we license and third party hardware we sell. We have experienced increasing annual revenue growth in all major geographies in part due to an increase in demand for our contact center solutions. We also attribute annual revenue growth to a number of other factors including but not limited to adoption of VoIP technologies by our customers and partners, increasing market awareness of our solutions, more effective lead generation activities and improvements in scalability and the reliability of our products. Factors also include reductions in hardware costs to deploy our solutions making our solutions more financially attractive to customers and partners, changes in our sales program to target new customers and partners and establishment of an inside sales group to work with our existing direct customers.
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Services revenues increased significantly during the year ended December 31, 2007, compared to the same period in 2006, primarily due to additional support fees and annually renewable license fees, which were recognized for our growing installed customer base, and an increase in revenues from professional services due to more of our customers utilizing our professional services group to assist in implementing our solutions and due to our April 2007 acquisition of the professional services division of Alliance Systems Ltd. (“Alliance”), as described in Note 14 of Notes to Consolidated Financial Statements.
Our costs of product continue to increase due to media servers and gateway appliances we have developed and licensed, additional hardware delivered by us and increased royalty expenses as a result of licensing more third party software as part of the orders received.
Our costs of services increased significantly during 2007, compared to the same period in 2006, primarily due to a 28% increase in services staffing, principally as a result of acquiring 13 professional engineers and one sales representative as part of our acquisition of the professional services division of Alliance.
Our operating expenses increased in 2007, compared to 2006, principally as a result of increased compensation expense related to a 15% increase in company-wide staffing, higher stock option compensation expense related to SFAS 123R, an increase in marketing expenses from our efforts to raise awareness of our company and products, and a full year’s worth of various expenses related to our satellite and two regional offices in the United States which were opened in late 2006, and related to the expansion of our facilities in the United Kingdom, which commenced in December 2006.
During 2007 and 2006, we determined that it was more likely than not, based on our projections of future taxable income, that we would be able to utilize a portion of the deferred tax assets that we had previously fully reserved. During the fourth quarter of 2007 and third quarter of 2006, we recorded an income tax benefit of $8.1 million and $5.0 million during 2007 and 2006, respectively, to eliminate the valuation allowance for our deferred tax assets. We will continue to evaluate the recoverability of the deferred tax assets. Because we no longer have valuation allowances against deferred tax assets, we expect to record income tax expense or credits at an effective rate of approximately 39%.
Since January 1, 2006, we have accounted for our employee and director stock options in accordance with SFAS 123R and the guidance of SAB 107. As a result, we have incurred stock-based compensation expense each quarter as stock options are granted and vested. The following table sets forth a brief summary of our stock-based compensation expense for the years ended December 31, 2007 and 2006 and the related impact on net income per share (in thousands, except per share amounts):
In 2008, we believe that our year-over-year revenue growth will continue and our costs of product and other expenses will increase. We anticipate staffing increases in 2008, which will result in expense increases across all areas of the company. We currently estimate that the stock option expense related to SFAS 123R will be approximately $3.1 million in 2008.
We had $46.3 million of cash and short-term investments as of December 31, 2007, an increase of $19.2 million or 71% over our cash and short-term investments of $27.1 million as of December 31, 2006. We believe that if we remain profitable, we will increase our liquidity and our equity positions. If our projected revenue growth slows or decreases, if we incur net losses or if we are not able to effectively collect on our outstanding accounts receivable, our liquidity position may weaken, which may result in the need to raise capital.
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Historical Results of Operations
The following table sets forth, for the periods indicated, our consolidated financial information expressed as a percentage of total revenues:
Comparison of Years Ended December 31, 2007, 2006 and 2005
Primary Sources of Revenues
We generate revenues from (i) licensing the right to use our software applications and, in certain instances, providing hardware as a component of our solution and (ii) annual support fees, annual renewal fees, professional services and educational services. Product revenues related to CIC represented approximately 47%, 42% and 46% of our total revenues for 2007, 2006 and 2005, respectively. Services revenues are primarily recognized for renewal fees and support related to annually renewable license agreements and support fees for perpetual license agreements. Revenues related to our renewal and support fees represented approximately 36%, 39% and 39% of our total revenues for 2007, 2006 and 2005, respectively.
Product revenues, which include software and hardware, increased in 2007, 2006 and 2005 compared to the previous years. The increase in 2007, compared to 2006, was principally due to a 27% increase in orders for our software across all regions. We also received an increase in hardware orders of 116% to over $6.6 million, which was primarily due to a higher demand for our media server and gateway appliances which have added to the scalability and functionality of our solutions. In 2007, we received five orders over $1.0 million and 48 orders between $250,000 and $1.0 million compared to four orders over $1.0 million and 30 orders between $250,000 and $1.0 million in 2006.
The increase in 2006, compared to 2005, was the result of product revenues related to Vonexus EIC of $5.2 million, a 14% increase in orders from existing customers purchasing additional licenses and products from 2005 to 2006, and a 50% increase in product revenues generated from our European customers and partners.
Product revenues can fluctuate from quarter to quarter depending on several factors including the mix of orders between perpetual licenses and annually renewable licenses. If other revenue recognition criteria are satisfied, we recognize license revenue upfront for perpetual licenses, and we recognize revenue for annually renewable licenses ratably over the term. The impact of the mix of contracts on our product revenues occurs only in the initial year of an order; subsequent renewal fees received for the annually renewable licenses and the renewal support fees for perpetual contracts are all allocated entirely to services revenues.
The amount of orders we receive, while impacting products revenues, does not have an exact correlation to revenues because the terms in the contracts, collection history with the customer or partner, and any other contractual conditions affect whether we can recognize the order during the quarter or in subsequent quarters. Consequently, product revenues for any particular quarter are impacted not only by orders received in the current quarter but also by orders received in previous quarters that are being recognized in the current quarter.
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Services revenues include the portion of the initial license arrangement allocated from annually renewable and perpetual contracts, license renewals of annually renewable contracts, and support fees for perpetual contracts, as well as professional services (16% of total services revenues in 2007), education (5% of total services revenues in 2007) and other miscellaneous revenues.
The increase in services revenues in 2007, 2006 and 2005 was due to increases in our growing installed base of customers and related payments of annual license renewal fees and support fees for perpetual licenses. License renewal and support revenues increased $7.3 million in 2007, compared to 2006, and $8.2 million in 2006 compared to 2005. As we sign contracts and install our solutions with new customers and partners, we expect that our services revenues will continue to increase as customers and partners renew licenses and pay for support on our software applications. The actual percentage fee charged for renewal of annually renewable licenses and perpetual support agreements as compared to the initial annually renewable license fee and perpetual license, respectively, is comparable on a relative percentage basis, and therefore, the mix of these types of contracts in the future is not expected to impact our future services revenues.
In April 2007, we acquired the professional services division of Alliance, which added 13 engineers to our professional services group and increased our resources to serve our customers and partners which resulted in our professional services revenues increasing $4.3 million, or 117%, during 2007 compared to 2006. Professional services revenues increased 68% in 2006, compared to 2005, primarily due to more customers and partners attending our educational classes and more customers and partners using our professional services. These services revenues have and will fluctuate based on the number of customers and partners that attend our educational classes and the amount of assistance our customers and partners need for implementation and installation. We anticipate these services revenues will continue to increase in the future if the number of our customers continues to grow.
Costs of product consist of hardware costs, principally for media server and gateway appliances which we have developed, telephone handsets, royalties for third party software and other technologies included in our solutions and, to a lesser extent, software packaging costs, which include product media, duplication and documentation. Costs of product can fluctuate depending on which software applications are licensed to our customers and partners, third party software, if any, which is licensed by the end user from us as part of our software applications and the dollar amount of orders for hardware.
Cost of product for 2007 increased $4.8 million compared to 2006. Hardware costs incurred in 2007 represented $2.5 million of the increase as we continue to sell servers, gateways and telephone handsets with our CIC and Vonexus EIC solutions. Royalties paid to third parties increased $1.8 million during 2007 compared to 2006 as we continue our use of technologies licensed from third parties. We also increased staffing in our distribution center which resulted in a $388,000 increase in total compensation costs. Costs of product for 2006, compared to 2005, included an increase of $3.5 million for hardware costs related to our products and an increase of $117,000 in our shipping and software packaging costs. In addition, royalties increased $854,000 as we increased our use of technologies licensed from third parties and integrated them into our software applications. We also increased staffing in our distribution center which resulted in a $99,000 increase in total compensation costs.
Costs of services consist primarily of compensation expenses for technical support, educational and professional services personnel and other costs associated with supporting our customers and partners. These expenses increased in 2007, as compared to 2006, primarily due to a $5.0 million increase in compensation expense for our costs of services personnel, which resulted from to a 28% increase in staffing during this period principally as a result of our April 2007 acquisition of the professional services division of Alliance. We incurred $360,000 of additional travel-related expenses during 2007 principally due to an increase in the demand for our professional services personnel to install our applications at the customers’ sites. The increase in cost of services from 2005 to 2006 was mainly due to a $2.3 million increase in compensation expense, $751,000 related to contracting outsourced professionals and $545,000 for travel-related expenses.
We anticipate these costs will continue to increase if the number of our customers continues to grow.
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Gross profit as a percentage of total revenues decreased during 2007, compared to 2006 and 2005, primarily due to additional costs of product and services as discussed previously. The gross margin on our hardware sales is less than the gross margin on our software licenses; therefore, as we continue to sell more hardware (i.e. gateways, media servers and telephone handsets), our total gross margin percentage may decrease compared to historical margins. Our services margin decreased during 2007, compared to 2006, principally due to the increase in compensation costs as a result of additional services personnel. Gross margin in any particular quarter is dependent upon revenues recognized versus costs of product and costs of services incurred and is expected to vary.
Sales and marketing expenses are comprised primarily of compensation expenses, travel and entertainment expenses and promotional costs related to our sales, marketing and channel management operations. These expenses increased in 2007, as compared to 2006, primarily due to a $4.0 million increase in compensation expense for our sales and marketing personnel, which resulted from a 14% increase in staffing during the period. We also increased our corporate marketing efforts during 2007, which included increased advertising and brand promotions, seminars, web seminars, tradeshows and special events such as our global user forum and partner conferences resulting in an increase of $1.4 million. Travel-related expenses also increased in 2007 by $352,000. During the year ended December 31, 2006, we enhanced our partner program by establishing a Channels Management group to assist with partner relations, grow our partner network and encourage further training on our products. The increase in 2006, as compared to 2005, was primarily related to additional compensation expense and increased corporate marketing efforts.
We expect sales and marketing costs to continue to increase primarily due to additional personnel and expansion of our marketing and channels efforts to increase our brand awareness and distribution.
Research and development expenses are comprised primarily of compensation and depreciation expenses. During 2007, as compared to 2006, these expenses increased primarily due to $3.0 million in compensation expense, which resulted from a 15% increase in staffing. During 2006, as compared to 2005, depreciation expense decreased by $356,000 as certain assets became fully depreciated. This decrease was offset by a $1.2 million increase in compensation expense for our research and development personnel, which resulted from a 13% increase in staffing during this period.
We continue to believe that investment in research and development is critical to our future growth and competitive position in the marketplace and is directly related to timely development of new and enhanced solutions that are central to our business. As a result, we expect research and development expenses will increase in future periods. In the short term, we expect research and development expenses to remain a relatively constant percentage of revenues.
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General and administrative expenses are comprised of compensation expense and general corporate expenses that are not allocable to other departments including legal and other professional fees and bad debt expense. General and administrative expenses increased in 2007 compared to 2006 principally due to a $1.2 million increase in compensation expense, which resulted from an 18% increase in staffing. Bad debt expense also increased $225,000 during 2007, compared to 2006, due to one of our large partners filing for bankruptcy. Professional consulting and outsourced services expenses increased $214,000 during 2007, principally due to increased accounting, legal and tax fees.
The increase in 2006, as compared to 2005, was primarily due to a $1.9 million increase in compensation expense, which resulted from a 39% increase in staffing. General and administrative expenses also increased in 2006, as compared to 2005, due to a $354,000 increase in professional services, which were primarily related to compliance with Section 404 of the Sarbanes-Oxley Act, an increase of $109,000 in recruiting expenses and other minor increases in miscellaneous expenses.
We expect general and administrative expenses will continue to increase due to compensation costs related to additional staffing and increases in supplies and depreciation expense of leasehold improvements and other assets as we continue to expand.
Other Income (Expense)
Interest Income, Net
Interest income, net primarily consists of interest earned from investments and interest-bearing cash accounts. Interest expense and fees, which are not material for any years reported, are also included in interest income, net. The following table details the return on investment that we have received over the last three years.
Interest earned on investments during 2007 and 2006 improved partially due to increasing cash and investment balances and increasing interest rates. In addition, we continue to monitor the allocation of funds in which we have invested to increase our return on investment. These new investments have higher interest rates and lower fees. Interest income increased during 2006, as compared to 2005, primarily due to an increasing cash and investment balance and an increase in the rate that we earned on our interest-bearing accounts. We had short-term investments of $17.1 million, $13.6 million and $3.6 million at December 31, 2007, 2006 and 2005, respectively. These short-term investments typically earn a higher yield than our cash accounts. We do not have any investments in subprime assets.
Other income (expense), net includes foreign currency transaction gains and losses, as well as foreign tax withholdings. These amounts depend on the amount of revenue that is generated in certain international currencies, particularly the Euro, and the exchange gain or loss that results from foreign currency disbursements and receipts. The expense for 2007 consisted of $233,000 of foreign tax withholdings, offset by $138,000 of gains related to foreign currency transactions. The expense for 2006 consisted of $160,000 of foreign tax withholdings, offset by $66,000 of gains related to foreign currency transactions. The expense in 2005 was due to a loss of $122,000 on foreign currency transactions related to foreign currency transactions and foreign withholding taxes of $166,000.
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We had over $45.5 million of tax net operating loss carryforwards and $1.6 million in tax credit carryforwards at December 31, 2007. During the fourth quarter of 2007 and third quarter of 2006, we recorded an income tax benefit of $8.1 million and $5.0 million, respectively, to reduce the valuation allowance for our deferred tax assets. There was no valuation allowance at December 31, 2007. Since we have recognized the deferred tax assets, we will record income tax expense beginning in the first quarter of 2008. However, due to the tax net operating loss carryforwards, the tax credit carryforwards and stock option compensation deductions, we do not expect to have a significant cash outlay to pay income taxes until after the year 2010.
Included in the net operating loss carryforwards at December 31, 2007 was $23.1 million of operating losses that were generated as a result of excess tax benefits for stock options. In accordance with SFAS 123R, these have not been recognized for financial reporting purposes because they have not yet reduced taxes payable. The tax benefit of these deductions will be primarily recorded as a credit to additional paid-in capital.
Liquidity and Capital Resources
We generate cash from the collections we receive related to licensing our contact center and IP-PBX applications and from annual license renewals, maintenance and support and other services revenues. During 2007, we also received $3.5 million in cash from employees exercising stock options. We had an unused $3.0 million line of credit, which expired on October 31, 2007. We did not renew this line of credit. We use cash primarily for paying our employees (including salaries, commissions and benefits), leasing office space, paying travel expenses and marketing activities, paying vendors for hardware, other services and supplies and purchasing property and equipment. We continue to be debt free.
We determine liquidity by combining cash and cash equivalents and short-term investments as shown in the table below. Our total liquidity position as of December 31, 2007 improved compared to our position at December 31, 2006, primarily due to increases in net income (excluding the non-cash tax benefit of $8.1 million recorded in 2007 and $5.0 million recorded in 2006) and deferred services revenues which were partially offset by an increase in accounts receivable balances. Based on our recent performance and current expectations, we believe that our current liquidity position, when combined with our anticipated cash flows from operations, will be sufficient to satisfy our working capital needs, capital expenditures, investment requirements, contractual obligations, commitments and other liquidity requirements associated with our operations over the next 12 months. If cash flows from operations are less than anticipated or we have additional cash needs (such as an unfavorable outcome in legal proceedings), our liquidity may not be sufficient to cover our needs. In this case, we may be forced to raise additional capital, either through the capital markets or debt financings. In doing so, we may not be able to receive favorable terms in raising this capital.
On October 17, 2007, October 23, 2007, and October 26, 2007, we filed separately with the SEC the first, second and third amendments, respectively, to the registration statement on Form S-3 utilizing the “shelf” registration process, which was originally filed on October 19, 2006. This registration statement, as amended, was declared effective by the SEC on October 31, 2007 and will allow us to offer and sell up to 3,000,000 shares of our common stock from time to time in one or more transactions. In addition, under this shelf registration statement, as amended, Dr. Donald E. Brown, our Chairman of the Board, President and CEO, registered 1,000,000 shares of our common stock that he owns for sale from time to time. Although the shelf registration statement, as amended, will permit us to offer and sell up to 3,000,000 shares of our common stock, doing so remains at the discretion of our Board of Directors, and there is no assurance that we would be able to complete any such offering of our common stock.
Our operating activities resulted in net cash provided of $20.2 million, $10.6 million and $5.0 million in 2007, 2006 and 2005, respectively. The net inflows of cash were the result of increased net income and increased deferred services revenues offset in part by increases in accounts receivable and prepaid expenses. Depreciation was $2.7 million, $1.8 million and $2.1 million in 2007, 2006 and 2005, respectively. Stock-based compensation expense related to stock options was $3.1 million and $2.1 million in 2007 and 2006, respectively. Total deferred revenues increased in 2007, 2006 and 2005 primarily due to an increase in deferred services revenues as our customer base continues to expand.
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The amount that we report as cash and cash equivalents or as short-term investments fluctuates depending on investing decisions in each period. Purchases of short-term investments are reported as a use of cash and the related receipt of proceeds upon maturity of the investment is reported as a source of cash. Our net purchases of available-for-sale investments in 2007, 2006 and 2005 were $3.1 million, $10.1 million and $3.6 million, respectively.
We purchased property and equipment with a cost of $4.1 million, $3.3 million and $2.0 million in 2007, 2006 and 2005, respectively. These purchases related mainly to computer hardware and leasehold improvements for our world headquarters and new regional headquarters offices. As staffing increases, as our property and equipment becomes obsolete and as our operations continue to increase, we anticipate that our purchases of property and equipment will continue to increase in future periods.
Net cash provided by financing activities was $3.8 million and $4.6 million in 2007 and 2006, respectively, and net cash used by financing activities was $2.4 million in 2005. The increase in cash provided in 2007 and 2006 was mainly due to proceeds of $3.5 million and $4.4 million from stock options that were exercised during the respective periods. The decrease in cash used in 2005 was primarily related to the repayment of $3.0 million on our previous line of credit as disclosed in Note 5 of Notes to Consolidated Financial Statements.
As set forth in the following Contractual Obligations table, we have operating lease obligations and purchase obligations that are not recorded in our consolidated financial statements. The operating lease obligations represent future payments on leases classified as operating leases and disclosed pursuant to SFAS No. 13, Accounting for Leases. These obligations include the amended operating lease of our world headquarters, and the leases of several other buildings for our offices in the United States as well as eight other countries and equipment leases. See Note 7 of Notes to Consolidated Financial Statements for further discussion on our lease commitments.
In addition, we have signed obligations securing accommodations and related expenses for a future sales incentive trip, global user forum and partner conferences as well as several other commitments, which are included in our purchase obligations. Finally, other obligations include amounts regarding our tax liabilities and uncertain tax positions related to Financial Accounting Standards Board ( “FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109. See Note 10 of Notes to Consolidated Financial Statements for further discussion on our uncertain tax positions. The amounts set forth in the following table are as of December 31, 2007 (in thousands).
In addition to the amounts set forth in the table above, we have contractual obligations with certain third party technology companies to pay royalties to them based upon future licensing of their products and patented technologies. We cannot estimate what these future amounts will be; however, we expect them to increase as our revenues continue to grow.
Off-Balance Sheet Arrangements
Except as set forth above in the Contractual Obligations table, we have no off-balance sheet arrangements that have or are reasonably likely to have a current or future impact on our financial condition, changes in financial condition, results of operations, liquidity, capital expenditures or capital resources as of December 31, 2007.
We develop software application products in the United States and license our products worldwide. As a result, our financial results could be affected by various factors, including changes in foreign currency exchange rates or weak economic conditions in certain markets. We transact business in certain foreign currencies including the British pound and the Euro. However, as a majority of the orders we receive are denominated in United States dollars, a strengthening of the dollar could make our products more expensive and less competitive in foreign markets. We have not historically used foreign currency options or forward contracts to hedge our currency exposures because of variability in the timing of cash flows associated with our larger contracts. We did not have any such hedge instruments in place at December 31, 2007. Rather, we attempt to mitigate our foreign currency risk by generally transacting business and paying salaries in the functional currency of each of the major countries in which we do business, thus creating natural hedges. Additionally, as our business matures in foreign markets, we may offer our products and services in certain other local currencies. As a result, foreign currency fluctuations would have a greater impact on our company and may have an adverse effect on our results of operations. Historically, our gains or losses on foreign currency exchange translations have been immaterial to our consolidated financial statements. For the year ended December 31, 2007, approximately 9% of our revenues and 16% of our expenses were denominated in a foreign currency, resulting in a loss of less than $50,000 from foreign currency exchange transactions.
We invest cash balances in excess of operating requirements in short-term securities that generally have maturities of one year or less. The carrying value of these securities approximates market value, and there is no long-term interest rate risk associated with these investments.
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
Interactive Intelligence, Inc.:
We have audited the accompanying consolidated balance sheets of Interactive Intelligence, Inc. and subsidiaries (the “Company”) as of December 31, 2007 and 2006 and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2007. In connection with our audits of the consolidated financial statements, we have also audited the consolidated financial statement Schedule II-Valuation and Qualifying Accounts. We also have audited the Company’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these consolidated financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule and an opinion on the Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Interactive Intelligence, Inc. and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Also, in our opinion, Interactive Intelligence, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
As discussed in Note 10 to the consolidated financial statements, effective January 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. As discussed in Note 2 to the consolidated financial statements, effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment and Securities and Exchange Commission Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements.
March 17, 2008
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Consolidated Balance Sheets
As of December 31, 2007 and 2006
(in thousands, except share and per share amounts)
See Accompanying Notes to Consolidated Financial Statements
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Interactive Intelligence, Inc.
Consolidated Statements of Income
For the Years Ended December 31, 2007, 2006 and 2005
(in thousands, except per share amounts)
See Accompanying Notes to Consolidated Financial Statements
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Interactive Intelligence, Inc.
Consolidated Statements of Shareholders’ Equity
For the Years Ended December 31, 2007, 2006 and 2005